ITEM 1.BUSINESS
Recent Acquisition
On March 18, 2014, Poage Bankshares, Inc. completed a merger with Town Square Financial Corporation (“Town Square Financial”) and its bank subsidiary, Town Square Bank for the purposes of expanding the Company’s reach in the market place. Pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), the Company incorporated a subsidiary known as Poage Merger Subsidiary, Inc. which was merged with and into Town Square Financial, with Town Square Financial as the surviving entity. Immediately following the merger, Town Square Financial was merged with and into the Company as the surviving entity and Town Square Bank was merged with and into Home Federal Savings and Loan Association (“Home Federal”) with Home Federal as the surviving entity.
On the date of the merger, 55% of the outstanding shares of Town Square Financial common stock was converted into the right to receive 2.3289 shares of Company common stock for each share of Town Square Financial common stock. The remaining 45% of the outstanding shares of Town Square Financial common stock was exchanged for $33.86 in cash per share of Town Square Financial common stock. Town Square Financial stockholders were given the right to receive cash or common stock, subject to the requirement that 55% of Town Square Financial common stock be exchanged for Company common stock in accordance with the proration and allocation procedures contained in the merger agreement.
As such, on March 18, 2014, in connection with the merger, $6.6 million of cash was paid to Town Square Financial stockholders and 435,398 shares of Town Square Financial common stock were exchanged for 557,621 shares of Poage Bankshares, Inc. common stock which had a closing price of $14.0684 on that date. On the date of the merger, Town Square Financial had total assets of approximately $154.1 million, total loans of $124.7 million, and total deposits of $116.8 million.
Name Change
Subsequent to the consummation of the merger transaction, the Board of Directors of Home Federal Savings and Loan Association elected to amend the charter to change the institution’s name from “Home Federal Savings and Loan Association” to “Town Square Bank.” The name change was effective as of June 25, 2014.
Pending Acquisition
On September 9, 2014, the Company and Commonwealth Bank, FSB (“Commonwealth”) issued a joint press release announcing that they had entered into a definitive agreement for the Company to acquire Commonwealth in a conversion merger transaction. Under the terms of the definitive agreement, which has been approved by the Boards of Directors of both institutions, Commonwealth will convert from a federally-chartered mutual savings association to a federally-chartered stock savings association and issue all of its outstanding shares of common stock to the Company. Commonwealth will merge with the Bank.
In connection with the acquisition and in accordance with a related Plan of Conversion Merger (the “Plan”), the Company will offer newly issued shares of its common stock in a subscription offering, on a priority basis, first to eligible depositors of Commonwealth as of the close of business on July 31, 2013, and then to other eligible members of Commonwealth. If any shares remain unsold in the subscription offering, the Company will offer those shares in a community offering and, if necessary, in a syndicated community offering. The amount of stock that the Company will issue and sell will be based on an independent appraisal of Commonwealth. Following the completion of the stock offering, Commonwealth will merge with and into Town Square Bank, with Town Square Bank as the surviving institution. The transaction is expected to close in the second quarter of 2015, subject to regulatory approval, the approval of Commonwealth’s members and the satisfaction of other customary closing conditions
Recent Fiscal Year Date Change
On August 29, 2013, the Board of Directors of Poage Bankshares amended its bylaws to change the fiscal year from September 30 to December 31 of each year. Accordingly, we have included in this annual report on Form 10-K, reporting consolidated financial data for the three month period ended December 31, 2013 and for the year ended September 30, 2013.
Cautionary Note on Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:
· statements of our goals, intentions and expectations;
· statements regarding our business plans, prospects, growth and operating strategies;
· statements regarding the asset quality of our loan and investment portfolios;
· estimates of our risks and future costs and benefits;
· statements about the benefits of the acquisition of Town Square Financial Corporation and Town Square Bank and the acquisition of Commonwealth Bank, including future financial and operating results, cost savings, enhancements to revenue and accretion to reported earnings that may be realized from the acquisition; and
· statements about the financial condition, results of operations and business of Poage Bankshares.
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Except as may be required by law, we do not take any obligation to update any forward-looking statements after the date of this Annual Report on Form 10-K. You should not place undue reliance on such forward-looking statements.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
· our ability to manage our operations under the current adverse economic conditions (including real estate values, loan demand, inflation, commodity prices and unemployment levels) nationally and in our market area;
· adverse changes in the financial industry, securities, credit and national local real estate markets (including real estate values);
· significant increases in our loan losses, including as a result of our inability to resolve classified assets, and management’s assumptions in determining the adequacy of the allowance for loan losses;
· credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and in our allowance for loan losses and provision for loan losses;
· our ability to successfully enhance internal controls;
· our business may not be combined successfully with the business of Town Square Bank and Commonwealth Bank, or such combination may take longer to accomplish than expected;
· the growth opportunities and cost savings from the acquisitions of Town Square Financial Corporation and Commonwealth Bank may not be fully realized or may take longer to realize than expected;
· our ability to manage increased expenses following the acquisitions of Town Square Financial Corporation and Commonwealth Bank, including salary and employee benefit expenses and occupation expenses;
· operating costs, customer losses and business disruption following the acquisitions of Town Square Financial Corporation and Commonwealth Bank, including adverse effects of relationships with employees, may be greater than expected;
· competition among depository and other financial institutions;
· our success in increasing our originations of adjustable-rate mortgage loans;
· our success in increasing our commercial business and commercial real estate;
·
our ability to improve our asset quality even as we increase our commercial business, commercial real estate and multi-family lending, including as a result of the acquisitions of Town Square Financial Corporation and Commonwealth Bank;
·our ability to retain customers and name recognition in the communities we serve as a result of changing our name to “Town Square Bank”;
· our success in introducing new financial products;
· our ability to attract and maintain deposits, including depositors of the former Town Square Bank and former depositors of Commonwealth Bank;
· decreases in our asset quality;
· changes in interest rates generally, including changes in the relative differences between short term and long term interest rates and in deposit interest rates, that may affect our net interest margin and funding sources;
· fluctuations in the demand for loans, which may be affected by the number of unsold homes, land and other properties in our market areas and by declines in the value of real estate in our market area;
· changes in consumer spending, borrowing and savings habits;
· declines in the yield on our assets resulting from the current low interest rate environment;
· risks related to a high concentration of loans secured by real estate located in our market area;
·
the results of examinations by our regulators, including the possibility that our regulators may, among other things, require us to increase our reserve for loan losses, write down assets, change our regulatory capital position, limit our ability to borrow funds or maintain or increase deposits, or prohibit us from paying dividends, which could adversely affect our dividends and earnings;
·changes in laws or government regulations or policies affecting financial institutions, including the Dodd-Frank Act and the JOBS Act, which could result in, among other things, increased deposit insurance premiums and assessments, capital requirements (particularly the new capital regulations), regulatory fees and compliance costs and the resources we have available to address such changes;
· changes in the level of government support of housing finance;
· our ability to enter new markets successfully and capitalize on growth opportunities;
·changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;
· changes in our organization, compensation and benefit plans and our ability to retain key members of our senior management team;
· loan delinquencies and changes in the underlying cash flows of our borrowers;
· the failure or security breaches of computer systems on which we depend;
· the ability of key third-party providers to perform their obligations to us; and
· changes in the financial condition or future prospects of issuers of securities that we own.
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. Please see “Risk Factors” beginning on page 33.
Poage Bankshares, Inc.
Poage Bankshares, Inc. is incorporated in the State of Maryland. We are the holding company for Town Square Bank (“Town Square”).
Our cash flow depends on earnings from the investment of the net proceeds from the offering that we retained, and any dividends we receive from Town Square. Poage Bankshares, Inc. neither owns nor leases any property, but instead pays a fee to Town Square for the use of its premises, equipment and furniture. At the present time, we employ only persons who are officers of Town Square to serve as officers of Poage Bankshares, Inc. We do, however, use the support staff of Town Square from time to time. We pay a fee to Town Square for the time devoted to Poage Bankshares, Inc. by employees of Town Square. However, these persons are not separately compensated by Poage Bankshares, Inc. Poage Bankshares, Inc. may hire additional employees, as appropriate, to the extent it expands its business in the future.
Our executive offices are located at 1500 Carter Avenue, Ashland, Kentucky 41101. Our telephone number at this address is (606) 324-7196.
Town Square Bank
General
Subsequent to the consummation of the merger transaction with Town Square Bank, Inc., the Board of Directors of Home Federal Savings and Loan Association elected to amend the charter to change the institution’s name from “Home Federal Savings and Loan Association” to “Town Square Bank.” The name change was effective as of June 25, 2014.
Town Square is a federal savings and loan association headquartered in Ashland, Kentucky. The association was originally chartered in 1889. Town Square’s business consists primarily of accepting savings accounts and certificates of deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, primarily in first lien one- to four-family mortgage loans and, to a lesser extent, commercial and multi-family real estate loans, consumer loans, consisting primarily of automobile loans and home equity loans and lines of credit, and construction loans. Town Square also purchases investment securities consisting primarily of mortgage-backed securities issued by United States Government agencies and government-sponsored enterprises, and obligations of state and political subdivisions. Town Square offers a variety of deposit accounts, including passbook accounts, NOW and demand accounts, certificates of deposits, money market accounts and retirement accounts. Town Square provides financial services to individuals, families and businesses through our banking offices located in and around Ashland and Nicholasville, Kentucky.
