ITEM 1. BUSINESS
Unless this Annual Report on Form 10-K indicates otherwise, or the context otherwise requires, the terms “we,” “our,” “us,” and “the Company,” as used herein refer to BNC Bancorp and its subsidiaries, including Bank of North Carolina, which we sometimes refer to as “the Bank” or "BNC." BNC Bancorp is individually referred to as the "Parent Company."
General
BNC Bancorp was formed in 2002 to serve as a one-bank holding company for Bank of North Carolina. BNC is a full service commercial bank, incorporated under the laws of the State of North Carolina on November 15, 1991, that opened for business on December 3, 1991. We are registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the bank holding company laws of North Carolina. BNC operates under the rules and regulations of and is subject to examination by the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Office of the Commissioner of Banks (the “NCCOB”). BNC is also subject to certain regulations of the Federal Reserve governing the reserves to be maintained against deposits and other matters. In addition to BNC we also maintain various limited purpose subsidiaries either located in or conducting business primarily in our three-state footprint that are closely related or incidental to the business of banking or financial in nature. Our principal executive office is located at 3980 Premier Drive, Suite 210, High Point, North Carolina 27265, and BNC’s administrative office is located at 831 Julian Avenue, Thomasville, North Carolina 27360.
We provide a wide range of banking services tailored to the particular banking needs of the communities we serve. We are principally engaged in the business of attracting deposits from the general public and using those deposits, together with other funding from our lines of credit, to make primarily commercial and consumer loans. We have pursued a strategy that emphasizes our local affiliations. This business strategy stresses the provision of high quality banking services to individuals and small to medium-sized local businesses. We also offer a wide range of banking services, including traditional products such as checking and savings accounts. We are also continuously developing new and innovative products and equipping our bankers with new technology to further differentiate us as a community bank with sophisticated product delivery. The Bank conducted operations through 62 full-service banking offices, including 36 branches in North Carolina, 17 branches in South Carolina and nine branches in Virginia. Our branches in Virginia and South Carolina operate as BNC Bank.
During recent years, we have focused much of our growth and expansion efforts on acquisitions of community banks that align with the Company’s strategy of growth focused within existing markets. As a result of these efforts, we have completed the following whole-bank and branch acquisitions over the past three years:
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On October 16, 2015, we acquired seven branch offices from CertusBank, N.A. in Upstate South Carolina (the "Certus branches");
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On July 1, 2015, we acquired Valley Financial Corporation ("Valley"), the parent company of Valley Bank, a commercial bank with nine branches in and around Roanoke, Virginia;
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On December 1, 2014, we acquired Harbor Bank Group, Inc., the parent company of Harbor National Bank, a commercial bank with four branches in Charleston and Mt. Pleasant, South Carolina;
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On June 1, 2014, we acquired Community First Financial Group, the parent company of Harrington Bank, a commercial bank with three branches located in the Raleigh-Durham-Chapel Hill area of North Carolina;
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On April 1, 2014, we acquired South Street Financial Corp., the parent company of Home Savings Bank of Albemarle, Inc. SSB, a commercial bank with four branches located in the Charlotte, North Carolina MSA; and
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On October 1, 2013, we acquired Randolph Bank & Trust Company, a commercial bank that served small businesses and professionals and operated six branches in the Piedmont-Triad area of North Carolina.
These acquisitions have allowed us to increase our presence and build scale in these key metropolitan markets and have enhanced our organic growth opportunities. We have also increased our focus on de novo branch growth with the opening of a new branch in Winston-Salem, North Carolina, the announcement of two new branches that will be opening in the Charlotte, North Carolina market during 2016, and the construction of a new branch and loan production office in Raleigh, North Carolina, which is scheduled to be completed in early 2017.
In August 2015, we announced our entry into a definitive agreement to acquire all of the common stock of Southcoast Financial Corporation ("Southcoast"), the holding company for Southcoast Community Bank. Southcoast operates 10 branches in and around Charleston, South Carolina and the transaction is expected to close in the first half of 2016, subject to regulatory approval and other customary conditions.
In November 2015, we announced our entry into a definitive agreement to acquire all of the common stock of High Point Bank Corporation ("HPTB"), the holding company for High Point Bank and Trust. HPTB operates 12 branches in the Piedmont-Triad area of North Carolina and the transaction is expected to close in the second half of 2016, subject to regulatory approval, the approval of HPTB shareholders and other customary conditions.
Lending Activities
The Bank’s loan portfolio, including loans originated by the Bank and acquired loans, include most types of real estate loans, consumer loans, commercial and industrial loans, and other types of loans. A majority, but not all, of the properties collateralizing the Bank’s loan portfolio are located within the Bank’s market area. Interest rates charged by the Bank vary with degree of risk, type, size, complexity, repricing frequency and other relevant factors associated with the loan or lease. Competition from other financial services companies also impacts interest rates charged on loans and leases.
Our lenders perform their lending duties subject to the oversight and policy direction of the Company’s and Bank’s board of directors. The Bank has adopted comprehensive lending policies, underwriting standards and loan review procedures, which are reviewed on a regular basis. In underwriting loans and leases, primary emphasis is placed on the borrower’s or lessee’s financial condition, including ability to generate cash flow to support the debt or lease obligations and other cash expenses. Additionally, substantial consideration is given to collateral value and marketability, the borrower’s or lessee’s character, reputation, industry knowledge and track record of success, as well as other relevant factors. We delegate designated credit officers with loan authority that can be utilized to approve credit commitments for a single borrowing relationship. The limit of delegated authority is based upon the experience, skill, and training of the relationship manager or credit officer. Certain types and size of loans and relationships must be approved by the Company's loan approval committee or, for loans above certain internal thresholds, the executive loan committee.
Our portfolio of real estate loans includes residential mortgages secured by residential 1-4 family properties, non-farm/non-residential, agricultural, construction/land development, multifamily residential properties and other land loans. Non-farm/non-residential loans include those secured by real estate mortgages on owner-occupied commercial buildings of various types, leased commercial, retail and office buildings, nursing and other medical facilities, hotels and motels, and other business and industrial properties. Real estate construction/land development loans include loans secured by vacant land, loans to finance land development or construction of industrial, commercial, residential or farm buildings or additions or alterations to existing structures. Included in our residential mortgage loans are home equity lines of credit.
We offer a variety of real estate loan products that are generally amortized over five to 30 years, payable in monthly or other periodic installments of principal and interest, and due and payable in full (unless renewed) at a balloon maturity generally within one to seven years. Certain loans may be structured as term loans with adjustable interest rates (adjustable daily, monthly, semi-annually, annually, or at other regular adjustment intervals usually not to exceed five years). Many of our adjustable rate loans have established “floor” and “ceiling” interest rates.
Our commercial and industrial loan portfolio consists of loans for commercial, industrial and professional purposes including loans to fund working capital requirements (such as inventory and receivables financing), purchases of machinery and equipment and other purposes. We offer a variety of commercial and industrial loan arrangements, including term loans, balloon loans and lines of credit with the purpose and collateral supporting a particular loan determining its structure. These loans are offered to businesses and professionals for short and medium terms on both a collateralized and uncollateralized basis. As a general practice, we obtain as collateral a lien on furniture, fixtures, equipment, inventory, receivables or other assets. The Bank’s lease portfolio consists primarily of small ticket direct financing commercial equipment leases and is subject to the same constraints and underwriting as the loan portfolio. The equipment collateral securing the lease portfolio is located in the markets that we serve, with the exception of rolling stock, which can be located throughout the United States.
Our portfolio of consumer loans generally includes loans to individuals for household, family and other personal expenditures. Proceeds from such loans are used to, among other things, fund the purchase of automobiles, recreational vehicles, boats, mobile homes and for other similar purposes. These consumer loans are generally collateralized and have terms typically ranging up to 72 months, depending upon the nature of the collateral, size of the loan, and other relevant factors.
Deposits
The Bank has several programs designed to attract depository accounts offered to consumers and to small and middle market businesses at interest rates generally consistent with market conditions. Deposits provide the most significant funding source for the Bank’s interest earning assets. Deposits are attracted principally from clients within our retail branch network through the offering of a broad array of deposit products to individuals and businesses, including non-interest bearing demand deposit accounts, interest-bearing transaction accounts, savings accounts, money market deposit accounts, and time deposit accounts. Terms vary among deposit products with respect to commitment periods, minimum balances, and applicable fees. Interest paid on deposits represents the largest component of our interest
expense. Interest rates offered on interest-bearing deposits are determined based on a number of factors, including, but not limited to, (1) interest rates offered in local markets by competitors, (2) current and expected economic conditions, (3) anticipated future interest rates, (4) the expected amount and timing of funding needs, and (5) the availability and cost of alternative funding sources. Management believes that the rates it offers, which are posted weekly on deposit accounts, are generally competitive with other financial institutions in the Bank’s respective market areas.
The Bank also holds public funds as deposits. Public deposits typically require the pledging of collateral, most commonly marketable securities. This requirement is taken into account when determining the level of interest to be paid on public deposits. Public funds have not historically presented any special risks to the Bank.
Wholesale deposits, including time deposits placed in the Certificate of Deposit Account Registry Service ("CDARS") and various brokered deposit programs, represented approximately 27.5% of BNC's total deposits at December 31, 2015. CDARS allows banking customers to access FDIC insurance protection on multi-million dollar certificates of deposit. When a customer places a large deposit through CDARS, funds are placed into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection.
Other Banking Services
Mortgage Lending
We offer a broad array of residential mortgage products, including long-term fixed rate and variable rate loans, which are sold on a servicing-released basis in the secondary mortgage market.
Small Business Administration Lending
The Company provides loans that are partially guaranteed by the Small Business Administration (“SBA”) for the purchase of businesses, business startups, business expansion, equipment and working capital. All SBA loans are underwritten and documented as prescribed by the SBA. The Company will generally sell the guaranteed portion of the SBA loans in the secondary market.
Wealth Management Services
The Bank offers a broad array of brokerage services to meet the needs of our clients. These services include financial planning, wealth management, private banking and insurance products, which are offered by designated representatives through our branch network.
Online and Mobile Banking
The Bank offers an online banking service for both business customers and consumers. Through this service customers can access their account information, pay bills, transfer funds, view images of cancelled checks, reorder checks, change addresses, issue stop payment requests, receive detailed statements and handle other banking business electronically from a laptop, desktop or tablet. Businesses are offered more advanced features which allow them to handle most treasury management functions electronically and access their account information on a more timely basis. The Bank also provides businesses and consumers the option to electronically receive monthly bank statements and provides an archive of monthly statements and cancelled check images. Our mobile banking application allows consumers to access their account information, pay bills, transfer funds, and even deposit checks conveniently through their mobile device.
Competition and Market Area
We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources than we do. Such competitors primarily include national, regional, and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loan associations, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries.
The financial services industry could become even more competitive as a result of legislative, regulatory, and technological changes and continued consolidation. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Also, technology has lowered barriers to entry and made it possible for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our non-bank competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many 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 than we can.
Employees
At December 31, 2015, we employed 850 full-time equivalent employees, and we believe our employee relations to be good.
Operating Segments
The Company’s operations are managed along two operating segments, consisting of banking operations and mortgage origination. The primary purpose of the mortgage origination operating segment is the origination and subsequent sale of residential mortgage loans, while all other banking activities are performed in the banking operations segment. These operating segments are aggregated into a single reportable operating segment in the Consolidated Financial Statements in Item 8 herein.
Available Information
We maintain a website at www.bncbancorp.com. Our annual reports on Form 10-K, proxy statements, quarterly reports on Form 10-Q, current reports on Form 8-K, and all other required filings are made available, free of charge, on the Investor Relations page on our website, as soon as reasonably practicable after we electronically file them or furnish them to the Securities and Exchange Commission (“SEC”). In addition, copies of the Company's annual report will be made available, free of charge, upon written request to Drema Michael, Director of Corporate Investor Relations, 3980 Premier Drive, Suite 210, High Point, North Carolina 27265.
Supervision and Regulation
Bank holding companies and state commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect us. This summary contains what management believes to be the material information related to our supervision and regulation but is not intended to be an exhaustive description of the statutes or regulations applicable to our business. Our supervision, regulation and examination by the regulatory agencies are intended primarily for the protection of depositors rather than our shareholders. We cannot predict whether or in what form any proposed statute or regulation will be adopted or the extent to which our business may be affected by a statute or regulation. The discussion is qualified in its entirety by reference to applicable laws and regulations. Changes in such laws and regulations may have a material effect on our business and prospects.
Bank Holding Company Regulation and Structure
As a bank holding company, we are subject to regulation under the BHCA and to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve System. BNC has a North Carolina state charter and is subject to regulation, supervision and examination by the FDIC and the NCCOB.
The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before:
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it may acquire substantially all of the assets of any other bank holding company, or direct or indirect ownership or control of any voting shares of any other bank holding company if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the voting shares of the other bank holding company;
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it may acquire substantially all of the assets of any bank, or direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the voting shares of the bank;
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it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or
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it may merge or consolidate with any other bank holding company.
The BHCA further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or that would substantially lessen competition in the banking business, unless the public interest in meeting the needs of the communities to be served outweighs the anti-competitive effects. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks involved and the convenience and needs of the communities to be served. Consideration of financial resources generally focuses on capital adequacy, and consideration of convenience and needs issues focuses, in part, on the performance under the Community Reinvestment Act of 1977, as amended (the "CRA"), both of which are discussed elsewhere in more detail.
Subject to various exceptions, the BHCA and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:
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the bank holding company has registered securities under Section 12 of the Exchange Act; or
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no other person owns a greater percentage of that class of voting securities immediately after the transaction.
Our common stock is registered under Section 12 of the Exchange Act. The regulations provide a procedure for challenging rebuttable presumptions of control.
The BHCA generally prohibits a bank holding company from engaging in, or acquiring 5% or more of the voting stock of a company engaged in, activities other than banking; managing or controlling banks or other permissible subsidiaries and performing servicing activities for subsidiaries; and engaging in any activities other than activities that the Federal Reserve has determined by order or regulation are so closely related to banking as to be a proper incident included thereto under the BHCA. In determining whether a particular activity is permissible, the Federal Reserve considers whether performing the activity can be expected to produce benefits to the public that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve has the power to order a bank holding company or its subsidiaries to terminate any activity or control of any subsidiary when the continuation of the activity or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.
Under the BHCA, a bank holding company may file an election with the Federal Reserve to be treated as a financial holding company and engage in an expanded list of financial activities. The election must be accompanied by a certification that all of the company’s insured depository institution subsidiaries are “well capitalized” and “well managed.” Additionally, the CRA rating of each subsidiary bank must be satisfactory or better. We have not filed an election to become a financial holding company.
We are required to act as a source of financial strength for BNC and to commit resources to support it. This support may be required at times when we might not be inclined to provide it. In addition, any capital loans made by us to BNC will be repaid only after its deposits and various other obligations are repaid in full.
Bank Merger Act
Section 18(c) of the Federal Deposit Insurance Act, as amended, popularly known as the “Bank Merger Act,” requires the prior written approval of the FDIC before any bank may (i) merge or consolidate with, (ii) purchase or otherwise acquire the assets of, or (iii) assume the deposit liabilities of, another bank if the resulting institution is to be a state nonmember bank.
The Bank Merger Act prohibits the FDIC from approving any proposed merger transaction that would result in a monopoly, or would further a combination or conspiracy to monopolize or to attempt to monopolize the business of banking in any part of the United States. Similarly, the Bank Merger Act prohibits the FDIC from approving a proposed merger transaction the effect of which in any section of the country may be substantially to lessen competition, or to tend to create a monopoly, or which in any other manner would be in restraint of trade. An exception may be made in the case of a merger transaction the effect of which would be to substantially lessen competition, tend to create a monopoly, or otherwise restrain trade, if the FDIC finds that the anticompetitive effects of the proposed transaction are clearly outweighed in the public interest by the probable effect of the transaction in meeting the convenience and needs of the community to be served.
In every proposed merger transaction, the FDIC must also consider the financial and managerial resources and future prospects of the existing and proposed institutions, the convenience and needs of the community to be served, and the effectiveness of each insured depository institution involved in the proposed merger transaction in combating money-laundering activities, including in overseas branches.
State Law
BNC is subject to extensive supervision and regulation by the NCCOB. The NCCOB oversees state laws that set specific requirements for bank capital and that regulate deposits in, and loans and investments by, banks, including the amounts, types, and in some cases, rates. The NCOCB supervises and performs periodic examinations of North Carolina-chartered banks to assure compliance with state banking statutes and regulations, and banks are required to make regular reports to the NCCOB describing in detail their resources, assets, liabilities, and financial condition. Among other things, the NCCOB regulates mergers and consolidations of state-chartered banks, capital requirements for banks, loans to officers and directors, record keeping, types and amounts of loans and investments, and the establishment of branches.
The NCCOB has extensive enforcement authority over North Carolina banks. Such authority includes the ability to issue cease and desist orders and to seek civil money penalties. The NCCOB may also take possession of a North Carolina bank in various circumstances, including for a violation of its charter or of applicable laws, operating in an unsafe and unsound manner, or as a result of an impairment of its capital, and may appoint a receiver.
On October 1, 2012, the North Carolina Banking Law Modernization Act became effective and many of the state banking laws to which BNC is subject were amended, including laws impacting capital requirements, authorized activities, permissible investments, and
numerous operational functions. It is not possible to predict fully the future effects that this legislation may have on the business and earnings of BNC.
BNC is also subject to numerous state and federal statutes and regulations that affect its businesses, activities and operations and are supervised and examined by state and federal bank regulatory agencies. The FDIC and the NCCOB regularly examine the operations of each bank and are given the authority to approve or disapprove mergers, consolidations, the establishment of branches and similar corporate actions.
Payment of Dividends and Other Restrictions
We are a legal entity separate and distinct from BNC. While there are various legal and regulatory limitations under federal and state law on the extent to which banks can pay dividends or otherwise supply funds to holding companies, the principal source of cash revenues for us is dividends from BNC. The relevant federal and state regulatory agencies also have authority to prohibit a state bank or bank holding company, which would include us and BNC, from engaging in what, in the opinion of such regulatory body, constitutes an unsafe or unsound practice in conducting its business. The payment of dividends could, depending upon the financial condition of a bank, be deemed to constitute an unsafe or unsound practice in conducting its business.
Insured depository institutions, such as BNC, are prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations). In addition, recently adopted capital rules limit capital distributions, including dividends, if the depository institution does not have a “capital conservation buffer.” See further details below under “Capital Adequacy.”
The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve, the Federal Reserve may prohibit a bank holding company from paying any dividends if one or more of the holding company’s bank subsidiaries are classified as undercapitalized.
A bank holding company is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the Federal Reserve. In addition, the Federal Reserve has indicated that bank holding companies should review their dividend policies, and has discouraged dividend payment ratios that are at maximum allowable levels unless both asset quality and capital levels are strong.
Transactions with Affiliates
Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Regulations promulgated by the Federal Reserve Board limit the types and amounts of these transactions (including loans due and extensions of credit from their U.S. bank subsidiaries) that may take place and generally require those transactions to be on an arm’s-length basis. In general, these regulations require that any “covered transactions” between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company be limited to 10% of the bank subsidiary’s capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary’s capital and surplus. Further, loans and extensions of credit to affiliates generally are required to be secured by eligible collateral in specified amounts.
Loans to Directors, Executive Officers and Principal Shareholders
The authority of the Bank to extend credit to our directors, executive officers and principal shareholders, including their immediate family members, corporations and other entities that they control, is subject to substantial restrictions and requirements under Section 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder, as well as the Sarbanes-Oxley Act of 2002. These statutes and regulations impose specific limits on the amount of loans our subsidiary bank may make to directors and other insiders, and specified approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans that our subsidiary bank makes to directors and other insiders must satisfy the following requirements:
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the loans must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not affiliated with us or our subsidiary bank;
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the subsidiary bank must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with persons who are not affiliated with us or our subsidiary bank; and
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the loans must not involve a greater than normal risk of non-payment or include other features not favorable to our subsidiary bank.
Furthermore, our subsidiary bank must periodically report all loans made to directors and other insiders to the bank regulators, and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O. Each loan to directors or other insiders must be pre-approved by the Bank's board of directors with the interested director abstaining from voting.
Capital Adequacy
In July 2013, the Federal Reserve Board and the FDIC approved a final rule (“final rule”) that changes the regulatory capital framework for all banking organizations and revises the prompt corrective action categories to incorporate the revised regulatory capital standards. The final rule implements for U.S. banks the Basel III regulatory capital reforms of the Basel Committee and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The final rule strengthens areas of weakness identified in the Basel I capital rules by: (1) enhancing the quantity and quality of regulatory capital in the banking system; (2) better reflecting the risk of certain on and off-balance sheet exposures in the measurement of risk-weighted assets; and (3) building additional capital capacity into the banking system to absorb losses in times of future market and economic stress. Subject to certain transition provisions, banking organizations with $250 billion or less in total assets were required to comply with the new requirements beginning January 1, 2015.
The final rule establishes new prompt corrective action requirements for all banks and includes a new Common Equity Tier 1 ("CET1")risk-based capital measure. The risk-based capital and leverage capital requirements under the final rule are set forth in the table that
follows:
The final rule also sets forth a capital ratio phase-in schedule. The phase-in provisions for banks with $250 billion or less in total assets are set forth in the following table:
(1)
The capital conservation buffer must be maintained in order for a banking organization to avoid being subject to limitations on capital distributions, including dividend payments, and discretionary bonus payments to executive officers.
The final rule includes comprehensive guidance with respect to the measurement of risk-weighted assets. For residential mortgages, Basel III retains the risk-weights contained in the current capital rules which assign a risk-weight of 50% to most first-lien exposures and 100% to other residential mortgage exposures. The final rule increases the risk-weights associated with certain on-balance sheet assets, such as high volatility commercial real estate loans, as defined, and loans that are more than 90 days past due or in nonaccrual status.
Capital requirements also increase for certain off-balance sheet exposures including, for example, loan commitments with an original maturity of one year or less.
