ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
We currently conduct business through our administrative office in West Point, Georgia, our branch offices in west-central Georgia, east-central Alabama, the Florida Panhandle and our cashless branch office in Norcross, Georgia. Our Georgia branch offices are located in Carrollton, LaGrange (three offices), Newnan (two offices) and West Point, and our Alabama branches are located in Auburn (two offices), Opelika and Valley. Our Florida Branch offices are in Milton, Pace, and Pensacola. The net book value of the land, buildings, furniture, fixtures and equipment owned by us was $20.6 million at September 30, 2014.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
As of the date of filing of this Annual Report on Form 10-K, we were not involved in any legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which, in the aggregate, involve amounts that we believe are immaterial to our consolidated financial condition, results of operations and cash flows.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURE
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market and Dividend Information
Our common stock currently trades on the Nasdaq Capital Market (“NASDAQ”) under the trading symbol “CHFN.” The following table sets forth, for the periods indicated, the high and low sales prices of our common stock. The table below also presents the cash dividends paid per share for the periods indicated. Share price and dividends paid per share prior to April 8, 2013, have been updated to reflect the completion of the second-step conversion using the conversion ratio of 1.2471.
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(1)
Charter Financial declared a special dividend of $0.25 per share in addition to its regular quarterly dividend of $0.05 per share on July 23, 2013.
Holders
As of December 1, 2014, there were approximately 709 holders of record of our common stock.
Dividends
The Company started paying a quarterly cash dividend in September 2002. Beginning with the dividend paid for the quarter ended March 31, 2010, we reduced our quarterly dividend from $0.25 per share to $0.05 per share. The reduction of the dividend reflected our decision to pursue opportunities for deployment of capital in FDIC-assisted transactions such as the Neighborhood Community Bank, McIntosh Commercial Bank and The First National Bank of Florida transactions. The dividend rate and the continued payment of dividends will primarily depend on our earnings, alternative uses for capital, such as capital requirements, acquisition opportunities, our financial condition and results of operations, statutory and regulatory limitations affecting dividends and the policies of the Board of Governors of the Federal Reserve System (“FRB”) and, to a lesser extent, tax considerations and general economic conditions. The Company briefly discontinued the quarterly cash dividend following the dividend paid in May 2012 but reinstated the quarterly cash dividend in May 2013.
Under the rules of the Office of Comptroller of the Currency and the FRB, CharterBank is not permitted to make a capital distribution if, after making such distribution, it would be undercapitalized. For information concerning additional federal laws and regulations regarding the ability of CharterBank to make capital distributions, including the payment of dividends to Charter Financial, see Part I, Item 1 Business “Taxation-Federal Taxation” and “Supervision and Regulation-Federal Banking Regulation.”
Unlike CharterBank, Charter Financial is not restricted by Office of the Comptroller of the Currency regulations on the payment of dividends to its shareholders. However, the FRB has issued a policy statement regarding the payment of dividends by bank holding companies that it has also made applicable to savings and loan holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. FRB guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory
policies could affect the ability of Charter Financial to pay dividends or otherwise engage in capital distributions. In addition, the source of dividends that may be paid by Charter Financial depends on dividends from CharterBank.
In addition, pursuant to applicable regulations, during the three-year period following our conversion and stock offering completed in April, 2013, we will not take any action to declare an extraordinary dividend to shareholders that would be treated by recipients as a tax-free return of capital for federal income tax purposes. Finally, we may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.
Securities Authorized for Issuance under Equity Compensation Plans
See Part III, Item 12(d) Equity Compensation Plan Information, in this Annual Report on Form 10-K, for the table providing information as of September 30, 2014 about Company common stock that may be issued upon the exercise of options under the Charter Financial Corporation 2001 Stock Option Plan and the Charter Financial Corporation 2013 Equity Incentive Plan.
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
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(1) We completed our third repurchase program for fiscal 2014 in September 2014 and announced a fourth share repurchase program allowing the repurchase of an additional 1.8 million shares, or approximately 10% of the Company's outstanding shares. For the fiscal year ended September 30, 2014, shares were repurchased at a cost of approximately $53.2 million.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The summary financial information presented below is derived in part from our consolidated financial statements. The following is only a summary and should be read in conjunction with the consolidated financial statements and notes contained in Item 8 of this Annual Report on Form 10-K. The information at September 30, 2014 and 2013 and for the years ended September 30, 2014, 2013 and 2012 is derived in part from the audited consolidated financial statements that appear in this annual report. The information at September 30, 2012, 2011 and 2010, and for years ended September 30, 2011 and 2010, is derived in part from the audited consolidated financial statements that do not appear in this annual report. The information presented below does not include the financial condition, results of operations or other data of First Charter, MHC prior to its elimination following the April 8, 2013 conversion. The information presented prior to April 8, 2013, is that of Charter Federal, Charter Financial's predecessor company.
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(1)
Excludes “covered loans” acquired from the FDIC subject to loss-sharing agreements. See Note 5 - Loans Receivable in the Notes to our Consolidated Financial Statements. Loans shown are net of deferred loan (fees) costs and allowance for loan losses and exclude loans held for sale.
(2)
Consists of loans acquired from the FDIC still subject to loss sharing agreements. See Note 5 - Loans Receivable in the Notes to our Consolidated Financial Statements. Loans shown are net of deferred loan fees, allowance for loan losses, and nonaccretable and accretable discounts.
(3)
Includes all CharterBank investment and mortgage securities available for sale.
(4)
Core deposits consist of transaction accounts, money market accounts and savings accounts.
(5)
Retail deposits include core deposits and certificates of deposit other than brokered and wholesale certificates of deposit.
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(1)
Share and share amounts held by the public prior to April 8, 2013 have been restated to reflect the completion of the second-step conversion on April 8, 2013 using a conversion ratio of 1.2471.
______________________________
(1)
The interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities for the year.
(2)
The net interest margin represents net interest income as a percent of average interest-earning assets for the year.
(3)
Net interest income excluding accretion and amortization of loss share loans receivable divided by average net interest earning assets excluding average loan accretable discounts in the amount of $4.9 million, $9.2 million, $17.9 million, $14.7 million, and $26.7 million for the years ended September 30, 2014, 2013, 2012, 2011 and 2010, respectively.
(4)
The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income.
(5)
The dividend payout ratio represents total dividends declared and not waived by First Charter, MHC as applicable prior to the completion of the conversion divided by total net income.
(6)
Excludes covered assets consisting of assets of Neighborhood Community Bank, McIntosh Commercial Bank, and The First National Bank of Florida acquired from the FDIC that are still subject to loss sharing agreements. Non-covered assets consist of assets other than covered assets, including acquired NCB loans that are no longer covered under the non-single family loss sharing agreement with the FDIC.
(7)
We also had $5.6 million of covered other real estate owned at September 30, 2014, representing 0.55% of consolidated assets. Loss sharing agreements cover any losses upon disposition of such assets at either 95% or 80%.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities, mortgage-backed securities, collateralized mortgage obligations and other interest-earning assets (primarily cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting primarily of deposits and Federal Home Loan Bank advances.
Our business is affected by prevailing general and local economic conditions, particularly market interest rates, and by government policies concerning, among other things, monetary and fiscal affairs and housing. In addition, we are subject to extensive regulations applicable to financial institutions, lending and other operations, privacy, and consumer disclosure.
As a result of our loan underwriting policies, management believes that we have not suffered the same level of loan losses during the recent economic downturn as many financial institutions in our market area. Consequently, we have been able to take advantage of attractive low-risk opportunities to enhance our banking franchise through the purchase of distressed banking franchises from the FDIC.
On April 8, 2013, we completed our conversion from the mutual holding company to the stock holding company form of organization. As a result of the stock offering, we received gross proceeds of $142.9 million.
Our net income decreased $301,000 and totaled $6.0 million for the year ended September 30, 2014, from $6.3 million for the year ended September 30, 2013. The decrease in net income for fiscal 2014 resulted primarily from a $5.8 million decrease in discount accretion and amortization of the FDIC loss share receivable, partially offset by an increase to noninterest income and decreases to both interest expense and provision for loan losses. Net interest income decreased $5.4 million to $29.9 million for the year ended September 30, 2014 due to lower average yields on loans and a decline in accretion income on acquired covered loans which was partially offset by a decrease in interest expense on certificates of deposit and borrowings. Our provision for non-covered loan losses was $300,000 for the year ended September 30, 2014 compared to $1.4 million for the year ended September 30, 2013. This decrease in the provision for non-covered loan losses was a result of an approximately $1.0 million decline in net charge-offs for the year ended September 30, 2014 compared with fiscal 2013, as well as an overall improvement in the asset quality of our non-covered loan portfolio. Our provision for covered loan losses decreased $1.1 million for the year ended September 30, 2014 compared to fiscal 2013 due to improved credit quality and the resolution of problem assets. Noninterest income increased $2.6 million to $14.3 million for the year ended September 30, 2014 due primarily to an increase in bankcard and deposit fees as well as a one-time true-up receipt from the completion and renegotiation of a processing contract. Noninterest expense decreased slightly to $36.2 million for the year ended September 30, 2014.
Our net income increased $1.3 million and totaled $6.3 million for the year ended September 30, 2013, from $5.0 million for the year ended September 30, 2012. The increase in net income for fiscal 2013 resulted primarily from decreases in noninterest expense and provision for loan losses and was partially offset by a decrease in net interest income and an increase in income tax expense. Net interest income decreased $2.2 million to $35.3 million for the year ended September 30, 2013 due primarily to a decrease in average loan balances and was partially offset by a decrease in interest expense on certificates of deposit and borrowings. Noninterest income decreased $1.3 million to $11.7 million for the year ended September 30, 2013 due primarily to decreases in FDIC indemnification asset income and gain on sale of securities available for sale, partially offset by increased fee income on deposits. Most of the reduction in the FDIC indemnification asset income was due to amortization of impairment. During the year ended September 30, 2013, we reduced income by $0.6 million and based on September 30, 2013 estimates of cash flows, have $0.7 million remaining to be amortized. Our provision for non-covered loan losses was $1.4 million for the year ended September 30, 2013 compared to $3.3 million for the year ended September 30, 2012. This decrease in the provision for non-covered loan loss was a result of a decrease in net charge-offs for the year ended September 30, 2013 as compared to a $1.2 million charge-off of specific allowances of impaired loans as required by the Office of the Comptroller of the Currency policy for the year ended September 30, 2012 as we converted to being regulated by the Office of the Comptroller of the Currency instead of the Office of Thrift Supervision. Noninterest expense decreased $4.0 million to $36.3 million for the year ended September 30, 2013 due primarily to a decrease in cost of Real Estate Owned (“REO”) and decreases in compensation expense and marketing expense both due to increased 2012 costs related to acquisitions.
Business Strategy
Our business strategy is to operate as a well-capitalized and profitable community bank dedicated to providing exceptional personal service to our individual and business customers. We believe that we have a competitive advantage in the markets we serve because of our knowledge of the local marketplace and our long-standing history of providing superior, relationship-based
customer service. This 60-year history in the community, combined with management’s extensive experience and adherence to conservative underwriting standards through numerous business cycles, has enabled us to maintain a strong capital position with favorable credit quality metrics despite the economic downturn. On April 8, 2013, we completed our conversion from the mutual holding company form of organization to the fully public stock holding company form of organization and raised $142.9 million in gross offering proceeds from the related stock offering. We intend to continue to manage our capital position in order to provide value to our shareholders through actions such as paying cash dividends and in the near term, repurchasing shares of common stock. The Company currently pays a quarterly cash dividend of $0.05 per share and paid a special dividend of $0.25 per share to shareholders in fiscal 2013. Additionally, during the year ended September 30, 2014, we completed three stock buyback programs whereby 4.9 million shares, or approximately 21% of our common stock were repurchased. In September 2014, we announced the approval of a new stock buyback program for up to 1.8 million shares, or approximately 10% of our outstanding shares, of which 1.2 million were repurchased subsequent to fiscal year end for an average price of $10.93 per share. The 6.1 million of total shares repurchased since December 2013 through December 5, 2014 were purchased at a combined discount to tangible book value of $6.6 million.
We believe that the current economic and financial services environment presents a significant opportunity for us to grow our retail banking operations. Through our FDIC-assisted acquisitions in June 2009, March 2010 and September 2011, we acquired sixteen full-service branch offices, of which six were retained. We also acquired deposits of $721.0 million in the three transactions. In each of the FDIC-assisted acquisitions, we participated in a competitive bid process in which we offered an asset discount bid on net assets acquired and no deposit premium. We also entered into loss sharing agreements with the FDIC which cover a majority of the assets acquired (referred to as “covered assets”) and provide for substantial protection on losses associated with the covered assets. See “FDIC-Assisted Acquisitions” below.
Based on the persistent challenges presented by the economic and regulatory climate along with increased compliance costs and an accelerated need for economies of scale, we expect there to be a significant amount of unassisted consolidation in our banking markets which we intend to explore as opportunities arise. We believe that our strong financial condition and capital position are desirable traits for smaller community banking institutions seeking a merger partner. Our knowledge of the marketplace and our experienced management team, together with our experience in managing problem assets acquired from the FDIC in the NCB, MCB, and FNB transactions position us to take advantage of future opportunities to acquire financial institutions.
Key aspects of our business strategy include the following:
•
Leverage capital through disciplined acquisitions. The economy and banking industry in our market area of west-central Georgia, east-central Alabama and the Florida Panhandle continue to face significant challenges as many banks have experienced capital and liquidity losses as a result of significant charge-offs associated with troubled loan credits. These challenges have created strategic growth opportunities for us. Our discipline and selectivity in identifying target franchises, along with our successful history of working with the FDIC, such as in the NCB, MCB and FNB transactions, and the additional capital raised through our second-step conversion provide us an advantage in pursuing and consummating future acquisitions. We intend to leverage our capital base and acquisition experience to selectively pursue conservatively structured unassisted transactions of select franchises that present attractive risk-adjusted returns. In addition, future acquisitions will enable us to further utilize our substantial infrastructure devoted to the workout of special assets.
•
Expand our retail banking franchise. Our focus is on growing our retail banking presence throughout the markets in west-central Georgia, east-central Alabama, and the Florida Panhandle, including our expanded retail footprint resulting from the NCB, MCB and FNB acquisitions, while reducing reliance on wholesale funding sources. Since September 30, 2010 we have reduced FHLB borrowings by $157.0 million and certificates of deposit by $279.0 million in our efforts to fund our balance sheet with core deposits (comprised of transaction, savings and money market accounts). Over this same time period we have increased core deposits from $313.2 million to $486.2 million while lowering our cost of funds from 2.55% for the year ended September 30, 2010 to 0.81% for the year ended September 30, 2014. These deposits provide a low cost source of funds for our lending operations, as well as a potential source of fee income.
We intend to build a diversified balance sheet to position us as a full-service community bank that offers both retail and commercial loan and deposit products to all markets within the I-85 corridor and the adjacent and other markets resulting from our acquisitions of NCB, MCB, and FNB. Moreover, we expect that the high level of customer service and expanded product offerings we provide, as well as our capital strength and financial position in an otherwise distressed banking market, will also facilitate organic growth and an opportunity to increase market share.
•
Provide quality customer service and convenience. In order to proactively address the needs of our clients, we continue to make and build out investments in infrastructure and technology to improve transactional efficiencies and minimize the amount of time required for customers to complete regular banking activities, such as making a deposit at a branch drive-thru. In addition, the customer experience is enhanced for in-branch transactions as unique amenities such as child-friendly
play areas, coffee cafes and change counters combine banking activities with everyday realities. To further emphasize convenience for our customers, we offer extended hours at the majority of our offices and alternative banking delivery systems, such as internet and mobile banking, that allow customers to pay bills, transfer funds and monitor account balances at any time. Additionally, we strive to create tailored products and services that are designed to meet the changing needs of our customers, such as our Rewards checking program discussed under the heading Item 1, Business “-Sources of Funds.”
•
Maintain strong asset quality. We emphasize a disciplined credit culture based on intimate market knowledge, close ties to our customers, sound underwriting standards and experienced loan officers. While the challenging operating environment which began several years ago contributed to an increase in problem assets, management’s primary objective has been to expeditiously reduce the level of nonperforming and classified assets through diligent monitoring and aggressive resolution efforts, including problem covered assets of NCB, MCB and FNB. The results of this effort are evidenced by our asset quality at September 30, 2014, with $6.0 million of non-performing assets not covered by loss sharing which represented 0.65% of total non-covered assets. This is compared to $4.5 million, or 0.49% of total non-covered assets, and $5.6 million, or 0.69% of total non-covered assets, of non-performing assets not covered by loss sharing at September 30, 2013 and September 30, 2012, respectively. Our ratio of allowance for loan losses to non-covered non-performing loans was 199.64% at September 30, 2014.
We have a dedicated problem asset resolution team with experienced leadership to resolve nonperforming assets and classified assets acquired in the NCB, MCB and FNB transactions. While the majority of these nonperforming assets do not pose a significant credit risk because they are substantially covered under loss sharing agreements with the FDIC, reducing the amount of contractually non-performing assets acquired in the NCB, MCB and FNB acquisitions will reduce the cost of carrying these assets. Covered loans are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan when cash flows are reasonably estimable. Accordingly, covered loans that are contractually past due are still considered to be accruing and performing loans. See -Asset Quality for additional detail.
•
Focus on relationship-driven banking. We are focused on meeting the financial needs of our customer base through offering a full complement of loan, deposit and online banking solutions (i.e. internet banking and mobile banking). Over the years we have introduced new products and services in order to more fully serve and deepen the relationship with customers which has enabled us to grow our core deposit base, which generally represents a customer’s primary banking relationship. Our quality customer relationships and core competencies provide opportunities for cross selling products to existing customers in an effort to deepen our “share of wallet” and we intend to actively develop such opportunities.
•
Scalable operating platform. Our acquisitions of NCB in June 2009, MCB in March 2010, and FNB in September 2011 highlight our ability to capitalize on opportunities that offer attractive risk-adjusted returns and provide a template for future acquisitions. We have closed 12 branch locations, 10 of which were acquired in FDIC acquisitions, since 2009 as part of efforts to improve operational efficiency and will continue to focus our attention on other initiatives to increase franchise value.
FDIC Loss-Share Resolution
The three FDIC-assisted acquisitions between 2009 and 2011 extended our retail branch footprint as part of our efforts to increase our retail deposits and reduce our reliance on brokered deposits and borrowings as a significant source of funds. As of September 30, 2014, our net covered loans totaled $69.6 million, or 11.5% of total loans.
The following table presents the estimated losses and losses incurred on acquired assets covered under loss share agreements as of September 30, 2014:
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(1)
Claimed loans and other real estate owned losses including expenses, net of revenues.
Under the FNB loss share agreements, all losses (whether or not they exceed the intrinsic loss estimate) are reimbursable by the FDIC at 80% of the losses and reimbursable expenses paid. During the year ended September 30, 2013, the losses and reimbursable expenses claimed under the MCB loss share agreements exceeded the FDIC established threshold and became reimbursable at 95% rather than the 80% rate. Additionally, during the year ended September 30, 2014, the losses and reimbursable expenses claimed under the NCB loss share agreements exceeded the FDIC established threshold and became reimbursable at 95% rather than the 80% rate.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. They require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The following are the accounting policies that we believe are critical. For a discussion of recent accounting pronouncements, see Note 1 - Summary of Significant Accounting Policies in the Notes to our Financial Statements.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay.