Town Square’s executive offices are located at 1500 Carter Avenue, Ashland, Kentucky 41101. Its telephone number at this address is (606) 324-7196, and its website address is http://www.townsquarebank.com. Information on this website is not and should not be considered to be part of this Annual Report on Form 10-K.
Market Area
Our primary lending markets are in Boyd, Greenup, Lawrence and Jessamine Counties in Kentucky, and Lawrence and Scioto Counties in Ohio. Our retail deposit market includes the areas surrounding our eight offices in northeastern Kentucky, including our main office in Ashland and our branch offices in Flatwoods, Greenup, Louisa, South Shore, Catlettsburg, Cannonsburg and Nicholasville. We also operate an automated teller machine at each of our offices and have a loan production office in the Cincinnati, Ohio area.
Our market area includes both rural and urban communities. The total population base in the six counties where we operate offices was estimated to be 151,000 in 2013, and also 2012. The economic base in our lending market was in the past primarily industrial and reliant upon a small number of large employers, particularly in the steel and petroleum industries. A decline in these segments of the local economy has resulted in slow economic growth and population loss over the last several decades. However, during recent years, a diversification of our employment base into services including healthcare has offset to some extent the adverse impact of the decline of our industrial base.
Per capita incomes in the counties comprising our lending market all lag the applicable Kentucky or Ohio State averages. As of December 2014, the unemployment rate in Boyd and Jessamine Counties, Kentucky was 5.3% and 3.9%, respectively, which is lower than the national unemployment rate, while the unemployment rates in Lawrence and Greenup Counties, Kentucky were 7.4% and 6.1%, respectively which are higher than the national unemployment rate. Our market area did not experience the high growth in 2003 through 2007 that characterized many “bubble” markets across the country. As a result, although real estate values have softened, our market area has not experienced the level of decline in real estate values that has occurred in many other markets.
Competition
We compete with national financial institutions, as well as numerous state chartered banking institutions of comparable or larger size and resources, smaller community banking organizations and a variety of nonbank competitors. We compete for deposits with other commercial banks, savings associations and credit unions and with the issuers of commercial paper and other securities, such as shares in money market mutual funds. In making loans, we compete with other banks, savings associations, consumer finance companies, credit unions, leasing companies and other lenders. Many of the institutions against whom we compete are national and regional banks that are significantly larger than us and, therefore, have significantly greater resources and the ability to achieve economies of scale by offering a broader range of products and services at more competitive prices than we can offer. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry.
As of June 30, 2014, our market share of deposits represented 17.74% of Federal Deposit Insurance Corporation-insured deposits in Boyd, Greenup, Lawrence and Jessamine Counties in Kentucky combined, taking into account the acquisition of Town Square Financial Corporation and Town Square Bank. To effectively compete, we seek to emphasize community orientation, local and timely decision making and superior customer service.
Lending Activities
Our principal lending activity has been the origination of first lien one- to four-family residential mortgage loans and, to a lesser extent, commercial and multi-family real estate loans, consumer loans, consisting primarily of automobile loans, home equity loans and lines of credit, and construction loans. In order to diversify our loan portfolio, we recently increased our emphasis on commercial business loans, commercial real estate loans and consumer loans.
During July 2010, we began selling substantially all of our fixed-rate residential mortgages to the Federal Home Loan Bank of Cincinnati (“FHLB-Cincinnati”) with servicing retained. Total proceeds from mortgages sold under this program equaled approximately $8.1 million for the twelve months ended December 31, 2014. In 2014 we also began a secondary market referral program to additional secondary market outlets with no servicing retained. The sale of our fixed-rate residential mortgage originations to the FHLB-Cincinnati along with referrals to other secondary market outlets and our increased originations of nonresidential loans, which generally have shorter terms than one- to four-family residential loans, assist in managing the interest rate risk associated with our portfolio of long-term fixed-rate one- to four-family residential loans.
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
Contractual Maturities and Interest Rate Sensitivity. The following table summarizes the scheduled maturities of our loan portfolio at December 31, 2014. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Loans are presented net of loans in process.
The following table sets forth our fixed and adjustable-rate loans at December 31, 2014 that are contractually due after December 31, 2015. Loans are presented net of loans in process.
One- to Four-Family Residential Real Estate Lending. A significant portion of our loan portfolio includes the origination of one- to four-family residential mortgage loans. At December 31, 2014, $179.5 million, or 59.0% of our total loan portfolio, consisted of loans secured by one- to four-family residences compared to $135.2 million, or 75.5% of our total loan portfolio at December 31, 2013.
Historically, we have originated both fixed-rate and adjustable-rate one- to four-family mortgage loans. At December 31, 2014, 32.3% of our total one- to four-family mortgage loans were fixed-rate loans and 67.7% were adjustable-rate loans.
Our fixed-rate one- to four-family residential mortgage loans are generally underwritten according to secondary market standards (e.g., Freddie Mac guidelines), and we refer to loans that conform to such guidelines as “conforming loans.” We generally originate both fixed- and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Federal Housing Finance Agency, which as of December 31, 2014 was generally $417,000 for single-family homes in our market area. We also originate adjustable rate loans above the lending limit for conforming loans, which are referred to as “jumbo loans.” The majority of our residential loans are secured by properties located in our market area.
We generally limit the loan-to-value ratios of our mortgage loans to 80% of the sales price or appraised value, whichever is lower. Loans with certain credit enhancements, such as private mortgage insurance, may be made with loan-to-value ratios up to 95%. Our fixed-rate one- to four-family mortgage loans typically have terms of 15 or 30 years.
Although we have offered adjustable-rate loans for many years, beginning in fiscal 2010 we began to increase our emphasis on such loans, subject to demand for such loans in a lower interest rate environment, and to increase the sale of fixed-rate mortgage loans that we originate, in order to enhance the interest rate sensitivity of our loan portfolio. Our owner-occupied adjustable-rate one- to four-family residential mortgage loans generally have fixed rates for initial terms of five years, and adjust annually thereafter at a margin (generally of 3.5% for owner-occupied properties) over the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of one year. The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6% over the initial interest rate of the loan. Our adjustable-rate loans carry terms to maturity of up to 30 years.
Although adjustable-rate mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because, as interest rates increase, they periodically reprice and the required payments due from the borrower also increase (subject to rate caps), and the ability of the borrower to repay the loan and the marketability of the underlying collateral may be adversely affected. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on most of our adjustable-rate loans generally do not adjust for five years after origination. As a result, the effectiveness of adjustable-rate mortgage loans in compensating for changes in general interest rates may be limited during periods of rapidly rising interest rates.
We do not offer “interest only” mortgage loans on one- to four-family residential properties (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan). We also do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. We do not offer “subprime loans” (i.e., loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios), or “Alt-A” loans (i.e., loans that generally target borrowers with better credit scores who borrow with alternative documentation such as little or no verification of income).
Until fiscal 2010, we generally retained in our portfolio all of the loans that we originated. In July 2010, as part of our interest rate risk management strategy, we initiated a secondary market program focused on reducing the origination of fixed-rate residential mortgage loans for our portfolio and selling some or all of our fixed rate mortgage originations in the FHLB-Cincinnati Mortgage Purchase Program, with servicing retained. For the year ended December 31, 2014, we sold approximately $8.1 million in fixed-rate mortgage loans to the FHLB-Cincinnati. We expect that loans sold under this program will continue to increase. As an enhancement to our mortgage program, in 2014 we began a secondary market referral program to various secondary market outlets with no servicing retained.
Based on our continued emphasis on adjustable rate lending and our continued implementation of a secondary market program for new fixed rate loan originations, we expect that adjustable-rate one- to four-family residential mortgage loans will account for the largest increase in our loan portfolio over the next three years. Currently, substantially all fixed rate one- to four- family residential mortgage loans we originate are sold in the secondary market, and we retain substantially all adjustable-rate one- to four-family residential mortgage loans we originate.
Consumer Lending and Home Equity Loans and Lines of Credit. At December 31, 2014, $8.0 million, or 2.6% of our total loan portfolio, consisted of home equity loans and lines of credit, and $17.1 million, or 5.6% of our total loan portfolio consisted of motor vehicles and other consumer loans, compared to $5.9 million, or 3.3% of our total loan portfolio, and $11.9 million, or 6.6% of our total loan portfolio, respectively, at December 31, 2013. In order to reduce the term of our loans and enhance the yields thereof, we intend to increase our consumer loans and home equity loans and lines of credit over the next three years.
Currently, our consumer loans include, among other loans, new and used automobile and truck loans, recreational vehicle loans and personal loans.
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or that are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. In determining whether to make a consumer loan, we consider the appraised value of collateral, and the borrower’s residence, employment history, annual income and debt service ratio which, including all mortgage payments and the credit line payment, generally may not exceed 40% of gross monthly income without prior approval of Town Square’s credit committee or senior officer with appropriate lending authority.
We offer home equity loans and lines of credit secured by a first or second mortgage on residential property (principal dwelling, condominium, etc.). Home equity loans and lines of credit are made with fixed or adjustable rates, and with combined loan-to-value ratios up to 85% on an owner-occupied principal residence and up to 80% on a second home, condominium or vacation home. On a limited basis, loan-to-value ratios may exceed 90% of appraised value if approved by Town Square’s credit committee or senior officer with appropriate lending authority.
Home equity loans and lines of credit may entail greater credit risk than one- to four-family residential mortgage loans, as they typically involve higher loan-to-value ratios and are typically second in priority behind first mortgages on the property. Therefore, any decline in real estate values may have a more detrimental effect on our home equity loans and lines of credit than on our one- to four-family residential mortgage loans.