Under the final rule, certain banking organizations, including the Company and BNC, are permitted to make a one-time election to continue the current treatment of excluding from regulatory capital most accumulated other comprehensive income (“AOCI”) components, including amounts relating to unrealized gains and losses on available-for-sale debt securities and amounts attributable to defined benefit post-retirement plans. Institutions that elect to exclude most AOCI components from regulatory capital under Basel III will be able to avoid volatility that would otherwise be caused by things such as the impact of fluctuations in interest rates on the fair value of available-for-sale debt securities. The Company and BNC elected to exclude AOCI components from regulatory capital under Basel III.
In December 2010, the Basel Committee published “Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring” and in January 2013 published a revised liquidity coverage ratio (collectively referred to as the “Liquidity Standard”). The Liquidity Standard includes: (1) a liquidity coverage ratio to ensure that sufficient high quality liquid resources are available in case of a liquidity crisis; (2) a net stable funding ratio to promote liquidity resiliency over longer time horizons by creating incentives for banks to fund their activities with stable sources of funding on an ongoing basis; and (3) additional liquidity monitoring metrics focused on maturity mismatch, concentration of funding and available unencumbered assets. The Liquidity Standard would be phased-in through 2019. On September 3, 2014, the U.S. banking agencies issued a final liquidity rule that establishes for the first time a standardized minimum liquidity requirement. The final rule applies to large and internationally active banking organizations and is not applicable to BNC. The U.S. banking agencies have not adopted or proposed rules to implement a quantitative liquidity requirement for banks such as BNC with less than $50 billion in total assets, and it is uncertain whether such a requirement will be established.
Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on taking brokered deposits and certain other restrictions on its business. As described below, the FDIC can impose substantial additional restrictions upon FDIC-insured depository institutions that fail to meet applicable capital requirements as set forth above.
The Federal Deposit Insurance Act (the “FDI Act”) requires the federal regulatory agencies to take “prompt corrective action” if a depository institution does not meet minimum capital requirements as set forth above. Generally, a receiver or conservator for a bank that is “critically undercapitalized” must be appointed within specific time frames. The regulations also provide that a capital restoration plan must be filed within 45 days of the date a bank is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for a bank required to submit a capital restoration plan must guarantee the lesser of (i) an amount equal to 5% of the bank’s assets at the time it was notified or deemed to be undercapitalized by regulator, or (ii) the amount necessary to restore the bank to adequately capitalized status. This guarantee remains in place until the bank is notified that it has maintained adequately capitalized status for specified time periods. Additional measures with respect to undercapitalized institutions include a prohibition on capital distributions, growth limits and restrictions on activities.
For further detail on capital and capital ratios see discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” sections, “Capital Resources” and “Liquidity,” contained in Item 7, and in Note 14, “Regulatory Capital,” to the accompanying Consolidated Financial Statements contained in Item 8.
Interstate Banking and Branching
Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 amended the FDI Act and certain other statutes to permit state and national banks with different home states to merge across state lines, with approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997 expressly prohibiting interstate mergers. Under the Riegle-Neal Act amendments, once a state or national bank has established branches in a state, that bank may establish and acquire additional branches at any location in the state at which any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the state which has opted out, whether through an acquisition or de novo.
However, under the Dodd-Frank Act, the national branching requirements have been relaxed and national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.
The FDI Act requires that the FDIC review (1) any merger or consolidation by or with an insured bank, or (2) any establishment of branches by an insured bank. Additionally, the Banking Department accepts applications for interstate merger and branching transactions, subject to certain limitations on ages of the Banks to be acquired and the total amount of deposits within the state a bank or financial holding company may control. We may, however, face increased competition from out-of-state banks that branch or make acquisitions in our primary markets.
Deposit Insurance Coverage and Assessments
BNC is a member of the FDIC. Through the Deposit Insurance Fund (the “DIF”), the FDIC provides deposit insurance protection that covers all deposit accounts in FDIC-insured depository institutions up to applicable limits (currently, $250,000 per depositor).
BNC must pay assessments to the FDIC under a risk-based assessment system in order to maintain the DIF for this federal deposit insurance protection. FDIC-insured depository institutions that are members of the Bank Insurance Fund pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (i.e., institutions that pose a greater risk of loss to the DIF) pay assessments at higher rates than institutions assigned to lower risk classifications. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to bank regulators. Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
As required by the Dodd-Frank Act, the FDIC also revised the deposit insurance assessment system, effective April 1, 2011, to base assessments on the average total consolidated assets of insured depository institutions during the assessment period, less the average tangible equity of the institution during the assessment period as opposed to solely bank deposits at an institution. This base assessment change necessitated that the FDIC adjust the assessment rates to ensure that the revenue collected under the new assessment system will approximately equal that under the existing assessment system.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of the Financing Corporation (the “FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and these assessments will continue until the debt matures in 2017 through 2019.
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), an FDIC-insured depository institution can be held liable for any losses incurred by the FDIC in connection with (1) the “default” of one of its FDIC-insured subsidiaries or (2) any assistance provided by the FDIC to one of its FDIC receivers, and “in danger of default” is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance.
The FDIC is also empowered to regulate interest rates paid by insured banks. Approval of the FDIC is also required before an insured bank retires any part of its common or preferred stock, or any capital notes or debentures.
Community Reinvestment Act
The CRA requires federal bank regulatory agencies to encourage financial institutions to meet the credit needs of low and moderate-income borrowers in their local communities. An institution’s size and business strategy determines the type of examination that it will receive. Large, retail-oriented institutions are examined using a performance-based lending, investment and service test. Small institutions are examined using a streamlined approach. All institutions may opt to be evaluated under a strategic plan formulated with community input and pre-approved by the bank regulatory agency.
The CRA regulations provide for certain disclosure obligations. Each institution must post a notice advising the public of its right to comment to the institution and its regulator on the institution’s CRA performance and to review the institution’s CRA public file. Each lending institution must maintain for public inspection a file that includes a listing of branch locations and services, a summary of lending activity, a map of its communities and any written comments from the public on its performance in meeting community credit needs. The CRA requires public disclosure of a financial institution’s written CRA evaluations. This promotes enforcement of CRA requirements by providing the public with the status of a particular institution’s community reinvestment record.
The Gramm-Leach-Bliley Act made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the Gramm-Leach-Bliley Act may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest examination. BNC received a “Satisfactory” rating in its last CRA examination which was conducted during April 2014.
Consumer Laws and Regulations
BNC is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Act and state law counterparts.
Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Consumer Financial Protection Bureau
The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provision, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits the state attorney general to enforce compliance with both the state and federal laws and regulations.
The CFPB has concentrated much of its rulemaking efforts on a variety of mortgage-related topics required under the Dodd-Frank Act, including mortgage origination disclosures, minimum underwriting standards and ability to repay, high-cost mortgage lending, and servicing practices. The rules related to ability to repay, qualified mortgage standards and mortgage servicing became effective during 2014, while the escrow and loan originator compensation rules became effective during 2013.
A final rule integrating mortgage loan disclosures required by the Truth in Lending Act (“TILA”) and the Real Estate Settlement and Procedures Act (“RESPA”) became effective during October 2015. The final rule consolidated four existing and separate disclosures required under TILA and RESPA for closed-end credit transactions secured by real property into two forms with a view towards making the mortgage loan disclosures less confusing and more consumer friendly.
Monitoring and Reporting Suspicious Activity
Under the Bank Secrecy Act (the "BSA"), the Bank is required to monitor and report unusual or suspicious account activity that might signify money laundering, tax evasion or other criminal activities, as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. The BSA is sometimes referred to as an “anti-money laundering” law (“AML”). Several AML statutes, including provisions in Title III of the USA PATRIOT Act of 2001, have been enacted to amend the BSA. Under the USA PATRIOT Act, financial institutions are subject to prohibition against specified financial transactions and account relationships, as well as enhanced due diligence and “know your customer” standards in their dealings with financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:
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to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;
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to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;
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to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and
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to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions are also required to establish BSA/AML compliance programs. The USA PATRIOT Act sets forth minimum standards for these programs, including;
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the development of internal policies, procedures, and controls;
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the designation of a compliance officer;
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an ongoing employee training program; and
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an independent audit function to test the programs.
In addition to the USA PATRIOT Act, the Secretary of the U.S. Department of the Treasury ("Treasury") has adopted rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to violate the privacy provisions of the Gramm-Leach-Bliley Act that are discussed below. Finally, under the regulations of the Office of Foreign Asset Control ("OFAC"), we are required to monitor and block transactions with certain “specially designated nationals” who OFAC has determined pose a risk to U.S. national security.
Technology Risk Management and Consumer Privacy
State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly operations, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology-related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology.
Under Section 501 of the Gramm-Leach-Bliley Act, the federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records and protection against unauthorized access to use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.
Under the Gramm-Leach-Bliley Act, a financial institution must also provide its customers with a notice of private policies and practices. Section 502 prohibits a financial institution from disclosing nonpublic personal information about a customer to non-affiliated third parties unless the institution satisfies various notice and opt-out requirements and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requires and restrictions on a financial institution’s ability to disclose nonpublic personal information about customers to non-affiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices which described in general terms the bank’s information sharing practices. Banks that share nonpublic personal information about customers with non-affiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit or transaction accounts to any non-affiliated third party for use in marketing.
Limitations on Incentive Compensation
In June 2010, the Federal Reserve Board, OCC and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
The Federal Reserve Board will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
In addition, Section 956 of the Dodd-Frank Act required certain regulators (including the FDIC, SEC and Federal Reserve Board) to adopt requirements or guidelines prohibiting excess compensation. On April 14, 2011, these regulators published a joint proposed rulemaking to implement Section 956 of the Dodd-Frank Act for depository institutions, their holding companies and various other financial institutions with $1 billion or more in assets. The proposed rule would (i) prohibit incentive-based compensation arrangements
for covered persons that would encourage inappropriate risks by providing excess compensation; (ii) prohibit incentive-based compensation arrangements for covered persons that would expose the institution to inappropriate risks by providing compensation that could lead to a material financial loss; (iii) require policies and procedures for incentive-based compensation arrangements that are commensurate with the size and complexity of the institution; and (iv) require annual reports on incentive compensation structures to the institution’s appropriate federal regulator. The comment period to the proposed rule ended on March 31, 2011. The proposed rules were re-proposed in June 2015, and final rules have not been issued to date.
In addition, the Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation at their first annual meeting taking place six months after the date of enactment and at least every three years thereafter and on so-called “golden parachute” payments in connections with approvals of mergers and acquisitions unless previously voted on by shareholders. The legislation also authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. Additionally, the Dodd-Frank Act directs the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion, regardless of whether the company is publicly traded or not. The Dodd-Frank Act gives the SEC authority to prohibit broker discretionary voting on elections of directors and executive compensation matters.
Fiscal and Monetary Policy
Banking is a business which depends on interest rate differentials for success. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, the earnings and growth of the Company and BNC will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve and the reserve requirements on deposits. The nature and timing of any changes in such policies and their effect on the Company and BNC cannot be predicted.
Current and future legislation and the policies established by federal and state regulatory authorities will affect the future operations of us and BNC. Banking legislation and regulations may limit our growth and the return to investors by restricting certain activities.
In addition, capital requirements could be changed and have the effect of restricting our activities or the activities of BNC or requiring additional capital to be maintained. We cannot predict with certainty what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our business and the business of BNC.
Federal Home Loan Bank System
We have a correspondent relationship with the Federal Home Loan Bank ("FHLB") of Atlanta, which is one of 12 regional FHLBs that administer the home financing credit function of savings companies. Each FHLB serves as a reserve or central bank for its members within its assigned region. FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system and make loans to members (i.e., advances) in accordance with policies and procedures, established by the Board of Directors of the FHLB which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing.
FHLB provides certain services to us such as processing checks and other items, buying and selling federal funds, handling money transfers and exchanges, shipping coin and currency, providing security and safekeeping of funds or other valuable items and furnishing limited management information and advice. As compensation for these services, we maintain certain balances with FHLB in interest-bearing accounts.
Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings companies and to contribute to low and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate-income housing projects.
Title 6 of the Gramm-Leach-Bliley Act, entitled the Federal Home Loan Bank System Modernization Act of 1999 (the “FHLB Modernization Act”), amended the Federal Home Loan Bank Act to allow voluntary membership and modernized the capital structure and governance of the FHLBs. The capital structure established under the FHLB Modernization Act sets forth leverage and risk-based capital requirements based on permanence of capital. It also requires some minimum investment in the stock of the FHLBs of all member entities. Capital includes retained earnings and two forms of stock: Class A stock redeemable within six months upon written notice and Class B stock redeemable within five years upon written notice. The FHLB Modernization Act also reduced the period of time in which a member exiting the FHLB system must stay out of the system.
Real Estate Lending Evaluations
The federal regulators have adopted uniform standards for evaluations of loans secured by real estate or made to finance improvements to real estate. Banks are required to establish and maintain written internal real estate lending policies consistent with safe and sound banking practices and appropriate to the size of the institution and the nature and scope of its operations. The regulations establish loan to value ratio limitations on real estate loans. BNC's loan policies establish limits on loan to value ratios that are equal to or less than those established in such regulations.
UDAP and UDAAP
Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act (the "FTC Act"), which is the primary federal law that prohibits "unfair or deceptive acts or practices" ("UDAP") and unfair methods of competition in or affecting commerce. “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with UDAP laws and regulations. However, UDAP laws and regulations have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” ("UDAAP"), which have been delegated to the CFPB for supervision. The CFPB has published its first Supervision and Examination Manual that addresses compliance with and the examination of UDAAP.
Economic Environment
The policies of regulatory authorities, including the monetary policy of the Federal Reserve, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
The Federal Reserve’s monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of these policies on our business and earnings and on the business and earnings of BNC cannot be predicted.
Regulatory Reform and Legislation
From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulators policies applicable to the Company or our subsidiaries could have a material effect on the Company’s business, financial condition and results of operations.
Enforcement Powers of Federal Banking Agencies
The Federal Reserve and other state and federal banking agencies and regulators have broad enforcement powers, including the power to terminate deposit insurance, issue cease-and-desist orders, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. Our failure to comply with applicable laws, regulations and other regulatory pronouncements could subject us, as well as our officers and directors, to administrative sanctions and potentially substantial civil penalties.
Annual Disclosure Statement
This Annual Report on Form 10-K also serves as the annual disclosure statement of BNC pursuant to Part 350 of the FDIC’s rules and regulations. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related To Our Company, Our Business, and Our Industry
Changes in the policies of monetary authorities and other government action could materially adversely affect our profitability.
The Bank’s results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government securities, changes in the discount rate or the federal funds rate on bank borrowings and changes in reserve requirements against bank deposits. In view of changing conditions in the national economy and in the money markets, particularly in light of the continuing threat of terrorist attacks and unrest in various places around the globe, we cannot predict with certainty possible future changes in interest rates, deposit levels, loan demand or our business and earnings.
Our revenues are highly correlated to market interest rates.
Our assets and liabilities are primarily monetary in nature, and as a result, we are subject to significant risks tied to changes in interest rates. Unexpected movement in interest rates, that may or may not change the slope of the current yield curve, could cause our net interest margins to decrease, subsequently decreasing net interest income. In addition, such changes could materially adversely affect the valuation of our assets and liabilities.
As with most financial institutions, our results of operations are affected by changes in interest rates and our ability to manage this risk. The difference between interest rates charged on interest-earning assets and interest rates paid on interest-bearing liabilities may be affected by changes in market interest rates, changes in relationships between interest rate indices, and changes in the relationships between long-term and short-term market interest rates. In addition, the mix of assets and liabilities could change as varying levels of market interest rates might present our customer base with more attractive options.
Certain changes in interest rates, inflation, deflation or the financial markets could affect demand for our products and our ability to deliver products efficiently.
Loan originations, and potentially loan revenues, could be materially adversely impacted by sharply rising interest rates. Conversely, sharply falling rates could increase prepayments within our securities portfolio lowering interest earnings from those investments. An unanticipated increase in inflation could cause our operating costs related to salaries and benefits, technology and supplies to increase at a faster pace than revenues.
The fair market value of our securities portfolio and the investment income from these securities also fluctuate depending on general economic and market conditions. In addition, actual net investment income and/or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment as a result of interest rate fluctuations.
A significant portion of our loans are for commercial real estate and construction, which carry greater credit risk than residential mortgage loans.
At December 31, 2015, $1.90 billion, or 45.3%, of our loan portfolio consisted of non-farm and nonresidential properties, multi-family residential properties and land acquisition, development and construction loans. These loans comprise 347.3% of BNC's capital, while acquisition, development and construction loans comprise 80.5% of BNC's capital. We also have two pending acquisitions that we expect will further increase the total balance outstanding for these types of loans. Given their larger balances and the complexity of the underlying collateral, commercial real estate and construction loans generally expose a lender to greater credit risk than residential mortgage loans. These loans also have greater credit risk than residential real estate for the following reasons:
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commercial real estate loans - repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service; and
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construction loans - repayment is dependent on completion of the project and the subsequent financing of the completed project as a commercial real estate or residential real estate loan, and in some instances on the rent or sale of the underlying project.
If loans that are collateralized by real estate become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.
The majority of our commercial real estate loans are secured by non-owner-occupied properties. These loans expose us to greater risk of non-payment and loss than loans secured by owner-occupied properties because repayment of such loans depends primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream, or other events beyond the borrower’s control. In addition, the physical condition of non-owner-occupied properties is often below that of owner-occupied properties due to lax property maintenance standards, which has a negative impact on the value of the collateral properties. Furthermore, some of our non-owner-occupied borrowers have more than one loan outstanding with us, which may expose us to a greater risk of loss compared to residential and commercial borrowers with only one loan.
Our allowance for loan losses may not be adequate to cover losses, and we may be required to materially increase our allowance, which may adversely affect our capital, financial condition and results of operations.
The Bank, as a lender, is exposed to the risk that our customers will be unable to repay their loans in accordance with their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on our operating results. Our credit risk with respect to our real estate and construction loan portfolio will relate principally to the creditworthiness of business entities and the value of the real estate serving as security for the repayment of loans. Our credit risk with respect to our commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and individuals within our local markets.
We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for estimated loan losses based on a number of factors. If our assumptions or judgments prove to be incorrect, the allowance for loan losses may not be sufficient to cover actual loan losses. We may have to increase our allowance in the future in response to the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of our loan portfolio. The actual amount of future provisions for loan losses cannot be determined at this time and may vary from the amounts of past provisions.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could negatively impact our access to liquidity sources include a decrease in the level of our business activity as a result of an economic downturn in the markets in which our loans are concentrated, adverse regulatory action against us, or our inability to attract and retain deposits. Our ability to borrow could be impaired by factors that are not specific to us or our region, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of recent turmoil faced by banking organizations and the unstable credit markets.
Our business is highly correlated to local economic conditions in a geographically concentrated part of the United States.
Unlike larger organizations that are more geographically diversified, our banking offices are primarily concentrated in select markets in Virginia, North Carolina and South Carolina. As a result of this geographic concentration, our financial results depend largely upon economic conditions in these market areas. Deterioration in economic conditions in the markets we serve could result in one or more of the following:
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an increase in loan delinquencies;
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an increase in problem assets and foreclosures;
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a decrease in the demand for our products and services; and
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a decrease in the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.
We rely on dividends from BNC for most of our revenue.
We are a separate and distinct legal entity from BNC. We receive substantially all of our revenue from dividends from BNC. These dividends are the principal source of funds to pay dividends on common stock and interest and principal on our debt. Various federal and state laws and regulations limit the amount of dividends that BNC may pay to us. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event BNC is unable to pay dividends to us, we may not be able to service debt, pay obligations or pay dividends on our common stock and our business, financial condition and results of operations may be materially adversely affected.
Impairment of our investment securities could require charges to earnings, which could result in a negative impact on our results of operations.
In assessing the impairment of investment securities, we consider the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, whether the decline in market value was affected by macroeconomic conditions and whether we have the intent to sell the security or will be required to sell the security before its anticipated recovery. Future declines in the market value or our investment securities may result in other-than-temporary impairment of these securities, which could lead to charges that could have a material adverse effect on our net income and capital levels.
We are subject to regulation by various federal and state entities.
We are subject to the regulations of the SEC, the Federal Reserve, the FDIC and the NCCOB. New regulations issued by these agencies may adversely affect our ability to carry on our business activities. We are subject to various federal and state laws and certain changes in these laws and regulations may adversely affect our operations. Noncompliance with certain of these regulations may impact our business plans, including our ability to branch, offer certain products or execute existing or planned business strategies.
We are subject to industry competition which may have an impact upon our success.
Our profitability depends on our ability to compete successfully. We operate in a highly competitive financial services environment. Certain competitors are larger and may have more resources than we do. We face competition in our regional market areas from other commercial banks, savings and loan associations, credit unions, internet banks, finance companies, mutual funds, insurance companies, brokerage and investment banking firms, and other financial intermediaries that offer similar services. Some of our nonbank competitors are not subject to the same extensive regulations that govern us or our bank subsidiary and may have greater flexibility in competing for business.
Another competitive factor is that the financial services market, including banking services, is undergoing rapid changes with frequent introductions of new technology-driven products and services. Our future success may depend, in part, on our ability to use technology competitively to provide products and services that offer convenience to customers and create additional efficiencies in our operations.
Our recent results may not be indicative of our future results.
We may not be able to grow our business at the same rate of growth achieved in recent years or even grow our business at all. Additionally, we may not have the benefit of several factors that have been favorable to our business in past years, such as an interest rate environment where changes in rates occur at a relatively orderly and modest pace, the ability to find suitable expansion opportunities, or otherwise to capitalize on opportunities presented, or other factors and conditions. Numerous factors, such as weakening or deteriorating economic conditions, regulatory and legislative considerations, and competition may impede or restrict our ability to expand our market presence and could adversely impact our future operating results.
We depend on key personnel for our success.
Our operating results and ability to adequately manage our growth and minimize loan losses is 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 the board of directors believes is capable of managing and growing the Company. 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. Additionally, our ability to retain our current executive officers and other key personnel may be further impacted by existing and proposed legislation and regulations affecting the financial services industry. There can be no assurance that we will be successful in retaining our current executive officers or other key personnel.
We face risks related to our operational, technological and organizational infrastructure.