We segment our allowance for loan losses into the following three major categories: (1) general allowances for Classified/Watch loans; (2) general allowances for loans with satisfactory ratings; and (3) an unallocated amount. Risk ratings are initially assigned in accordance with our loan and collection policy. A department independent from our loan origination staff reviews risk grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan based on the fair value of the collateral, if the loan is considered collateral-dependent, as the measure for the amount of the impairment. Impaired and Classified/Watch loans are aggressively monitored. The allowances for loans by credit grade are further subdivided by loan type. We have developed specific quantitative allowance factors to apply to each loan grade which considers loan charge-off experience over the most recent seven years by loan type. In addition, we apply loss estimates for certain qualitative allowance factors that are subjective in nature and require considerable judgment on the part of management. Such qualitative factors include economic and business conditions, the volume of past due loans, changes in the value of collateral in collateral-dependent loans, and other economic uncertainties. An unallocated component of the allowance is also for losses that specifically exist in the remainder of the portfolio, but have yet to be identified.
While management uses available information to recognize losses on loans, future additions or reductions to the allowance may be necessary based on changes in economic conditions or changes in accounting guidance on reserves. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The Company incorporates certain refinements and improvements to its allowance for loan losses methodology from time to time. During the year ended September 30, 2014, the Company made certain refinements in its allowance methodology. The Company increased the look back period of historical losses from 24 months to 84 months as net charge-offs were not as reflective of a full credit cycle for the two year period ended September 30, 2014 as compared with the seven year period ended September 30, 2014. In addition, some qualitative factors were removed and the loss allocation for qualitative risk factors was decreased to better reflect risks related to this period. The change in the historical look back period more closely aligns the quantitative aspect of the Company's allowance methodology with the risks inherent in a full credit cycle. The adjustments in our methodology were not material to the overall allowance or provision for the year ended September 30, 2014.
Management believes that the current allowance for non-covered loan losses is adequate. At September 30, 2014, we had 94.6% of our total non-covered loan portfolio secured by real estate, with commercial real estate loans comprising 55.0% of the total non-covered loan portfolio, one- to four-family residential mortgage loans comprising 28.0% of the total non-covered loan portfolio, and construction loans comprising 11.6% of the total non-covered loan portfolio. We carefully monitor our commercial real estate loans since the repayment of these loans is generally dependent upon earnings from the collateral real estate or the liquidation of the real estate and is affected by national and local economic conditions. For many owner-occupied commercial
real estate loans, debt service may be dependent upon cash flow from business operations. The residential category represents those loans we choose to maintain in our portfolio rather than selling into the secondary market. The residential loans held for sale category comprises loans that are in the process of being sold into the secondary market. The credit has been approved by the investor and the interest rate and purchase price fixed so we take no credit or interest rate risk with respect to these loans.
Relating to the FDIC-assisted acquisitions of the loans of NCB and FNB, we have established an allowance for loan losses for loans covered by loss-sharing agreements and such allowance for loan losses was $1.0 million at September 30, 2014. Management believes this allowance for covered loans is adequate.
Through the FDIC-assisted acquisitions of the loans of NCB, MCB, and FNB, we established nonaccretable discounts for the acquired impaired loans and we also established nonaccretable discounts for all other loans of MCB. These nonaccretable discounts were based on estimates of future cash flows. Subsequent to the acquisition dates, we continue to assess the experience of actual cash flows on a quarterly basis compared to our estimates. When we determine that nonaccretable discounts are insufficient to cover expected losses in the applicable covered loan portfolios, an allowance for covered loans is recorded with a corresponding provision for covered loan losses as a charge to earnings and an increase in the applicable FDIC receivable based on additional future cash expected to be received from the FDIC due to loss sharing indemnification.
Other-Than-Temporary Impairment of Investment Securities. A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and the establishment of a new cost basis for that security. In connection with the assessment for other-than-temporary impairment of investment securities, mortgage-backed securities, collateralized mortgage-backed securities and collateralized mortgage obligations, management obtains fair value estimates by independent quotations, assesses current credit ratings and related trends, reviews relevant delinquency and default information, assesses expected cash flows and coverage ratios, reviews average credit score data of underlying mortgages, and assesses other current data. The severity and duration of an impairment and the likelihood of potential recovery of an impairment is considered along with the intent and ability to hold any impaired security to maturity or recovery of carrying value.
Real Estate Owned. Real estate acquired through foreclosure, consisting of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, is reported on an individual asset basis at the lower of cost or fair value, less disposal costs. Fair value is determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized and charged to the allowance for loan losses. Subsequent write downs are charged to a separate allowance for losses pertaining to real estate owned, established through provisions for estimated losses on real estate owned which are charged to expense. Based upon management’s evaluation of the real estate acquired through foreclosure, additional expense is recorded when necessary in an amount sufficient to reflect any declines in estimated fair value. Gains and losses recognized on the disposition of the properties are recorded in noninterest expense in the consolidated statements of income.
Goodwill and Other Intangible Assets. Intangible assets include costs in excess of net assets acquired and deposit premiums recorded in connection with the acquisitions. In accordance with accounting requirements, we test our goodwill for impairment annually or more frequently as circumstances and events may warrant. No impairment charges have been recognized through September 30, 2014.
Deferred Income Taxes. Management estimates income tax expense using the asset and liability method. Under this method, deferred income tax assets and liabilities are recognized for future income tax consequences attributable to differences between the amount of assets and liabilities reported in the consolidated financial statements and their respective tax bases. In estimating the liabilities and corresponding expense related to income taxes, management assesses the relative merits and risks of various tax positions considering statutory, judicial and regulatory guidance. Because of the complexity of tax laws and regulations, interpretation is difficult and subject to differing judgments. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management’s determination of the realization of the net deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. Management has determined that no valuation allowances were necessary relating to the realization of its deferred tax assets.
Changes in the estimate of income tax liabilities occur periodically due to changes in actual or estimated future tax rates and projections of taxable income, interpretations of tax laws, the complexities of multi-state income tax reporting, the status of examinations being conducted by various taxing authorities and the impact of newly enacted legislation or guidance as well as income tax accounting pronouncements.
Receivable from FDIC Under Loss Sharing Agreements. Under loss sharing agreements with the FDIC, we recorded a receivable from the FDIC equal to 80 percent or 95 percent, as applicable, of the estimated losses in the covered loans and other real estate acquired in an FDIC-assisted transaction. The receivable was recorded at the present value of the estimated cash flows at the date of the acquisition and is reviewed and updated prospectively as loss estimates related to covered loans and other real estate acquired through foreclosure change. Most third party expenses on other acquired real estate and covered impaired loans are covered under the loss sharing agreements and the cash flows from the reimbursable portion are included in the estimate of the FDIC receivable when incurred.
Estimation of Fair Value. The estimation of fair value is significant to certain of our assets, including investment securities available for sale, other real estate owned, assets and liabilities subject to acquisition accounting and the value of loan collateral for impaired loans. These are all recorded at either fair value or the lower of cost or fair value. Fair values are determined based on third party sources, when available. Furthermore, generally accepted accounting principles require disclosure of the fair value of financial instruments as a part of the notes to the consolidated financial statements. Fair values may be influenced by a number of factors, including market interest rates, prepayment speeds, liquidity considerations, discount rates and the shape of yield curves. For additional information relating to the fair value of our financial instruments, see Note 15 - Fair Value of Financial Instruments and Fair Value Measurement in the consolidated financial statements.
Comparison of Financial Condition at September 30, 2014 and 2013
Assets. Total assets decreased $79.0 million, or 7.3%, to $1.0 billion at September 30, 2014, compared to $1.1 billion at September 30, 2013. Assets decreased primarily due to declines in cash and cash equivalents, securities available for sale and FDIC receivable for loss sharing agreements of $62.0 million, $26.4 million and $19.4 million, respectively, partially offset by an increase in net loans of $26.5 million.
Cash and cash equivalents. Cash and cash equivalents declined to $99.5 million at September 30, 2014, down from $161.5 million at September 30, 2013. This decrease was primarily the result of the Company's share repurchase programs during fiscal 2014 along with funding the increase in total loans.
Loans. At September 30, 2014, total loans were $606.4 million, or 60.0% of total assets. During the year ended September 30, 2014, our total loan portfolio increased by $26.5 million, or 4.6%. The increase was primarily due to an increase of $65.9 million, or 14.0%, in net loans not covered by loss sharing agreements, partially offset by a reduction of balances of acquired loan portfolios covered by loss sharing agreements. Of the $65.9 million in net non-covered loan growth, $8.3 million was due to a transfer of non-single family loans that are no longer covered by the FDIC due to the expiration of the NCB non-single family loss sharing agreement during fiscal 2014. Of the $606.4 million in net loans as of September 30, 2014, $69.6 million were covered by FDIC loss sharing agreements.
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(1)
Non-covered loans are shown net of deferred loan fees and allowance for loan losses.
(2)
Covered loans are shown net of deferred loan fees, allowances, nonaccretable differences and accretable discounts.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at the dates indicated.
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(1)
Excludes loans held for sale of $2.1 million, $1.9 million, $2.7 million, $0.3 million and $2.1 million at September 30, 2014, 2013, 2012, 2011 and 2010, respectively.
(2)
Net of undisbursed proceeds on loans-in-process.
(3)
Consists of loans and commitments acquired in the NCB, MCB, and FNB acquisitions that are covered by loss sharing agreements with the FDIC. Such amounts are presented net of nonaccretable discounts of $6.3 million, $10.8 million, $19.4 million, $69.1 million and $52.9 million at September 30, 2014, 2013, 2012, 2011 and 2010, respectively.
(4)
See Note 5 - Loans Receivable in the Notes to our Consolidated Financial Statements.
Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2014. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
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(1)
Includes $10.7 million of covered loans.
(2)
Includes $61.3 million of covered loans.
(3)
Includes $3.5 million of covered loans.
(4)
Presented net of undisbursed proceeds on loans-in-progress.
(5)
Includes $0.1 million of covered loans.
(6)
Excludes accretable discounts, allowance for loan losses on noncovered loans, and net deferred loan fees on both covered and noncovered loans.
(7)
Does not include any accretable discount associated with FDIC Covered Loans.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2014 that are contractually due after September 30, 2015.
Investment and Mortgage Securities Portfolio. At September 30, 2014, our investment and mortgage securities portfolio totaled $188.7 million, compared to $215.1 million at September 30, 2013. The decrease was attributable to $15.4 million in securities that were called or matured, $9.7 million in net sales and $26.8 million in principal paydowns, partially offset by $23.9 million in securities purchased and a $1.6 million decrease in unrealized losses on available for sale securities during fiscal 2014. During 2012, we also had approximately $273,000 in other-than-temporary impairment charges on non-government agency collateralized mortgage obligations. There were no other-than-temporary impairment charges in 2014 or 2013.
We review our investment portfolio on a quarterly basis for indications of impairment. In addition to management’s intent and ability to hold the investments to maturity or recovery of carrying value, the review for impairment includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer. Our review of mortgage securities includes loan geography, loan to value ratios, credit scores, types of loans, loan vintage, credit ratings, loss coverage from tranches less senior than our investment tranche and cash flow analysis. Our investments are evaluated using our best estimate of future cash flows. If, based on our estimate of cash flows, we determine that an adverse change has occurred, other-than-temporary impairment would be recognized for the credit loss. At September 30, 2014, we held one private-label security which had a cumulative $380,000 other-than-temporary impairment charge recorded in prior years.
The following table sets forth the composition of our investment and mortgage securities portfolio at the dates indicated. At September 30, 2014, all investment and mortgage securities were classified as available for sale.
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(1)
Includes private-label mortgage securities. See Note 4 - Securities Available for Sale in the Notes to Consolidated Financial Statements.
We analyze our non-agency collateralized mortgage securities for other-than-temporary impairment at least quarterly. We use a multi-step approach using Bloomberg analytics considering market price, ratings, ratings changes, and underlying mortgage performance including delinquencies, foreclosures, deal structure, underlying collateral losses, prepayments, loan-to-value ratios, credit scores, and loan structure and underwriting, among other factors. We apply the Bloomberg default model, and if the bond shows no losses we consider it not other-than-temporarily impaired. If a bond shows losses or a break in yield with the Bloomberg default model, we create a probable vector of loss severities and defaults and if it shows a loss we consider it other-than-temporarily impaired.
Cash flow analysis indicates that the yields on all of the private-label securities noted above are maintained. The unrealized losses may relate to general market liquidity and, in the securities with the larger unrealized losses, weakness in the underlying collateral, market concerns over foreclosure levels, and geographic concentration. We consider these unrealized losses to be temporary impairment losses primarily because cash flow analysis indicates that there are continued sufficient levels of credit enhancements and credit coverage levels of less senior tranches. As of September 30, 2014, the private-label securities were classified as available for sale and a cumulative $380,000 other-than-temporary impairment charge had been recorded in prior periods. Based on the analysis performed by management as of September 30, 2014, we deemed it probable that all contractual principal and interest payments other than the single security identified above as being other-than-temporarily impaired, will be collected and therefore there is no new other-than-temporary impairment. See Note 4 - Securities Available for Sale in our Financial Statements for further information.
Securities Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at September 30, 2014 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect scheduled amortization or the impact of prepayments or redemptions that may occur.
Bank Owned Life Insurance. We invest in bank owned life insurance to provide us with a funding source for our benefit plan obligations. Bank owned life insurance also generally provides us non-interest income that is non-taxable. The total cash surrender values of such policies at September 30, 2014 and 2013 were $47.2 million and $39.8 million, respectively.
Deposits. Total deposits decreased $34.1 million, or 4.54%, to $717.2 million at September 30, 2014 from $751.3 million at September 30, 2013. The decrease was caused primarily by a $39.5 million decline in retail certificates of deposit from acquired institutions, a $7.1 million decline in money market accounts and a $5.4 million decline in wholesale time deposits, partially offset by a $17.7 million increase in transaction accounts. We reduced the rates paid on the certificates of deposit to better match our interest-bearing liabilities with loans. At September 30, 2014, all of our deposits were retail deposits while $745.9 million of deposits were retail deposits and $5.4 million were brokered and other wholesale deposits at September 30, 2013. Funds on deposit from internet services and brokered deposits are considered as wholesale deposits.
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(1)
March 31, 2013 core deposits were reduced by $138.6 million of deposits held by the Bank for stock orders from the second-step conversion which closed April 8, 2013.
The following table sets forth the distribution of total deposit accounts, by account type, for the periods indicated.
The following table sets forth certificates of deposit classified by interest rate as of the dates indicated.
The following table sets forth, by interest rate ranges, information concerning our certificates of deposit.
As of September 30, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $250,000 was approximately $23.6 million. As of September 30, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $110.4 million. The following table sets forth the maturity of those certificates greater than or equal to $100,000 as of September 30, 2014.
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(1)
Retail certificates of deposit consist of deposits held directly by customers. The weighted average interest rate for all retail certificates of deposit at September 30, 2014, was 1.07%.
(2)
Wholesale certificates of deposit include brokered deposits and deposits from other financial institutions.
Borrowings. Our borrowings consist of advances from the Federal Home Loan Bank of Atlanta. From time to time, our borrowings also have included securities sold under agreements to repurchase. At September 30, 2014, borrowings totaled $55.0 million, a decrease of $5.0 million from September 30, 2013. The decrease was due to the payoff of maturing, high rate Federal Home Loan Bank advances in March 2014.
At September 30, 2014, we had available Federal Home Loan Bank advances of up to $310.7 million under existing lines of credit of which $55.0 million was advanced and $255.7 million was available. Based upon available investment and loan collateral except cash, additional advances of $168.9 million were available at September 30, 2014. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances at the dates and for the years indicated.
At September 30, 2014, approximately $65.8 million of credit was available to us at the Federal Reserve Bank based on loan collateral pledged. The credit at the Federal Reserve Bank was not used other than periodic tests to ensure the line was functional.
Stockholders’ Equity. At September 30, 2014, total stockholders’ equity totaled $225.0 million (or $12.32 per share), a $48.8 million decrease from September 30, 2013. The decline was primarily due to $53.2 million of shares repurchased during the year ended September 30, 2014 as well as $4.2 million in dividends paid to stockholders. The decrease was partially offset by $6.0 million of net income and a decrease in unrealized losses on securities available for sale of $1.1 million during fiscal 2014.
Average Balances and Yields
The following table sets forth average balance sheets, average yields and costs, and certain other information for the years indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
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(1)
Tax exempt or tax-advantaged securities and loans are shown at their contractual yields and are not shown at a tax equivalent yield.
(2)
Includes net loan fees deferred and accreted pursuant to applicable accounting requirements.
(3)
Interest income on loans is interest income as recorded in the income statement and, therefore, does not include interest income on nonaccrual loans.
(4)
Interest income on loans excludes discount accretion and amortization of the indemnification asset.
(5)
Accretion of accretable purchase discount on loans acquired in FDIC-assisted acquisitions and amortization of the overstatement of FDIC indemnification asset.
(6)
Net interest-earning assets represent total average interest-earning assets less total average interest-bearing liabilities.
(7)
Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.
(8)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
(9)
Net interest margin, excluding the effects of purchase accounting represents net interest income excluding accretion and amortization of loss share loans receivable as a percentage of average net interest earning assets excluding loan accretable discounts in the amount of $4.9 million, $9.2 million and $17.9 million for the years ended September 30, 2014, 2013 and 2012, respectively.
Rate/Volume Analysis
The following tables present the effects of changing rates and volumes on our net interest income for the fiscal years indicated. The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The combined column represents the net change in volume between the two periods multiplied by the net change in rate between the two periods. The net column represents the sum of the prior columns.
Comparison of Operating Results for the Years Ended September 30, 2014 and 2013
General. Net income decreased $301,000, or 4.8%, to $6.0 million for the year ended September 30, 2014 from $6.3 million for the year ended September 30, 2013. The decrease in net income for fiscal 2014 resulted primarily from a decrease in discount accretion and amortization of the FDIC loss share receivable, partially offset by an increase to noninterest income and decreases to both interest expense and provision for loan losses. Net interest income after provision for loan losses decreased $3.2 million, or 9.3%, to $30.6 million for the year ended September 30, 2014 from $33.8 million for the year ended September 30, 2013, primarily attributable to a $5.8 million decrease in discount accretion and amortization of the FDIC loss share receivable as well as a compression of loan and investment yields which caused a decrease in interest rate spread and net interest margin in fiscal 2014 as compared to fiscal 2013. Our provision for loan losses decreased $2.2 million for the year ended September 30, 2014 as compared to the prior year due to an overall improvement in the non-covered loan portfolio as well as improved credit quality and the resolution of problem assets on our covered loan portfolio. For the year ended September 30, 2014, our net interest margin decreased to 3.22% from 3.82% for the year ended September 30, 2013 due to lower interest rates related to interest-earning assets. Net interest margin, excluding accretion and amortization of loss share receivable, was 2.87% for the year ended September 30, 2014, compared with 2.82% for the year ended September 30, 2013. Noninterest income increased $2.6 million, or 22.52%, to $14.3 million for the year ended September 30, 2014 from $11.7 million for the year ended September 30, 2013, due primarily to an increase in bankcard and deposit fees as well as a one-time true-up receipt from the completion and renegotiation of a processing contract. Noninterest expense decreased slightly to $36.2 million for the year ended September 30, 2014 compared to $36.3 million for the year ended September 30, 2013. Noninterest expense experienced decreases in the net cost of real estate owned and other expenses, nearly offset by increases in salaries and employee benefits and federal deposit insurance premiums and other regulatory fees.
