ITEM 1: BUSINESS
Our Company
We are a bank holding company incorporated in late 2009 with the goal of creating a regional banking franchise in the southeastern region of the United States through organic growth and acquisitions of other banks, including failed, underperforming and undercapitalized banks. We have raised $955.6 million to make acquisitions through a series of private placements and an initial public offering of our common stock. Since inception, we have acquired seven depository institutions, including the assets and certain deposits of three failed banks from the Federal Deposit Insurance Corporation (“FDIC”). We operate 162 branches in Florida, North and South Carolina, Tennessee, and Virginia. Through our branches, we offer a wide range of commercial and consumer loans and deposits, as well as ancillary financial services.
We were founded by a group of experienced bankers with a multi-decade record of leading, operating, acquiring and integrating financial institutions.
Our executive management team is led by our Chief Executive Officer, R. Eugene Taylor. Mr. Taylor is the former Vice Chairman of Bank of America Corp., where his career spanned 38 years and included responsibilities as Vice Chairman and President of the Consumer and Commercial Bank. Mr. Taylor also served on Bank of America’s Risk & Capital and Management Operating Committees. He has extensive experience executing and overseeing bank acquisitions, including NationsBank Corp.’s acquisition and integration of Bank of America, Maryland National Bank and Barnett Banks, Inc.
Our Chief Financial Officer, Christopher G. Marshall, has over 32 years of financial and managerial experience, including serving as Senior Advisor to the Chief Executive Officer and Chief Restructuring Officer at GMAC, Chief Financial Officer of Fifth Third Bancorp and as the Chief Operations Executive for Bank of America’s Global Consumer and Small Business Bank. Mr. Marshall also served as Chief Financial Officer of Bank of America’s Consumer Products Group. Prior to joining Bank of America, Mr. Marshall served as Chief Financial Officer and Chief Operating Officer of Honeywell International Inc. Global Business Services.
Our Chief Credit Officer, R. Bruce Singletary, has over 34 years of experience, including 21 years of experience managing credit risk. He has served as Head of Credit for NationsBank Corp. for the Mid-Atlantic region. Mr. Singletary then relocated to Florida to establish a centralized underwriting function to serve middle market commercial clients in the southeastern region of the United States. Mr. Singletary also served as Senior Risk Manager for commercial banking for Bank of America’s Florida Bank and as Senior Credit Policy Executive of C&S Sovran (renamed NationsBank Corp).
Our Chief of Strategic Planning and Investor Relations, Kenneth A. Posner, spent 13 years as an equity research analyst including serving as a Managing Director at Morgan Stanley focusing on a wide range of financial services firms. Mr. Posner also served in the United States Army, rising to the rank of Captain and has received professional designations as a Certified Public Accountant, as a Chartered Financial Analyst and for Financial Risk Management.
Our Acquisitions
Overview
Our banking operations commenced on July 16, 2010, when we purchased $1.2 billion of assets and assumed $960.1 million of deposits of three failed banks from the FDIC. We did not pay the FDIC a premium for the deposits of the failed banks. In connection with these acquisitions, we entered into loss sharing agreements with the FDIC covering approximately $796.1 million of outstanding loans balances and real estate of the failed banks that we acquired. Under the loss sharing agreements, the FDIC has agreed to absorb 80% of all future credit losses and workout expenses on these assets which occur prior to the expiration of the loss sharing agreements. On September 30, 2010, we invested $175.0 million in TIB Financial Corp. (“TIB Financial”), a publicly held financial services company that had total assets of $1.7 billion and operated 28 branches in southwest Florida and the Florida Keys. On January 28, 2011, we invested $181.1 million in Capital Bank Corporation (“Capital Bank Corp.”), a publicly held financial services company that had $1.7 billion in assets and operated 32 branches in central and western North Carolina. On September 7, 2011, we invested $217.0 million in Green Bankshares, Inc. (“Green Bankshares”), a publicly held financial services company that had $2.4 billion in assets and operated 63 branches across East and middle Tennessee in addition to one branch in each of Virginia and North Carolina. In addition, on October 1, 2012, we invested approximately $99.3 million in Southern Community Financial Corporation, a publicly held financial services company that had approximately $1.4 billion in assets and operated 22 branches in North Carolina. We have integrated our seven acquired institutions and combined them all onto a single scalable processing platform.
The Failed Banks
On July 16, 2010, we purchased substantially all of the assets and assumed all of the deposits of First National Bank in Spartanburg, South Carolina, Metro Bank in Miami, Florida and Turnberry Bank in Aventura, Florida (collectively, the “Failed Banks”). None of the Failed Banks were affiliated with one another. First National Bank, founded in 1999, was a mid-sized community bank targeting customers located in the Spartanburg, Greenville, Charleston, Columbia and York County markets in South Carolina that operated 13 branches at the time we acquired it from the FDIC. Metro Bank, founded in 1984, was a privately held community bank that operated six branches in Miami, Coral Gables, Sunrise and Lighthouse Point, Florida at the time we acquired it from the FDIC. Turnberry Bank, founded in 1985, was a privately held community bank that operated four branches in Aventura, Coral Gables, Pinecrest and South Miami, Florida at the time we acquired it from the FDIC.
Our acquisition of the Failed Banks resulted in our acquiring assets with an estimated fair value of $1.2 billion, which included $768.6 million of loans, $74.4 million of investment securities, $184.3 million of cash and cash equivalents and a $137.3 million FDIC indemnification asset. We also assumed liabilities with a fair value of $1.1 billion, which included $960.1 million of deposits and $148.6 million of borrowings.
These transactions gave us an initial market presence in Miami, which we targeted because of its size and concentrated business activity, and South Carolina, which we targeted because of its attractive demographic growth trends.
Loss Sharing Agreements
In connection with our acquisition of the Failed Banks, we entered into loss sharing agreements with the FDIC covering approximately $796.1 million of outstanding loan balances and other real estate owned of the Failed Banks that we acquired. Under the loss sharing agreements, the FDIC agreed to absorb 80% of all future credit losses and workout expenses on these assets which occur prior to the expiration of the loss sharing agreements.
We will reimburse the FDIC for its share of recoveries with respect to losses for which the FDIC paid us a reimbursement under the loss sharing agreements and 50% of certain fully charged-off loans.
The loss sharing agreements consists of three (one for each Failed Bank) single-family shared-loss agreements and three (one for each Failed Bank) commercial and other loans shared-loss agreements. The single family shared-loss agreements provide for FDIC loss sharing and our reimbursement for recoveries to the FDIC for ten years from July 16, 2010 for single-family residential loans. The commercial shared-loss agreements provide for FDIC loss sharing for five years from July 16, 2010 and our reimbursement for recoveries to the FDIC for eight years from July 16, 2010 for all other covered assets.
The covered assets that we acquired in connection with our acquisition of the Failed Banks include one-to-four family residential real estate loans (both owner occupied and non-owner occupied), home equity loans, commercial loans and foreclosed real estate.
We have agreed to make a true-up payment, also known as clawback liability, to the FDIC on the date that is 45 days following the last day of the final shared loss month, or upon the final resolution of all covered assets under the loss sharing agreements in the event losses thereunder fail to reach expected levels, not to exceed ten years from the date of our acquisition of the Failed Banks. The estimated fair value of the true-up payment as of the acquisition date was $1.0 million. As of December 31, 2014, we have a $1.3 million accrual for the estimated fair value of this liability.
Under the loss sharing agreements, we are limited in our ability to dispose of covered assets and we are required to follow specific servicing procedures and to undertake loss mitigation efforts. Additionally, the FDIC has information rights with respect to our performance, requiring us to maintain detailed compliance records.
The carrying value of the FDIC indemnification asset at December 31, 2014 was $16.8 million.
TIB Financial Corp.
On September 30, 2010, we invested approximately $175.0 million in TIB Financial, a publicly held bank holding company headquartered in Naples, Florida that had total assets of approximately $1.7 billion and operated 28 branches in southwest Florida and the Florida Keys. Upon the closing of the TIB Financial investment on September 30, 2010, we owned approximately 99% of the outstanding voting power of TIB Financial. TIB Financial subsequently completed a rights offering to legacy TIB Financial stockholders, which reduced our ownership interest in TIB Financial to approximately 94%. In connection with our TIB Financial investment, we acquired a warrant to purchase an additional $175.0 million in TIB common stock on substantially the same terms as our initial investment, exercisable in whole or in part until March 30, 2012. On March 31, 2012, the warrant expired unexercised. On April 29, 2011, we combined TIB Financial’s banking subsidiary, TIB Bank, with our banking subsidiary, NAFH National Bank (whose name has since changed to Capital Bank, National Association) in an all-stock transaction.
TIB Financial executed a community bank business strategy for individuals and businesses in the Florida Keys for 37 years. It operated 28 full-service banking offices in Florida that were located in Monroe, Miami-Dade, Collier, Lee and Sarasota counties.
The TIB Financial investment resulted in us acquiring assets with a fair value of $1.7 billion, which included $1.0 billion of loans, $309.3 million of investment securities and $229.7 million of cash and cash equivalents. We also assumed liabilities with a fair value of $1.6 billion, which included $1.3 billion of deposits and $208.8 million of subordinated debt and other borrowings.
This acquisition expanded our geographic reach in Florida to include markets that we believe have particularly attractive deposit customer characteristics and provided a platform to support our future growth.
Capital Bank Corp.
On January 28, 2011, we invested approximately $181.1 million in Capital Bank Corp., a publicly held bank holding company headquartered in Raleigh, North Carolina that had approximately $1.7 billion in assets and operated 32 branches in central and western North Carolina. Upon closing of the Capital Bank Corp. investment, we owned approximately 85% of the voting power of Capital Bank Corp. Also, in connection with the investment, each existing Capital Bank Corp. stockholder received one contingent value right (which we refer to as a “CVR”) per share that entitles the holder to receive up to $0.75 in cash per CVR at the end of a five-year period based on the credit performance of Capital Bank Corp.’s existing loan portfolio.
The maximum amount that may be payable under the Capital Bank Corp. CVR at the end of its five-year term is approximately $9.7 million. Based on the credit performance of Capital Bank Corp.’s existing loan portfolio to date, we currently anticipate that holders of Capital Bank Corp. CVRs are unlikely to receive a payment at the end of the five-year term of the Capital Bank Corp. CVRs. If there is a change of control of the Company prior to the end of such five-year term, the CVRs will receive the maximum payout amount of $0.75 in cash per CVR.
Capital Bank Corp. subsequently completed a rights offering to legacy Capital Bank Corp. stockholders, which reduced our ownership interest to approximately 83%. On June 30, 2011, we combined Capital Bank Corp.’s banking subsidiary, Capital Bank, with our banking subsidiary, NAFH National Bank, in an all-stock transaction and, simultaneously with the consummation of the transaction, changed the name of NAFH National Bank to Capital Bank, National Association.
Capital Bank Corp., incorporated in 1998, was a community bank engaged in the general commercial banking business, primarily in markets in central and western North Carolina. It operated 32 branch offices in North Carolina: five branch offices in Raleigh, four in Asheville, four in Fayetteville, three in Burlington, three in Sanford, two in Cary and one in each of Clayton, Graham, Hickory, Holly Springs, Mebane, Morrisville, Oxford, Siler City, Pittsboro, Wake Forest and Zebulon.
The Capital Bank Corp. investment resulted in us acquiring assets with an estimated fair value of $1.7 billion at the acquisition date, which included $1.1 billion of loans, $225.3 million of investment securities and $208.3 million of cash and cash equivalents. We also assumed liabilities with a fair value of $1.5 billion, which included $1.4 billion of deposits and $143.7 million of subordinated debt and other borrowings.
This transaction gave us a strong presence in fast-growing North Carolina markets, including the Raleigh MSA, which, according to SNL Financial, has the fourth highest projected population growth rate in the nation, with over 8.2% growth projected between 2014 and 2019.
Green Bankshares, Inc.
On September 7, 2011, we invested $217.0 million in Green Bankshares, a publicly held bank holding company headquartered in Greeneville, Tennessee that had $2.4 billion in assets reported at the date of acquisition and operated 63 branches across East and middle Tennessee in addition to one branch in each of Virginia and North Carolina. Total assets at the date of acquisition included gross loans of $1.3 billion. Also, in connection with the investment, each existing Green Bankshares stockholder received one CVR per share that entitles the holder to receive up to $0.75 in cash per CVR at the end of a five-year period based on the credit performance of Green Bankshares’ existing loan portfolio. We estimate that the maximum amount that may be payable under the Green Bankshares CVR at the end of its five-year term to be $10.0 million, based on the number of Green Bankshares common shares outstanding as of September 6, 2011. As of December 31, 2014 and 2013, we had no liability and had $0.1 million accrued related to these CVRs, respectively. Based on the credit performance of Green Bankshares’ existing loan portfolio to date, we currently anticipate that holders of Green Bankshares CVRs are unlikely to receive a payment at the end of the five-year term of the Green Bankshares CVRs. If there is a change of control of the Company prior to the end of such five-year term, the CVRs will receive the maximum payout amount of $0.75 in cash per CVR.
Upon completion of our investment, we owned approximately 90% of Green Bankshares’ common stock. On September 7, 2011, we merged GreenBank, Green Bankshares’ banking subsidiary, into Capital Bank in an all-stock transaction similar to the other bank mergers described above.
Green Bankshares was the third largest bank holding company headquartered in Tennessee and parent company of GreenBank, a Tennessee-chartered commercial bank established in 1890. GreenBank provided general banking services through its branches located in Greene, Blount, Cocke, Hamblen, Hawkins, Knox, Loudon, McMinn, Monroe, Sullivan and Washington Counties in East Tennessee and in Davidson, Lawrence, Macon, Montgomery, Rutherford, Smith, Sumner and Williamson Counties in middle Tennessee. GreenBank also operated one branch in Madison County, North Carolina and one branch in Bristol, Virginia as well as a mortgage banking operation in Knox County, Tennessee.
The Green Bankshares investment resulted in us acquiring assets with an estimated fair value at the date of acquisition of $2.4 billion, including $1.3 billion of loans, $174.2 million of investment securities and $542.7 million of cash and cash equivalents. We also assumed liabilities with a reported carrying value at the date of acquisition of $2.1 billion, including $1.9 billion of deposits and $231.2 million of subordinated debt and other borrowings. This transaction extended our market area into Tennessee including the fast-growing metropolitan areas of Nashville and Knoxville.
Southern Community Financial Corporation
On October 1, 2012, we completed the acquisition of all of the preferred and common equity interests in Southern Community Financial Corporation (“SCMF” or “Southern Community”), a publicly held bank holding company headquartered in Winston Salem, North Carolina with approximately $1.4 billion in assets and 22 branches in Winston-Salem, the Piedmont Triad and other North Carolina markets. The consideration consisted of approximately $99.3 million in cash. Also, in connection with the acquisition, each common shareholder of SCMF received one CVR per share that entitles the holder to receive up to $1.30 in cash per share at the end of a five-year period based on the credit performance of SCMF’s existing loan portfolio (the “Maximum Payment Amount”). The maximum amount that may be payable under the Southern Community CVR at the end of its five-year term is $21.9 million. As of December 31, 2014 and 2013, we had accrued $17.4 million and $15.7 million, respectively, related to these CVRs. Based on the credit performance of SCMF’s existing loan portfolio to date, we currently anticipate that, absent the receipt of the Redemption Proceeds pursuant to the consent solicitation currently being conducted with respect to the Southern Community CVRs and discussed below, holders of Southern Community CVRs are likely to receive the Maximum Payment Amount at the end of the five-year term of the Southern Community CVRs. The CVRs will also receive the Maximum Payment Amount upon the consummation of a change of control of the Company prior to the end of such five-year term.
Southern Community, founded in 1996, was the parent of Southern Community Bank and Trust and controlled the third largest share of deposits in the Winston-Salem MSA, the fifth largest MSA in North Carolina. It operated in the neighboring counties of Guilford, Stokes, Surry and Yadkin counties with a branch each in Raleigh and Asheville.
The SCMF acquisition resulted in us acquiring assets with an estimated fair value at the date of acquisition of $1.4 billion, including $0.8 billion of loans, $0.3 billion of investment securities and $0.1 billion of cash and cash equivalents. We also assumed liabilities with a reported carrying value of $1.3 billion, including $1.1 billion of deposits and $0.2 billion of subordinated debt and other borrowings.
This acquisition expanded our market area in the North Carolina markets including Winston-Salem and the Piedmont Triad.
Reorganization
Substantially concurrent with the completion of our initial public offering, we merged each of our majority-held bank holding company subsidiaries (TIB Financial, Capital Bank Corp. and Green Bankshares) with the Company (the “reorganization”). In connection with the mergers of our majority-held subsidiaries, the then existing third-party stockholders of these subsidiaries received shares of Class A common stock in exchange for their minority existing shares. We issued 3,709,832 shares of Class A common stock to the other shareholders of our bank holding company subsidiaries that were merged with the Company in the reorganization. Following the completion of our initial public offering and the reorganization, we became a publicly traded bank holding company with a single directly and wholly-owned bank subsidiary, Capital Bank, N.A.
Southern Community CVR Consent Solicitation
On February 6, 2015, we announced a consent solicitation with respect to the Southern Community CVRs (the “Solicitation”). Through the Solicitation, we are seeking consents from holders of the Southern Community CVRs to permit us to (1) redeem the Southern Community CVRs from the consenting holders at a price of $1.00 per CVR, in cash, without interest (the “Redemption Proceeds”) promptly following the expiration date of the Solicitation (currently scheduled for February 27, 2015, but which can be amended at any time in our sole discretion) (the “Expiration Date”) and (2) amend the CVR Agreement for the Southern Community CVR to permit us to redeem all of the Southern Community CVRs at any time prior to March 31, 2015 at a price equal to the Redemption Proceeds. We are also offering to pay a $0.03 per CVR consent fee to each holder of Southern Community CVRs who gives their consent prior to the Expiration
Date. If consents are received from at least a majority of the CVRs outstanding prior the Expiration Date, we expect to amend the terms of the Southern Community CVR Agreement to permit us to redeem the remaining Southern Community CVRs (including CVRs of non-consenting holders) at any time prior to March 31, 2015 at a per-CVR price equal to the Redemption Proceeds (the “Proposed Amendment”). If the Proposed Amendment is completed, we presently intend to redeem the remaining Southern Community CVRs before March 31, 2015, although our decision whether to redeem the Southern Community CVRs will be made at the relevant time based on all relevant factors, including the availability of funds, the calculation of “Credit Losses” and the corresponding payment amount under the Southern Community CVR Agreement, and our capital and liquidity needs at the time.
We have no obligation to complete the Solicitation and reserve the right to alter or terminate the Solicitation at any time in our sole discretion. We do not make any recommendation as to whether or not any holder of Southern Community CVRs should grant their consent in the Solicitation.
Our Business Strategy
Our business strategy is to build a mid-sized regional bank by operating, integrating and growing our existing operations as well as to acquire other banks, including failed, underperforming and undercapitalized banks and other complementary assets. We believe recent and continuing dislocations in the southeastern U.S. banking industry have created an opportunity for us to create a mid-sized regional bank that will be able to realize greater economies of scale compared to smaller community banks while still providing more personalized, local service than larger-sized banks. We view our market area as the southeastern region of the United States, with a focus on high growth urban markets that offer us opportunities for organic loan and deposit growth.
Operating Strategy
Our operating strategy emphasizes relationship banking focused on commercial and consumer lending and deposit gathering. We have organized operations under a line of business model, under which we have appointed experienced bankers to oversee loan and deposit production in each of our markets, while centralizing credit, finance, technology and operations functions. Our management team possesses significant executive-level leadership experience at Fortune 500 financial services companies, and we believe this experience is an important advantage in executing this regional, more focused, bank business model.
Organic Loan and Deposit Growth
The primary components of our operating strategy are to originate high-quality loans and low-cost customer deposits. Our executive management team has developed a hands-on operating culture focused on performance and accountability, with frequent and detailed oversight by executive management of key performance indicators. We have implemented a sales management system for our branches that is focused on growing loans and core deposits in each of our markets. We believe that this system holds loan officers and branch managers accountable for achieving loan production goals, which are subject to the conservative credit standards and disciplined underwriting practices that we have implemented as well as compliance, profitability and other standards that we monitor. We also believe that accountability is crucial to our results. Our executive management monitors production, credit quality and profitability measures on a quarterly, monthly, weekly and, in some cases, daily basis and provides ongoing feedback to our business unit leaders.
The current market conditions have forced many banks to focus internally, which we believe creates an opportunity for organic growth by strongly capitalized banks such as ourselves. We seek to grow our loan portfolio by offering personalized customer service, local market knowledge and a long-term perspective. We have selectively hired experienced loan officers with local market knowledge and existing client relationships. Additionally, our executive management team takes an active role in soliciting, developing and maintaining client relationships.
Efficiency and Cost Savings
Another key element of our strategy is to operate efficiently by carefully managing our cost structure and taking advantage of economies of scale afforded by our acquisitions. We have been able to reduce salary expense by consolidating duplicative operations of the acquired banks and streamlining management. We plan to further improve efficiency by boosting the productivity of our sales force through our focus on accountability and employee incentives and through selective hiring of experienced loan officers with existing books of business.
Acquisition and Integration Strategy
We seek acquisition opportunities consistent with our business strategy that we believe will produce attractive returns for our stockholders. We plan to pursue acquisitions that position us in southeastern U.S. markets with attractive demographics and business growth trends, expand our branch network in existing markets, increase our earnings power or enhance our suite of products. Our future acquisitions may include distressed assets sold by the FDIC or another seller where our operations, underwriting and servicing capabilities or management experience give us an advantage in evaluating and resolving the assets.
Our acquisition process begins with detailed research of target institutions and the markets they serve. We then draw on our management team’s extensive experience and network of industry contacts in the southeastern region of the United States. Our research and analytics team, led by our Chief of Strategic Planning and Investor Relations, maintains lists of priority targets for each of our markets. The team analyzes financial, accounting, tax, regulatory, demographic, transaction structures and competitive considerations for each target and prepares acquisition projections for review by our executive management team and Board of Directors.
As part of our diligence process in connection with potential acquisitions, we undertake a detailed portfolio- and loan-level analysis conducted by a team of experienced credit analysts led by our Chief Credit Officer. In addition, our management team engages the target management teams in active dialog and personally conducts extensive on and off-site diligence.
Our executive management team has demonstrated success not only in acquiring financial institutions and combining them onto a common platform, but also in managing the integration of those financial institutions. Our management team develops integration plans prior to the closing of a given transaction that allow us to (1) reorganize the acquired institution’s management team under our line of business model immediately after closing; (2) implement our credit, risk and interest rate risk management, liquidity and compliance and governance policies and procedures; and (3) integrate our target’s technology and processing systems rapidly. Using this process, we have already integrated credit and operational policies across each of our acquisitions. We reorganized the management of the Failed Banks within three months of closing, and we merged their core processing systems with TIB Financial’s platform within six months. We also fully integrated Capital Bank Corp. in July 2011, Green Bankshares in February 2012 and Southern Community in November 2012.
Sound Risk Management
Sound risk management is an important element of our commercial/retail bank business model. Our risk management framework seeks to identify, assess and mitigate risk and minimize any resulting losses. Under this framework, we have implemented processes to identify measure, monitor, and report and analyze the types of risk to which we are subject. Such risks include, but are not limited to the following: credit, liquidity, market, operational, legal and compliance, reputational, and strategic and business risk. Our credit risk policy, which has been implemented across our organization, establishes prudent underwriting guidelines, limits portfolio concentrations by geography and loan type and incorporates an independent loan review function. Our Chief Credit Officer has also created a special assets division. This team’s responsibility is to resolve or dispose of legacy problem assets using a detailed process which takes into account borrower repayment capacity, available guarantees, collateral and other factors. We believe our risk management policies establish restrictions on interest rate risk, and conservative regulatory capital ratio and liquidity targets (including contingency planning), limitations on wholesale funding (including brokered CDs), holding company debt and advances from the Federal Home Loan Bank of Atlanta (which we refer to as the “FHLB”).
Our Competitive Strengths
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Experienced and Respected Management Team with a Successful Track Record. Members of our executive management team and Board of Directors have served in executive leadership roles at Fortune 500 financial services companies, including Bank of America, Fifth Third Bancorp and Morgan Stanley. The executive management team has extensive experience overseeing commercial and consumer banking, mergers and acquisitions, systems integrations, technology, operations, credit and regulatory compliance. Many members of our executive management team are from the southeastern region of the United States and have an extensive network of contacts with banking executives, existing and potential customers, and business and civic leaders throughout the region. We believe our executive management team’s reputation and track record give us an advantage in negotiating acquisitions and hiring and retaining experienced bankers.
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Growth-Oriented Business Model. Our executive management team seeks to foster a strong sales culture with a focus on developing key client relationships, including direct participation in sales calls, and through regular reporting and accountability while emphasizing risk management. Our executive management and line of business
executives monitor performance on a quarterly, monthly, weekly and in some cases daily basis, and our compensation plans reward core deposit and responsible commercial loan growth, subject to credit quality, compliance and profitability standards. We have an integrated, scalable core processing platform and centralized credit, finance and technology operations that we believe will support future growth.
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Highly Skilled and Disciplined Acquirer. We executed and integrated six acquisitions successfully in just 18 months and we executed a seventh during the second half of 2012. We integrated our first four investments into a common core processing platform within six months, the fifth in July 2011, the sixth in February 2012 and the seventh in November 2012. We believe our track record of completing and integrating transactions quickly has helped us negotiate transactions on more economically favorable terms.
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Reduced-Risk Legacy Portfolio. Our acquired loan portfolios have been marked-to-market with the application of the acquisition method of accounting, meaning that the carrying value of these assets at the time of their acquisitions reflected our estimate of lifetime credit losses. In addition, as of December 31, 2014, approximately 14.5% of our purchased credit-impaired (“PCI”) loan portfolio was covered by the loss sharing agreements we entered into with the FDIC, resulting in limited credit risk exposure for these assets.
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Excess Capital and Liquidity. As a result of our private placements and the capital we raised in our initial public offering as well as the disciplined deployment of capital, we have ample capital with which to make acquisitions. As of December 31, 2014, we had a 13.63% tangible common equity ratio (which is a non-GAAP measure used by certain regulators, financial analysts and others to measure core capital strength) and a 14.3% Tier 1 leverage ratio, which provides us with $279.7 million in excess capital relative to the 10% Tier 1 leverage standard required under Capital Bank’s operating agreement with the Office of the Comptroller of the Currency (which we refer to as the “OCC”). This operating agreement requires us to maintain this 10% Tier 1 leverage standard. As of December 31, 2014, Capital Bank, N.A. had a 13.5% Tier 1 leverage ratio, a 17.0% Tier 1 risk-based ratio and an 18.1% total risk-based capital ratio. As of December 31, 2014, we had cash and securities equal to 17.3% of total assets, representing $158.7 million of liquidity in excess of our target of 15%, which provides ample liquidity to support our existing banking franchises. Further, our investment portfolio consists primarily of U.S. agency-guaranteed mortgage-backed securities, which have limited credit or liquidity risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Capital Resources and Liquidity” for a discussion of the use of the tangible common equity ratio in our business and the reconciliation of the tangible common equity ratio.
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Scalable Back-Office Systems. All of our acquired institutions have been legally and operationally merged and operate on a single information processing system. Our systems are designed to accommodate all of our projected future growth and allow us to offer our customers virtually all of the critical services currently offered by the nation’s largest financial institutions. Enhancements made to our systems are intended to improve our commercial and consumer loan origination, electronic banking and direct response marketing processes, as well as enhance cash management, streamlined reporting, reconciliation support and sales support.
Our Market Area
We view our market area as the southeastern region of the United States. Our seven acquisitions have established a footprint defined by the Miami-Raleigh-Nashville triangle, which includes the Carolinas, Southwest Florida (Naples), Southeast Florida (Miami-Dade and the Keys) and Central and Western Tennessee. These markets include a combination of large and fast-growing metropolitan areas that we believe will offer us opportunities for organic loan and deposit growth. According to SNL Financial, the Raleigh MSA has the fourth highest projected population growth rate in the nation, with approximately 8.2% growth projected between 2014 and 2019. Similarly, the Charlotte and Nashville MSAs are projected to grow by 6.3% and 6.2%, respectively. The Miami MSA is already considered a large metropolitan area with a population in excess of 5.9 million. Approximately 46% of our current branches are located in our target MSAs. The following table highlights key demographics of our target market areas:
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Source: SNL Financial.
(1)
In thousands.
(2)
Population growth and median household income metrics are deposit weighted by MSA.
Products and Services
Banking Services by Business Line
We have integrated our seven acquisitions under a line of business model. Under this model, we have appointed experienced bankers to oversee loan and deposit growth in each of our markets, while we have centralized other functions, including credit, finance, operations, marketing, human resources and information technology.
The Commercial Bank
Our commercial bank business line consists of teams of commercial loan officers operating under the leadership of commercial market presidents in Florida, the Carolinas and Tennessee. The commercial banking executives are responsible for portfolio balances and production goals for loans, deposits and fees. They work with senior credit officers to ensure that loan production is consistent with our loan policies and with financial officers to ensure that loan pricing is consistent with our profitability goals. We focus our commercial bank business on loan originations for established small and middle-market businesses with whom we develop personal relationships that we believe give us a competitive advantage and differentiates us from larger banking institutions.
In addition, our commercial lending teams coordinate with personnel in our consumer bank business line to provide personal loans and other services to the owners, managers and employees of the Bank’s commercial clients. At December 31, 2014, total commercial loans were $3.3 billion (or 66% of our total loan portfolio). Commercial underwriting is driven by cash flow analysis supported by collateral analysis and review. Our commercial lending teams offer a wide range of commercial loan products, including:
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owner occupied and non-owner occupied commercial real estate;
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construction;
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working capital loans and lines of credit;
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demand, and time loans; and
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equipment, inventory and accounts receivable financing.
During 2014, we originated $1.0 billion of new commercial loans. Our commercial lending teams also seek to gather low-cost deposits from commercial customers in connection with extending credit. In addition to business demand, savings and money market accounts, we also provide specialized cash management services and deposit products.
The Consumer Bank
Our consumer bank business line consists of Capital Bank’s retail banking branches and associated businesses. Similar to our commercial bank business, we have organized the consumer bank by geographical market, with divisions consisting of our Florida, Carolina and Tennessee branches. Each division reports to a consumer banking executive responsible for achieving core deposit and consumer loan growth goals. Pricing of our deposit products is reviewed and approved by our asset-liability committee and the standards for consumer loan credit quality are documented in our loan policy and reviewed by our credit executives.
We seek to differentiate our consumer bank business line from competitors through the personalized service offered by our branch managers, customer service representatives, tellers and other staff. We offer various services to meet the needs of our customers, including checking, savings and money market accounts, certificates of deposit and debit and credit cards. Our products are designed to foster relationships by rewarding our best customers for desirable activities such as debit card transactions, e-statements and direct deposit. In addition to traditional products and services, we offer competitive technology in Internet banking services. Consumer loan products we offer include:
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home equity loans and lines of credit;
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residential first lien mortgages;
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second lien mortgages;
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new and used auto loans;
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new and used boat loans;
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overdraft protection; and
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unsecured personal credit lines.
Branch managers and their staff are charged with growing core deposits with a special focus on new demand deposit accounts and expected to conduct outbound telephone campaigns, generate qualified referrals, collaborate with business partners in the commercial lending teams and evaluate, and make informed decisions with respect to, existing and prospective customers.
Ancillary Fee-Based Businesses
Mortgage Banking
Through our established mortgage banking business, we aim to originate high-quality loans for customers who are willing to establish a deposit relationship with us. The mortgage loans in our portfolio that do not meet these criteria are generally sold in to the secondary market to buyers, such as Fannie Mae and Freddie Mac, and provide an additional source of fee income. Our mortgage banking capabilities include conventional and nonconforming mortgage underwriting and construction and permanent financing.
Trust and Investment Management
We offer wealth management services to affluent clients, business owners and retirees, with a focus on building new relationships and expanding existing relationships to grow deposits, loans and fiduciary and investment management fee income. Through wealth management, we offer investment accounts providing access to a wide range of mutual funds, annuities and other financial products.
Lending Activities
We originate a variety of loans, including loans secured by real estate, loans for construction, loans for commercial purposes, loans to individuals for personal and household purposes, loans to municipalities and loans for new and used cars and boats. A significant portion of our loan portfolio is related to real estate. As of December 31, 2014, loans collateralized by real estate totaled $3.5 billion (or 70% of our total loan portfolio). The economic trends in the regions we serve are influenced by the industries within those regions. Consistent with our emphasis on being a community-oriented financial institution, most of our lending activity is with customers located in and around counties in which we have banking offices.