Commercial Real Estate and Multi-Family Loans. At December 31, 2014, our commercial real estate loans totaled $63.0 million and our multi-family loans totaled $5.9 million compared to $17.3 million and $889,000, respectively, at December 31, 2013. Subject to market conditions, we intend to continue to increase the proportion of these nonresidential real estate loans in our portfolio over the next few years.
Maturities for our commercial real estate and multi-family loans generally do not exceed 15 years, although exceptions may be made for terms of up to 20 years. Rates are generally adjustable based upon the weekly average yield on U.S. treasury securities adjusted to a constant maturity of one year or another floating index. The maximum loan-to-value ratio is 80% on our owner-occupied commercial real estate loans. The maximum loan-to-value ratio on one- to four-family residential rental properties, and office or retail non-owner-occupied commercial real estate or rental properties with greater than five units is 75%. We generally require a first mortgage on all commercial real estate loans, as well as a debt service coverage ratio of 1.25:1.
Set forth below is information regarding our commercial real estate loans at December 31, 2014.
Commercial and multi-family real estate loans generally carry higher interest rates and have shorter terms than one- to four-family residential mortgage loans. Multi-family and commercial real estate loans, however, entail greater credit risks compared to one- to four-family residential mortgage loans because they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property. Additionally, any decline in real estate values may be more pronounced for commercial and multi-family real estate than residential properties.
Commercial Business Loans. Our portfolio of commercial business loans increased to $25.5 million, or 8.4% of our total loan portfolio at December 31, 2014 from $5.6 million, or 3.2% of our total loan portfolio at December 31, 2013. Our commercial business loans generally consist of regular lines of credit and revolving lines of credit to businesses to finance short-term working capital needs like accounts receivable and inventory. These loans are generally priced on an adjustable-rate basis and may be secured or unsecured. We generally obtain personal guarantees with all commercial business loans. Business assets such as accounts receivable, inventory and equipment, or real estate may be used to secure lines of credit. Our revolving lines of credit typically have a maximum term of 12 months.
We also originate commercial term loans to fund long-term borrowing needs such as purchasing equipment, property improvements or other fixed asset needs. We fix the maturity of a term loan to correspond to 75% of the useful life of any equipment purchased or seven years, whichever is less. Term loans can be secured with a variety of collateral, including business assets such as accounts receivable and inventory or intermediate and long-term assets such as equipment, commercial vehicles or real estate.
Unlike one- to four-family residential real estate loans, which we generally originate on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, we typically originate commercial loans (including real estate as well as non-real estate loans) on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business or rental income produced by the property. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent on the success of the business or rental property itself and the general economic environment. Therefore, commercial loans that we originate have greater credit risk than one- to four-family residential real estate loans or consumer loans. In addition, commercial loans generally result in larger outstanding balances to single borrowers, or related groups of borrowers, and also generally require substantially greater evaluation and oversight efforts.
Construction and Land Loans. At December 31, 2014, $5.1 million, or 1.7% of our total loan portfolio consisted of construction and land loans, compared to $2.2 million, or 1.2% of our total loan portfolio at December 31, 2013. We make construction loans to individuals for the construction of their primary residences. These loans generally have maximum terms of 12 months, and upon completion of construction convert to conventional amortizing mortgage loans. These construction loans have higher risk based interest rates and terms. During the construction phase, the borrower generally pays interest only. The maximum loan-to-value ratio of our owner-occupied construction loans is generally 80% of construction costs or completed-appraised-value, whichever is less. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential mortgage loans.
We also make construction loans for the construction of homes “on speculation.” These loans are for “pre-sold” and “spec” homes, and no more than two such loans may be outstanding to one borrower at any time. These loans generally have initial maximum terms of nine months, although the term may be extended to up to 18 months. The loans generally carry variable rates of interest. The maximum loan-to-value ratio of these construction loans is generally 80% of construction costs or completed-appraised-value, whichever is less. We also make loans for the construction of commercial and multi-family buildings.
In addition, we make loans secured by unimproved land to complement our construction and non-residential lending activities. These loans have terms of up to 15 years, and maximum loan-to-value ratios of 65%.
Set forth below is information regarding our construction and land loans at December 31, 2014.
To the extent our construction loans are not made to owner-occupants of single-family homes, they are more vulnerable to changes in economic conditions and the concentration of credit with a limited number of borrowers. Further, the nature of these loans is such that they are more difficult to evaluate and monitor. Our risk of loss on a construction or land loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project with a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage.
Loan Approval Procedures and Authority. The aggregate amount of loans that we are permitted to make to any one borrower or group of related borrowers is generally limited to 15% of Town Square’s unimpaired capital and surplus (25% if the amount in excess of 15% is secured by “readily marketable collateral”). At December 31, 2014, based on the 15% limitation, Town Square’s loans-to-one-borrower limit was approximately $10.05 million. On the same date, Town Square had no lending relationships with outstanding balances in excess of this amount.
Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers approved by our Board of Directors, as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, financial statements and tax returns.
Under our loan policy, the individual processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to an officer for approval. Once all documentation is obtained, an officer then reviews these materials and verifies that the requested loan meets our underwriting guidelines.
Our loan approval authority is based upon the knowledge and experience of our individual lending officers. Larger and more complicated loans require the approval of Town Square’s internal Credit Committee, which is chaired by the Chief Credit Officer and includes the President, Chief Executive Officer and three other senior officers with appropriate credit backgrounds. All loans on an aggregate basis exceeding $2 million require the approval of both the internal Credit Committee and Directors Credit Committee, which is chaired by the Chief Executive Officer and includes four outside directors. All loans on an aggregate basis exceeding $4 million up to our legal lending limit, require the approval of a majority of the Board of Directors.
Generally, we require title insurance or abstracts on our mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan.
Originations, Sales and Servicing. Lending activities are conducted solely by our salaried loan personnel. All loans originated by us are underwritten pursuant to our policies and procedures. We originate both fixed-rate and adjustable-rate loans. Our ability to originate fixed or adjustable-rate loans is dependent upon relative customer demand for such loans, which is affected by current and expected future levels of market interest rates. We originate real estate and other loans through our loan officers, marketing efforts, our customer base, walk-in customers and referrals from real estate brokers, builders and attorneys.
We sell certain of our fixed rate one- to four-family mortgage loan originations in the FHLB-Cincinnati Mortgage Purchase Program. We have also undertaken a review of our existing loan portfolio to identify customers who may qualify and benefit from this product. Loans are sold to the FHLB-Cincinnati without recourse, except for limited circumstances including failure of the mortgage to meet FHLB-Cincinnati guidelines or our breach of any representation and warranty in the sales transaction.
In addition to the representations and warranties described above, Town Square provides credit enhancements to the FHLB-Cincinnati by sharing losses with other members of the program in an aggregated pool. A Fixed Lender Risk Account (“LRA”) has been established and is maintained by the FHLB-Cincinnati on behalf of Town Square and other members selling mortgages to the FHLB-Cincinnati. The LRA amount is established as a percentage applied to the sum of the initial unpaid principal balance of each mortgage in the Aggregated Pool at the time of the purchase of the mortgage as determined by the FHLB-Cincinnati and is funded by the deduction from the proceeds of sale of each mortgage in the Aggregated Pool to the FHLB-Cincinnati. Town Square had on deposit with the FHLB-Cincinnati $712,000 at December 31, 2014 and $592,000 at December 31, 2013 in these LRA’s. These accounts are held by the FHLB-Cincinnati and Town Square bears the risk of receiving less than 100% of its LRA contribution in the event of losses, either by Town Square or other members selling mortgages in the aggregated pool. Any losses will be deducted first from the individual LRA contribution of the institution that sold the mortgage of which the loss was incurred. If losses incurred in the aggregated pool are greater than the member’s LRA contribution, such losses will be deducted from the LRA contribution of other members selling mortgages in that aggregated pool. Any portion of the LRA not used to pay losses will be released over a thirty year period and will not start until the end of five years after the initial fill-up period. Town Square has not had any of the LRA amounts released as of December 31, 2014. Unless Town Square is required to buy back a loan because it did not meet the criteria under the representations and warranties to be covered as part of the aggregated pool, the credit risk is limited to the amount provided in the LRA.
All of the loans sold during the periods ended December 31, 2014 and 2013 were subject to these representations and warranties. As of December 31, 2014 there have been no required repurchases of loans sold, there have been no recourse claims, nor does Town Square believe it has incurred any such losses. Therefore, no liabilities have been accrued for loans sold at December 31, 2014 or 2013.
Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of un-remedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We retain a portion of the interest paid by the borrower on the loans we service as consideration for our servicing activities. For the year ended December 31, 2014 and the three months ended December 31, 2013, we received loan servicing fees of $85,000 and $16,000, respectively. As of December 31, 2014 and December 31, 2013, the principal balance of loans serviced for the FHLB-Cincinnati totaled $37.0 million and $32.9 million, respectively.
We currently purchase whole loans or interests in loans from third parties, which includes loans to health care professionals and motor vehicle loans.
The following table shows our loan origination and principal repayment activity for loans originated during the periods indicated. One- to four-family loans included $22.4 million, $9.0 million and $12.2 million of adjustable rate mortgage loans originated during the year ended December 31, 2014 and three months ended December 31, 2013 and year ended September 30, 2013, respectively. Loans are presented net of loans in process.