Interest Income. Total interest income decreased $7.0 million, or 16.4%, to $35.6 million for the year ended September 30, 2014 from $42.6 million for the year ended September 30, 2013 due primarily to a decrease in interest income on loans. Interest on loans decreased $3.8 million, or 9.8%, to $35.0 million for the year ended September 30, 2014 as a result of a lower average yield on loans. The average yield on loans declined to 5.36% for the year ended September 30, 2014 compared to 6.73% for the year ended September 30, 2013. The lower average yield on loans for the year ended September 30, 2014 was primarily attributable to a decrease in purchase discount accretion and the improvement in estimated cash flows related to covered loans resulting in amortization of the indemnification asset of $3.5 million, as well as continued low interest rates and the repayment of higher yielding loans. Our loans acquired through FDIC acquisitions carry higher yields than our legacy loan portfolio due to accretion. As our accretion income continues to decline in future periods, our net interest margin will likely also decline. The average balance of loans receivable increased $10.4 million to $587.5 million for the year ended September 30, 2014 compared to $577.1 million for the year ended September 30, 2013. We were able to increase the average balance of loans not covered by loss share agreements more than the decrease in the average balance of loans covered by loss share agreements due to loan repayments and charge-offs. We had $3.1 million of net discount accretion and amortization included in interest income for the year ended September 30, 2014 compared to $8.9 million for the year ended September 30, 2013. At September 30, 2014, there was currently projected to be $2.9 million in amortization and $6.0 million of discount remaining to accrete into interest income over the remaining life of all acquired loans with the accretion heavily weighted towards early quarters based on current cash flow projections.
The table below shows discount accretion and amortization included in income over the past six years and the remaining discount to be recognized:
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(1)
Based on revised estimated cash flows related to covered loans, as of September 30, 2014, it was determined that approximately $2.9 million of the FDIC indemnification asset will be amortized into interest income over the remaining life of the acquired loan pools or the agreements with the FDIC, whichever is shorter. $3.5 million was amortized as an offset to loan interest income in the year ended September 30, 2014.
(2)
Amortization of the FDIC indemnification asset due to improved estimated cash flows related to covered loans.
Interest on mortgage-backed securities and collateralized mortgage obligations increased $418,000 to $3.6 million for the year ended September 30, 2014 from $3.2 million for the year ended September 30, 2013, reflecting an 18 basis point increase in average yield to 1.99% and a $5.0 million increase in the average balance of such securities to $181.8 million.
Interest income on Federal Home Loan Bank of Atlanta common stock increased slightly to $135,000 for the year ended September 30, 2014 from $123,000 for the year ended September 30, 2013 as the FHLB dividend rate increased.
Interest on other investment securities, which consisted of agency and municipal securities decreased $103,000 to $72,000 for the year ended September 30, 2014 from $175,000 for the year ended September 30, 2013 as investment securities average balances declined by $7.0 million to $18.3 million for the year ended September 30, 2014, and the average yield of such securities decreased 29 basis points to 0.40%, for the year ended September 30, 2014, as interest rates remained low.
Interest on interest earning deposits increased slightly to $331,000 for the year ended September 30, 2014 from $328,000 for the year ended September 30, 2013 as the average yield went up one basis point.
Interest Expense. Total interest expense decreased $1.6 million, or 22.2%, to $5.7 million for the year ended September 30, 2014 compared to $7.4 million for the year ended September 30, 2013. Interest expense decreased due to a 14 basis point, or 14.7%, decrease in the average cost of interest-bearing liabilities to 0.81% for the year ended September 30, 2014 from 0.95% for the year ended September 30, 2013, reflecting continued low market interest rates. The average balance of interest-bearing liabilities decreased by $65.7 million, or 8.5%, to $707.5 million for the year ended September 30, 2014 compared to $773.2 million for the year ended September 30, 2013 as FHLB advances matured and were repaid and higher costing certificates of deposit acquired in FDIC acquisitions were reduced.
Interest expense on deposits decreased $1.0 million, or 23.3%, to $3.3 million for the year ended September 30, 2014 compared to $4.3 million for the year ended September 30, 2013. The decrease was due to an 11 basis point decrease in the average cost of deposits to 0.50% for fiscal year 2014, compared to 0.61% for the year ended September 30, 2013. The decrease in the average cost of deposits was largely due to lower market interest rates, an increase in the mix of lower costing demand deposits relative to higher costing certificates of deposit and the repricing downward of higher costing certificates of deposit. The average cost of NOW accounts decreased from 0.13% for the year ended September 30, 2013 to 0.11%, for the year ended September 30, 2014 as the average balance of such deposits increased $17.7 million, or 11.2%, for the year ended September 30, 2014 compared with the year ended September 30, 2013. The average cost on rewards checking decreased 11 basis points to 0.24% for the year ended September 30, 2014 compared to 0.35% for the year ended September 30, 2013. Rewards checking is a premium rate demand account based on average balance, electronic transaction activity, and other criteria. The average cost of savings accounts decreased three basis points to 0.02% for the year ended September 30, 2014 compared to 0.05% for the year ended September 30, 2013. The average cost of money market accounts decreased two basis points to 0.22% for the year ended September 30, 2014 compared to 0.24% for the year ended September 30, 2013. Interest expense on certificates of deposit decreased $866,000 to $2.7 million for the year ended September 30, 2014, from $3.5 million for the year ended September 30, 2013, reflecting the $56.2 million, or 18.2%, decrease in the average balance of such deposits and a nine basis point decrease in average certificate of deposit cost.
Interest expense on Federal Home Loan Bank advances decreased $644,000 to $2.5 million for the year ended September 30, 2014 compared to $3.1 million for fiscal 2013, due to a decrease of $17.0 million, or 22.9%, in the average balance of advances. There was, however, a 13 basis point increase in the average cost of advances for fiscal 2014 compared to fiscal 2013 due to lower costing advances maturing in March 2014 and September 2013, leaving us with higher rate advances at September 30, 2014.
Net Interest Income. Net interest income decreased $5.4 million, or 15.2%, to $29.9 million for the year ended September 30, 2014, compared to $35.3 million for the year ended September 30, 2013. The decrease was primarily due to a decrease in interest income of $7.0 million, partially offset by a decrease in interest expense of $1.6 million. Interest income decreased primarily due to lower average yields on loans and the impact of accretion income and FDIC loss share receivable amortization on acquired covered loans but was partially offset by increases in the average balances of loans receivable and mortgage-backed securities and collateralized mortgage obligations available for sale for the year ended September 30, 2014. The average yield on interest-earning assets decreased 78 basis points during the year ended September 30, 2014 as compared to the prior year.
Our net interest margin decreased 60 basis points to 3.22% for fiscal 2014 from 3.82% for fiscal 2013, while our net interest rate spread decreased 64 basis points to 3.02% for fiscal 2014 from 3.66% for fiscal 2013. Lower average yields on loans, due primarily to reduced accretion on acquired loans, was primarily responsible for the reduced net interest margin but was partially offset by lower average balances of certificates of deposit and FHLB advances and lower rates paid on the certificates of deposit. Net interest margin excluding the effects of purchase accounting was 2.87% for fiscal 2014 compared to 2.82% for fiscal 2013.
The decrease in interest expense was primarily due to decreases of $56.2 million and $17.0 million in the average balances of certificates of deposits and FHLB advances, respectively, combined with an 11 basis point decline in the average cost of total interest bearing deposits to 0.50% for the year ended September 30, 2014 from 0.61% for the year ended September 30, 2013.
Provision for Non-Covered Loan Losses. The provision for loan losses for the year ended September 30, 2014 was $300,000 for non-covered loans, compared to $1.4 million for non-covered loans for year ended September 30, 2013. The Company did not make a provision in the final three quarters of fiscal 2014 due to the trend of declining levels of net charge-offs, along with an overall improvement in the asset quality of the non-covered loan portfolio. Net charge-offs on non-covered loans decreased to $416,000 for the year ended September 30, 2014, from $1.4 million for the year ended September 30, 2013. The allowance for loan losses for non-covered loans was $8.5 million, or 1.55% of total non-covered loans receivable at September 30, 2014 compared to $8.2 million, or 1.70% of total non-covered loans receivable, at September 30, 2013. Our non-covered nonperforming loans increased to $4.2 million at September 30, 2014 from $2.9 million at September 30, 2013. As a result, our allowance as a percent of nonperforming non-covered loans decreased to 199.6% at September 30, 2014 compared to 280.3% at September 30, 2013.
Provision for Covered Loan Losses. For the year ended September 30, 2014, the reversal of provision for covered loan losses was $1.0 million compared to a provision expense of $89,000 for the year ended September 30, 2013. The reversal of provision for covered loans for the year ended September 30, 2014 was primarily due to the release of allowance reserves due to improved credit quality and resolution of problem assets. If future losses occur due to declines in the market during the periods covered by loss share agreements, the losses on loans acquired from both NCB and MCB will be reimbursed at 95% and FNB at 80% based on the terms of the FDIC loss sharing agreements. At September 30, 2014 covered loans totaled $69.6 million and is net of $13.3 million in related nonaccretable and accretable discounts and allowances, compared with $109.0 million, net of $19.6 million in related nonaccretable and accretable discounts and allowances, at September 30, 2013.
Noninterest Income. Noninterest income increased $2.6 million, or 22.5%, to $14.3 million for the year ended September 30, 2014 from $11.7 million for the year ended September 30, 2013. The increase was primarily attributable to an increase of $1.1 million in bankcard fees and a one-time true-up receipt from the completion and renegotiation of a processing contract of approximately $1.1 million in the year ended September 30, 2014. As the use of bankcards increase due to the continued transition from paper to electronic transactions, we have experienced significant growth in third-party processing fees associated with this increased usage.
The increase in noninterest income was partially offset by decreases in gains on the sale of loans and servicing released fees and FDIC receivable accretion during the year ended September 30, 2014. Gains on the sale of loans and servicing released fees decreased $231,000 as a result of lower mortgage loan production due to lower loan refinances in this fiscal year. Discount accretion on FDIC-assisted transactions declined $208,000 for the year ended September 30, 2014 compared to the prior year, due to a decline in covered loans during the year as well as impairments of $522,000 recorded on the FDIC indemnification asset during the year ended September 30, 2014 due to an assessment of the collectability of previous loss estimates which established the covered portion of the allowance for loan losses. Additionally, a $248,000 write down of fixed assets associated with a branch that was closed in the fourth quarter of fiscal 2014 was recorded in the year ended September 30, 2014.
Noninterest Expense. Total noninterest expense decreased slightly to $36.2 million for the year ended September 30, 2014 compared with $36.3 million for the year ended September 30, 2013. The decrease was due in part to a decrease in the net cost of real estate owned of $583,000 due to a $1.2 million decrease in provisions recorded for valuation allowances in the year ended
September 30, 2014, as compared to the year ended September 30, 2013, and a decrease in other noninterest expense of $798,000 largely related to a write-down of an asset available for sale recorded in fiscal 2013.
These decreases were nearly offset by increases in salaries and employee benefits of $1.3 million due to stock awards being granted during the year ended September 30, 2014, and federal insurance premiums and other regulatory fees of $302,000.
Income Taxes. Income taxes decreased to $2.7 million for year ended September 30, 2014 from $2.9 million for the year ended September 30, 2013 due to a decrease in our income before provision for income taxes of $428,000. Our effective tax rate was 31.53% in the year ended September 30, 2014 and 31.44% in the year ended September 30, 2013.
Comparison of Operating Results for the Years Ended September 30, 2013 and 2012
General. Net income increased $1.3 million, or 25.7%, to $6.3 million for the year ended September 30, 2013 from $5.0 million for the year ended September 30, 2012. Net interest income after provision for loan losses increased $0.8 million, or 2.3%, to $33.8 million for the year ended September 30, 2013 from $33.0 million for the year ended September 30, 2012, reflecting decreased provision for loan losses but partially offset by the compression of loan and investment yields causing decreased interest rate spreads and net interest margins. Our provision for loan losses decreased $3.0 million for the year ended September 30, 2013 as compared to the prior year due to a decrease in net charge-offs during 2013. For the year ended September 30, 2013, our net interest margin declined to 3.82% from 4.17% for the year ended September 30, 2012, due to lower interest rates related to interest-earning assets and an increase in lower yielding cash and cash equivalents from our conversion and stock offering completed on April 8, 2013. Net interest margin without accretion for the years ended September 30, 2013 and 2012, was 2.82% and 3.11%, respectively. Noninterest income decreased $1.3 million, or 9.8%, to $11.7 million for the year ended September 30, 2013 from $12.9 million for the year ended September 30, 2012, due primarily to a decrease in the FDIC receivable. Noninterest expense decreased $4.0 million to $36.3 million for the year ended September 30, 2013 from $40.3 million for the year ended September 30, 2012, due primarily to decreases in net cost of REO, salaries and employee benefits expense and marketing expense.
Interest Income. Total interest income decreased $5.5 million, or 11.4%, to $42.6 million for the year ended September 30, 2013 from $48.1 million for the year ended September 30, 2012 due primarily to a decrease in loan receivable income. Interest on loans decreased $5.4 million, or 12.2%, to $38.8 million for the year ended September 30, 2013 as a result of the $64.2 million, or 10.0%, decrease in the average balance of loans receivable to $577.1 million for the year ended September 30, 2013. Our average yields on covered loans are higher than the average yields on non-covered loans. The decreased volume of loans during the year ended September 30, 2013 was primarily in the covered loan portfolio. The average yield on loans declined slightly to 6.73% for fiscal 2013 compared to 6.89% for fiscal 2012. As our percentage of covered loans to total loans declines and discount accretion runs off in future periods, our net interest margin will likely continue to decline.
Interest on mortgage-backed securities and collateralized mortgage obligations decreased $0.2 million to $3.2 million for the year ended September 30, 2013 from $3.4 million for the year ended September 30, 2012, reflecting a 37 basis point decrease
in average yield to 1.81%, partially offset by a $22.1 million, or 14.3%, increase in the average balance of such securities to $176.8 million.
Interest income on Federal Home Loan Bank of Atlanta common stock increased slightly to $123,000 for the year ended September 30, 2013 from $115,000 for the year ended September 30, 2012 as the FHLB dividend rate increased.
Interest on other investment securities, which consisted of agency and municipal securities decreased $87,000 to $175,000 for the year ended September 30, 2013 from $262,000 for the year ended September 30, 2012 as investment securities average balances decreased by $2.1 million to $25.3 million for the year ended September 30, 2013, and the average yield of such securities decreased 27 basis points to 0.69%, for the year ended September 30, 2013, as interest rates remain low.
Interest on interest earning deposits increased $167,000 to $328,000 for the year ended September 30, 2013 from $161,000 for the year ended September 30, 2012 as the average balance of interest earning deposit increased $71.9 million as a result of the investment of proceeds from our conversion and stock offering completed on April 8, 2013.
Interest Expense. Total interest expense decreased $3.2 million, or 30.5%, to $7.4 million for the year ended September 30, 2013 compared to $10.6 million for the year ended September 30, 2012, primarily as a result of lower interest expenses on certificates of deposit and borrowings. Components of interest expense changed with an increase in lower costing demand deposits resulting in a 28 basis point, or 22.8%, decrease in the average cost of interest-bearing liabilities to 0.95% for fiscal 2013 from 1.23% for fiscal 2012, reflecting low market interest rates. The average balance of interest-bearing liabilities decreased $86.7 million, or 10.1%, to $773.2 million for the year ended September 30, 2013 compared to $859.9 million for the year ended September 30, 2012, as higher costing FHLB advances matured and were repaid during the current year and through a reduction of higher cost certificates of deposit primarily acquired in FDIC acquisitions.
Interest expense on deposits decreased $2.4 million, or 35.7%, to $4.2 million for the year ended September 30, 2013 compared to $6.6 million for the year ended September 30, 2012. The decrease was due to a 25 basis point decrease in the average cost of deposits to 0.61% for fiscal year 2013, compared to 0.86% for the year ended September 30, 2012. The decrease in the average cost of deposits was largely due to lower market interest rates, an increase in the mix of lower costing demand deposits relative to higher costing certificates of deposit and the repricing downward of higher costing certificates of deposit. The average cost of NOW accounts decreased from 0.16% for the year ended September 30, 2012 to 0.13%, for the year ended September 30, 2013. The average cost on rewards checking decreased 24 basis points to 0.35% for the year ended September 30, 2013 compared to 0.59% for the year ended September 30, 2012. Rewards checking is a premium rate demand account based on average balance, electronic transaction activity, and other criteria. The average cost of savings accounts decreased 14 basis points to 0.05% for the year ended September 30, 2013 compared to 0.19% for the year ended September 30, 2012, due to a decrease of $4.5 million, or 8.3%, in the average balance of savings accounts. The average cost of money market accounts decreased 13 basis points to 0.24% for the year ended September 30, 2013 compared to 0.37% for the year ended September 30, 2012. Interest expense on certificates of deposit decreased $2.0 million to $3.5 million for the year ended September 30, 2013, from $5.5 million for the year ended September 30, 2012, reflecting the $76.1 million, or 19.8%, decrease in the average balance of such deposits and a 28 basis point decrease in average certificate of deposit cost. Interest expense on Federal Home Loan Bank advances decreased $876,000 to $3.1 million for the year ended September 30, 2013 compared to $4.0 million for fiscal 2012, due to a decrease of $20.0 million, or 21.2%, in the average balance of advances. There was a 4 basis point decrease in the average cost of advances for fiscal 2013 compared to fiscal 2012.
Net Interest Income. Net interest income decreased $2.2 million, or 6.0%, to $35.3 million for the year ended September 30, 2013, compared to $37.5 million for the year ended September 30, 2012. The decrease was primarily due to a decrease in interest income of $5.5 million, partially offset by a decrease in interest expense of $3.2 million. Interest income decreased primarily due to the decrease in the average balance of loans receivable of $64.2 million partially offset by an increase in the average balance of interest-earning deposits of $71.9 million for the year ended September 30, 2013.
Our net interest margin decreased 35 basis points to 3.82% for fiscal 2013 from 4.17% for fiscal 2012, while our net interest rate spread decreased 46 basis points to 3.66% for fiscal 2013 from 4.12% for fiscal 2012. Lower average balances on loans outstanding, partially offset by lower rates paid on certificates of deposits contributed to reduced net interest margin. The net interest margin without accretion for the years ended September 30, 2013 and 2012, was 2.82% and 3.11%, respectively.
The decrease in interest expense was due to a 25 basis point decline in the average cost of total interest bearing deposits to 0.61% for the year ended September 30, 2013 from 0.86% for the year ended September 30, 2012, and a decrease of $20.0 million in the average balance of borrowed funds for the year ended September 30, 2013.
Provision for Non-Covered Loan Losses. The provision for loan losses for the year ended September 30, 2013 was $1.4 million for non-covered loans, compared to $3.3 million for non-covered loans for year ended September 30, 2012. Net charge-offs on non-covered loans decreased to $1.4 million for the year ended September 30, 2013, from $4.5 million for the year ended
September 30, 2012. The allowance for loan losses for non-covered loans was $8.2 million, or 1.70% of total non-covered loans receivable at September 30, 2013 compared to $8.2 million, or 1.87% of total non-covered loans receivable, at September 30, 2012. Our nonperforming loans declined to $2.9 million at September 30, 2013 from $3.4 million at September 30, 2012. As a result, our allowance as a percent of nonperforming non-covered loans increased to 280.3% at September 30, 2013 compared to 237.7% at September 30, 2012. In addition, our two-year historical loss experience in all but one loan category, which is a determining factor in our required provision, improved at September 30, 2013 as compared to September 30, 2012.