As of December 31, 2014, our owner occupied commercial real estate loans, non-owner occupied commercial real estate loans, residential mortgage loans and commercial and industrial loans represented 20.9%, 16.0%, 18.5% and 21.5%, respectively, of our $5.0 billion loan portfolio.
We use a centralized risk management process to ensure uniform credit underwriting that adheres to our loan policies as approved annually by our Board of Directors. Lending policies are reviewed on a regular basis to confirm that we are prudent in setting underwriting criteria. Credit risk is managed through a number of methods, including a loan approval process that establishes consistent procedures for the processing and approval of loan requests, risk grading of all commercial loans and certain consumer loans and coding of all loans by purpose, class and collateral type. We seek to focus on underwriting loans that lead to a balanced, diversified portfolio. Management analyzes our commercial real estate concentrations by market and region on a regular basis in an attempt to prevent overexposure to any one type of commercial real estate loan and incorporates third-party real estate and market analysis to monitor market conditions. As of December 31, 2014, the carrying value of our commercial real estate loans in North Carolina, South Carolina, Florida and Tennessee totaled $560.7 million, $172.5 million, $277.4 million $146.5 million, respectively. At December 31, 2014, commercial loans in all regions totaled $3.3 billion (31.9% of which was owner occupied).
We believe that early detection of potential credit problems through regular contact with our clients, coupled with consistent reviews of the borrowers’ financial condition, are important factors in overall credit risk management. Our approach to proactively manage credit quality is to aggressively work with customers for whom a problem loan has been identified and assist in resolving issues before a default occurs.
A key component of our growth strategy is to grow our loan portfolio by originating high-quality commercial and consumer loans, with a lesser emphasis on non-owner occupied real estate loans, that comply with our conservative credit policies and that produce revenues consistent with our financial objectives. In 2014, our loan portfolio increased by $448.2 million as a result of $1.6 billion in new loans, partially offset by $281.9 million of resolutions and $866.5 million of principal repayments.
In addition, we operate an indirect auto lending business which originates loans for new and used cars through relationships with dealers in southwest and southeast Florida, the Florida Keys, and Tennessee. Loans are approved subject to review of FICO credit scores, vehicle age, and loan-to-value ratio. We set pricing for loans based on credit score, vehicle age, and loan term. As of December 31, 2014, we had $242.9 million of auto loans.
Deposits
Deposits are the primary source of funds for lending and investing activities and their cost is the largest category of interest expense. Deposits are attracted principally from clients within our branch network through the offering of a wide selection of deposit instruments to individuals and businesses, including non-interest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money market deposit accounts, certificates of deposit and individual retirement accounts. We are focused on reducing our reliance on high-cost certificates of deposit as a source of funds by replacing them with low-cost deposit accounts. Deposit account terms vary with respect to the minimum balance required; the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (1) the interest rates offered by competitors, (2) the anticipated amount and timing of funding needs, (3) the availability and cost of alternative sources of funding and (4) the anticipated future economic conditions and interest rates. Client deposits are attractive sources of funding because of their stability and relatively low cost. Deposits are regarded as an important part of the overall client relationship and provide opportunities to cross-sell other services. In addition, we gather a portion of our deposit base through brokered deposits. At December 31, 2014, total deposits were $5.3 billion of which $4.9 billion (or 94%) were non-brokered deposits and $317.5 million (or 6%) were brokered deposits. At December 31, 2014, our core deposits of $3.8 billion (total deposits less time deposits) consisted of $1.1 billion of non-interest checking accounts, $1.4 billion of negotiable order of withdrawal accounts, $500.0 million of savings accounts and $898.3 million of money market deposits. For the foreseeable future, we remain focused on retaining and growing a strong deposit base and transitioning certain of our customers to low-cost banking services as high-cost funding sources, such as high-interest certificates of deposit, mature.
Marketing
Our marketing activities support all of our products and services described above. Historically, most of our marketing efforts have supported our real estate mortgage, commercial and retail banking businesses. Our marketing strategy aims to:
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capitalize on our personal relationship approach, which we believe differentiates us from our larger competitors in both the commercial and residential mortgage lending businesses;
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meet our growth objectives based on current economic and market conditions;
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attract core deposits held in checking, savings, money market and negotiable order of withdrawal accounts;
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provide customers with access to our local executives;
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appeal to customers in our region who value quality banking products and personal service;
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pursue commercial and industrial lending opportunities with small to mid-sized businesses that are underserved by our larger competitors;
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cross-sell our products and services to our existing customers to leverage our relationships, grow fee income and enhance profitability;
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utilize existing industry relationships cultivated by our senior management team; and
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adhere to safe and sound credit standards.
We use a variety of targeted marketing media including the Internet, print, direct mail and financial newsletters. Our online marketing activities include paid advertising, as well as cross-sale marketing through our website and Internet banking services. We believe our marketing strategy will enable us to take advantage of lower average customer acquisition costs, build valuable brand awareness and minimize our funding costs.
Information Technology Systems
We have made and continue to make investments in our information technology systems for our banking and lending operations and cash management activities. Our enhancements are tailored to improve our commercial and consumer loan origination, electronic banking and direct response marketing processes, as well as enhance cash management, streamlined reporting, reconciliation support and sales support. We work closely with certain third-party service providers to which we outsource certain of our systems and infrastructure. We use the Jack Henry SilverLake System as our banking platform and believe that the scalability of our infrastructure will support our growth strategy and needs.
Competition
The financial services industry in general and our primary markets of the Carolinas, Florida and Tennessee are highly competitive. We compete actively with national, regional and local financial services providers, including banks, thrifts, credit unions, mortgage bankers and finance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation and restrictions imposed upon us. Our largest competitors include Bank of America, Wells Fargo, JPMorgan Chase, Citigroup, BB&T, First Citizens, SunTrust, Regions, FNB United Corp., Toronto-Dominion, Synovus, First Financial, SCBT, EverBank, Fifth Third Bancorp, First Horizon, Pinnacle Financial, First South and U.S. Bancorp.
Competition among providers of financial products and services continues to increase, with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The primary factors driving commercial and consumer competition for loans and deposits are interest rates, the fees charged, customer service levels and the range of products and services offered. In addition, other competitive factors include the location and hours of our branches and customer service.
Employees
At December 31, 2014, we had approximately 1,424 full-time employees and 91 part-time employees. None of our employees are parties to a collective bargaining agreement. We consider our relationship with our employees to be adequate.
Available Information
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports will be made available free of charge through the Investor Relations section of our website (http://www.capitalbank-us.com) as soon as practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. Material contained on our website is not incorporated by reference into this report.
SUPERVISION AND REGULATION
The U.S. banking industry is highly regulated under federal and state law. These regulations affect the operations of the Company and its subsidiaries. Investors should understand that the primary objectives of the U.S. bank regulatory regime is the protection of depositors and consumers and maintaining the stability of the U.S. financial system, and not the protection of stockholders.
As a bank holding company, we are subject to supervision and regulation by the Board of Governors of the Federal Reserve System (which we refer to as the “Federal Reserve”). Our national bank subsidiary (which is our sole bank subsidiary following the reorganization) is subject to supervision and regulation by the OCC, the Consumer Financial Protection Bureau (which we refer to as the “CFPB”) and the FDIC. In addition, we expect that the additional businesses that we may invest in or acquire will be regulated by various state and/or federal regulators, including the OCC, the Federal Reserve, the CFPB and the FDIC.
The description below summarizes certain elements of the applicable bank regulatory framework. This description is not intended to describe all laws and regulations applicable to us and our subsidiaries. Banking statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies and changes in them, including changes in how they are interpreted or implemented, could have material effects on our business. For example, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (which we refer to as the “Dodd-Frank Act”), which imposes significant regulatory and compliance changes. Some of the provisions of the Dodd-Frank Act became effective immediately upon its enactment. Many provisions, however, require regulations to be promulgated by various federal agencies which could have a material effect on our business. In addition to laws and regulations, state and federal bank regulatory agencies may issue policy statements, interpretive letters and similar written guidance applicable to us and our subsidiaries. These issuances also may affect the conduct of our business or impose additional regulatory obligations. The description is qualified in its entirety by reference to the full text of the statutes, regulations, policies, interpretive letters and other written guidance that are described.
Capital Bank Financial Corp. as a Bank Holding Company
Any entity that acquires direct or indirect control of a bank must obtain prior approval of the Federal Reserve to become a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (which we refer to as the “BHCA”). We became a bank holding company in connection with the acquisition of the assets and assumption of certain liabilities of the Failed Banks from the FDIC by our newly chartered bank subsidiary, Capital Bank. As a bank holding company, we are subject to regulation under the BHCA and to examination, supervision and enforcement by the Federal Reserve. While subjecting us to supervision and regulation, we believe that being a bank holding company (as opposed to a non-controlling investor) broadens the investment opportunities available to us among public and private financial institutions, failing and distressed financial institutions, seized assets and deposits and FDIC auctions. Federal Reserve jurisdiction also extends to any company that is directly or indirectly controlled by a bank holding company, such as subsidiaries and other companies in which the bank holding company makes a controlling investment.
Statutes, regulations and policies could restrict our ability to diversify into other areas of financial services, acquire depository institutions and make distributions or pay dividends on our equity securities. They may also require us to provide financial support to any bank that we control, maintain capital balances in excess of those desired by management and pay higher deposit insurance premiums as a result of a general deterioration in the financial condition of Capital Bank or other depository institutions we control. They may also limit the fees and prices we charge for our consumer services.
Capital Bank, N.A. as a National Bank
Capital Bank is a national bank and is subject to supervision (including regular examination) by its primary banking regulator, the OCC. Retail operations of the bank are also subject to supervision and regulation by the CFPB. Capital Bank’s deposits are insured by the FDIC through the deposit insurance fund (“DIF”) up to applicable limits in the manner and extent provided by law. Capital Bank is subject to the Federal Deposit Insurance Act, as amended (which we refer to as the “FDI Act”), and FDIC regulations relating to deposit insurance and may also be subject to supervision by the FDIC under certain circumstances.
Capital Bank was originally formed as NAFH National Bank for the purpose of completing the acquisition of the Failed Banks. On April 29, 2011, we combined TIB Financial’s banking subsidiary, TIB Bank, with NAFH National Bank in an all-stock transaction. On June 30, 2011, we combined Capital Bank Corp.’s banking subsidiary, Capital Bank, with NAFH National Bank in an all-stock transaction and, simultaneously with the consummation of the transaction, changed the name of NAFH National Bank to Capital Bank, National Association.
On September 7, 2011, we combined Green Bankshares’ banking subsidiary, GreenBank, with Capital Bank in an all-stock transaction. In October 2012, we merged Southern Community Bank and Trust, the wholly-owned bank subsidiary of Southern Community Financial, with and into Capital Bank, N.A.
OCC Operating Agreement and FDIC Order
Capital Bank is subject to specific requirements pursuant to the OCC Operating Agreement, which it entered into with the OCC in connection with our acquisition of the Failed Banks. The OCC Operating Agreement requires, among other things, that Capital Bank maintain various financial and capital ratios and provide notice to, and obtain consent from, the OCC with respect to any additional failed bank acquisitions from the FDIC or the appointment of any new director or senior executive officer of Capital Bank.
Capital Bank (and, with respect to certain provisions, the Company) is also subject to the FDIC Order issued in connection with the FDIC’s approval of our applications for deposit insurance for the Failed Banks. The FDIC Order requires, among other things, that Capital Bank maintain an adequately funded allowance for loan and lease losses and that Capital Bank’s Board of Directors meet certain independence and experience standards.
A failure by us or Capital Bank to comply with the requirements of the OCC Operating Agreement or the FDIC Order could subject us to regulatory sanctions; and failure to comply, or the objection, or imposition of additional conditions by the OCC or the FDIC, in connection with any materials or information submitted thereunder, could prevent us from executing our business strategy and negatively impact our business, financial condition, liquidity and results of operations.
Regulatory Notice and Approval Requirements for Acquisitions of Control
We must generally receive federal regulatory approval before we can acquire an institution or business. Specifically, a bank holding company must obtain prior approval of the Federal Reserve in connection with any acquisition that results in the bank holding company owning or controlling 5% or more of any class of voting securities of a bank or another bank holding company. In acting on such applications of approval, the Federal Reserve considers, among other factors: the effect of the acquisition on competition; the financial condition and future prospects of the applicant and the banks involved; the managerial resources of the applicant and the banks involved; the convenience and needs of the community, including the record of performance under the Community Reinvestment Act (which we refer to as the “CRA”); the effect of the acquisition on the stability of the United States banking or financial system; and the effectiveness of the applicant in combating money laundering activities. Our ability to make investments in depository institutions will depend on our ability to obtain approval of the Federal Reserve. The Federal Reserve could deny our application based on the above criteria or other considerations. We may also be required to sell branches as a condition to receiving regulatory approval, which may not be acceptable to us or, if acceptable to us, may reduce the benefit of any acquisition.
Federal and state laws impose additional notice, approval and ongoing regulatory requirements on any investor that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank holding company. These laws include the BHCA and the Change in Bank Control Act. Among other things, these laws require regulatory filings by an investor that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank holding company.
The determination whether an investor “controls” a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, an investor is deemed to control a depository institution or other company if the investor owns or controls 25% or more of any class of voting securities. However, subject to rebuttal, an investor is generally presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting securities. If an investor’s ownership of our voting securities were to exceed certain thresholds, the investor could be deemed to “control” us for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
Broad Supervision and Enforcement Powers
A principal objective of the U.S. bank regulatory regime is to protect depositors by ensuring the financial safety and soundness of banks and other insured depository institutions. To that end, the Federal Reserve, the OCC and the FDIC have broad supervisory and enforcement authority with regard to bank holding companies and banks, including the power to conduct examinations and investigations, issue cease and desist orders, impose fines and other civil and criminal penalties, terminate deposit insurance and appoint a conservator or receiver. The CFPB similarly has broad regulatory supervision and enforcement authority with regard to consumer protection matters affecting us or our subsidiaries.
Bank regulators regularly examine the operations of banks and bank holding companies. In addition, banks and bank holding companies are subject to periodic reporting and filing requirements.
Bank regulators have various remedies available if they determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of a banking organization’s operations are unsatisfactory. The regulators may also take action if they determine that the banking organization or its management is violating or has violated any law or regulation. The regulators have the power to, among other things: enjoin “unsafe or unsound” practices, require affirmative actions to correct any violation or practice, issue administrative orders that can be judicially enforced, direct increases in capital, direct the sale of subsidiaries or other assets, limit dividends and distributions, restrict growth, assess civil monetary penalties, remove officers and directors and terminate deposit insurance.
Engaging in unsafe or unsound practices or failing to comply with applicable laws, regulations and supervisory agreements could subject the Company, its subsidiaries and their respective officers, directors and institution-affiliated parties to the remedies described above and other sanctions. In addition, the FDIC may terminate a bank’s depository insurance upon a finding that the bank’s financial condition is unsafe or unsound or that the bank has engaged in unsafe or unsound practices or has violated an applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency.
Interstate Banking
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act (which we refer to as the “Riegle-Neal Act”), a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company’s initial entry into the state, more than 30% of such deposits in the state (or such lesser or greater amount set by the state). The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. The Dodd-Frank Act permits a national or state bank, with the approval of its regulator, to open a branch in any state if the law of the state in which the branch is located would permit the establishment of the branch if the bank were a bank chartered in that state. National banks may provide trust services in any state to the same extent as a trust company chartered by that state.
Limits on Transactions with Affiliates
Federal law restricts the amount and the terms of both credit and non-credit transactions between a bank and its nonbank affiliates. Transactions with any single affiliate may not exceed 10% of the capital stock and surplus of the bank. For a bank, capital stock and surplus refers to Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus any portion of the allowance for credit losses excluded from Tier 2 capital. The bank’s transactions with any one affiliate, and with all of its affiliates in the aggregate, are limited to 10% and 20%, respectively, of the foregoing capital. Transactions that are extensions of credit may require collateral to be held to provide added security to the bank and the types of permissible collateral may be limited.
The Dodd-Frank Act generally enhances the restrictions on transactions with affiliates, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered credit transactions must be satisfied. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s Board of Directors.
Bank Holding Companies as a Source of Strength
By statute and regulation, a bank holding company must serve as a source of financial and managerial strength to each bank that it controls and, under appropriate circumstances, may be required to commit resources to support each such controlled bank. This support may be required at times when the bank holding company may not have the resources to provide the support.
Under the prompt corrective action provisions of the FDI Act, if a controlled bank is undercapitalized, then the regulators could require the bank holding company to guarantee the bank’s capital restoration plan. In addition, if the Federal Reserve believes that a bank holding company’s activities, assets or affiliates represent a significant risk to the financial safety, soundness or stability of a controlled bank, then the Federal Reserve could require the bank holding company to terminate the activities, liquidate the assets or divest the affiliates.
The regulators may require these and other actions in support of controlled banks even if such actions are not in the best interests of the bank holding company or its stockholders. Because we are a bank holding company, we (and our consolidated assets) are viewed as a source of financial and managerial strength for any controlled depository institutions, like Capital Bank.
Separately, the Dodd-Frank Act codified a long standing Federal Reserve policy and regulation by amending the FDI Act to require that all companies that directly or indirectly control an insured depository institution serve as sources of financial strength for the institution. The term “source of financial strength” is defined under the statute as the ability of a company to provide financial assistance to its insured depository institution subsidiaries in the event of financial distress. The appropriate federal banking agency for such a depository institution may require reports from companies that control the insured depository institution to assess their abilities to serve as sources of strength and to enforce compliance with the source-of-strength requirements. The appropriate federal banking agency may also require a holding company to provide financial assistance to a bank with impaired capital. Under this requirement, in the future we could be required to provide financial assistance to Capital Bank should it experience financial distress. Based on our ownership of a national bank subsidiary, the OCC could assess us if the capital of Capital Bank were to become impaired. If we failed to pay the assessment within three months, the OCC could order the sale of our stock in Capital Bank to cover the deficiency.
In addition, capital loans by us to Capital Bank will be subordinate in right of payment to deposits and certain other indebtedness of Capital Bank. In the event of our bankruptcy, any commitment by us to a Federal bank regulatory agency to maintain the capital of Capital Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.
Depositor Preference
The FDI Act provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution (including the claims of the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the institution. If our insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, nondeposit creditors, including us, with respect to any extensions of credit they have made to such insured depository institution.
Liability of Commonly Controlled Institutions
FDIC-insured depository institutions can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC due to the default of an FDIC-insured depository institution controlled by the same bank holding company and for any assistance provided by the FDIC to an FDIC-insured depository institution that is in danger of default and that is controlled by the same bank holding company. “Default” means generally the appointment of a conservator or receiver for the institution. “In danger of default” means generally the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The cross-guarantee liability for a loss at a commonly controlled institution would be subordinated in right of payment to deposit liabilities, secured obligations, any other general or senior liability and any obligation subordinated to depositors or general creditors, other than obligations owed to any affiliate of the depository institution (with certain exceptions).
Dividend Restrictions
The Company is a legal entity separate and distinct from each of its subsidiaries. Our ability to pay dividends and make other distributions may depend upon the receipt of dividends from our bank subsidiary and is limited by federal and state law and accompanying regulations or guidance. The specific limits depend on a number of factors, including the Bank’s type of charter, recent earnings, recent dividends, level of capital and regulatory status. The regulators are authorized, and under certain circumstances are required, to determine that the payment of dividends or other distributions by a bank would be an unsafe or unsound practice and to prohibit that payment. For example, the FDI Act generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized.
The Dodd-Frank Act and its accompanying regulations also limit a banking organization's ability to make capital distributions if they do not hold a 2.5% capital buffer above the required minimum risk-based capital ratios. However, the regulators also review and limit proposed dividend payments as part of the supervisory process and review of the institution’s capital planning. State-chartered subsidiary banks are also subject to state regulations that limit dividends. Nonbank subsidiaries are also limited by certain federal and state statutory provisions and regulations covering the amount of dividends that may be paid in any given year.
The OCC Operating Agreement prohibited Capital Bank from paying a dividend to us for three years following our acquisition of the Failed Banks (which period elapsed in July 2013) and, once the three-year period has elapsed, imposes other restrictions on Capital Bank’s ability to pay dividends, including requiring prior approval from the OCC before any distribution is made.
The ability of a bank holding company to pay dividends and make other distributions can also be limited. The Federal Reserve has authority to prohibit a bank holding company from paying dividends or making other distributions. The Federal Reserve has issued a policy statement that a bank holding company should not pay cash dividends unless its net income available to common stockholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition. Accordingly, a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. Further, as noted above, the Dodd-Frank Act and accompanying regulations impose additional limitations on capital distributions.
Regulatory Capital Requirements
In General
Bank regulators view capital levels as important indicators of an institution’s financial soundness. FDIC-insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. The final supervisory judgment on an institution’s capital adequacy is based on the regulator’s individualized assessment of numerous factors.
As a bank holding company, we are subject to various regulatory capital adequacy requirements administered by the Federal Reserve. In addition, the OCC imposes capital adequacy requirements on our subsidiary bank. The FDIC also may impose these requirements on Capital Bank and other depository institution subsidiaries that we may acquire or control in the future. The FDI Act requires that the federal regulatory agencies adopt regulations defining five capital categories for banks: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial condition.
Revised Rules
The federal banking agencies recently revised capital guidelines to reflect the requirements of the Dodd-Frank Act and to effect the implementation of Basel III Accords. The quantitative measures, established by the regulators to ensure capital adequacy, require that a bank holding company maintain minimum ratios of capital to risk-weighted assets. These minimums are discussed below. There are three categories of capital under the rules. With the implementation of the Dodd-Frank Act, certain changes have been made as to the type of capital that falls under each of these categories. For us, as a bank holding company, common equity Tier 1 capital, a new category, includes only common stock, related surplus, retained earnings and qualified minority investments. Additional Tier 1 capital includes non-cumulative perpetual preferred stock, certain qualifying minority interests, and for bank holding companies with less than $15.0 billion in consolidated assets, cumulative perpetual preferred stock and grandfathered trust preferred securities. Tier 2 capital includes subordinated debt, certain qualifying minority investments, and for bank holding companies with less than $15 billion in consolidated assets, non-qualifying capital instruments issued before May 19, 2010 that exceed 25% of Tier 1. The capital rules also codify a Tier 1 leverage ratio that has long been used by the agencies as an indicator of risk.
Under the guidelines, capital is compared with the relative risk related to the balance sheet. To derive the risk included in the balance sheet, a risk weighting is applied to each balance sheet asset and off-balance sheet item, primarily based on the relative credit risk of the asset or counterparty. The revised capital rules also modified the risk-weights applied to particular on and off balance sheet assets. The full definitions of each capital component and related adjustments are included in subpart C of the Federal Reserve’s new Regulation Q. 12 C.F.R. § 217 subpart C.
The revised capital rules require banks and bank holding companies to maintain a minimum common equity Tier 1 capital ratio of 4.5%, a total Tier 1 capital ratio of 6%, a total capital ratio of 8%, and a leverage ratio of 5%. Bank holding companies are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and executive compensation payments. The revised capital rules also require banks and bank holding companies to maintain a common equity Tier 1 capital ratio of 6.5%, a total Tier 1 capital ratio of 8%, a total capital ratio of 10%, and a leverage ratio of 5% to be deemed “well capitalized.” These new capital ratios became effective as of January 1, 2015.
The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements in order to meet well-capitalized standards, and future regulatory change could impose higher capital standards as a routine matter. As of December 31, 2014, our regulatory capital ratios and those of Capital Bank exceeded the levels established for “well-capitalized” institutions under the new requirements.
Prompt Corrective Action
The FDI Act requires federal bank regulatory agencies to take “prompt corrective action” with respect to FDIC-insured depository institutions that do not meet minimum capital requirements. A depository institution’s treatment for purposes of the prompt corrective action provisions will depend upon how its capital levels compare to various capital measures and certain other factors, as established by regulation.
As noted above, the federal banking regulators have established five capital categories, well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, in which all institutions are placed. The federal banking regulators have also specified by regulation the relevant capital levels for each of the categories. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
Reserve Requirements
Pursuant to regulations of the Federal Reserve, all banks are required to maintain average daily reserves at mandated ratios against their transaction accounts. In addition, reserves must be maintained on certain non-personal time deposits. These reserves must be maintained in the form of vault cash or in an account at a Federal Reserve Bank.
Deposit Insurance Assessments
FDIC-insured banks are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. The FDIC recently raised assessment rates to increase funding for the DIF, which is currently underfunded.
The Dodd-Frank Act made permanent the general $250,000 deposit insurance limit for insured deposits. In addition, on January 1, 2013, federal deposit insurance for non-interest-bearing transaction accounts was limited to the standard maximum deposit insurance amount of $250,000.
The Dodd-Frank Act changed the deposit insurance assessment framework, primarily by basing assessments on an institution’s total assets less tangible equity (subject to risk-based adjustments that would further reduce the assessment base for custodial banks) rather than domestic deposits, which is expected to shift a greater portion of the aggregate assessments to large banks, as described in detail below. The Dodd-Frank Act also eliminated the upper limit for the reserve ratio designated by the FDIC each year, increases the minimum designated reserve ratio of the DIF from 1.15% to 1.35% of the estimated amount of total insured deposits by September 30, 2020, and eliminated the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.
The Dodd-Frank Act requires the DIF to reach a reserve ratio of 1.35% of insured deposits by September 30, 2020. On December 20, 2010, the FDIC raised the minimum designated reserve ratio of DIF to 2%. The ratio is higher than the minimum reserve ratio of 1.35% as set by the Dodd-Frank Act. Under the Dodd-Frank Act, the FDIC is required to offset the effect of the higher reserve ratio on insured depository institutions with consolidated assets of less than $10 billion.
On February 7, 2011, the FDIC approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing. The final rule, mandated by the Dodd-Frank Act, changed the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. Because the new assessment base under the Dodd-Frank Act is larger than the previous assessment base, the final rule’s assessment rates are lower than the previous rates, which achieved the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry.
In addition, the final rule adopted a “scorecard” assessment scheme for larger banks and suspended dividend payments if the DIF reserve ratio exceeds 1.5% but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds. The final rule also determines how the effect of the higher reserve ratio will be offset for institutions with less than $10 billion of consolidated assets.
Continued action by the FDIC to replenish the DIF as well as changes contained in the Dodd-Frank Act may result in higher assessment rates. Capital Bank may be able to pass part or all of this cost on to its customers, including in the form of lower interest rates on deposits, or fees to some depositors, depending on market conditions.
The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. If deposit insurance for a banking business we invest in or acquire were to be terminated, that would have a material adverse effect on that banking business and potentially on the Company as a whole.
Permitted Activities and Investments by Bank Holding Companies
The BHCA generally prohibits a bank holding company from engaging in activities other than banking or managing or controlling banks except for activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Financial Modernization Act of 1999 (which we refer to as the “GLB Act”) expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the GLB Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities. We have not yet determined whether it would be appropriate or advisable in the future to become a financial holding company.
Privacy Provisions of the GLB Act and Restrictions on Cross-Selling
Federal banking regulators, as required under the GLB Act, have adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors.
Federal financial regulators have issued regulations under the Fair and Accurate Credit Transactions Act, which have the effect of increasing the length of the waiting period, after privacy disclosures are provided to new customers, before information can be shared among different companies that we own or may come to own for the purpose of cross-selling products and services among companies we own. A number of states have adopted their own statutes concerning financial privacy and requiring notification of security breaches.
Anti-Money Laundering Requirements
Under federal law, including the Bank Secrecy Act, Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (which we refer to as the "PATRIOT Act") and the International Money Laundering Abatement and Anti-Terrorist Financing Act, certain types of financial institutions, including insured depository institutions, must maintain anti-money laundering programs that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. Among other things, these laws are intended to strengthen the ability of U.S. law enforcement agencies and intelligence communities to work together to combat terrorism on a variety of fronts. Financial institutions are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and customer identification in their dealings with non-U.S. financial institutions and non-U.S. customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
The Office of Foreign Assets Control (which we refer to as "OFAC") is responsible for helping to insure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of persons, organizations and countries suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we or Capital Bank find a name on any transaction, account or wire transfer that is on an OFAC list, we or Capital Bank must freeze or block such account or transaction, file a suspicious activity report and notify the appropriate authorities.
Consumer Laws and Regulations
Banks and other financial institutions are subject to numerous laws and regulations intended to protect consumers in their transactions with banks. These laws include, among others, laws regarding unfair and deceptive acts and practices and usury laws, as well as the following consumer protection statutes: Truth in Lending Act, Truth in Savings Act, Electronic Funds Transfer Act, Expedited Funds Availability Act, Equal Credit Opportunity Act, Fair and Accurate Credit Transactions Act, Fair Housing Act, Fair Credit Reporting Act, Fair Debt Collection Act, GLB Act, Home Mortgage Disclosure Act, Right to Financial Privacy Act and Real Estate Settlement Procedures Act.
Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers when taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and local attorney generals and civil or criminal liability.
The Dodd-Frank Act created the Consumer Financial Protection Bureau ("CFPB"), a new independent bureau that has broad authority to regulate, supervise and enforce retail financial services activities of banks and various non-bank providers. The CFPB has the authority to promulgate regulations, issue orders, guidance and policy statements, conduct examinations and bring enforcement actions with regard to consumer financial products and services. In general, banks with assets of $10 billion or less, such as Capital Bank, are subject to regulation of the CFPB but will continue to be examined for consumer compliance by their bank regulator. However, given our growth and bank acquisition strategy, if our total assets were to exceed $10 billion, then we will become subject to the CFPB’s exclusive examination authority and primary enforcement authority.
Mortgage Loan Origination Rules.
The Dodd-Frank Act imposes new standards for mortgage loan originations on all lenders, including banks, in an effort to require steps to verify a borrower’s ability to repay. Over the last two years, the CFPB issued a number of final rules relating to residential mortgages: Ability-to-Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z); Mortgage Servicing Rules Under the Real Estate Settlement Procedures Act (Regulation X); Mortgage Servicing Rules Under the Truth in Lending Act (Regulation Z); Loan Originator Compensation Requirements Under the Truth in Lending Act (Regulation Z); Appraisals for Higher-Priced Mortgage Loans (Regulation Z); Disclosure and Delivery Requirements for Copies of Appraisals and Other Written Valuations Under the Equal Credit Opportunity Act (Regulation B); High-Cost Mortgage and Homeownership Counseling Amendments to the Truth in Lending Act (Regulation Z); Homeownership Counseling Amendments to the Real Estate Settlement Procedures Act (Regulation X); and Escrow Requirements Under the Truth in Lending Act (Regulation Z).
Additionally, the CFPB has issued a number of revisions and clarifications to these rules and implementing guidance. Several proposed revisions are still pending finalization. These rules have materially restructured the origination, servicing, and securitization of residential mortgages in the United States. All participants in the mortgage market have felt, and will continue to feel, the influence of the new rules on their business. One of the more critical rules outlines requirements that lenders must follow to establish that a borrower has the ability to repay the mortgage. For a loan to be a “qualified mortgage” (“QM”), which reduces risk to the creditor, the loan must satisfy certain limits on terms and conditions, pricing, and a maximum debt-to-income (“DTI”) ratio. Loans eligible for purchase, guarantee, or insurance by a government agency or government-sponsored enterprise (“GSE”) are exempt from some of these requirements. Satisfying the technical QM standards, ensuring correct calculations are made for individual loans, recordkeeping and monitoring as well as understanding the effect of the QM standards on CRA obligations are key challenges for creditors, including Capital Bank.
The Community Reinvestment Act
The CRA is intended to encourage banks to help meet the credit needs of their service areas, including low- and moderate-income neighborhoods, consistent with safe and sound operations. The regulators examine banks and assign each bank a public CRA rating. A bank’s record of fair lending compliance is part of the resulting CRA examination report.
The CRA then requires bank regulators to take into account the bank’s record in meeting the needs of its service area when considering an application by a bank to establish a branch or to conduct certain mergers or acquisitions. The Federal Reserve is required to consider the CRA records of a bank holding company’s controlled banks when considering an application by the bank holding company to acquire a bank or to merge with another bank holding company.
When we apply for regulatory approval to make certain investments, the regulators will consider the CRA record of the target institution and our depository institution subsidiary. An unsatisfactory CRA record could substantially delay approval or result in denial of an application.
Changes in Laws, Regulations or Policies and the Dodd-Frank Act
Various federal, state and local legislators introduce from time to time measures or take actions that would modify the regulatory requirements or the examination or supervision of banks or bank holding companies. Such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks and other financial institutions, all of which could affect our investment opportunities and our assessment of how attractive such opportunities may be. We cannot predict whether potential legislation will be enacted and, if enacted, the effect that it or any implementing regulations would have on our business, results of operations or financial condition.