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make their required monthly payment on or before the late payment date, a notice is generated stating the amount of the payment and applicable late charge(s) that are due. An attempt is also made at this time to contact the borrower by telephone regarding their late payment. Collection procedures provide that if no response or payment is received from the borrower, additional collections efforts will be taken through the generation of a 30-day right to cure or demand letter. Contact with the borrower regarding establishment of payment arrangements to satisfy their delinquency will be coordinated through the lending officer and collections department. If, at this point, no response is received from the borrower, further accelerated collection efforts such as the pursuit of legal action, repossession or foreclosure may be initiated. If any of these actions are pursued, all further communication with the borrower will be directed to the collections area.
When we acquire real estate as a result of foreclosure or by deed in lieu of foreclosure, the real estate is classified as foreclosed real estate and held in the other real estate owned (OREO) asset account until it is sold. The real estate is appraised and recorded at estimated fair value after acquisition less estimated costs to sell, and any write-down resulting from the acquisition, is charged to the allowance for loan losses. Subsequent decreases in the value of the property are charged to expense. After acquisition, all costs in maintaining the property are expensed as incurred. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.
Delinquent Loans. The following table sets forth our loan delinquencies still accruing, non-accrual loans, by type and amount at the dates indicated, and excludes PCI loans.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Office of the Comptroller of the Currency (“OCC”) to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” by our management.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover probable incurred losses. General allowances represent loss allowances which have been established to cover probable incurred losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies a problem asset as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific loss allowances.
In connection with the filing of our periodic reports with the OCC and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations.
On the basis of this review of our assets, our classified and special mention assets at the dates indicated were as set forth below. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. Thus, the homogenous pools are not considered for classification or special mention status. At December 31, 2014, December 31, 2013 and September 30, 2013, all loans classified as substandard were comprised of loans that were individually evaluated for impairment and loans that were deemed to be impaired were subsequently adjusted and are carried at fair value.
Non-Performing Assets. We generally cease accruing interest on our loans when contractual payments of principal or interest have become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed. Funds received on nonaccrual loans generally are applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
The table below sets forth the amounts and categories of our non-performing assets at the dates indicated. At the dates indicated, we had no loan classified as a troubled debt restructuring.
Non-performing Assets
There were no loans that are not disclosed above under “-Classified Assets” and “-Non Performing Assets” where there is information about possible credit problems of borrowers that caused us serious doubts about the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure of such loans in the future.
Allowance for Loan Losses
Analysis and Determination of the Allowance for Loan Losses. Our allowance for loan losses is the amount considered necessary to reflect probable incurred losses in our loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Our methodology for assessing the appropriateness of the allowance for loan losses consists of two key elements: (i) specific allowances for identified problem loans; and (ii) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
Specific Allowances for Identified Problem Loans. We establish a specific allowance when loans are determined to be impaired. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Factors in identifying a specific problem loan include: (i) the strength of the customer’s personal or business cash flows; (ii) the availability of other sources of repayment; (iii) the amount due or past due; (iv) the type and value of collateral; (v) the strength of our collateral position; (vi) the estimated cost to sell the collateral; and (vii) the borrower’s effort to cure the delinquency. In addition, for loans secured by real estate, we consider the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.
General Valuation Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not classified as impaired to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management’s evaluation of the collectability of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated on a quarterly basis.
In addition, as an integral part of their examination process, the OCC will periodically review our allowance for loan losses, and they may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Allowance for Loan Losses. The following table sets forth activity in our allowance for loan losses for the periods indicated.
Analysis of Loan Loss Experience
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the general allowance to absorb losses in other categories.
The allowance for loan losses was $1.9 million, or 0.63% of total loans at December 31, 2014 compared to $1.9 million, or 1.07% of total loans, at December 31, 2013. Provision of $504,000 was recorded for the 12 months ended December 31, 2014. No provision was recorded for the three months ended December 31, 2013. We had net charge-offs of $501,000 for the twelve months ended December 31, 2014 compared to $81,000 for the three months ended December 31, 2013. Total nonperforming loans were $3.4 million at December 31, 2014 compared to $926,000 at December 31, 2013. At December 31, 2014, December 31, 2013 and September 30, 2013, we had no specific allocations of the allowance related to impaired loans. As a percentage of nonperforming loans, the allowance for loan losses was 33.78% at December 31, 2014 compared to 206.1% at December 31, 2013. The increase in the provision and resulting allowance for loan losses for the year ended December 31, 2014 compared to the year ended December 31, 2013 reflected net charge-offs for the twelve months ended December 31, 2014.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, regulators, in reviewing our loan portfolio, may require us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate and increases may be necessary if the quality of our loans deteriorates as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
Investment Activities
General. The goals of our investment policy are to provide and maintain liquidity to meet deposit withdrawal and loan funding needs, to help manage our interest rate risk, and to generate a favorable return on idle funds within the context of our interest rate and credit risk objectives.
Our Board of Directors is responsible for monitoring compliance with our investment policy. The investment policy is reviewed annually by management and any changes to the policy are recommended to and subject to the approval of the Board of Directors. A management committee made up of four of the highest ranking officers or a combination of directors and officers may purchase investments based on recommendations of the Asset/Liability Committee and submit the purchase to the full Board of Directors at the next scheduled meeting.
Our current investment policy permits investments in securities issued by the United States Government and its agencies or government sponsored enterprises, including residential mortgage-backed securities, municipalities, school boards and fully insured certificates of deposit. We maintain investment securities concentration limits that we periodically amend based on market conditions and changes in our assets. Current concentration restrictions limit investments to no more than $50 million of mortgage-backed securities per each U.S. Government-sponsored enterprise, $25 million of securities per each U.S. Government agency, $5 million per each issuing municipal authority and an aggregate of $30 million of all municipal investments. Our investment policy also permits investment in FHLB-Cincinnati stock.
At December 31, 2014, we did not have an investment in the securities of any single non-government issuer that exceeded 10% of equity at that date.
Our current investment policy does not permit investment in stripped mortgage-backed securities, complex securities and derivatives as defined in federal banking regulations and other high-risk securities. Our current policy does not permit hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.
At December 31, 2014, none of the collateral underlying our securities portfolio was considered subprime or Alt-A and we did not hold any common or preferred stock issued by Freddie Mac or Fannie Mae as of that date.
State and Political Subdivision Debt Securities. We have purchased primarily bank-qualified and rated general obligation and revenue bonds of certain state and political subdivisions, which provide interest income that is mostly exempt from federal income taxation. All purchases are approved by Town Square’s Board of Directors and are reviewed each quarter. At December 31, 2014, substantially all of our state and political subdivision portfolio consisted of revenue bonds issued by the Commonwealth of Kentucky.
U.S. Government and Federal Agency Obligations. We may invest in U.S. Government and federal agency securities. While these securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and for prepayment protection.
Residential Mortgage-Backed Securities. Residential mortgage-backed securities are securities issued in the secondary market that are collateralized by pools of mortgages. We also invest in mortgage-backed securities commonly referred to as “pass-through” certificates. The principal and interest of the loans underlying these certificates “pass through” to investors, net of certain costs, including servicing and guarantee fees. We invest primarily in residential mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as Town Square. The interest rate of the security is lower than the interest rates of the underlying loans to allow for payment of servicing and guaranty fees. Most of our mortgage-backed securities are either backed by Ginnie Mae, a United States Government agency, or government-sponsored enterprises, such as Fannie Mae and Freddie Mac.
Residential mortgage-backed securities issued by United States Government agencies and government-sponsored enterprises are more liquid than individual mortgage loans because there is an active trading market for such securities. In addition, residential mortgage-backed securities may be used to collateralize our borrowings. Investments in residential mortgage-backed securities involve a risk that actual payments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such interests, thereby affecting the net yield on our securities. Current prepayment speeds determine whether prepayment estimates require modification that could cause amortization or accretion adjustments.
Federal Home Loan Bank Stock. We held common stock of the FHLB-Cincinnati in connection with our borrowing activities totaling $2.68 million at December 31, 2014, and $1.95 million at December 31, 2013. The common stock of the FHLB-Cincinnati is carried at cost and classified as restricted equity securities.
Company-Owned Life Insurance. We invest in company-owned life insurance to provide us with a funding source for our benefit plan obligations. Company-owned life insurance also generally provides us non-interest income that is non-taxable. Federal regulations generally limit our investment in bank-owned life insurance to 25% of our Tier 1 capital plus our allowance for loan losses. At December 31, 2014, we had invested $6.8 million in company-owned life insurance.
Securities Portfolio Composition. The following table sets forth the composition of our securities portfolio at the dates indicated.
Securities Portfolio Maturities and Yields. The following table sets forth the contractual maturities and weighted average yields of our securities portfolio at December 31, 2014. Mortgage-backed securities are anticipated to be repaid in advance of their contractual maturities as a result of projected mortgage loan prepayments.
At December 31, 2014 we did not hold securities issued by a single issuer that exceeded 10% of stockholders’ equity.
Sources of Funds
General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also use borrowings, primarily FHLB-Cincinnati advances, to supplement cash flow needs, to lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. In addition, we receive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings, income on earning assets and the sale of assets from time to time. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition.
Deposits. Our deposits are generated primarily from within our primary market area. We offer a selection of deposit accounts, including statement savings accounts, NOW accounts, business checking, certificates of deposit, money market accounts and retirement accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. We have not accepted brokered deposits in the past, although we have the authority to do so.
Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. We rely upon personalized customer service, long-standing relationships with customers, convenient offices and ATM locations and the favorable image of Town Square in the community to attract and retain deposits. We have also expanded our products to include debit cards, on-line banking services and mobile banking services for the convenience of our customers.