Provision for Covered Loan Losses. Provision for covered loan losses for the year ended September 30, 2013 decreased $1.1 million to $89,000 from $1.2 million for the year ended September 30, 2012. If there are future losses due to declines in the market, the losses on loans acquired from both NCB and MCB will be reimbursed at 95% and FNB at 80%. The FNB agreement provides that all losses are reimbursed at 80%. At September 30, 2013 there were $128.6 million in covered loans, with $14.8 million in related nonaccretable differences and allowances.
Noninterest Income. Noninterest income decreased $1.3 million, or 9.8%, to $11.7 million for the year ended September 30, 2013 from $12.9 million for the year ended September 30, 2012. Discount accretion on FDIC-assisted transactions declined $1.4 million to $33,000 for the year ended September 30, 2013 from $1.5 million for the year ended September 30, 2012, due to a decline in covered loans during that same period as well as impairments of $642,000 recorded on the FDIC indemnification asset during the year ended September 30, 2013 due to an assessment of the collectability of previous loss estimates which established the covered portion of the allowance for loan losses. Net gains on the sale of securities declined $690,000 to $250,000 for the year ended September 30, 2013, from $940,000 for the year ended September 30, 2012. The fiscal year ended September 30, 2012, included charges of $273,000 for other-than-temporary impairment of non-agency collateralized mortgage-backed securities, of which there were none in the year ended September 30, 2013. The declines in noninterest income were partially offset by an increase of $743,000, or 10.6%, in fees on deposits due primarily to increases in network exchange fees and slight increases in NSF and other deposit service charges. Gains on loans and servicing release fees increased $373,000 as a result of higher mortgage loan production.
Noninterest Expense. Total noninterest expense decreased $4.0 million, or 9.9%, to $36.3 million for the year ended September 30, 2013, compared to $40.3 million for the year ended September 30, 2012. The decrease was primarily due to lower costs associated with other real estate owned operations and salaries and employee benefits expense in the year ended September 30, 2013. The decrease in compensation costs was primarily due to higher personnel and occupancy costs associated with the acquisition of FNB assets incurred in the year ended September 30, 2012. During the year ended September 30, 2013, net cost of operations of other real estate owned properties decreased $1.1 million or 52.6% to $1.0 million partially as a result of the recognition of a $450,000 deferred gain on a property previously sold and gains recognized on other properties. Occupancy expense declined $497,000 or 6.4% and salaries and employee benefits decreased $874,000 or 4.5% primarily due to costs related to the FNB acquisition in the prior year referenced above. Marketing expenses decreased $581,000 or 31.0% due to higher costs relating to our entry into the FNB marketplace during the year ended September 30, 2012. The $761,000 decline in FDIC insurance premiums and other regulatory fees was a result of lower regulatory fees as well as the early recognition in the previous year of the FDIC prepaid assessment.
Income Taxes. Income taxes increased to $2.9 million for the year ended September 30, 2013 from $639,000 for the year ended September 30, 2012. Our effective tax rate was 31.4% in fiscal year 2013 and 11.4% in fiscal year 2012. The increase in the effective tax rate for 2013 was due to a $1.0 million tax reserve that was reversed in June 2012 as our uncertain tax position was resolved with the closing of the tax year. Excluding the uncertain tax position resolution our effective tax rate for 2012 would have been 29.2%.
Asset Quality
Delinquent Loans and Foreclosed Assets. Our policies require that management continuously monitor the status of the loan portfolio and report to the Loan Committee of the Board of Directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate, and our actions and plans to cure the delinquent status of the loans and to dispose of the foreclosed property. The Loan Committee consists of two inside and three outside directors. One position on the committee, the chairman, is permanent, and the other two positions alternate between four outside directors.
We generally stop accruing interest income when we consider the timely collectability of interest or principal to be doubtful. We generally stop accruing for loans that are 90 days or more past due unless the loan is well secured and we determine that the ultimate collection of all principal and interest is not in doubt. When we designate loans as nonaccrual, we reverse all outstanding interest that we had previously credited. These loans remain on nonaccrual status until a regular pattern of timely payments is established.
Impaired loans are individually assessed to determine whether the carrying value exceeds the fair value of the collateral or the present value of the expected cash flows to be received. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, are collectively evaluated for impairment.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at the lower of the related loan balance or its fair value as determined by an appraisal, less estimated costs of disposal. If the value of the property is less than the loan, less any related specific loan loss reserve allocations, the difference is charged against the allowance for loan losses. Any subsequent write-down of real estate owned or loss at the time of disposition is charged against earnings.
Management has taken several steps to resolve the nonperforming and classified assets acquired in the NCB, MCB, and FNB transactions, including the following:
•
Established a special assets department with experienced leadership that continues to actively manage the nonperforming and classified assets acquired in the FDIC-assisted transactions.
•
Senior management reviews and updates resolution strategy quarterly, updates appraisals periodically, has appraisal reviews and validates expected cash flow through any other sources available.
•
Through September 30, 2014, we had received $226.8 million from the FDIC for reimbursements associated with the FDIC loss-sharing agreements. We have a remaining indemnification asset of $10.5 million as of September 30, 2014 of which $2.9 million is related to the MCB acquisition for which the loss share reimbursement period ends in March 2015.
As of September 30, 2014 our nonperforming assets not covered by loss sharing totaled $6.0 million, or 0.65% of total assets not covered by loss sharing. Real estate owned covered by loss sharing totaled $5.6 million. Loans covered by loss sharing were performing as anticipated due to the discount accretion and therefore are considered performing, however, $7.5 million of these covered loans are contractually delinquent.
We are also continuing to review the MCB and FNB loan portfolios, along with the NCB single-family loan portfolio, with the objective of aggressively classifying all loans appropriately so that resolution plans can be established and delinquent assets can be returned to performing status.
Non-Performing Assets. The table below sets forth the amounts and categories of our non-covered non-performing assets at the dates indicated.
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(1)
Included in nonaccrual loans are $1.7 million, $0.4 million, $0.5 million, $1.4 million and $1.9 million of non-accruing troubled debt restructured loans at September 30, 2014, 2013, 2012, 2011 and 2010, respectively.
(2)
Acquired NCB FAS ASC 310-30 loans that are no longer covered under the non-single family loss sharing agreement with the FDIC in the amount of $1.0 million are not included in this table as of September 30, 2014. Due to the recognition of accretion income related to these loans, FAS ASC 310-30 loans that are greater than 90 days delinquent or designated nonaccrual status are regarded as accruing loans.
(3)
Other real estate owned in the amount of $363,400 that is no longer covered under the non-single family loss sharing agreement with the FDIC that expired in fiscal 2014 is now included in this table.
Non-performing assets not covered by loss share increased $1.5 million during the year ended September 30, 2014 due to an increase of $634,000 in non-covered nonaccrual loans, an increase of $689,000 in non-covered loans that are 90 days or greater delinquent and still accruing, and an increase of $143,000 in non-covered real estate owned. These increases were primarily attributable to acquired loans that are no longer covered due to the expiration of the NCB commercial loss sharing agreement with the FDIC. We have 31 non-covered loans that remain non-performing at September 30, 2014, and the largest non-performing non-covered loan had a balance of $1.5 million at September 30, 2014 and was secured by commercial real estate.
For the years ended September 30, 2014 and 2013, interest income recognized on non-accruing non-covered loans was approximately $405,000 and $664,000, respectively. Additional gross interest income that would have been recorded had our non-accruing non-covered loans been current in accordance with their original terms was approximately $260,000 and $223,000, respectively, for the years ended September 30, 2014 and 2013.
Troubled Debt Restructurings. Loans are classified as restructured when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. We only restructure loans for borrowers in financial difficulty that have presented a viable business plan to fully pay off all obligations, including outstanding debt, interest, and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute upon their plans. The concessions granted on troubled debt restructurings generally include terms to reduce the interest rate or extend the term of the debt obligation.
Loans on nonaccrual status at the date of modification are initially classified as nonaccrual troubled debt restructurings. At September 30, 2014, we had $1.7 million in nonaccrual troubled debt restructurings. Loans on accruing status at the date of concession are initially classified as accruing troubled debt restructurings if the loan is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Troubled debt restructurings are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months). At September 30, 2014, we had $6.2 million in accruing troubled debt restructurings. As of September 30, 2014, no loans that were modified as troubled debt restructurings within the previous twelve months defaulted after their restructure. The tables below show the number and amount of non-covered non-accruing troubled debt restructurings at September 30, 2014, 2013 and 2012.
Delinquent Loans, Excluding Nonaccrual Loans. The following tables set forth certain information with respect to our loan portfolio delinquencies as to contractual payments, excluding nonaccrual loans (refer to preceding page for disclosure of nonaccrual loans), at the dates indicated.
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(1)
Previously covered loans in the amount of $1.0 million are now reflected in the Greater than 90 Days Accruing column in the non-covered loans. These loans which are accounted for under ASC 310-30 are reported as accruing loans because of accretable discounts established at the time of acquisition.
Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans considered to be of lesser quality as “substandard,” “doubtful,” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that we will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” so that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated “special mention.”
We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. We regularly monitor the value of underlying collateral on classified and nonperforming loans. This monitoring involves physical site inspection, consultation with real estate professionals, our knowledge of our markets, and assessing appraisal trends.
Potential problem loans are non-covered loans as to which management has serious doubts about the ability of the borrowers to comply with present repayment terms. Management classifies potential problem loans as either special mention or substandard. Potential problem loans aggregated $29.7 million and $35.4 million at September 30, 2014 and 2013, respectively, with $3.4 million and $6.0 million classified special mention and $26.3 million and $29.4 million classified substandard at September 30, 2014 and 2013, respectively.
The following table sets forth the aggregate amount of our classified assets at the dates indicated. Classified assets as of September 30, 2014, 2013 and 2012 have been divided into those assets that were acquired in connection with the NCB, MCB
and FNB transactions and are still covered under loss sharing agreements with the FDIC, and those assets that are not still covered by the loss sharing agreements.
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(1)
Substandard securities represent certain non-investment grade investments.
(2)
Covered assets represent only the portion of the asset that is not covered by FDIC loss sharing agreements. The remaining portion of the covered assets is not shown because they are covered by FDIC loss sharing agreements, and therefore cannot be considered classified assets.
Our largest substandard loan relationship at September 30, 2014 was an $8.1 million loan relationship. As of September 30, 2014, all loans in the relationship are current and interest and taxes due have been paid. The loan relationship is collateralized by income producing properties in Alabama. We believe we are adequately collateralized, even at lower current real estate values.
Allowance for Loan Losses. The allowance for loan losses represents a reserve for probable loan losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans with particular emphasis on impaired, non-accruing, past due and other loans that management believes require special attention. The determination of the allowance for loan losses is considered a critical accounting policy.
Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on management’s analysis of loss inherent in the loan portfolio. The amount of the provision for loan losses is determined by an evaluation of the level of loans outstanding, loss risk as determined based on a loan grading system, the level of non-performing loans, historical loss experience, delinquency trends, the amount of losses charged to the allowance in a given period, and an assessment of economic conditions. Management believes the current allowance for loan losses is adequate based on its analysis of the losses in the portfolio.
Our allowance for loan loss methodology is a loan classification-based system. Our allowance for loan losses is segmented into the following four major categories: (1) specific reserves; (2) general allowances for Classified/Watch loans; (3) general allowances for loans with satisfactory ratings; and (4) an unallocated amount. We base the required reserve on a percentage of the loan balance for each type of loan and classification level. Loans may be classified manually and are automatically classified if they are not previously classified when they reach certain levels of delinquency. Unclassified loans are reserved at different percentages based on our loan loss history for the last two years. Reserve percentages are also adjusted based upon our estimate of the effect that the current economic environment will have on each type of loan.
We have no loans for which there is known information about possible credit problems of borrowers that causes management to have serious doubts about their ability to comply with present loan repayment terms that are not currently disclosed as non-accrual, past due, classified, underperforming, restructured or potential problem.
We incorporate certain refinements and improvements to the allowance for loan losses methodology from time to time. During the year ended September 30, 2014, we made certain refinements in our allowance methodology. We increased the look back period of historical losses from 24 months to 84 months as net charge-offs were not reflective of a full credit cycle for the two year period ended September 30, 2014 as compared with the seven year period ended September 30, 2014. In addition, some qualitative factors were removed and the loss allocation for qualitative risk factors was decreased. The change in the historical look back period more closely aligns the quantitative aspect of the allowance methodology with the risks inherent in a full credit cycle. The adjustments in our methodology were not material to the overall allowance or provision for the year ended September 30, 2014.
As of September 30, 2014 and 2013, allowances of approximately $100,000 and $3.5 million, respectively, had been established for loan losses on covered loans acquired in the NCB transaction. In addition $900,000 and $400,000 in allowances had been established for expected losses incurred on FNB loans as of September 30, 2014 and 2013, respectively. The nonaccretable discounts for covered loans amounted to $6.3 million and $10.8 million at September 30, 2014 and 2013, respectively.
No allowance was established for loans acquired in the MCB or FNB acquisition at the time of acquisition as accounting standards prohibit carrying over an allowance for loan losses for loans purchased in those acquisitions. These loans were recorded at fair value through establishing nonaccretable discounts. If credit deterioration is observed subsequent to the acquisition dates, such deterioration will be accounted for pursuant to our revised estimates of expected cash flows on covered loans and a provision for loan losses will be charged to earnings for our loss share with an increase to the FDIC receivable for the FDIC indemnification amount. Amounts expected to be recovered from the FDIC under loss sharing agreements are separately disclosed as the FDIC receivable.
The following table sets forth activity in our allowance for loan losses for the years indicated. Loans covered by the loss sharing agreement with the FDIC are excluded from the table.
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(1)
CharterBank’s primary regulator changed from the Office of Thrift Supervision to the Office of the Comptroller of the Currency during the latter part of the 2011 fiscal year. The Office of the Comptroller of the Currency’s policy is for the immediate charge-off of specific allowances on impaired loans, which increased our charge-offs by $1.2 million in 2012.
(2)
Does not include loans held for sale or deferred fees.
The following table sets forth activity in our covered allowance for loan losses for the years indicated.
Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses for non-covered loans allocated by loan category and the percent of loans in each category to total loans at the dates indicated. Loans covered by the loss sharing agreement with the FDIC are excluded from the table. An unallocated allowance is generally maintained in a range of 4% to 12.0% of the total allowance in recognition of the imprecision of the estimates. In times of greater economic downturn and uncertainty, the higher end of this range is provided. Lower allocations in the real estate construction portfolio in the last two years reflected decreased nonperforming loans, decreased charge-offs in the recent two year period, and improved credit quality of those loans. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future short-term financial obligations. Our primary sources of funds consist of deposit inflows, advances from the Federal Home Loan Bank, loan payments and prepayments, mortgage-backed securities and collateralized mortgage obligations repayments and maturities and sales of loans and other securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions and competition. Our Asset/Liability Management Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs of our customers as well as unanticipated contingencies. At September 30, 2014 and 2013, we had access to immediately available funds of approximately $334.1 million and $397.1 million, respectively, including overnight funds, FHLB borrowing capacity and a Federal Reserve line of credit.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term securities.
Our most liquid assets are cash and cash equivalents. The levels of these assets are subject to our operating, financing, lending and investing activities during any given period. At September 30, 2014, cash and cash equivalents totaled $99.5 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $188.7 million at September 30, 2014. At September 30, 2014, we had $55.0 million in advances from the FHLB outstanding. However, based on available collateral other than cash, $168.9 million in additional advances would be available as of September 30, 2014.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.
At September 30, 2014, we had $1.8 million of new loan commitments outstanding, and $115.3 million of unfunded construction and development loans. In addition to commitments to originate loans, we had $24.9 million of unused lines of credit to borrowers. Certificates of deposit due within one year of September 30, 2014 totaled $159.1 million, or 22.2% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2015. We believe, however, based on past experience, that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
Our primary investing activities are the origination of loans and the purchase of securities. During the year ended September 30, 2014, we originated $365.5 million of loans and purchased $23.9 million of securities.
Financing activities consist primarily of additions to deposit accounts and Federal Home Loan Bank advances. We experienced a net decrease in total deposits of $34.1 million for the year ended September 30, 2014. This decrease represented reductions in our time deposits, partially offset by an increase in transaction accounts. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank, which provides an additional source of funds. Federal Home Loan Bank of Atlanta advances decreased by $5.0 million to $55.0 million during the year ended September 30, 2014. Federal Home Loan Bank advances have been used primarily to fund loan demand and to purchase securities. Our current asset/liability management strategy has been to pay off Federal Home Loan Bank of Atlanta advances as cash is available and the advances mature.
Cash receipts arising from payments on covered loans and loss-sharing collections from the FDIC are providing and are expected to continue to provide positive net cash flows in periods following the wholesale funding outflows.
CharterBank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2014, CharterBank exceeded all regulatory capital requirements. CharterBank is considered “well-capitalized” under regulatory guidelines. See Part I, Item 1 Business “Supervision and Regulation-Federal Banking Regulation-Capital Requirements” and Note 16 - Regulatory Matters in the Notes to our Consolidated Financial Statements.
The table of regulatory compliance with capital requirements for CharterBank is presented below.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit, standby letters of credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans made by us. We consider commitments to extend credit in determining our allowance for loan losses.
Contractual Obligations. The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at September 30, 2014. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments. Fixed rates on loans ranged from 3.88% to 4.27% as of September 30, 2014.
Impact of Inflation and Changing Prices
The consolidated financial statements and related notes of Charter Financial have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management of Market Risk
As a financial institution, we face risk from interest rate volatility. Fluctuations in interest rates affect both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates also affect the market value of all interest-earning assets.
The primary goal of our interest rate risk management strategy is to maximize net interest income while maintaining an acceptable interest rate risk profile. We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, portfolio equity and net interest income remain within an acceptable range.
We have emphasized commercial real estate lending, and to a lesser extent, one- to four-family residential lending. Our sources of funds include retail deposits, Federal Home Loan Bank advances and wholesale deposits. We employ several strategies to manage the interest rate risk inherent in our mix of assets and liabilities, including:
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selling fixed rate mortgages we originate to the secondary market, generally on a servicing released basis;
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maintaining the diversity of our existing loan portfolio by originating commercial real estate and consumer loans, which typically have adjustable rates and shorter terms than residential mortgages;
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emphasizing investments with adjustable interest rates;
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maintaining fixed rate borrowings from the Federal Home Loan Bank of Atlanta; and
•
increasing retail transaction deposit accounts, which typically have long durations.
Changes in market interest rates have a significant impact on the repayment and prepayment of loans. Prepayment rates also vary due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal factors, demographic changes, the assumability of the loans, related refinancing opportunities and competition. We monitor interest rate
sensitivity so that we can attempt to adjust our asset and liability mix in a timely manner and thereby minimize the negative effects of changing rates.
Extension risk, or lower prepayments causing loans to have longer average lives, is our primary exposure to higher interest rates. Faster prepayment of loans and investing the funds from prepayments in mortgage loans and securities at lower interest rates which results in a lower net interest income and is our primary exposure to declining market interest rates.
Interest Risk Measurement.