As noted above, The Dodd-Frank Act, has had and will continue to have a broad impact on the financial services industry, imposing significant regulatory and compliance changes, increased capital, leverage and liquidity requirements and numerous other provisions designed to improve supervision and oversight of the financial services sector. The following items briefly describe some of the key provisions of the Dodd-Frank Act not previously discussed:
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Limitation on Federal Preemption. The Dodd-Frank Act may limit the ability of national banks to rely upon federal preemption of state consumer financial laws. Under the Dodd-Frank Act, the OCC will have the ability to make preemption determinations only if certain conditions are met and on a case-by-case basis. The Dodd-Frank Act also eliminates the extension of preemption to operating subsidiaries of national banks. However, the Dodd-Frank Act preserves certain preemption standards articulated by the U.S. Supreme Court and existing interpretations thereunder, as well as express preemption provisions in other federal laws (such as the Equal Credit Opportunity Act and the Truth in Lending Act) that specifically address the application of state law in relation to that federal law. The Dodd-Frank Act authorizes state enforcement authorities to bring lawsuits under state law against national banks and authorizes suits by state attorney generals against national banks to enforce rules issued by the CFPB. With this broad grant of enforcement authority to states, institutions, including national banks, could be subject to varying and potentially conflicting interpretations of federal law by various state attorney generals, state regulators and the courts.
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Corporate Governance. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including the Company. The Dodd-Frank Act (1) grants stockholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers; and (4) provides the SEC with authority to adopt proxy access rules that would allow stockholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company’s proxy materials.
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Interchange Fees. Under the so-called Durbin Amendment of the Dodd-Frank Act, interchange transaction fees that a card issuer receives or charges for an electronic debit transaction must be “reasonable and proportional” to the cost incurred by the card issuer in processing the transaction. Banks that have less than $10 billion in assets are exempt from the interchange transaction fee limitation. On June 29, 2011, the Federal Reserve issued a final rule establishing standards for determining whether the amount of any interchange transaction fee is reasonable and proportional, taking into consideration fraud prevention costs, and prescribing regulations to ensure that network fees are not used, directly or indirectly, to compensate card issuers with respect to electronic debit transactions or to circumvent or evade the restrictions that interchange transaction fees be reasonable and proportional. Under the final rule, the maximum permissible interchange fee that an issuer may receive for an electronic debit will be the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction. The Federal Reserve also approved on June 29, 2011 an interim final rule that allows for an upward adjustment of no more than $0.01 to an issuer’s debit card interchange fee if the issuer develops and implements policies and procedures reasonably designed to achieve certain fraud-prevention standards set out in the interim final rule. The Dodd-Frank Act also bans card issuers and payment card networks from entering into exclusivity arrangements for debit card processing and prohibits card issuers and payment networks from inhibiting the ability of merchants to direct the routing of debit card transactions over networks of their choice.
Finally, merchants will be able to set minimum dollar amounts for the use of a credit card and provide discounts to consumers who pay with various payment methods, such as cash.
The requirements of the Dodd-Frank Act are being implemented over time, and most will be subject to regulations implemented over the course of several years. Given the number of new regulations and uncertainty surrounding the manner in which many of the Dodd-Frank Act’s provisions will be implemented by the various regulatory agencies, the full extent of the impact on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business.
ITEM 1A:
ITEM 1A: RISK FACTORS
Risks Relating to Our Banking Operations
Our acquisition history may not be indicative of our ability to execute our growth strategy.
Our prior acquisitions should be viewed in the context of the opportunities available to us at that time as a result of the confluence of our access to capital at a time when market dislocations of historical proportions resulted in attractive asset acquisition opportunities. We may prove to be unable to execute our growth strategy, which could impact our future earnings, reputation and results of operations. We have completed the process of integrating seven of the acquired banking platforms into a single unified operating platform (the Failed Banks, TIB Financial, Capital Bank Corp., Green Bankshares and Southern Community Financial), with our last acquisition closing on October 1, 2012.
A decline in general business and economic conditions could have a material adverse effect on our business, financial position, results of operations and cash flows.
Our business and results of operations are affected by the financial markets and general economic conditions, including factors such as the level and volatility of interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income and consumer spending. While the national economy and certain regions have improved since the recent financial crisis and economic recession, we continue to operate in a challenging and uncertain economic environment. The risks associated with our business become more acute in periods of a slowing economy or slow growth. A return or continuation of recessionary conditions or negative events in the housing markets, including significant and continuing home price reductions and increased delinquencies and foreclosures, will likely result in poor performance of mortgage and construction loans and asset write-downs. In addition, poor economic conditions, including continued high unemployment in the United States and the European sovereign debt crisis, have contributed to increased volatility in the financial and capital markets and diminished expectations for the U.S. economy. There can be no assurance that economic conditions will continue to improve, and these conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and saving habits. All of these negative conditions could have a material adverse effect on the credit quality of our loans or our business, financial condition or results of operations.
Our business is also significantly affected by fiscal, monetary and related policies of the U.S. federal government, its agencies and government-sponsored entities. Changes in any of these policies including U.S. government spending cuts, are beyond our control, difficult to predict and could have a material adverse effect on our business, financial position, results of operations and cash flows.
The geographic concentration of our markets in the southeastern region of the United States makes our business highly susceptible to downturns in the local economies and depressed banking markets, which could be detrimental to our financial condition.
Unlike larger financial institutions that are more geographically diversified, we are a regional banking franchise concentrated in the southeastern region of the United States. We operate branches located in Florida, North Carolina, South Carolina, Tennessee and Virginia. As of December 31, 2014, 37% of our loans were in North Carolina, 30% were in Florida, 22% were in Tennessee, and 11% were in South Carolina. Deterioration in local economic conditions in the loan market or in the residential, commercial or industrial real estate market could have a material adverse effect on the quality of our portfolio, the demand for our products and services, the ability of borrowers to timely repay loans and the value of the collateral securing loans. In addition, if the population or income growth in the region is slower than projected, income levels, deposits and real estate development could be adversely affected and could result in the curtailment of our expansion, growth and profitability. If any of these developments were to result in losses that materially and adversely affected Capital Bank’s capital, we and Capital Bank might be subject to regulatory restrictions on operations and growth and to a requirement to raise additional capital.
We depend on our executive officers and key personnel to continue the implementation of our long-term business strategy and could be harmed by the loss of their services.
We believe that our continued growth and future success will depend in large part on the skills of our management team and our ability to motivate and retain these individuals and other key personnel. In particular, we rely on the leadership and experience in the banking industry of our Chief Executive Officer R. Eugene Taylor. Mr. Taylor is the former Vice Chairman of Bank of America and has extensive experience executing and overseeing bank acquisitions. The loss of service of Mr. Taylor or one or more of our other executive officers or key personnel could reduce our ability to successfully implement our long-term business strategy, our business could suffer and the value of our common stock could be materially adversely affected. Leadership changes will occur from time to time and we cannot predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel. We believe our management team possesses valuable knowledge about the banking industry and that their knowledge and relationships would be very difficult to replicate. Although Messrs. Taylor, Marshall, Singletary and Posner have each entered into an employment agreement with us, it is possible that they may not complete the term of their employment agreements or renew them upon expiration. Our success also depends on the experience of our branch managers and lending officers and on their relationships with the customers and communities they serve. The loss of these key personnel could negatively impact our banking operations. The loss of key personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition or operating results.
Our loss sharing agreements impose restrictions on the operation of our business; failure to comply with the terms of our loss sharing agreements with the FDIC or other regulatory agreements or orders may result in significant losses or regulatory sanctions, and we are exposed to unrecoverable losses on the Failed Banks’ assets that we acquired.
In July 2010, we purchased substantially all of the assets and assumed all of the deposits and certain other liabilities of the Failed Banks in FDIC-assisted transactions, and a material portion of our revenue is derived from such assets. Certain of the purchased assets are covered by the loss sharing agreements with the FDIC, which provide that the FDIC will bear 80% of losses on the covered loan assets and other real estate owned we acquired in our acquisition of the Failed Banks within the loss sharing agreement period, which expires after 5 years for covered commercial loans and 10 years for covered residential loans. We are subject to audit by the FDIC at its discretion to ensure we are in compliance with the terms of these agreements. We may experience difficulties in complying with the requirements of the loss sharing agreements, the terms of which are extensive and failure to comply with any of the terms could result in a specific asset or group of assets losing their loss sharing coverage.
The FDIC has the right to refuse or delay payment partially or in full for such loan losses if we fail to comply with the terms of the loss sharing agreements, which are extensive. Additionally, the loss sharing agreements are limited in duration. Therefore, any losses that we experience after the terms of the loss sharing agreements have ended will not be recoverable from the FDIC and would negatively impact our net income.
Our loss sharing agreements also impose limitations on how we manage loans covered by loss sharing. For example, under the loss sharing agreements, we are not permitted to sell a covered loan even if in the ordinary course of our business we determine that taking such action would be advantageous for us. These restrictions could impair our ability to manage problem loans and extend the amount of time that such loans remain on our balance sheet and could negatively impact our business, financial condition, liquidity and results of operations.
In addition to the loss sharing agreements, in August 2010, Capital Bank entered into an Operating Agreement with the OCC (which we refer to as the “OCC Operating Agreement”), in connection with our acquisition of the Failed Banks. Capital Bank (and, with respect to certain provisions, the Company) is also subject to an Order of the FDIC, dated July 16, 2010 and amended on December 21, 2011 (which we refer to as the “FDIC Order”) issued in connection with the FDIC’s approval of our deposit insurance applications for the Failed Banks. The OCC Operating Agreement requires that Capital Bank maintain various financial and capital ratios and the OCC Operating Agreement and the FDIC Order require prior regulatory notice and consent to take certain actions in connection with operating the business and may restrict Capital Bank’s ability to pay dividends to us and to make changes to its capital structure. A failure by us or Capital Bank to comply with the requirements of the OCC Operating Agreement or the FDIC Order could subject us to regulatory sanctions; and failure to comply, or the objection, or imposition of additional conditions, by the OCC or the FDIC, in connection with any materials or information submitted thereunder, could prevent us from executing our business strategy and negatively impact our business, financial condition, liquidity and results of operations.
Any requested or required changes in how we determine the impact of loss share accounting on our financial information could have a material adverse effect on our reported results.
A material portion of our financial results is based on loss share accounting, which is subject to assumptions and judgments made by us and the regulatory agencies to which we report such information. Loss share accounting is a complex accounting methodology.
If these assumptions are incorrect or the regulatory agencies to whom we report require that we change or modify our assumptions, such change or modification could have a material adverse effect on our financial condition, operations or our previously reported results. As such, any financial information generated through the use of loss share accounting is subject to modification or change. Any significant modification or change in such information could have a material adverse effect on our results of operations and our previously reported results.
Our financial information reflects the application of the acquisition method of accounting. Any change in the assumptions used in such methodology could have an adverse effect on our results of operations.
As a result of our recent acquisitions, our financial results are heavily influenced by the application of the acquisition method of accounting. The acquisition method of accounting requires management to make assumptions regarding the assets purchased and liabilities assumed to determine their fair market value. Our interest income, interest expense and net interest margin (which were equal to $270.8 million, $24.7 million and 4.21%, respectively, in 2014) reflect the impact of accretion of the fair value adjustments made to the carrying amounts of interest earning assets and interest-bearing liabilities and our non-interest income (which totaled $43.8 million in 2014) for periods subsequent to the acquisitions includes the effects of discount accretion and amortization of the FDIC indemnification asset. In addition, the balances of non-performing assets were significantly reduced by the adjustments to fair value recorded in conjunction with the relevant acquisition. If our assumptions are incorrect or the regulatory agencies to whom we report require that we change or modify our assumptions, such change or modification could have a material adverse effect on our financial condition or results of operations or our previously reported results.
Our business is highly susceptible to credit risk.
As a lender, we are exposed to the risk that our customers will be unable to repay their loans according to their terms and that the collateral (if any) securing the payment of their loans may not be sufficient to assure repayment. The risks inherent in making any loan include risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting and guidelines, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. The credit standards, procedures and policies that we have established for borrowers may not prevent the incurrence of substantial credit losses.
Although we have not restructured many of our new or non-purchased credit impaired (“non-PCI”) loans for borrowers in financial difficulty, in the future, we may restructure more originated or acquired loans if we believe the borrowers have a viable business plan to fully pay off all obligations. However, for our originated loans, if interest rates or other terms are modified upon extension of credit or if terms of an existing loan are renewed in such a situation and a concession is granted, we may be required to classify such action as a troubled debt restructuring (which we refer to as a “TDR”). We classify loans as TDRs when certain modifications are made to the loan terms and concessions are granted to the borrowers due to their financial difficulty. Generally, these loans are restructured to provide the borrower additional time to execute its business plan. With respect to restructured loans, we may grant concessions by (1) reducing of the stated interest rate for the remaining original life of the debt or (2) extending the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. In situations where a TDR is unsuccessful and the borrower is unable to satisfy the terms of the restructured agreement, the loan would be placed on nonaccrual status and written down to the underlying collateral value.
The overall ratio of non-performing loans to total loans declined from 11.12% as of December 31, 2010 to 2.6% as of December 31, 2014. This decline is due primarily to resolution of problem loans coupled with the increased proportion of loans originated by us under our credit policies and underwriting standards and the lower relative proportion of non-performing loans we acquired through our acquisitions. Non-performing loans include loans classified as non-accrual as well as loans which may be contractually past due 90 or more days but are still accruing interest either because they are well secured and in the process of collection or because they are accounted for according to accounting guidance for acquired impaired loans. Criticized and classified loans, which management seeks to resolve, totaled $349.2 million as of December 31, 2014. If management is unable to effectively resolve these loans, they could have a material adverse effect on our consolidated results of operations.
Recent economic and market developments and the potential for continued economic disruption present considerable risks to us and it is difficult to determine the depth and duration of the economic and financial market problems and the many ways in which they may impact our business in general. Any failure to manage such credit risks may materially adversely affect our business and our consolidated results of operations and financial condition.
A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio is secured by real estate. As of December 31, 2014, approximately 70% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholders’ equity could be adversely affected.
Additionally, weakness in the secondary market for residential lending could have an adverse impact on our profitability. Significant disruptions in the secondary market for residential mortgage loans have limited the market for, and liquidity of, most mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of ongoing mortgage market challenges and uncertainty, including uncertainty with respect to U.S. monetary policy, could result in price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, any future mortgage loan originations and gains on sale of mortgage loans. Declines in real estate values and home sales volumes and financial stress on borrowers as a result of job losses or other factors could have further adverse effects on borrowers that result in higher delinquencies and charge-offs in future periods, which could adversely affect our financial position and results of operations.
Our construction and land development loans are based upon estimates of costs and the values of the complete projects.
While we focus on originating loans other than non-owner occupied commercial real estate loans, our portfolio includes construction and land development loans (which we refer to as “C&D loans”) extended to builders and developers, primarily for the construction and/or development of properties. These loans have been extended on a presold and speculative basis and they include loans for both residential and commercial purposes.
In general, C&D lending involves additional risks because of the inherent difficulty in estimating a property’s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. The repayment of construction and land acquisition and development loans is often dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to a residential builder are often associated with homes that are not presold and, thus, pose a greater potential risk than construction loans to individuals on their personal residences. Slowing housing sales could cause an increase in non-performing loans as well as an increase in delinquencies.
As of December 31, 2014, C&D loans totaled $269.4 million (or 5.4% of our total loan portfolio), of which $68.7 million was for construction and/or development of residential properties and $200.8 million was for construction/development of commercial properties. As of December 31, 2014, non-performing C&D loans not covered under FDIC loss share agreements totaled $25.7 million. There were $4.0 million non-performing C&D loans covered under FDIC loss share agreements.
Our non-owner occupied commercial real estate loans may be dependent on factors outside the control of our borrowers.
While we focus on originating loans other than non-owner occupied commercial real estate loans, in the acquisitions we acquired non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This may be adversely affected by changes in the economy or local market conditions. Non-owner occupied commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. In such cases, we may be compelled to modify the terms of the loan or engage in other potentially expensive work-out techniques. If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral typically is longer than a 1-4 family residential property because there are fewer potential purchasers of the collateral. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
As of December 31, 2014, our non-owner occupied commercial real estate loans totaled $798.6 million (or 16.0% of our total loan portfolio). As of December 31, 2014, non-performing non-owner occupied commercial real estate loans not covered under FDIC loss share agreements totaled $15.5 million. There were $1.6 million non-performing non-owner occupied commercial real estate loans covered under FDIC loss share agreements.
Repayment of our commercial business loans is dependent on the cash flows of borrowers, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
Our business plan focuses on originating different types of commercial business loans. We classify types of commercial loans offered as owner-occupied term real estate loans, business lines of credit and term equipment financing. Commercial business lending involves risks that are different from those associated with non-owner occupied commercial real estate lending. Our commercial business loans are primarily underwritten based on the cash flow of the borrower and secondarily on the underlying collateral, including real estate. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use.
As of December 31, 2014, our commercial business loans totaled $2.1 billion (or 42.4% of our total loan portfolio). Of this amount, $1.0 billion was secured by owner-occupied real estate and $1.1 billion was secured by business assets. As of December 31, 2014, non-performing commercial business loans covered under FDIC loss share agreements totaled $1.3 million and non-performing commercial business loans not covered under FDIC loss share agreements totaled $42.5 million.
Our allowance for loan and lease losses and fair value adjustments may prove to be insufficient to absorb losses for loans that we originate.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
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cash flow of the borrower and/or the project being financed;
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the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
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the duration of the loan;
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the discount on the loan at the time of acquisition;
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the credit history of a particular borrower; and
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changes in economic and industry conditions.
Non-performing loans covered under loss share agreements with the FDIC totaled $13.5 million, and non-performing loans not covered under loss share agreements with the FDIC totaled $117.2 million as of December 31, 2014. We maintain an allowance for loan and lease losses with respect to loans we originate, which is a reserve established through a provision for loan and lease losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management team through periodic reviews. As of December 31, 2014, the allowance for loans covered by loss share agreements with the FDIC was $9.8 million, and the allowance for loans not covered by loss share agreements with the FDIC was $40.4 million. As of December 31, 2014, the ratio of our allowance for loan and lease losses to nonperforming loans covered by loss share agreements with the FDIC was 72.8%, and the ratio of our allowance for loan and lease losses to non-performing loans not covered by loss share agreements with the FDIC was 34.5%.
The application of the acquisition method of accounting to our completed acquisitions impacted our allowance for loan and lease losses. Under the acquisition method of accounting, all loans were recorded in our financial statements at their fair value at the time of their acquisition and the related allowance for loan and lease loss was eliminated because the fair value at the time was determined by the net present value of the expected cash flows taking into consideration estimated credit quality. We may in the future determine that our estimates of fair value are too high, in which case we would provide for additional loan losses associated with the acquired loans. As of December 31, 2014, the allowance for loan and lease losses on purchased credit impaired (“PCI”) loan pools totaled $28.9 million, of which $9.6 million was related to loan pools covered by loss share agreements with the FDIC and $19.3 million was related to loan pools not covered by loss share agreements with the FDIC.
The determination of the appropriate level of the allowance for loan and lease losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans that we originate, identification of additional problem loans originated by us and other factors, both within and outside of our control, may require an increase in the allowance for loan and lease losses. If real estate values decline, we expect that we will experience increased credit losses, particularly with respect to construction, land development and land loans. In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require an increase in the provision for probable loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan and lease losses, we will need additional provisions to increase the allowance for loan and lease losses. Any increases in the allowance for loan and lease losses will result in a decrease in net income and, possibly, capital and may have a material adverse effect on our financial condition and results of operations. Refer to Note 1. Summary of Significant Accounting Policies and Note 6. Allowance for Loan and Lease Losses to our Consolidated Financial Statements for further information about this estimate and our methodology.
We continue to hold and acquire other real estate, which has led to increased operating expenses and vulnerability to additional declines in real property values.
We foreclose on and take title to the real estate serving as collateral for many of our loans as part of our business. Real estate owned by us and not used in the ordinary course of its operations is referred to as “other real estate owned” or “OREO” property. At December 31, 2014, we had $77.6 million of OREO. OREO balances have led to greater expenses as we incur costs to manage and dispose of the properties. We expect that our earnings will continue to be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership, as well as by the funding costs associated with assets that are tied up in OREO. Any decrease in real estate market prices may lead to additional OREO write-downs, with a corresponding expense in our statement of operations. We evaluate OREO properties periodically and write down the carrying value of the properties if the results of our evaluation require it. The expenses associated with OREO and any further property write-downs could have a material adverse effect on our financial condition and results of operations.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
Recent laws might restrict or delay our ability to foreclose and collect payments for single family residential loans.
Recent laws delay the initiation or completion of foreclosure proceedings on specified types of residential mortgage loans (some for a limited period of time), or otherwise limit the ability of residential loan servicers to take actions that may be essential to preserve the value of the mortgage loans. Any such limitations are likely to cause delayed or reduced collections from mortgagors and generally increased servicing costs. As a servicer of mortgage loans, any restriction on our ability to foreclose on a loan, any requirement that we forgo a portion of the amount otherwise due on a loan or any requirement that we modify any original loan terms will in some instances require us to advance principal, interest, tax and insurance payments, which may negatively impact our business, financial condition, liquidity and results of operations.
In addition, for the single family residential loans covered by the loss sharing agreements, we cannot collect loss share payments until we liquidate the properties securing those loans. These loss share payments could be delayed by an extended foreclosure process, including delays resulting from a court backlog, local or national foreclosure moratoriums or other delays, and these delays could have a material adverse effect on our results of operations.
Like other financial services institutions, our asset and liability structures are monetary in nature. Such structures are affected by a variety of factors, including changes in interest rates, which can impact the value of financial instruments held by us.
Like other financial services institutions, we have asset and liability structures that are essentially monetary in nature and are directly affected by many factors, including domestic and international economic and political conditions, broad trends in business and finance, legislation and regulation affecting the national and international business and financial communities, monetary and fiscal policies, inflation, currency values, market conditions, the availability and cost of short-term or long-term funding and capital, the credit capacity or perceived creditworthiness of customers and counterparties and the level and volatility of trading markets. Such factors can impact customers and counterparties of a financial services institution and may impact the value of financial instruments held by a financial services institution.
Our earnings and cash flows largely depend upon the level of our net interest income, which is the difference between the interest income we earn on loans, investments and other interest earning assets, and the interest we pay on interest-bearing liabilities, such as deposits and borrowings. Because different types of assets and liabilities may react differently and at different times to market interest rate changes, changes in interest rates can increase or decrease our net interest income. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly, and because the magnitude of repricing of interest earning assets is often greater than interest-bearing liabilities, falling interest rates could reduce net interest income.
Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans and decrease loan repayment rates, while a decrease in the general level of interest rates may adversely affect the fair value of our financial assets and liabilities and our ability to realize gains on the sale of assets. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits.
Accordingly, changes in the level of market interest rates affect our net yield on interest earning assets, loan origination volume, loan and mortgage-backed securities portfolios and our overall results. Changes in interest rates may also have a significant impact on any future mortgage loan origination revenues. Historically, there has been an inverse correlation between the demand for mortgage loans and interest rates. Mortgage origination volume and revenues usually decline during periods of rising or high interest rates and increase during periods of declining or low interest rates. Changes in interest rates also have a significant impact on the carrying value of a significant percentage of the assets on our balance sheet. Interest rates are highly sensitive to many factors beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve. We cannot predict the nature and timing of the Federal Reserve’s interest rate policies or other changes in monetary policies and economic conditions, which could negatively impact our financial performance.
We have benefited in recent periods from a favorable interest rate environment, but we believe that this environment cannot be sustained indefinitely and interest rates would be expected to rise as the economy recovers. A strengthening U.S. economy would be expected to cause the Board of Governors of the Federal Reserve to increase short-term interest rates, which would increase our borrowing costs.
The fair value of our investment securities can fluctuate due to market conditions out of our control.
As of December 31, 2014, approximately 96% of our investment securities portfolio was comprised of U.S. government agency and sponsored enterprises obligations, U.S. government agency and sponsored enterprises mortgage-backed securities and securities of municipalities. As of December 31, 2014, the fair value of our investment securities portfolio was approximately $1.0 billion. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency downgrades of the securities, defaults by the issuer or with respect to the underlying securities, changes in market interest rates and continued instability in the credit markets. In addition, we have historically taken a conservative investment posture, concentrating on government issuances of short duration. In the future, we may seek to increase yields through more aggressive investment strategies, which may include a greater percentage of corporate issuances and structured credit products. Any of these mentioned factors, among others, could cause other-than-temporary impairments in future periods and result in a realized loss, which could have a material adverse effect on our business. The process for determining whether impairment is other-than-temporary usually requires complex, subjective judgments about the future financial performance of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security.
Because of changing economic and market conditions affecting issuers and the performance of the underlying collateral, we may recognize realized and/or unrealized losses in future periods, which could have an adverse effect on our financial condition and results of operations.
We have a significant deferred tax asset that may not be fully realized in the future.
Our net deferred tax asset totaled $129.6 million as of December 31, 2014, of which $64.4 million was excluded from Tier 1 Capital. The ultimate realization of a deferred tax asset is dependent upon the generation of future taxable income during the periods prior to the expiration of the related net operating losses and the limitations of Section 382 of the Internal Revenue Code. If our estimates and assumptions about future taxable income are not accurate, the value of our deferred tax asset may not be recoverable and may result in a valuation allowance that would impact our earnings.
If we are unable to maintain sufficient liquidity, we may not be able to meet the cash flow requirements of our depositors and borrowers.
Liquidity is important to our business as our liquidity is used to make loans and to repay deposit liabilities as they become due or are demanded by customers. Further deterioration in the credit markets or market liquidity could present significant challenges in the management of our liquidity and could adversely affect our business, results of operations and prospects. For example, if as a result of a sudden decline in depositor confidence resulting from negative market conditions, a substantial number of bank customers tried to withdraw their bank deposits simultaneously; our reserves may not be able to cover the withdrawals.
Furthermore, an inability to increase our deposit base at all or at attractive rates would impede our ability to fund our continued growth, which could have an adverse effect on our business, results of operations and financial condition. Collateralized borrowings such as advances from the FHLB are an important potential source of liquidity. Our borrowing capacity is generally dependent on the value of the collateral pledged to the FHLB. An adverse regulatory change could reduce our borrowing capacity or eliminate certain types of collateral and could otherwise modify or even eliminate our access to FHLB advances, Federal Fund line borrowings and discount window advances. Liquidity may also be adversely impacted by bank supervisory and regulatory authorities mandating changes in the composition of our balance sheet to asset classes that are less liquid. Any such change or termination may have an adverse effect on our liquidity.
Our access to other funding sources could be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of recent turmoil faced by banking organizations and the unstable credit markets. We may need to incur additional debt in the future to achieve our business objectives, in connection with future acquisitions or for other reasons. Any borrowings, if sought, may not be available to us or, if available, may not be on favorable terms. Without sufficient liquidity, we may not be able to meet the cash flow requirements of our depositors and borrowers, which could have a material adverse effect on our financial condition and results of operations.
We may not be able to retain or develop a strong core deposit base or other low-cost funding sources.
We expect to depend on checking, savings and money market deposit account balances and other forms of customer deposits as our primary source of funding for our lending activities. Our future growth will largely depend on our ability to retain and grow a strong deposit base. It may prove harder to maintain and grow our deposit base than would otherwise be the case. We are also working to transition certain of our customers to lower cost traditional banking services as higher cost funding sources, such as high interest certificates of deposit, mature. There may be competitive pressures to pay higher interest rates on deposits, which could increase funding costs and compress net interest margins. Customers may not transition to lower yielding savings or investment products or continue their business with us, which could adversely affect our operations. In addition, with recent concerns about bank failures, customers have become concerned about the extent to which their deposits are insured by the FDIC, particularly customers that may maintain deposits in excess of insured limits. Customers may withdraw deposits in an effort to ensure that the amount that they have on deposit with us is fully insured and may place them in other institutions or make investments that are perceived as being more secure. Further, even if we are able to grow and maintain our deposit base, the account and deposit balances can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments (or similar products at other institutions that may provide a higher rate of return), we could lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income and net income. Additionally, any such loss of funds could result in lower loan originations, which could materially negatively impact our growth strategy and results of operations.
We operate in a highly competitive industry and face significant competition from other financial institutions and financial services providers, which may decrease our growth or profits.
Consumer and commercial banking is highly competitive. Our market contains not only a large number of community and regional banks, but also a significant presence of the country’s largest commercial banks. We compete with other state and national financial institutions as well as savings and loan associations, savings banks and credit unions for deposits and loans. In addition, we compete with financial intermediaries, such as consumer finance companies, mortgage banking companies, insurance companies, securities firms, mutual funds and several government agencies as well as major retailers, all actively engaged in providing various types of loans and other financial services. Some of these competitors may have a long history of successful operations in our markets, greater ties to local businesses and more expansive banking relationships, as well as better established depositor bases. Competitors with greater resources may possess an advantage by being capable of maintaining numerous banking locations in more convenient sites, operating more ATMs and conducting extensive promotional and advertising campaigns or operating a more developed Internet platform.
The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions may adversely affect our ability to market our products and services. Also, technology has lowered barriers to entry and made it possible for banks to compete in our market without a retail footprint by offering competitive rates, as well as non-banks to offer products and services traditionally provided by banks. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may offer a broader range of products and services as well as better pricing for certain products and services than we can. Our ability to compete successfully depends on a number of factors, including:
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the ability to develop, maintain and build upon long-term customer relationships based on quality service and high ethical standards;
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the ability to attract and retain qualified employees to operate our business effectively;
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the ability to expand our market position;
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the scope, relevance and pricing of products and services offered to meet customer needs and demands;
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the rate at which we introduce new products and services relative to our competitors;
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customer satisfaction with our level of service; and
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industry and general economic trends.
Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could harm our business, financial condition and results of operations.
We may be adversely affected by the lack of soundness of other financial institutions
Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial institutions, or the financial services industry generally, may lead to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions.
We are subject to losses due to the errors or fraudulent behavior of employees or third parties.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical recordkeeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially adversely affected if one of our employees causes a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. When we originate loans, we rely upon information supplied by loan applicants and third parties, including the information contained in the loan application, property appraisal and title information, if applicable, and employment and income documentation provided by third parties. If any of this information is misrepresented and such misrepresentation is not detected prior to loan funding, we generally bear the risk of loss associated with the misrepresentation. Any of these occurrences could result in a diminished ability of us to operate our business, potential liability to customers, reputational damage and regulatory intervention, which could negatively impact our business, financial condition and results of operations.
We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions could have an adverse effect on our financial condition and results of operations.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We outsource many of our major systems, such as data processing, loan servicing and deposit processing systems. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
A failure in or breach of our security systems or infrastructure, or those of our third-party service providers, could result in financial losses to us or in the disclosure or misuse of confidential or proprietary information, including client information.
As a financial institution, we may be the target of fraudulent activity that may result in financial losses to us or our clients, privacy breaches against our clients or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, unauthorized intrusion into or use of our systems, and other dishonest acts. We provide our customers the ability to bank remotely, including online over the Internet. The secure transmission of confidential information is a critical element of remote banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss and other security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities.
Information security risks for financial institutions like us have increased recently in part because of new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against large financial institutions, particularly denial of service attacks, that are designed to disrupt key business services, such as customer-facing web sites. We are not able to anticipate or implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently and because attacks can originate from a wide variety of sources. We employ detection and response mechanisms designed to contain and mitigate security incidents, but early detection may be thwarted by sophisticated attacks and malware designed to avoid detection.
We also face risks related to cyber-attacks and other security breaches in connection with credit and debit card transactions that typically involve the transmission of sensitive information regarding our customers through various third parties, including merchant acquiring banks, payment processors, payment card networks (e.g., Visa, MasterCard) and our processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that we do not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them. We also rely on numerous other third party service providers to conduct other aspects of our business operations and face similar risks relating to them. While we regularly conduct security assessments on these third parties, we cannot be sure that their information security protocols are sufficient to withstand a cyber-attack or other security breach.
Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could adversely affect our reputation, results of operations and ability to attract and maintain customers and businesses. In addition, a security breach could also subject us to additional regulatory scrutiny, expose us to civil litigation and possible financial liability and cause reputational damage. Our risk and exposure to these matters remains heightened because of the evolving nature and complexity of the threats from organized cybercriminals and hackers, and our plans to continue to provide electronic banking services to our customers.