The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. Our ability to gather deposits is impacted by the competitive market in which we operate, which includes numerous financial institutions of varying sizes offering a wide range of products. We may use promotional rates to meet asset/liability and market segment goals.
The variety of rates and terms on the deposit accounts we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on our experience, we believe that NOW and demand deposits may be somewhat more stable sources of funding than certificates of deposits.
The following table sets forth the distribution of total deposits by account type, at the dates indicated.
As of December 31, 2014, the aggregate amount of our outstanding time deposits in amounts greater than or equal to $100,000 was $82.6 million. The following table sets forth the maturity of these time deposits as of December 31, 2014.
The following table sets forth our time deposits classified by interest rate as of the dates indicated.
The following table sets forth the amount and maturities of our time deposits at December 31, 2014.
Borrowings. Our borrowings currently consist primarily of advances from the FHLB-Cincinnati. We obtain advances from the FHLB-Cincinnati upon the security of our capital stock in the FHLB-Cincinnati and certain of our mortgage loans. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. To the extent such borrowings have different terms to repricing than our deposits, they can change our interest rate risk profile.
From time to time during recent years, we have utilized short-term borrowings to fund loan demand. To a limited extent, we have also used borrowings where market conditions permit us to purchase securities and make loans of a similar duration in order to increase our net interest income by the amount of the spread between the asset yield and the borrowing cost. Finally, from time to time, we have obtained advances with longer terms for asset liability management.
The following table sets forth information concerning balances and interest rates on our FHLB-Cincinnati advances at the date and for the noted year.
At December 31, 2014, based on available collateral and our ownership of FHLB-Cincinnati common stock, we had access to additional FHLB-Cincinnati advances of up to $90.2 million.
Subsidiary and Other Activities
Poage Bankshares, Inc. has two subsidiaries; Town Square Bank and Town Square Statutory Trust I. Town Square has no subsidiaries. Town Square Statutory Trust I has no subsidiaries.
Expense and Tax Allocation
Town Square has entered into an agreement with Poage Bankshares to provide it with certain administrative support services for compensation not less than the fair market value of the services provided. In addition, Town Square and Poage Bankshares have entered into an agreement to establish a method for allocating and for reimbursing the payment of their consolidated tax liability.
Personnel
As of December 31, 2014, we had 101 full-time employees and 19 part-time employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relations with our employees.
Federal Taxation
General. Poage Bankshares and Town Square are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to Poage Bankshares and Town Square.
Method of Accounting. For federal income tax purposes, Town Square currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its federal income tax return. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995.
Minimum Tax. The Internal Revenue Code of 1986, as amended, imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, referred to as “alternative minimum taxable income.” The alternative minimum tax is payable to the extent alternative minimum taxable income is in excess of an exemption amount. Net operating losses can, in general, offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years.
Net Operating Loss Carryovers. Generally, a financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At December 31, 2014, Town Square had no net operating loss carry forward for federal income tax purposes.
Corporate Dividends-Received Deduction. Poage Bankshares will be able to exclude from its income 100% of dividends received from Town Square as a member of the same affiliated group of corporations.
Audit of Tax Returns. Town Square’s and Poage Bankshares’ federal income tax returns have not been audited in the most recent five-year period.
State Taxation
Poage Bankshares is subject to the Kentucky corporation income tax and Limited Liability Entity Tax (“LLET”). The income of corporations subject to Kentucky income tax is similar to income reported for federal income tax purposes except that dividend income, among other income items, is exempt from taxation. Corporations pay the greater of the income tax or the LLET. The LLET is the greater of (i) $175 or (ii) the lesser of (a) $0.095 per $100 of the corporation’s gross receipts, or (b) $0.75 per $100 of the corporation’s gross profits. Gross profits equal gross Kentucky receipts reduced by returns and allowances attributable to Kentucky gross receipts, less Kentucky cost of goods sold. Poage Bankshares, in its capacity as a holding company for a financial institution, will not have a material amount of cost of goods sold.
Town Square is exempt from both the Kentucky corporation income tax and LLET, but is subject to an annual franchise tax imposed on federally or state-chartered savings and loan associations, savings banks and other similar institutions operating in Kentucky. The tax is 0.1% of taxable capital stock held as of January 1 each year. Taxable capital stock includes an institution’s undivided profits, surplus and general reserves plus deposits and paid-up stock less deductible items. Deductible items include certain exempt federal obligations and Kentucky municipal bonds. Savings and loans that are subject to tax both within and without Kentucky must apportion their net capital.
SUPERVISION AND REGULATION
General. The federal system of regulation and supervision establishes a comprehensive framework of activities in which Town Square may engage and is intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation’s deposit insurance fund. Town Square is periodically examined by the Office of the Comptroller of the Currency, or OCC, to ensure that it satisfies applicable standards with respect to its capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Town Square also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, or Federal Reserve Board, which governs the reserves to be maintained against deposits and other matters. In addition, Town Square is a member of and owns stock in the FHLB-Cincinnati, which is one of the twelve regional banks in the Federal Home Loan Bank System. Town Square’s relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a much lesser extent, state law, including in matters concerning the ownership of deposit accounts and the form and content of Town Square’s loan documents.
As a savings and loan holding company, Poage Bankshares is subject to examination and supervision by, and is required to file certain reports with, the Federal Reserve Board. Poage Bankshares is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.
Set forth below are certain material regulatory requirements that are applicable to Town Square and Poage Bankshares. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on Town Square and Poage Bankshares. Any change in these laws or regulations, whether by Congress or the applicable regulatory agencies, could have a material adverse impact on Poage Bankshares, Town Square and their operations.
Dodd-Frank Act
The Dodd-Frank Act made significant changes to the regulatory structure for depository institutions and their holding companies. However, the Dodd-Frank Act’s changes go well beyond that and affect the lending, investments and other operations of all depository institutions. The Dodd-Frank Act required the Federal Reserve Board to set minimum capital levels for both bank holding companies and savings and loan holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital for holding companies were restricted to capital instruments that were then currently considered to be Tier 1 capital for insured depository institutions. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards in effect upon passage, and directed the federal banking regulators to implement new leverage and capital requirements that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act also created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Town Square, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, such as Town Square, will continue to be examined for compliance by their applicable bank regulators. The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate and solicit votes for their own candidates using a company’s own proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. The Dodd-Frank Act provided for originators of certain securitized loans to return a percentage of the risk for the transferred loan, directed the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contained a number of reforms related to mortgage origination.
The Dodd-Frank Act also required the Consumer Financial Protection Bureau to issue regulations requiring lenders to make a reasonable good faith determination as to a prospective borrower’s ability to repay a residential mortgage loan. The final “Ability to Repay” rules, which were effective January 10, 2014, establish a “qualified mortgage” safe harbor for loans whose terms and features are deemed to make the loan less risky.
Many provisions of the Dodd-Frank Act involve delayed effective dates and/or require implementing regulations or have not been issued in final form. Their impact on our operations cannot yet fully be assessed. However, there is a significant possibility that the Dodd-Frank Act will result in an increased regulatory burden and compliance, operating and interest expense for Town Square and Poage Bankshares.
Federal Banking Regulation
Business Activities. A federal savings and loan association derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and the regulations of the OCC. Under these laws and regulations, Town Square may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other assets, subject to applicable limits. Town Square also may establish subsidiaries that may engage in activities not otherwise permissible for Town Square, including real estate investment and securities and insurance brokerage. The Dodd-Frank Act authorized depository institutions to commence paying interest on business checking accounts, effective July 21, 2011.
Capital Requirements. OCC regulations currently require savings and loan associations to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest rating on the CAMELS rating system), a 4% core capital to risk-weighted assets ratio and an 8% risk-based capital ratio.
The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 200%, assigned by the regulation, based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a federal savings and loan association that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings and loan association. In assessing an institution’s capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual associations where necessary.
At December 31, 2014, Town Square’s capital exceeded all applicable requirements.
New Capital Rule. On July 9, 2013, the OCC and the other federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies and top-tier savings and loan holding companies with total consolidated assets of $500 million or more.
The rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The minimum leverage ratio will be established at a uniform 4%.
The rule also includes changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. Finally, Tier 1 capital will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a two-year transition period. Town Square has the one-time option in the first quarter of 2015 to permanently opt out of the inclusion of accumulated other comprehensive income in its capital calculation. Town Square is considering whether to opt out in order to reduce the impact of market volatility on its regulatory capital levels.
The new capital requirements also include changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 day past due or otherwise on non-accrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (from 0% to up to 600%) for equity exposures.
Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
The final rule became effective for Town Square on January 1, 2015. The more stringent deduction requirements are subject to transition through January 1, 2018. The capital conservation buffer requirement will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets increasing each year until fully implemented at 2.5% on January 1, 2019.
Town Square Bank has conducted an analysis of the application of these new capital requirements as of December 31, 2014. We have determined that Town Square Bank meets all of these new requirements, as if these new requirements had been in effect on that date.
Loans-to-One Borrower. Generally, a federal savings and loan association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2014, Town Square was in compliance with its loans-to-one borrower limitations.
Qualified Thrift Lender Test. As a federal savings and loan association, Town Square must satisfy the qualified thrift lender, or “QTL,” test. Under the QTL test, Town Square must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” (primarily residential mortgages and related investments, including mortgage-backed securities) in at least nine months of the most recent 12-month period. “Portfolio assets” generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings bank’s business.