We compute the amounts by which the difference between the present value of an institution's assets and liabilities (the institution's net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. Our simulation model uses a discounted cash flow analysis to measure the interest rate sensitivity of NPV. Depending on current market interest rates we historically have estimated the economic value of these assets and liabilities under the assumption that interest rates experience an instantaneous and sustained increase of 100, 200, or 300 basis points, or a decrease of 100 and 200 basis points. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, a NPV calculation for an interest rate decrease of greater than 100 basis points has not been prepared.
The table below sets forth, as of September 30, 2014, our calculation of the estimated changes in CharterBank’s net portfolio value that would result from the designated instantaneous parallel shift in the interest rate yield curve.
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(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
(2)
NPV is the difference between the present value of an institution’s assets and liabilities.
(3)
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)
NPV Ratio represents NPV divided by the present value of assets.
The table above indicates that at September 30, 2014, in the event of a 200 basis point increase in interest rates, we would experience a 0.9% decrease in net portfolio value. In the event of a 100 basis point decrease in interest rates, we would experience a 2.1% decrease in net portfolio value. Additionally, our internal policy states that our minimum NPV of estimated present value of assets and liabilities shall range from a low of 5.5% for a 300 basis point change in rates to 7.5% for no change in interest rates. As of September 30, 2014, we were in compliance with our Board approved policy limits.
The effects of interest rates on net portfolio value and net interest income are not predictable. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, prepayments, and deposit run-offs, and should not be relied upon as indicative of actual results. Certain shortcomings are inherent in these computations. Although some assets and liabilities may have similar maturity or periods of repricing, they may react at different times and in different degrees to changes in market interest rates. Rates on other types of assets and liabilities may lag behind changes in market interest rates. Assets, such as adjustable rate mortgages, generally have features that restrict changes in interest rates on a short-term basis and over the life of the asset. After a change in interest rates, prepayments and early withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, increased credit risk may result if our borrowers are unable to meet their repayment obligations as interest rates increase.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Charter Financial Corporation
We have audited Charter Financial Corporation’s internal control over financial reporting as of September 30, 2014 based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Charter Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of September 30, 2014 based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Charter Financial Corporation and subsidiary as of September 30, 2014 and 2013, and for each of the years in the three-year period ended September 30, 2014, and our report dated December 12, 2014, expressed an unqualified opinion on those consolidated financial statements.
/s/ Dixon Hughes Goodman LLP
Atlanta, GA
December 12, 2014
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Charter Financial Corporation
We have audited the accompanying consolidated statements of financial condition of Charter Financial Corporation and subsidiary as of September 30, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended September 30, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Charter Financial Corporation and subsidiary as of September 30, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2014, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal controls over financial reporting as of September 30, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated December 12, 2014, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ Dixon Hughes Goodman LLP
Atlanta, GA
December 12, 2014
CHARTER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
See accompanying notes to consolidated financial statements.
CHARTER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
CHARTER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes to consolidated financial statements.
CHARTER FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
CHARTER FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Summary of Significant Accounting Policies
On April 8, 2013, Charter Financial Corporation, a Maryland corporation (“Charter Financial” or the “Company”), completed its conversion and reorganization pursuant to which First Charter, MHC, our federally chartered mutual holding company, was converted to the stock holding company form of organization. Charter Financial sold 14,289,429 shares of common stock at $10.00 per share, for gross offering proceeds of $142.9 million in its stock offering. CharterBank (the “Bank”), as of April 8, 2013, was 100% owned by Charter Financial and Charter Financial was 100% owned by public stockholders. Concurrent with the completion of the offering, shares of common stock of Charter Financial Corporation, the former federally chartered corporation (“Charter Federal”), were converted into the right to receive 1.2471 shares of Charter Financial’s common stock for each share of Charter Federal common stock that was owned immediately prior to completion of the transaction. Cash in lieu of fractional shares was paid based on the offering price of $10.00 per share. As a result of the offering and the exchange on April 8, 2013, Charter Financial had 22,752,214 shares outstanding. Also, as of April 8, 2013, Charter Federal and First Charter, MHC ceased to exist. As part of the elimination, the net asset position of First Charter, MHC, in the amount of $229,564, was assumed by Charter Financial. Any reference to the Company following April 8, 2013 refers to Charter Financial Corporation, a Maryland corporation. In regards to weighted average shares outstanding, share and per share amounts held by the public prior to April 8, 2013, have been restated to reflect the completion of the second-step conversion at a conversion ratio of 1.2471 unless noted otherwise.
Charter Financial Corporation, the federally chartered corporation, was established in October 2001 to be the holding company for the Bank in connection with the Bank’s reorganization from a federal mutual savings and loan association into the two-tiered mutual holding company structure. Charter Federal's business activity was the ownership of the outstanding capital stock of CharterBank.
The consolidated financial statements of Charter Financial Corporation and subsidiary include the financial statements of Charter Financial Corporation and its wholly owned subsidiary, CharterBank. All intercompany accounts and transactions have been eliminated in consolidation. The term “Company” will apply as applicable to Charter Financial and Charter Federal depending on the context.
The Company primarily provides real estate loans and a full range of deposit products to individual and small business consumers through its branch offices in west-central Georgia, east-central Alabama and the Florida Panhandle. In addition, the Company operates a cashless branch in Norcross, Georgia. The Company primarily competes with other financial institutions in its market area. The Company’s primary lending market has been the states of Georgia, Alabama and Florida. The Company operates and manages as a one-bank holding company and, as such, has no reportable segments.
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to prevailing practices within the financial institutions industry. The following is a summary of the significant accounting policies that the Company follows in presenting its consolidated financial statements.
(a)
Basis of Presentation
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenue and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, the estimates used for fair value acquisition accounting and the FDIC receivable for loss sharing agreements, and the assessment for other-than-temporary impairment of investment securities, mortgage-backed securities, and collateralized mortgage obligations. In connection with the determination of the allowance for loan losses and the value of real estate owned, management obtains independent appraisals for significant properties. In connection with the assessment for other-than-temporary impairment of investment securities, mortgage-backed securities, and collateralized mortgage obligations, management obtains fair value estimates by independent quotations, assesses current credit ratings and related trends, reviews relevant delinquency and default information, assesses expected cash flows and coverage ratios, assesses the relative strength of credit support from less senior tranches of the securities, reviews average credit score data of underlying mortgages, and assesses other current data. The severity and duration of an impairment and the likelihood of potential recovery of an impairment is considered along with the intent and ability to hold any impaired security to maturity or recovery of carrying value.
A substantial portion of the Company’s loans is secured by real estate located in its market area. Accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio is susceptible to changes in the real estate market conditions of this market area.
Certain reclassifications of 2012 and 2013 balances have been made to conform to classifications used in 2014. These reclassifications did not change net income or total stockholders equity.
(b)
Cash and Cash Equivalents
Cash and cash equivalents, as presented in the consolidated financial statements, include amounts due from other depository institutions and interest-bearing deposits in other financial institutions. Generally, interest-bearing deposits in other financial institutions are for one-day periods.
(c)
Investments, Mortgage-Backed Securities, Collateralized Mortgage-Backed Securities, Collateralized Mortgage Obligations, and Federal Home Loan Bank Stock
Investments, mortgage-backed securities, collateralized mortgage-backed securities, and collateralized mortgage obligations available for sale are reported at fair value, as determined by pricing services. The pricing service valuations are reviewed by management for reasonableness. Investment in stock of the Federal Home Loan Bank (FHLB) is required of every federally insured financial institution, which utilizes its services. The investment in FHLB stock is carried at cost and such stock is evaluated for any potential impairment.
Purchase premiums and discounts on investment securities are amortized and accreted to interest income using a level yield method over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities and collateralized mortgage obligations are amortized and accreted to interest income using the interest method over the remaining lives of the securities, taking into consideration assumed prepayment patterns.
Gains and losses on sales of investments, mortgage-backed securities, collateralized mortgage-backed securities, and collateralized mortgage obligations are recognized on the trade date, based on the net proceeds received and the adjusted carrying amount of the specific security sold.
A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and the establishment of a new cost basis for that security.
(d)
Loans and Interest Income
Loans are reported at the principal amounts outstanding, net of unearned income, deferred loan fees/origination costs, and the allowance for loan losses.
Interest income is recognized using the simple interest method on the balance of the principal amount outstanding. Unearned income, primarily arising from deferred loan fees, net of certain origination costs, and deferred gains on the sale of the guaranteed portion of Small Business Administration (SBA) loans, is amortized over the expected lives of the underlying loans using the interest method.
Generally, the accrual of interest income is discontinued on loans when reasonable doubt exists as to the full, timely collection of interest or principal. Interest previously accrued but not collected is reversed against current period interest income when such loans are placed on nonaccrual status. Interest on nonaccrual loans, which is ultimately collected, is credited to income in the period received.
Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement. Large pools of smaller balance homogeneous loans, such as consumer and installment loans, are collectively evaluated for impairment by the Company. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on impaired loans for which the accrual of interest has been discontinued are recorded as income when received unless full recovery of principal is in doubt whereby cash received is recorded as principal reduction.
Gains or losses on the sale of mortgage loans are recognized at settlement dates and are computed as the difference between the sales proceeds received and the net book value of the mortgage loans sold.
Loans held for sale are carried at the lower of aggregate cost or market, with market determined on the basis of open commitments for committed loans. For uncommitted loans, market is determined on the basis of current delivery prices in the secondary mortgage market.
Acquired loans are recorded at fair value at the date of acquisition. The fair values of loans with evidence of credit deterioration (impaired loans) are recorded net of a nonaccretable difference and, if appropriate, an accretable yield. The difference between contractually required principal and interest payments at acquisition and the cash flows expected to be collected at acquisition is the nonaccretable difference, which is included in the carrying amount of acquired loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions, or a reclassification of the difference from nonaccretable to accretable with a positive impact on the accretion of interest income in future periods. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The expected cash flows method of income recognition is also used for other acquired loans in the NCB and MCB acquisitions where the loans were acquired at a discount attributable, at least in part, to credit quality.
Performing loans acquired in the FNB acquisition are accounted for using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value. Credit losses on acquired performing loans are estimated based on analysis of the performing portfolio. Such estimated credit losses are recorded as an acquisition fair value adjustment and are accreted as an adjustment to yield over the estimated lives of the loans. Effective October 1, 2009, as a result of the adoption of new accounting guidance, there is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition.
Loans covered under loss sharing agreements with the FDIC (“Covered Loans”) are reported in loans exclusive of the expected reimbursement from the FDIC as it is not contractually embedded in the loans and loss sharing is not transferable with the loans should a decision be made to dispose of them. Covered loans are initially recorded at fair value at the acquisition date and are continually reviewed for collectability based on the expectation of cash flows on these loans. Prospective losses incurred on Covered loans are eligible for partial reimbursement by the FDIC under loss sharing agreements. Subsequent decreases in the amount expected to be collected result in a provision for credit losses, an increase in the allowance for loan and lease losses, and a proportional adjustment to the FDIC receivable for the estimated amount to be reimbursed. Subsequent significant increases in the amount expected to be collected result in the reversal of any previously recorded provision for credit losses and related allowance for loan and lease losses and adjustments to the FDIC receivable. Decreases in credit losses expected to occur within the loss share term reduce the amount collectible from the FDIC and increase the amount collectible from customers in the form of prospective accretion on loans. Increases in the portion of indemnification asset collectible from customers are amortized to income. Periodic amortization represents the amount that is expected to result in symmetrical recognition of pool-level accretion and amortization over the shorter of 1) the life of the loan or 2) the life of the shared loss agreement. Interest is accrued daily on the outstanding principal balances of non-impaired loans. Accretable discounts related to certain fair value adjustments are accreted into income over the estimated lives of the loans on a level yield basis.
Covered loans which are more than 90 days past due with respect to contractual interest or principal, unless they are well secured and in the process of collection, and other covered loans on which full recovery of principal or interest is in doubt, are placed on nonaccrual status as to contractual interest.
In accordance with the loss sharing agreements with the FDIC, certain expenses relating to covered assets of external parties such as legal, property taxes, insurance, and the like may be partially reimbursed by the FDIC. Such qualifying future expenditures on covered assets will result in an increase to the FDIC receivable.
(e)
Allowance for Loan Losses
The allowance for loan losses is adjusted through provisions for loan losses charged or credited to operations. Loans are charged off against the allowance for loan losses when management believes that the collection of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is determined through consideration of such factors as changes in the nature and volume of the portfolio, overall portfolio quality, delinquency trends, adequacy of collateral, loan concentrations, specific problem loans, and economic conditions that may affect the borrowers’ ability to pay.
To the best of management’s ability, all known and inherent losses that are both probable and reasonable to estimate have been recorded. While management uses available information to recognize losses on loans, future additions to
the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to adjust the allowance based on their judgment about information available to them at the time of their examination.
(f)
Real Estate Owned
Real estate acquired through foreclosure, consisting of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, is reported on an individual asset basis at the lower of cost or fair value, less disposal costs. Fair value is determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. While initial fair value is determined by independent third parties, management may subsequently reassess these valuations and apply additional discounts if necessary. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized and charged to the allowance for loan losses. Subsequent write-downs are charged to a separate allowance for losses pertaining to real estate owned, established through provisions for estimated losses on real estate owned charged to operations. Based upon management’s evaluation of the real estate acquired through foreclosure, additional expense is recorded when necessary in an amount sufficient to reflect any estimated declines in fair value. Gains and losses recognized on the disposition of the properties are recorded in noninterest expense in the consolidated statements of income.
Other real estate acquired through foreclosure covered under loss sharing agreements with the FDIC is reported exclusive of expected reimbursement cash flows from the FDIC. Subsequent decreases to the estimated recoverable value of covered other real estate result in a reduction of covered other real estate, and a charge to other expense, and an increase in the FDIC receivable for the estimated amount to be reimbursed, with a corresponding amount recorded in noninterest expense.
Costs of improvements to real estate are capitalized, while costs associated with holding the real estate are charged to operations.
(g)
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation, which is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets range from 20 to 39 years for buildings and improvements and 3 to 15 years for furniture, fixtures, and equipment.
(h)
Receivable from FDIC for Loss Sharing Agreements
Under loss sharing agreements with the FDIC, the Bank recorded a receivable from the FDIC equal to the reimbursable portion of the estimated losses in the covered loans and other real estate acquired. The receivable is measured separately from the covered assets acquired as it is not contractually embedded in the loans and not transferable with the loans should a decision be made to dispose of them. The receivable was recorded at the present value of the estimated cash flows using discount rates of approximately four percent for NCB, one and a half percent for MCB, and two percent for FNB at the date of the respective acquisition and will be reviewed and updated prospectively as loss estimates related to covered loans and other real estate acquired through foreclosure change. These cash flows were discounted to reflect the uncertainty of the timing and receipt of the loss share reimbursements from the FDIC. Certain adjustments to the receivable are recorded over the lesser of the remaining life of applicable covered loans or the term of loss sharing. The Bank may also record adjustments/impairment to the receivable based on a collectablility analysis as it nears the end of the various loss sharing agreements with the FDIC. Most third party expenses on real estate and covered loans are covered under the loss sharing agreements and the cash flows from the reimbursable portion are included in the estimate of cash flows.
(i)
Mortgage Banking Activities
As a part of normal business operations, the Company originates residential mortgage loans that have been pre-approved by secondary investors. The terms of the loans are set by the secondary investors, and the purchase price that the investor will pay for the loan is agreed to prior to the commitment of the loan by the Company. Generally within three weeks after funding, the loans are transferred to the investor in accordance with the agreed-upon terms. The Company records gains from the sale of these loans on the settlement date of the sale equal to the difference between the proceeds received and the carrying amount of the loan. The gain generally represents the portion of the proceeds attributed to servicing release premiums received from the investors and the realization of origination fees received from borrowers which were deferred as part of the carrying amount of the loan. Between the initial funding of the loans by the Company and the subsequent reimbursement by the investors, the Company carries the loans on its balance sheet at the lower of cost or market. The fair value of the underlying commitment is not material to the consolidated financial statements.
Fees for servicing loans for investors are based on the outstanding principal balance of the loans serviced and are recognized as income when earned.
(j)
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In assessing the reliability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies by jurisdiction and entity in making this assessment. The Company allocates income taxes to the members of the consolidated tax return group based on their proportion of taxable income.
(k)
Comprehensive Income
Comprehensive income for the Company consists of net income for the period, unrealized holding gains and losses on investments, mortgage-backed securities, collateralized mortgage-backed securities, and collateralized mortgage obligations classified as available for sale, net of income taxes, and certain reclassification adjustments. For the periods ended September 30, 2014 and 2013 there were no items reclassified out of other comprehensive income with the exception of realized gains and other-than-temporary impairment on securities held for sale. Items reclassified out of comprehensive income are included within non-interest income on the Consolidated Statements of Income for all periods presented.
(l)
Goodwill and Other Intangible Assets
Intangible assets include costs in excess of net assets acquired and core deposit intangibles recorded in connection with the acquisitions of EBA Bancshares, Inc. and subsidiary, Eagle Bank of Alabama (collectively “EBA”), and core deposits of McIntosh Commercial Bank and The First National Bank of Florida. The core deposit intangible is being amortized over thirteen, five and six years, respectively.
The Company tests its goodwill for impairment annually unless interim events or circumstances make it more likely than not that an impairment loss has occurred. Impairment is defined as the amount by which the implied fair value of the goodwill is less than the goodwill’s carrying value. Impairment losses, if incurred, would be charged to operating expense. For the purposes of evaluating goodwill, the Company has determined that it operates only one reporting unit. The Company performed a qualitative assessment and determined that it was not more likely than not that the fair value of the reporting unit was less than the carrying amount at September 30, 2014.
(m)
Acquisitions
Accounting principles generally accepted in the United States (US GAAP) requires that the acquisition method of accounting be used for all business combinations and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date.
The Company’s wholly-owned subsidiary acquired certain assets and liabilities of Neighborhood Community Bank (“NCB”) headquartered in Newnan, Georgia on June 26, 2009, McIntosh Commercial Bank (“MCB”) headquartered in Carrollton, Georgia on March 26, 2010 and The First National Bank of Florida (“FNB”) headquartered in Milton, Florida on September 9, 2011. The acquisitions were completed with the assistance of the Federal Deposit Insurance Corporation (FDIC), which had been appointed Receiver of the entities by their respective state banking authorities immediately prior to the Bank’s acquisition. The acquired assets and assumed liabilities of these three acquisitions were measured at estimated fair value. Management made significant estimates and exercised significant judgment in accounting for the acquisition of NCB, MCB and FNB. Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows, prepayment speeds and estimated loss factors to measure fair values for loans. Other real estate acquired through foreclosure was valued based upon pending sales contracts and appraised values, adjusted for current market conditions. Management used quoted or current market prices to determine the fair value of investment securities, short-term borrowings and long-term obligations that were assumed from NCB, MCB and FNB. The carrying value of certain long-term assets acquired in the acquisition of NCB, primarily the estimated value of core deposits of approximately $1.1 million, were reduced to zero by the excess of fair value of net assets acquired over liabilities assumed in the acquisition.
(n)
Stock-Based Compensation
The Company recognizes the estimated fair value of such equity instruments as expense as services are performed. The Company recognizes the total cost of the Company’s share based awards equal to the grant date fair value as expense on a straight line basis over the service periods of the awards.