The Bank's ability to grow and compete is dependent on our ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while we expand. Similar to other large corporations, in our case, operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or outside persons and exposure to external events. We are dependent on our operational infrastructure to help manage these risks. In addition, we are heavily dependent on the strength and capability of our technology systems which we use both to interface with our customers and to manage our internal financial and other systems. Our ability to develop and deliver new products that meet the needs of our existing customers and attract new customers depends in part on the functionality of our technology systems. Additionally, our ability to run our business in compliance with applicable laws and regulations is dependent on these infrastructures.
We continuously monitor our operational and technological capabilities and make modifications and improvements when we believe it will be cost effective to do so. In some instances, we may build and maintain these capabilities ourselves. We also outsource some of these functions to third parties. These third parties may experience errors or disruptions that could adversely impact us and over which we may have limited control. We also face risk from the integration of new infrastructure platforms and/or new third party providers of such platforms into our existing businesses.
Financial services companies depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
The soundness of other financial institutions with which we do business could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, including counterparties in the financial industry, such as commercial banks and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions will expose us to credit risk in the event of default of a counterparty or client. In addition, this credit risk may be exacerbated when the collateral we hold cannot be realized upon liquidation or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Consumers may decide not to use local banks to complete their financial transactions.
Technology and other changes are allowing parties to complete, through alternative methods, financial transactions that historically have involved community banks. For example, consumers can now maintain funds that would have historically been held as local bank deposits in brokerage accounts, mutual funds with an internet-only bank, or with virtually any bank in the country through on-line banking. Consumers can also complete transactions such as purchasing goods and services, paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower-cost deposits as a source of funds could have an adverse effect on our financial condition, results of operations and liquidity.
Reputational risk and social factors may impact our results.
Our ability to originate and maintain accounts, particularly in the context of acquired institutions, is highly dependent upon customer and other external perceptions of our business practices and our financial health. Adverse perceptions regarding our business practices or our financial health could damage our reputation in both the customer and funding markets, leading to difficulties in generating and maintaining accounts as well as in financing them. Adverse developments with respect to the consumer or other external perceptions regarding the practices of our competitors, or our industry as a whole, may also adversely impact our reputation. In addition, adverse reputational impacts on third parties with whom we have important relationships may also adversely impact our reputation. Adverse impacts on our reputation, or the reputation of our industry, may also result in greater regulatory or legislative scrutiny, which may lead to laws, regulations or regulatory actions that may change or constrain the manner in which we engage with our customers and the products we offer. Adverse reputational impacts or events may also increase our litigation risk. We carefully monitor internal and external developments for areas of potential reputational risk and have established governance structures to assist in evaluating such risks in our business practices and decisions.
The financial services industry is experiencing continual technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new, technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we do. We may not be able to effectively implement new, technology-driven products and services or be successful in marketing these products and services to our customers. In addition, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may also cause service interruptions, transaction processing errors and system conversion delays and may cause us to fail to comply with
applicable laws. Failure to successfully keep pace with technological change affecting the financial services industry and avoid interruptions, errors and delays could have a material adverse effect on our business, financial condition or results of operations.
We expect that new technologies and business processes applicable to the consumer and commercial credit industry will continue to emerge, and these new technologies and business processes may be better than those we currently use. Because the pace of technological change is high and our industry is intensely competitive, we may not be able to sustain our investment in new technology as critical systems and applications become obsolete or as better ones become available. A failure to maintain current technology and business processes could cause disruptions in our operations or cause our products and services to be less competitive, all of which could have a material adverse effect on our business, financial condition or results of operations.
We may experience interruptions or breaches in our information system security.
We rely heavily on communications and information systems to conduct our business. In addition to our own systems we also rely on external vendors to provide certain services and are therefore exposed to their information security risks. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of these information systems, there can be no assurance that any failure or interruption of our systems, or our external vendors systems, will not occur, or, if they do occur that they will be adequately addressed. The volume of business conducted through electronic devices continues to grow and our computer systems and network infrastructure, as well as the systems of external vendors and customers, present security risks and could be susceptible to hacking and identify theft. A breach in security of our systems, including a breach resulting from our newer online capabilities such as mobile banking, increases the potential for fraud losses. The occurrence of any failure, interruption or security breach of our information systems could result in damage to 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 effect on our financial condition and results of operations.
A failure in or breach of our operational or security systems or infrastructure, or those of external vendors and other service providers, including as a result of cyber-attacks, could disrupt our business, result in disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
As a financial institution, we are susceptible to fraudulent activity that may be committed against us or our customers, which may result in financial losses to us or our customers, privacy breaches against our customers or damage to our reputation. Such fraudulent activity may take various forms, including check fraud, electronic fraud, wire fraud, phishing, and other dishonest activities. In recent years, there has been a rise in electronic fraudulent activity within the financial services industry, especially in the commercial banking sector, due to cyber-criminals targeting commercial bank accounts.
In addition, our operations rely on secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of our and our customers’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve and become increasingly sophisticated. As a result, our computer systems, software and networks and those of our customers may be vulnerable to unauthorized access, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service, computer viruses or other malicious codes, cyber-attacks and other events that could have an adverse security impact and result in significant losses by us and/or our customers. These threats may originate externally from third parties, such as cyber-criminal and other hackers, third party vendors providing processing or infrastructure-support services, or internally from within our organization. Despite the defensive measures we take to manage our internal technological and operational infrastructure, given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they are discovered and rectified.
We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. These parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, we may be at risk of an operation failure with respect to our customers' systems. Our risk and exposure to these matters remain heightened because of, among other things, the evolving nature of the threats, the outsourcing of some of our business operations and the continued uncertain global economic environment. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information system vulnerabilities.
Our deposit insurance premiums could increase in the future, which may adversely affect our future financial performance.
The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the DIF at a certain level. Economic conditions since 2008 have increased the rate of bank failures and expectations
for further bank failures, requiring the FDIC to make payments for insured deposits from the DIF and prepare for future payments from the DIF.
During 2009, the FDIC imposed a special deposit insurance assessment on all institutions which it regulates, including the Bank. This special assessment was imposed due to the need to replenish the DIF, as a result of increased bank failures and expected future bank failures. Any similar, additional measures taken by the FDIC to maintain or replenish the DIF may have an adverse effect on our financial condition and results of operations.
In 2011, final rules to implement changes required by the Dodd-Frank Act with respect to the FDIC assessment rules became effective. The rules provide that a depository institution’s deposit insurance assessment will be calculated based on the institution’s total assets less tangible equity, rather than the previous base of total deposits. These changes have not materially increased the Company’s FDIC insurance assessments for comparable asset and deposit levels. However, if the Bank’s asset size increases or the FDIC takes other actions to replenish the DIF, the Bank’s FDIC insurance premiums and assessments could increase.
Changes in accounting standards and management’s selection of accounting methods, including assumptions and estimates, could materially impact our financial statements.
From time to time the SEC and the Financial Accounting Standards Board ("FASB") update accounting principles generally accepted in the United States ("GAAP"), which govern the preparation of our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings. In addition, management is required to use certain assumptions and estimates in preparing our financial statements, including determining the fair value of certain assets and liabilities, among other items. Incorrect assumptions or estimates may have a material adverse effect on our financial condition and results of operations.
The value of our goodwill and other intangible assets may decline in the future.
As of December 31, 2015, we had $153.0 million of goodwill and other intangible assets. A significant decline in our financial condition, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock may necessitate taking charges in the future related to the impairment of our goodwill and other intangible assets. If we were to conclude that a future write-down of goodwill and other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations.
Risks Related to Our Growth Strategy
We may not be able to implement aspects of our growth strategy.
Our growth strategy contemplates the future expansion of our business and operations both organically and by acquisitions, such as through the establishment or acquisition of banks and banking offices in our market area and other markets in Virginia and the Carolinas. Implementing these aspects of our growth strategy depends, in part, on our ability to successfully identify acquisition opportunities and strategic partners that will complement our operating philosophy and to successfully integrate their operations with ours, as well as to generate loans and deposits within acceptable risk and expense tolerances. To successfully acquire or establish banks or banking offices, we must be able to correctly identify profitable or growing markets, as well as attract the necessary relationships and high caliber banking personnel to make these new banking offices profitable. In addition, we may not be able to identify suitable opportunities for further growth and expansion or, if we do, we may not be able to successfully integrate these new operations into our business.
As consolidation of the financial services industry continues, the competition for suitable acquisition candidates may increase. We will compete with other financial services companies for acquisition opportunities, and many of these competitors have greater financial resources than we do and may be able to pay more for an acquisition than we are able or willing to pay.
We can offer no assurance that we will have opportunities to acquire other financial institutions or acquire or establish any new branches or loan production offices, or that we will be able to negotiate, finance and complete any opportunities available to us.
If we are unable to effectively implement our growth strategies, our business, results of operations and stock price may be materially and adversely affected.
Future expansion involves risks.
Our acquisition of other financial institutions or parts of those institutions involves a number of risks, including the risks that:
•
we may not be able to realize all of, or it may take longer than expected to realize, the anticipated benefits or cost savings of acquisitions;
•
prices at which future acquisitions may be made may not be acceptable to us;
•
we may incur substantial costs in identifying and evaluating potential acquisitions and merger partners, or in evaluating new markets, hiring experienced local managers, and opening new offices;
•
the institutions we acquire may have distressed assets or unknown or contingent liabilities, and there can be no assurance that we will be able to realize the value we predict from those assets or that we will make sufficient provisions or have sufficient capital for future losses;
•
we may be required to take write-downs or write-offs, restructurings and impairment, or other charges related to the institutions we acquire that could have a significant negative effect on our financial condition and results of operations;
•
there may be substantial lag-time between completing an acquisition and generating sufficient assets and deposits to support costs of the expansion;
•
our management’s attention in negotiating a transaction and integrating the operations and personnel of the combining businesses may be diverted from our existing business and we may not be able to successfully integrate such operations and personnel;
•
our announcement of additional transactions prior to the completion of an acquisition could result in a delay in obtaining regulatory or shareholder approval for the acquisition, which could have the effect of limiting our ability to fully realize the expected financial benefits from the transaction;
•
we may not be able to obtain regulatory approval for an acquisition;
•
we may enter new markets where we lack local experience or that introduce new risks to our operations, or that otherwise result in adverse effects on our results of operations;
•
we may introduce new products and services we are not equipped to manage or that introduce new risks to our operation, or that otherwise result in adverse effects on our results of operations;
•
we may incur intangible assets in connection with an acquisition, or the intangible assets we incur may become impaired, which could result in adverse short-term effects on our results of operations;
•
we may assume liabilities in connection with an acquisition, including unrecorded liabilities that are not discovered at the time of the transaction, and the repayment of those liabilities may have an adverse effect on our results of operations, financial condition and stock price;
•
we may lose key employees, or we maybe be required to recruit experienced personnel; or
•
we may not be able to retain existing customers or attract new customers.
We cannot assure you that we will be able to successfully integrate any banking offices that we acquire into our operations or retain customers of those offices. If any of these risks occur in connection with our expansion efforts, it may have a material and adverse effect on our results of operations and financial condition.
We may not be able to maintain and manage our organic growth, which may adversely affect our results of operations and financial condition.
We have grown rapidly in recent years and our business strategy contemplates continued levels of growth, both organically and through acquisitions. We can provide no assurance that we will continue to be successful in increasing the volume of loans and deposits or in introducing new products and services at acceptable risk levels and upon acceptable terms while managing the costs and implementation risks associated with our historical or modified organic growth strategy. We may be unable to continue to increase our volume of loans and deposits or to introduce new products and services at acceptable risk levels for a variety of reasons, including an inability to maintain
capital and liquidity sufficient to support continued growth. If we are successful in continuing our growth, we cannot assure you that further growth would offer the same levels of potential profitability or that we would be successful in controlling costs and maintaining asset quality. Accordingly, an inability to maintain growth, or an inability to effectively manage growth, could adversely affect out results of operations, financial condition and stock price.
New bank office facilities and other facilities may not be profitable.
We may not be able to organically expand into new markets that are profitable for our franchise. The costs to start up new bank branches and loan production offices in new markets, other than through acquisitions, and the additional costs to operate these facilities would increase our non-interest expense and may decrease our earnings. It may be difficult to adequately and profitably manage our growth through the establishment of bank branches and loan production offices in new markets. In addition, we can provide no assurance that our expansion into any such new markets will successfully attract enough new business to offset the expenses of their operation. If we are not able to do so, our earnings and stock price may be negatively impacted.
The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand.
Our growth strategy contemplates that we will expand our business and operations to other markets, particularly in Virginia and the Carolinas. We intend to primarily target market areas that we believe possess attractive demographic, economic or competitive characteristics. To expand into new markets successfully, we must identify and retain experienced key management members with local expertise and relationships in these markets. Competition for qualified personnel in the markets in which we may expand may be intense, and there may be a limited number of qualified persons with knowledge of and experience in the commercial banking industry in these markets. Even if we identify individuals that we believe could assist us in establishing a presence in a new market, we may be unable to recruit these individuals away from other banks or may be unable to do so at a reasonable cost. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, results of operations and stock price.
We may need additional access to capital, which we may be unable to obtain on attractive terms or at all.
We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our stock price negatively affected.
Risks Related to Our Common Stock
The price of our common stock is volatile and may decline.
The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. Among the factors that could affect our stock price are:
•
actual or anticipated quarterly fluctuations in our operating results and financial condition;
•
changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to our securities or those of other financial institutions;
•
failure to meet analysts’ revenue or earnings estimates;
•
speculation in the press or investment community;
•
strategic actions by us or our competitors, such as acquisitions or restructurings;
•
actions by institutional shareholders;
•
fluctuations in the stock price and operating results of our competitors;
•
general market conditions and, in particular, developments related to market conditions for the financial services industry;
•
proposed or adopted regulatory changes or developments;
•
anticipated or pending investigations, proceedings or litigation that involve or affect us; or
•
domestic and international economic factors unrelated to our performance.
A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.
Securities issued by us, including our common stock, are not FDIC insured.
Securities issued by us, including our common stock, are not savings or deposit accounts or other obligations of any bank and are not insured by the FDIC, the DIF or any other governmental agency or instrumentality, or any private insurer, and are subject to investment risk, including the possible loss of principal.
The holders of our subordinated notes and junior subordinated debentures have rights that are senior to those of our shareholders.
As of December 31, 2015, the Company had $70.7 million of subordinated notes outstanding and $40.2 million in junior subordinated debentures outstanding that were issued by the Company's wholly-owned subsidiaries. The subordinated notes and the junior subordinated debentures are senior to the Company's shares of common stock. As a result, the Company must make payments on the subordinated notes and the junior subordinated debentures before any dividends can be paid on its common stock and, in the event of the Company's bankruptcy, dissolution, or liquidation, the holders of the subordinated notes and junior subordinated debentures must be satisfied before any distributions can be made to the holders of the common stock. The Company's ability to pay future distributions depends upon the earnings of BNC and the issuance of dividends from BNC to the Company, which may be inadequate to service the obligations.
We may borrow funds or issue additional debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in liquidation, which could negatively affect the value of our common stock.
In the future, we may attempt to increase our capital resources by entering into debt or debt-like financing that is unsecured or secured by all or up to all of our assets, or by issuing additional debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, preferred stock, common stock, or securities convertible into or exchangeable for equity securities. In the event of our liquidation, our lenders and holders of our debt and preferred securities would receive a distribution of our available assets before distributions to the holders of our common stock. Because our decision to incur debt and issue securities in our future offerings will depend on market conditions and other factors beyond our control, we cannot predict or estimate with certainty the amount, timing or nature of our future offerings and debt financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. In addition, the borrowing of funds or the issuance of debt would increase our leverage and decrease our liquidity, and the issuance of additional equity securities would dilute the interests of our existing shareholders.
Sales of a significant number of shares of our common stock in the public markets, or the perception of such sales, could depress the market price of our common stock.
Sales of a substantial number of shares of our common stock in the public markets, including shares issued to shareholders of acquired institutions, and the availability of those shares for sale could adversely affect the market price of our common stock. In addition, future issuances of equity securities, including pursuant to outstanding options, could dilute the interests of our existing shareholders and could cause the market price of our common stock to decline. We may issue such additional equity or convertible securities to raise additional capital. Depending on the amount offered and the levels at which we offer the stock, issuances of common or preferred stock could be substantially dilutive to shareholders of our common stock. Moreover, to the extent that we issue restricted stock, phantom shares, stock appreciation rights, options or warrants to purchase our common stock in the future and those stock appreciation rights, options or warrants are exercised or as shares of the restricted stock vest, our shareholders may experience further dilution. Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro-rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our shareholders. We cannot predict with certainty the effect that future sales of our common stock would have on the market price of our common stock.
We may reduce or eliminate dividends on our common stock.
Although we have historically paid a quarterly cash dividend to the holders of our common stock, holders of our common stock are not entitled to receive dividends. Downturns in the domestic and global economies could cause our Board of Directors to consider, among other things, reducing or eliminating dividends paid on our common stock. This could adversely affect the market price of our common stock. Furthermore, as a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends before declaring or paying any dividends. Dividends also may be limited as a result of safety and soundness considerations.
Our articles of incorporation, as amended, amended and restated bylaws, and certain banking laws may have an anti-takeover effect.
Provisions of our articles of incorporation and bylaws, as amended, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may prohibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
The Company’s executive office is located in High Point, North Carolina. The Company's administrative headquarters is located in Thomasville, North Carolina. The Company operates 62 full service banking offices, with 36 located in various markets in North Carolina, 17 in various markets in South Carolina and nine in the Roanoke, Virginia area. In addition, the Company has four limited service offices and five mortgages offices in these markets. The Company owns 38 of these facilities, and the remaining facilities are subject to leases, each of which we consider reasonable and appropriate for its location. The Company makes portions of certain other facilities available for lease to third parties, although such incidental leasing activity is not material to the Company’s overall operations.
All properties, whether owned or leased, are maintained in suitable condition. We also evaluate our banking facilities on an ongoing basis to identify possible under-utilization and to determine the need for functional improvements, relocations, closures or possible sales. The Company also holds a variety of property interests acquired in settlement of loans.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is subject, in the normal course of business, to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company will be material to the Company’s consolidated financial position. On an on-going basis the Company assesses any potential liabilities or contingencies in connection with such legal proceedings. For those matters where it is deemed probable that the Company will incur losses and the amount of the losses can be reasonably estimated, the Company would record an expense and corresponding liability in its consolidated financial statements.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II. OTHER INFORMATION
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ Capital Market under the symbol “BNCN”. The high and low closing sale prices, which represent actual transactions as quoted on the NASDAQ Capital Market, of the Company’s common stock for each quarterly period in 2015 and 2014 are presented below. The per share dividends declared by the Company in each quarterly period in 2015 and 2014 for its voting and non-voting common stock are also presented below.
As of February 23, 2016, we had approximately 3,355 shareholders of record not including persons or entities whose stock is held in nominee or “street” name and by various banks and brokerage firms.
The Company’s ability to pay dividends on its common stock is principally dependent on BNC’s ability to pay dividends to the Company, which is subject to various regulatory restrictions and limitations. See “Item 1. Business - Supervision and Regulation - Payment of Dividends and Other Restrictions” above for regulatory restrictions which limit the ability of BNC to pay dividends. The Company expects to continue to pay comparable dividends on its common stock for the foreseeable future.
We made no purchases, nor did any of our “affiliated purchasers” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended) make any purchases, of our common stock during the three months ended December 31, 2015.
Performance Graph
The following graph and table, which were prepared by SNL Financial LC (“SNL”), compares the cumulative total return on our common stock over a measurement period beginning December 31, 2010 with (i) the cumulative total return on the stocks included in the National Association of Securities Dealers, Inc. Automated Quotation (“NASDAQ”) Composite Index; (ii) the cumulative total return of the Standard & Poor's ("S&P") 500; (iii) the cumulative return on the stocks included in the SNL U.S. Bank Index; and (iv) the cumulative total return on the stocks included in the SNL Southeast U.S. Bank Index. All of these cumulative returns are computed assuming the quarterly reinvestment of dividends paid during the applicable period.
The stock performance graph assumes $100.00 was invested December 31, 2010. The stock price performance included in this graph is not necessarily indicative of future stock price performance.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Table 1
Selected Financial Data
(dollars in thousands, except per share and non-financial information, shares in thousands)
(1)
Tangible common book value per share is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition. See Table 2 for a reconciliation of non-GAAP measures to the most directly comparable GAAP measure.
(2)
Calculated by dividing net income available to common shareholders by average assets.
(3)
Calculated by dividing net income available to common shareholders by average common equity.
(4)
Average tangible common equity is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition. See Table 2 for a reconciliation of non-GAAP measures to the most directly comparable GAAP measure.
(5)
Calculated by dividing tax equivalent net interest income by average interest-earning assets. The tax equivalent adjustment was $7.6 million, $7.7 million, $7.2 million, $5.7 million and $5.6 million for the years ended December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
(6)
Calculated by dividing non-interest expense by the sum of the tax equivalent net interest income and non-interest income.
(7)
Includes loans covered under loss-share agreements of $40.9 million, $137.5 million, $187.7 million, $248.9 million and $320.0 million at December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
(8)
Nonperforming loans consist of nonaccrual loans and accruing loans greater than 90 days past due. Includes nonperforming loans covered under loss-share agreements of $4.0 million, $11.1 million, $23.7 million, $47.0 million and $73.3 million at December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
(9)
Nonperforming assets consist of nonperforming loans and other real estate owned ("OREO"). Includes nonperforming loans and OREO covered under loss-share agreements of $5.6 million, $18.3 million, $42.5 million, $70.1 million and $120.9 million at December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
(10)
Capital ratios are for BNC.
Table 2
Reconciliation of Non-GAAP Financial Measures
(dollars in thousands, except per share data, shares in thousands)
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion is management’s analysis to assist in the understanding and evaluation of the consolidated financial condition and results of operations of the Company. It should be read in conjunction with the consolidated financial statements and notes and the selected financial data presented elsewhere in this report.
The detailed financial discussion that follows focuses on 2015 results compared to 2014. Discussion of 2014 results compared to 2013 is predominantly in section “2014 Compared to 2013.”