As a public company, we are required to meet periodic reporting requirements under the rules and regulations of the United States Securities and Exchange Commission. Complying with federal securities laws as a public company is expensive, and we will incur significant time and expense enhancing, documenting, testing and certifying our internal control over financial reporting. Any deficiencies in our financial reporting or internal controls could adversely affect our business and the trading price of our Class A common stock.
Prior to becoming a public company, we were not required to comply with Securities and Exchange Commission (which we refer to as the “SEC”) requirements to have our financial statements completed and reviewed or audited within a specified time. As a publicly traded company we are required to file periodic reports containing our financial statements with the SEC within a specified time following the completion of quarterly and annual periods. We may experience difficulty in meeting the SEC’s reporting requirements. Any failure by us to file our periodic reports with the SEC in a timely manner could harm our reputation and reduce the trading price of our Class A common stock.
As a public company, we will incur significant legal, accounting, insurance and other expenses. Compliance with other rules of the SEC and the rules of The Nasdaq Global Select Market (which we refer to as “Nasdaq”) will increase our legal and financial compliance costs and make some activities more time consuming and costly. Beginning with the fiscal year ending December 31, 2018, or such earlier time as we are no longer an “emerging growth company” as defined in the Jumpstart Our Business Startups Act (which we refer to as the “JOBS Act”), our independent registered certified public accounting firm will be required to attest to our assessment of our internal controls over financial reporting. This process will require significant documentation of policies, procedures and systems, review of that documentation by our internal staff and our outside auditors and testing of our internal controls over financial reporting by our internal staff and our outside independent registered certified public accounting firm. This process will involve considerable time and expense, may strain our internal resources and have an adverse impact on our operating costs. We may experience higher than anticipated operating expenses and outside auditor fees during the implementation of these changes and thereafter.
During the course of our testing, we may identify deficiencies that would have to be remediated to satisfy the SEC rules for certification of our internal controls over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC material weaknesses in our system of internal controls. The existence of a material weakness would preclude management from concluding that our internal controls over financial reporting are effective and would preclude our independent auditors from issuing an unqualified opinion that our internal controls over financial reporting are effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our financial reporting and may negatively affect the trading price of our Class A common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have deficiencies in our disclosure controls and procedures or internal controls over financial reporting, it may negatively impact our business, results of operations and reputation.
We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our Class A common stock less attractive to investors. In addition, our election not to opt out of JOBS Act extended accounting transition period may make our financial statements less easily comparable to the financial statements of other companies.
We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. Currently, we take advantage of not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, but we do not currently take advantage of the other reporting exemptions available under the JOBS Act. However, we may avail ourselves of these reduced requirements applicable to emerging growth companies from time to time in the future, so long as we are an emerging growth company. We will remain an emerging growth company for up to five years, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million). We cannot predict if investors will find our Class A common stock less attractive because we do or may rely on these exemptions in the future. If some investors find our Class A common stock less attractive as a result, there may be a less active trading market for our Class A common stock and our stock price may be more volatile.
Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act of 1933, amended (which we refer to as the “Securities Act”) registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. We have elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. Although we are not currently taking advantage of this extended transition period, we could choose to do so in the future (so long as we are an emerging growth company) and this could make comparison of our financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accounting standards used.
Hurricanes or other adverse weather events would negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Our market areas in the southeastern region of the United States are susceptible to natural disasters, such as hurricanes, tornadoes, tropical storms, other severe weather events and related flooding and wind damage, and manmade disasters. Our market areas in Tennessee are susceptible to natural disasters, such as tornadoes and floods. These natural disasters could negatively impact regional economic conditions, cause a decline in the value or destruction of mortgaged properties and an increase in the risk of delinquencies, foreclosures or loss on loans originated by us, damage our banking facilities and offices and negatively impact our growth strategy. Such weather events can disrupt operations, result in damage to properties and negatively affect the local economies in the markets where they operate. We cannot predict whether or to what extent damage that may be caused by future hurricanes or tornadoes will affect our operations or the economies in our current or future market areas, but such weather events could negatively impact economic conditions in these regions and result in a decline in local loan demand and loan originations, a decline in the value or destruction of properties securing our loans and an increase in delinquencies, foreclosures or loan losses. Our business or results of operations may be adversely affected by these and other negative effects of natural or manmade disasters.
Risks Relating to Our Growth Strategy
We may not be able to effectively manage our growth.
Our future operating results depend to a large extent on our ability to successfully manage our growth. Our growth has placed, and it may continue to place, significant demands on our operations and management. Whether through additional acquisitions or organic growth, our current plan to expand our business is dependent upon:
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the ability of our officers and other key employees to continue to implement and improve our operational, credit, financial, management and other internal risk controls and processes and our reporting systems and procedures in order to manage a growing number of client relationships;
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to scale our technology platform;
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to integrate our acquisitions and develop consistent policies throughout the various businesses; and
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to manage a growing number of client relationships.
We may not successfully implement improvements to, or integrate, our management information and control systems, procedures and processes in an efficient or timely manner and may discover deficiencies in existing systems and controls. In particular, our controls and procedures must be able to accommodate an increase in expected loan volume and the infrastructure that comes with new branches and banks. Thus, our growth strategy may divert management from our existing businesses and may require us to incur additional expenditures to expand our administrative and operational infrastructure and, if we are unable to effectively manage and grow our banking franchise, our business and our consolidated results of operations and financial condition could be materially and adversely impacted. In addition, if we are unable to manage future expansion in our operations, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could adversely affect our business.
Many of our new activities and expansion plans require regulatory approvals, and failure to obtain them may restrict our growth.
We intend to complement and expand our business by pursuing strategic acquisitions of banks and other financial institutions. Generally, any acquisition of target financial institutions or assets by us will require approval by, and cooperation from, a number of governmental regulatory agencies, possibly including the Federal Reserve, the OCC and the FDIC, as well as state banking regulators. In acting on such applications of approval, federal banking regulators consider, among other factors:
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the effect of the acquisition on competition;
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the financial condition and future prospects of the applicant and the banks involved;
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the managerial resources of the applicant and the banks involved;
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the convenience and needs of the community, including the record of performance under the CRA;
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the effectiveness of the applicant in combating money-laundering activities; and
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the extent to which the acquisition would result in greater or more concentrated risks to the stability of the United States banking or financial system.
Such regulators could deny our application based on the above criteria or other considerations or the regulatory approvals may not be granted on terms that are acceptable to us. For example, we could be required to sell branches as a condition to receiving regulatory approvals, and such a condition may not be acceptable to us or may reduce the benefit of any acquisition. In addition, prior to the submission of an application our regulators could discourage us from pursuing strategic acquisitions or indicate that regulatory approvals may not be granted on terms that would be acceptable to us, which could have the same effect of restricting our growth or reducing the benefit of any acquisitions.
The success of future transactions will depend on our ability to successfully identify and consummate transactions with target financial institutions that meet our investment criteria. Because of the significant competition for acquisition opportunities and the limited number of potential targets, we may not be able to successfully consummate acquisitions necessary to grow our business.
The success of future transactions will depend on our ability to successfully identify and consummate transactions with target financial institutions that meet our investment criteria. There are significant risks associated with our ability to identify and successfully consummate transactions with target financial institutions. There are a limited number of acquisition opportunities, and we expect to encounter intense competition from other banking organizations competing for acquisitions and also from other investment funds and entities looking to acquire financial institutions. Many of these entities are well established and have extensive experience in identifying and effecting acquisitions directly or through affiliates. Many of these competitors possess ongoing banking operations with greater technical, human and other resources than we do, and our financial resources will be relatively limited when contrasted with those of many of these competitors.
These organizations may be able to achieve greater cost savings through consolidating operations than we could. Our ability to compete in acquiring certain sizable target institutions will be limited by our available financial resources. These inherent competitive limitations give others an advantage in pursuing the acquisition of certain target financial institutions. In addition, increased competition may drive up the prices for the types of acquisitions we intend to target, which would make the identification and successful consummation of acquisition opportunities more difficult. Competitors may be willing to pay more for target financial institutions than we believe are justified, which could result in us having to pay more for target financial institutions than we prefer or to forego target financial institutions. As a result of the foregoing, we may be unable to successfully identify and consummate future transactions to grow our business on commercially attractive terms, or at all.
Because the institutions we intend to acquire may have distressed assets, we may not be able to realize the value we predict from these assets or make sufficient provision for future losses in the value of, or accurately estimate the future writedowns taken in respect of, these assets.
Delinquencies and losses in the loan portfolios and other assets of financial institutions that we acquire may exceed our initial forecasts developed during the due diligence investigation prior to acquiring those institutions. Even if we conduct extensive due diligence on an entity we decide to acquire, this diligence may not reveal all material issues that may affect a particular entity. The diligence process in FDIC-assisted transactions is also expedited due to the short acquisition timeline that is typical for these depository institutions. If, during the diligence process, we fail to identify issues specific to an entity or the environment in which the entity operates, we may be forced to later write down or write off assets, restructure our operations, or incur impairment or other charges that could result in other reporting losses. Any of these events could adversely affect the financial condition, liquidity, capital position and value of institutions we acquire and of the Company as a whole.
Current economic conditions have created an uncertain environment with respect to asset valuations and there is no certainty that we will be able to sell assets of target institutions if we determine it would be in our best interests to do so. The institutions we will target may have substantial amounts of asset classes for which there is currently limited or no marketability.
The success of future transactions will depend on our ability to successfully combine the target financial institution’s business with our existing banking business and, if we experience difficulties with the integration process, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.
The success of future transactions will depend, in part, on our ability to successfully combine the target financial institution’s business with our existing banking business. As with any acquisition involving financial institutions, there may be business disruptions that result in the loss of customers or cause customers to remove their accounts and move their business to competing banking institutions. It is possible that the integration process could result in additional expenses in connection with the integration processes and the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the acquisition. Integration efforts, including integration of the target financial institution’s systems into our systems may divert our management’s attention and resources, and we may be unable to develop, or experience prolonged delays in the development of, the systems necessary to operate our acquired banks, such as a financial reporting platform or a human resources reporting platform call center. If we experience difficulties with the integration process, the anticipated benefits of any future transaction may not be realized fully or at all or may take longer to realize than expected. Additionally, we may be unable to recognize synergies, operating efficiencies and/or expected benefits within expected timeframes or expected cost projections, or at all. We may also not be able to preserve the goodwill of the acquired financial institution.
Projected operating results for entities to be acquired by us may be inaccurate and may vary significantly from actual results.
We will generally establish the pricing of transactions and the capital structure of entities to be acquired by us on the basis of financial projections for such entities. In general, projected operating results will be based primarily on management judgments. In all cases, projections are only estimates of future results that are based upon assumptions made at the time that the projections are developed and the projected results may vary significantly from actual results. General economic, political and market conditions, which are not predictable, can have a material adverse impact on the reliability of such projections. In the event that the projections made in connection with our acquisitions, or future projections with respect to new acquisitions, are not accurate, such inaccuracies could materially and adversely affect our business and our consolidated results of operations and financial condition.
Our officers and directors may have conflicts of interest in determining whether to present business opportunities to us or another entity with which they are, or may become, affiliated.
Our officers and directors may become subject to fiduciary obligations in connection with their service on the boards of directors of other corporations. To the extent that our officers and directors become aware of acquisition opportunities that may be suitable for entities other than us to which they have fiduciary or contractual obligations, or they are presented with such opportunities in their capacities as fiduciaries to such entities, they may honor such obligations to such other entities. In addition, our officers and directors will not have any obligation to present us with any acquisition opportunity that does not fall within certain parameters of our business (which opportunities and parameters are described in more detail in the section entitled “Business”). You should assume that to the extent any of our officers or directors becomes aware of an opportunity that may be suitable both for us and another entity to which such person has a fiduciary obligation or contractual obligation to present such opportunity as set forth above, he or she may first give the opportunity to such other entity or entities and may give such opportunity to us only to the extent such other entity or entities reject or are unable to pursue such opportunity. In addition, you should assume that to the extent any of our officers or directors becomes aware of an acquisition opportunity that does not fall within the above parameters but that may otherwise be suitable for us, he or she may not present such opportunity to us. In general, officers and directors of a corporation incorporated under Delaware law are required to present business opportunities to a corporation if the corporation could financially undertake the opportunity, the opportunity is within the corporation’s line of business and it would not be fair to the corporation and its stockholders for the opportunity not to be brought to the attention of the corporation. However, our certificate of incorporation provides that we renounce any interest or expectancy in certain acquisition opportunities that our officers or directors become aware of in connection with their service to other entities to which they have a fiduciary or contractual obligation.
Changes in accounting standards may affect how we report our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (which we refer to as the “FASB”) or other regulatory authorities change the financial accounting and reporting standards that govern the preparation of financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in us restating prior period financial statements.
Risks Relating to the Regulation of Our Industry
We operate in a highly regulated industry and the laws and regulations that govern our operations, corporate governance, executive compensation and financial accounting, or reporting, including changes in them, or our failure to comply with them, may adversely affect us.
We are subject to extensive regulation and supervision that govern almost all aspects of our operations. Intended to protect customers, depositors, consumers, deposit insurance funds and the stability of the U.S. financial system, these laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on our business activities (including foreclosure and collection practices), limit the dividend or distributions that we can pay, restrict the ability of institutions to guarantee our debt and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than accounting principles generally accepted in the United States (“GAAP”). Compliance with laws and regulations can be difficult and costly and changes to laws and regulations often impose additional compliance costs. We are currently facing increased regulation and supervision of our industry as a result of the financial crisis in the banking and financial markets. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. Further, our failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition.
We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of these agencies, we may be required to make adjustments to our business that could adversely affect us.
Federal and state banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a result of an examination, a Federal banking agency were to determine that the financial condition, capital resources, asset quality, asset concentration, earnings prospects, management, liquidity sensitivity to market risk or other aspects of any of our operations has become unsatisfactory, or that we or our management is in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the asset composition of our portfolio or balance sheet, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted.
The enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 may have a material effect on our operations.
On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which imposes significant regulatory and compliance changes. The key effects of the Dodd-Frank Act on our business are:
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changes to regulatory capital requirements;
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exclusion of hybrid securities, including trust preferred securities, issued on or after May 19, 2010 from Tier 1 capital;
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creation of new government regulatory agencies (such as the Financial Stability Oversight Council, which will oversee systemic risk, and the Consumer Financial Protection Bureau, which will develop and enforce rules for bank and non-bank providers of consumer financial products);
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potential limitations on federal preemption;
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changes to deposit insurance assessments;
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regulation of debit interchange fees we earn;
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changes in retail banking regulations, including potential limitations on certain fees we may charge; and
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changes in regulation of consumer mortgage loan origination and risk retention.
In addition, the Dodd-Frank Act restricts the ability of banks to engage in certain proprietary trading or to sponsor or invest in private equity or hedge funds. The Dodd-Frank Act also contains provisions designed to limit the ability of insured depository institutions, their holding companies and their affiliates to conduct certain swaps and derivatives activities and to take certain principal positions in financial instruments.
Some provisions of the Dodd-Frank Act became effective immediately upon its enactment. Many provisions, however, will require regulations to be promulgated by various federal agencies in order to be implemented. Some of these regulations are complete and others have been proposed by the applicable federal agencies. The provisions of the Dodd-Frank Act may have unintended effects, which will not be clear until full implementation. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to investors in our Class A common stock.
The short-term and long-term impact of the new regulatory capital standards and the new capital rules is uncertain.
As discussed in detail above, the Federal banking agencies recently revised capital guidelines to reflect the requirements of the Dodd-Frank Act and to effect the implementation of the Basel III Accords. The quantitative measures, established by the regulators to ensure capital adequacy, require that a bank holding company maintain minimum ratios of capital to risk-weighted assets. These minimums are outlined above. Various provisions of the Dodd-Frank Act increase the capital requirements of bank holding companies, such as the Company, and non-bank financial companies that are supervised by the Federal Reserve. For us, as a bank holding company, common equity Tier 1 capital, a new category, includes only common stock, related surplus, retained earnings and qualified minority investments. Additional Tier 1 capital includes non-cumulative perpetual preferred stock, certain qualifying minority interests, and for bank holding companies with less than $15 billion in consolidated assets, cumulative perpetual preferred stock and grandfathered trust preferred securities. Tier 2 capital includes subordinated debt, certain qualifying minority investments, and for bank holding companies with less than $15 billion in consolidated assets, non-qualifying capital instruments issued before May 19, 2010 that exceed 25% of Tier 1. Bank holding companies are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and executive compensation payments. The capital rules also codify a Tier 1 leverage ratio that has long been used by the agencies as an indicator of risk.
Under the guidelines, capital is compared with the relative risk related to the balance sheet. To derive the risk included in the balance sheet, a risk weighting is applied to each balance sheet asset and off-balance sheet item, primarily based on the relative credit risk of the asset or counterparty. The revised capital rules also modified the risk-weights applied to particular on and off balance sheet assets.
The revised capital rules, which became effective as of January 1, 2015, require banks and bank holding companies to maintain a common equity Tier 1 capital ratio of 6.5%, a total Tier 1 capital ratio of 8%, a total capital ratio of 10%, and a leverage ratio of 5% to be deemed “well capitalized.”
The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements in order to meet well-capitalized standards, and future regulatory change could impose higher capital standards as a routine matter. Our regulatory capital ratios and those of Capital Bank are in excess of the levels established for “well-capitalized” institutions.
The FDIC’s restoration plan and the related increased assessment rate could adversely affect our earnings.
The FDIC insures deposits at FDIC-insured depository institutions, such as our subsidiary bank, up to applicable limits. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Market developments have significantly depleted the DIF and reduced the ratio of reserves to insured deposits.
As a result of recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased the deposit insurance assessment rates and thus raised deposit premiums for insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, there may need to be further special assessments or increases in deposit insurance premiums. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect results of operations, including by reducing our profitability or limiting our ability to pursue certain business opportunities.
We are subject to federal and state and fair lending laws, and failure to comply with these laws could lead to material penalties.
Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the CRA and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.
We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The federal Bank Secrecy Act, the PATRIOT Act and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service.
There is also increased scrutiny of compliance with the rules enforced by the OFAC. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.
Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.
Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. It is our policy not to make predatory loans, but these laws create the potential for liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.
The Federal Reserve may require us to commit capital resources to support our subsidiary bank.
The Federal Reserve, which examines us and our subsidiaries, requires a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. In addition, both statue and regulation require that all companies that directly or indirectly control an insured depository institution serve as a source of strength for the institution. Under these requirements, in the future, we could be required to provide financial assistance to our subsidiary bank if it experiences financial distress.
A capital injection may be required at times when we do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely impact the holding company’s cash flows, financial condition, results of operations and prospects.
Stockholders may be deemed to be acting in concert or otherwise in control of Capital Bank, which could impose prior approval requirements and result in adverse regulatory consequences for such holders.
We are a bank holding company regulated by the Federal Reserve. Accordingly, acquisition of control of us (or our bank subsidiary) requires prior regulatory notice or approval. With certain limited exceptions, federal regulations prohibit potential investors from, directly or indirectly, acquiring ownership or control of, or the power to vote, more than 10% (more than 5% if the acquirer is a bank holding company) of any class of our voting securities, or obtaining the ability to control in any manner the election of a majority of directors or otherwise exercising a controlling influence over our management or policies, without prior notice or application to, and approval of, the Federal Reserve under the Change in Bank Control Act or the BHCA. Any bank holding company or foreign bank with a U.S. presence also is required to obtain the approval of the Federal Reserve under the BHCA to acquire or retain more than 5% of our outstanding voting securities.
In addition to regulatory approvals, any stockholder deemed to “control” us for purposes of the BHCA would become subject to investment and activity restrictions and ongoing regulation and supervision. Any entity owning 25% or more of any class of our voting securities, or a lesser percentage if such holder or group otherwise exercises a “controlling influence” over us, will be subject to regulation as a “bank holding company” in accordance with the BHCA. In addition, such a holder may be required to divest holdings of 5% or more of the voting securities of investments that may be deemed impermissible for a bank holding company, such as an investment in a company engaged in non-financial activities.
Regulatory determination of “control” of a depository institution or holding company is based on all of the relevant facts and circumstances. In certain instances, stockholders may be determined to be “acting in concert” and their shares aggregated for purposes of determining control for purposes of the Change in Bank Control Act. “Acting in concert” generally means knowing participation in a joint activity or parallel action towards the common goal of acquiring control of a bank or a parent company, whether or not pursuant to an express agreement. How this definition is applied in individual circumstances can vary among the various federal bank regulatory agencies and cannot always be predicted with certainty. Many factors can lead to a finding of acting in concert, including whether:
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stockholders are commonly controlled or managed;
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stockholders are parties to an oral or written agreement or understanding regarding the acquisition, voting or transfer of control of voting securities of a bank or bank holding company;
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the holders each own stock in a bank and are also management officials, controlling stockholders, partners or trustees of another company; or
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both a holder and a controlling stockholder, partner, trustee or management official of the holder own equity in the bank or bank holding company. Our common stock owned by holders determined by a bank regulatory agency to be acting in concert would be aggregated for purposes of determining whether those holders have control of a bank or bank holding company for Change in Bank Control Act purposes. Because the control regulations under the Change in Bank Control Act and the BHCA are complex, potential investors should seek advice from qualified banking counsel before making an investment in our Class A common stock.
Risks Related to Our Common Stock
We could issue additional common stock, which might dilute the book value of our common stock and reduce your influence over matters on which stockholders vote.
Our Board of Directors has the authority, without action or vote of our stockholders, to issue all or any part of our authorized but unissued shares of common stock, including shares that may be issued to satisfy our obligations under our incentive plans, shares of our authorized but unissued preferred stock and securities and instruments that are convertible into our common stock. Such stock issuances could be made at a price that reflects a discount or a premium from the then-current trading price of our common stock and might dilute the book value of our common stock. In addition, issuances of common stock or voting preferred stock would reduce your influence over matters on which our stockholders vote and, in the case of issuances of preferred stock, likely would result in your interest in us being subject to the prior rights of holders of that preferred stock.
If shares of Class B non-voting common stock are converted into shares of Class A common stock, your voting power will be diluted.
Generally, holders of Class B non-voting common stock have no voting power and have no right to participate in any meeting of stockholders or to have notice thereof. However, holders of Class B non-voting common stock that are converted into Class A common stock will have all the voting rights of the other holders of Class A common stock. Class B non-voting common stock is not convertible in the hands of the initial holder. However, a transferee unaffiliated with the initial holder that receives Class B non-voting common stock subsequent to transfer permitted by our certificate of incorporation may elect to convert each share of Class B non-voting common stock into one share of Class A common stock. Upon conversion of any Class B non-voting common stock, your voting power will be diluted in proportion to the decrease in your ownership of the total outstanding Class A common stock.
The market price of our Class A common stock may be volatile, which could cause the value of an investment in our Class A common stock to decline.
The market price of our Class A common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:
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general market conditions;
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domestic and international economic factors unrelated to our performance;
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actual or anticipated fluctuations in our quarterly operating results;
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changes in or failure to meet publicly disclosed expectations as to our future financial performance;
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downgrades in securities analysts’ estimates of our financial performance or lack of research and reports by industry analysts;
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changes in market valuations or earnings of similar companies;
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any future sales of our common stock or other securities; and
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additions or departures of key personnel.
The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These types of broad market fluctuations may adversely affect the trading price of our Class A common stock. In the past, stockholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention and resources and harm our business or results of operations. For example, we are currently operating in, and have benefited from, a protracted period of historically low interest rates that may not be sustained indefinitely, and future fluctuations in interest rates could cause an increase in volatility of the market price of our Class A common stock.
Our ability to pay dividends will be subject to restrictions under applicable banking laws and regulations.
Banks and bank holding companies are subject to certain regulatory restrictions on the payment of cash dividends. Federal bank regulatory agencies have the authority to prohibit bank holding companies from engaging in unsafe or unsound practices in conducting their business. The payment of dividends by us, depending on our financial condition, could be deemed an unsafe or unsound practice. Our ability to pay dividends will directly depend on the ability of our subsidiary bank to pay dividends to us, which in turn will be restricted by the requirement that it maintains an adequate level of capital in accordance with requirements of its regulators and, in the future, can be expected to be further influenced by regulatory policies and capital guidelines. In addition, on August 24, 2010, Capital Bank entered into the OCC Operating Agreement, which in certain circumstances will restrict Capital Bank’s ability to pay dividends to us, to make changes to its capital structure and to make certain other business decisions.
Certain provisions of our certificate of incorporation and the loss sharing agreements may have anti-takeover effects, which could limit the price investors might be willing to pay in the future for our common stock and could entrench management. In addition, Delaware law may inhibit takeovers of us and could limit our ability to engage in certain strategic transactions our Board of Directors believes would be in the best interests of stockholders.
Our certificate of incorporation contains provisions that may discourage unsolicited takeover proposals that stockholders may consider to be in their best interests. These provisions include the ability of our Board of Directors to designate the terms of and issue new series of preferred stock, which may make the removal of management more difficult and may discourage
transactions that otherwise could involve payment of a premium over prevailing market prices for our securities, including our Class A common stock.
Our loss sharing agreements with the FDIC require that we receive prior FDIC consent, which may be withheld by the FDIC in its sole discretion, prior to us or our stockholders engaging in certain transactions. If any such transaction is completed without prior FDIC consent, the FDIC would have the right to discontinue the relevant loss sharing arrangement. Among other things, prior FDIC consent is required for (1) a merger or consolidation of us or our bank subsidiary with or into another company if our stockholders will own less than 66.66% of the combined company, (2) the sale of all or substantially all of the assets of any of our bank subsidiary and (3) a sale of shares by a stockholder, or a group of related stockholders, that will effect a change in control of Capital Bank, as determined by the FDIC with reference to the standards set forth in the Change in Bank Control Act (generally, the acquisition of between 10% and 25% of any class of our voting securities where the presumption of control is not rebutted, or the acquisition by any person, acting directly or indirectly or through or in concert with one or more persons, of 25% or more of any class of our voting securities). If we or any stockholder desired to enter into any such transaction, the FDIC may not grant its consent in a timely manner, without conditions, or at all. If one of these transactions were to occur without prior FDIC consent and the FDIC withdrew its loss share protection, there could be a material adverse effect on our financial condition, results of operations and cash flows. In addition, statutes, regulations and policies that govern bank holding companies, including the BHCA, may restrict our ability to enter into certain transactions.
We are also subject to anti-takeover provisions under Delaware law. We have not opted out of Section 203 of the Delaware General Corporation Law (which we refer to as the “DGCL”), which, subject to certain exceptions, prohibits a public Delaware corporation from engaging in a business combination (as defined in such section) with an “interested stockholder” (defined generally as any person who beneficially owns 15% or more of the outstanding voting stock of such corporation or any person affiliated with such person) for a period of three years following the time that such stockholder became an interested stockholder, unless (1) prior to such time the Board of Directors of such corporation approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; (2) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of such corporation at the time the transaction commenced (excluding for purposes of determining the voting stock outstanding (but not the outstanding voting stock owned by the interested stockholder) the voting stock owned by directors who are also officers or held in employee benefit plans in which the employees do not have a confidential right to tender or vote stock held by the plan); or (3) on or subsequent to such time the business combination is approved by the Board of Directors of such corporation and authorized at a meeting of stockholders by the affirmative vote of at least two-thirds of the outstanding voting stock of such corporation not owned by the interested stockholder.
ITEM 1B:
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.
ITEM 2:
ITEM 2: PROPERTIES
The Company’s primary administrative offices are located at 121 Alhambra Plaza Suite 1601 Coral Gables, Florida. We own or lease numerous other premises for use in conducting business activities, including operations centers, offices, and branch and other facilities. We include here by reference the additional information regarding our properties in Note 8. Premises and Equipment in Item 8 of this Report.
We currently lease approximately 341,477 square feet of office and operations space in Florida, North Carolina, South Carolina and Tennessee. We operate 35 branches in Florida, 53 in North Carolina, 12 in South Carolina, 61 in Tennessee and one in Virginia. Of these branches, 43 were leased and the rest were owned. Management believes the terms of the various leases are consistent with market standards and were arrived at through arm’s-length bargaining.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
From time to time we are a party to various litigation matters incidental to the conduct of our business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, prospects, financial condition, results of operations or liquidity.
ITEM 4:
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5:
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Class A common stock has been listed on the NASDAQ Global Select Market under the symbol “CBF” since September 20, 2012. There is no public trading market for our Class B non-voting common stock and it is not listed on any stock exchange. The following table sets forth, for the periods indicated, the high and low sale prices per share for our common stock on the NASDAQ Global Select Market:
On December 31, 2014, the closing price per share of our Class A common stock on the NASDAQ Global Select Market was $26.80. As of December 31, 2014, there were approximately 2,470 holders of record for our Class A common stock and approximately 10 holders of record for our Class B non-voting common stock. The actual number of stockholders is greater than the number of holders of record and includes stockholders who are beneficial owners and whose shares are held in street name by brokers or other nominees.
We have never paid cash dividends to holders of our common stock. We intend to reinvest cash flow generated by operations in our business. As a bank holding company, any dividends paid to us by our subsidiary financial institution(s) are subject to various federal and state regulatory limitations and also subject to the ability of our subsidiary financial institution(s) to pay dividends to us. In the future, we may enter into credit agreements or other borrowing arrangements that restrict our ability to declare or pay cash dividends. Any determination to pay cash dividends in the future will be at the discretion of our Board of Directors and will depend on various factors, including our financial condition, earnings, cash requirements, legal restrictions, regulatory restrictions and other factors deemed relevant by our Board of Directors.
In addition, on August 24, 2010, Capital Bank entered into the OCC Operating Agreement, which in certain circumstances will restrict Capital Bank’s ability to pay dividends to us, to make changes to its capital structure and to make certain other business decisions. On September 5, 2013 and July 8, 2014, the OCC approved dividends to the Company by its subsidiary Capital Bank N.A., of $105.0 million and $56.0 million, respectively.
On January 30, 2015, upon Board and regulatory approval, our subsidiary Capital Bank N.A. paid a $199.4 million dividend, which we may use for general corporate purposes including acquisitions, or as a return of capital to shareholders through future share repurchases or dividends.
With respect to information regarding our securities authorized for issuance under equity incentive plans, the information contained in the section entitled “Executive Compensation - Long-Term Incentive Plan Information” of our definitive Proxy Statement for the 2015 Annual Meeting of Shareholders is incorporated herein by reference.
STOCK PRICE PERFORMANCE GRAPH
The stock price performance graph below shall not be deemed incorporated by reference by any general statement incorporating by reference this Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates this information by reference, and shall not otherwise be deemed filed under such Acts. The stock price performance graph below compares the cumulative total return of the Company, Nasdaq Composite Index and a peer group index:
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RAPIMAG
Share Repurchases
The following table provides information regarding repurchases of the Company’s common stock by the Company during the three months ended December 31, 2014:
During 2013 and 2014, the Company’s Board of Directors authorized stock repurchase plans of up to $200.0 million. Stock repurchases may be made from time to time, on the open market or in privately negotiated transactions. The approved stock repurchase programs do not obligate the Company to repurchase any particular amount of shares, and the programs may be extended, modified, suspended, or discontinued at any time.
During the year ended December 31, 2014, the Company repurchased $103.2 million, or 4,324,382 common shares at an average price of $23.87 per share. As of December 31, 2014, the Company has repurchased a total of $173.2 million or 8,085,699 common shares at an average price of $21.42 per share, and had $26.8 million of remaining availability for future share repurchases.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial information. You should read this information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes thereto included elsewhere in this report.
On July 16, 2010, we purchased certain assets and assumed certain liabilities, including substantially all deposits, of First National Bank, Metro Bank and Turnberry Bank from the FDIC, as receiver. On September 30, 2010, January 28, 2011, September 7, 2011 and October 1, 2012, we consummated controlling investments in TIB Financial, Capital Bank Corp., Green Bankshares and Southern Community Financial, respectively. Although we were formed in November 2009, our activities prior to our first acquisition consisted solely of organizational, capital raising and related activities and activities related to identifying and analyzing potential acquisition candidates. We did not engage in any substantive operations (including banking operations) prior to our first acquisition.