(o)
Income Per Share
Basic net income per share is computed on the weighted average number of shares outstanding. Diluted net income per share is computed by dividing net income by weighted average shares outstanding plus potential common shares resulting from dilutive stock options and restricted shares, determined using the treasury stock method.
__________________________________
(1)
Share and share amounts held by the public prior to April 8, 2013 have been restated to reflect the completion of the second-step conversion on April 8, 2013 using a conversion ratio of 1.2471.
(p)
Treasury Stock
Treasury stock was accounted for at cost. Prior to the completion of the second-step conversion on April 8, 2013, the Company included in treasury stock unvested shares of the Company's recognition and retention plan. The Company no longer recognizes these unvested shares as treasury stock and subsequent to the second-step conversion, has no treasury stock at September 30, 2014.
(q)
Employee Stock Ownership Plan (ESOP)
The Company has an internally-leveraged ESOP trust that covers substantially all of its employees. The Company’s common stock not yet allocated to participants is reflected as unearned compensation in stockholders’ equity. The Company records compensation expense associated with the ESOP based on the average market price (fair value) of the total Company shares committed to be released, and subsequently allocated to participants, during the year. The Company further records as compensation expense any dividends declared on unallocated Company shares in the ESOP trust. Earnings per share computations include any allocated shares in the ESOP trust.
(r)
Bank Owned Life Insurance
The Company owns life insurance policies to provide for the payment of death benefits related to existing deferred compensation and supplemental income plans maintained for the benefit of certain executives and directors of the Company. The total cash surrender value amounts of such policies at September 30, 2014 and 2013 was $47,178,128 and $39,825,881, respectively. The Company recorded, as income, increases to the cash surrender value of $1,252,246, $993,961, and $1,057,397, for the three years ended September 30, 2014, 2013, and 2012, respectively.
(s)
Recent Accounting Pronouncements
In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)2014-14, Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure (“ASU 2014-14”). This standard provides guidance on how holders of certain government-guaranteed loans (e.g., mortgage loans guaranteed by the FHA or VA) should present such loans upon foreclosure. Specifically, the ASU provides that, upon foreclosure, government-guaranteed loans within the scope of the standard should be derecognized and re-recognized as a separate other receivable (i.e., a receivable from the government entity guaranteeing the loan). The standard does not require any new disclosures about such loans. ASU 2014-14 is effective for the Company for annual and interim periods beginning after December 15, 2014, and is not expected to have a material impact on the Company’s balance sheet or results of operations.
In June 2014, the FASB issued ASU 2014-12, Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. ASU 2014-12 is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. An entity may apply the standards (1) prospectively to all share-based payment awards that are granted or modified on or after the effective date, or (2) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. Earlier application is permitted. The adoption of ASU 2014-12 is not expected to have a material impact on the Company’s financial statements.
Additionally, in June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This standard amends the guidance in ASC 860 on accounting for certain repurchase agreements (“repos”). The standard (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings, (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) that are accounted for as secured borrowings. This standard is effective for annual periods beginning after December 15, 2014 and is not expected to have a material impact on the Company’s balance sheet or results of operations.
In May 2014, the FASB issued ASU 2014-09, Revenue From Contracts With Customers. This standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is effective for annual reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact this standard will have on its balance sheet and results of operations.
In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction.
ASU No. 2014-04 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued an update to the accounting standards to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this update require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update was effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this update increased disclosures in the Company's consolidated financial statements.
Note 2: Goodwill and Other Intangible Assets
Goodwill and other intangible assets include cost in excess of net assets acquired and core deposit intangibles recorded in connection with certain acquisitions. Management tests goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. The core deposit intangibles are being amortized over the average remaining life of the acquired customer deposits, ranging from five to thirteen years. The Company recorded amortization expense related to the core deposit intangible of $380,210, $476,423, and $547,153 for the years ended September 30, 2014, 2013, and 2012, respectively.
At September 30, 2014 and 2013, intangible assets are summarized as follows:
Amortization expense for the core deposit intangible for the next five years as of September 30, 2014 is as follows:
Note 3: Federally Assisted Acquisitions
The First National Bank of Florida
On September 9, 2011, the Bank purchased substantially all of the assets and assumed substantially all the liabilities of The First National Bank of Florida (“FNB”) from the FDIC, as Receiver of FNB. FNB operated eight commercial banking branches and was headquartered in Milton, Florida. The FDIC took FNB under receivership upon its closure by the Office of the Comptroller of the Currency. The Bank’s bid to purchase FNB included the purchase of substantially all FNB’s assets at a discount of $28,000,000 in exchange for assuming all FNB deposits and certain other liabilities. No cash, deposit premium or other consideration was paid by the Bank. The Bank and the FDIC entered into loss sharing agreements regarding future losses incurred on loans and other real estate acquired through foreclosure existing at the acquisition date. Under the terms of the loss sharing agreements, the FDIC will reimburse the Bank for 80 percent of net losses on covered assets. The term for loss sharing on residential real estate loans is ten years, while the term for loss sharing on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. As a result of the loss sharing agreements with the FDIC, the Bank recorded a receivable of $51,555,999 at the
time of acquisition. As of September 30, 2014, the Bank has submitted $57,361,802 in net cumulative losses to the FDIC under the loss-sharing agreements of which $45,889,442 is reimbursable.
The loss share agreements include a true-up payment in the event FNB’s losses do not reach the FDIC’s total intrinsic loss estimate, as defined in the loss sharing agreement, of $59,483,125. On September 9, 2021, the true-up measurement date, CharterBank is required to make a true-up payment to the FDIC equal to 50 percent of the excess, if any, of the following calculation: A-(B+C+D), where (A) equals 20 percent of the Total Intrinsic Loss Estimate, or $11,896,625; (B) equals 20 percent of the Net Loss Amount; (C) equals 25 percent of the asset (discount) bid, or ($7,000,000); and (D) equals 3.5 percent of total Shared Loss Assets at Bank Closing or $7,380,467. Current loss estimates indicate that no true-up payment will be paid to the FDIC. The FDIC-assisted acquisitions of Neighborhood Community Bank (NCB”) and McIntosh Commercial Bank (“MCB”) are not subject to true-up payments.
Note 4: Securities Available for Sale
Securities available for sale are summarized as follows:
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Credit ratings are current as of September 30, 2014.
(2)
Bonds with split ratings represent securities with both investment and non-investment grades.
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Bonds with split ratings represent securities with both investment and non-investment grades.
Proceeds from called or matured securities available for sale during the years ended September 30, 2014, 2013 and 2012 were $15.4 million, $13.5 million, and $6.8 million, respectively. Proceeds from sales of securities available for sale during years ended September 30, 2014, 2013, and 2012 were $9.9 million, $21.1 million, and $41.6 million, respectively. Gross realized gains on the sale of these securities were $202,053, $252,483, and $950,511, for the years ended September 30, 2014, 2013 and 2012, respectively and gross realized losses were $1,349, $2,966 and $10,745, for the years ended September 30, 2014, 2013 and 2012, respectively.
The amortized cost and estimated fair value of investment securities available for sale as of September 30, 2014, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s investment in FHLB stock was $3.4 million and $3.9 million at September 30, 2014 and 2013, respectively. The investment in FHLB stock is carried at cost because it is considered a restricted stock investment with no readily determinable market value. As of September 30, 2014, the investment in FHLB stock represented approximately 0.34% of total assets and the amortized cost and fair value of this investment are equal. In determining the carrying amount of the FHLB stock, the Company evaluated the ultimate recoverability of the par value. The Company has reviewed the assessments by rating agencies, which have concluded that debt ratings are likely to remain unchanged and the FHLB has the ability to absorb economic losses, given the expectation that the various FHLB Banks have a very high degree of government support.
Furthermore, the Company currently has sufficient liquidity or has access to other sources of liquidity to meet all operational needs in the foreseeable future, and would not have the need to dispose of this stock below the recorded amount. For the reasons
above, the Company concluded that the investment in FHLB stock is not other-than-temporarily impaired as of September 30, 2014 and ultimate recoverability of the par value of this investment is probable.
Securities available for sale with an aggregate carrying amount of $101.7 million and $149.2 million at September 30, 2014 and 2013, respectively, were pledged to secure FHLB advances.
Securities available for sale in a continuous unrealized loss position for less than 12 months at September 30, 2014 are as follows:
Securities available for sale that have been in a continuous unrealized loss position for greater than 12 months at September 30, 2014 and 2013 are as follows:
At September 30, 2014, the Company had approximately $158,000 of gross unrealized losses on private-label mortgage securities with aggregate amortized cost of approximately $6.1 million. During the years ended September 30, 2014 and 2013, the Company did not record any other-than-temporary impairment charges. Other than previously stated, the Company is projecting that it will receive essentially all contractual cash flows so there is no break in yield or additional other-than-temporary impairment. The remaining decline in fair value of the mortgage securities resulted from illiquidity and other concerns in the market place. The increase in the fair value of the remaining mortgage securities primarily resulted from increased liquidity and an overall improvement in the market for these securities.
Regularly, the Company performs an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired other-than-temporarily. The assessment considers many factors including the severity and duration of the impairment, the Company’s intent and ability to hold the security for a period of time sufficient for recovery in value, recent events specific to the industry, and current characteristics of each security such as delinquency and foreclosure levels, credit enhancements, and projected losses and loss coverage ratios. It is possible that the underlying collateral of these securities will perform worse than current expectations, which may lead to adverse changes in cash flows on these securities and potential future other-than-temporary impairment losses. Events that may trigger material declines in fair values for these securities in the future include but are not limited to, deterioration of credit metrics, significantly higher levels of default and severity of loss on the underlying collateral, deteriorating credit enhancement and loss coverage ratios, or further illiquidity. All of these securities were evaluated for other-than-temporary impairment based on an analysis of the factors and characteristics of each security as previously enumerated. The Company considers these unrealized losses to be temporary impairment losses primarily because of continued sufficient levels of credit enhancements and credit coverage levels of less senior tranches to tranches held by the Company.
The following table summarizes the changes in the amount of credit losses on the Company’s investment securities recognized in earnings for the years ended September 30, 2014, 2013 and 2012:
The following table shows issuer-specific information, including current par value, book value, fair value, credit rating and unrealized gain (loss) for the Company’s portfolio of private-label mortgage obligations as of September 30, 2014.
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Credit ratings are current as of September 30, 2014.
The underlying credit and cash flow characteristics of the private-label securities improved during the year ended September 30, 2014. There were no credit rating changes in the three non-investment grade securities during the year ended September 30, 2014.
Changes in accumulated other comprehensive income by component for the years ended September 30, 2014, 2013 and 2012 are shown in the table below. All amounts are net of tax. The line items affected in the consolidated statements of income by the reclassified amounts were gain on securities available for sale and net impairment losses recognized in earnings.
Note 5: Loans Receivable
Loans not covered by loss share agreements are summarized as follows:
The carrying amount of covered loans at September 30, 2014 and 2013 consisted of impaired loans at acquisition date and all other acquired loans and are presented in the following tables.
The following table documents changes in the accretable discount on acquired credit impaired loans during the years ended September 30, 2014 and 2013:
The following is a summary of transactions during the years ended September 30, 2014, 2013 and 2012 in the allowance for loan losses on loans covered by loss sharing:
The following table documents changes in the carrying value of the FDIC receivable for loss sharing agreements relating to covered loans and other real estate owned during the years ended September 30, 2014, 2013 and 2012:
Loan Origination and Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
Commercial real estate loans are generally made by the Company to Georgia, Alabama or Florida panhandle entities and are secured by properties in these states. Commercial real estate lending involves additional risks compared to one- to four-family residential lending. Repayment of commercial real estate loans often depends on the successful operations and income stream of the borrowers, and commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. The Company’s underwriting criteria for commercial real estate loans include maximum loan-to-value ratios, debt coverage ratios, secondary sources of repayment, guarantor requirements, net worth requirements and quality of cash flow. As part of the loan approval and underwriting of commercial real estate loans, management undertakes a cash flow analysis, and generally requires a debt-service coverage ratio of at least 1.15 times. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2014, approximately 23.8% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.
The Company makes construction and land development loans primarily for the construction of one- to four-family residences but also for multi-family and nonresidential real estate projects on a select basis. The Company offers construction loans to builders including both speculative (unsold) and pre-sold loans to pre-approved local builders. The number of speculative loans that management will extend to a builder at one time depends upon the financial strength and credit history of the builder. The Company’s construction loan program is expected to remain a modest portion of the loan volume and management generally limits the number of outstanding loans on unsold homes under construction within a specific area.
The Company also originates first and second mortgage loans secured by one- to four-family residential properties within Georgia, Alabama and the Florida panhandle. Management currently originates mortgages at all branch locations, but utilizes a centralized processing location to reduce the underwriting risk. The Company originates both fixed rate and adjustable rate one- to four-family residential mortgage loans. Fixed rate 30 year conforming loans are generally originated for resale into the secondary market on a servicing-released basis and loans that are non-conforming due to property exceptions and that have adjustable rates are generally retained in the Company’s portfolio. The non-conforming loans originated are not considered to be subprime loans and the amount of subprime and low documentation loans held by the Company is not material.
The Company originates consumer loans that consist of loans on deposits, second mortgage loans, home equity lines of credit, auto loans and various other installment loans. The Company primarily offers consumer loans (excluding second mortgage loans and home equity lines of credit) as an accommodation to customers. Consumer loans tend to have a higher credit risk than residential mortgage loans because they may be secured by rapidly depreciable assets, or may be unsecured. The Company’s consumer lending generally follows accepted industry standards for non subprime lending, including credit scores and debt to income ratios. The Company also offers home equity lines of credit as a complement to one- to four-family residential mortgage lending. The underwriting standards applicable to home equity credit lines are similar to those for one- to four-family residential mortgage loans, except for slightly more stringent credit-to-income and credit score requirements. Home equity loans are generally limited to 80% of the value of the underlying property unless the loan is covered by private mortgage insurance or a loss sharing
agreement. At September 30, 2014, the Company had $11.8 million of home equity lines of credit and second mortgage loans not covered by FDIC loss sharing agreements (“loss sharing”).
The Company’s commercial business loans are generally limited to terms of five years or less. Management typically collateralizes these loans with a lien on commercial real estate or, much less frequently, with a lien on business assets and equipment. Management also generally requires the personal guarantee of the business owner. Interest rates on commercial business loans are generally higher than interest rates on residential or commercial real estate loans due to the risk inherent in this type of loan. Commercial business loans are generally considered to have more risk than residential mortgage loans or commercial real estate loans because the collateral may be in the form of intangible assets and/or readily depreciable inventory. Commercial business loans may also involve relatively large loan balances to single borrowers or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation and income stream of the borrower. Such risks can be significantly affected by economic conditions. In addition, commercial business lending generally requires substantially greater supervision efforts by management compared to residential mortgage or commercial real estate lending.
The Company maintains an internal loan review function that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures. The Company further engages an independent, external loan reviewer on an annual basis.
Nonaccrual and Past Due Loans. Nonaccrual loans not covered by loss sharing, segregated by class of loans were as follows:
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Acquired Neighborhood Community Bank FAS ASC 310-30 loans that are no longer covered under the commercial loss sharing agreement with the FDIC in the amount of $1,292,296 are excluded from this table. Due to the recognition of accretion income established at the time of acquisition, the FAS ASC 310-30 loans that are greater than 90 days delinquent or designated nonaccrual status are regarded as accruing loans for reporting purposes.
An age analysis of past due loans not covered by loss sharing, segregated by class of loans at September 30, 2014 and 2013 were as follows:
September 30, 2014
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Previously covered loans in the amount of $1,003,007 are now reflected in the Greater than 90 Days Accruing column. These loans which are accounted for under ASC 310-30 are reported as accruing loans because of accretable discounts established at the time of acquisition.
September 30, 2013
An age analysis of past due loans covered by loss sharing, segregated by class of loans at September 30, 2014 and 2013 were as follows:
September 30, 2014
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Covered loan balances are net of nonaccretable differences and allowance for covered loan losses and have not been reduced by $5,986,428 of accretable discounts.
(2)
Covered loans contractually past due greater than ninety days are reported as accruing loans because of accretable discounts established at the time of acquisition.
September 30, 2013
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Covered loan balances are net of nonaccretable differences and allowance for covered loan losses and have not been reduced by $4,851,229 of accretable discounts.
(2)
Covered loans contractually past due greater than ninety days are reported as accruing loans because of accretable discounts established at the time of acquisition.
Impaired Loans. The Company evaluates “impaired” loans, which includes nonperforming loans and accruing troubled debt restructured loans, having risk characteristics that are unique to an individual borrower on a loan-by-loan basis with balances above a specified level. For smaller loans, the allowance is calculated based on the credit grade utilizing historical loss experience and other qualitative factors.
Impaired loans not covered by loss sharing, segregated by class of loans were as follows:
September 30, 2014
There were no recorded allowances for impaired loans not covered by loss sharing at September 30, 2014. The recorded investment in accruing troubled debt restructured loans at September 30, 2014 totaled $6,154,420 and is included in the impaired loan table above.
September 30, 2013
There were no recorded allowances for impaired loans not covered by loss sharing at September 30, 2013. The recorded investment in accruing troubled debt restructured loans at September 30, 2013 totaled $12,302,311 and is included in the impaired loan table above.
Credit Quality Indicators. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio for both loans covered and not covered by loss sharing agreements, management tracks certain credit quality indicators including the level of classified loans, net charge-offs, non-performing loans (see details above) and the general economic conditions in its market areas.
The Company utilizes a risk grading to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 8. The risk grade for each individual loan is determined by the loan officer and other approving officers at the time of loan origination and is changed from time to time to reflect an ongoing assessment of loan risk. Risk grades are reviewed on specific loans monthly for all delinquent loans as a part of monthly meetings held by the Loan Committee, quarterly for all nonaccrual and special reserve loans, and annually as part of the Company’s internal loan review process. In addition, individual loan risk grades are reviewed in connection with all renewals, extensions and modifications. Risk grades for covered loans are determined by officers within the Special Assets Division based on an ongoing assessment of loan risk. Such risk grades are updated in a manner consistent with non-covered loans, except the grading of such loans are assessed quarterly, as applicable, relating to revised estimates of expected cash flows. A description of the general characteristics of the 8 risk grade factors is as follows:
Grade 1: Virtual Absence of Credit Risk - Loans graded 1 are substantially risk-free. They are characterized by loans to borrowers with unquestionable financial strength and a long history of solid earnings performance or loans collateralized by cash or equivalent liquidity may be included here. Loans secured, within margin, by readily marketable collateral may also be graded 1 provided the relationship meets all other characteristics of the grade.
Grade 2: Minimal Credit Risk - Loans graded 2 are above average quality and will carry all credit attributes of a Grade 3 loan as well as unquestionably strong balance sheets and exhibit secondary repayment sources which would allow for repayment of the debt within a reasonable period of time.
Grade 3: Average Credit Risk - 1 - Loans graded 3 are of average credit quality, are properly structured and documented. Financial data is current and documents adequate revenue, cash flow, and satisfactory payment history to indicate that financial condition is satisfactory. Grade 3 loans have properly margined collateral. Repayment terms are realistic, clearly defined and based upon a primary, identifiable source of repayment. Grade 3 loans meet bank product guidelines.
Grade 4: Acceptable Credit Risk - 2 - Loans Graded 4 loans will be performing credits and will not necessarily represent weakness. Loans most commonly graded 4 will likely include loans with parameter(s) that fall outside of a product guideline.