Overview and Executive Summary
BNC Bancorp was formed in 2002 to serve as the holding company for Bank of North Carolina. We provide a wide range of banking services tailored to the particular banking needs of the communities we serve. We are principally engaged in the business of attracting deposits from the general public and using those deposits, together with other funding from our lines of credit, to make primarily consumer and commercial loans. We have pursued a strategy that emphasizes our local affiliations and are continuously developing new and innovative products and equipping our bankers with new technology to further differentiate us as a community bank with sophisticated product delivery.
Some highlights for fiscal year 2015 were as follows:
•
Net income totaled $44.5 million, or $1.24 per diluted share, compared to $29.4 million, or $1.01 per diluted share, for 2014 (per share results were impacted by the acquisitions of Valley and the Certus branches and the public stock offering detailed below);
•
Originated loans increased $585.4 million, or 27.7%, between December 31, 2014 and 2015, excluding loans that were reclassified from acquired;
•
Total deposits increased $1.35 billion, or 39.6%, between December 31, 2014 and 2015;
•
Total assets increased $1.60 billion, or 39.2%, between December 31, 2014 and 2015.
•
Return on average assets of 0.94% for 2015, compared to 0.83% for 2014;
•
Return on average tangible common equity of 13.40% for 2015, compared to 11.51% for 2014;
•
Total nonperforming assets of $51.3 million at December 31, 2015, a decrease of 23.8% as compared to $67.3 million at December 31, 2014;
•
Nonperforming assets to total assets ratio of 0.90% at December 31, 2015, as compared to 1.65% at December 31, 2014;
•
Announced pending acquisitions of Southcoast and HPTB;
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Southcoast acquisition expected to close during the first half of 2016, subject to regulatory approval and other customary closing conditions.
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HPTB acquisition expected to close during the second half of 2016, subject to regulatory approval, approval of High Point Bank Corporation shareholders, and other customary closing conditions.
•
Completed acquisition and conversion of Valley and the Certus branches; and
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Acquisition of Valley marked Company's entry into Roanoke, Virginia and surrounding markets.
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Acquisition of Certus branches expanded the Company’s presence in attractive Upstate South Carolina markets.
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Completed public offering of 2.59 million shares of voting common stock.
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Net proceeds of approximately $57.6 million after underwriting discount and expenses.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in conformity with GAAP. The preparation of these consolidated financial statements 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 amount of revenues and expenses during the reporting period. We believe the more critical accounting and reporting policies that currently affect our financial condition and results of operations include the following: accounting for the allowance for credit losses, valuation of goodwill and intangible assets, and valuation of assets acquired and liabilities assumed in business combinations. Accordingly, our significant accounting policies and effects of new accounting pronouncements are discussed in detail in Note 1, “Summary of Significant Accounting Policies” to the accompanying Consolidated Financial Statements contained in Item 8 for further details.
Allowance for Loan Losses
We establish an allowance for loan losses that represents management’s best estimate of probable credit losses inherent in the portfolio at the balance sheet date. Estimates for loan losses are determined by management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss and delinquency experience, trends in past due and nonaccrual loans, risk characteristics of the various classifications of loans, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the appropriateness of the allowance for loan losses, could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require additions to the allowance for loan losses or may require that certain loan balances be charged off or downgraded to criticized loan categories when their credit evaluations differ
from those of management, based on their judgments about information available to them at the time of their examination. See Note 1, “Summary of Significant Accounting Policies” and Note 5, “Loans and Allowance for Loan Losses” to the accompanying Consolidated Financial Statements contained in Item 8 for further details.
Valuation of Goodwill and Intangible Assets
Business acquisitions are accounted for using the acquisition method of accounting. Under the acquisition method, we are required to record the assets acquired, including identified intangible assets, and liabilities assumed at their fair value, which often involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques, all of which are inherently subjective. The amortization of identified intangible assets is based upon the estimated economic benefits to be received, which is also subjective. The Company reviews identified intangible assets for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in which case an impairment charge would be recorded.
Goodwill is subject to impairment testing on at least an annual basis. In addition, goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The Company has identified two reporting units for purposes of testing our goodwill for impairment, which are our mortgage origination business and our banking operations unit, which contains all other activities performed by the Company. All goodwill is allocated to the banking operations reporting unit.
The Company conducted its annual impairment testing as of June 30, 2015 utilizing a qualitative assessment. Factors that management considered in this assessment included macroeconomic conditions, industry and market considerations, overall financial performance of the Company and the banking operations reporting unit (both current and projected), continued acquisition activity, continued levels of organic growth and changes in the composition or carrying amount of net assets. In addition, management considered the significant increases in both the Company’s common stock price and in the overall bank common stock index (based on the SNL Southeast United States Bank Index), as well as the Company’s improving earnings trend over the past year. Based on these assessments, management concluded that the 2015 annual qualitative impairment assessment indicated that it is more likely than not that the estimated fair value exceeded the carrying value (including goodwill) for the banking operations reporting unit. Therefore, a step one quantitative analysis was not required.
There were no impairment charges recorded in 2015, 2014 or 2013, respectively. See Note 7, “Goodwill and Other Intangible Assets” to the accompanying Consolidated Financial Statements contained in Item 8 for further details.
Valuation of Assets Acquired in Business Combinations
We account for acquisitions under FASB Accounting Standards Codification ("ASC") Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, and liabilities assumed, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.
Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"), and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of ASC 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, such as lines of credit (consumer and commercial) and loans for which there was no discount attributable to credit are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.
See Note 1, “Summary of Significant Accounting Policies,” Note 2, "Acquisitions," and Note 5, “Loans and Allowance for Loan Losses", to the accompanying Consolidated Financial Statements contained in Item 8 for further details.
Analysis of Results of Operations
Net Interest Income
Net interest income is the primary source of BNC’s revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and the interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, repricing frequencies, and loan prepayment behavior. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt loans and investment securities is computed on a fully-taxable equivalent ("FTE") basis. Net interest income and net interest margin are discussed on a FTE basis.
Net interest income for 2015 was $179.4 million, an increase of 22.9% from $146.0 million for 2014. The increase was primarily driven by a $1.08 billion increase in average interest-earning assets as compared to 2014. This increase was primarily due to the acquisitions of Valley and the Certus branches, respectively, as well as continued organic loan growth in our markets. Average interest-earning assets for 2015 were $4.28 billion, as compared to $3.20 billion for 2014.
Net interest margin decreased 37 basis points from 4.56% during 2014 to 4.19% during 2015. The Company’s average yield on interest-earning assets was 4.82% for 2015, a decrease of 36 basis points from 5.18% for 2014. The decrease is primarily due to a decrease in the yield earned on the Company’s portfolio loans, which was 4.92% for 2015, as compared to 5.33% for 2014. This decrease is primarily due to pricing pressure on new and renewed loans. This decrease in interest rates was partially offset by $20.5 million of accretion earned on the acquired loan portfolio, as compared to $14.9 million earned in 2014. The average yield earned on the investment securities portfolio was 4.65%, a decrease of 46 basis points from 5.11% earned during 2014. This decrease was primarily due to the purchase of new investment securities that have a lower yield than the current portfolio.
Average interest-bearing liabilities were $3.57 billion for 2015, an increase of 28.3% from $2.78 billion for 2014. The increase was due to an additional $712.6 million of average interest-bearing deposits, primarily from acquisitions. The Company also increased average borrowings by $76.0 million, which is comprised of additional advances from the FHLB, as well as subordinated notes and junior subordinated debentures acquired from Valley. The additional advances from the FHLB and increased deposit base were used to fund the Company's increased lending activity and as part of the Company's strategic plan to increase on-balance sheet liquidity. The Company’s average cost of interest-bearing liabilities was 0.75% for 2015, an increase of 3 basis points from 0.72% for 2014.
The following table details the major components of net interest income and the related yields and rates:
Table 3
Average Balance and Net Interest Income (FTE)
(1)
Average outstanding balances are net of deferred costs and unearned discounts and include nonaccrual loans.
(2)
Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis. The taxable-equivalent adjustment was $7.6 million, $7.7 million and $7.2 million for the years ended December 31, 2015, 2014 and 2013, respectively.
The following table details the variances caused by changes in interest rates and changes in volumes:
Table 4
Volume and Rate Variance Analysis
(1)
Interest income on tax-exempt investments has been adjusted to a fully taxable-equivalent basis.
Provision for Loan Losses
The Company recorded a provision for loan losses of $1.9 million for 2015, a decrease of 72.9% from $7.0 million recorded during 2014.
Provision for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include recent growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. See additional discussion under "Asset Quality - Analysis of Allowance for Loan Losses” section.
Non-Interest Income
Non-interest income was $32.4 million for 2015, an increase of 29.7% from $25.0 million for 2014. The following table presents the components of non-interest income:
Table 5
Non-Interest Income
Mortgage loan and related fee income increased $2.8 million, or 37.0%, to $10.5 million for 2015, as compared to $7.7 million in 2014. In 2015, the Company closed 1,879 mortgage loans totaling $412.6 million, compared with 1,429 loans totaling $317.8 million in 2014. The Company continues to invest in its mortgage business by hiring new lenders in our markets.
Income from service charges was $8.1 million for 2015, an increase of $2.0 million, or 32.3%, from $6.1 million for 2014. The increase was directly due to the increase in deposits and transactions from the Company's recent acquisitions and organic growth.
The Company recognized net securities gains of $0.9 million during 2015, as compared to a net loss of $0.5 million during 2014. The Company sold a number of securities during the third quarter of 2015 in order to re-balance the portfolio after the Valley acquisition.
Many of the non-interest income sources, such as income from recoveries on acquired loans, income derived from the sale of loans partially guaranteed by the SBA and income derived from our investment brokerage services, are volatile and can vary significantly from period to period.
Non-Interest Expense
Non-interest expense was $139.2 million for 2015, an increase of 19.5% from $116.5 million for 2014. Included in non-interest expense for 2015 and 2014 was $13.3 million and $9.0 million, respectively, of transaction-related expenses related to the Company's recent acquisitions. The following table presents the components of non-interest expense:
Table 6
Non-Interest Expense
Salaries and employee benefits expense for 2015 was $72.5 million, an increase of $10.3 million, or 16.5%, from 2014. Occupancy expense for 2015 was $11.8 million, an increase of $2.6 million, or 28.9%, from 2014. These increases are a direct result of the increased headcount and facilities following the acquisitions of Valley and the Certus branches. Salaries and employee benefits also increased due to higher production and performance incentives, as well as an increase in the level of the Company's match of employee contributions to the Company's 401(k) plan.
Loan, foreclosure and OREO expenses include foreclosure and carrying costs and realized losses and write-downs of foreclosed properties. Realized losses and valuation adjustments on foreclosed property totaled a net loss of $5.2 million for the year ended December 31, 2015, as compared to a net loss of $4.3 million for 2014. The Company incurred a higher level of losses during 2015 as a result of concerted efforts to liquidate certain properties in the portfolio.
Other expenses totaled $15.8 million for 2015, an increase of $4.8 million, or 43.2%, from 2014. Included in other expenses for 2015 and 2014 are $0.8 million and $0.7 million, respectively, in losses on the extinguishment of debt, as well as $4.0 million and $2.3 million, respectively, of amortization of intangible assets.
Income Taxes
Income tax expense was $18.7 million for 2015, an increase of 80.9% from $10.4 million for 2014. We generate significant amounts of non-taxable income from tax-exempt investment securities and from investments in bank-owned life insurance. Accordingly, the level of such income in relation to income before income taxes significantly affects our effective tax rate. Due to an increase in our level of taxable income relative to non-taxable income, our effective tax rate for 2015 was 29.7%, as compared to an effective tax rate of 26.1% for 2014.
Analysis of Financial Condition
Investment Securities
Our investment securities portfolio is intended to provide us with adequate liquidity, flexibility in asset/liability management, a source of stable income, and is structured with minimum credit exposure. Investment securities classified as available for sale are carried at fair value in the consolidated balance sheet, while investment securities classified as held to maturity are shown at amortized cost in the consolidated balance sheet.
The following table presents the composition of our investment securities portfolio:
Table 7
Composition of Investment Securities Portfolio
We continually evaluate our investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, and the level of interest rate risk to which we are exposed. These evaluations may cause us to change the level of funds we deploy into investment securities, change the composition of our investment securities portfolio, and change the proportion of investments made into the available-for-sale and held-to-maturity investment categories.
The following table presents the composition of our available-for-sale and held-to-maturity securities portfolio at December 31, 2015 with ranges of maturities and weighted average yields:
Table 8
Investment Securities Portfolio by Expected Maturities
(1)
Yields for available-for-sale securities are calculated based on the amortized cost of the securities.
(2)
Yields on tax-exempt investment securities are calculated on a taxable-equivalent basis using an income tax rate of 34%.
(3)
For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been included in maturity groupings based on the contractual maturity. The expected life of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans with or without prepayment penalties.
At December 31, 2015, our investment securities portfolio included 347 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The Company continually assesses the risk of credit default for the municipal bond portfolio and believes the portfolio has a low risk of credit default. The following table is a summary, by U.S. state, of our investment in the obligations of state and political subdivisions at December 31, 2015:
Table 9
Obligations of State and Political Subdivisions
Our largest exposure in general obligation bonds was 65 bonds issued by various school districts in Texas with a total amortized cost basis of $87.2 million and total fair value of $91.5 million at December 31, 2015. Of this total, $71.2 million in amortized cost and $74.4 million in fair value are guaranteed by the Permanent School Fund of the State of Texas.
Our investments in revenue bonds at December 31, 2015 are summarized in the following table:
Table 10
Revenue Bonds by Source
Our largest individual exposures in revenue bonds at December 31, 2015 were three bonds to be repaid by future pledged power and utility revenue, and seven bonds to be repaid by future pledged revenues generated from a leading academic healthcare system. The total amortized cost for these 10 securities was $18.4 million and the total fair value was $18.9 million at December 31, 2015.
Currently, all of our investments in state and political subdivisions are rated as investment grade by Standard & Poor's and/or Moody's. Investments in state and political subdivisions are subject to an initial pre-purchase credit assessment and ongoing monitoring. The factors considered in this analysis include capacity to pay, market and economic data, soundness of budgetary position, sources, strength, and stability of tax or enterprise revenue, review of the credit rating, as provided by one or more nationally recognized credit ratings agencies, as well as any other factors as are available and relevant to the security or issuer. While we do not place sole reliance on the credit rating of the security, no investment in a state or political subdivision is considered for purchase unless it has an investment grade credit rating by one or more nationally recognized credit ratings agencies. We perform additional detailed risk analysis should any security be downgraded below investment grade to determine if the security should be retained or sold. This risk analysis includes, but is not limited to, discussions with third party municipal credit analysts and review of any changes that may affect the credit worthiness of the issuer and its ability to make timely principal and interest payments.
Our evaluation of investments in state and political subdivisions at December 31, 2015 did not uncover any facts or circumstances resulting in significantly different credit ratings than those assigned by Standard & Poor's and/or Moody's.
Due to the recent decline in crude oil prices, the Company reviewed the investment portfolio to determine the level of exposure to the energy sector and potential risk of loss. At December 31, 2015, we owned asset-backed securities from six separate issuers that had some portion of collateral associated with the oil and gas industry. The collateral specific to the energy sector was less than 3% of the total collateral of these issuances, and the Company's proportional ownership was less than 1%. We also noted that, while we have a significant amount of investments in state and political subdivisions that rely on the oil and gas industry, the vast majority of our investments are backed by revenue sources or guaranteed by programs that are not dependent on the energy industry. Based on this analysis, the Company's overall exposure was determined to be negligible.
Loans
Total portfolio loans were $4.20 billion at December 31, 2015, an increase of 36.6% from $3.08 billion at December 31, 2014. The loan portfolio is widely diversified by types of borrowers, industry groups, and market areas within our core footprint. Significant loan concentrations are considered to exist when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions.
The following table presents the composition of our loan portfolio for the past five years:
Table 11
Loan Portfolio Composition
(1) Amount includes $40.9 million, $137.5 million, $187.7 million, $248.9 million and $320.0 million of acquired loans covered under FDIC loss-share agreements at December 31, 2015, 2014, 2013, 2012 and 2011, respectively.
The following table presents the scheduled maturities of the Company's portfolio loans at December 31, 2015:
Table 12
Loan Portfolio by Contractual Maturities
Notable contributions to the change in 2015 loan balances were as follows:
•
The commercial real estate portfolio, which consists of multi-family residential property and owner and non-owner occupied nonresidential properties, was $2.25 billion at December 31, 2015, an increase of $660.9 million, or 41.7%, from December 31, 2014. Excluding loans acquired in business combinations, commercial real estate loans were $1.58 billion at December 31, 2015, an increase of $394.1 million, or 33.4%, from December 31, 2014. At December 31, 2015, the largest industry group within the commercial real estate category was for office and warehouse buildings, including both investment and owner occupied locations. Office and warehouse buildings represented 17.9% of total portfolio loans and 33.5% of the total commercial real estate portfolio at December 31, 2015. The next largest industry groups within the commercial real estate category were shopping centers/retail stores and multi-family, which each represented 10.9% and 4.2%, respectively, of total loans and 20.4% and 7.9%, respectively, of the total commercial real estate portfolio at December 31, 2015. The remaining commercial and business lending portfolio is spread over a diverse range of industries, none of which exceed 3% of total loans.
•
The commercial construction portfolio totaled $365.0 million at December 31, 2015, an increase of $50.4 million, or 16.0%, from December 31, 2014. This portfolio includes projects that span multiple industries and locations within our footprint, with the primary components being multi-family and shopping center construction projects. The residential home builder segment continues to experience strong demand in the metropolitan markets. The Company actively manages the inventory of pre-sold and speculative loans and believes the home builder loan portfolio is well balanced, with a focus on regional builders with strong financial performance and proven track records.
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The commercial and industrial portfolio totaled $419.1 million at December 31, 2015, an increase of $226.8 million, or 117.9%, from December 31, 2014. Excluding loans acquired in business combinations, commercial and industrial loans were $279.5 million at December 31, 2015, an increase of $125.4 million, or 81.3%, from December 31, 2014. The Company's dedicated middle-market lending group has focused on growing this portfolio, with a primary driver for growth in this loan portfolio is loans to municipalities and county governments, as well as owner-managed operating companies.
•
Residential mortgage loans totaled $1.05 billion at December 31, 2015, an increase of $176.0 million, or 20.2%, from December 31, 2014. Excluding loans acquired in business combinations, residential mortgage loans were $484.9 million at December 31, 2015, an increase of $45.3 million, or 10.3%, from December 31, 2014. At December 31, 2015, the residential mortgage portfolio was comprised of $453.0 million of fixed-rate residential real estate mortgages and $595.4 million of variable-rate residential real estate mortgages.
At December 31, 2015, second mortgage loans and home equity lines of credit for which the Company did not own or service the related first mortgage loans totaled approximately $235.0 million, which represented approximately 97% of the total second liens held by the
Company. Since substantially all first mortgage loans originated by the Company are eligible for sale in the secondary market, and the Company typically does not service the related first mortgage loans if they are sold, the Company may be unable to track the delinquency status of the related first mortgage loans and whether such loans are at risk of foreclosure by others. The Company monitors the increased credit risk associated with second mortgage loans and home equity lines of credit for which the Company does not own or service the related first mortgage loans as part of the overall management of the relationship. If the Company identifies significant deterioration in a borrower’s credit quality, the Company may freeze the borrower’s ability to make additional principal draws under the home equity lines of credit.
Home equity lines of credit are offered as “revolving” lines of credit which have a 15-year maturity and draw period. Borrowers are able to choose scheduled monthly interest-only payments during the term of the line or monthly payments of 1.5% of the outstanding principal, along with associated interest. The full principal amount is due at maturity as a lump-sum balloon payment under the interest-only payment option. At December 31, 2015, approximately 98% of the home equity lines of credit were paying scheduled monthly interest-only payments. At maturity, home equity loans are re-underwritten based on our current underwriting standards and updated appraisals are obtained. Our underwriting criteria include analysis of the loan amount in relation to the borrower's total mortgage debt, in addition to normal credit underwriting guidelines. If the borrower qualifies under our current underwriting standards, the loans are either converted to conventional second mortgage loans that are fully amortizing or refinanced along with the existing first mortgage into a new first mortgage loan. Borrowers may be required to repay a portion of the outstanding principal balance to qualify for such renewals.
The following table summarizes the maturity dates of our home equity lines of credit at December 31, 2015:
Table 13
Home Equity Line of Credit Maturities
Deposits
We provide a range of deposit services, including non-interest bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management's desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. Total deposits at December 31, 2015 were $4.74 billion, an increase of 39.6% from total deposits of $3.40 billion at December 31, 2014.
The following is our average deposits and weighted-average interest rates paid thereon for the past three fiscal years:
Table 14
Average Deposits
Average deposits increased by $934.4 million, or 31.0%, during 2015, primarily due to the acquisitions of Valley and the Certus branches, respectively. The Company has also continued to organically grow the deposit base and attract new customers in our markets. Wholesale deposits were 27.5% of total deposits at December 31, 2015, an increase compared to 25.7% at December 31, 2014. This increase was used to fund the Company's increased lending activity and as part of the Company's strategic plan to increase on-balance sheet liquidity.
The following is our maturities of time deposits of $100,000 or more at December 31, 2015:
Table 15
Maturities of Time Deposits of $100,000 or More
Time deposits of $100,000 or more represented 26.5% and 25.4%, respectively, of our total deposits at December 31, 2015 and 2014.
Borrowings
Total borrowings at December 31, 2015 were $292.8 million, an increase of $31.0 million from total borrowings of $261.7 million at December 31, 2014. At December 31, 2015, $103.2 million of these borrowings were classified as short-term, while the remaining $189.6 million were classified as long-term. Short-term borrowings are comprised of short-term FHLB advances, securities sold under agreements to repurchase and Federal funds purchased. Many short-term funding sources, particularly Federal funds purchased and securities sold under agreements to repurchase, are expected to be reissued and, therefore, do not represent an immediate need for cash. Long-term funding is comprised of long-term FHLB advances, subordinated notes and junior subordinated debentures. The Company will prepay FHLB advances from time to time as funding needs change. See Note 11, “Borrowings” to the accompanying Consolidated Financial Statements contained in Item 8 for additional details.