The selected historical consolidated financial information in the following tables as of and for the years ended December 31, 2014 and 2013, include our results, including First National Bank, Metro Bank, Turnberry Bank, TIB Financial, Capital Bank Corp., Green Bankshares and Southern Community Financial. The selected historical consolidated financial information in the following tables as of and for the year ended December 31, 2012 includes our results, including First National Bank, Metro Bank, Turnberry Bank, TIB Financial, Capital Bank Corp., Green Bankshares and Southern Community Financial, subsequent to October 1, 2012. The selected historical consolidated financial information in the following tables as of and for the year ended December 31, 2011, includes our results, including First National Bank, Metro Bank, Turnberry Bank and TIB Financial, as well as the results of Capital Bank Corp. subsequent to January 28, 2011 and Green Bankshares subsequent to September 7, 2011. The selected historical consolidated financial information in the following tables as of and for the year ended December 31, 2010 includes our results, including First National Bank, Metro Bank and Turnberry Bank subsequent to July 16, 2010 and TIB Financial subsequent to September 30, 2010.
Because substantially all of our business is composed of acquired operations and because the operations of each acquired business were substantially changed in connection with its acquisition, our results of operations for the year ended December 31, 2012, for the year ended December 31, 2011 and for the year ended December 31, 2010 reflect different operations in different periods (or portions of periods) and therefore cannot be meaningfully compared. In addition, results of operations for these periods reflect, among other things, the acquisition method of accounting. Under the acquisition method of accounting, all of the assets acquired and liabilities assumed were initially recorded on our consolidated balance sheet at their estimated fair values as of the dates of acquisition. These estimated fair values differed substantially from the carrying amounts of the assets acquired and liabilities assumed as reflected in the financial statements of the Failed Banks and of TIB Financial, Capital Bank Corp., Green Bankshares and Southern Community Financial.
1 Refer to Capital Resources and Liquidity under Management's Discussion and Analysis of Financial Condition and Results of Operations for a reconciliation of this non-GAAP measure.
ITEM 7:
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion addresses the factors that have affected the financial condition and results of operations of the Company as reflected in the audited consolidated statements of condition as of December 31, 2014 and 2013, and statements of income for the years ended December 31, 2014, 2013 and 2012. Except as noted in tables or otherwise, dollar amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in millions.
The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and involve risks and uncertainties. Our actual results and the timing of certain events may differ materially from those anticipated in these forward-looking statements as a result of several factors, including, but not limited to, those discussed in the section titled “Risk Factors” included under Part I, Item 1A and elsewhere in this report. See “Cautionary Notice Regarding Forward Looking Statements” in the beginning of this report. The following discussion pertains to our historical results, which includes the operations of First National Bank of the South, Metro Bank, Turnberry Bank (collectively, the “Failed Banks”), TIB Financial ("TIBB"), Capital Bank Corp. ("CBKN"), Green Bankshares ("GRNB") and Southern Community Financial ("SCMF" or "Southern Community") subsequent to our acquisition of each such entity. Throughout this discussion we collectively refer to the above acquisitions as the “acquisitions” and we refer to loans originated or purchased by Capital Bank, N.A. as “new loans” or “originated loans”.
Overview
We are a bank holding company incorporated in late 2009 with the goal of creating a regional banking franchise in the southeastern region of the United States through organic growth and acquisitions of other banks, including failed, underperforming and undercapitalized banks. We have raised $955.6 million to make acquisitions through a series of private placements and an initial public offering of our common stock. Since inception, we have acquired seven depository institutions, including the assets and certain deposits from the Failed Banks. We operate 162 branches in Florida, North and South Carolina, Tennessee and Virginia. Through our branches, we offer a wide range of commercial and consumer loans and deposits, as well as ancillary financial services.
We were founded by a group of experienced bankers with a multi-decade record of leading, operating, acquiring and integrating financial institutions.
Our executive management team is led by our Chief Executive Officer, R. Eugene Taylor. Mr. Taylor is the former Vice Chairman of Bank of America Corp., where his career spanned 38 years and included responsibilities as Vice Chairman and President of the Consumer and Commercial Bank. Mr. Taylor also served on Bank of America’s Risk & Capital and Management Operating Committees. He has extensive experience executing and overseeing bank acquisitions, including NationsBank Corp’s acquisition and integration of Bank of America, Maryland National Bank and Barnett Banks, Inc.
Our Chief Financial Officer, Christopher G. Marshall, has over 32 years of financial and managerial experience, including serving as Senior Advisor to the Chief Executive Officer and Chief Restructuring Officer at GMAC, Chief Financial Officer of Fifth Third Bancorp and as the Chief Operations Executive for Bank of America’s Global Consumer and Small Business Bank. Mr. Marshall also served as Chief Financial Officer of Bank of America’s Consumer Products Group. Prior to joining Bank of America, Mr. Marshall served as Chief Financial Officer and Chief Operating Officer of Honeywell International Inc. Global Business Services.
Our Chief Credit Officer, R. Bruce Singletary, has over 34 years of experience, including 21 years of experience managing credit risk. He has served as Head of Credit for NationsBank Corp. for the Mid-Atlantic region. Mr. Singletary then relocated to Florida to established a centralized underwriting function to serve middle market commercial clients in the southeastern region of the United States. Mr. Singletary also served as Senior Risk Manager for commercial banking for Bank of America’s Florida Bank and as Senior Credit Policy Executive of C&S Sovran (renamed NationsBank Corp).
Our Chief of Strategic Planning and Investor Relations, Kenneth A. Posner, spent 13 years as an equity research analyst including serving as a Managing Director at Morgan Stanley focusing on a wide range of financial services firms. Mr. Posner also served in the United States Army, rising to the rank of Captain and has received professional designations as a Certified Public Accountant, as a Chartered Financial Analyst and for Financial Risk Management.
Comparability to Past Periods
The consolidated financial information presented throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the years ended December 31, 2014 and 2013 include our consolidated results including the Failed Banks, TIBB, CBKN, GRNB and SCMF. For the year ended December 31, 2012, our consolidated results, include the Failed Banks, TIBB, CBKN, GRNB and SCMF subsequent to October 1, 2012.
Primary Factors Used to Evaluate Our Business
As a financial institution, we manage and evaluate various aspects of both our results of operations and our financial condition. We evaluate the levels and trends of the line items included in our balance sheet and income statement, as well as various financial ratios that are commonly used in our industry. We analyze these ratios and financial trends against our budgeted performance and the financial condition and performance of comparable financial institutions in our region and nationally. Our financial information is prepared in accordance with U.S. GAAP. Application of these principles requires management to make complex and subjective estimates and judgments that affect the amounts reported in the following discussion and in our consolidated financial statements and accompanying notes. For more information on our accounting policies and estimates, refer to Note 1. Summary of Significant Accounting Policies to our Consolidated Statements.
Yearly Summary
For the year ended December 31, 2014, we had net income of $50.9 million, or $1.02 per diluted share, an increase of 40% over the prior year. Results include the following non-core items: $1.7 million of contingent value right (“CVR”) expense; $1.0 million of net gains on sales of investment securities; and $1.5 million of stock-based compensation expense associated with original founders awards.
Operating and financial highlights for the year include the following:
•
Loan portfolio grew 10%;
•
Record new loans of $1.6 billion, up 27%;
•
Nonperforming loans declined 51%;
•
Legacy credit expenses declined 47%;
•
Efficiency and core efficiency1 ratios declined to 72% and 71%, respectively;
•
ROA and core ROA1 increased to 0.77% and 0.80%, respectively; and
•
Tangible book value1 per share increased to $19.28, up $0.73.
1 Refer to Non-Interest Expense, Financial Condition and Capital Resources and Liquidity for a reconciliation of these non-GAAP measures.
Results of Operations
Net Interest Income
Net interest income is the largest component of our income and is affected by the interest rate environment and the volume and composition of interest-earning assets and interest-bearing liabilities. Our interest-earning assets include loans, interest-bearing deposits in other banks and investment securities. Our interest-bearing liabilities include deposits, subordinated debentures, repurchase agreements and other short-term borrowings.
Year ended December 31, 2014 compared to year ended December 31, 2013
Net interest income for 2014 declined by $17.5 million, or 6.6%, to $246.1 million from $263.6 million for 2013. The decline was due to the lower yield on new loans, partially offset by increased loan balances and investment securities yields. The net interest margin declined 19 basis points to 4.21% from 4.40% and the net interest spread declined to 4.09% from 4.27%. Loan yields declined to 5.30% from 6.00% due to the lower yield on new loans as compared to the yields of our legacy portfolio in addition to the decline of our PCI loan portfolio. New and acquired non-impaired loans now represent 73% of our total loan portfolio as compared to 59% at December 31, 2013. The average yield of PCI loans outstanding is 4.90%. New loans were $1.6 billion with an average yield of 3.55% compared to 2013 new loans of $1.3 billion with an average yield of 3.90%. The increase in investment securities yields was mainly due to the repositioning of a portion of our portfolio into agency-backed CMBS as part of our strategy to manage the bank’s overall interest rate risk position. The cost of core deposits remained flat at 0.15% while the cost of total deposits declined six basis points as a result of planned shrinkage of high-cost time deposits. Total funding cost declined eight basis points due to the reduction of time deposits and rates combined with a full year impact of the 2013 prepayment of $42.5 million of trust preferred securities.
Rate/Volume Analysis
(1)
Interest income and rates include the effects of a tax equivalent adjustment using applicable statutory tax rates in adjusting tax-exempt interest on tax-exempt investment securities and loans to a fully taxable basis. Average loan volumes include non-performing assets which results in the impact of the non-accrual of interest being reflected in the change in average rate.
(2)
Includes Federal Reserve Bank, Federal Home Loan Bank and Bankers Bank stock.
(3)
For each major category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes due to average volumes and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.
Year ended December 31, 2013 compared to year ended December 31, 2012
Net interest income for 2013 increased by $8.4 million, or 3.3%, to $263.6 million from $255.2 million in 2012. The increase reflects a full year of net interest income from our SCMF acquisition, partially offset by a decline in new loan portfolio yields. Contributing to the increase in net interest income was a decline in rates paid across all deposit types, the prepayment of high coupon trust preferred securities and the repayment of FHLB advances during the second half of 2012. The net interest margin of 4.40% remained relatively flat year-over-year. Loan yields declined to 6.00% for 2013 from 6.30% in 2012, largely driven by new loans of $1.3 billion with an average yield of 3.90% compared to 2012 new loans of $0.9 billion with an average yield of 4.66%. The decline in new loan yields was partly due to the change in our production mix favoring variable rate products, the majority of which were commercial and industrial loans. Securities yields declined to 1.50% in 2013 from 1.77% in 2012 due to interest rates remaining at historic lows limiting the yield of reinvestment of cash flows of higher yield investments acquired with our legacy banks. Our cost of funds declined to 0.53% for 2013 from 0.71% in 2012, led by a time deposit rate decline of 10 basis points and reduced volumes in high-cost legacy time deposits as a result of continued planned shrinkage. In addition, money market rates and NOW accounts declined 20 basis points and nine basis points, respectively. Borrowing rates declined due to the repayment of FHLB advances in 2012 and prepayment of $42.5 million of high coupon trust preferred securities.
Rate/Volume Analysis
(1)
Interest income and rates include the effects of a tax equivalent adjustment using applicable statutory tax rates in adjusting tax-exempt interest on tax-exempt investment securities and loans to a fully taxable basis. Average loan volumes include non-performing assets which results in the impact of the non-accrual of interest being reflected in the change in average rate.
(2)
Includes Federal Reserve Bank, Federal Home Loan Bank and Bankers Bank stock.
(3)
For each major category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes due to average volumes and changes due to rates, with the changes in both volumes and rates allocated to these two categories based on the proportionate absolute changes in each category.
Provision for Loan and Lease Losses
The following table presents the provision (reversal) for loan and lease losses for PCI and non-PCI loans for the years ended December 31, 2014, 2013 and 2012:
Year ended December 31, 2014 compared to year ended December 31, 2013.
The net provision (reversal) for loan and lease losses for 2014 was $(0.6) million compared to a provision of $14.1 million for 2013. The improvement was mainly due to the reversal of provision associated with PCI loans and a lower level of net charge offs on new loans. The reversal of impairment associated with PCI loans was mainly due to improvements in our expectations of future cash flows resulting from higher than anticipated payoffs across all market areas and product types. Improvement in cash flows for covered and non-covered loans resulted in reversal of impairments of $3.5 million and $5.5 million, respectively. In contrast, in the prior year, improvement in cash flows resulted in reversals of impairment of $3.8 million for covered loans, partially offset by additional impairment of $1.9 million for non-covered loans. Charge offs declined to $9.2 million from $18.7 million in the prior year. For our new loan portfolio, a $7.8 million charge off was recorded during the prior year related to a single commercial credit relationship associated with suspected fraud. A recovery of $0.6 million was recorded in 2014 in connection with the resolution of this loan.
The table below illustrates the impact of our fourth quarter 2014 estimates of expected cash flows on PCI loans on impairment and prospective yield:
(1)
Covered loan pools are comprised of loans acquired in acquisition of the Failed Banks with loans types guaranteed by the FDIC under loss sharing agreements. Accordingly, certain pools classified as covered may include individual loans which are not, or are no longer covered.
(2)
Loan balance represents the recorded investment of all loans in the covered and non-covered pools, respectively. Not all covered loans are classified as PCI.
Year ended December 31, 2013 compared to year ended December 31, 2012
The net provision for loan and lease losses for 2013 was $14.1 million compared to a provision of $24.5 million for 2012. The lower provision was mainly due to improvements in our expectations of future cash flows on PCI loans resulting from higher than anticipated payoffs across all market areas and product types, partially offset by an increase of provision for new loans. Improvements in cash flows resulted in a $3.8 million reversal of impairment for covered loans, partially offset by additional impairment of $1.9 million for non-covered loans. In contrast, in the prior year, estimation of cash flows resulted in a
$5.1 million and $8.4 million in additional impairment for covered and non-covered loans, respectively. The increase in provision for new loans mainly related to a $7.8 million charge off due to a single commercial credit relationship associated with suspected fraud.
Non-interest Income
Year ended December 31, 2014 compared to year ended December 31, 2013.
Non-interest income declined $9.2 million to $43.8 million for 2014 from $53.0 million for the 2013. The decline was mainly due to lower credit loss expectations in our legacy loan portfolios, which resulted in an increase of $5.9 million in FDIC indemnification asset amortization, the absence of a $1.5 million gain recorded in the prior year upon exchange of two small investment company partnership interests, and the absence of $1.9 million in legal settlements and insurance recoveries. Contributing to the decline was a $2.5 million, or 10%, decline in service charges on deposit accounts as a result of a 11% decline in customer accounts in overdraft, and a $1.3 million decline in fees on mortgage loans originated and sold as residential mortgage loans sold declined 14% as compared to 2013. Partially offsetting this decline was an increase of $0.9 million in gains on sales of investment securities, and an increase of $2.1 million in investment advisory and trust fees, which benefited from an 8% increase in assets under management coupled with higher advisory commissions.
Year ended December 31, 2013 compared to year ended December 31, 2012.
Non-interest income declined $9.7 million to $53.0 million for 2013 from $62.7 million for 2012. The decline was mainly due to an $8.5 million decline in investment security gains as a result of a strategy to sell non-core assets to lower premium and prepayment risk in our investment portfolio in 2012. Additionally, a $7.0 million increase in FDIC indemnification asset expense resulted from lower credit loss expectations in our legacy loan portfolio. A $1.6 million decline in legal settlements and insurance recoveries further contributed to the decline. Partially offsetting these items was a $1.5 million gain on exchange of two investment company partnership interests for common stock of a newly public company, increases in rents received on foreclosed properties and investment advisory and trust fees, respectively.
The following table sets forth the components of non-interest income for the periods indicated:
Non-interest Expense
Year ended December 31, 2014 compared to year ended December 31, 2013.
Non-interest expense declined $27.4 million, or 11.6%, to $208.8 million for 2014 from $236.2 million for 2013. The decline was mainly due to a $16.7 million decline in the OREO valuation expense, foreclosed asset and loan workout expense components of our legacy credit expenses; a reflection of the continued resolution of special assets. Contributing to the decline in non-interest expense was a $2.8 million decline in stock-based compensation expense mainly associated with original founders awards, a $2.1 million decline in professional fees as we developed in-house capabilities and a $1.1 million decline in CVR expense as a result of our most recent estimate of expected credit losses from our legacy portfolios.
The CVR liability is measured each quarter and is payable after the fifth anniversary of the consummation of the respective acquisition and the current amount of the liability represents the expected payout discounted at an estimated market discount rate from the payout date to the reporting date. Based on the credit performance of SCMF’s existing loan portfolio to date, we currently anticipate that, absent the receipt of the Redemption Proceeds pursuant to the consent solicitation currently being conducted with respect to the SCMF's CVRs, the Maximum Payment Amount will be owed at the end of the five-year term of the SCMF's CVRs. Based on the credit performance of CBKN's and GRNB's existing loan portfolio to date, we currently anticipate that holders of these CVRs are unlikely to receive a payment at the end of the five-year term of the CBKN's CVRs and GRNB's CVRs
Partially offsetting these expense reductions was an increase in salary and employee benefits of $3.3 million mainly as a result of rising healthcare costs.
OREO sales during the year resulted in $80.3 million in cash proceeds, including $4.6 million in gains, reducing our OREO balance by 40.0% from December 31, 2013.
Net occupancy expense declined $1.1 million as a result of our continued focus on consolidating facilities, partially offset by contractual increases in operating lease costs. During 2014 we purchased two branches at more favorable terms than our lease agreements and reduced square footage by closing two branches and consolidating lease space in one branch.
Other operating expense declined $5.1 million mainly due to a decline of approximately $1.0 million in insurance costs as a result of the renegotiation of insurance premiums, a decline of approximately $1.3 million in supplies, postage and stationary and $0.9 million in miscellaneous expenses as a result of costs savings initiatives. Contributing to the decline, was a decline of $0.8 million due to amortization run off in intangible assets acquired with our legacy banks and a $0.5 million decline in operational charge-offs.
Year ended December 31, 2013 compared to year ended December 31, 2012
Non-interest expense declined $23.7 million, or 9.1%, to $236.2 million for 2013 from $260.0 million for 2012. The decline was mainly due to a reduction of $13.2 million in stock-based compensation associated with founders’ grants and a net gain on extinguishment of debt of $0.1 million on pre-paid trust preferred securities compared to a $3.3 million loss on extinguishment of debt on the repayment of FHLB advances in 2012. Contributing to the decline in non-interest expense was a $7.3 million decline in conversion and merger related expenses due to integration of the acquired banks in 2012 and a $3.1 million and $2.2 million decline in professional fees and legal settlement expenses, respectively. Offsetting this decline was an increase of $2.7 million in CVR expense as a result of 2013 estimates of lower expected credit losses from our legacy portfolios.
OREO sales during year resulted in $75.5 million in cash proceeds, including $3.5 million in gains, reducing our OREO balance by 16.0% from December 31, 2012.
Salaries and employee benefits decreased slightly for 2013 as compared to 2012.
Computer services, software expense and net occupancy expense increased by $3.3 million, $2.0 million and $1.1 million, respectively, mainly as a result of a full year of operations in 2013 of the SCMF network and facilities, which we acquired in the fourth quarter of 2012, as compared to three months in 2012.
The following table sets forth the components of non-interest expense for the periods indicated:
Legacy credit expenses for the years ended December 31, 2014, 2013 and 2012 are as presented below:
Our efficiency ratios for the years ended December 31, 2014, 2013 and 2012 were 72.05%, 74.62% and 81.77%, respectively. Our core efficiency ratios for the years ended December 31, 2014, 2013 and 2012 were 71.17%, 72.24% and 72.84%, respectively.
The core efficiency ratio, which equals core non-interest expense divided by core net revenues (net interest income plus core non-interest income), for the years ended December 31, 2014, 2013 and 2012 is as follows:
The core efficiency ratio is a non-GAAP measure which we believe provides analysts and investors with information useful in understanding our business and evaluating our operating efficiency. We monitor the core efficiency ratio to evaluate and control operating costs. The core efficiency ratio is also a measure utilized by our Board of Directors in measuring management’s performance in controlling operating costs in comparison to peers. This non-GAAP measure has inherent limitations and is not required to be uniformly applied. It should not be considered in isolation or as a substitute for analysis of results reported under GAAP. This non-GAAP measure may not be comparable to similarly titled measures reported by other companies and should not be viewed as a substitute for non-interest expense.
Income Taxes
The provision (benefit) for income taxes was $30.7 million, $27.4 million and $(21.5) million for 2014, 2013 and 2012, respectively. The effective income tax rates were 38%, 41% and (64)% for these periods, respectively. The higher 2013 effective income tax rate as compared to 2014 was mainly due to the impact of a $1.5 million charge to income tax expense as a result of changes in certain statutory rates that were enacted into law during the third quarter of 2013 and the change in value of the CVR as a result our most recent estimate of expected credit losses from our legacy portfolios.
The 2012 tax benefit was due to the $34.0 million increase in our deferred tax asset due to an improvement in forecasted tax deductible losses from loans obtained through our acquisitions of TIB Financial, Capital Bank Corp, and Green Bankshares, Inc. At each respective acquisition date, we recorded an estimate of deferred tax assets expected to be realized in connection with differences between the estimated fair value and tax bases of loans acquired. Such estimates included assumptions of the amounts and timing of credit losses associated with each of the acquired loan portfolios. These estimates were based on facts and circumstances existing at each respective acquisition date. According to Section 1374 of the Internal Revenue Code of 1986 (the “Code”), bad debt deductions arising from debts owed at the beginning of the recognition period are limited as built-in-losses under Section 382 of the Code, if the deduction is properly taken into account during the first twelve months of the recognition period. Conversely, bad debt deductions taken subsequent to this twelve month period are not limited. As the actual credit losses on acquired loans which qualified as bad debt deductions limited by Section 382 were lower than initially estimated as of the respective dates of acquisition, during the third quarter of 2012, we increased our deferred tax assets to amounts which were consistent with the deductions recognized upon the filing of our 2011 tax returns and then current expectations of the timing of recognition of future credit losses on acquired loans.
At December 31, 2014 and 2013, the Company had no amounts recorded for uncertain tax positions and no unrecognized tax benefits. We do not expect to identify any material unrecognized tax benefits during the next 12 months.
Refer to Note 17. Income Taxes to our Consolidated Financial Statements for further information on our provision for income taxes.
Financial Condition
Our assets totaled $6.8 billion at December 31, 2014 and $6.6 billion at December 31, 2013. Total loans increased $448.2 million to $5.0 billion at December 31, 2014 compared to $4.6 billion at December 31, 2013. The increase in total loans was due to $1.6 billion of new loans, partially offset by $281.9 million in resolutions of problem loans and $866.5 million in net principal repayments. Investment securities declined by $161.6 million mainly due to principal cash flows retained and redeployed to fund loan growth. Total deposits were $5.3 billion at December 31, 2014 and $5.2 billion at December 31, 2013. Our core deposits increased by $98.8 million as a result of our continued focus in growing lower cost checking accounts, which were up $192.2 million, or 9%, partially offset by some contraction in money market balances. Core deposits now represent 73.0% total deposits at December 31, 2014 compared to 72.1% at December 31, 2013. Time deposits declined by $28.8 million as a result of continued planned shrinkage in high-cost time deposits, which declined by $227.4 million, partially offset by an increase in lower cost brokered time deposits of $198.6 million. Borrowed funds, consisting of FHLB advances, short-term borrowings, notes payable and subordinated debentures, totaled $459.2 million and $259.7 million at December 31, 2014 and 2013, respectively. The increase in borrowed funds was mainly due to $199.8 million of new short-term FHLB advances.
Shareholders’ equity was $1.1 billion at December 31, 2014 and December 31, 2013. During 2013 and 2014, the Company’s Board of Directors authorized stock repurchase plans of up to $200.0 million. Stock repurchases may be made from time to time, on the open market or in privately negotiated transactions. The approved stock repurchase programs do not obligate the Company to repurchase any particular amount of shares, and the programs may be extended, modified, suspended, or discontinued at any time.
During 2014, the Company repurchased $103.2 million, or 4,324,382 common shares at an average price of $23.87 per share. As of December 31, 2014, the Company has repurchased a total of $173.2 million or 8,085,699 common shares at an average price of $21.42 per share, and had $26.8 million of remaining availability for future share repurchases.
Core return-on-assets (“core ROA”) is a non-GAAP measure which we believe provides management and investors with useful information to understand the effects of certain non-interest items and provide an alternative view of the Company’s performance over time and in comparison to the Company’s competitors. This non-GAAP measure has inherent limitations and is not required to be uniformly applied. It should not be considered in isolation or as a substitute for analysis of results reported under GAAP. This non-GAAP measure may not be comparable to similarly titled measures reported by other companies and should not be viewed as a substitute for non-interest expense. A reconciliation to the most directly comparable GAAP financial measure is shown in the table below:
Loans
Our loan portfolio is our primary earning asset. Our strategy is to grow the loan portfolio by originating commercial and consumer loans that we believe to be of high quality, that comply with our conservative credit policies and that produce revenues consistent with our financial objectives. Additionally, we have worked to reduce excessive concentrations in commercial real estate loans, which were the predominant portion of the acquisitions’ legacy portfolios, in order to achieve a more diversified portfolio mix.
The following table sets forth the carrying amounts of our loan portfolio:
The following tables set forth the carrying amounts of our non-PCI and PCI loan portfolio by category:
During 2014, our loan portfolio increased by $448.2 million as $1.6 billion of new loans were partially offset by $281.9 million in resolutions of problem loans and $866.5 million in net principal repayments. New and acquired non-impaired loans now represent 72.7% of our total loan portfolio as compared to 58.8% at December 31, 2013.
The composition of new loan production is indicative of our business strategy of emphasizing commercial and industrial and consumer loans. As illustrated in the table below, commercial loans and consumer and other loans represented approximately 45.6% and 34.6%, respectively, of new loan production for the year ended December 31, 2014. We expect that this production will be more balanced going forward, as we expect commercial real estate to comprise a larger proportion of new loan production.
The following table sets forth our new loans (excluding renewals of existing loans) segmented by loan type:
We underwrite commercial real estate loans based on the value of the collateral, the ratio of debt service to property income and the creditworthiness of tenants. Due to the inherent risk of commercial real estate lending, we underwrite loans selectively. Accordingly, we have reduced the concentration in our portfolio over time, which had characterized our acquired loan portfolios.
Florida, North Carolina, South Carolina and Tennessee accounted for 29.3%, 29.9%, 11.9% and 28.9%% of our new loans, respectively, for the year ended December 31, 2014. Florida, North Carolina, South Carolina and Tennessee accounted for 26.9%, 41.7%, 11.9% and 19.5% of our new loans, respectively, for the years ended December 31, 2013. During 2014, we purchased $101.2 million of high quality residential loans.
The contractual maturity distribution of our loan portfolio as of December 31, 2014 is presented in the tables below. The majority of these are amortizing loans.
Asset Quality
Consistent with our strategy of operating with a sound risk profile, we have focused on originating loans we believe to be of high quality, disposing of non-performing assets as rapidly as possible, and reducing the size of our legacy commercial real estate loan portfolio. To achieve these objectives, we underwrite new loans and manage existing loans in accordance with our underwriting standards under the direction of our Chief Credit Officer. Additionally, we have assigned senior credit officers to oversee the Florida, Tennessee and Carolinas markets, and we have established a special assets division to dispose of legacy problem loans and OREO.
We refer to our loans covered under loss sharing agreements with the FDIC as “covered loans.” These are the legacy loans of Metro Bank, Turnberry Bank, and First National Bank of the South where the FDIC reimburses us for 80% of net charge-offs and OREO losses over a five-year period for commercial loans (expiring in the third quarter of 2015) and a ten-year period for residential loans (expiring in the third quarter of 2020). We refer to all other loans as “non-covered loans.” These are new loans we originate or purchase, loans acquired through the acquisitions of Capital Bank, TIB Bank, Green Bankshares and Southern Community Financial and certain loans of the Failed Banks that we acquired, which are not covered by any loss sharing agreement.
Covered Loans
As of December 31, 2014, covered loans were $197.6 million, representing 4.0% of our loan portfolio of which 0.2% were past due 30-89 days, 6.5% were greater than 90 days past due and still accruing/accreting and 0.3% were nonaccrual. As of December 31, 2013, covered loans were $285.3 million, representing 6.3% of our loan portfolio of which 0.3% were past due 30-89 days, 14.2% were greater than 90 days past due and still accruing/accreting and 0.5% were nonaccrual. The status of these loans reflects the severity of the real estate downturn and the excessive concentrations in commercial real estate and poor quality underwriting that characterized the banks we acquired from the FDIC under their prior business models. We have recorded these loans at estimated fair value reflecting expected lifetime losses estimated as of their acquisition date.
As of December 31, 2014, covered loans and OREO subject to the commercial shared-loss agreements expiring on July 16, 2015, were $108.9 million and $14.7 million, respectively. The commercial shared-loss agreements provide for FDIC loss sharing for five years from July 16, 2010 and our reimbursement for recoveries to the FDIC for eight years from July 16, 2010 for all other covered assets. Covered loans and OREO subject to the single family shared-loss agreements expiring on July 16, 2020, were $88.7 million and $1.0 million, respectively. The single family shared-loss agreements provide for FDIC loss sharing and our reimbursement for recoveries to the FDIC for ten years from July 16, 2010.
We manage credit risk associated with loans covered under loss sharing agreements in the same manner as credit risk associated with non-covered loans. This includes following consistent policies and procedures relating to the process of working with borrowers in efforts to resolve problem loans resulting in the lowest losses possible and collection including foreclosure, repossession and the ultimate liquidation of any applicable underlying collateral. The loss sharing agreements also contain certain restrictions and conditions which, among other things, provide that certain credit risk management strategies such as loan sales, under certain conditions, could be prohibited under the agreements and may lead to the termination of coverage of any applicable losses on the related loans. Accordingly, actions taken by management in the process of prudently managing credit risk and borrower relationships, including, but not limited to, the renewal of covered loans for periods extending beyond the expiration of the applicable loss sharing agreement, the extension of additional credit or the making of certain modifications of loan terms, can lead to the termination of coverage under the loss sharing agreements for these particular loans.
Collection of loss claims under the loss sharing agreements requires extensive and specific recordkeeping and incremental quarterly reporting to the FDIC on the status of covered loans. The loss claims filed and the related reporting on covered loans to the FDIC are subject to review and approval by the FDIC and various subcontractors utilized by the FDIC. The requirements for such reporting and interpretations thereof are occasionally revised by the FDIC and its subcontractors. Such changes along with our ability to comply with the requirements and revisions require interpretation and can lead to delays in the collection of claims on losses incurred. Claims filed by us for losses realized through December 31, 2014, totaling $129.7 million have been collected from the FDIC. Additionally, the loss sharing agreements provide for regular examination of compliance with loss sharing agreements including reviews of relevant policies and procedures and detailed audits of claims filed. Noncompliance with the provisions of the loss sharing agreements can lead to termination of the agreements.
Non-Covered Loans
As of December 31, 2014, non-covered loans were $4.8 billion, representing 96.0% of our loan portfolio, of which 0.2% were past due 30-89 days, 2.3% were greater than 90 days past due and still accruing/accreting and 0.2% were nonaccrual. As of December 31, 2013, non-covered loans were $4.3 billion, representing 93.7% of our loan portfolio, of which 0.5% were past due 30-89 days, 5.0% were greater than 90 days past due and still accruing/accreting and 0.2% were nonaccrual.
As a percentage of the non-covered loans are acquired impaired loans, these loans had excessive commercial real estate concentrations, which had characterized our acquired loan portfolios. However, the credit quality of these loans is generally higher than that of the covered loans. In connection with the acquisitions, we applied acquisition accounting adjustments to the non-covered loans not originated by us to reflect estimates at the time of acquisition of the expected lifetime losses of such loans.
Covered and Non-Covered Loan Credit Quality Summary
The table below summarizes key loan credit quality indicators for covered and non-covered loan portfolios as of the dates indicated:
Of the loans past due greater than 90 days and still in accruing/accreting status as of December 31, 2014, $12.9 million (or approximately 10.63%) were loans covered by loss sharing agreements with the FDIC. Of the loans past due greater than 90 days and still in accruing/accreting status as of December 31, 2013, $40.4 million (or approximately 15.9%) were loans covered by loss sharing agreements with the FDIC. All of the covered and non-covered loans classified as delinquent 90 days or more accruing/accreting are entirely comprised of components of PCI loan pools. There were no non-PCI loans included in this category at the end of each period presented.
Total non-performing loans as of December 31, 2014 declined by $135.0 million, or 51%, to $130.6 million as compared to $265.6 million at December 31, 2013. The change in non-performing loans during the year ended December 31, 2014 was attributable to $132.1 million in resolutions and $35.0 million in transfers to other real estate owned through foreclosures or receipt of deeds in lieu of foreclosures. Partially offsetting these decreases were $32.0 million of loans that became non-performing.