Grade 5: Special Mention - A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Grade 6: Substandard - A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
Grade 7: Doubtful - An asset classified doubtful has all the weaknesses inherent in one classified 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.
Grade 8: Loss - Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be effected in the future.
The following table presents the risk grades of the loan portfolio not covered by loss sharing, segregated by class of loans:
September 30, 2014
September 30, 2013
The following tables present the risk grades, ignoring grade enhancement provided by the FDIC loss sharing, of the loan portfolio covered by loss sharing agreements, segregated by class of loans at September 30, 2014 and 2013. Numerical risk ratings
5-8 constitute classified assets for regulatory reporting; however, regulatory authorities consider the FDIC loss sharing percentage of either 80% or 95%, as applicable, as a reduction of the regulatory classified balance for covered loans.
September 30, 2014
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Covered loan balances are net of nonaccretable differences and allowances for covered loan losses and have not been reduced by $5,986,428 of accretable discounts.
September 30, 2013
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Covered loan balances are net of nonaccretable differences and allowances for covered loan losses and have not been reduced by $4,851,229 of accretable discounts.
With respect to classified assets covered by loss sharing agreements, numerical risk ratings 5-8, for regulatory reporting purposes are done under FDIC guidance reporting the bank’s non-reimbursable amount of the book balance of the loan as classified. The remaining reimbursable portion is classified as pass, numerical risk ratings 1-4.
Allowance for Loan Losses. The allowance for loan losses is established through a provision for loan losses charged to expense and is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely and subsequent recoveries are added to the allowance.
Management’s allowance for loan losses methodology is a loan classification-based system. Management bases the required reserve on a percentage of the loan balance for each type of loan and classification level. Loans may be classified manually and are automatically classified if they are not previously classified when they reach certain levels of delinquency. Unclassified loans are reserved at different percentages based on the loan loss history of the last seven years. Reserve percentages are also adjusted based upon our estimate of the effect that the current economic environment will have on each type of loan.
Management segments its allowance for loan losses into the following four major categories: (1) specific reserves; (2) general allowances for Classified/Watch loans; (3) general allowances for loans with satisfactory ratings; and (4) an unallocated amount. Risk ratings are initially assigned in accordance with CharterBank’s loan and collection policy. An organizationally independent department reviews risk grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates
a portion of the allowance for loan losses for that loan based on the fair value of the collateral, if the loan is considered collateral-dependent, as the measure for the amount of the impairment. Impaired and Classified/Watch loans are aggressively monitored.
The allowances for loans by credit grade are further subdivided by loan type. Charter Financial has developed specific quantitative allowance factors to apply to each loan which considers loan charge-off experience over the most recent seven years by loan type. In addition, loss estimates are applied for certain qualitative allowance factors that are subjective in nature and require considerable judgment on the part of management. Such qualitative factors include economic and business conditions, the volume of past due loans, changes in the value of collateral of collateral-dependent loans, and other economic uncertainties. An unallocated component of the allowance is also established for potential losses that exist in the remainder of the portfolio, but have yet to be identified.
The Company incorporates certain refinements and improvements to its allowance for loan losses methodology from time to time. During the year ended September 30, 2014, the Company made certain refinements in its allowance methodology. The Company increased the look back period of historical losses from 24 months to 84 months as net charge-offs were not reflective of a full credit cycle for the two year period ended September 30, 2014 as compared with the seven year period ended September 30, 2014. In addition, some qualitative factors were removed and the loss allocation for qualitative risk factors was decreased. The change in the historical look back period more closely aligns the quantitative aspect of the companies allowance methodology with the risks inherent in a full credit cycle. The adjustments in our methodology were not material to the overall allowance or provision for the year ended September 30, 2014.
An unallocated allowance is generally maintained in a range of 4% to 12% of the total allowance in recognition of the imprecision of the estimates and other factors. In times of greater economic downturn and uncertainty, the higher end of this range is provided.
Through the FDIC-assisted acquisitions of the loans of NCB, MCB and FNB, management established nonaccretable discounts for the acquired impaired loans and also for all other loans of MCB. These nonaccretable discounts were based on estimates of future cash flows. Subsequent to the acquisition dates, management continues to assess the experience of actual cash flows compared to estimates. When management determines that nonaccretable discounts are insufficient to cover expected losses in the applicable covered loan portfolios, the allowance for covered loans is increased with a corresponding provision for covered loan losses as a charge to earnings and an increase in the applicable FDIC receivable based on loss sharing indemnification.
The Company maintained its allowance for loan losses for the years ended September 30, 2014 and 2013 in response to continued weak economic conditions, net charge-offs, financial indicators for borrowers in the real estate sectors, continuing low collateral values of commercial and residential real estate, and nonaccrual and impaired loans. The following table details the allowance for loan losses on loans not covered by loss sharing by portfolio segment as of September 30, 2014 and 2013. Allocation of a portion of the allowance to one category of loans does not preclude availability to absorb losses in other categories.
The following tables are a summary of transactions in the allowance for loan losses on loans not covered by loss sharing by portfolio segment:
The Company also serviced mortgage loans primarily for others with aggregate principal balances of $14,264,243, $8,116,349, and $10,858,784 at September 30, 2014, 2013, and 2012, respectively. Also, for further information, see Note 11 - Borrowings for loans pledged as collateral.
Loans to certain executive officers, directors, and their associates totaled $414,195 and $683,995 at September 30, 2014 and 2013, respectively. Management believes that such loans were made in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal credit risk nor present other unfavorable features.
The following is a summary of activity with respect to such aggregate loans to these individuals and their associates and affiliated companies:
For the years ended September 30, 2014 and 2013, the following tables present a breakdown of the types of concessions determined to be troubled debt restructurings (“TDRs”) during the period by loan class:
Loans are classified as restructured by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. The Company only restructures loans for borrowers in financial difficulty that have presented a viable business plan to fully pay off all obligations, including outstanding debt, interest, and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute upon their plans. The concessions granted on TDRs generally include terms to reduce the interest rate or extend the term of the debt obligation.
Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the loan is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).
At September 30, 2014, restructured loans with a modified balance of $6,154,420 were accruing and $1,673,375 were non-accruing. At September 30, 2013, restructured loans with a modified balance of $12,302,311 were accruing and $438,789 were non-accruing.
As of September 30, 2014 and 2013, there were no loans that defaulted within twelve months after their restructure.
Note 6: Derivative Instruments and Hedging Activities
Previously, the Bank entered into interest rate swap contracts in connection with its hedging of specific loans. As of June 30, 2013, the Bank had entered into interest rate swaps totaling approximately $4.4 million using a receive-variable swap to mitigate the exposure to changes in the fair value attributable to the benchmark interest rate (fixed rate) and the hedged items (loans receivable) from the effective date of the hedged instruments. During the quarter ended September 30, 2013, the Company closed out its interest rate contract with an unwind date of August 26, 2013. A gain position of $189,054 was realized on the termination of this contract which will be accreted into income as an adjustment to yield over the remaining life of the loans.
Note 7: Accrued Interest and Dividends Receivable
At September 30, 2014 and 2013, accrued interest and dividends receivable are summarized as follows:
Note 8: Real Estate Owned
The following is a summary of transactions in other real estate owned:
Non-covered real estate owned
Covered real estate owned
Note 9: Premises and Equipment
Premises and equipment at September 30, 2014 and 2013 is summarized as follows:
Depreciation expense for premises and equipment for the years ended September 30, 2014, 2013, and 2012, was $1,015,748, $1,095,575, and $1,235,436, respectively. During the year ended September 30, 2014, the Company transferred select assets with a value of $295,134 and accumulated depreciation of $19,250 from premises and equipment to assets available for sale. These assets were subsequently sold in the fourth quarter of fiscal 2014.
Note 10: Deposits
At September 30, 2014 and 2013, deposits are summarized as follows:
Accrued interest payable is included in other liabilities in the consolidated statements of financial condition.
Historically, the Company accepted out of market time deposits from various credit unions and/or brokers as a source of funds. The balance of the broker deposits was $5.0 million at September 30, 2013, and the balance of the credit union deposits was $399,391 at September 30, 2013. The Company had no broker deposits or credit union deposits at September 30, 2014.
At September 30, 2014, scheduled maturities of time deposits are as follows:
Interest expense on deposits for the years ended September 30, 2014, 2013, and 2012 is summarized as follows:
Deposits of certain officers, directors, and their associates totaled $2.4 million and $2.9 million at September 30, 2014 and 2013, respectively. Management believes that such deposits have substantially the same terms as those for comparable transactions with other unrelated parties.
Note 11: Borrowings
At September 30, 2014 and 2013, borrowings are summarized as follows:
FHLB advances at September 30, 2014 and 2013 are summarized by year of maturity in the table below:
During 2014, the Company paid off $5.0 million of FHLB advances that matured in March 2014. Additionally, during 2013, the Company paid off $20.0 million of FHLB advances with $10.0 million maturing in March 2013 and another $10.0 million maturing in September 2013.
At September 30, 2014, the Company pledged, under a blanket floating collateral lien with the FHLB, all stock of the FHLB, certain qualifying first mortgage loans with unpaid principal balances totaling $97.8 million certain commercial real estate loans with unpaid principal balances totaling $53.8 million, and certain available for sale securities, with an aggregate carrying amount of $101.7 million.
All of the FHLB advances were fixed rates at September 30, 2014. The Company’s FHLB advances include $25.0 million of advances that are callable by the FHLB under certain circumstances. The advances from the FHLB are subject to prepayment penalties.
At September 30, 2014, the Company had available line of credit commitments with the FHLB totaling $310.7 million, of which $55.0 million was advanced and $255.7 million was available at September 30, 2014 based on total assets; however, based on actual collateral available, $168.9 million was available. At September 30, 2014, the Company had an available line of credit based on the collateral available of $65.8 million with the Federal Reserve Bank of Atlanta.
Interest expense on borrowings for the years ended September 30, 2014, 2013, and 2012, is summarized as follows:
Note 12: Income Taxes
Income tax expense (benefit) attributable to income from continuing operations for the years ended September 30, 2014, 2013, and 2012 consists of:
The difference between the actual total provision for federal and state income taxes and federal income taxes computed at the statutory rate of 35% for the years ended September 30, 2014, 2013, and 2012 is summarized as follows:
The effective tax rate for the years ended September 30, 2014, 2013, and 2012, was 31.53%, 31.44%, and 11.38%, respectively.
In assessing the reliability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies by jurisdiction and entity in making this assessment.
Based upon the level of historical taxable income and projections for future taxable income over the periods which the temporary differences resulting in the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefit of these deductible differences at September 30, 2014.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of September 30, 2014 and 2013 are presented below:
The Company adopted the accounting standard relating to accounting for uncertainty in income taxes during 2009. The Company classifies interest and penalties related to income tax assessments, if any, in income tax expense in the consolidated statements of operations. An audit by the Internal Revenue Service of First Charter, MHC, Charter Federal and CharterBank’s federal income taxes for 2009 to 2011 was completed in fiscal 2013. Tax years 2012 and 2013 are subject to examination by the Internal Revenue Service. Tax years 2011 through 2013 are subject to examination by state taxing authorities in Georgia, Alabama and Florida. The Company had no material uncertain tax positions at September 30, 2014 and 2013.
There was no unrecognized tax benefit as of September 30, 2014, 2013 or 2012. A reconciliation of the beginning and ending unrecognized tax benefit for the years ended September 30, 2014, 2013, and 2012 is as follows:
Note 13: Employee Benefits
The Company has a 401(k) Profit Sharing Plan and Trust (the Plan) which covers substantially all of its employees. The Company has no match of employee contributions to the Plan.
The Company has a short-term incentive plan which covers substantially all employees. For the years ended September 30, 2014, 2013, and 2012, the Company expensed $1,793,522, $1,505,329, and $1,860,695, respectively, related to the incentive plans which is recorded in salaries and employee benefits in the consolidated statements of income.
The Company has a 2002 stock option plan which allows for stock option awards of the Company’s common stock to eligible directors and key employees of the Company. The option price is determined by a committee of the board of directors at the time of the grant and may not be less than 100% of the market value of the common stock on the date of the grant. For options granted under the 2002 stock option plan, when granted, the options vest over periods up to 4 or 5 years from grant date or upon death, disability, or qualified retirement. All options must be exercised within a 10-year period from grant date. The Company may grant either incentive stock options, which qualify for special federal income tax treatment, or nonqualified stock options, which do not receive such tax treatment. The Company’s stockholders have authorized 882,876 shares for the plan of which 72,154 have been issued or retired upon the exercise of the option granted under the plan, 656,059 are granted and outstanding and no shares were available to be granted at September 30, 2014 within this plan. All share and share amounts related to employee benefits have been updated to reflect the completion of the second-step conversion on April 8, 2013 at a conversion ratio of 1.2471.
In addition to the plan above, on December 19, 2013, the Company's stockholders approved the 2013 Equity Incentive Plan which allows for stock option awards of the Company’s common stock to eligible directors and key employees of the Company. The option price is determined by a committee of the board of directors at the time of the grant and may not be less than 100% of the market value of the common stock on the date of the grant. When granted, the options vest over periods no less than 5 years from grant date or upon death or disability. All options must be exercised within a 10-year period from grant date. The Company may grant either incentive stock options, which qualify for special federal income tax treatment, or nonqualified stock options, which do not receive such tax treatment. The Company’s stockholders have authorized 1,428,943 shares for the plan of which 971,680 were granted and outstanding during the fiscal year ended September 30, 2014, with the remaining 457,263 shares available to be granted at September 30, 2014.
The fair value of the 971,680 options granted during the fiscal year ended September 30, 2014, was estimated on the date of grant using the Black-Scholes-Merton model with the following assumptions:
The following table summarizes activity for shares under option and weighted average exercise price per share:
The stock price at September 30, 2014 was higher than the exercise prices of all options outstanding and exercisable. Total options outstanding at September 30, 2014 had an intrinsic value of $1,481,256 with the stock price higher than all options except for the 971,680 shares granted in this fiscal year. The total intrinsic value of the 395,540 shares exercisable at September 30, 2014 was $744,713.
For the years ended September 30, 2014, 2013, and 2012, 393,545, 1,995, and 0 stock options vested, respectively.
For the years ended September 30, 2014, 2013 and 2012 stock option expense of $291,512, $69,581, and $93,877, respectively, was recorded. As of September 30, 2014, the Company had $1.9 million of unrecognized stock option expense which will be recognized over the next four years.
The following table summarizes information about the options outstanding at September 30, 2014:
In June 2012 the Company adopted a supplemental retirement plan for three executives. The benefit restoration plan and Supplemental Retirement Plan that were previously in place have been frozen. The plan targets 50%, 30% and 10% of salary as a retirement benefit at normal retirement age as a combined payout from all three plans. The Benefit Restoration Plan and prior
Supplemental Retirement Plan provided benefits for 15 years. The new Supplemental Retirement Plan provides benefits for life but at the same level of payment as for the first 15 years. It does not increase to restore the benefit to the targeted level when the benefits under the other plans cease. In the stock conversion and reorganization completed on April 8, 2013, the Company assumed the liability of a supplemental retirement plan, which was previously held at the mutual holding company above Charter Financial Corporation, for the former Chairman of the Board with a balance of $958,576 at September 30, 2014. The combined accrued liability for the four plans at September 30, 2014 and September 30, 2013 was $2,606,816 and $2,685,992, respectively. The expense for the years ended September 30, 2014, 2013 and 2012 was $214,873, $178,031, and $123,288, respectively.
The Company has a Charter Financial Corporation 2001 Recognition and Retention Plan and has granted 14,965 shares of restricted stock to key employees and directors, of which 5,610 shares vested during the year ended September 30, 2014. As of September 30, 2014, 9,355 shares remain in the trust and have not yet vested.
In addition to the above, the Company implemented the Charter Financial Corporation 2013 Equity Incentive Plan as described above, which has 571,577 shares authorized, and during the fiscal year ended September 30, 2014 the Company granted 360,092 shares of restricted stock to key employees and directors. The remaining 211,485 shares are available to be granted at September 30, 2014.
Grants between January 1, 2009 and December 1, 2013 will be expensed to the earlier of scheduled vesting or substantive vesting which is when the recipient becomes qualified for retirement at age 65. Grants subsequent to December 1, 2013 will be expensed to the scheduled vesting.
The Company has implemented the Employee Stock Ownership Plan (ESOP) which covers substantially all of its employees. During the initial stock offering of the Company, the ESOP trust borrowed $3,171,580 from the Company to purchase 317,158 shares for allocation under the ESOP. In the incremental stock offering in fiscal 2010 the ESOP purchased an additional 300,000 shares using an additional loan from the Company in the amount of $2,334,000. The ESOP loan amount at April 8, 2013, before the stock conversion was $2,857,780. The conversion proceeds included an allocation to the ESOP Plan that brought the loan amount to $6,480,949 after the stock conversion. The loan to the ESOP is reflected as unearned compensation in stockholders’
equity. As the Company receives principal payments on the loan, shares are released for allocation to participants in the ESOP and unearned compensation is reduced. Shares are freed for allocation to participants in the ESOP based on the principal and interest allocation method. Vesting in the shares of the ESOP occurs after three years of service. Participants in the ESOP may receive a distribution equal to the value of their account upon retirement, death, disability, termination of employment, or termination of the ESOP. The Company records compensation expense associated with the ESOP based on the average market price of the total shares committed to be released during the year as well as the dividends declared on the unallocated shares. The Company expensed $537,675, $495,905, and $311,866, related to the ESOP during the years ended September 30, 2014, 2013, and 2012, respectively, which is included in salaries and employee benefits in the consolidated statements of income. The Company allocated 50,000 shares and 21,006 shares, to participants in the plan during the years ended September 30, 2013 and 2012, respectively, and estimate releasing approximately 50,000 shares for the year ending September 30, 2014. At September 30, 2014, there were 729,190 unallocated shares with a market value of $7,802,333 in the ESOP.
Note 14: Commitments and Contingent Liabilities
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 and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
Standby letters of credit are commitments guaranteeing performance of a customer to a third party. In order to minimize its exposure, the Company's formalized credit practices govern the issuance of standby letters of credit.
The Company’s exposure to credit loss, in the event of nonperformance by the customer for commitments to extend credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded loans.
The Company sells loans on a best efforts basis and had loans as reported in the statement of condition as loans held for sale in the process of being sold.
Commitments to sell fixed rate loans are contracted on a best efforts basis and the value of the funded commitments approximates the commitment to sell the loans.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but consists primarily of real estate.
A summary of the Company’s financial instruments with off-balance-sheet risk at September 30, 2014 and 2013 is as follows:
The carrying amount of commitments to extend credit approximates fair value. The carrying amount of the off-balance sheet financial instruments is based on fees charged to enter into such agreements.
Future minimum lease commitments under all noncancellable operating leases with terms of one year or more are as follows:
Rent expense for the years ended September 30, 2014, 2013, and 2012 was $734,940, $706,616 and $1,039,369, respectively, which were included in occupancy expense in the consolidated statements of income.
The Company and subsidiary have been named as defendants in various legal actions arising from their normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, any such liability will not have a material effect on the Company’s consolidated financial statements.
Note 15: Fair Value of Financial Instruments and Fair Value Measurement
Accounting standards define fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting standards also establish a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The applicable standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. For example, changes in market activity or the addition of new unobservable inputs could, in the Company’s judgment, cause a transfer to either a higher or lower level. For the years ended September 30, 2014 and 2013, there were no transfers between levels.