Asset Quality
We consider asset quality to be of primary importance, and employ a formal internal loan review process to ensure adherence to our lending policy as approved by our Board of Directors. It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated. The Company's internal credit risk review function, through focused review and sampling, validates the accuracy of commercial loan risk grades. Each loan risk grade corresponds to an estimated default probability. In addition, as a given loan's credit quality improves or deteriorates, the Company will update the borrower's risk grade accordingly. The function of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in our market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates,
including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management's estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. Our policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a nonaccrual status are generally collateralized and probable losses are considered in the determination of the allowance for loan losses.
Nonperforming Assets
Nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due and OREO, totaled $51.3 million, or 0.90% of total assets, at December 31, 2015, as compared to $67.3 million, or 1.65% of total assets, at December 31, 2014. Nonperforming assets that were not acquired by the Company totaled $22.2 million at December 31, 2015, a decrease of 31.6% from $32.5 million at December 31, 2014.
The following table summarizes total nonperforming assets for the past five years:
Table 16
Nonperforming Assets
Total nonaccrual loans were $18.7 million at December 31, 2015, a decrease of $6.0 million, or 24.3%, from total nonaccrual loans of $24.7 million at December 31, 2014. Nonaccrual loans that were originated by the Company decreased by $1.9 million, or 21.9%, from $8.5 million at December 31, 2014 to $6.6 million at December 31, 2015. The decrease was primarily due to a few large dollar relationships being repaid in full during fiscal year 2015. The amount of interest that would have been recorded on nonaccrual loans had the loans not been classified as nonaccrual was $1.4 million, $2.0 million and $5.3 million for the years ended December 31, 2015, 2014 and 2013, respectively.
Total OREO was $32.6 million at December 31, 2015, a decrease of $9.9 million, or 23.4%, from total OREO of $42.5 million at December 31, 2014. OREO properties that were originated by the Company decreased by $8.4 million, or 35.0%, from $24.0 million at December 31, 2014 to $15.6 million at December 31, 2015. The carrying values of OREO represent the lower of the carrying amount or fair value less costs to sell. During 2015, the Company had $18.9 million of additions to OREO, with $8.1 million coming from the Valley acquisition and recorded net valuation adjustments of $2.9 million, a decrease from net valuation adjustments of $3.8 million for the year ended December 31, 2014.
Troubled debt restructurings ("TDRs") are modified loans in which a concession is provided to a borrower experiencing financial difficulties. Nonaccrual TDRs are included in nonaccrual loans, whereas accruing TDRs are excluded from nonaccrual loans as it is probable that all contractual principal and interest due under the restructured terms will be collected. We accrue interest on TDRs at the restructured interest rate when management anticipates that no loss of original principal will occur.
Our consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis. We account for loans on a nonaccrual basis when we have serious doubts about the ability to collect principal or interest in full. Loans are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than ninety (90) days, unless such loans are well-secured and in the process of collection. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected.
Analysis of Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Management increases allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off. The allowance is reduced by loans charged off. Management evaluates the adequacy of the allowance at least monthly. In addition, on a monthly basis our Board of Directors reviews the loan portfolio, conducts an evaluation of credit quality and reviews the computation of the loan loss allowance. In evaluating the adequacy of the allowance, management considers the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors deriving from our history of operations. In addition to our history, management also considers the loss experience and allowance levels of other similar banks and the historical experience encountered by our management and senior lending officers prior to joining us. In addition, regulatory agencies, as an integral part of their examination process, periodically review allowance for loan losses and may require us to make additions for estimated losses based upon judgments different from those of management. No regulatory agency asked for a change in our allowance for loan losses during 2015 or 2014.
Management uses the risk-grading program, as described under "Asset Quality," to facilitate evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers, reviewed by Credit Administration, and a sample of these loans are tested by the Company's Credit Risk Review department. The testing program includes an evaluation of a sample of both new and existing loans, including large loans, loans that are identified as having potential credit weaknesses, and loans past due 90 days or more and still accruing. We strive to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of our market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies. Generally, we do not engage in significant lease financing, highly leveraged transactions or loans to customers domiciled outside the United States.
Management follows a loan review program designed to evaluate the credit risk in our loan portfolio. Through this loan review process, we maintain an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower's ability to repay, the borrower's payment history and the current delinquent status. As a result of this process, certain loans are categorized as substandard, doubtful or loss and the allowance is allocated based on management's judgment and historical experience.
Acquired loans are recorded at fair value as of the loan's acquisition date and allowances are recorded for post-acquisition credit quality deterioration. Subsequent to the acquisition date, recurring analyses are performed on the credit quality of acquired loans to determine if expected cash flows have changed. Based upon the results of the individual loan reviews, revised impairment amounts are calculated which could result in additional allowance for loan losses.
A loan is considered to be impaired under GAAP when, based upon current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan. The Company calculates a specific reserve for each loan that has been deemed impaired, which include commercial nonaccrual loans and TDRs. The amount of the reserve is based on the present value of expected cash flows discounted at the loan’s effective interest rate, and/or the value of collateral. If foreclosure is probable or the loan is collateral dependent, impairment is measured using the fair value of the loan’s collateral, less estimated costs to sell.
During the fourth quarter of 2014, we enhanced the methodology used to calculate the allowance for loan losses by incorporating a detailed loss migration analysis using historical loss experience of 60 months, and changing the assumptions used in calculating loss reserve rates from two-year historical charge-offs to using probability of default and loss-given default. These enhancements did not have a material impact on the level of allowance for loan losses. See further details of the Company's accounting policy for the calculation of the allowance for loan losses in Note 1, “Summary of Significant Accounting Policies” to the accompanying Consolidated Financial Statements in Item 8 of Part II of this Form 10-K.
The allowance for loan losses was $31.6 million at December 31, 2015, an increase of $1.2 million from $30.4 million at December 31, 2014. The ratio of the allowance for loan losses to total portfolio loans was 0.75% and 0.99% at December 31, 2015 and 2014, respectively. The decrease in this ratio was due to the significant amount of loans acquired through the acquisitions of Valley and the Certus branches during 2015, as well as the significant level of organic loan growth during 2015. Excluding loans acquired by the Company, the ratio of the allowance for loans to portfolio loans was 1.05% and 1.25% at December 31, 2015 and 2014, respectively.
The Company experienced $0.4 million in net recoveries of previously charged-off loans during 2015, compared to net charge-offs of $7.9 million, or 0.30% of average loans, for 2014. Gross charge-offs were $5.4 million during 2015, as compared to $14.6 million during 2014.
The following table details the allocation of the allowance for loan losses for the past five years:
Table 17
Allocation of the Allowance for Loan Losses
(1)
Allowance for loan losses category as a percentage of total loans by category.
The following table presents information related to the allowance for loan losses for the periods presented:
Table 18
Analysis of Allowance for Loan Losses
The allowance for loan losses represents management's estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. We make specific allowances that are allocated to certain individual loans and pools of loans based on risk characteristics, as discussed below. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.
Capital Resources
Total shareholders’ equity was $592.1 million at December 31, 2015, an increase of 51.7% from shareholders’ equity of $390.4 million at December 31, 2014. In addition to net income for fiscal year 2015, shareholders' equity increased due to the issuance of 2.59 million shares of voting common stock in our public offering, as well as the issuance of 5.5 million shares of voting common stock as consideration for the purchase of Valley.
We are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and the regulatory framework for prompt corrective action prescribe specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. We use our capital primarily for our lending activities as well as acquisitions and expansions of our business and other operating requirements.
In July 2013, the Federal Reserve Board and the FDIC approved and published the final Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. See "Business - Supervision and Regulation - Capital Adequacy" for additional information.
The Bank and the Company's capital levels remained characterized as "well-capitalized" under the Basel III Capital Rules. The capital adequacy ratios for the Company and BNC are set forth below:
Table 19
Capital Adequacy Ratios
(1) Calculated under framework based on Basel III.
(2) Calculated under framework based on Basel I.
Liquidity
The objective of liquidity management is to ensure that the Company has the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to satisfy the cash flow requirements of depositors and borrowers and to meet its other commitments as they fall due, including the ability to pay dividends to shareholders, service debt, invest in subsidiaries or acquisitions, and satisfy other operating requirements. In addition to satisfying cash flow requirements in the ordinary course of business, the Company actively monitors and manages its liquidity position to ensure sufficient resources are available to meet cash flow requirements in adverse situations.
The Company also has multiple funding sources that could be used to increase liquidity and provide additional financial flexibility. In August 2014, the Company filed a $150 million shelf registration statement with the SEC under which the Company may, from time to time, offer senior debt securities, subordinated debt securities, convertible debt securities, preferred stock, common stock, warrants or units. The Company has issued $60 million of subordinated notes and $60.8 million of voting common stock under the shelf registration statement, with $29.2 million remaining available for future issuances.
While dividends from BNC and proceeds from issuance of capital are primary funding sources for the Parent Company, these sources could be limited or costly (such as by regulation or subject to the capital needs of its subsidiaries or by market appetite for bank holding company securities). The Parent Company received dividends of $11.1 million during the year ended December 31, 2015 from subsidiaries.
BNC has $120.0 million of established federal funds and other unsecured lines with counterparty banks, with $85.2 million available at December 31, 2015. BNC also has the ability to borrow from the FHLB and the Federal Reserve Bank, with $819.2 million and $261.6 million, respectively, in available credit at December 31, 2015. BNC also has excess loan and investment securities collateral which could be pledged to secure additional deposits or to counterparty banks, the FHLB or other parties as necessary.
Investment securities are an important tool to the Company’s liquidity objective. Of the $734.6 million in the Company's investment securities portfolio at December 31, 2015, $490.1 million are designated as available-for-sale. Some of these securities are pledged to secure collateralized deposits, borrowings and for other purposes as required or permitted by law. The remaining investment securities could be pledged or sold to enhance liquidity, if necessary.
For the year ended December 31, 2015, net cash provided by operating activities and financing activities was $56.3 million and $463.1 million, respectively, while net cash used in investing activities was $400.4 million, for a net increase in cash and cash equivalents of $119.0 million since December 31, 2014. The primary cash outflows during the year ended December 31, 2015 related to the funding the Company's continued organic loan growth, the purchase of investment securities, and the repayment of short-term borrowings. The primary cash inflows related to cash received from core operations, increases in deposits, and cash received from the common stock issuance described above.
For the year ended December 31, 2014, net cash provided by operating activities was $40.5 million, while net cash used in investing and financing activities was $47.1 million and $16.6 million, respectively, for a net decrease in cash and cash equivalents of $23.2 million since December 31, 2013. The primary cash outflows during the year ended December 31, 2014 related to the increase in loans and repayment of borrowings, while the primary cash inflows related to cash received from core operations, cash received from acquisitions, and cash received from payments and sales of investment securities.
Asset/Liability Management
Interest rate risk is defined as the exposure of net interest income and fair value of financial instruments to movements in interest rates. The Company’s results of operations are largely dependent on its net interest income and its ability to manage interest rate risk. Net interest income is susceptible to interest rate risk when interest-bearing liabilities mature or reprice on a different basis than interest-earning assets. The Company monitors its position of rate-sensitive assets and liabilities on a regular basis in order to stabilize net interest income and preserve capital in several different scenarios of interest rate movements. The goal is to control exposure to changing rates within the guidelines set by management and the Board of Directors, while maintaining an acceptable balance between the level of risk and current earnings. The Company maintains and complies with an asset/liability management policy that provides these guidelines for controlling exposure to interest rate risk.
We use simulation analysis to calculate the income effect and economic value of assets, liabilities, and equity at current and forecasted rate environments, as well as immediate and parallel shifts in interest rates at one percent intervals. Also included in the modeling are non-parallel and gradual rate shifts, which are traditionally more realistic and provide a more robust assessment of embedded risk. The model uses estimated cash flows based on embedded options, prepayments, early withdrawals, and weighted average contractual rates and maturities to forecast the impact of rate changes on the balance sheet. To calculate economic value, the model uses discount rates that are equal to the current market rate of similar financial instruments. The economic values of longer-term fixed-rate instruments are generally more sensitive to changes in interest rates, whereas the values of adjustable- or variable-rate instruments are valued based on next contractual interest rate repricing and are generally less sensitive to interest rate movements, subject to rate caps and floors.
The model results are driven by key assumptions, which are based on historical data as well as anticipated future needs of the Company. These assumptions include prepayments on loans and investment securities, deposit decay rates, loan and deposit volumes and pricing, and replacement/reinvestment of all asset and liability cash flows. Management also performs pro forma modeling to assess the interest rate risk impact of mergers and acquisitions, incorporating market-specific assumptions that may affect assets and liabilities in different regions of the Company’s existing and pro forma footprint. Model assumptions are inherently uncertain and, as a result, actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes and changes in market conditions, pending acquisitions, and management strategies, among other factors. However, the model is continually monitored through back-testing, which compares the results of the net interest income forecasts with actual financial results of previous periods, in order to ensure modeling assumptions remain relevant.
We utilize internal modeling capabilities to perform our interest rate risk analysis, which allows management and the Board to use the model for both regulatory and strategic purposes. A third party vendor is engaged to perform an independent interest rate risk analysis on at least an annual basis to verify the reasonableness of results.
Our interest rate risk position is measured by estimated changes in net interest income (short-term risk) and economic value of equity (long-term risk) in various interest rate environments. The net interest income simulation assumes instantaneous and parallel rate shocks, which are measured in 100 basis point increments from base case. Other analyses are performed on an ongoing basis that may include gradual or rapid changes in interest rates, yield curve twists, and changes in assumptions about customer behavior in various rate scenarios. The Company also examines changes in economic value of equity, which is a measure of long-term interest rate risk currently embedded in the balance sheet. This analysis takes into account all cash flows over the estimated remaining life of all balance sheet positions and is measured at a point in time. As with the net interest income simulation model, net economic value analysis is based on key assumptions about the timing and variability of balance sheet cash flows.
The following table represents a summary of the Company’s interest rate risk as measured by estimated changes in both net interest income and economic value of equity in parallel rate shocks of 100 basis point increments.
Table 20
Net Interest Income at Risk & Economic Value of Equity
The Company’s interest rate risk management strategy also involves the use of interest rate derivatives. Interest rate swaps are used to hedge the repricing characteristics of certain liabilities as to mitigate adverse effects on net interest margin and cash flows from changes in interest rates. The interest rate swaps are designated as cash flow hedges, with changes in market value classified through accumulated other comprehensive income. These derivative instruments add stability to interest expense, extend the duration of specific liabilities, and help to manage the Company’s exposure to movements in interest rates.
Additionally, the Company executes derivative instruments in the form of interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those derivatives are immediately hedged by offsetting derivative contracts, such that the Company minimizes net interest rate risk exposure resulting from such transactions.
The Company’s policy limits the potential exposure of net interest income and economic value of equity to a certain percentage change from the base case for each 100 basis point shock in interest rates. While the policy limits exist to establish the maximum amount of risk that management and the Board of Directors will tolerate, management also adheres to a set of internal “target” limits that are significantly lower than those in the policy. These internal limits act as a buffer to help management maintain a comfortable level of risk, while ensuring that changes in simulation results do not approach official policy limits. As of December 31, 2015, both net interest income and economic value of equity simulation results were within both target and policy limits.
Market Risk
Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of BNC’s asset/liability management function. See “Asset/Liability Management” section of this Item 7.
Credit Risk
An active credit risk management process is used for commercial loans to ensure that sound and consistent credit decisions are made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed and graded on an ongoing basis for early identification of potential problems. Further analyses by customer, industry, and geographic location are performed to monitor trends, financial performance, and concentrations.
Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, and appropriate allowance for loan losses, nonaccrual and charge-off policies. Each class of financing receivable detailed below is subject to risks that could have an adverse impact on the credit quality of the loan portfolio.
Commercial real estate loans
Commercial real estate loans consist primarily of loans secured by nonresidential (owner-occupied and/or non-owner occupied) real estate, which includes multifamily housing, retail strip centers and hotels. Commercial real estate is primarily dependent on successful operation or management of the property in order to generate sufficient cash to repay the outstanding debt. While these loans are normally
secured by commercial use buildings, it is possible that the liquidation of the collateral will not fully satisfy the obligation. High unemployment, generally weak economic conditions or oversupply of properties may result in customers having to provide rental rate concessions to achieve adequate occupancy rates. The value of the commercial property securing these loans can vary over the life of the loan.
Commercial construction loans
Commercial construction loans, which consist primarily of loans for the development of land, retail strip centers, hotels and multi-family properties, are highly dependent on the supply and demand for commercial real estate in the markets served by BNC. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for customers.
Commercial and industrial loans and leases
Each commercial loan or lease is underwritten based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. A complete understanding of the borrower’s business, including the strength of the borrower's balance sheet and experience and background of the principals is obtained prior to approval. Collateral securing these loans is primarily business assets such as inventory or accounts receivable. To the extent that the principals or other parties provide personal guarantees, the relative financial strength and liquidity of each guarantor is assessed. Common risks include general economic conditions within the markets BNC serves, as well as risks that are specific to each transaction, including demand for products and services and reductions in the fair value of collateral.
Residential construction loans
Residential construction loans are made to established homebuilders for pre-sold homeowners and speculative home building purposes and are typically secured by 1-4 family residential property. The credit risk associated with residential construction loans is generally confined to specific geographic areas but is also influenced by general economic conditions. The Company controls the credit risk on these types of loans by making loans in familiar markets to developers, reviewing the merits of individual projects, controlling loan structure, and monitoring project progress and construction advances.
Residential mortgage loans
Each residential mortgage loan is underwritten using credit scoring and analysis tools. These tools take into account factors such as payment history, credit utilization, length of credit history, types of credit currently in use, and recent credit inquiries. In addition to the credit score, the borrowers' debt-to-income ratio, sources of income and employment history and the loan-to-value ratio, among other factors, are also evaluated as part of the underwriting process. To the extent that the loan is secured by collateral, the likely value of that collateral is evaluated. Common risks to each class of non-commercial loans include risks that are not specific to individual transactions such as general economic conditions within the markets BNC serves, particularly unemployment and potential declines in real estate values. Personal events such as disability or change in marital status also add risk to residential mortgage loans. Second mortgage loans and home equity lines of credit generally involve greater credit risk than first mortgage loans because they are secured by mortgages that are subordinate to the first mortgage on the property. If the borrower is forced into foreclosure, the Bank will not receive any proceeds from the sale of the property until the first mortgage has been satisfied. After origination, residential mortgage loans are sold on a servicing-released basis into the secondary mortgage market.
Consumer and other loans
Consumer and other loans include loans secured by personal property such as residential real estate, automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment. Consumer loan repayments are sensitive to job loss, illness and other personal factors.
Off-Balance Sheet Risk - Contractual Obligations and Commitments
In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on our consolidated balance sheets. We apply the same credit standards to these commitments as we use in all our lending activities and have included these commitments in our lending risk evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. We do not expect that all such commitments will fund. See Note 16, "Commitments and Contingencies" to the accompanying Consolidated Financial Statements in Item 8 of Part II of this Form 10-K.
In addition, we have entered into certain contractual obligations and other commitments, including leasing arrangements, to support our ongoing activities and commitments related to funding of our operations through deposits or borrowings. See Note 8, "Premises and Equipment," Note 10, "Deposits," and Note 11, "Borrowings," respectively, in Item 8 of Part II of this Form 10-K for further details.
The required payments under such commitments at December 31, 2015 are shown in the following table:
Table 21
Contractual Obligations and Other Commitments
The Company’s derivative interest rate-related instruments, under which the Company is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheet. Because neither the derivative assets and liabilities, nor their notional amounts, represent the amounts that may ultimately be paid under these contracts, they are not included in Table 21. For further information and discussion of derivative contracts, see section “Asset/Liability Management,” and Note 1, “Summary of Significant Accounting Policies” and Note 9, “Derivatives” to the accompanying Consolidated Financial Statements in Item 8 of Part II of this Form 10-K.
Quarterly Financial Information
The following table sets forth, for the periods indicated, certain of our consolidated quarterly financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with the accompanying Consolidated Financial Statements in Item 8 of Part II of this Form 10-K. The results for any quarter are not necessarily indicative of results for any future period.
Table 22
Quarterly Financial Information
Fourth Quarter Results
Net income for the quarter ended December 31, 2015 was $12.7 million, or $0.32 per diluted share, an increase of 49.8% from net income of $8.5 million, or $0.28 per diluted share, for the quarter ended December 31, 2014. The increase in net income from 2014 is primarily due to the significant increase in interest-earning assets due to the acquisitions of Valley and the Certus branches, respectively, during 2015, as well as the acquisition of Harbor, which closed on December 1, 2014. The Company also has experienced high levels of organic loan growth during 2015. Average interest-earning assets for fourth quarter 2015 were $4.93 billion, as compared to $3.44 billion for fourth quarter 2014.
FTE net interest income for the fourth quarter of 2015 was $50.7 million, an increase of 28.7% from $39.4 million for the fourth quarter of 2014. FTE net interest margin was 4.08% for the fourth quarter of 2015, a decrease of 47 basis points from 4.55% for the fourth quarter of 2014. The decrease is primarily due to a decrease in the yield earned on the Company’s portfolio loans, which was 4.81% for fourth quarter 2015, as compared to 5.28% for fourth quarter 2014. This decrease is primarily due to pricing pressure on new and renewed loans. This decrease in interest rates was partially offset by $5.6 million of accretion earned on the acquired loan portfolio, as compared to $4.9 million earned during the fourth quarter 2014. The average yield earned on the investment securities portfolio was 4.38%, a decrease of 66 basis points from 5.04% earned during fourth quarter 2014. This decrease was primarily due to the purchase of new investment securities that have a lower yield than the current portfolio.
Average interest-bearing liabilities were $4.07 billion for fourth quarter 2015, an increase of 39.7% from $2.91 billion for fourth quarter 2014. The increase was due to an additional $1.12 billion of average interest-bearing deposits, primarily from acquisitions. The Company also increased average borrowings by $42.0 million, which is comprised of additional advances from the FHLB, as well as subordinated notes and junior subordinated debentures acquired from Valley. The Company’s average cost of interest-bearing liabilities was 0.73% for fourth quarter 2015, as compared to 0.74% for fourth quarter 2014.