During the year ended December 31, 2014, of the loans we foreclosed, or received deeds in lieu of foreclosure, approximately 42.9% consisted of commercial real estate loans, 31.9% consisted of commercial loans and 24.9% consisted of residential loans.
The customer-owed principal balances and carrying amounts as of December 31, 2014 and 2013 are set forth in the tables below:
(1)
The carrying amount for total covered and non-covered loans represents a discount from the total gross customer balance of $200.8 million million, or 50.4%, and $729.3 million or 13.2%, respectively.
(2)
Includes loans greater than 90 days past due.
(1)
The carrying amount for total covered and non-covered loans represents a discount from the total gross customer balance of $215.1 million, or 43.0%, and $748.8 million, or 14.9%, respectively.
(2)
Includes loans greater than 90 days past due.
Allowance and Provision for Loan and Lease Losses
At December 31, 2014, the allowance for loan and lease losses was $50.2 million, of which $28.9 million was associated with PCI loans and $21.3 million related to new loans or acquired non-PCI loans. At December 31, 2014, the allowance for loan and lease losses represents 1.0% of our total $5.0 billion loan portfolio. At December 31, 2013, the allowance for loan and lease losses was $56.9 million of which $19.0 million related to new loans or acquired non-PCI loans, and $37.9 million was associated with PCI loans. At December 31, 2013, the allowance for loan and lease losses represented 1.25% of our total $4.6 billion loan portfolio.
For non PCI loans, the allowance for loan and lease losses reflects an allowance for probable incurred credit losses in the loan portfolio. Our formalized process for assessing the adequacy of the allowance for loan and lease losses and the resultant need, if any, for periodic provisions to the allowance charged to income, includes both individual loan analysis and loan pool analysis. Individual loan analysis are periodically performed on loan relationships of a significant size, or when otherwise deemed necessary, and are performed primarily on commercial real estate and other commercial loans. The result is that commercial real estate loans and commercial loans are divided into the following risk categories: Pass, Special Mention, Substandard and Loss. The allowance consists of specific and general components. When appropriate, a specific reserve will be established for individual loans based upon the risk classifications and the estimated potential for loss. The specific component relates to loans that are individually classified as impaired.
Home equity loans, indirect auto loans, residential loans and consumer loans generally are not analyzed individually or separately identified for impairment disclosures. These loans are grouped into pools and assigned risk categories based on their current payment status and management’s assessment of risk inherent in the various types of loans. The allocations are based on the same factors mentioned above. However, should such loans exceeding certain size thresholds exhibit signs of impairment; they may be individually evaluated for impairment.
For PCI loans, the allowance for loan and lease losses is a measure of impairment based upon our most recent estimates of expected cash flows. Our estimation of expected cash flows, which is used to determine the need for provisions to or reversals of the allowance every reporting period, is determined by assigning probability of default (“PD”) and loss given default (“LGD”) assumptions, amongst other assumptions such as prepayment speeds and recovery or liquidation timing. For commercial real estate and other commercial loans, we generally assign PD assumptions through the mapping of the following loan level risk ratings: Pass, Watch, Sub-Performing and Non-Performing. For home equity loans, residential loans, and consumer loans, PD is determined by mapping payment performance and delinquency status to market based default assumptions. Estimated loan to value ratios, determined using appraisals and/or real estate indices, are used to derive loss given default assumptions for real estate collateralized loans.
Senior management and our Board of Directors review this calculation and the underlying assumptions on a routine basis not less frequently than quarterly.
The provision for loan and lease losses is a charge to income in the current period to establish or replenish the allowance and maintain it at a level that management has determined to be adequate to absorb estimated incurred losses in the loan portfolio for new loans. A provision for loan and lease losses is also required for any unfavorable changes in expected cash flows related to pools of purchased impaired loans. The provision for loan and lease losses and expectations of cash flows may be impacted by many factors, including changes in the value of real estate collateralizing loans, net charge-offs and credit losses incurred, changes in loans outstanding, changes in impaired loans, historical loss rates and the mix of loan types.
As the majority of our acquired loans are considered PCI loans, our provision for loan and lease losses in future periods for acquired loans will be most significantly influenced in the short term by the differences between the actual credit losses resulting from the resolution of problem loans and the estimated credit losses used in determining the estimated fair values of purchased impaired loans as of their acquisition dates. For new loans, the provision for loan and lease losses will be affected by the loss potential of impaired loans and trends in the delinquency of loans, non-performing loans and net charge offs, which cannot be reasonably predicted. Refer to Provision for loan and lease losses section for further discussion.
Management continuously monitors and actively manages the credit quality of the entire loan portfolio and will continue to recognize the provision required to maintain the allowance for loan and lease losses at an appropriate level.
The following table presents the roll-forward of the allowance for loan and lease losses for PCI and non-PCI loans for the years ended December 31, 2014, 2013 and 2012 by the class of loans against which the allowance is allocated:
No portion of the allowance allocated to non-PCI loans is in any way restricted to any individual loan or group of new loans or non-PCI loans, and the entirety of such allowance is available to absorb probable incurred credit losses from any and all such loans. The following table represents management’s best estimate of the allocation of the allowance for loan and lease losses for non-PCI loans to the various segments of the loan portfolio based on information available as of December 31, 2014 and 2013:
Criticized and Classified Loans
Loans with the following attributes are categorized as criticized and classified loans: (1) a potential weakness that deserves management’s close attention; (2) inadequate protection by the current net worth and paying capacity of the obligor or of the collateral pledged; or (3) weaknesses which make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
The following table summarizes criticized and classified loans at December 31, 2014 and 2013:
(1) PCI and non-PCI loans are included in the balances presented.
Total criticized and classified loans declined $227.5 million during 2014 as a result of $35.0 million in transfers to other real estate owned and $273.4 million of pay downs, charge offs and upgrades. Loan downgrades of $80.9 million partially offset the decline.
Impaired Loans
Non-performing loans and impaired loans are defined differently. Some loans may be included in both categories, whereas other loans may only be included in one category. A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. Generally, residential mortgages, commercial and commercial real estate loans exceeding certain size thresholds established by management are individually evaluated for impairment. Non-accrual loans and restructured loans where loan term concessions benefiting the borrowers have been made are generally designated as impaired.
Within the context of the accounting for impaired loans described in the preceding paragraph, other than the PCI loans described above, as of December 31, 2014, there were 22 loans individually evaluated for impairment and 14 deemed impaired with a related allowance for loan and lease losses of $43 thousand. At December 31, 2013, there were 28 loans individually evaluated for impairment and 7 deemed impaired with a related allowance for loan and lease losses of $0.5 million. The specific reserve at December 31, 2013 was primarily related to a commercial loan with a balance $1.8 million.
Due to the pool method of accounting for purchased credit impaired loans, non-performing PCI loans are reported as 90 days past due and still accruing/accreting. Going forward, additional acquired loans not classified as purchased credit impaired and new loans originated by us may become impaired and will be classified as such. Impaired loans also include loans which were not classified as non-accrual, but otherwise meet the criteria for classification as an impaired loan (i.e., loans for which the collection of all principal and interest amounts as specified in the original loan contract are not expected, or where management has substantial doubt that the collection will be as specified, but is still expected to occur in its entirety). In our evaluation of the adequacy of the allowance for loan and lease losses, we consider (1) purchased credit impaired loans and loans classified as impaired, (2) our historical portfolio loss experience and trends as well as that of peers and (3) certain other quantitative and qualitative factors.
Non-Performing Assets
Non-performing assets include accruing/accreting loans delinquent 90 days or more, non-accrual loans and investment securities, repossessed personal property and other real estate. Non-PCI loans and investments in debt securities are placed on non-accrual status when management has concerns relating to the ability to collect the principal and interest and generally when such assets are 90 days past due. Non-performing assets were as follows:
At December 31, 2014 and 2013, covered and non-covered loans classified as delinquent 90 days or more and accruing/accreting are entirely comprised of components of PCI loan pools. There were no non-PCI loans included in this category at the end of each period presented. In addition to the discussion in the previous section, please refer to Note 5. Loans in our consolidated financial statements for a description of the accounting for pooled PCI loans.
Total non-performing assets at December 31, 2014 declined by $187.5 million to $208.4 million compared to $395.9 million at December 31, 2013. The change in non-performing assets was attributable to the decline in non-performing loans and other real estate owned of $135.0 million and $51.8 million, respectively. The decline in non-performing loans was due to $132.1 million in resolutions and $35.0 million in transfers to other real estate owned through foreclosures or receipt of deeds in lieu of foreclosures, offset by $32.0 million of loans that became non-performing. The decline in other real estate owned was mainly due to sales of $75.8 million, partially offset by valuation adjustments and acquisitions as noted above.
Investment Securities
Investment securities represent a significant portion of our assets. We invest in a variety of securities including obligations of U.S. government agencies, U.S. government-sponsored entities, including mortgage-backed securities, obligations of states or political subdivisions, privately issued mortgage-backed securities, bank eligible corporate obligations, mutual funds and limited types of equity securities.
Our investment activities are governed internally by a written, Board-approved policy. The investment policy is carried out by our Treasury department. Investment strategies are reviewed by the Risk Committee of the Board based on the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and our overall interest rate sensitivity. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (1) to provide a margin of liquid assets sufficient to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (2) to provide eligible securities to secure public funds and other borrowings; and (3) to manage interest rate risk and earn the maximum return on funds invested that is commensurate with meeting our first two goals.
Trading securities totaled $2.4 million and $6.3 million at December 31, 2014 and December 31, 2013, respectively.
Our investment securities consisted primarily of U.S. agency mortgage-backed securities, which expose us to a lower degree of credit and liquidity risk. The following tables set forth our investment securities as of December 31, 2014 and 2013:
Contractual maturities of investment securities at December 31, 2014 and 2013 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or repay obligations without call or prepayment penalties. Other securities include mortgage-backed securities and marketable equity securities which are not due at a single maturity date. The following table segments our investment portfolio by maturity date:
We regularly review each investment security for impairment based on criteria that include the extent to which cost exceeds the estimated fair value, the financial health of and specific prospects for the issuer(s) and our ability and intention with regard to holding the security to maturity. Future declines in the fair value of securities may result in impairment charges which may be material to our financial condition and results of operations. More specifically, our impairment analysis is based on the following: (1) whether it is “more likely than not” we would have to sell a security prior to recovery of the amortized cost; (2) whether we intend to sell the security; and (3) whether or not we expect to recover our recorded investment on an amortized cost basis based on credit characteristics of the investment. If, based upon our analysis, any of those conditions exist for a given security; we would generally be required to record an impairment charge in the amount of the difference between the carrying amounts and estimated fair value of such security. Based on our analysis there were no investment securities considered to be other-than-temporarily impaired at December 31, 2014.
At December 31, 2013, the Company owned shares of an investment fund with the principal investment strategy to invest in debt securities and other debt instruments that will cause shares of the fund to be deemed qualified under the Community Reinvestment Act (the “CRA”), so that financial institutions that are subject to the CRA may receive investment test or similar credit under the CRA with respect to shares of the Fund held by them. The Company evaluated the intent and ability to hold for any anticipated recovery in fair value and the length of time and extent to which the fair value has been less than cost. Based on the extended period the security’s fair value had been less than cost, and market information indicated the prospects for recovery in the near-term were unlikely, the Company determined there to be OTTI during the year ended December 31, 2013. The Company recognized $54 thousand of impairment loss in earnings, equal to the entire difference between the securities' cost basis and its fair value. The Company sold its shares of the investment fund on December 18, 2014. Proceeds from the sale were $1.0 million and gross gains were $12 thousand.
At December 31, 2013, the Company owned a collateralized debt obligation ("CDO") collateralized by trust preferred securities issued primarily by banks and several insurance companies. The Company sold its investment in the CDO on January 7, 2014, and based on the sales price, the estimated fair value of the CDO increased by $0.5 million during the year ended December 31, 2013. Since previous credit impairment was recognized, no recovery was allowed under U.S. GAAP. The CDO was recorded at fair value and the remaining unrealized gain was recognized as a component of accumulated other comprehensive income. Proceeds from the sale were $0.8 million and gross gains were $0.3 million.
For a rollforward of the OTTI credit losses recognized in earnings for the years ended December 31, 2014, 2013 and 2012, refer to Note 4. Investment Securities, to the consolidated financial statements.
Deposits
Our strategy is to fund asset growth primarily with low-cost customer deposits in order to maintain a stable liquidity profile and net interest margin.
As of December 31, 2014, our core deposits, which we define as demand deposits, savings and money market accounts, increased by $98.8 million as compared to December 31, 2013. Net new checking account growth contributed to the increase in core deposits during the year ended December 31, 2014, as we are building our deposit base around service-oriented customer relationships. The average contractual rate on core deposits remained flat at 0.14% during 2014 and 2013.
Time deposit balances declined by $28.8 million during 2014. At December 31, 2014, our wholesale time deposits increased by $198.6 million as compared to December 31, 2013, providing a lower cost source of funding as compared with higher rate legacy time deposits. The $227.4 million decrease in retail time deposit accounts was primarily a result of planned shrinkage in these high-cost legacy time deposits. The average contractual rate on time deposits decreased to 1.01% from 1.18% at December 31, 2013. The total cost of deposits decreased six basis points during 2014.
The following table sets forth the balances and average contractual rates payable to customers on our deposits, segmented by account type as of December 31, 2014 and 2013:
The following table sets forth our average deposits and the average rates expensed for the periods indicated:
(1)
The average rates on time deposits include the amortization of premiums on time deposits assumed in connection with the acquisitions. Such premiums were required to be recorded by the acquisition method of accounting to initially record these deposits at their fair values as of the respective acquisition dates.
The following table sets forth our time deposits segmented by months to maturity and deposit amount:
Capital Resources and Liquidity
Capital Resources
In order to maintain a conservative risk profile, we operate with a prudent cushion of capital in relation to regulatory requirements and to the risk of our assets and business model. For planning purposes, we expect to operate with a minimum capital target equal to an 8% leverage ratio (defined as Tier 1 capital equal to 8% of average tangible assets), which would be in excess of regulatory standards for “well-capitalized” banks. We believe the 8% target is appropriate for our business model because of our conservative loan underwriting policies, investment portfolio composition, funding strategy, interest rate risk management limits and liquidity risk profile and because of the experience of our senior management team and Board of Directors.
As of December 31, 2014 and 2013, we had 13.63% and 14.82% tangible common equity ratios, respectively. We calculate tangible common equity, tangible assets and the tangible common equity ratio, which are non-GAAP measures, because we believe they are useful for both investors and management as these are measures commonly used by financial institutions, regulators and investors to measure the capital adequacy of financial institutions. The tangible common equity ratio is calculated as tangible common shareholders’ equity divided by tangible assets. Tangible common equity is calculated as total shareholders’ equity less preferred stock and less goodwill and other intangible assets, net, and tangible assets are total assets less goodwill and other intangible assets, net. We believe these measures facilitate comparison of the quality and composition of the Company’s capital over time and in comparison to its competitors.
These non-GAAP measures have inherent limitations and are not required to be uniformly applied. They should not be considered in isolation or as a substitute for analysis of results reported under GAAP. These non-GAAP measures may not be comparable to similarly titled measures reported by other companies and should not be viewed as a substitute for shareholders’ equity or total assets. The following table provides reconciliations of tangible common equity and the tangible common equity ratio to GAAP total common shareholders’ equity and tangible assets to GAAP total assets:
The Company operates with a significant level of excess capital above regulatory requirements (see the table below for the historical capital ratios as well as minimum and well capitalized ratio requirements).
As of December 31, 2014, we had a Tier 1 leverage ratio of 14.3%, which provided us with $279.7 million in excess capital relative to the 10% Tier 1 leverage ratio required under our OCC Operating Agreement and $410.4 million in excess capital relative to our longer-term target of 8%. As of December 31, 2014, Capital Bank, N.A. had a 13.5% Tier 1 leverage ratio, an 17.0% Tier 1 risk-based ratio and an 18.1% total risk-based capital ratio.
As of December 31, 2013, we had a Tier 1 leverage ratio of 14.9%, which provided us with $314.3 million in excess capital relative to the 10% Tier 1 leverage ratio required under the OCC Operating Agreement and $441.4 million in excess capital relative to our longer-term target of 8%. As of December 31, 2013, Capital Bank, N.A. had a 13.4% Tier 1 leverage ratio, an 17.7% Tier 1 risk-based ratio and an 18.9% total risk-based capital ratio.
At present, the OCC Operating Agreement requires Capital Bank, N.A. to maintain total capital equal to at least 12% of risk-weighted assets, Tier 1 capital equal to at least 11% of risk-weighted assets and a minimum leverage ratio of 10% (Tier 1 Capital ratio). We expect to operate under this capital standard until we demonstrate that we have stabilized our acquired operations, improved our profitability and reduced legacy problem assets.
The minimum ratios along with the actual ratios for us and Capital Bank, N.A. as of December 31, 2014 and 2013 are presented in the following tables:
In July 2013, the U.S. banking regulators adopted a final rule which implements the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision, and certain changes required by the Dodd-Frank Act. The final rule establishes an integrated regulatory capital framework and introduces the “Standardized Approach” for risk weighted assets, which will replace the Basel I risk-based guidance for determining risk-weighted assets as of January 1, 2015 (the date we became subject to the new rules). We do not believe adoption of the final rules and relevant provisions will have a significant impact on our operations.
Liquidity
Liquidity involves our ability to raise funds to support asset growth or reduce assets to meet deposit withdrawals and other funding needs, to maintain reserve requirements and to otherwise operate on an ongoing basis. To mitigate liquidity risk, our strategy is to fund asset growth primarily with low-cost customer deposits. We also operate under a liquidity policy and contingent liquidity plan that requires us to monitor indicators of potential liquidity risk, utilize cash flow projection models to forecast liquidity needs, identify alternative back-up sources of liquidity and maintain a cushion of cash and liquid securities at 15% of total assets.
Our liquidity needs are met primarily by our cash position, growth in core deposits and cash flow from our amortizing investment and loan portfolios (including scheduled payments, prepayments, and maturities from portfolios of loans and investment securities). Our ability to borrow funds from non-deposit sources provides additional flexibility in meeting our liquidity needs. Short-term borrowings include federal funds purchased, securities sold under repurchase agreements and brokered deposits. We also utilize longer-term borrowings when management determines that the pricing and maturity options available through these sources create cost effective options for funding asset growth and satisfying capital needs. Our long-term borrowings include structured repurchase agreements and subordinated notes underlying our trust preferred securities.
As of December 31, 2014 and 2013, cash and liquid securities totaled 17.3% and 20.0% of assets, respectively, providing us with $158.7 million and $328.7 million, respectively, of excess liquidity relative to our planning target. As of December 31, 2014 and 2013, the ratio of wholesale to total funding was 13.6% and 7.2%, respectively, which is below our planning target of 15%. In addition to maintaining a stable core deposit base, we maintain adequate liquidity primarily through the use of investment securities, short term investments such as federal funds sold and unused borrowing capacity. We hold investments in FHLB stock for the purpose of maintaining credit lines with the FHLB. The credit availability is based on a percentage of the Bank’s total assets as reported in their most recent quarterly financial information submitted to the FHLB and subject to the pledging of sufficient collateral.
At December 31, 2014 and 2013, there were $296.1 million and $96.3 million, respectively, in FHLB advances outstanding. In addition, we had $25.7 million and $25.6 million in letters of credit outstanding as of December 31, 2014 and 2013, respectively. Collateral available under our agreements with the FHLB provided for incremental borrowing availability of up to approximately $247.7 million and $95.4 million, respectively.
We believe that we have adequate funding sources through unused borrowing capacity from the FHLB, unpledged investment securities, cash on hand and on deposit in other financial institutions, loan principal repayment and potential asset maturities and sales to meet our foreseeable liquidity requirements and contractual obligations.
The following table reflects the average daily outstanding, year-end outstanding, maximum month-end outstanding and the weighted average rates paid for each of the categories of short-term borrowings and FHLB advances:
As of December 31, 2014 and 2013, our holding company had cash of approximately $54.8 million and $109.9 million, respectively. This cash is available for providing capital support to our subsidiary bank and for other general corporate purposes, including potential future acquisitions. The decline in cash at our holding company was primarily due to the repurchase of $103.2 million of common stock during 2014. Partially offsetting this decline was $56 million of dividends to the Company by its subsidiary Capital Bank N.A., which was approved by the OCC on July 8, 2014.
On January 30, 2015, upon Board and regulatory approval, our subsidiary Capital Bank N.A. paid a $199.4 million dividend, which we may use for general corporate purposes including acquisitions, or as a return of capital to shareholders through future share repurchases or dividends.
We calculate tangible book value, and tangible book value per share, which are non-GAAP measures because we believe they are useful for both investors and management as these are measures commonly used by financial institutions, regulators and investors to measure the capital adequacy of financial institutions. Tangible book value is equal to book value, or stockholders' equity, less goodwill and core deposit intangibles, net of related deferred tax liabilities. We believe these measures facilitate comparison of the quality and composition of the Company’s capital over time and in comparison to its competitors. Non-GAAP measures have inherent limitations and are not required to be uniformly applied. They should not be considered in isolation or as a substitute for analyzes of results reported under GAAP. These non-GAAP measures may not be comparable to similarly titled measures reported by other companies and should not be viewed as a substitute for total shareholders’ equity. The following table sets forth a reconciliation of tangible book value and tangible book value per share to total shareholders’ equity, which is the most directly comparable GAAP measure:
Off-Balance Sheet Arrangements and Contractual Obligations
Our off-balance sheet arrangements and contractual obligations as of December 31, 2014 are summarized in the table below:
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. The total amount committed under these financial instruments was $1.2 billion and $907.4 million as of December 31, 2014 and 2013, respectively. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. We believe the likelihood of these commitments either needing to be totally funded or funded at the same time is low. However, should significant funding requirements occur, we have liquid assets including cash and investment securities along with available borrowing capacity from various sources as discussed below.
Our exposure to credit loss in the event of nonperformance by the other party to financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. We use the same credit policies in making commitments to extend credit and generally use the same credit policies for letters of credit as for on-balance sheet instruments.
Commitments to extend credit are legally binding agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since some of these commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Unused commercial lines of credit, which comprise a substantial portion of these commitments, generally expire within a year from their date of origination. The amount of collateral obtained, if any, by us upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies but may include security interests in business assets, mortgages on commercial and residential real estate, deposit accounts with Capital Bank, NA or other financial institutions, and securities.
Standby and performance letters of credit are conditional commitments issued by us to assure the performance or financial obligations of a customer to a third party. The credit risk involved in issuing such letters of credit is essentially the same as that involved in extending loans to customers. We generally hold collateral and/or obtain personal guarantees supporting these commitments.
We are obligated under operating leases for office and banking premises which expire in periods varying from six months to eighteen years. Future minimum lease payments, before considering renewal options that we have in many cases, totaled $52.9 million and $76.5 million at December 31, 2014 and 2013, respectively.
Purchase obligations consist of computer and item processing services, and debit and ATM card processing and support services contracted by us under long-term contractual relationships and based upon estimated utilization.
Long-term debt includes subordinated debentures with par amounts of $154.4 million and carrying values totaling $83.6 million and $81.6 million at December 31, 2014 and 2013, respectively. Structured repurchase agreements with notional amounts of $50.0 million and carrying values of $52.5 million and $53.4 million are included at December 31, 2014 and 2013, respectively.
The Bank has invested in FHLB stock for the purpose of maintaining credit lines with the FHLB. The credit availability to the Bank is based on the amount of collateral pledged. FHLB advances totaled $296.1 million at December 31, 2014.
ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk Management
The Company pursues a conservative strategy with respect to interest rate risk management, with the goal of minimizing the risk that interest rate volatility will negatively impact our financial results. Due to the current low level of interest rates, we regard rising interest rates as the most likely source of risk and accordingly have sought to maintain an asset-sensitive position.
There are several components to our conservative interest rate strategy. First, we avoid holding loans with long duration. At December 31, 2014, approximately 53% of the loan portfolio was variable rate and of the remaining fixed rate loans, the vast majority had terms of five years or less. Second, the purpose of our securities portfolio is to provide liquidity and to manage interest rate sensitivity, and as such we limit its duration. At December 31, 2014, securities accounted for 15% of assets, and the effective duration of the portfolio was 3.7 years with limited extension risk to 4.0 years in a plus 300 immediate parallel shift in interest rates. We utilize average life estimates based on prepayment rates obtained from an independent source. Third, we seek to fund the Bank, to the extent possible, with long-duration core deposits, and within core deposits, we emphasize checking account balances as the most stable and least risky source of funds. At December 31, 2014, core deposits accounted for 73% of total deposits, and checking balances accounted for 64% of core deposits.
We continuously monitor the Bank’s interest rate risk profile through our Asset Liability Committee, which consists of our Chief Executive Officer, Chief Financial Officer, Chief Credit Officer, Chief of Strategic Planning, Treasurer, business unit heads and certain other officers. To manage interest rate risk, our Board of Directors has established quantitative and qualitative guidelines with respect to our net interest income exposure and how predefined interest rate shocks affect our financial performance, measured in terms of forecast net interest income and economic value of equity, which is the intrinsic value of assets, less the intrinsic value of liabilities. Under our policy, these predefined rate shocks include minus 300, minus 200, minus 100, plus 100, plus 200 and plus 300 basis point immediate parallel shifts in interest rates.
If a predefined immediate parallel rate shock cannot be modeled due to the low level of interest rates, a proportional rate shock and policy limit applies and all other declining rate shocks will be suspended until such scenarios can be modeled. Because of the current low level of interest rates, the minus 100, minus 200 and minus 300 rate shocks have been suspended. The maximum negative impact on forecast net interest income and economic value of equity in a minus 25 basis point immediate parallel shift in interest rates is measured on a proportional basis. In addition to monitoring our compliance with these policies, management undertakes additional analysis, considering a wide range of possible interest rate fluctuations, including changes in the shape of the yield curve, and assessing the sensitivity of these results to key assumptions, including the behavior of depositors and loan customers.
Based upon the current interest rate environment, as of December 31, 2014, our sensitivity to interest rate risk was as follows:
We used many assumptions to calculate the impact of changes in interest rates on our portfolio, and actual results may not be similar to projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. Actual results may also differ due to our actions, if any, in response to the changing rates. In calculating these exposures, we use an interest rate simulation model which is validated by third-party reviewers on an annual basis.
In the event the model indicates an unacceptable level of risk, we may take a number of actions to reduce this risk, including changing the terms, pricing, and conditions of new loans and deposits, the sale of a portion of our available-for-sale investment portfolio or the use of risk management strategies such as interest rate swaps and caps. As of December 31, 2014, we were in compliance with all of the limits and policies established by our Board of Directors for active scenarios.
Inflation Risk Management
Inflation has an important impact on the growth of total assets in the banking industry and creates a need to increase equity capital to higher than normal levels in order to maintain an appropriate equity-to-assets ratio. We cope with the effects of inflation by managing our interest rate sensitivity position through our asset/liability management program, and by periodically adjusting our pricing of services and banking products to take into consideration current costs.
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, notes thereto and report of independent registered certified public accounting firm thereon included on the following pages are incorporated herein by reference.
Index to Consolidated Financial Statements
Report of Independent Registered Certified Public Accounting Firm
To the Board of Directors and Shareholders of Capital Bank Financial Corp.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of comprehensive income, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of Capital Bank Financial Corp. and its subsidiaries at December 31, 2014 and 2013 and, the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Miami, Florida
February 26, 2015
Capital Bank Financial Corp.
Consolidated Balance Sheets
The accompanying notes are an integral part of these financial statements.
Capital Bank Financial Corp.
Consolidated Statements of Income
The accompanying notes are an integral part of these financial statements.
Capital Bank Financial Corp.
Consolidated Statements of Comprehensive Income
The accompanying notes are an integral part of these financial statements.
Capital Bank Financial Corp.
Consolidated Statements of Changes in Shareholders’ Equity
The accompanying notes are an integral part of these financial statements.
Capital Bank Financial Corp.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these financial statements.
1. Summary of Significant Accounting Policies
Nature of Operations and Principles of Consolidation
Capital Bank Financial Corp. (“CBF” or the “Company”; formerly known as North American Financial Holdings, Inc.) is a bank holding company incorporated in late 2009 in Delaware and headquartered in Florida whose business is conducted primarily through Capital Bank, National Association (“Capital Bank, NA” or the “Bank”). The Company was incorporated with the goal of creating a regional banking franchise in the southeastern region of the United States through organic growth and acquisitions of other banks, including failed, underperforming and undercapitalized banks. CBF has raised $955.6 million to make acquisitions through a series of private placements and an initial public offering of its common stock. Since inception, CBF has acquired seven depository institutions, including the assets and certain deposits from failed banks. CBF has a total of 162 full service banking offices located in Florida, North and South Carolina, Tennessee and Virginia. Through its branches CBF offers a wide range of commercial and consumer loans and deposits, as well as ancillary financial services.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). All significant inter-company accounts and transactions have been eliminated in consolidation. The following is a summary of the more significant accounting policies.
Certain prior period amounts have been reclassified to conform to the current period presentation.
Use of Estimates and Assumptions
To prepare financial statements in conformity with U. S. GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as presented in the financial statements. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. Material estimates that are particularly susceptible to significant change include the determination of the allowance for loan and lease losses, including estimates of expected cash flows for impaired loans, determination of fair value, determination of impairment of financial instruments, goodwill and intangible assets and the determination of deferred income tax assets and liabilities. Changes in assumptions or in market conditions could significantly affect the fair value estimates.
Out of Period Adjustment
During the three months ended March 31, 2014, the Company recorded a correction of an error resulting from the state net operating loss that the Company was not entitled to subsequent to the 2011 Green Bankshares acquisition. The impact of this correction decreased deferred tax assets and increased goodwill by $2.5 million. After evaluating the quantitative and qualitative aspects of this error, the Company concluded that its prior period financial statements were not materially misstated.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and highly-liquid items with an original maturity of three months or less including amounts due from banks, federal funds sold, and interest-bearing deposits at the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank of Atlanta (“FRB”). Accordingly, the carrying amount of such instruments is considered to be a reasonable estimate of fair value.
Trading Securities
Marketable equity securities are recorded on a trade-date basis and are accounted for based on the securities’ quoted market prices from a national securities exchange. Those purchased with the intention of recognizing short-term profits are classified as and included in trading securities on our balance sheet. Both realized and unrealized gains and losses on trading securities are included in noninterest income.
Investment Securities and Other than Temporary Impairment
Investment securities which may be sold prior to maturity are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported in other comprehensive income. Other securities such as Federal Home Loan Bank stock are carried at cost and are included in other assets on the balance sheets. Investment securities where the Company has both the intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized using the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are realized on the trade date and determined using the specific identification method based on the amortized cost of the security sold.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Management regularly reviews each investment security for impairment based on criteria that include the extent to which cost exceeds fair value, the financial health of and specific prospects for the issuer(s) and our ability and intention with regard to holding the security. Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In determining OTTI under accounting guidance, management considers many factors, including but not limited to: (1) the financial condition and near-term prospects of the issuer, (2) whether the market decline was affected by macroeconomic conditions, and (3) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.
The assessment of whether an OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. When OTTI is determined to have occurred, the amount of the impairment recognized in earnings depends on whether management intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If management intends to sell or it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the impairment is required to be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If management does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the credit worthiness of the issuer is analyzed to determine if there is a credit component of the unrealized loss that would require recognition in earnings. Impairment identified through this analysis is separated into the amount representing the credit loss and the amount related to all other factors (i.e., changes in market interest rates, liquidity premiums, etc.). The amount of impairment related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the impairment related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. Future declines in the fair value of securities may result in impairment charges which may be material to the financial condition and results of operations of the Company.
Loans Held for Sale
Certain residential fixed rate mortgage loans originated by the Company are sold to third parties on a servicing released basis. Certain of these sales are subject to temporary recourse provisions. The recourse provisions may require the repurchase of the outstanding balance of loans which default within a limited period of time subsequent to the sale. The recourse periods vary by investor and extend up to seven months subsequent to the sale of the loan. All origination fees are recognized as income at the time of the sale. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Purchased Credit-Impaired Loans
When it is probable that the Company will not collect all contractual cash flows associated with acquired loans, unless specifically exempt, these acquired loans are accounted for under accounting guidance for purchased credit-impaired (“PCI”) loans. Any Allowance for Loan and Lease Losses (“the Allowance”) previously associated with these loans does not carry over to the Company and is eliminated in the purchase accounting adjustments. The fair value of the PCI loans is then assigned based on the present value of estimated future cash flows including prepayments but exclusive of any loss-sharing arrangements. The excess of the gross cash flows expected to be collected over the present value of cash flows at the acquisition date (i.e., the accretable yield) is accreted into income over the estimated remaining term of the PCI loans using the effective yield method, provided that the timing and amount of future cash flows is reasonably estimable. Accordingly, such loans are not classified as nonaccrual as the accretable yield is reported as interest income. The impact of changes in variable interest rates is recognized prospectively as adjustments to the accretable yield.