A federal savings and loan association that fails the QTL test must either convert to a commercial bank charter or operate under specified restrictions set forth in the Home Owners’ Loan Act. The Dodd-Frank Act made noncompliance with the QTL test potentially subject to agency enforcement action for a violation of law. At December 31, 2014, Town Square satisfied the QTL test with approximately 85.34% of its portfolio assets in qualified thrift investments.
Capital Distributions. Federal regulations govern capital distributions by a savings and loan association, which include cash dividends, stock repurchases and other transactions charged to the savings and loan association’s capital account. A federal savings and loan association must file an application for approval of a capital distribution if:
· the total capital distributions for the applicable calendar year exceed the sum of the savings and loan association’s net income for that year to date plus the savings and loan association’s retained net income for the preceding two years;
· the savings and loan association would not be at least adequately capitalized following the distribution;
· the distribution would violate any applicable statute, regulation, agreement or written regulatory condition; or
· the savings and loan association is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings and loan association that is a subsidiary of a holding company must still file a notice with the Federal Reserve Board at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
A notice or application for capital distribution may be disapproved if:
· the savings and loan association would be undercapitalized following the distribution;
· the proposed capital distribution raises safety and soundness concerns; or
· the capital distribution would violate a prohibition contained in any statute, regulation or regulatory condition.
In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution if, after making such distribution, the institution would fail to meet any applicable regulatory capital requirement. A federal savings and loan association also may not make a capital distribution that would reduce its regulatory capital below the amount required for the liquidation account established in connection with its conversion to stock form. In addition, beginning in 2016, Town Square’s ability to pay dividends will be limited if Town Square does not have the capital conservation buffer required by the new capital rules, which may limit the ability of Poage Bankshares to pay dividends to its stockholders.
Liquidity. A federal savings and loan association is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.
Community Reinvestment Act and Fair Lending Laws. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations of the OCC to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a federal savings and loan association, the OCC is required to assess the institution’s record of compliance with the Community Reinvestment Act. A savings and loan association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the OCC, as well as other federal regulatory agencies and the Department of Justice. Town Square received a satisfactory Community Reinvestment Act rating in its most recent federal examination. The Community Reinvestment Act requires all Federal Deposit Insurance-insured institutions to publicly disclose their rating. Town Square received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Transactions with Related Parties. A federal savings and loan association’s authority to engage in transactions with its affiliates is limited by OCC regulations and by Sections 23A and 23B of the Federal Reserve Act and its implementing Regulation W promulgated by the Federal Reserve Board. An affiliate is generally a company that controls, is controlled by, or is under common control with an insured depository institution such as Town Square. Poage Bankshares is an affiliate of Town Square. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative and collateral requirements. In addition, OCC regulations prohibit a savings and loan association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates. The OCC requires federal savings associations to maintain detailed records of all transactions with affiliates.
Town Square’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders:
(i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and
(ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Town Square’s capital.
In addition, extensions of credit in excess of certain limits must be approved by Town Square’s Board of Directors. Extensions of credit to executive officers are subject to additional limits based on the type of credit extension involved. As of December 31, 2014 Town Square is in compliance with these credit limitations.
Enforcement. The OCC has primary enforcement responsibility over federal savings associations and has the authority to bring enforcement action against all “institution-affiliated parties,” including directors, officers, stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on the savings and loan association. Formal enforcement action by the OCC may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution, and the appointment of a receiver or conservator. Civil money penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance or to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If such action is not taken, the FDIC has authority to take action under specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Prompt Corrective Action Regulations. Under prompt corrective action regulations, the OCC is authorized and, under certain circumstances, required to take supervisory actions against undercapitalized savings and loan associations. For this purpose, a federal savings and loan association is placed in one of the following five categories based on the savings association’s capital:
· well-capitalized (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total risk-based capital);
· adequately capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital and 8% total risk-based capital);
· undercapitalized (less than 4% leverage capital, 4% Tier 1 risk-based capital or 8% total risk-based capital);
· significantly undercapitalized (less than 3% leverage capital, 3% Tier 1 risk-based capital or 6% total risk-based capital); and
· critically undercapitalized (less than 2% tangible capital).
Generally, the OCC is required to appoint a receiver or conservator for a savings bank that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the OCC within 45 days of the date a savings and loan association receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for a savings and loan association that is required to submit a capital restoration plan must guarantee the lesser of an amount equal to 5% of the association’s assets at the time it was notified or deemed to be undercapitalized by the OCC, or the amount necessary to restore the savings and loan association to adequately capitalized status. This guarantee remains in place until the OCC notifies the saving and loan association that it has maintained adequately capitalized status for each of four consecutive calendar quarters, and the OCC has the authority to require payment and collect payment under the guarantee. Failure by a holding company to provide the required guarantee will result in certain operating restrictions on the savings and loan association, such as restrictions on the ability to declare and pay dividends, pay executive compensation and management fees, and increase assets or expand operations. The OCC may also take any one of a number of discretionary supervisory actions against undercapitalized associations, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At December 31, 2014, Town Square met the criteria for being considered “well-capitalized.”
In addition, the final capital rule adopted in July 2013 revises the prompt corrective action categories to incorporate the revised minimum capital requirements of that rule when it becomes effective. The OCC’s prompt corrective action standards will change when these new capital ratios become effective. Under the new standards, in order to be considered well-capitalized, Town Square would have to have a common equity Tier 1 ratio of 6.5% (new), a Tier 1 risk-based capital ratio of 8.0% (increased from 6.0%), a total risk-based capital ratio of 10.0% (unchanged), and a Tier 1 leverage ratio of 5.0% (unchanged). See “-New Capital Rule.”
Insurance of Deposit Accounts. Deposit accounts in Town Square are insured by the Federal Deposit Insurance Corporation generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The Federal Deposit Insurance Corporation charges the insured financial institutions premiums to maintain the Deposit Insurance Fund.
Under the Federal Deposit Insurance Corporation’s current risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Assessments are based on an individual institution’s category, with the institutions perceived as riskiest paying higher assessments.
In February 2011, the FDIC published a final rule under the Dodd-Frank Act to reform the deposit insurance assessment system. The rule redefined the assessment base used for calculating deposit insurance assessments effective April 1, 2011. Under the new rule, assessments are based on an institution’s average consolidated total assets minus average tangible equity instead of total deposits. The proposed rule revised the assessment rate schedule to establish assessments ranging from 2.5 to 45 basis points.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Town Square. Management cannot predict what assessment rates will be in the future.
In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. For the quarter ended December 31, 2014, the annualized FICO assessment rate equaled 0.60 basis point. The FICO assessment is based on total assets less tangible capital. The fourth quarter 2014 FICO assessment rate is 0.15 basis point. The bonds issued by the FICO are due to mature in 2017 through 2019.
Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
Prohibitions Against Tying Arrangements. FDIC insured savings and loan associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. Town Square is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the FHLB-Cincinnati, Town Square is required to acquire and hold shares of capital stock in the FHLB-Cincinnati. As of December 31, 2014, Town Square was in compliance with this requirement.
Other Regulations
Interest and other charges collected or contracted for by Town Square are subject to state usury laws and federal laws concerning interest rates. Town Square’s operations are also subject to federal laws applicable to credit transactions, such as the:
· Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
· Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;
· Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
· Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
· Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
· Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
· Truth in Savings Act;
· the Biggert-Waters Flood Insurance Reform Act of 2012; and
· rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. Town Square devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.
The operations of Town Square also are subject to the:
· Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
· Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
· Check Clearing for the 21 st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
· The USA PATRIOT Act, which requires savings and loan associations operating to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
· The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.
· Volcker Rule, which on December 10, 2013, in implementing section 619 of the Dodd-Frank Act, was approved by the OCC, the Federal Reserve, the FDIC, the SEC and the Commodities Futures Trading Commission (“CFTC”). The Volcker Rule attempts to reduce risk and banking system instability by restricting U.S. banks from investing in or engaging in proprietary trading and speculation and imposing a strict framework to justify exemptions for underwriting, market making and hedging activities. U.S. banks will be restricted from investing in funds with collateral comprised of less than 100% loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. The Company does not believe the Volcker Rule will have a significant effect on operations.
Holding Company Regulation
General. Poage Bankshares is a non-diversified savings and loan holding company within the meaning of the Home Owners’ Loan Act. As such, Poage Bankshares is registered with the Federal Reserve Board and subject to Federal Reserve Board regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve Board has enforcement authority over Poage Bankshares and its subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Permissible Activities. Under present law, the business activities of Poage Bankshares are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve Board, and certain additional activities authorized by Federal Reserve Board regulations.
Federal law prohibits a savings and loan holding company, including Poage Bankshares, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:
(i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and
(ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition.
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. When it reaches $500 million in total assets, Poage Bankshares, Inc. will be subject to the Federal Reserve Board’s capital adequacy regulations for savings and loan holding companies (on a consolidated basis). These capital standards have historically been similar to, though less stringent than, those of the OCC for Town Square. The Dodd-Frank Act, however, required the Federal Reserve Board to establish, for all savings and loan holding companies with total assets of $500 million or more, minimum consolidated capital requirements that are as stringent as those required for the insured depository subsidiaries. Under regulations recently enacted by the Federal Reserve Board and effective January 1, 2015, all such savings and loan holding companies will be subject to regulatory capital requirements that are the same as the new capital requirements for Town Square. These new capital requirements include provisions that, when applicable, might limit the ability of Poage Bankshares, Inc. to pay dividends to its stockholders or repurchase its shares. See “-Federal Banking Regulation-New Capital Rule.” Poage Bankshares, Inc. has conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2014, and has determined that it meets all of these new requirements, including the full 2.5% capital conservation buffer, and would be well-capitalized, if these new requirements had been in effect on that date.