At September 30, 2014, the Company held, as part of its investment portfolio, available for sale securities reported at fair value consisting of municipal securities, U.S government sponsored entities, mortgage-backed securities, and collateralized mortgage obligations. The fair value of the majority of these securities is determined using widely accepted valuation techniques including matrix pricing and broker-quote based applications. Inputs include benchmark yields, reported trades, issuer spreads, prepayment speeds and other relevant items. These are inputs used by a third-party pricing service used by the Company. All of the Company’s available for sale securities fall into Level 2 of the fair value hierarchy. To validate the appropriateness of the valuations provided by the third party, the Company regularly updates its understanding of the inputs used and compares valuations to an additional third party source.
Previously, the Company has used interest-rate swaps to provide long-term fixed rate funding to its customers. The majority of these derivatives were exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract. Therefore, these derivative contracts were classified as Level 2. The Company utilized an independent third party valuation company to validate the dealer prices. In cases where significant credit valuation adjustments were incorporated into the estimation of fair value, reported amounts were considered as Level 3 inputs. The Company also utilized this approach to estimate its own credit risk on derivative liability positions. To date, the Company has not realized any losses due to a counterparty’s inability to pay any net uncollateralized position. As of September 30, 2013, the Company exited its interest rate swap contracts (see Note 6 - Derivative Instruments and Hedging Activities for additional detail).
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS - The carrying amount approximates fair value because of the short maturity of these instruments.
INVESTMENTS AVAILABLE FOR SALE AND FHLB STOCK - The fair value of investments and mortgage-backed securities and collateralized mortgage obligations available for sale is estimated based on bid quotations received from securities dealers. The FHLB stock is considered a restricted stock and is carried at cost which approximates its fair value.
LOANS RECEIVABLE - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions.
Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. In prior periods, including at September 30, 2013, the Company affected estimated fair value by a liquidation discount of 5.5%. Due to the continued stabilization of the whole loan market, this liquidation discount was discontinued during the year ended September 30, 2014.
LOANS HELD FOR SALE - Loans held for sale are carried at the lower of cost or market value. The fair values of loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics.
CASH SURRENDER VALUE OF LIFE INSURANCE - The Company’s cash surrender value of bank owned life insurance approximates its fair value.
FDIC RECEIVABLE FOR LOSS SHARING AGREEMENTS - Fair value is estimated based on discounted future cash flows using current discount rates, for instruments with similar risk and cash flow volatility.
ASSETS HELD FOR SALE - The fair value of assets held for sale by the Company is generally based on the most recent appraisals of the asset or other market information as it becomes available to management.
DEPOSITS - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW accounts, and money market and checking accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
BORROWINGS - The fair value of the Company’s Federal Home Loan Bank advances is estimated based on the discounted value of contractual cash flows. The fair value of securities sold under agreements to repurchase approximates the carrying amount because of the short maturity of these borrowings. The discount rate is estimated using rates quoted for the same or similar issues or the current rates offered to the Company for debt of the same remaining maturities.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - The Company has used interest-rate swaps to provide long-term fixed rate funding to its customers. The majority of these derivatives were exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract. Therefore, these derivative contracts were classified as Level 2. The Company utilized an independent third party valuation company to validate the dealer prices. In cases where significant credit valuation adjustments were incorporated into the estimation of fair value, reported amounts were classified as Level 3.
ACCRUED INTEREST AND DIVIDENDS RECEIVABLE AND PAYABLE - The carrying amount of accrued interest and dividends receivable on loans and investments and payable on borrowings and deposits approximate their fair values.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT - The value of these unrecognized financial instruments is estimated based on the fee income associated with the commitments which, in the absence of credit exposure, is considered to approximate their settlement value. Since no significant credit exposure existed, and because such fee income is not material to the Company’s financial statements at September 30, 2014 and 2013, the fair value of these commitments is not presented.
Many of the Company’s assets and liabilities are short-term financial instruments whose carrying amounts reported in the Statement of Condition approximate fair value. These items include cash and due from banks, interest-bearing bank balances, federal funds sold, other short-term borrowings and accrued interest receivable and payable balances. The estimated fair value of the Company’s remaining on-balance sheet financial instruments as of September 30, 2014 and 2013 are summarized below.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time
the Company’s entire holdings of a particular financial instrument. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. 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 instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax liabilities and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
The Company also holds assets available for sale reported at fair value consisting of three former branches, a parcel of land adjacent to a current branch and a parcel of land initially acquired as a proposed branch site that are included in other assets. The fair value of these assets is determined using current appraisals adjusted at management's discretion to reflect any decline in the fair value of the properties since the time the appraisal was performed. Appraisal values are reviewed and monitored internally and fair value is reassessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. All of the Company's assets held for sale fall into level 3 of the fair value hierarchy.
Assets and Liabilities Measured on a Recurring Basis:
Assets and liabilities measured at fair value on a recurring basis are summarized below.
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(1)
Bonds with split ratings represent securities with both investment and non-investment grades.
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(1)
Bonds with split ratings represent securities with both investment and non-investment grades.
When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.
A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis is as follows:
Assets and Liabilities Measured on a Nonrecurring Basis:
Assets and liabilities measured at fair value on a nonrecurring basis are summarized below.
Loans considered impaired are loans for which, based on current information and events, it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect write-downs that are based on the market price or current appraised value of the collateral, adjusted to reflect local market conditions or other economic factors. After evaluating the underlying collateral, the fair value of the impaired loans is determined by allocating specific reserves from the allowance for loan and lease losses to the loans. Thus, the fair value reflects the loan balance as adjusted by partial chargedowns less the specifically allocated reserve. Certain collateral-dependent impaired loans are reported at the fair value of the underlying collateral. Impairment is measured based on the fair value of the collateral, which is typically derived from appraisals that take into consideration prices in observed transactions involving similar assets and similar locations. Each appraisal is updated on an annual basis, either through a new appraisal or through the Company’s comprehensive internal review process. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. The fair value of impaired loans that are not collateral dependent is measured using a discounted cash flow analysis considered to be a Level 3 input.
Other real estate owned (“OREO”) is initially accounted for at fair value, less estimated costs to dispose of the property. Any excess of the recorded investment over fair value, less costs to dispose, is charged to the allowance for loan and lease losses at the time of foreclosure. A provision is charged to earnings for subsequent losses on other real estate owned when market conditions indicate such losses have occurred. The ability of the Company to recover the carrying value of other real estate owned is based upon future sales of the real estate. The ability to effect such sales is subject to market conditions and other factors beyond our control, and future declines in the value of the real estate would result in a charge to earnings.
The recognition of sales and sales gains is dependent upon whether the nature and terms of the sales, including possible future involvement of the Company, if any, meet certain defined requirements. If those requirements are not met, sale and gain recognition is deferred. OREO represents real property taken by the Company either through foreclosure or through a deed in lieu thereof from the borrower. The fair value of OREO is based on property appraisals adjusted at management’s discretion to reflect a further decline in the fair value of properties since the time the appraisal analysis was performed. It has been the Company’s experience that appraisals may become outdated due to the volatile real-estate environment. Appraised values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when circumstances occur that indicate a change in fair value. Therefore, the inputs used to determine the fair value of OREO and repossessed assets fall within Level 3. The Company may include within OREO other repossessed assets received as partial satisfaction of a loan. These assets are not material and do not typically have readily determinable market values and are considered Level 3 inputs.
The following table provides information describing the valuation processes used to determine recurring and nonrecurring fair value measurements categorized within Level 3 of the fair value hierarchy.
Accounting standards require disclosures of fair value information about financial instruments, whether or not recognized in the Statement of Condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair value is 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 instrument. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Also, the fair value estimates presented herein are based on pertinent information available to Management as of September 30, 2014 and 2013.
Note 16: Regulatory Matters
The Bank is required to maintain noninterest-bearing cash reserve balances. The aggregate average cash reserve balances maintained at September 30, 2014 and 2013 to satisfy the regulatory requirement were $2.5 million and $10.5 million, respectively.
Under OCC regulations, the Bank is required to measure its interest rate risk and maintain the interest rate risk within limits the Bank establishes. Based on its asset/liability structure at September 30, 2014, the Bank’s earnings may be negatively impacted if interest rates increase significantly.
The Bank is required to meet certain core, tangible, and risk-based regulatory capital ratios. The regulations require institutions to have a minimum regulatory tangible capital ratio equal to 1.5% of total assets, a minimum 3% core capital ratio, and 8% risk-based capital ratio.
The prompt corrective action regulations define specific capital categories based on an institution’s capital ratios. The capital categories, in declining order, are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Institutions categorized as “undercapitalized” or worse are subject to certain restrictions, including the requirement to file a capital plan with its primary federal regulator, prohibitions on the payment of dividends and management fees, restrictions on executive compensation, and increased supervisory monitoring, among other things. Other restrictions may be imposed on the institution either by its primary federal regulator or by the FDIC, including requirements to raise additional capital, sell assets, or sell the entire institution. Once an institution becomes “critically undercapitalized,” it must generally be placed in receivership or conservatorship within 90 days.
To be considered “adequately capitalized,” an institution must generally have a leverage ratio of at least 4%, a Tier 1 risk-based capital ratio of at least 4%, and a total risk-based capital ratio of at least 8%. An institution is deemed to be “critically undercapitalized” if it has a tangible equity ratio of 2% or less.
As of September 30, 2014, the most recent notification from the OCC categorized CharterBank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, CharterBank must maintain minimum total risk-based, Tier 1 risk-based and core/leverage ratios as set forth in the following table. Management is not aware of the existence of any conditions or events occurring subsequent to September 30, 2014 which would affect CharterBank’s well-capitalized classification.
The table of regulatory compliance with minimum capital requirements for CharterBank is presented below at September 30, 2014 and 2013:
The OCC imposes various restrictions or requirements on CharterBank’s ability to make capital distributions, including cash dividends. A savings bank that is the subsidiary of a savings and loan holding company must file a notice with the OCC at least 30 days before making a capital distribution. CharterBank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to CharterBank’s net income for that year plus CharterBank’s retained net income for the previous two years. The OCC may disapprove a notice or application if: (a) CharterBank would be undercapitalized following the distribution; (b) the proposed capital distribution raises safety and soundness concerns; or (c) the capital distribution would violate a prohibition contained in any statute, regulation, or agreement.
Prior to the Company's completion of its conversion and reorganization on April 8, 2013, the Company’s ability to pay dividends and the amount of such dividends was affected by the election of First Charter, MHC, the Company’s mutual holding company, to waive the receipt of dividends declared by Charter Federal. First Charter, MHC had historically waived its right to receive most dividends on its shares of Charter Federal common stock, which meant that Charter Federal had more cash resources to pay dividends to its public stockholders than if First Charter, MHC had accepted such dividends. First Charter, MHC received a waiver in early 2011 from the Office of Thrift Supervision that provided permission to First Charter, MHC to waive dividends in calendar 2011 including the dividend that was paid on December 29, 2011. First Charter, MHC also received a waiver in 2012 from the Federal Reserve that provided permission to First Charter, MHC to waive dividends that were paid on May 25, 2012. First Charter, MHC waived dividends of $422,896, during the year ended September 30, 2012.
The OCC has guidelines that limit the Bank’s investment in BOLI to 25% of the Bank’s regulatory capital. The Bank subsidiary had 25.3% of its regulatory capital invested in BOLI at September 30, 2014. Although the Company slightly exceeded the recommended limit of regulatory capital invested in BOLI, no undue concentration of risk was assumed during the period.
Note 17: Related Parties
During the years ended September 30, 2014, 2013, and 2012 the Company paid approximately $33,517, $37,820 and $148,449, respectively, in insurance premiums to a broker in which a board member is one of the principals of the company.
See Note 5 - Loans Receivable and Note 10 - Deposits for disclosures of loan and deposit relationships of related parties. Management believes transactions entered into with related parties are in the ordinary course of business and on terms similar to transactions with unaffiliated parties.
Note 18: Condensed Financial Statements of Charter Financial Corporation (Parent Only)
The following represents Parent Company only condensed financial information of Charter Financial Corporation:
Note 19: Common Stock Offering
Plan of conversion and reorganization. On April 8, 2013, Charter Financial Corporation, a Maryland corporation, completed its conversion and reorganization pursuant to which First Charter, MHC was converted to the stock holding company form of organization. Charter Financial sold 14,289,429 shares of common stock at $10.00 per share, for gross offering proceeds of $142.9 million in its stock offering. The Bank, as of April 8, 2013, was 100% owned by Charter Financial and Charter Financial was 100% owned by public stockholders. Concurrent with the completion of the offering, shares of common stock of Charter Federal were converted into the right to receive 1.2471 shares of Charter Financial’s common stock for each share of Charter Federal common stock that was owned immediately prior to completion of the transaction. Cash in lieu of fractional shares was paid based on the offering price of $10.00 per share. As a result of the offering and the exchange on April 8, 2013, Charter Financial had 22,752,214 shares outstanding. Also, as of April 8, 2013, Charter Federal and First Charter, MHC ceased to exist. As part of the elimination, the net asset position of First Charter, MHC, in the amount of $229,564, was assumed by Charter Financial. Costs related to the offering were approximately $5.6 million and net proceeds of the offering were approximately $137.3 million.
In accordance with the Board of Governors of the Federal Reserve System regulations, at the time of the reorganization, the Company substantially restricted retained earnings by establishing a liquidation account. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after conversion. The Bank will establish a parallel liquidation account to support the Company's liquidation account in the event the Company does not have sufficient assets to fund its obligations under its liquidation account. The liquidation accounts will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation accounts. In the event of a complete liquidation of the Bank or the Company, each account
holder will be entitled to receive a distribution in an amount proportionate to the adjusted qualifying account balances then held. The Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures.
Our President and Chief Executive Officer, our Chief Financial Officer, and other members of our senior management team have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e)), as of September 30, 2014. Based on such evaluation, the President and Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by us in reports that are filed or submitted under the Exchange Act, (1) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to our management, including our principal executive and principal financial officers as appropriate to allow timely discussions regarding required disclosures.
Management’s Report on Internal Control Over Financial Reporting.
The Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2014, utilizing the framework established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of September 30, 2014 is effective.
Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
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. 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.
The Company’s independent registered public accounting firm, Dixon Hughes Goodman LLP, has issued an attestation report on Management’s assessment of the Company’s internal control over financial reporting as of September 30, 2014. The report, which expresses an unqualified opinion on the Company’s internal control over financial reporting as of September 30, 2014, is included in this Report on Form 10-K.
Changes to Internal Control Over Financial Reporting
There has been no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15 that occurred during the quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information relating to the directors and officers of Charter Financial, information regarding compliance with Section 16(a) of the Exchange Act and information regarding the audit committee and audit committee financial expert is incorporated herein by reference to Charter Financial’s Proxy Statement for the Annual Meeting of Stockholders (the “Proxy Statement”).
Charter Financial has adopted a code of ethics that applies to its principal executive officer, the principal financial officer and principal accounting officer. The Code of Ethics is posted on Charter Financial’s Internet Web site at www.charterbank.net.
The information regarding executive compensation, compensation committee interlocks and insider participation is incorporated herein by reference to the Proxy Statement.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS
(a)Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(b)Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(c)Changes in Control
Management of Charter Financial knows of no arrangements, including any pledge by any person or securities of Charter Financial, the operation of which may at a subsequent date result in a change in control of the registrant.
(d)Equity Compensation Plan Information
The following table sets forth information as of September 30, 2014 about Company common stock that may be issued upon the exercise of options under the Charter Financial Corporation 2001 Stock Option Plan and the Charter Financial Corporation 2013 Equity Incentive Plan which were both approved by Charter Financial’s stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information relating to certain relationships and related transactions and director independence is incorporated herein by reference to the Proxy Statement.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information relating to the principal accounting fees and expenses is incorporated herein by reference to the Proxy Statement.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1)
The financial statements required in response to this item are incorporated by reference from Item 8 of this report.
(2)
All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3)
Exhibits
__________________________________
(1)
Incorporated by reference to Exhibit 2.2 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(2)
Incorporated by reference to Exhibit 2.3 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(3)
Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K/A of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on September 16, 2011.
(4)
Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(5)
Incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(6)
Incorporated by reference to Exhibit 4.0 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(7)
Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K of Charter Financial Corporation, a Maryland corporation (File No. 001-35870), filed with the Securities and Exchange Commission on December 11, 2014.
(8)
Filed herewith.
(9)
Incorporated by reference to Exhibit 10.3 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(10)
Incorporated by reference to Exhibit 10.4 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(11)
Incorporated by reference to Exhibit 10.5 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(12)
Incorporated by reference to Exhibit 10.6 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(13)
Incorporated by reference to Exhibit 10.7 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(14)
Incorporated by reference to Exhibit 10.7 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(15)
Incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(16)
Incorporated by reference to Exhibit 10.8 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(17)
Incorporated by reference to Exhibit 10.11 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(18)
Incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(19)
Incorporated by reference to Exhibit 10.10 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(20)
Incorporated by reference to Exhibit 10.11 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(21)
Incorporated by reference to Exhibit 10.12 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(22)
Incorporated by reference to Exhibits 10.13, 10.14, 10.15 and 10.16 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(23)
Incorporated by reference to Exhibit 10.17 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(24)
Incorporated by reference to Exhibit 10.5 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(25)
Incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(26)
Incorporated by reference to Exhibit 10.7 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(27)
Incorporated by reference to Exhibit 10.21 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
(28)
Incorporated by reference to Exhibit 10.6 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(29)
Incorporated by reference to Exhibit 10.18 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(30)
Incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(31)
Incorporated by reference to Exhibit 10.20 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(32)
Incorporated by reference to Exhibit 10.21 to the Registration Statement on Form S-1 (File No. 333-167634) of Charter Financial Corporation, a Federal corporation, originally filed with the Securities and Exchange Commission on June 18, 2010.
(33)
Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(34)
Incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(35)
Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(36)
Incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K of Charter Financial Corporation, a Federal corporation (File No. 001-34889), filed with the Securities and Exchange Commission on October 1, 2012.
(37)
Incorporated by reference to Appendix A to the proxy statement for the Special Meeting of Shareholders of Charter Financial Corporation, a Maryland corporation (file no. 001-35870) filed with the Securities and Exchange Commission on November 6, 2013.
(38)
Incorporated by reference to Exhibit 21 to the Registration Statement on Form S-1 (File No. 333-185482) of Charter Financial Corporation, a Maryland corporation, originally filed with the Securities and Exchange Commission on December 14, 2012.
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, on December 12, 2014.
CHARTER FINANCIAL CORPORATION
By:
/s/ Robert L. Johnson
Robert L. Johnson
Chairman, President and Chief Executive Officer
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 with Charter Financial Corporation indicated on December 12, 2014.
/s/ Robert L. Johnson
Chairman, President and Chief Executive Officer
Robert L. Johnson
(principal executive officer)
/s/ Curtis R. Kollar
Senior Vice President and Chief Financial Officer
Curtis R. Kollar
(principal accounting and financial officer)
/s/ David Z. Cauble, III
Director
David Z. Cauble, III
/s/ Jane W. Darden
Director
Jane W. Darden
/s/ Edward Smith
Director
Edward Smith
/s/ Curti M. Johnson
Senior Vice President, General Counsel and Director
Curti M. Johnson
/s/ Thomas M. Lane
Director
Thomas M. Lane
/s/ David L. Strobel
Director
David L. Strobel