For further discussion of the Company’s acquisitions and loan accounting, see Note 3. Business Combinations and Acquisitions and Note 5. Loans, respectively.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
New Loans and Acquired Non-PCI Loans
New loans that management has the intent and ability to hold are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan and lease losses. Acquired non-PCI loans are initially reported at their acquisition date fair value. Subsequently, acquired non-PCI loans are reported net of amortization or accretion of any applicable acquisition discount or premium and an allowance for loan and lease losses. Interest income on New and non-PCI acquired loans is reported on the interest method and includes amortization of net deferred loan fees, costs and any applicable acquisition discount or premium over the loan term. Amortization of deferred loan fees and costs is based on the contractual lives of the loans and does not include anticipation of prepayments. If the collectability of interest appears doubtful, the loan is classified as nonaccrual.
Nonaccrual Loans
The majority of loans are placed on nonaccrual status when it is probable that principal or interest is not fully collectible, or generally when principal or interest becomes 90 days past due, whichever occurs first. Certain loans past due 90 days or more may remain on accrual status if management determines that it does not have concern over the collectability of principal and interest and such loans are in the process of collection.
Generally, when loans are placed on nonaccrual status, accrued and unpaid interest receivable is reversed against interest income in the current period. Interest payments received thereafter are generally applied as a reduction to the remaining principal balance as long as concern exists as to the ultimate collection of the principal. Loans are generally removed from nonaccrual status when they become current as to both principal and interest and concern no longer exists as to the collectability of principal and interest. The Company’s policies related to when loans are placed on nonaccrual status conform to guidelines prescribed by bank regulatory authorities.
Direct Financing Leases
Direct financing leases are carried at the aggregate of lease payments receivable and estimated residual value of the leased property, if applicable, less unearned income. Interest income on direct financing leases is recognized over the term of the leases to achieve a constant periodic rate of return on the outstanding investment. Initial direct costs are deferred and amortized over the lease term as a reduction to interest income using the effective interest method.
Allowance for Loan and Lease Losses
The Company maintains an allowance for loan and lease losses to absorb losses incurred in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the probable estimated incurred losses inherent in the portfolio of loans held for investment. The allowance is increased by the provision for loan and lease losses, which is charged against current period operating results and decreased by the amount of charge offs, net of recoveries. The Company’s methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formulaic allowance and the specific allowance for impaired loans.
Management develops and documents its systematic methodology for determining the allowance for loan and lease losses by first dividing its portfolio into segments-commercial real estate, commercial, consumer and other. The Company further divides the portfolio segments into classes and subclasses based on initial measurement attributes, risk characteristics or its method of monitoring and assessing credit risk (such as owner occupied commercial real estate, for which the Company believes risk characteristics and cash flows are aligned with the Commercial class).
The classes and subclasses for the Company are as follows:
Commercial real estate
•
Non-owner occupied commercial real estate
•
Other commercial construction and land
•
Multifamily commercial real estate
•
1-4 family residential construction and land
Commercial
•
Owner occupied commercial real estate
•
Commercial and industrial
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
•
Lease Financing
Consumer
•
1-4 family residential
•
HELOC
•
Junior lien
•
Other consumer loans
•
Indirect auto
Other
•
Farmland
•
Agriculture
•
All other loans
For non-PCI loans, the allowance for loan and lease losses is calculated by applying loss factors to outstanding loans. It is the Company’s policy to use loss factors based on historical loss experience which may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. The Company has limited historical loss experience on newly originated loans and the historical loss information available relating to the portfolios of acquired loans is considered by management to be irrelevant to newly originated loans due to differences in underwriting criteria and loan type. Accordingly, the Company currently is utilizing loss rates from a peer group of comparable banks based on size, portfolio type and geography as the basis for determining loss factors to apply to any outstanding loans. The Company derives the loss factors for all segments from pooled loan loss factors. Such pooled loan loss factors (for loans not individually graded) are based on expected net charge off ranges. Loan loss factors, which are used in determining the allowance, are adjusted quarterly primarily based upon the changes in the level of historical net charge offs and parameter updates by management. Management estimates probable incurred losses in the portfolio based on a historical loss look-back period. The look-back period is representative of management’s consideration of relevant historical loss experience.
Furthermore, based on management’s judgment, the Company’s methodology permits adjustments to any loss factor used in the computation of the allowance for significant factors, which affect the collectability of the portfolio as of the evaluation date, but are not reflected in the loss factors. By assessing the probable estimated incurred losses in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates based upon the most recent information that has become available. This includes changing the number of periods that are included in the calculation of the loss factors and adjusting qualitative factors to be representative of the current economic cycle and other factors impacting the portfolio.
Generally, for Commercial loans, the Company evaluates individual nonaccrual loans with recorded investment balances greater than or equal to $0.5 million and substandard but accruing loans with recorded investment balances greater than or equal to $1.0 million for impairment. Residential mortgage and consumer loans are generally not individually evaluated for impairment unless they become non-accrual and exceed $0.5 million in recorded investment or represent troubled debt restructuring. Loans are considered impaired when the individual evaluation of current information regarding the borrower’s financial condition, loan collateral, and cash flows indicates that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including interest payments. Impaired loans are carried at the lower of the recorded investment in the loan, the present value of expected future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of the collateral, if the loan is collateral dependent. Excluded from the impairment analysis are large groups of smaller balance homogeneous loans such as consumer, home equity line, indirect auto and residential mortgage loans, which are evaluated on a pool basis.
Loans are charged off in whole or in part when they are considered to be uncollectible. For commercial and agricultural, construction and vacant land and commercial mortgage loans, such evaluations are generally considered for collectability based on borrower financial condition as well as the value of any collateral. For residential mortgage and consumer loans, this evaluation is generally based on past due status as discussed above, as well as an evaluation of borrower creditworthiness and the value of any collateral. Recoveries of amounts previously charged off are recorded as an increase in the allowance for loan and lease losses.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Significant risk characteristics considered in estimating the allowance for credit losses include the following:
•
Commercial and agricultural-industry specific economic trends and individual borrower financial condition;
•
Construction and vacant land, farmland and commercial mortgage loans-type of property (i.e., residential, commercial, industrial) and geographic concentrations and risks and individual borrower financial condition; and
•
Residential mortgage, indirect auto and consumer-historical charge-offs and current trends in borrower’s credit, property collateral, and loan characteristics.
The allowance for loan and lease losses associated with PCI loans is comprised of an allowance necessary for certain pools of loans. An allowance related to a PCI loan pool is established when the present value of expected cash flows from the loan pool is less than its recorded investment. The amount of the allowance is equal to the difference between these amounts. In calculating the present value of expected cash flows for this purpose, changes in cash flow estimates pursuant to credit factors are isolated from those related to changes in interest rate indices. Any subsequent improvement in the expected cash flows related to the loan pool results in a reduction of any previously established allowance. Any changes in the allowance, including the initial establishment, are recorded in earnings for the current period as a component of the provision for loan losses.
Estimates of expected cash flows incorporate assumptions of expected prepayments, probability of default and loss severity given default. Probability of default assumptions are derived from incurred and expected loss data published in third party research reports for commercial, commercial real estate and residential loans. Probability of default assumptions for residential loans are adjusted to incorporate increased risk for historical delinquency occurrence and high loan to collateral value (“LTV”) ratios, and updated borrower credit information. For commercial and commercial real estate loans, probability of default assumptions are based upon loan risk ratings of the Company. Loss severity given default assumptions are developed based upon third party research reports or estimates of current LTV ratios which use real estate price index values for the applicable state or Metropolitan Statistical Area (“MSA”) where available.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure or repossession are generally held for sale and are initially recorded at fair value less cost to sell when acquired, establishing a new cost basis. If fair value subsequently declines below the initial recorded value, a valuation allowance is recorded through expense so that the asset is reported at the lower of cost or fair value less cost to sell. If fair value subsequently increases, a reduction of any previous valuation allowance is recorded, which is limited to the total amount of the valuation allowance. Costs incurred after acquisition are generally expensed.
FDIC Indemnification Asset
Pursuant to purchase and assumption agreements with the FDIC, the Bank has entered into loss share agreements in which the FDIC will reimburse the Company for certain amounts related to certain acquired loans and other real estate owned should the Company experience a loss during the term of the agreement. An indemnification asset is recorded at fair value at the acquisition date. The indemnification asset is recognized at the same time as the indemnified loans, and measured on the same basis, subject to collectability or contractual limitations. The indemnification asset on the acquisition date reflects the present value of future cash flows expected to be received from the FDIC using an appropriate discount rate which reflects counterparty credit risk.
Subsequent to initial recognition, the indemnification asset continues to be measured on the same basis as the related indemnified loans and OREO and is impacted by changes in estimated cash flows associated with these loans and foreclosed properties. Deterioration in expected cash flows of the loans are immediately recorded as an adjustment to the allowance for loan and lease losses and would correspondingly result in an increase in the indemnification asset, with the offset recorded through the consolidated statement of income. Improvements in the cash flows of the loans would first result in a reversal of any existing cumulative impairment and related valuation allowance and a corresponding decrease in the indemnification asset. Subsequent to the full reversal of any such valuation allowance, additional improvement in loan cash flows is reflected as an adjustment to yield that is accreted into income over the remaining term of the loans along with increased amortization of the indemnification asset. Such amortization is recognized over the shorter of a) the remaining term of the loans or b) the life of the shared loss agreements. Loss assumptions used for the basis of the indemnified loans are consistent with the loss assumptions used to measure the indemnification asset. Fair value accounting incorporates into the fair value of the indemnification asset an element of the time value of money, which is accreted back into income over the life of the loss sharing agreements.
Upon the determination of an incurred loss, the indemnification asset will be reduced by the amount owed by the FDIC. A corresponding claim receivable is recorded until cash is received from the FDIC.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Premises and Equipment
Land is carried on the balance sheet at its cost. Premises and equipment are reported at cost less accumulated depreciation. For financial reporting purposes, premises and equipment are depreciated using the straight-line method over their estimated useful lives. Expenditures for maintenance and repairs are charged to operations as incurred, while major renewals and betterments are capitalized. For Federal income tax reporting purposes, depreciation is computed using primarily accelerated methods.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets (including core deposit base premiums, customer relationship intangibles, and mortgage servicing rights) arising from business purchase combinations are initially recorded at fair value. Goodwill and other intangible assets with indefinite useful lives are not amortized and are tested for impairment at least annually as of the first day of our third quarter, or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Other intangible assets with finite useful lives are amortized over their estimated useful lives to their estimated residual values and tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Other intangible assets are considered to be impaired if the undiscounted cash flows from its associated asset group are less than their recorded net book value; if impairment is determined to exist, the asset must be written down to its fair value based upon discounted cash flows in the period in which impairment is determined to exist. Factors considered in the impairment evaluation include but are not limited to fair market value, general market conditions and projections of future operating results.
In addition, after evaluating the Company’s structure and components, it has been determined that the Company consists of one reporting unit.
Company Owned Life Insurance
The Company owns life insurance policies on certain current and former directors and employees of its subsidiaries. These policies are recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement, if applicable.
Derivative Instruments
The Company has stand-alone derivative financial instruments which it acquired in its’ purchase of Southern Community, primarily in the form of interest rate swaps, foreign exchange contracts, option agreements, and interest rate caps. Additionally, forward loan sales contracts are derived from mortgage loans commitments. These transactions involve both credit and market risk.
The Company does not enter into derivative financial instruments for speculative purposes. None of the derivatives held are designated as hedging instruments or otherwise qualify for hedge accounting treatment and all changes in fair value are recognized in non-interest income or non-interest expense during the period of change. Derivatives are recorded at fair value in other assets and other liabilities on the Company’s balance sheet.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and agreements that specify collateral levels to be maintained by the Company and the counterparties. These collateral levels are based on the credit rating of the counterparties.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates include uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Operating Leases
Rent expense for the Company’s operating leases is recorded on a straight-line basis over the initial lease term and those renewal periods that are reasonably assured. It is common for lease agreements to contain various provisions for items such as step rent or other escalation clauses and lease concessions, which may offer a period of no rent payment.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
These types of transactions are recorded into expense on a straight line basis over the minimum lease terms. Certain leases require the Company to pay property taxes, insurance and routine maintenance.
Income Taxes
The provision for income taxes is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities between periods. Deferred tax assets and liabilities are measured using the balance sheet method. Under this method, deferred tax asset and liabilities are determined based on differences between the carrying amount of balance sheet items and their corresponding tax values. Changes in the deferred tax assets and liabilities represent decreases and increases in the future tax liability due to reversals of temporary differences and utilization of net operating loss carryforwards and tax credit carryforwards. Current recognition is given to changes in tax rates and laws.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of benefit that is greater than 50% likely to be realized upon settlement. For tax positions not meeting the “more likely than not” test, no benefit is recorded. If applicable, accrual of penalties and interest related to an unrecognized tax benefit are recorded in income tax expense.
A valuation allowance related to the deferred tax asset is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. As of December 31, 2014 and 2013, management considered the need for a valuation allowance and based upon its assessment of the evidence available at the time of the analysis, concluded that a valuation allowance was not necessary. In addition, management’s assessment for a valuation allowance includes interpretations of tax laws, lapse of statute of limitations and changes in statutory and regulatory guidance. The Company is no longer subject to federal, state and local examinations by tax authorities for years before 2011.
Loan Commitments and Related Financial Instruments
Loan Commitments and Related Financial instruments include off-balance sheet credit instruments such as commitments to make loans and letters of credit issued to meet customer financing needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded on the balance sheet when they are funded.
Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase
Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized lending and borrowing transactions, respectively, and are recorded at the amounts at which the securities were acquired or sold plus accrued interest. The fair value of collateral either received from or provided to a third party to secure these transactions is regularly monitored and additional collateral is obtained, provided or requested to be returned as appropriate.
Loss Contingencies, Contingent Value Rights and Loss Share Clawback Liabilities
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Current contingent value rights and FDIC loss clawback liabilities are recorded within accrued expenses and other liabilities and periodically remeasured, with any changes in measurement accounted for as non-interest expense. The balances at December 31, 2014 and 2013 for the contingent value rights was $17.4 million and $15.7 million, respectively. The balance at December 31, 2014 and 2013 for the clawback liability was $1.3 million and $1.0 million, respectively.
Related Party Transaction
Certain of the directors and executive officers of Capital Bank, NA, members of their immediate families and entities with which they are associated are customers of and borrowers from the Bank. As of December 31, 2014 and 2013, total loans outstanding to directors and executive officers of the Bank, and their associates as a group, equaled approximately $13.9 million and $10.9 million, respectively. All outstanding loans and commitments included in such transactions were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time in comparable transactions with persons not related to the Bank, and did not involve more than the normal risk of collectability or present other unfavorable features.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Operating Segments
While the chief operating decision-makers monitor the revenue streams of the various products and services, the financial services operations are considered by management to be one reportable segment. Operations are managed and financial performance is evaluated on a Company-wide basis.
Recent Accounting Pronouncements
In November 2014, the Financial Accounting Standard Board (the “FASB”) issued Accounting Standards Update ("ASU") 2014-17, “Business Combinations-Pushdown Accounting” (Topic 805)”. The objective of ASU 2014-17 is to provide guidance on whether and at what threshold an acquired entity that is a business or nonprofit activity can apply pushdown accounting in its separate financial statements. The amendments in ASU 2014-17 are effective on November 18, 2014. The adoption of ASU 2014-17 did to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In November 2014, the FASB issued ASU 2014-16, “Derivative and Hedging” (Topic 815)”. The amendments in ASU 2014-16 do not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required, but clarifies how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments explain that an entity should consider all relevant terms and features in evaluating the nature of the host contract. Furthermore, the amendments specify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. In addition, the amendments clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features. The amendments in ASU 2014-16 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The adoption of ASU 2014-16 is not expected to have a material impact on the Company's consolidated financial position, results of operations and cash flows.
In August 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements-Going Concern (Subtopic 205-40)-Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern". The amendments in ASU 2014-15 provide guidance in U.S. GAAP about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The amendments in ASU 2014-15 apply to all entities and will be effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The adoption of ASU 2014-15 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In August 2014, the FASB issued ASU 2014-14, "Receivables-Troubled Debt Restructuring by Creditors (Subtopic 310-40)-Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure". The amendment in ASU 2014-14 requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if certain conditions are met. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in ASU 2014-14 affect creditors that hold government-guaranteed mortgage loans, including those guaranteed by the Federal Housing Administration ("FHA") of the U.S. Department of Housing and Urban Development ("HUD"), and the U.S. Department of Veterans Affairs ("VA"). This ASU 2014-14 will be effective for the annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of ASU 2014-14 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In June 2014, the FASB issued ASU No. 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 provides specific guidance on whether to treat a performance target that could be achieved after the requisite service period as a performance condition that affects vesting or as a nonvesting condition that affects the grant-date fair value of an award. ASU 2014-12 is effective for fiscal years and interim periods beginning after December 15, 2015. The adoption of ASU 2014-12 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (topic 860)-Repurchase-to-Maturity Transactions, Repurchase Financing, and Disclosures”. ASU 2014-11 changes the accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements. The amendments also require two new disclosures. The first disclosure requires an entity to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements. The second disclosure provides increased transparency about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The accounting changes in ASU 2014-11 are effective for the first interim or annual period beginning after December 15, 2014. The disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after December 15, 2015. The adoption of ASU 2014-11 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In May 2014, the FASB issued ASU No. 2014-9, “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-9 clarifies the principles for recognizing revenue from contracts with customers. ASU 2014-9, which does not apply to financial instruments, is effective for interim and annual reporting periods beginning after December 15, 2016. The Company is currently evaluating ASU 2014-9 to determine the impact on its consolidated financial position, results of operations and cash flows.
In January 2014, the FASB issued ASU 2014-4, “Receivables-Troubled Debt Restructuring by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” ASU 2014-4 clarifies that when 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. ASU 2014-4 is effective for fiscal years and interim periods beginning after December 15, 2014. The adoption of ASU 2014-4 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In January 2014, the FASB issued ASU 2014-1, “Investments-Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” ASU 2014-1 allows for use of the proportional amortization method for qualified affordable housing projects if certain conditions are met. Under the proportional amortization method, the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received and the net investment performance is recognized in the income statement as a component of income tax expense. ASU 2014-1 provides for a practical expedient, which allows for amortization of only expected tax credits over the period tax credits are expected to be received. This method is permitted if it produces a measurement that is substantially similar to the measurement that would result from using both tax credits and other tax benefits. ASU 2014-1 is effective for fiscal years and interim periods beginning after December 15, 2014. The adoption of ASU 2014-1 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
2. Earnings Per Common Share
Basic earnings per share is computed as net income attributable to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock options and unvested restricted shares computed using the treasury stock method. Earnings per share have been computed based on the following:
The dilutive effect of stock options and unvested restricted shares are the only common stock equivalents for purposes of calculating diluted earnings per common share.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Weighted average anti-dilutive stock options and unvested restricted shares excluded from the computation of diluted earnings per share are as follows:
3. Business Combinations and Acquisitions
On October 1, 2012, the acquisition of all of the preferred and common share interests of Southern Community was consummated for a total purchase price of $99.3 million in cash. In addition, SCMF shareholders received a contingent value right (“CVR”) which could pay up to $1.30 per share (maximum potential payment of $21.9 million) in cash at the end of a five-year period based on 75% of the savings to the extent that legacy loan and foreclosed asset losses are less than a prescribed amount. As part of the acquisition, the Company purchased from the United States Department of the Treasury (the “Treasury”) all of the outstanding shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A and related warrants originally issued by SCMF to the Treasury in connection with SCMF’s participation in the Treasury’s Troubled Asset Relief Program (“TARP”). The cash purchase price was approximately $46.9 million which is equal to the outstanding liquidation amount of the preferred stock and is included in the $99.3 million above. Subsequently, SCMF cancelled the Series A Preferred stock. SCMF was the parent of Southern Community Bank and Trust, a bank with 22 branches in Winston-Salem, the Piedmont Triad, and other North Carolina markets.
The estimated fair values of assets acquired and liabilities assumed in the acquisition of SCMF were based on the information that was available at the time. During the third quarter of 2013, CBF concluded that the underlying asset quality in the SCMF loan portfolio should lead to better credit performance than originally anticipated in our preliminary estimates of fair value. Completion of portfolio due diligence of credit attributes of the acquired loans not initially known but existing at the acquisition date, including assessment of the predecessor institution’s underwriting approach and practices, quality of risk ratings, and borrower credit scores, ultimately resulted in the necessity to revise the original estimate of fair value during the third quarter. As required by the acquisition method of accounting, the Company retrospectively adjusted the acquisition date balance sheet and the results of operations of the fourth quarter of 2012 and first two quarters of 2013 to reflect the following: (1) an increase in the estimated fair value of the loan portfolio; (2) an increase in the associated CVR liability; (3) a decrease in the deferred tax asset related to the increased value of loans; (4) a decrease in goodwill caused by the net effect of these adjustments.
4. Investment Securities
Trading securities totaled $2.4 million and $6.3 million at December 31, 2014 and December 31, 2013, respectively.
The amortized cost and estimated fair value of investment securities available-for-sale and held-to-maturity at December 31, 2014 and December 31, 2013, are presented below:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Proceeds from sales of securities were $216.9 million, $2.1 million and $496.3 million for the years ended December 31, 2014, 2013 and 2012, respectively. Gross gains of $1.1 million, $0.2 million and $8.4 million were realized on sales of these investments during the years ended December 31, 2014, 2013 and 2012, respectively.
During the third quarter of 2013, the Company transferred $511.0 million of available-for-sale securities to held-to-maturity securities, reflecting the Company’s intent and ability to hold those securities to maturity. Transfers of investment securities into the held-to-maturity category from the available-for-sale category are accounted for at fair value at the date of transfer. The related $9.7 million of unrealized holding loss, net of tax, that was included in the transfer is retained in other comprehensive income (loss) and is being amortized as an adjustment to interest income over the remaining life of the securities. There were no gains or losses recognized as a result of this transfer.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The estimated fair value of investment securities at December 31, 2014, by contractual maturity, is shown in the table that follows. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations without call or prepayment penalties. Debt securities not due at a single maturity date are shown separately.
Securities with unrealized losses not recognized in income, and the period of time they have been in an unrealized loss position, are as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The table below presents a rollforward of the other than temporary impairment credit losses recognized in earnings for the years ended December 31, 2014, 2013 and 2012:
The Company owned shares of an investment fund with the principal investment strategy to invest in debt securities and other debt instruments that will cause shares of the fund to be deemed qualified under the Community Reinvestment Act (the “CRA”), so that financial institutions that are subject to the CRA, may receive investment test or similar credit under the CRA with respect to shares of the Fund held by them. The Company evaluated the intent and ability to hold for any anticipated recovery in fair value and the length of time and extent to which the fair value has been less than cost. Based on the extended period the CRA security’s fair value had been less than cost, and market information indicated the prospects for recovery in the near-term were unlikely, the Company determined there to be OTTI during the third quarter of 2013. The Company recognized $54 thousand of impairment loss in earnings, equal to the entire difference between the CRA security’s cost basis and its fair value. The Company sold its shares of the investment on December 18, 2014. Proceeds from the sale were $1.0 million and gross gains were $12 thousand.
At December 31, 2013, the Company owned a collateralized debt obligation ("CDO") collateralized by trust preferred securities issued primarily by banks and several insurance companies. The Company sold its investment in the CDO on January 7, 2014, and based on the sales price, the estimated fair value of the CDO increased by $0.5 million during the year ended December 31, 2013. Since previous credit impairment was recognized, no recovery is allowed under U.S. GAAP. The CDO was recorded at fair value and the remaining unrealized gain was recognized as a component of accumulated other comprehensive income. Proceeds from the sale were $0.8 million and gross gains were $0.3 million, respectively.
As of December 31, 2014, the Company’s security portfolio consisted of 129 securities, 26 of which were in an unrealized loss position. The majority of unrealized losses are related to the Company’s mortgage-backed securities.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
All of the mortgage-backed securities at December 31, 2014, and December 31, 2013 were issued by U.S. government-sponsored entities and agencies, which the government has affirmed its commitment to support. Unrealized losses associated with these securities are attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is more likely than not that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2014 or 2013.
Investment securities having carrying values of approximately $339.0 million and $313.4 million at December 31, 2014 and December 31, 2013, respectively, were pledged to secure public funds on deposit, securities sold under agreements to repurchase, and for other purposes as required by law.
5. Loans
Major classifications of loans, including loans held for sale, are as follows:
Total loans include $5.5 million and $8.0 million of 1-4 family residential loans held for sale and $10.1 million and $3.8 million of net deferred loan origination costs and fees as of December 31, 2014 and December 31, 2013, respectively.
As of December 31, 2014, other loans include $41.3 million, $76.9 million and $1.7 million of farm land, state and political subdivision obligations and deposit customer overdrafts, respectively. As of December 31, 2013, other loans include $49.7 million, $36.2 million and $2.2 million of farm land, state and political subdivision obligations and deposit customer overdrafts, respectively.
Covered loans represent loans acquired from the FDIC subject to loss sharing agreements. Covered loans are further broken out into (i) loans acquired with evidence of credit impairment (“Purchased Credit Impaired or PCI Loans”) and (ii) non-PCI loans. Loans originated or purchased by the Company (“New Loans”) and loans acquired through the purchase of CBKN, GRNB, SCMF and TIBB, are not subject to the loss sharing agreements and are classified as “non covered.” Additionally, certain consumer loans acquired through the acquisition of First National Bank of the South, Metro Bank and Turnberry Bank (collectively, the “Failed Banks”) from the FDIC, are specifically excluded from the loss sharing agreements.
The Company designates loans as PCI by evaluating both qualitative and quantitative factors. At the time of acquisition, the Company accounted for the PCI loans by segregating each portfolio into loan pools with similar risk characteristics. Over the lives of the acquired PCI loans, the Company continues to estimate cash flows expected to be collected on each loan pool. The Company evaluates, at each balance sheet date, whether its estimates of the present value of the cash flows from the loan pools, determined using the effective interest rates, has decreased, such that the present value of such cash flows is less than the recorded investment of the pool, and if so, recognizes a provision for loan loss in its consolidated statement of income, unless interest rate driven.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Additionally, if we have favorable changes in our estimates of cash flows expected to be collected for a loan pool such that the then-present value exceeds the recorded investment of that pool, we will first reverse any previously established allowance for loan and lease losses for the pool. If such estimate exceeds the amount of any previously established allowance, we will accrete future interest income over the remaining life of the pool at a rate which, when used to discount the expected cash flows, results in the then-present value of such cash flows equaling the recorded investment of the pool at the time of the revised estimate.
The table below presents a roll forward of accretable yield and income expected to be earned related to PCI loans and the amount of non-accretable difference at the end of the period. Nonaccretable difference represents estimated contractually required payments in excess of estimated cash flows expected to be collected. The accretable yield represents the excess of estimated cash flows expected to be collected over the carrying amount of the PCI loans. Other represents reductions of accretable yield due to non-credit events such as interest rate reductions on variable rate PCI loans and prepayment activity on PCI loans.
The following table represents the periods we estimate the remaining accretable yield will accrete into income based on the Company’s most recent estimates of cash flows for PCI loans:
The accretable yield is accreted into interest income over the estimated life of the PCI loans using the level yield method. The accretable yield will change due to changes in:
•
The estimate of the remaining life of PCI loans which may change the amount of future interest income, and possibly principal, expected to be collected;
•
The estimate of the amount of contractually required principal and interest payments over the estimated life that will not be collected (the nonaccretable difference); and
•
Indices for PCI loans with variable rates of interest.
For PCI loans, the impact of loan modifications is included in the evaluation of expected cash flows for subsequent decreases or increases of cash flows. For variable rate PCI loans, expected future cash flows will be recalculated as the rates
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
adjust over the lives of the loans. At acquisition, the expected future cash flows were based on the variable rates that were in effect at that time.
Because of the loss protection provided by the FDIC, the risks of covered loans and foreclosed real estate are significantly different from those assets not covered under the loss share agreement. Refer to Note 10 - Other Real Estate Owned for the covered balances of other real estate owned.
Non-covered Loans
The following is a summary of the major categories of non-covered loans outstanding as of December 31, 2014 and December 31, 2013:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Covered Loans
The following is a summary of the major categories of covered loans outstanding as of December 31, 2014, and December 31, 2013:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following tables present the aging of the recorded investment in past due loans, based on contractual terms, as of December 31, 2014:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following tables present the aging of the recorded investment in past due loans, based on contractual terms, as of December 31, 2013:
Pooled PCI loans are not classified as nonaccrual as they are considered to be accruing because their interest income relates to the accretable yield recognized under accounting for purchased credit-impaired loans and not to contractual interest payments.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed at origination and upon identification of a material change for all loans, on an annual basis for commercial loans exceeding $0.5 million, and at least quarterly for commercial loans not rated Pass. The Company uses the following definitions for risk ratings:
•
Pass -These loans range from superior quality with minimal credit risk to loans requiring heightened management attention but that are still an acceptable risk and continue to perform as contracted.
•
Special Mention -Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
•
Substandard -Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
•
Doubtful -Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
The following table summarizes loans, excluding PCI loans by internal rating at December 31, 2014:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following table summarizes loans, excluding PCI loans by internal rating at December 31, 2013:
6. Allowance for Loan and Lease Losses
Activity in the allowance for loan and lease losses for the years ended December 31, 2014, 2013 and 2012 is as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following tables present the roll forward of the allowance for loan and lease losses for the year ended December 31, 2014 by the class of loans against which the allowance is allocated:
The following tables present the roll forward of the allowance for loan and lease losses for the year ended December 31, 2013 by the class of loans against which the allowance is allocated:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following tables present the roll forward of the allowance for loan and lease losses for the year ended December 31, 2012 by the class of loans against which the allowance is allocated:
The following tables present the roll forward of the allowance for loan and lease losses for PCI and non-PCI loans for the years ended December 31, 2014, 2013 and 2012, by the class of loans against which the allowance is allocated:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following table presents the balance in the allowance for loan and lease losses and the recorded investment in loans by class of loan and by impairment evaluation method as of December 31, 2014:
(1)
Loans collectively evaluated for impairment include $355.4 million of acquired loans which are presented net of unamortized purchase discounts of $11.7 million.
The following table presents the balance in the allowance for loan and lease losses and the recorded investment in loans by class of loan and by impairment evaluation method as of December 31, 2013:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
(1)
Loans collectively evaluated for impairment include $435.0 million of acquired loans which are presented net of unamortized purchase discounts of $14.7 million.
Troubled Debt Restructuring
If a borrower is experiencing financial difficulty, the Bank may consider, in certain circumstances, modifying the terms of their loan to maximize collection of amounts due. A troubled debt restructuring (“TDR”) typically involves either a reduction of the stated interest rate of the loan, an extension of the loan’s maturity date(s) with a stated rate lower than the current market rate for a new loan with similar risk, or in limited circumstances, a reduction of the principal balance of the loan or the loan’s accrued interest. Upon modification of a loan, the Bank measures the related impairment as the excess of the recorded investment in the loan over the discounted expected future cash flows. The present value of expected future cash flows is discounted at the loan’s effective interest rate. If the impairment analysis results in a loss, an allowance for loan and lease losses is established for the loan. During the year ended December 31, 2014 and 2013, loans modified in TDRs were nominal. Because of the insignificance of the amount and the nature of the modifications, the modifications did not have a material impact on the Company’s consolidated financial statements or on the determination of the allowance for loan and lease losses at December 31, 2014 and 2013. The Company had loans modified in TDRs with recorded investments of $3.8 million and $1.2 million for the years ended December 31, 2014 and 2013, respectively.
7. FDIC Indemnification Asset
The Company has recorded an indemnification asset related to loss sharing agreements entered into with the FDIC wherein the FDIC will reimburse the Company for certain amounts related to certain acquired loans and other real estate owned should the Company experience a loss. Under the loss sharing arrangements, the FDIC has agreed to absorb 80% of all future credit losses and workout expenses on these assets which occur prior to the expiration of the loss sharing agreements. These agreements resulted from the purchase of the Failed Banks.
The loss sharing agreements consist of three (one for each Failed Bank) single-family shared-loss agreements and three (one for each Failed Bank) commercial and other loans shared-loss agreements. The single family shared-loss agreements provide for FDIC loss sharing and our reimbursement for recoveries to the FDIC for ten years from July 16, 2010 for single-family residential loans. The commercial shared-loss agreements provide for FDIC loss sharing for five years from July 16, 2010 and our reimbursement for recoveries to the FDIC for eight years from July 16, 2010 for all other covered assets.