Source of Strength. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has issued regulations requiring that all savings and loan holding companies serve as a source of managerial and financial strength to their subsidiary savings associations by providing capital, liquidity and other support in times of financial stress.
Dividends. The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The policy statement also states that a savings and loan holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the savings and loan holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies could affect the ability of Poage Bankshares to pay dividends or otherwise engage in capital distributions.
Acquisition. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of the company. A change in control definitively occurs upon the acquisition of 25% or more of the company’s outstanding voting stock. Under the Change in Bank Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.
Federal Securities Laws
Our common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. We are subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
Future Changes in Interest Rates Could Reduce Our Profits.
Future changes in interest rates could impact our financial condition and results of operations.
Net income is the amount by which net interest income and non-interest income exceeds non-interest expense and the provision for loan losses. Net interest income makes up a majority of our income and is based on the difference between:
· interest income earned on interest-earning assets, such as loans and securities; and
· interest expense paid on interest-bearing liabilities, such as deposits and borrowings.
We are vulnerable to changes in interest rates including the shape of the yield curve because of a mismatch between the terms to repricing of our assets and liabilities. Historically, our liabilities repriced more quickly than our assets, which made us vulnerable to increases in interest rates. For the years ended December 31, 2014 and September 30, 2013, our net interest margin was 4.16% and 3.27%, respectively and for the three months ended December 31, 2013 our net interest margin was 3.54%. Our Asset/Liability Management Committee utilizes a computer simulation model to provide an analysis of estimated changes in net interest income in various interest rate scenarios. At December 31, 2014, in the event of an immediate 100 basis point decrease in interest rates, our model projects an increase in our net portfolio value of $573,000, or 0.65%. In the event of an immediate 200 basis point increase in interest rates, our model projects a decrease in our net portfolio value of $1.7 million, or 2.00%.
Changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable-rate loans.
We Have Increased and Plan to Continue to Increase Our Levels of Commercial Real Estate, Multi-Family, Commercial Business and Construction and Land Loans, Which Would Increase Our Exposure to Credit Risks.
At December 31, 2014, our portfolio of commercial real estate, multi-family, commercial business and construction and land loans totaled $99.6 million, or 32.7% of our total loans, compared to $26.0 million, or 14.5% of our total loans at December 31, 2013. We intend to continue to emphasize the origination of these types of loans consistent with safety and soundness.
Non-residential loans generally expose a lender to a greater risk of loss than one- to four-family residential loans. Repayment of such loans generally depends, in large part, on sufficient income from the property or the borrower’s business, respectively, to cover operating expenses and debt service. These types of loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Changes in economic conditions that are beyond the control of the borrower and lender could affect the value of the security for the loan, the future cash flow of the affected property or business, or the marketability of a construction project with respect to loans originated for the acquisition and development of property. As we increase our portfolio of these loans, we may experience higher levels of non-performing assets and/or loan losses.
We target our business lending and marketing strategy towards small- to medium-sized businesses. These small- to medium-sized businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions negatively impact these businesses, our results of operations and financial condition may be adversely affected.
As a result of the acquisition of Town Square Financial Corporation and Town Square Bank, our portfolio of commercial real estate, multi-family and commercial business loans has increased significantly, which will further increase our exposure to the risks associated with these types of loans. We conducted a thorough review of Town Square Bank’s loan portfolio and made certain assumptions as to the future performance of these loans and the likelihood that such loans would become delinquent or subject to charge-offs in the future. The assessment of the risk as related to Town Square Bank’s loan portfolio is based upon assumptions that may be inaccurate, or may become inaccurate based upon uncertainties, contingencies, and factors beyond the control of Poage Bankshares.
We May Not Be Successful in Executing Our Plan to Increase Significantly the Percentage of Our One- to Four-Family Residential Mortgage Loans With Adjustable-Rate Mortgages.
In order to reduce our vulnerability to changes in interest rates, in 2009, we changed our business strategy to increase our focus on adjustable-rate mortgage loans. In addition, in fiscal year 2010, we began selling substantially all of our originated fixed-rate one- to four-family residential mortgage loans.
Historically, it has often been difficult for thrift institutions to originate adjustable-rate mortgage loans with a spread that compares favorably with the cost of funds. In addition, borrower demand for adjustable-rate mortgage loans decreases significantly during periods of low interest rates, including the current low interest rate environment. During the year ended December 31, 2014, we were able to originate $22.4 million of adjustable-rate mortgage loans, most of which carried rates that adjust annually after five years at a spread of 3.5% over the applicable index (the weekly average yield on United States Treasury securities). At December 31, 2014, $130.6 million, or 42.9% of our total loan portfolio, consisted of adjustable-rate mortgage loans.
Although adjustable-rate mortgage loans may reduce, to an extent, our vulnerability to changes in market interest rates because they periodically reprice, as interest rates increase the required payments due from the borrower also increase (subject to rate caps), increasing the potential for default by the borrower. At the same time, the ability of the borrower to repay the loan and the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on most of our adjustable-rate loans do not adjust for up to five years after origination. As a result, the effectiveness of adjustable-rate mortgage loans in compensating for changes in general interest rates may be limited during periods of rapidly rising interest rates.
Our loan portfolio includes a substantial number of motor vehicle loans, as well as other consumer loans. At December 31, 2014, our consumer loans totaled $25.1 million, or 8.2% of our total loan portfolio, of which motor vehicle loans totaled $10.3 million, or 3.4% of total loans.
As of December 31, 2014, we had $24,000 of motor vehicle loans delinquent 60 days or more, which was 1.0% of total delinquent loans 60 days or more past due. For the twelve months ended December 31, 2014, we had charge-offs of motor vehicle loans totaling $6,000. As we continue to increase our automobile loan portfolio, we may experience increased delinquencies and charge-offs in future periods.
Consumer loans generally have a greater risk of loss or default than one- to four-family residential real estate loans, particularly in the case of loans that are secured by rapidly depreciable assets, such as automobiles. We face the risk that any collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. Thus, the recovery and sale of such property could be insufficient to compensate us for the principal outstanding on these loans. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit our ability to recover on such loans. As a result of our relatively large portfolio of consumer loans, it may become necessary to increase our provision for loan losses in the event our losses on these loans increase, which would reduce our profits.
If Our Allowance for Loan Losses Is Not Sufficient to Cover Actual Loan Losses, Our Earnings Will Decrease.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to our allowance. While our allowance for loan losses was 0.63% of total loans at December 31, 2014, future additions to our allowance could materially decrease our net income.
In addition, the OCC periodically reviews our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by regulatory authorities might have a material adverse effect on our financial condition and results of operations.
The Expiration of Full FDIC Insurance on Certain Non-Interest-Bearing Transaction Accounts May Increase Our Costs and Reduce Our Liquidity Levels. Increased FDIC Insurance Assessments Could Significantly Increase Our Expenses.
On December 31, 2012, full FDIC insurance on certain non-interest-bearing transaction accounts expired. Full insurance coverage does not apply to money market deposit accounts or negotiable order of withdrawal accounts. The reduction in FDIC insurance on other types of accounts may cause depositors to place such funds in fully insured interest-bearing accounts, which would increase our costs of funds and negatively affect our results of operations, or may cause depositors to withdraw their deposits and invest uninsured funds in investments perceived as being more secure, such as securities issued by the United States Treasury. This may reduce our liquidity, or require us to pay higher interest rates to maintain our liquidity by retaining deposits.
In addition, the FDIC may increase deposit insurance fees and expenses. In particular, if our regulators issue downgraded ratings of Town Square in connection with their examinations, the FDIC could impose significant additional fees and assessments on us.
The United States Economy Remains Weak and Unemployment Levels Are High. Continued Adverse Economic Conditions, Especially Affecting Our Geographic Market Area, Could Adversely Affect Our Financial Condition and Results of Operations.
The United States experienced a severe economic recession in 2008 and 2009, the effects of which have continued. Recent growth has been slow and unemployment remains at high levels; as a result, economic recovery is expected to be slow. Loan portfolio quality has remained poor at many financial institutions reflecting, in part, the weak United States economy and high unemployment rates. In addition, the value of real estate collateral supporting many commercial loans and home mortgages throughout the United States has declined. The real estate downturn also has resulted in reduced demand for the construction of new housing and increased delinquencies in construction, residential and commercial mortgage loans in many markets across the United States.
Our lending market area consists of Greenup, Lawrence, Boyd and Jessamine Counties in Kentucky, and Lawrence and Scioto Counties in Ohio. Five of these six counties have experienced minimal changes in population and households from April 1, 2010 to July 1, 2013, including population growth or shrinkage of -1.1%, 0.0%, -1.3%, 3.3%, -0.9% and -1.7%, respectively. In addition, five of these six counties have recorded only modest changes in the number of households from 2000 to 2010, consisting of household growth or shrinkage of 5.7%, 8.9%, 0.3%, 29.5%, 2.9% and -1.5%, respectively. While we did not originate or invest in sub-prime mortgages, our lending business is tied, in part, to the real estate market, which has been weakened by the recession. While we believe our lending market area has not been as adversely affected by the real estate crisis as some other areas of the country, real estate values and demand have softened and we remain vulnerable to adverse changes in the real estate market. In addition, a significant weakening in general economic conditions such as inflation, recession, unemployment or other factors beyond our control, could negatively affect our financial results. Finally, negative developments in the securities markets could adversely affect the value of our securities.