Total non-interest income was $8.3 million for the fourth quarter of 2015, a increase of 6.4% from $7.8 million for the fourth quarter 2014. Service charges income was $2.3 million for fourth quarter 2015, an increase of 42.1%, from $1.6 million for fourth quarter 2014. The increase was directly due to the increase in deposits and transactions from the Company's recent acquisitions and organic growth. Many of the other non-interest income sources, such as income from recoveries on acquired loans, income derived from the sale of loans partially guaranteed by the Small Business Administration and income derived from our investment brokerage services, are volatile and can vary significantly from period to period.
Non-interest expense was $37.6 million for fourth quarter 2015, an increase of 16.1% from $32.4 million for fourth quarter 2014. Included in non-interest expense for the fourth quarter 2015 and 2014 was $4.3 million and $1.2 million, respectively, of transaction-related expenses related to the Company's recent acquisitions. The increase was primarily due to additional headcount and facilities charges from our recent acquisitions.
During the fourth quarter of 2015, the Company recorded a provision for loan losses of $1.3 million, an increase of 28.6% from $1.0 million recorded during the fourth quarter of 2014. The additional provision was recorded due to the high levels of loan growth in the originated loan portfolio.
The Company experienced $0.4 million in net charge-offs, or 0.30% of average loans, during fourth quarter 2015, compared to net charge-offs of $0.9 million, or 0.13% of average loans, for fourth quarter 2014. Gross charge-offs were $1.5 million during fourth quarter 2015, as compared to $2.2 million during fourth quarter 2014.
Income tax expense was $5.4 million for fourth quarter 2015, an increase of 60.6% from $3.4 million for fourth quarter 2014. We generate significant amounts of non-taxable income from tax-exempt investment securities and from investments in bank-owned life insurance. Accordingly, the level of such income in relation to income before income taxes significantly affects our effective tax rate. Due to an increase in our level of taxable income relative to non-taxable income, our effective tax rate for fourth quarter 2015 was 29.9%, as compared to an effective tax rate of 28.4% for fourth quarter 2014.
2014 Compared to 2013
Net income for the fiscal year ended December 31, 2014 was $29.4 million, or $1.01 per diluted share, an increase of 81.6% from net income available to common shareholders of $16.2 million, or $0.61 per diluted share, for the fiscal year ended December 31, 2013. The increase was primarily due to the significant increase in interest-earning assets due to the acquisitions of South Street Financial Corporation and Community First Financial Group, Inc., respectively, during the second quarter of 2014, as well as the acquisition of Harbor Bank Group, which closed on December 1, 2014 (collectively the "acquisitions").
Net Interest Income
FTE net interest income for 2014 was $146.0 million, an increase of 26.1% from $115.8 million for 2013. FTE net interest margin was 4.56% for 2014, an increase of 27 basis points from 4.29% for 2013. This increase was primarily driven by a 49 basis point decrease in our cost of funds due to a $9.2 million reduction in interest expense associated with our interest rate hedging instrument, which matured in February 2014.
Average interest-earning assets were $3.20 billion for 2014, an increase of 18.8% from $2.70 billion for 2013. These increases were due to interest-earning assets acquired from the acquisitions, as well as continued organic loan growth across the Company's markets.
The Company’s average yield on interest-earning assets was 5.18% for 2014, a decrease of 23 basis points from 5.41% for 2013. The decrease was due to lower interest rates being earned on portfolio loans. At the end of 2013, the Company began a robust home equity line of credit campaign, which provided customers a low introductory rate for the first 18 months of the agreement, which has contributed to a significant increase in interest-earning assets, as well as a decrease in the average yield on the loan portfolio. The decrease in yield for the remainder of the loan portfolio is due to competitive pricing pressures in a low interest rate environment. These decreases were slightly offset by a 21 basis point increase in rates earned on the Company's investment portfolio.
Average interest-bearing liabilities were $2.78 billion for 2014, an increase of 14.6% from $2.43 billion for 2013. The increase was due to an additional $343.6 million of average interest-bearing deposits, primarily from the acquisitions. The Company also increased average
borrowings by $10.2 million during 2014, which is comprised of additional borrowings from the FHLB and additional net borrowings from the issuance of subordinated notes and repayment of unsecured term debt during 2014.
The Company’s average cost of interest-bearing liabilities was 0.72% for 2014, a decrease of 52 basis points from 1.24% for 2013. The decrease was primarily due to the expiration of the interest rate cap. The Company incurred hedging instrument expense of $0.7 million for 2014, a significant decrease from the $9.9 million expense incurred in 2013. The Company also continues to allow higher rate time deposits to expire and be replaced with lower cost funding.
Provision for Loan Losses
The Company recorded a provision for loan losses of $7.0 million for 2014, a decrease of 42.5% from $12.2 million recorded during 2013. The provision for loan losses consists of $7.5 million for loans not covered under loss-share agreements and a negative provision of $0.5 million for loans covered under loss-share agreements.
Non-Interest Income
Non-interest income was $25.0 million for 2014, an increase of 9.7% from $22.8 million for 2013. Adjusted non-interest income, which excludes acquisition-related gains, one-time income arising from insurance settlements and gain (loss) on sale of investment securities, was $24.8 million for 2014, an increase of 14.4% from $21.7 million for 2013. The increase from 2013 was primarily due to an increase in investment brokerage income, income derived from the sale of loans partially guaranteed by the SBA and income from CRA equity investments. Many of the non-interest income sources, such as income from recoveries on acquired loans, income derived from the sale of loans partially guaranteed by the SBA, income derived from our investment brokerage services, income derived from our CRA equity investments and income received from the FDIC related to our acquired loan portfolio, are volatile and can vary significantly from period to period.
Non-Interest Expense
Non-interest expense was $116.5 million for 2014, an increase of 18.9% from $97.9 million for 2013. Excluding non-operating expenses, adjusted non-interest expense for 2014 was $106.9 million, an increase of 16.0% from $92.2 million for 2013. The increase from 2013 is primarily due to additional facilities charges and headcount from our recent acquisitions, as well as overall Company growth.
Income Taxes
Our income tax expense was $10.4 million and $4.0 million for 2014 and 2013, respectively. The increase in income tax is a direct result of our increase in taxable income due to our acquisitions, as well as overall Company growth.
We generate significant amounts of non-taxable income from tax-exempt investment securities and from investments in bank-owned life insurance. Accordingly, the level of such income in relation to income before income taxes significantly affects our effective tax rate. Due to an increase in our level of taxable income relative to non-taxable income, our effective tax rate for 2014 increased to 26.1%, as opposed to an effective tax rate of 19.0% for 2013.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A discussion regarding our management of market risk is included in “Asset/Liability Management" in this report in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Shareholders of BNC Bancorp
We have audited the accompanying consolidated balance sheets of BNC Bancorp and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2015. We also have audited the Company’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). The Company’s management is responsible for these consolidated financial statements, 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 these consolidated financial statements and an opinion on the Company’s internal control over financial reporting 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 consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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 consolidated 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 consolidated 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 consolidated 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BNC Bancorp and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, BNC Bancorp and subsidiaries 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).
/s/ Cherry Bekaert LLP
Raleigh, North Carolina
February 29, 2016
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
See accompanying notes to Consolidated Financial Statements.
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
See accompanying notes to Consolidated Financial Statements.
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
See accompanying notes to Consolidated Financial Statements.
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollars in thousands, except per share data)
See accompanying notes to Consolidated Financial Statements.
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (continued)
(Dollars in thousands, except per share data)
BNC BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See accompanying notes to Consolidated Financial Statements.
BNC BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Year ended December 31, 2015, 2014 and 2013
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
BNC Bancorp (individually referred to herein as the “Parent Company” and together with all of its wholly-owned subsidiaries, collectively referred to as the "Company") is a bank holding company headquartered in High Point, North Carolina that provides a wide range of banking services tailored to the particular banking needs of the communities we serve. We are principally engaged in the business of attracting deposits from the general public and using those deposits, together with other funding from our lines of credit, to make primarily consumer and commercial loans. The Company's banking offices are located in North Carolina, South Carolina and Virginia. The Company is regulated by federal and state agencies and is subject to periodic examinations by those agencies.
Basis of Presentation
The accompanying consolidated financial statements include the accounts and transactions of the Company and all significant intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with 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. On an ongoing basis, the Company evaluates its estimates, including those relating to the allowance for loan losses, determination of fair value of acquired assets and assumed liabilities, and valuation of goodwill and intangible assets.
Reclassifications
Certain amounts in the 2014 consolidated financial statements have been reclassified to conform to the 2015 presentation. The reclassifications had no effect on net income, net income available to common shareholders or shareholders' equity as previously reported.
Business Combinations
The Company accounts for its business combinations using the acquisition method of accounting. This method requires the use of fair values in determining the carrying values of the purchased assets and assumed liabilities, which are recorded at fair value at acquisition date, and identifiable intangible assets are recorded at fair value. Costs directly related to the business combinations are recorded as expenses as they are incurred. Fair values are subject to refinement for up to one year after the closing date of an acquisition as information relative to closing date fair values become available.
Cash and Cash Equivalents
For the purpose of presentation in the statements of cash flows, cash and cash equivalents include cash and due from banks and interest-earning deposits in other banks.
Federal regulations require financial institutions to set aside a specified amount as a reserve against transaction accounts and time deposits. At December 31, 2015 and 2014, the Company’s reserve requirement was $9.9 million and $12.1 million, respectively.
Investment Securities
Investment securities are classified as held-to-maturity or available-for-sale at the time of purchase. Investment securities classified as held-to-maturity, which management has the positive intent and ability to hold to maturity, are reported at amortized cost. Investment securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in shareholders’ equity as a separate component of other comprehensive income. Any decision to sell investment securities available for sale would be based on various factors, including, but not limited to, asset / liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations.
Premiums are amortized and discounts accreted using the interest method over the remaining terms of the related securities. Dividend and interest income are recognized when earned. Sales of investment securities are recorded at trade date, with realized gains and losses on sales determined using the specific identification method and included in non-interest income.
Transfers of investment securities into the held-to-maturity category from the available-for-sale category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer is retained in accumulated other comprehensive income and in the carrying value of the held-to-maturity securities. Such amounts are amortized over the remaining life of the security.
The Company evaluates securities for other-than-temporary impairment ("OTTI") on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, the Company considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Federal Home Loan Bank Stock
As a member of the FHLB of Atlanta, the Company is required to maintain an investment in the stock of the FHLB based upon the amount of outstanding FHLB borrowings. This stock does not have a readily determinable fair value and is carried at cost.
Loans and Leases
Originated Loans and Leases
Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal balances, adjusted for any charge-offs, unearned discounts, and unamortized fees and costs. Interest income on loans is accrued and credited to income based upon the principal amount outstanding. The net amount of nonrefundable loan origination fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using methods that approximate the interest method.
The Company classifies all loans and leases past due when the payment of principal and/or interest based upon contractual terms is greater than 30 days delinquent. When commercial loans are placed on nonaccrual status as described below, a charge-off is recorded, as applicable, to decrease the carrying value of such loans to the estimated fair value of the collateral securing the loan. Consumer loans are placed on nonaccrual status at a specified delinquency date consistent with regulatory guidelines. As such, consumer loans are subject to collateral valuation and charge-off, as applicable, when they are moved to nonaccrual status. The accrual of interest income for commercial loans is discontinued when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, while the accrual of interest income for consumer loans is discontinued when loans reach specific delinquency levels.
Acquired Loans
Acquired loans are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan losses is not recorded at the acquisition date.
Acquired loans are evaluated upon acquisition and classified as either purchased impaired or purchased non-impaired. Purchased impaired loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. For purchased impaired loans, expected cash flows at the acquisition date in excess of the fair value of loans are recorded as interest income over the life of the loans using a level yield method if the timing and amount of the future cash flows is reasonably estimable. Subsequent to the acquisition date, increases in cash flows over those expected at the acquisition date are recognized prospectively as interest income. Decreases in expected cash flows after the acquisition date are recognized immediately through the provision for loan losses. For purchased non-impaired loans, the difference between the fair value and unpaid principal balance of the loan at the acquisition date is amortized or accreted to interest income over the economic life of the loans using a method that approximates the interest method.
Loans Held for Sale
The Company originates certain single family, residential first mortgage loans for sale on a presold basis and these loans are classified as loans held for sale. Loans held for sale are carried at the lower of cost or estimated fair value in the aggregate as determined by outstanding commitments from investors. Upon closing, these loans, together with their servicing rights, are sold to other financial institutions under prearranged terms on a best-efforts basis. Gains or losses on loan sales are recognized at the time of sale and are determined by the difference between net sales proceeds and the principal balance of the loans sold, adjusted for net deferred loan fees or costs. Loan origination and commitment fees, net of certain direct loan origination costs, are deferred as an adjustment to the carrying value of the loan until it is sold. The commitments to sell loans and the commitments to originate loans held for sale at a set interest rate, if originated, are considered derivatives under GAAP. The impact of the estimated fair value adjustment was not significant to the consolidated financial statements.
Nonperforming Loans
The Company considers a loan impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. All impaired loans are measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent.
The Company uses several factors in determining if a loan is impaired. Internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status and the borrowers' financial data, cash flows, operating income or loss, and other factors. These discounted cash flow analyses incorporate adjustments to future cash flows that reflect management’s best estimate based on a combination of historical experience and management judgment.
Loans are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than ninety (90) days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than ninety (90) days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt.
Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time and there is a sustained period of repayment performance (generally, a minimum of six months) by the borrower in accordance with the contractual terms of interest and principal.
While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When future collection of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
Restructurings
Modifications to a borrower’s debt agreement is considered a TDR if a concession is granted for economic or legal reasons related to a borrower’s financial difficulties that otherwise would not be considered. TDRs are undertaken in order to improve the likelihood of recovery on the loan and may take the form of modifications made with the stated interest rate lower than the current market rate for new debt with similar risk, modifications to the terms and conditions of the loan that fall outside of normal underwriting policies and procedures, or a combination of these modifications. Modifications of covered and other acquired loans that are part of a pool accounted for as a single asset are not considered TDRs. TDRs can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accruing status, depending on the individual facts and circumstances of the borrower.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on quarterly evaluations of the collectability and historical loss experience of loans. Actual credit losses, net of recoveries, are deducted from the allowance for loan losses. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio.
All commercial loans that are originated by the Company are assigned risk grades based on an assessment of conditions that affect the borrower’s ability to meet contractual obligations under the loan agreement. This process includes reviewing borrowers’ financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. Loans with outstanding balance of $1 million or more, as well as all other loans included in such relationships, are reviewed on an annual basis. Loans with total committed exposure of $500,000 or more that are risk graded as Special Mention or worse are reviewed on a quarterly basis. All other loans are reviewed at any point management becomes aware of information affecting the borrower’s ability to fulfill their obligations.
Accounting standards require the presentation of certain disclosure information at the portfolio segment level, which represents the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. The Company concluded that its loan and lease portfolio comprises two portfolio segments: originated loans (which include purchased non-credit impaired loans) and purchased credit impaired loans. Originated loans include both commercial loans, which include commercial real estate, commercial construction, commercial and industrial and leases, and retail loans, which include residential construction, residential mortgage and
consumer and other loans. The following provides a description of the Company’s accounting policies and methodologies related to each of its portfolio segments:
Originated Loans
The allowance for loan and lease losses consists of two components. This first component is the specific reserve, which is calculated on all individual loans in the following categories: nonperforming TDRs, commercial nonaccrual loans with net credit exposure of $250,000 or greater, and performing commercial and retail TDRs with net credit exposure of $250,000 or greater. If foreclosure is probable or the loan is collateral dependent, impairment is measured using the fair value of the loan’s collateral, less estimated costs to sell. If the loan is not considered collateral dependent, the amount of reserve is calculated based on the present value of expected cash flows discounted at the loan’s effective interest rate. Performing TDRs and nonaccrual loans with net credit exposure less than $250,000, respectively, are pooled and evaluated for impairment in the aggregate.
The second component of the allowance for loan and lease losses is the general reserve. For the commercial loan portfolio, the estimate of losses are based on pools of loans and leases with similar characteristics by applying a probability of default ("PD") factor and a loss-given default ("LGD") factor to each individual loan based on a regularly updated loan grade, using a standardized loan grading system. The PD factor and the LGD factor are determined for each loan grade using statistical models based on historical performance data. These reserve factors are developed based on credit migration models that track historical movements of loans between loan ratings over time and a combination of long-term average loss experience of our own portfolio and external industry data using a loss emergence period ranging from 18 to 20 months.
In the case of more homogeneous portfolios, such as automobile loans, home equity loans, and residential mortgage loans, the determination of the transaction reserve also incorporates PD and LGD factors. The estimate of loss is based on pools of loans and leases with similar characteristics. The PD factor considers current number of days past due, which are then translated to a proxy risk grade, and this information is used to estimate expected losses over a 12-month loss emergence period.
The general reserve also includes a qualitative assessment of certain factors and the impact of changing market and economic conditions on portfolio performance. The qualitative assessment considers items unique to the Company's structure, policies, processes, and portfolio composition, as well as measurements and assessments of the loan portfolios including, but not limited to, management quality, concentrations, portfolio composition, industry comparisons, and internal review functions.
For acquired loans that are not deemed credit impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans, however, the Company records a provision for loan losses only when the required allowance, net of any expected reimbursement under any loss-share agreements, exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the economic life of the loans.
Purchased Credit Impaired Loans
The allowance for loan and lease losses related to purchased credit impaired loans is based on an analysis that is performed each period to estimate the expected cash flows for each of the loan pools. To the extent that the expected cash flows of a loan pool have decreased since the acquisition date, the Company establishes an allowance for loan losses.
OREO
OREO acquired through, or in lieu of, loan foreclosure is held for sale and is initially recorded at estimated fair value less cost of disposal at the date of foreclosure, establishing a new cost basis. When property is acquired, the excess, if any, of the loan balance over estimated fair value is charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in loan, foreclosure and OREO expenses as a component of non-interest expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Land is carried at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the respective assets, which are 40 years for buildings and 3 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are recorded as a component of non-interest expense as incurred.
Bank-Owned Life Insurance
The Company has purchased life insurance policies on certain current and past key employees and directors where the insurance policy benefits and ownership are retained by the employer. These policies are recorded at their cash surrender value. Income from these policies and changes in the net cash surrender value are recorded in non-interest income as earnings on bank-owned life insurance. The cash value accumulation is permanently tax deferred if the policy is held to the insured person’s death and certain other conditions are met.
Goodwill and Other Intangible Assets
The excess of the cost of an acquisition over the fair value of the net assets acquired consists primarily of goodwill, core deposit intangibles, and other identifiable intangibles (primarily related to customer relationships acquired). Other intangible assets, which consists of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions, are amortized on an accelerated method over their estimated useful lives, which range from 7 to 10 years. The Company reviews long-lived assets and other intangible assets for impairment at least annually, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in which case an impairment charge would be recorded.
Goodwill is not amortized and is tested for impairment at least annually, or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. The impairment testing process is conducted by assigning net assets and goodwill to each reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of each reporting unit is calculated and compared to the recorded book value. If the calculated fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired and no further testing is considered necessary. If the carrying value of a reporting unit exceeds its calculated fair value, the impairment test continues by comparing the carrying value of the reporting unit’s goodwill to the implied fair value of goodwill. The implied fair value is computed by adjusting all assets and liabilities of the reporting unit to current fair value with the offset adjustment to goodwill. The adjusted goodwill balance is the implied fair value of the goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill.
Derivatives
The Company applies hedge accounting to certain interest rate derivatives entered into for risk management purposes. To qualify for hedge accounting, a derivative must be highly effective at reducing the risk associated with the exposure being hedged. In addition, key aspects of achieving hedge accounting are documentation of hedging strategy and hedge effectiveness at the hedge inception and substantiating hedge effectiveness on an ongoing basis. A derivative must be highly effective in accomplishing the hedge objective of offsetting changes in the cash flows of the hedged item for the risk being hedged. Any ineffectiveness in the hedge relationship is recognized in earnings. The effective portion of changes in the fair value of derivatives designated in a hedge relationship and that qualify as cash flow hedges is recorded in accumulated other comprehensive income, net of tax, and is subsequently reclassified into earnings in the period that the hedged transaction affects earnings.
The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.
When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non-interest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.
Earnings Per Share
Basic earnings per common share is computed using the weighted average number of common shares and participating securities outstanding during the reporting period. Diluted earnings per common share is the amount of earnings available to each share of common stock during the reporting period adjusted to include the effect of potentially dilutive common shares. Potentially dilutive common shares are excluded from the computation of dilutive earnings per share in the periods in which the effect would be anti-dilutive.
Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary differences between financial statement carrying amounts and the tax bases of existing assets and liabilities that will result in taxable or deductible amounts in future years. These temporary differences are multiplied by the enacted income tax rate expected to be in effect when the taxes become payable or receivable. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based on available evidence.
Operating Segments
The Company’s operations are managed along two operating segments, consisting of banking operations and mortgage origination. While the chief operating decision maker uses financial information related to these segments to analyze business performance and allocate resources, the mortgage origination segment does not meet the quantitative threshold under GAAP to be considered a reportable segment. As such, these operating segments are aggregated into a single reportable operating segment in the Consolidated Financial Statements. No revenues are derived from foreign countries or from external customers that comprise more than 10% of the Company’s revenues.
Stock Compensation Plans
The Company follows the provisions of the authoritative guidance regarding share-based compensation. This guidance values share-based awards at the grant date fair value and recognizes the expense over the requisite service period.