The following is a summary of the activity in the FDIC indemnification asset:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
8. Premises and Equipment
The following is a summary of the cost and accumulated depreciation of premises and equipment:
Depreciation expense for the years ended December 31, 2014, 2013 and 2012 was $13.4 million, $14.6 million and $13.1 million, respectively.
The Company is obligated under operating leases for office and banking premises which expire in periods varying from six months to eighteen years. Rent expense for the years ended December 31, 2014, 2013 and 2012 was $9.6 million, $10.3 million and $9.4 million, respectively. Future minimum lease payments, before considering renewal options that generally are present, are as follows at December 31, 2014:
9. Goodwill and Intangible Assets
Changes in goodwill during the years ended December 31, 2014, 2013 and 2012 consist of the following:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Goodwill is tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company completed its annual goodwill impairment test as of the first day of our third quarter in 2014, by performing a qualitative assessment of goodwill at the reporting unit level to determine whether any indicators of impairment existed. In performing this qualitative assessment, the Company evaluated events and circumstances since the date of the last quantitative impairment test including the results of that test, macroeconomic conditions, banking industry and market conditions, key financial metrics and overall financial performance of the Company. After assessing the totality of the events and circumstances, the Company determined that it was not more likely than not that the fair value of its reporting unit was less than its carrying amount and, therefore, the first and second steps of the quantitative goodwill impairment test were deemed unnecessary. As of December 31, 2014, we are not aware of any items or events that would cause a further adjustment to the carrying value of goodwill.
Changes in intangible assets during the years ended December 31, 2014, 2013 and 2012 are presented below:
All of the identified intangible assets are amortized as noninterest expense over their estimated useful lives which range from two to eight years, except for a trademark of $100 thousand with an indefinite useful life. Impairment of the customer relationship intangible asset of $0.2 million and the wealth management trade name intangible asset of $33 thousand were recorded in 2012. No intangibles associated with the customer intangible remains at December 31, 2014.
Estimated intangible asset amortization expense for each of the next five years is as follows:
10. Other Real Estate Owned
The activity within Other Real Estate Owned (“OREO”) for the years ended December 31, 2014, 2013 and 2012 is presented in the table below. Ending balances for OREO covered by loss sharing agreements with the FDIC for these periods were $15.7 million, $25.3 million and $35.9 million, respectively. Non-covered OREO ending balances for these periods were $61.9 million, $104.1 million and $118.2 million, respectively.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
For the year ended December 31, 2014, proceeds on sales of OREO were $80.4 million and net gains on sales were $4.6 million. For the year ended December 31, 2013, proceeds on sales of OREO were $75.5 million and net gains were $3.5 million. For the year ended December 31, 2012, proceeds on sales of OREO were $100.7 million and net gains were $3.8 million.
11. Time Deposits
Time deposits of $100 thousand or more at December 31, 2014 and 2013 were $592.1 million and $657.8 million, respectively.
At December 31, 2014, the scheduled contractual maturities of time deposits are as follows:
12. Federal Home Loan Bank Advances and Short-Term Borrowings
Short-term borrowings include securities sold under agreements to repurchase and advances from the Federal Home Loan Bank (“FHLB”).
The Bank has securities sold under agreements to repurchase with customers. These agreements are collateralized by investment securities of the United States Government or its agencies which are chosen by the Bank. The amounts outstanding at December 31, 2014 and 2013 were $23.4 million and $24.9 million, respectively.
The Bank invests in FHLB stock for the purpose of establishing credit lines with the FHLB. The credit availability to the Bank is based on a percentage of the Bank’s total assets as reported on the most recent quarterly financial information submitted to the regulators subject to the pledging of sufficient collateral. The Bank’s collateral with the FHLB consists of a blanket floating lien pledge of the Bank’s residential 1-4 family mortgage, multifamily, home equity line of credit and commercial real estate secured loans. The amounts of eligible collateral at December 31, 2014 and 2013 provided for incremental borrowing availability of up to $247.7 million and $95.4 million, respectively.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
At December 31, 2014 and 2013, the Bank had $25.7 million and $25.6 million in letters of credit issued by the FHLB respectively, of which $25.2 million are used as collateral for public fund deposits in lieu of pledging securities to the State of Florida.
The advances as of December 31, 2014 and 2013 consisted of the following:
(*) FRC = FHLB Fixed Rate Credit interest rate.
13. Long-Term Borrowings
Structured repurchase agreements
The repurchase agreements as of December 31, 2014 and 2013 consisted of the following:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
These repurchase agreements have a weighted-average rate of 4.06% at December 31, 2014 and 2013 and are collateralized by $61.4 million and $62.1 million, respectively, of mortgage-backed securities.
Subordinated Debentures
Through its acquisitions of CBKN, GRNB, SCMF and TIBB, the Company assumed thirteen separate pooled offerings of trust preferred securities. The Company is not considered the primary beneficiary of the trusts (variable interest entities), therefore the trusts are not consolidated in the Company’s consolidated financial statements, but rather the subordinated debentures are presented as liabilities. The trusts consist of wholly-owned statutory trust subsidiaries for the purpose of issuing the trust preferred securities. The trusts used the proceeds from the issuance of trust preferred securities to acquire junior subordinated deferrable interest debentures of the Company. The trust preferred securities essentially mirror the debt securities, carrying a cumulative preferred dividend equal to the interest rate on the debt securities. The debt securities and the trust preferred securities each have 30-year lives. The trust preferred securities and the debt securities are callable by the Company or the trust, at their respective option after a period of time, and at varying premiums and sooner in specific events, subject to prior approval by the Federal Reserve Board (“FRB”), if then required. Deferral of interest payments on the trust preferred securities is allowed for up to 60 months without being considered an event of default. On March 18, 2013, the Company called and redeemed $34.5 million of trust preferred securities issued by SCMF, which had a fixed interest rate of 7.95%. The prepayment resulted in a $0.3 million loss on extinguishment of debt. On September 7, 2013 the Company called and redeemed $8.0 million of trust preferred securities issued by TIBB, which had a fixed interest rate of 10.60% The prepayment resulted in a $0.4 million gain on extinguishment of debt.
The subordinated debentures as of December 31, 2014 and 2013 consisted of the following:
Other Subordinated Debentures
Through the acquisition of CBKN, the Company assumed $3.4 million in aggregate principal amount of subordinated promissory notes with a fixed interest rate of 10.0% due March 18, 2020. The notes had a carrying value of $3.5 million and $3.6 million as of December 31, 2014 and 2013, respectively. The notes may be prepaid at any time after March 18, 2015. The Company has notified the holders that it intends to prepay the notes on April 1, 2015.
At December 31, 2014, the maturities of long-term borrowings were as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
14. Employee Benefit Plans
The Company maintains the Capital Bank 401(k) Plan that covers all employees who are qualified as to age. An employee may contribute from 1% to 90% of eligible pretax salary subject to limitation under the Internal Revenue Code. The Company may make discretionary contributions to employees’ accounts on an annual basis to employees who are employed as of December 31. The amount of the match is determined annually by the Board of Directors and is subject to change. All employee and discretionary matching contributions are 100% vested. Discretionary matching contributions expensed for each of the years ended December 31, 2014, 2013 and 2012 were $0.4 million. During 2013 and 2012 the SCMF and CBKN, GRNB and TIB plans were merged into the Company’s plan.
Prior to their acquisition by the Company, CBKN, GRNB, SCMF and TIBB maintained certain benefit plans for the benefit of their respective employees and directors. Upon acquisition of the companies, the Company assumed the accrued liabilities associated with these plans. The plans have been terminated and no deferrals were made in 2014 or 2013. The amounts accrued under these plans totaled $6.7 million and $7.5 million as of December 31, 2014 and 2013, respectively. The (income) expense related to the vested benefits was $(0.8) million, $0.4 million and $0.5 million for 2014, 2013 and 2012, respectively.
In 2013, the Company adopted the Capital Bank Financial Corp. Nonqualified Excess Plan, a nonqualified deferred compensation plan that provides highly compensated employees of the Company, including its executive officers, with the opportunity to elect to defer his or her base salary and performance-based compensation, which upon such election, will be credited to the applicable participant’s deferred compensation account. Each deferred compensation account will be invested in one or more investment funds made available by the Company and selected by the participant. The Company may make discretionary contributions to the individual deferred compensation accounts, with the amount, if any, to be determined annually by the Company. All contributions, both by the participant and the Company, are fully vested at all times. Each deferred compensation account will be paid out in a lump sum upon a participant’s separation from service with the Company, unless another payment event has been elected in a timely manner by the participant. The amount deferred under this plan totaled $0.7 million and $0.2 million as of December 31, 2014 and 2013, respectively. The amounts expensed related to the vested benefits were $0.5 million and $0.2 million for 2014 and 2013, respectively.
The Company owns life insurance policies which were purchased for former employees and directors covered by salary continuation agreements and director deferred compensation agreements. The cash surrender value of these policies totaled $55.2 million and $53.6 million at December 31, 2014 and 2013. Cash value income (net of related insurance premium expense) related to these policies totaled $1.6 million, $1.6 million and $0.9 million during 2014, 2013 and 2012, respectively.
The Company also has a non-contributory defined benefit pension plan which was acquired from Southern Community, covering substantially all employees of an acquired bank, The Community Bank. This plan was assumed as part of the purchase of The Community Bank in January 2004. Benefits under the plan are based on length of service and qualifying compensation during the final years of employment. Contributions to the plan are based upon the projected unit credit actuarial funding method to comply with the funding requirements of the Employee Retirement Income Security Act. The plan was frozen effective May 1, 2004. No contribution was required for the years ended December 31, 2014, and 2013 .
The unfunded status of the plan was $0.2 million at December 31, 2014. The end of year plan assets and benefit obligation were $1.1 million and $1.3 million, respectively at December 31, 2014.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
15. Stock-Based Compensation
As of December 31, 2014, the Company had two compensation plans, the 2010 Equity Incentive Plan ("the "2010 Plan") and the 2013 Omnibus Compensation Plan (the “2013 Plan”) under which shares of its common stock are issuable in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, stock bonus awards and other incentive awards. The 2010 Plan was replaced by the 2013 Plan and no further awards may be made pursuant to the 2010 Plan.
The 2013 Plan was effective May 22, 2013 and expires on May 22, 2023, the tenth anniversary of the effective date. The maximum number of shares of common stock of the Company that may be optioned or awarded under this plan is 2,639,000 shares. Awards under this plan may be made to any person selected by the Compensation Committee.
The following table summarizes the components and classification of stock-based compensation expense for the years ended December 31, 2014, 2013 and 2012:
The tax benefit related to stock-based compensation expense arising from restricted stock awards and non-qualified stock options was $1.0 million, $2.1 million and $7.3 million for the years ended December 31, 2014 , 2013 and 2012, respectively.
At December 31, 2014. unrecognized stock-based compensation expense was $0.3 million related to stock options and $0.7 million related to restricted stock. The stock-based compensation expense is expected to be recognized over the weighted-average remaining requisite service period of 5 months.
Stock Options
Under the 2010 Plan and 2013 Plan, the exercise price for common stock must equal at least 100% of the fair market value of the stock on the day an option is granted. The exercise price under an incentive stock option granted to a person owning stock representing more than 10% of the common stock must equal at least 110% of the fair market value at the date of grant, and such option is not exercisable after five years from the date the incentive stock option was granted. The Board of Directors may, at its discretion, provide that an option not be exercised in whole or in part for any period or periods of time as specified in the option agreements. No option may be exercised after the expiration of ten years from the date it is granted. No stock options were granted under these plans during the year ended December 31, 2014.
During the year ended December 31, 2013, 264,000 options were granted to employees at an exercise price of $18.00 vesting over average service periods of 2 years. During the year ended December 31, 2012, 631,000 options were granted to employees at an exercise price of $20.00 and 26,000 options were granted at an exercise price ranging from $28.44 to $2,026.00 vesting over an average service period of 6 months.
The fair value of each option is estimated as of the date of the grant using the Black-Scholes Option Pricing Model. This model requires the input of subjective assumptions that will usually have a significant impact on the fair value estimate. The dividend yield assumption is consistent with management expectations of dividend distributions based upon the Company’s business plan at the date of grant. The risk-free interest rate was developed using the U.S. Treasury yield curve for a period equal to the expected life of the options on the grant date. The expected option life for the current period grants was estimated using the vesting period, the term of the option and estimates of future exercise behavior patterns. The volatility was estimated using a peer group assessment for periods approximating the expected option life. Appropriate weight is attributed to financial theory, according to which the volatility of an institution’s equity should be related to the volatility of its assets and the entity’s financial leverage.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The following table summarizes the weighted average assumptions used to compute the grant-date fair value of options granted during the years ended December 31, 2013 and 2012 :
ASC 718 requires the recognition of stock-based compensation for the number of awards that are ultimately expected to vest. During the years ended December 31, 2014, 2013 and 2012, stock based compensation expense was recorded based upon assumptions that the Company would experience no forfeitures. This assumption of forfeitures will be reassessed in subsequent periods based on historical forfeiture rates and may change based on new facts and circumstances. Any changes in assumptions will be accounted for prospectively in the period of change.
A summary of the stock option activity for the years ended December 31, 2014, 2013 and 2012 is as follows:
At December 31, 2014, the weighted average remaining contractual life for outstanding stock options was approximately 5.65 years and the aggregate intrinsic value were $21.6 million and $20.5 million for stock options outstanding and exercisable, respectively.
The intrinsic value for stock options is calculated as the difference between the exercise price of the underlying awards and the market price of the Company’s common stock as of the reporting date.
Options outstanding at December 31, 2014 were as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Restricted Stock
Restricted stock provides the grantee with voting, dividend and anti-dilution rights equivalent to common shareholders, but is restricted from transfer until vested, at which time all restrictions are removed. The terms of the restricted stock awards granted to employees provide for vesting upon the achievement of stock price goals as follows: (1) one-third at $25.00 per share; (2) one-third at $28.00 per share; and (3) one-third at $32.00 per share. Achievement of stock price goals is generally defined as the average closing price of the shares for any consecutive 30-day trading period exceeding the applicable price target. The value of the restricted stock is being amortized on a straight-line basis over the implied service periods. No restricted stock awards were granted under the 2013 Plan during the year ended December 31, 2014.
On May 21, 2013, 4,000 restricted stock awards were granted under the 2010 Plan. The fair value of the restricted stock was estimated to be equal to the closing stock price on the grant date.
On January 12, 2012, 307,000 restricted stock awards were granted under the 2010 Plan. The fair value of each restricted stock awards was estimated as of the date of grant using a Monte Carlo approach based on Geometric Brownian Motion that simulated daily stock prices and the related consecutive 30 day average of the simulated stock price over a period of 10 years. The model projected the Company’s fair value of each vesting tranche of the restricted stock award from the mean or expected value from the 100,000 scenarios used.
The models described above require the input of subjective assumptions that will usually have a significant impact on the fair value estimate. The following table summarizes the weighted average assumptions used to compute the grant-date fair value of restricted stock awards granted during the years ended December 31, 2013 and 2012:
The risk-free interest rate was developed using the U.S. Treasury yield curve for a period equal to the expected life of the options on the grant date. The volatility assumptions were estimated using a peer group assessment for periods approximating the expected option life. Appropriate weight is attributed to financial theory, according to which the volatility of an institution’s equity should be related to the volatility of its assets and the entity’s financial leverage.
The value of the restricted stock is being amortized on a straight-line basis over the implied service periods.
On April 2, 2014, 405,133 restricted stock awards vested upon achievement of the $25.00 stock price goal. The Company recognized $1.7 million in excess tax benefits related to the vesting of such awards.
The following table summarizes unvested restricted stock activity for the years ended December 31, 2014, 2013 and 2012:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Full Value Stock Awards
On June 5, 2014, 11,880 shares of stock were granted to Directors under the 2013 Plan. The fair value of each stock award was estimated to be equal to the closing stock price on the date of the grant. The Company recognized the $0.3 million fair value of the stock awards in compensation expense on the grant date.
16. Shareholders’ Equity and Minimum Regulatory Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements results in certain discretionary and required actions by regulators that could have an effect on the Company’s operations. The regulations require the Company and the Bank to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
To be considered well capitalized or adequately capitalized as defined under the regulatory framework for prompt corrective action, the Bank must maintain minimum Tier 1 leverage, Tier 1 risk-based and Total Risk-based ratios. At December 31, 2014 and 2013 the Bank maintained capital ratios exceeding the requirement to be considered well capitalized. These minimum ratios along with the actual ratios for the Company and the Bank are presented in the following tables:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
In August 2010, Capital Bank, NA entered into an Operating Agreement with the Office of the Comptroller of the Currency (the “OCC Operating Agreement”). The OCC Operating Agreement requires Capital Bank, NA to maintain total capital equal to at least 12% of risk-weighted assets, Tier 1 capital equal to at least 11% of risk-weighted assets and a minimum leverage ratio of 10% (Tier 1 Capital ratio).
As of December 31, 2014 and 2013, the Company and the Bank met all capital requirements to which they were subject. Tier 1 Capital for the Company includes trust preferred securities to the extent allowable.
The OCC Operating Agreement prohibited Capital Bank, NA from paying a dividend to the Company for three years following the acquisition of the Failed Banks and, now that the three-year period elapsed, imposes other restrictions on Capital Bank’s ability to pay dividends, including requiring prior approval from the OCC before any distribution is made. Dividends that may be paid by a national bank are limited to that bank’s retained net profits for the preceding two years plus retained net profits up to the date of any dividend declaration in the current calendar year. On September 5, 2013 and July 8, 2014, the OCC approved dividends to the Company by its subsidiary Capital Bank N.A., of $105.0 million and $56.0 million, respectively.
On January 30, 2015, upon Board and regulatory approval, our subsidiary Capital Bank N.A. paid a $199.4 million dividend, which we may use for general corporate purposes including acquisitions, or as a return of capital to shareholders through future share repurchases or dividends.
In July 2013, the U.S. banking regulators adopted a final rule which implements the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision, and certain changes required by the Dodd-Frank Act. The final rule establishes an integrated regulatory capital framework and introduces the “Standardized Approach” for risk weighted assets, which will replace the Basel I risk-based guidance for determining risk-weighted assets as of January 1, 2015 (the date we became subject to the new rules). We do not believe adoption of the final rules and relevant provisions will have a significant impact on our operations.
Share Repurchases
During 2013 and 2014, the Company’s Board of Directors authorized stock repurchase plans of up to $200.0 million. Stock repurchases may be made from time to time, on the open market or in privately negotiated transactions. The approved stock repurchase programs do not obligate the Company to repurchase any particular amount of shares, and the programs may be extended, modified, suspended, or discontinued at any time.
During the year ended December 31, 2014, the Company repurchased $103.2 million, or 4,324,382 common shares at an average price of $23.87 per share. As of December 31, 2014, the Company has repurchased a total of $173.2 million, or 8,085,699 common shares at an average price of $21.42 per share with $26.8 million of remaining availability for future share repurchases.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The Company accounts for treasury stock using the cost method as a reduction of shareholders’ equity in the accompanying consolidated balance sheets and statement of changes in shareholders’ equity.
17. Income Taxes
Income tax expense (benefit) for the years ended December 31, 2014, 2013 and 2012 was as follows:
A reconciliation of income tax computed at applicable Federal statutory income tax rates to total income tax expense reported for the years ended December 31, 2014, 2013 and 2012 is as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The composition of the net deferred tax asset as of December 31, 2014 and 2013 is as follows:
A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. In assessing the need for a valuation allowance, management considered the following positive factors:
1.
projections of future operating results which forecast that the Company will continue to recognize pre-tax income on a consolidated basis;
2.
reductions in operating expenses have been achieved as evidenced by continued progress in reducing operating costs and legacy credit expenses; and
3.
the Company expects interest rates to rise in the future, which should have a favorable impact on our net interest income trend and overall return on assets.
A negative factor that management considered was the severe losses incurred by the acquired institutions as a result of the severe recession and significant decline in real estate values in their local markets. In addition, Section 382 of the Internal Revenue Code limits the ability of the Company to utilize net operating losses and deduct built in losses for income tax purposes. The Company appropriately considers these limitations and has taken them into account in calculating the net deferred tax assets. These factors represent the most significant positive and negative evidence that management considered in concluding that no valuation allowance was necessary at December 31, 2014 and 2013. The Company and its subsidiaries are subject to U.S. federal income tax, as well as income tax of the states of Florida, New York, South and North Carolina and Tennessee.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
During 2013, changes in certain statutory rates were enacted into law, which reduced the Company's expected state income tax rate. As a result, the Company recorded a $1.5 million charge to income tax expense.
At December 31, 2014 and 2013 the company had $91.1 million and $103.7 million of gross federal and state net operating loss carryforwards, respectively, which begin to expire after 2029 if unused and are subject to annual cumulative limitation of $10.9 million.
At December 31, 2014 and 2013, the Company had no unrecognized tax benefits and no amounts recorded for uncertain tax positions.
18. Loan Commitments and Other Related Activity
Some financial instruments, such as loan commitments, credit lines, letters of credit and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk of credit losses exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral upon exercise of the commitment.
The contractual amount of financial instruments with off-balance-sheet risk at December 31, 2014 is as follows :
Commitments to make loans are made for periods ranging from 30 days to 90 days. As of December 31, 2014, the fixed rate loan commitments have interest rates ranging from 1.9% to 13.0%, and specific loan maturities ranging from 1 year to 10 years.
As of December 31, 2014 the Bank was subject to performance letters of credit totaling $32.4 million and financial letters of credit totaling $27.6 million.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
19. Fair Value
FASB guidance on fair value measurements defines fair value, establishes a framework for measuring fair value, and requires fair value disclosures for certain assets and liabilities measured at fair value on a recurring and non-recurring basis.
This guidance defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability.
This guidance establishes a fair value hierarchy for disclosure of fair value measurements to maximize the use of observable inputs, that is, inputs that reflect the assumptions market participants would use in pricing an asset or liability based on market data obtained from sources independent of the reporting entity. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity can 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 in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3:
Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Cash & cash equivalents
Cash and cash equivalents include cash on hand and highly-liquid items with an original maturity of three months or less. Accordingly, the carrying amount of such instruments is considered to be a reasonable estimate of fair value.
Derivative financial instruments
Fair values for interest rate swaps, forward loan sales agreements and interest rate caps are based upon the amounts required to settle the contracts. Fair values for commitments to originate loans held for sale are based on fees currently charged to enter into similar agreements. Fair values for fixed-rate commitments also consider the difference between current levels of interest rates and the committed rates.
Valuation of Investment Securities
The fair values of available-for-sale, held-to-maturity and trading securities are determined by: 1) obtaining quoted prices on nationally recognized securities exchanges when available (Level 1 inputs); 2) matrix pricing, which is a mathematical technique widely used in the financial markets to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs); and 3) for certain other debt securities that are not actively traded, custom discounted cash flow modeling (Level 3 inputs).
As of December 31, 2014, Capital Bank held industrial revenue bonds which are floating rate issues. Since there is no active secondary market for the trading of the bonds, the Company has developed a model to estimate fair value. This model determines an appropriate discount rate for the bonds based on current market rates for liquid corporate bonds with an equivalent credit rating plus an estimated illiquidity factor, and calculates the present value of expected future cash flows using this discount rate.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or estimated fair value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustment for mortgage loans held for sale is classified as nonrecurring Level 2.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Valuation of Impaired Loans and Other Real Estate Owned
The fair value of collateral dependent impaired loans with specific allocations of the allowance for loan and lease losses and other real estate owned is generally based on recent real estate appraisals and other available observable market information. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.
The Company generally uses independent external appraisers in this process who routinely make adjustments to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. The Company’s policy is to update appraisals, at a minimum, annually for classified assets, which include collateral dependent loans and OREO. We consider appraisals dated within the past 12 months to be current and do not typically make adjustments to such appraisals. In the Company’s process for reviewing third-party prepared appraisals, any differences of opinion on values, assumptions or adjustments to comparable sales data are typically reconciled directly with the independent appraiser prior to acceptance of the final appraisal.
Sensitivity to Changes in Significant Unobservable Inputs
As discussed above, as of December 31, 2014, the Company owns industrial revenue bonds, which require recurring fair value estimates categorized within level 3 of the fair value hierarchy. The significant unobservable inputs used in the fair value measurement of these securities are incorporated in the discounted cash flow modeling valuation. Rates utilized in the modeling of these securities are estimated based upon a variety of factors including the market yields of other non-investment grade corporate debt. Significant changes in any inputs in isolation would result in significantly different fair value estimates.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 are summarized below:
There were no transfers of assets and liabilities between levels of the fair value hierarchy during the year ended December 31, 2014.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 are summarized below:
(1)
Transferred from Level 1 to Level 2 due to limited observable market data.
The tables below present the activity and income statement classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended and held at December 31, 2014:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The tables below present the activity and income statement classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended and held at December 31, 2013:
(2) Transferred from Level 3 to Level 2 as a result of recent transaction information.
Quantitative Information about Recurring Level 3 Fair Value Measurements
Assets and Liabilities Measured on a Nonrecurring Basis
Assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2014 are summarized below:
Other real estate owned measured at fair value as of December 31, 2014 had a carrying amount of $85.1 million, less valuation allowances totaling $19.1 million. Other repossessed assets are primarily comprised of repossessed vehicles and equipment and are measured at fair value as of the date of repossession.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2013 are summarized below:
Other real estate owned measured at fair value as of December 31, 2013 had a carrying amount of $138.4 million, less valuation allowances totaling $19.8 million. Other repossessed assets are primarily comprised of repossessed vehicles and equipment and are measured at fair value as of the date of repossession.
Quantitative Information about Nonrecurring Level 3 Fair Value Measurements
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
Carrying amount and estimated fair values of financial instruments were as follows:
(1) Includes Federal Reserve Bank, Federal Home Loan Bank and Bankers Bank stocks.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The methods and assumptions used to estimate fair value are described as follows:
Carrying amount is the estimated fair value for cash and cash equivalents, receivable from FDIC, derivatives, noncontractual demand deposits and certain short-term borrowings. As it is not practicable to determine the fair value of Federal Reserve, Federal Home Loan Bank stock, FDIC indemnification asset and correspondent bank’s stocks due to restrictions placed on transferability, the estimated fair value is equal to their carrying amount. Security fair values are based on market prices or dealer quotes and, if no such information is available, on the rate and term of the security and information about the issuer including estimates of discounted cash flows when necessary. For fixed rate loans or contractual deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life, adjusted for the allowance for loan and lease losses. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of long-term debt is based on current rates for similar financing. The fair value of off-balance sheet items that include commitments to extend credit to fund commercial, consumer, real estate construction and real estate-mortgage loans and to fund standby letters of credit is considered nominal.
20. Derivative Instruments
The Company had derivative financial instruments acquired in its purchase of SCMF, primarily in the form of interest rate swaps. The forward loan sales contracts are derived from loans held for sale or in the Company’s pipeline. These transactions involve both credit and market risk.
The Company’s derivative instrument contracts which are recorded in other assets and other liabilities on the Company’s balance sheets consist of the following:
The Company does not enter into derivative financial instruments for speculative purposes. None of the derivatives held are designated as hedging instruments or otherwise qualify for hedge accounting treatment and all changes in fair value are recognized in non-interest income or non-interest expense during the period of change.
For the year ended December 31, 2014, the Company recorded $1.7 million in non-interest income and $118 thousand in non-interest expense as a result of changes in fair value of derivatives. The interest rate swaps associated with certificates of deposit were terminated in September 2014, and, as a result, the Company recognized a $0.3 million loss in non-interest expense.
For the year ended December 31, 2013, the company recorded $(0.8) million in non-interest income and $0.3 million in non-interest expense as a result of changes in fair value of derivatives.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures and agreements that specify collateral levels to be maintained by the Company and the counterparties. These collateral levels are based on the credit rating of the counterparties.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
The primary objective for each of these contracts is to minimize risk. Interest rate risk being the primary risk for the interest rate swaps and forward loan sales contracts.
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
21. Condensed Financial Information about Capital Bank Financial Corp.
The Condensed Balance Sheets as of December 31, 2014 and 2013 and Income Statements and Statement of Cash Flows for the years ended December 31, 2014, 2013 and 2012 for Capital Bank Financial Corp. (parent only) are as follow:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
1 Refer to note 13. Long-Term Borrowings for a maturity schedule of long-term borrowings.
2 Refer to note 16. Shareholders' Equity and Minimum Regulatory Capital requirements for dividends to the Company by its subsidiary Capital Bank N.A.
22. Supplemental Financial Data
Components of other expense in excess of 1.0% of total interest and non-interest income are as follows:
Capital Bank Financial Corp.
Notes to Consolidated Financial Statements
23. Quarterly Financial Data (Unaudited)
The following is a summary of unaudited quarterly results for 2014 and 2013:
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A:
ITEM 9A: CONTROLS AND PROCEDURES
(a)
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, they have concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and are also designed to ensure that the information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
(b)
Internal Control Over Financial Reporting
Management’s Report on Internal Control over Financial Reporting
The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of the Company’s management, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting based on the framework described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission 2013 (the “COSO Criteria”). Based on management’s evaluation under the COSO Criteria, the Company’s management has concluded that the company’s internal control over financial reporting was effective as of December 31, 2014.
Changes in internal control over financial reporting
There have been no changes in the Company’s internal control over financial reporting during the period ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
None.
PART III
ITEM 10:
ITEM 10: DIRECTORS, EXCECUTIVE OFFICERS AND CORPORTE GOVERNACE
The information set forth under the captions “Information about the Board of Directors and Their Committees” and “Executive Officers” under the caption “Election of Directors”, “Audit Committee Report” and “Filings Under Section 16(A) Beneficial Ownership Reporting Compliance” in the Proxy Statement to be utilized in connection with the Company’s 2015 Annual Shareholders Meeting is incorporated herein by reference.
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller, and persons performing similar functions. We have posted the text of our code of ethics on our website at www.capitalbank-us.com in the section titled “Investor Relations.” In addition, we intend to promptly disclose (i) the nature of any amendment to our code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions and (ii) the nature of any waiver, including an implicit waiver, from a provision of our code of ethics that is granted to one of these specified individuals, the name of such person who is granted the waiver, and the date of the waiver on our website in the future.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
The information contained under the captions “Compensation Discussion and Analysis,” “Compensation Committee Report”, “Compensation Committee Interlocks and Insider Participation”, “Executive Compensation” and “Compensation of Directors” in the Proxy Statement to be utilized in connection with the Company’s 2015 Annual Shareholders Meeting is incorporated herein by reference.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERS MATTERS
The information contained under the captions “Management and Principal Shareholders” and “Equity Compensation Plan Information” under “Executive Compensation” in the Proxy Statement to be utilized in connection with the Company’s 2015 Annual Shareholders Meeting is incorporated herein by reference.
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORS INDEPENDENCE
The information contained under the captions “Director Independence” under “Election of Directors” and “Certain Relationships and Related Transactions” in the Proxy Statement to be utilized in connection with the Company’s 2015 Annual Shareholders Meeting is incorporated herein by reference.
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES
The information contained under the caption “Independent Registered Certified Public Accountants” in the Proxy Statement to be utilized in connection with the Company’s 2015 Annual Shareholders Meeting is incorporated herein by reference.
PART IV
ITEM 15:
ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements
The consolidated financial statements, notes thereto and independent registered certified public accountants’ report thereon, filed as part hereof, are listed in Item 8.
2. Financial Statement Schedules
Financial Statement schedules have been omitted as the required information is not applicable or the required information has been incorporated in the consolidated financial statements and related notes incorporated by reference herein.
3. Exhibits
*
Users of this data are advised that pursuant to Rule 406T of Regulation S-T, the interactive data files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
†
Indicates a management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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 indicated on February 26, 2015.
Signature
Title
/s/ R. Eugene Taylor
Chairman and Chief Executive Officer
R. Eugene Taylor
/s/ Christopher G. Marshall
Chief Financial Officer
Christopher G. Marshall
(Principal Accounting Officer)
/s/ Martha M. Bachman
Director
Martha M. Bachman
/s/ Richard M. DeMartini
Director
Richard M. DeMartini
/s/ Peter N. Foss
Director
Peter N. Foss
/s/ William A. Hodges
Director
William A. Hodges
/s/ Oscar A. Keller III
Director
Oscar A. Keller III
/s/ Marc D. Oken
Director
Marc D. Oken
/s/ William G. Ward Sr., M.D.
Director
William G. Ward Sr., M.D.