Recently Adopted and Issued Accounting Standards
In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), which will require lessees to recorded as an asset on the balance sheet for the right to use the leased asset and a liability for the corresponding lease obligation for leases with terms of more than 12 months. The accounting treatment for lessors will remain relatively unchanged. The ASU also requires additional qualitative and quantitative disclosures related to the nature, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which revises the accounting treatment related to classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured as fair value. Upon adoption, investments in equity securities, except those accounted for under the equity method or that result in the consolidation of the investee, will be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost minus impairment, plus or minus changes from observable price changes in an orderly transaction. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption of certain provisions is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (Topic 805), which eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize measurement period adjustments during the period in which it determines the amount of the adjustment. ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs (Subtopic 835-30), which amends the presentation of debt issuance costs in the balance sheet as a direct deduction from the related debt liability. This update affects disclosures related to debt issuance costs but does not affect existing recognition and measurement guidance for these items. ASU 2015-03 is effective for annual and interim periods beginning after December 15, 2015. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In February 2015, the FASB issued ASU 2015-02 Amendments to the Consolidation Analysis (Topic 810), which amends the consolidation analysis required under GAAP. The revised guidance amends the consolidation analysis based on certain fee arrangements or relationships to the reporting entity and, for limited partnerships, requires entities to consider the limited partner’s rights relative to the general partner. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all of its previous consolidation conclusions. ASU 2015-02 is effective for annual and interim periods beginning after December 15, 2015, with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual
period containing the adoption date. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU was developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date by one year (i.e., interim and annual reporting periods beginning after December 15, 2017). Early adoption is permitted, but not before the original effective date (i.e., interim and annual reporting periods beginning after December 15, 2016). The ASU may be adopted using either a modified retrospective method or a full retrospective method. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.
In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (Subtopic 310-40), to clarify that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or 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. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. The amendments may be adopted using either a modified retrospective transition method or a prospective transition method and early adoption is permitted. The adoption of this ASU did not have a material impact on the Company's consolidated financial statements.
NOTE 2 - ACQUISITIONS
Acquisition of Branches from CertusBank, N.A.
On October 16, 2015, the Company completed the acquisition of seven branches from CertusBank, N.A., pursuant to the terms of the Purchase and Assumption Agreement dated June 1, 2015.
A summary of the fair value of assets received and liabilities assumed are as follows:
Explanation of fair value adjustments:
(1)
Adjustment to reflect estimated fair value of loans.
(2)
Adjustment to reflect estimated fair value of premises and equipment.
(3)
Adjustment to reflect recording of core deposit intangible.
(4)
Adjustment to reflect recording of deferred tax asset recognized from acquisition.
(5)
Adjustment to reflect estimated fair value of time deposits based on market rates for similar products.
(6)
Adjustment to reflect the estimated fair market value of certain leases.
This acquisition expands and further strengthens the Company's presence in upstate South Carolina, provides a low-cost base of core deposits and provides an experienced in-market team that enhances our ability to grow in that market. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.
Acquisition of Valley Financial Corporation
On July 1, 2015, the Company completed the acquisition of Valley Financial Corporation ("Valley"), the holding company for Valley Bank, pursuant to the terms of the Agreement and Plan of Merger dated November 17, 2014. Under the merger agreement, Valley's shareholders received 1.1081 shares of the Company's voting common stock for each share of Valley common stock owned.
A summary of assets received and liabilities assumed for Valley, as well as the associated fair value adjustments, are as follows:
Explanation of fair value adjustments:
(1)
Adjustment to reflect estimated fair value of investment securities available-for-sale.
(2)
Adjustment to reflect estimated fair value of loans.
(3)
Adjustment to reflect estimated fair value of premises and equipment.
(4)
Adjustment to reflect recording of core deposit intangible.
(5)
Adjustment to reflect recording of deferred tax asset recognized from acquisition.
(6)
Adjustment to reflect estimated fair value of time deposits based on market rates for similar products.
(7)
Adjustment to reflect estimated fair value of borrowings based on market rates for similar products.
(8)
Adjustment to reflect the estimated fair market value of certain leases.
A summary of the consideration paid is as follows:
With this acquisition, the Company expanded its footprint into Roanoke, Virginia with the addition of nine branches and an experienced in-market team that enhances the Company’s ability to compete in that market. The Company projects cost savings will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.
The following table presents financial information regarding the former Valley operations included in our Consolidated Statements of Income from the date of acquisition through December 31, 2015 under the column “Actual from acquisition date.” These amounts do not include transaction-related costs incurred by the Company. The following table also presents unaudited pro-forma information as if the acquisition of Valley had occurred on January 1, 2015 under the “Pro-forma” columns. In addition, the following table presents unaudited pro-forma information as if the acquisition of Valley, Harbor Bank Group, Inc., Community First Financial Group, Inc., and South Street Financial Corp. had occurred on January 1, 2014 under the “Pro-forma” columns. This pro-forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles and related income tax effects and is based on our historical results for the periods presented. Transaction-related costs related to the acquisition are not reflected in the pro-forma amounts. The pro-forma information does not necessarily reflect the results of operations that would have occurred had the Company acquired Valley at the beginning of 2014. Cost savings are also not reflected in the unaudited pro-forma amounts.
Acquisition of Harbor Bank Group, Inc.
On December 1, 2014, the Company completed the acquisition of Harbor Bank Group, Inc., the holding company for Harbor National Bank ("Harbor"). Under the merger agreement, Harbor's shareholders received 0.950 shares of the Company's voting common stock for each share of Harbor common stock owned.
A summary of assets received and liabilities assumed for Harbor, as well as the associated fair value adjustments, are as follows:
Explanation of fair value adjustments:
(1)
Adjustment to reflect estimated fair value of loans.
(2)
Adjustment to reflect recording of core deposit intangible.
(3)
Adjustment to reflect recording of deferred tax asset recognized from acquisition.
(4)
Adjustment to reflect estimated fair value of time deposits based on market rates for similar products.
(5)
Adjustment to reflect estimated fair value of borrowings based on market rates for similar products.
(6)
Adjustment to reflect the estimated fair market value of certain leases.
With this acquisition, the Company expanded its presence in Charleston, South Carolina through the addition of four branches, a low-cost base of core deposits and an experienced in-market team that enhances our ability to grow in that market. Additionally, goodwill was also created by the expected cost savings that will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.
Acquisition of Community First Financial Group, Inc.
On June 1, 2014, the Company completed the acquisition of Community First Financial Group, Inc. ("Community First"), the parent company of Harrington Bank, FSB, pursuant to the terms of the Agreement and Plan of Merger dated December 17, 2013.
Community First shareholders could elect to receive 0.4069 shares of the Company's voting common stock for each share of Community First common stock or cash in the amount of $5.90 per share, subject to allocation and pro-rata procedures to ensure that approximately 75% of Community First common shares were converted into the right to receive the Company's voting common stock, while the remaining 25% were converted into the right to receive cash. As part of the closing, Community First's preferred shareholders received cash payments equal to the liquidation value of their preferred shares.
A summary of assets received and liabilities assumed for Community First, as well as the associated fair value adjustments, are as follows:
Explanation of fair value adjustments:
(1)
Adjustment to reflect estimated fair value of loans.
(2)
Adjustment to reflect estimated fair value of premises and equipment.
(3)
Adjustment to reflect estimated fair value of OREO.
(4)
Adjustment to reflect recording of core deposit intangible.
(5)
Adjustment to reflect recording of deferred tax asset recognized from acquisition.
(6)
Adjustment to reflect estimated fair value of time deposits based on market rates for similar products.
(7)
Adjustment to reflect the estimated fair market value of certain leases.
A summary of the consideration paid is as follows:
With this acquisition, the Company expanded its presence in the Raleigh-Durham-Chapel Hill area of North Carolina through the addition of three branches, a low-cost base of core deposits and an experienced in-market team that enhances our ability to grow in that market. Additionally, goodwill was also created by the expected cost savings that will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.
Acquisition of South Street Financial Corp.
On April 1, 2014, the Company completed the acquisition of South Street Financial Corp. ("South Street"), the parent company of Home Savings Bank of Albemarle, Inc. SSB, pursuant to the terms of the Agreement and Plan of Merger dated December 17, 2013.
South Street shareholders could elect to receive 0.60 shares of the Company's voting common stock for each share of South Street common stock owned, or cash in the amount of $8.85 per share. Eighty percent of South Street's common shares were converted into the right to receive the Company's voting common stock, while the remaining 20% were converted into the right to receive cash. As part of the closing, each share of South Street's Series A Preferred Stock automatically converted into one share of South Street common stock.
A summary of assets received and liabilities assumed for South Street, as well as the associated fair value adjustments, are as follows:
Explanation of fair value adjustments:
(1)
Adjustment to reflect estimated fair value of loans.
(2)
Adjustment to reflect estimated fair value of premises and equipment.
(3)
Adjustment to reflect estimated fair value of OREO.
(4)
Adjustment to reflect recording of core deposit intangible.
(5)
Adjustment to reflect recording of deferred tax asset recognized from acquisition.
(6)
Adjustment to reflect estimated fair value of time deposits based on market rates for similar products.
A summary of the consideration paid is as follows:
With this acquisition, the Company expanded its presence in the metropolitan Charlotte, North Carolina market through the addition of four branches, an attractive loan portfolio and an experienced in-market team that enhances our ability to grow in that market. Additionally, goodwill was also created by the expected cost savings that will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.
The Company incurred total transaction-related costs of $13.3 million, $9.0 million and $5.8 million during the years ended December 31, 2015, 2014 and 2013, respectively, which were expensed as incurred as a component of non-interest expense. Transaction-related costs primarily included, but were not limited to, severance costs, professional services, data processing fees, marketing and advertising expenses.
The Company has determined the above noted acquisitions each constitute a business combination as defined by FASB ASC Topic 805: Business Combinations (“ASC Topic 805”), which establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed. The Company has recorded the assets purchased and liabilities assumed at their estimated fair value in accordance with ASC Topic 805.
The estimated fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information regarding closing date fair value becomes available. During this one year period, the causes of any changes in cash flow estimates are considered to determine whether the change results from circumstances that existed at the acquisition date or if the change results from an event that occurred after the date of acquisition.
NOTE 3 - EARNINGS PER SHARE
Basic earnings per common share is computed using the weighted average number of common shares and participating securities outstanding during the reporting period. Diluted earnings per common share is the amount of earnings available to each share of common stock during the reporting period adjusted to include the effect of potentially dilutive common shares. Potentially dilutive common shares include incremental shares issued for stock options and restricted stock awards (collectively referred to herein as “Stock Rights”). Potentially dilutive common shares are excluded from the computation of dilutive earnings per share in the periods in which the effect would be anti-dilutive.
The Company's basic and diluted earnings per share calculations are presented in the following table:
For the years ended December 31, 2015 and 2014, respectively, there were no shares of Stock Rights excluded in computing diluted common shares outstanding. For the year ended December 31, 2013, there were 106,283 shares of Stock Rights excluded in computing diluted common shares outstanding.
NOTE 4 - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, and estimated fair values of investment securities are presented in the following tables:
The amortized cost and estimated fair value of investment securities at December 31, 2015, by contractual maturity, are shown below. The expected life of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities have been included in maturity groupings based on the contractual maturity.
At December 31, 2015 and 2014, investment securities with an estimated fair value of approximately $371.8 million and $269.2 million, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
The following table presents a summary of realized gains and losses from the sale of investment securities:
During the year ended December 31, 2015, the Company sold $0.6 million of state and municipal debt obligations that were classified as held-to-maturity due to a downgrade in the credit rating of securities and concerns related to the issuer. As a result of the downgrade of the securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. The Company recorded an immaterial gain on this sale.
During the year ended December 31, 2014, the Company made two sales of investment securities classified as held-to-maturity. The Company sold $3.3 million of state and municipal debt obligations that were downgraded by Moody's as a result of allegations of fraud and multiple pending investigations of the issuer. As a result of the downgrade of the securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. The Company recorded a realized gain of $0.2 million on this sale. The Company also sold $5.2 million of corporate debt securities due to regulatory capital restrictions. The Company recorded a realized loss of $0.1 million on this sale.
As the Company's intent and ability to hold the remaining held-to-maturity securities was not impacted by these sales, the Company did not reclassify the remaining securities to the available-for-sale category.
The following tables detail gross unrealized losses and fair values of investment securities aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position:
All state and municipal securities in an unrealized loss position were rated as investment grade at December 31, 2015. The Company continually assesses the risk of credit default for the municipal bond portfolio. The corporate debt securities are issued by well-capitalized and sound financial institutions. The asset-backed debt securities are rated at least Aa2 by Moody’s and the majority of these securities have been in an unrealized loss position for less than 12 months. The gross unrealized losses reported for the mortgage-backed securities relate to investment securities issued or guaranteed by the Federal National Mortgage Association, the Government National Mortgage Association, or the Federal Home Loan Mortgage Corporation. The Company does not intend to sell, and it is not more likely than not that the Company will be required to sell, these investment securities before the anticipated recovery of the amortized cost basis. The unrealized losses for the debt securities are caused by changes in market interest rates, as opposed to credit concerns related to the respective issuers.
The equity securities held by the Company in an unrealized loss position at December 31, 2015 consist of publicly-traded common stock of an investment company, as well as preferred stock of a well-capitalized and sound financial institution. The Company concluded there are no concerns about the long-term viability of the issuers. The Company has the positive intent and ability to hold these securities until the anticipated recovery of value occurs.
Based on this analysis, the Company does not consider any investment securities to be other-than-temporarily impaired at December 31, 2015.
NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES
Major categories of loans are presented below:
(1)
Amount includes $40.9 million and $137.5 million of acquired loans covered under FDIC loss-share agreements at December 31, 2015 and 2014, respectively. The unpaid principal balance for acquired loans covered under FDIC loss-share agreements was $41.4 million and $140.4 million at December 31, 2015 and 2014, respectively.
Unearned income and net deferred loan fees totaled $0.9 million at December 31, 2015 and 2014, respectively.
The Company evaluates loans acquired with evidence of credit deterioration in accordance with the provisions of ASC 310-30. Credit-impaired loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, the Company will not collect all contractually required principal and interest payments. Generally, the acquired loans that meet the Company’s definition for substandard status fall within the definition of credit-impaired covered loans. The following table presents loans acquired during the year ended December 31, 2015, at acquisition date, accounted for under ASC 310-30:
The acquisition date unpaid balance of loans acquired during the year ended December 31, 2015 that did not have credit deterioration was $774.7 million with an estimated fair value of $758.7 million. The discount will be amortized on a level-yield basis over the economic life of the loans.
The following table presents a summary of the activity of the Company's loans accounted for under ASC 310-30:
The following table presents a summary of changes in accretable difference on purchased loans accounted for under ASC 310-30:
The Company has the ability to borrow funds from the FHLB and from the Federal Reserve Bank. At December 31, 2015 and 2014, real estate loans with carrying values of $1.68 billion and $1.10 billion, respectively, were pledged to secure borrowing facilities from these institutions.
The Company has loan relationships with its directors, executive officers, or their related interests. These loans were made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other unrelated customers, and do not involve more than a normal risk of collection. Loan activity with principal officers, directors, and their affiliates during 2015 was as follows:
A summary of the changes to the allowance for loan losses, by class of financing receivable, is presented below:
(1)
The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $(0.4) million for the year ended December 31, 2015. This resulted in a decrease in the FDIC indemnification asset of $1.1 million, which is the difference between the net provision on covered loans and the total reduction to the allowance for loan losses allocable to the covered loan portfolio of $1.5 million.
(2)
The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $(0.6) million for the year ended December 31, 2014. This resulted in a decrease in the FDIC indemnification asset of $1.6 million, which is the difference between the net provision on covered loans and the total reduction to the allowance for loan losses allocable to the covered loan portfolio of $2.2 million.
The following table provides a breakdown of the recorded investment in loans and the allowance for loan losses based on the method of determining the allowance:
The following tables present information related to impaired loans, excluding purchased impaired loans:
The following table presents information related to the average recorded investment and interest income recognized on impaired loans, excluding purchased impaired loans:
For the years ended December 31, 2015 and 2014, the amount of interest income recognized within the period that the loans were impaired was primarily related to loans modified as a TDR that remained on accrual status. The amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.
At December 31, 2015 and 2014, respectively, the Company had $2.5 million of consumer mortgage loans secured by residential real estate properties for which foreclosure proceedings were in progress.
The following tables present an aging analysis of the recorded investment in the Company's loans:
Credit Quality Indicators
The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's primary credit quality indicators use an internal credit risk rating system that categorizes loans and leases into pass, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans and leases that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans and leases to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans and leases that are underwritten and structured using standardized criteria and characteristics are typically risk rated and monitored collectively. These are typically loans and leases to individuals in the classes which comprise the consumer portfolio segment.
The Company uses the following definitions for risk ratings:
Pass - Loans classified as pass are considered to be a satisfactory credit risk and generally considered to be collectible in full.
Special Mention - Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard - Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss - Loans classified as loss are considered uncollectable and are in the process of being charged-off, as soon as practicable, once so classified.
The following tables present the recorded investment in the Company’s loans by credit quality indicator:
Modifications
Loan modifications are considered a TDR if concessions have been granted to borrowers that are experiencing financial difficulty. The concessions granted generally involve the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included and treated with all other nonaccrual loans. In addition, all accruing restructured loans are reported as TDRs, which are considered and accounted for as impaired loans. Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on accrual status. If the borrower’s ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual status.
Loans modified in a TDR are, in many cases, already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates. Once we classify a loan as a TDR, the loan is only removed from TDR classification under three circumstances: (1) the loan is paid off, (2) the loan is charged off or (3) if, at the beginning of the current fiscal year, the loan has performed in accordance with the modified terms for a minimum of six consecutive months and at the time of modification the loan’s interest rate represented a then current market interest rate for a loan of similar risk.
The following tables provide a summary of loans modified as TDRs:
At December 31, 2015 and 2014, the Company had no available commitments outstanding on TDRs.
The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:
Rate modification - A modification in which the interest rate is changed.
Term modification - A modification in which the maturity date, timing of payments or frequency of payments is changed.
Payment modification - A modification in which the principal and interest payment are lowered from the original contractual terms.
Interest only modification - A modification in which the loan is converted to interest only payments for a period of time.
Combination modification - Any other type of modification, including the use of multiple categories above.
The following tables present new TDRs by modification category. All balances represent the recorded investment at the end of the period in which the modification was made.
The following tables summarize the period-end balance for loans modified and classified as TDRs in the previous 12 months for which a payment default has occurred. The Company defines payment default as movement of the restructuring to nonaccrual status, foreclosure or charge-off, whichever occurs first.
Loans Held for Sale
The Company originates certain single family, residential first mortgage loans for sale on a presold basis. Loan sale activity is summarized below:
NOTE 6 - FDIC INDEMNIFICATION ASSET
The Company has recorded an indemnification asset related to loss-share agreements entered into with the FDIC wherein the FDIC will reimburse the Company for certain amounts related to certain acquired loans and OREO should the Company experience a loss. Under the loss-sharing arrangements, the FDIC has agreed to absorb 80% of all future losses and workout expenses on these assets which occur prior to the expiration of the loss-sharing agreements. The Company entered into the respective loss-share agreements with the acquisitions of Beach First on April 9, 2010 and Blue Ridge Savings Bank on October 14, 2011.
Each loss-sharing arrangement consists of one single family residential mortgage loan agreement and one non-single family residential loan agreement. The non-single family residential loan loss-share agreements provide for FDIC loss-sharing to the end of the fiscal quarter five years from the purchase date and reimbursement to the FDIC to the end of the fiscal quarter eight years from the purchase date. The single family residential mortgage loan loss-share agreements provide for FDIC loss-sharing and reimbursement for recoveries to the FDIC to the end of the fiscal quarter ten years from the purchase date.
On July 1, 2015, the Company’s loss-share agreement related to the non-single family residential mortgage loans of Beach First expired. Accordingly, the Company will bear all future losses on this portfolio of loans and foreclosed real estate. Immediately prior to the expiration of the loss-sharing arrangement, the loans in this portfolio had a carrying value of $74.4 million and the foreclosed real estate in this portfolio had a carrying value of $0.5 million.
The following table presents activity for the FDIC indemnification asset for the years ended December 31, 2015 and 2014:
The FDIC indemnification asset is measured separately from the related covered assets and is initially recorded at fair value. The fair value was estimated using projected cash flows related to the loss-share agreements based on the expected reimbursements for losses and the applicable loss-share percentages. Cash flow projections are reviewed and updated prospectively as loss estimates related to both covered loans and covered OREO change.
NOTE 7 - GOODWILL AND OTHER INTANGIBLE ASSETS
The following table presents activity for goodwill and other intangible assets:
The Company has identified two reporting units for purposes of testing goodwill for impairment. These reporting units are the mortgage origination unit and the banking operations unit, which contains all other activities performed by the Company. All goodwill is allocated to the banking operations reporting unit.
The Company conducted its annual impairment testing as of June 30, 2015, utilizing a qualitative assessment. Based on this assessment, management concluded that it is more likely than not that the estimated fair value of the banking operations reporting unit exceeded the carrying value (including goodwill) of this reporting unit. Therefore, a step one quantitative analysis was not required. There were no impairment charges recorded in 2015 or 2014.
The following table presents the gross carrying amount and accumulated amortization for the Company’s core deposit intangible assets, which are the only identifiable intangible assets subject to amortization:
At December 31, 2015, the weighted-average remaining life of core deposit intangibles was 5.3 years.
The following table presents estimated future amortization expense for other intangible assets:
NOTE 8 - PREMISES AND EQUIPMENT
The following tables present a summary of the Company’s premises and equipment:
Depreciation and amortization expense for the years ended December 31, 2015, 2014 and 2013 amounted to $6.1 million, $5.3 million and $4.2 million, respectively.
The Company has entered into various non-cancellable operating leases for land and buildings used in its operations that expire at various dates through 2033. Most of the leases contain renewal options and certain leases provide for periodic rate negotiation or escalation. The leases generally provide for payment of property taxes, insurance and maintenance costs by the Company. Rental expense, including month-to-month leases, reported in non-interest expense was $5.5 million, $3.8 million and $3.1 million for the years ended December 31, 2015, 2014 and 2013, respectively.
At December 31, 2015, future minimum rental commitments under non-cancellable operating leases are as follows:
NOTE 9 - DERIVATIVES
The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recorded on the balance sheet at their respective fair values. The Company does not use financial instruments or derivatives for any trading or other speculative purposes.
The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company simulates the net portfolio value and net income expected to be earned over a twelve-month period following the date of simulation. The simulation is based on a projection of market interest rates at varying levels and estimates the impact of such market rates on the levels of interest-earning assets and interest-bearing liabilities during the measurement period. Based upon the outcome of the simulation analysis, the Company considers the use of derivatives as a means of reducing the volatility of net portfolio value and projected net income within certain ranges of projected changes in interest rates. The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates. The Company also has derivatives that are a result of a service it provides to certain qualifying customers, which includes a matched book of derivative instruments offered to customers in order to minimize their interest rate risk.
Derivatives Designated as Cash Flow Hedges of Interest Rate Risk
The Company has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. The Company entered into an interest rate swap transaction with a notional amount of $125 million. The interest rate swap was designated as a hedge against the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on the first $125 million of the Company's variable rate money market funding arrangement.
The Company receives interest at the one-month LIBOR rate and pays a fixed interest rate under the terms of the swap agreement. The termination date of the swap agreement is March 18, 2019.
Derivatives Not Designated as Hedges
The Company utilizes derivative financial instruments, which may include interest rate swaps, caps and/or floors, as part of its ongoing efforts to mitigate its interest rate risk exposure and to help its commercial customers manage their exposure to interest rate fluctuations. To mitigate the interest rate risk associated with these customer contracts, the Company enters into an offsetting derivative contract position. These derivative positions are recorded at fair value on the Company’s consolidated balance sheet and, due to the matched nature of these derivative instruments, changes in fair value do not impact the Company’s earnings. At December 31, 2015 and 2014, the Company had notional amounts of $63.3 million and $34.7 million, respectively, on interest rate contracts with corporate customers and in offsetting interest rate contracts with another financial institution to mitigate the Company’s rate exposure on its corporate customers’ contracts.
The following table presents the fair value of the Company’s derivatives:
The derivative instruments held by the Company are subject to master netting arrangements which contain a legally enforceable right to offset recognized amounts and settle such amounts on a net basis. The Company has elected to present the financial assets and financial liabilities associated with these arrangements on a gross basis in the Consolidated Balance Sheets. Cash collateral is posted by the counterparty with net liability positions in accordance with contract thresholds.
Information about financial instruments that are eligible for offset in the consolidated balance sheets is presented in the following table:
The Company has recorded a net loss of $0.7 million, net of tax, as component of accumulated other comprehensive income at December 31, 2015 associated with cash flow hedging instruments and expects $1.0 million, net of tax, to be reclassified as an increase to interest expense during the next 12 months.
The following table presents the amounts recorded in the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income, respectively, relating to derivative instruments designated as cash flow hedges, net of tax:
(1) Amount recorded in interest expense on demand deposits in the Consolidated Statements of Income.
The amounts included in accumulated other comprehensive income will be reclassified to interest expense should the hedge no longer be considered effective. No amount of ineffectiveness was included in net income for the years ended December 31, 2015, 2014 and 2013, respectively. The Company will continue to assess the effectiveness of the hedge on a quarterly basis.
Counterparty Credit Risk - By entering into derivative instrument contracts, the Company exposes itself, from time to time, to counterparty credit risk. Counterparty credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to the Company, which creates credit risk for the Company. The Company attempts to minimize this risk by selecting counterparties with investment grade credit ratings, limiting its exposure to any single counterparty and regularly monitoring its market position with each counterparty.
Credit-Risk Related Contingent Features - The Company’s derivative instruments contain provisions allowing the financial institution counterparty to terminate the contracts in certain circumstances, such as a default by the Company on its indebtedness or the failure to maintain its regulatory status as a well-capitalized institution. These derivative agreements also contain provisions regarding the posting of collateral by each party. At December 31, 2015, the aggregate fair value of derivative instruments with credit-risk-related contingent features that were in a net liability position was $2.4 million, for which the Company has posted collateral with a fair value of $6.5 million.
NOTE 10 - DEPOSITS
The following tables present the scheduled maturities of time deposits at December 31, 2015:
NOTE 11 - BORROWINGS
The following table presents the Company’s short-term borrowings:
(1) Securities sold under agreements to repurchase generally mature within one day from the transaction date and are collateralized by either U.S. Government Agency obligations, government sponsored mortgage-backed securities or securities issued by local governmental municipalities.
The Company may purchase federal funds through unsecured federal funds lines of credit totaling $95.0 million at December 31, 2015. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate.
The Company has an uncollateralized 364-day revolving credit facility (the “Credit Agreement”) for an aggregate principal amount of up to $25 million at any time outstanding. The Credit Agreement matures on November 12, 2016 with an interest rate of 3.50% at December 31, 2015.
Additional information on the Company’s short-term borrowings is presented in the following table:
The following table presents the Company’s long-term debt:
The following table details the Company's long-term FHLB advances outstanding:
(1) Interest rate on advances at December 31, 2015.
The advances from the FHLB have been made against a $904.2 million line of credit secured by real estate loans and investment securities with carrying values of $1.27 billion and $6.3 million, respectively, at December 31, 2015.
On September 30, 2014, the Parent Company issued $60.0 million of 5.5% Fixed to Floating Rate Subordinated Notes (the "Subordinated Notes"), all of which are outstanding at December 31, 2015. The Subordinated Notes bear interest at a fixed rate of 5.5% per year for the first 5 years and, from October 1, 2019 to the October 1, 2024 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month LIBOR plus 359 basis points. The Subordinated Notes are redeemable by the Parent Company at any quarterly interest payment date beginning on October 1, 2019 to maturity at par, plus accrued and unpaid interest.
The Company assumed a junior subordinated note in conjunction with the Valley acquisition with an outstanding balance of $10.7 million at December 31, 2015. The junior subordinated note bears interest at a variable rate of LIBOR plus 5.00% per annum, with a floor of 5.50% and a cap of 9.50%, and has a maturity date of October 15, 2023. The interest rate for the subordinated note is 5.50% at December 31, 2015. The unamortized premium of $1.1 million at December 31, 2015 is being amortized using a level-yield methodology over the estimated holding period of approximately eight years.
In addition, the Company has the ability to borrow funds from the Federal Reserve Bank of Richmond utilizing the discount window and the borrower-in-custody of collateral arrangement. At December 31, 2015, commercial loans and investment securities with carrying values of $414.6 million and $2.8 million, respectively, were assigned under these arrangements. At December 31, 2015, the Company had approximately $261.6 million in borrowing capacity available under these arrangements with no outstanding balance due.
The following table details the junior subordinated debentures outstanding:
The junior subordinated debentures issued by the trusts currently qualify as Tier I capital for the Company, subject to certain limitations, and constitute a full and unconditional guarantee by the Company of the trust’s obligations under the preferred securities. At December 31, 2015 and 2014, the Company had $1.2 million and $0.7 million, respectively, of equity investment in the above wholly-owned Capital Trusts and is included in other assets in the accompanying consolidated balance sheets. The weighted average rate for the junior subordinated debentures outstanding for the years ending December 31, 2015 and 2014 was 2.13% and 2.71%, respectively.
The Company was not aware of any violations of loan covenants at December 31, 2015.
NOTE 12 - ACCUMULATED OTHER COMPREHENSIVE INCOME
The following table presents the changes in accumulated other comprehensive income, net of taxes:
The following table details reclassification adjustments from accumulated other comprehensive income:
(1)
The amortization of the unrealized holding gains in accumulated other comprehensive income at the date of transfer partially offsets the amortization of the difference between the par value and fair value of the investment securities at the date of transfer. Both components are amortized as an adjustment of yield.
NOTE 13 - FAIR VALUE MEASUREMENT
ASC Topic 820, Fair Value Measurements and Disclosures, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability at the measurement date. The three levels of valuations are defined as follows:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement, and require significant management judgment or estimation using pricing models, discounted cash flow methodologies or similar techniques.
Fair Value on a Recurring Basis - The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets.
Investment securities available-for-sale - The fair value of a portion of our investment in equity securities available-for-sale is determined by observing quoted prices in an active market for identical securities. As such, the Company classifies these securities as Level 1 valuation. The fair value of the remainder of our investment securities available-for-sale are determined by a third-party pricing service. The valuations provided by the third-party pricing service are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and reference data obtained from market research publications. The valuation of mortgage-backed securities also includes new issue data, monthly payment information and “To Be Announced” prices. The valuation of state and municipal securities also include the use of material event notices. We review the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness. At least annually, we will validate prices supplied by the independent pricing service by comparing to prices obtained from a second third-party source. The Company classifies these investment securities as Level 2 valuation.
Derivative assets and liabilities - The values of derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivative instruments as Level 2 valuation.
The following tables present information about certain assets and liabilities measured at fair value on a recurring basis:
Fair Value on a Nonrecurring Basis - The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.
Loans held for sale - Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2 valuation.
Impaired loans - The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that nonaccrual loans and loans that have had their terms restructured in a TDR meet this impaired loan definition. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the underlying collateral for collateral-dependent loans, which the Company classifies as a Level 3 valuation.
OREO - OREO is initially recorded at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation.
The following tables present information about certain assets and liabilities measured at fair value on a nonrecurring basis:
The following table presents the valuation and unobservable inputs for Level 3 assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2015:
Estimated fair values of financial instruments have been estimated by the Company using the provisions of ASC Topic 825, Financial Instruments (“ASC 825”), which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The following tables present the carrying value and estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis:
The following methods and assumptions were used to estimate the fair value of financial instruments that have not been previously discussed:
Cash and cash equivalents - The carrying amounts reported in the balance sheets for cash and cash equivalents approximate the fair value of those assets.
Investment securities held-to-maturity - The fair value of our investment securities held-to-maturity are determined by a third-party pricing service. The valuations provided by the third-party pricing service for state and municipal securities are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and the use of material event notices.
We review the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness. At least annually, we will validate prices supplied by the independent pricing service by comparing to prices obtained from a second third-party source.
Federal Home Loan Bank stock - The fair value for FHLB stock is its carrying value, since this is the amount for which it could be redeemed. There is no active market for this stock and the Company, in order to be a member of the FHLB, is required to maintain a minimum investment.
Loans receivable, net - The fair values for loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms and credit ratings for the same remaining maturities, adjusted for the allowance for loan losses.
FDIC indemnification asset - The fair value for the FDIC indemnification asset is estimated based on discounted future cash flows using current discount rates.
Investment in bank-owned life insurance - The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.
Accrued interest receivable and accrued interest payable - The carrying amount of accrued interest is assumed to approximate fair value.
Deposits - The fair values disclosed for deposits with no stated maturity (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for deposits with a stated maturity date (time deposits) are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits.
Short-term borrowings - The carrying amount of short-term borrowings is assumed to approximate fair value.
Long-term debt - The fair value is estimated by discounting the future contractual cash flows using current market interest rates for similar debt over the same remaining term.
NOTE 14 - REGULATORY CAPITAL
The Company is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about component risk weightings and other factors. At December 31, 2015 and 2014 the Company’s and the Bank’s Tier 1 and total capital ratios and their Tier 1 leverage ratios exceeded minimum requirements.
In July 2013, the Federal Reserve Board approved and published the final Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The Basel III Capital Rules, among other things, (i) introduce CET1 as a new capital measure, (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. The Basel III Capital Rules were effective for BNC and the Company on January 1, 2015 (subject to a phase-in period for
certain components). CET1 capital for the Company and BNC consists of common stock, related paid-in capital, and retained earnings. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in CET1. CET1 for both the Company and BNC is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions.
Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk-weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.50% on January 1, 2019. When fully phased in on January 1, 2019, Basel III will require (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.50%, plus a 2.50% capital conservation buffer, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.00%, plus the 2.50% capital conservation buffer and (iv) a minimum leverage ratio of 4.00%.
The following tables present BNC’s regulatory capital ratios:
The following table presents the Company’s regulatory capital ratios:
NOTE 15 - INCOME TAXES
The following tables present the Company’s income tax expense (benefit):
The following tables present the difference between income tax expense and the amount computed by applying the statutory income tax rate:
Significant components of deferred tax assets and liabilities were as follows:
The valuation allowance of $1.4 million at December 31, 2015 relates to the net operating loss carryforwards and capital loss carryforwards obtained from business combinations for which realizability is uncertain. The reduction in valuation allowance from 2014 was due to the expiration of capital loss carryforwards that were fully reserved under the valuation allowance.
The Company adjusted its net deferred income tax asset as a result of reductions in the North Carolina corporate income tax rate, which reduced the state income tax rate to 4% effective January 1, 2016.
In assessing the realizability of the Company's deferred income tax asset, the Company considered whether it is more likely than not that some portion or all of the deferred income tax asset will not be realized in accordance with the guidance provided by ASC 740. The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. The Company considers the scheduled reversal of deferred income tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the weight of available evidence, the Company determined that it is more likely than not that it will be able to realize the benefits of the deferred income tax asset, net of valuation allowance, at December 31, 2015.
At December 31, 2015, the Company had net operating loss and other carryforwards of approximately $14.6 million available to offset future taxable income, which begin expiring in 2029.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of
being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company did not have an accrual for uncertain tax positions at December 31, 2015 or 2014.
We are subject to routine audits of our tax returns by the Internal Revenue Service and various state taxing authorities. With few exceptions, we are no longer subject to Federal and state income tax examinations by tax authorities for years before 2012. There are no indications of any material adjustments relating to any examination currently being conducted by any taxing authority.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unfunded lines of credit, and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying consolidated financial statements.
The Company's risk of loss in the event of nonperformance by the other party to the commitment to extend credit, lines of credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management's evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, real estate and time deposits with financial institutions. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent cash requirements.
The following table presents the outstanding off-balance sheet financial instruments whose contract amounts represent potential credit risk:
In addition to the above noted credit commitments, the Company has committed to invest up to $10.8 million in limited partnership interests of unconsolidated entities, of which $6.9 million was unfunded at December 31, 2015.
During 2015 the Company sold their credit card portfolio and have no additional credit exposure related to these lines.
The Company is subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company will be material to the Company’s consolidated financial position. On an on-going basis the Company assesses any potential liabilities or contingencies in connection with such legal proceedings. For those matters where it is deemed probable that the Company will incur losses and the amount of the losses can be reasonably estimated, the Company would record an expense and corresponding liability in its consolidated financial statements.
NOTE 17 - EMPLOYEE BENEFITS
The Compensation Committee of the Company's Board of Directors may grant or award eligible participants stock options, restricted stock, restricted stock units, stock appreciation rights, and other stock-based awards or any combination of awards (collectively referred to herein as “Rights”). At December 31, 2015, the Company had Rights outstanding from the 2006 BNC Bancorp Omnibus Stock Ownership and Long Term Incentive Plan (the "2006 Omnibus Plan"), the BNC Bancorp 2013 Omnibus Stock Incentive Plan (the "2013 Omnibus Plan") and the KeySource Non-Statutory and Incentive Stock Option plans (the "KeySource Plans"). The 2013 Omnibus Plan and the KeySource Plans are the only plans that are available for future grants. The Company had 118,000 Rights issued under the 2006 Omnibus Plan, 463,517 Rights issued and 872,470 Rights available for grants or awards under the 2013 Omnibus Plan, and 88,139 stock options issued and 35,607 stock options available for issuance related to the KeySource Plans.
Stock Option Awards. The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.
A summary of the Company’s stock option activity for the year ended December 31, 2015 is presented below:
The stock options issued were replacement awards to certain Valley employees in connection with the business combination. These stock options were fully vested at the acquisition date.
The related compensation expense recognized for stock options, the intrinsic value of stock option exercised and the grant-date fair value of options that vested was immaterial for the years ended December 31, 2015, 2014 and 2013, respectively.
Net cash received from stock option exercises under all share-based payment arrangements for the years ended December 31, 2015, 2014 and 2013 was $1.8 million, $0.2 million and $0, respectively. The actual tax benefit realized for income tax deductions from stock option exercises was $0.3 million, $0.1 million and $0 for the years ended December 31, 2015, 2014 and 2013, respectively.
Restricted Stock Awards. A summary of the activity of the Company’s unvested restricted stock awards for the year ended December 31, 2015 is presented below:
The Company measures the fair value of restricted shares based on the price of the Company's common stock on the grant date, and compensation expense is recorded over the vesting period. Compensation expense recognized for restricted stock awards for the years ended December 31, 2015, 2014 and 2013 was $2.7 million, $2.2 million and $1.2 million, respectively. At December 31, 2015, there was $5.9 million of total unrecognized compensation cost related to unvested restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 2.14 years. The grant-date fair value of restricted stock grants vested during the years ended December 31, 2015, 2014 and 2013 was $1.7 million, $1.7 million and $0.9 million, respectively.
Qualified Profit Sharing 401(k) Plan - The Company maintains a qualified profit sharing 401(k) plan for employees 20.5 years of age or over which covers substantially all employees. Under the plan, employees may contribute up to an annual maximum as determined by the Internal Revenue Code. Prior to January 1, 2015, the Company matched 50% of the employee contributions up to 6% of the participant's contribution. Effective January 1, 2015, the Company's match of participant contributions increased to 100% up to 3% of the participant's contributions and 50% on 4% and 5% of participant's contributions. The plan provides that employees' contributions are 100% vested at all times and, prior to January 1, 2015, the Company's contributions vested at 20% each year after the second year of service. Effective January 1, 2015, the Company's contributions, both past and future, were immediately vested at 100%. The expense related to the 401(k) plan for the years ended December 31, 2015, 2014 and 2013 was $2.0 million, $1.0 million and $0.9 million, respectively.
Employment Agreements - The Company has entered into employment agreements with its chief executive officer and chief financial officer to ensure a stable and competent management base. The agreements provide for a three-year term, with an automatic one-year renewal on each anniversary date. The agreements provide for benefits as set forth in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested benefits, including compensation. In the event of a change in control of the Company, as outlined in the agreements, the acquiror will be bound to the terms of the contracts.
Director and Executive Officer Benefit Plans - The Company has Salary Continuation Agreements and supplemental retirement benefits with its chief executive officer and certain other officers. The Salary Continuation Agreements provide for lifetime benefits to be paid to each executive with the payment amounts varying upon different retirement scenarios, such as normal retirement, early termination, disability, or change in control. The Company has purchased life insurance policies on the participating officers in order to provide future funding of benefit payments. Provisions for the years ended December 31, 2015, 2014 and 2013 totaled $0.5 million, $0.4 million and $0.3 million, respectively. The corresponding liability related to these benefit plans was $7.9 million and $7.4 million as of December 31, 2015 and 2014, respectively.
The Company also has a deferred compensation plan for its directors. Expense provided under the plan totaled $0.5 million, $0.1 million and $0.4 million for the years ended December 31, 2015, 2014 and 2013, respectively. Since 2003, directors have had the option to invest amounts deferred in Company common stock that is held in a rabbi trust established for that purpose. At December 31, 2015 and 2014, the trust held 367,885 and 353,207 shares of Company common stock, respectively.
NOTE 18 - PARENT COMPANY FINANCIAL DATA
The following are condensed financial statements of the Parent Company as of and for the years ended December 31, 2015, 2014 and 2013:
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
CONDENSED STATEMENTS OF CASH FLOWS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures as required under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of December 31, 2015, the Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures. Based on the foregoing, its Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2015.
No changes were made to the Company’s internal control over financial reporting (as defined Rule 13a-15(f) and Rule 15d-15(f) promulgated under the Exchange Act) during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Our internal control system is designed to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management of the Company, including the Chief Executive Officer and the Chief Financial Officer, has assessed the Company’s internal control over financial reporting as of December 31, 2015, based on criteria for effective internal control over financial reporting described in “Internal Control - Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2015.
Our independent registered public accounting firm which audited the financial statements included in this Annual Report has issued an attestation report on our internal control over financial reporting as of December 31, 2015, which is contained in this Annual Report. The Report of Independent Registered Public Accounting Firm, which includes the attestation report on our internal control over financial reporting, is included with the financial statements in Part II, Item 8 of this annual report on Form 10-K and is incorporated herein by reference.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers. The information concerning our directors and named executive officers required by this Item 10 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
Section 16(a) Beneficial Ownership Reporting Compliance. The information concerning compliance with the reporting requirements of Section 16(a) of the Exchange Act by our directors, officers, and ten percent shareholders required by this Item 10 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
Code of Ethics. We have adopted a Code of Business Conduct and Ethics that is applicable to all of our directors, officers and employees, including its principal executive and senior financial officers, as required by Section 406 of the Sarbanes-Oxley Act of 2002 and applicable SEC rules. A copy of our Code of Business Conduct and Ethics adopted by our Board of Directors may be found on BNC’s website: www.bncbancorp.com.
In the event that we make any amendment to, or grant any waivers of, a provision of its Code of Business Conduct and Ethics that applies to the principal executive officer or senior financial officer that requires disclosure under applicable SEC rules, we intend to disclose such amendment or waiver by filing a Form 8-K with the SEC.
The information regarding our Nominating and Corporate Governance Committee and Audit Committee required by this Item 10 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning compensation and other matters required by this Item 11 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information concerning security ownership of certain beneficial owners and management required by this Item 12 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
The information required to be disclosed under Item 201(d) of Regulation S-K is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information concerning certain relationships and related transactions and director independence required by this Item 13 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information concerning principal accounting fees and services required by this Item 14 is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Shareholders, a copy of which will be filed with the SEC not later than 120 days after the end of our fiscal year.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1)
The following consolidated financial statements of BNC Bancorp and subsidiaries are filed as part of this report under Item 8 - Financial Statements and Supplementary Data:
Consolidated Balance Sheets - December 31, 2015 and 2014
Consolidated Statements of Income - Years ended December 31, 2015, 2014 and 2013
Consolidated Statements of Comprehensive Income - Years ended December 31, 2015, 2014 and 2013
Consolidated Statements of Shareholders' Equity - Years ended December 31, 2015, 2014 and 2013
Consolidated Statements of Cash Flows - Years ended December 31, 2015, 2014 and 2013
Notes to Consolidated Financial Statements - Years ended December 31, 2015, 2014 and 2013
(a)(2) List of Financial Schedules
All schedules are omitted as they are not applicable or the required information is shown under Item 8 - Financial Statements and Supplementary Data.
(a)(3) Exhibits
The list of exhibits filed as a part of this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated by reference in this Item 15(a)(3).
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.
BNC BANCORP
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.
EXHIBIT INDEX
* Indicates a management contract or compensatory plan or arrangement.