If We Fail to Maintain an Effective System of Internal and Disclosure Controls, We May Not Be Able to Accurately Report Our Financial Results or Prevent or Detect Fraud. As a Result, Current and Potential Shareholders Could Lose Confidence in Our Financial Reporting, Which Would Harm Our Business and the Trading Price of Our Securities.
Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent or detect fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We continually review and analyze our internal control over financial reporting for Sarbanes-Oxley Section 404 compliance. As part of that process, during the first quarter of the fiscal year ended September 30, 2013, we discovered and disclosed material weaknesses in our internal control over financial reporting, and identified certain deficiencies in some of our disclosure controls and procedures that required remediation. Although we have made efforts to improve our internal control over financial reporting and disclosure controls and procedures, our improved internal control and disclosure controls may still prove ineffective in future periods. Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could hinder our ability to accurately report our operating results or cause us to fail to meet our reporting obligations, which could affect our ability to remain listed with The NASDAQ Capital Market. Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our securities.
Government Responses to Economic Conditions May Adversely Affect Our Operations, Financial Condition and Earnings.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has changed the bank regulatory framework. For example, it has created an independent Consumer Financial Protection Bureau that has assumed the consumer protection responsibilities of the various federal banking agencies, established more stringent capital standards for banks and bank holding companies and gives the Federal Reserve Board exclusive authority to regulate savings and loan holding companies. The legislation has also resulted in new regulations affecting the lending, funding, trading and investment activities of banks and bank holding companies. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Town Square, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Banks and savings institutions with $10.0 billion or less in assets will continue to be examined by their applicable bank regulators. The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws. The Dodd-Frank Act also requires the federal banking agencies to promulgate rules requiring mortgage lenders to retain a portion of the credit risk related to loans that are securitized and sold to investors. We expect that such rules would make it more difficult for us to sell loans into the secondary market. Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations. Ongoing uncertainty and adverse developments in the financial services industry and in the domestic and international credit markets, and the effect of new legislation and regulatory actions in response to these conditions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms, or foreclose on property securing loans.
Effective July 21, 2011, the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts, which could result in an increase in our interest expense.
The Dodd-Frank Act also broadened the base for FDIC deposit insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than deposits. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009. The legislation also increased the required minimum reserve ratio for the Deposit Insurance Fund from 1.15 to 1.35% of insured deposits, and directs the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets.
The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. It also provides that the listing standards of the national securities exchanges shall require listed companies to implement and disclose “clawback” policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting restatements. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives.
Effective December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued final rules to implement Section 619 of the Dodd-Frank Act (the “Volcker Rule”). Generally, subject to a transition period and certain exceptions, the Volcker Rule restricts insured depository institutions and their affiliated companies from engaging in short-term proprietary trading of certain securities, investing in funds with collateral comprised of less than 100% loans that are not registered with the Securities and Exchange Commission (“SEC”) and from engaging in hedging activities that do not hedge a specific identified risk. After the transition period, the Volcker Rule prohibitions and restrictions will apply to banking entities, including Poage Bankshares, unless an exception applies.
The full impact of the Dodd-Frank Act on our business will not be known until all of the regulations implementing the statute are adopted and implemented. As a result, we cannot at this time predict the extent to which the Dodd-Frank Act will impact our business, operations or financial condition. However, compliance with these new laws and regulations may require us to make changes to our business and operations and will likely result in additional costs and divert management’s time from other business activities, any of which may adversely impact our results of operations, liquidity or financial condition.
Furthermore, the Federal Reserve Board, in an attempt to help the overall economy, has, among other things, adopted a low interest rate policy through its targeted federal funds rate and the purchase of mortgage-backed securities. If the Federal Reserve Board increases the federal funds rate, market interest rates would likely rise, which may negatively affect the housing markets and the U.S. economic recovery.
The Short-Term and Long-Term Impact of the Changing Regulatory Capital Requirements and New Capital Rules is Uncertain.
On July 9, 2013, the OCC and the other federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies and top-tier savings and loan holding companies with total consolidated assets of $500 million or more. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule became effective for Town Square on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
Under the new capital standards, in order to be well-capitalized, Town Square would be required to have a common equity to tier 1 capital ratio of 6.5% and a tier 1 capital ratio of 8.0%. We have conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2014 and have determined that Town Square meets all of these new requirements, including the full 2.5% capital conservation buffer, as if these new requirements had been in effect on that date.
The application of more stringent capital requirements for Town Square could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy, and could limit our ability to make distributions, including paying out dividends or buying back shares. Specifically, beginning in 2016, Town Square’s ability to pay dividends will be limited if Town Square does not have the capital conservation buffer required by the new capital rules, which may limit our ability to pay dividends to stockholders. See “Regulation and Supervision-Federal Banking Regulation-New Capital Rule.”
Strong Competition Within Our Market Areas May Limit Our Growth and Profitability.
Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. In our six-county market area, including Boyd, Greenup, Lawrence and Jessamine Counties in Kentucky and Lawrence and Scioto Counties in Ohio, there are a total of 26 commercial bank and savings institution competitors, along with several credit union competitors. The commercial banks and savings institutions operate a total of 101 branch offices in those counties, containing $2.7 billion of deposits. The commercial bank and savings institution competitors include larger institutions with nationwide or regional operations, and local community institutions such as us that serve the local markets only. The credit union competitors consist of local community based institutions. Some of our competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we can, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends upon our continued ability to successfully compete in our market areas. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected. For additional information see “Item 1 - Business-Town Square-Market Area” and -“Competition.”
The financial services industry could become even more competitive as a result of new legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.
We Are a Community Bank and Our Ability to Maintain Our Reputation is Critical to the Success of Our Business and the Failure to Do So May Materially Adversely Affect Our Performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely affected. We will continue to face additional challenges maintaining our reputation with respect to customers of Town Square in our current market area and in building our reputation in the new market areas that we serve as a result of the acquisition of Town Square Financial and Town Square Bank and will serve as a result of the acquisition of Commonwealth Bank.
We Depend on Our Management Team to Implement Our Business Strategy and Execute Successful Operations and We Could Be Harmed by the Loss of Their Services.
We are dependent upon the services of our senior management team. Our strategy and operations are directed by the senior management team. Any loss of the services of our president and chief executive officer or other members of our senior management team could impact our ability to implement our business strategy, and have a material adverse effect on our results of operations and our ability to compete in our markets. See “Directors, Executive Officers and Corporate Governance.”
We Operate in a Highly Regulated Environment and May Be Adversely Affected by Changes in Laws and Regulations.
We are subject to extensive regulation, supervision, and examination by the OCC, the FDIC, and the Federal Reserve Board. Such regulators govern the activities in which we may engage, primarily for the protection of depositors. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a financial institution, the classification of assets by a financial institution, and the adequacy of a financial institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on us and our operations. Because our business is highly regulated, the applicable laws, rules and regulations are subject to regular modification and change. Laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
Changes in Accounting Standards Could Affect Reported Earnings.
The accounting standard setters, including the Financial Accounting Standards Board, the Securities and Exchange Commission and other regulatory bodies, periodically change the financial accounting and reporting guidance that governs the preparation of our consolidated financial statements. These changes can be hard to predict and can materially affect how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.
The Issuance of Awards Under Our Stock-Based Benefit Plans Will Dilute Your Ownership Interest.
On January 8, 2013, the shareholders of Poage Bankshares approved the Poage Bankshares, Inc. 2013 Equity Incentive Plan (the “Plan”) for employees and directors of Poage Bankshares. The Plan authorizes the issuance of up to 472,132 shares of Poage Bankshares common stock, with no more than 134,895 of shares as restricted stock awards and 337,237 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Plan may not be less than the fair value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted. If awards under the Plan are funded from the issuance of authorized but unissued shares of common stock, Poage Bankshares stockholders would experience a dilution of their ownership interest. On April 16, 2013, the board of directors awarded the authorized 134,895 restricted shares as designated by the compensation committee and through December 31, 2014 have granted 320,000 stock option awards and restricted shares. The implementation of any additional stock-based benefit plans in the future would cause further dilution of such ownership interests.
The Price of Poage Bankshares Common Stock Might Decrease As a Result of our Acquisition of Commonwealth Bank and May Be Affected By Factors Different from Those Affecting the Shares of Poage Bankshares Prior to the Acquisition.
Poage Bankshares common stock could decline in value due the acquisition of Commonwealth Bank. For example, during the twelve month period ending on December 31, 2014, the price of Poage Bankshares common stock varied from a low of $12.46 to a high of $16.60 and ended that period at $14.87. The market value of Poage Bankshares common stock fluctuates based upon general market economic conditions, Poage Bankshares’ business and prospects and other factors.
Poage Bankshares’ business differs in important respects from that of Commonwealth Bank, and, accordingly, the results of operations of the combined company and the market price of Poage Bankshares common stock in the future may be affected by factors different from those that affected the independent results of operations of Poage Bankshares.
Poage Bankshares May Fail to Realize the Anticipated Benefits of the Acquisitions, and the Value of the Poage Bankshares Stock May Decline.
The success of the acquisitions of Town Square Financial and Commonwealth Bank will depend on, among other things, Poage Bankshares’ ability to realize anticipated cost savings and to combine the businesses of Poage Bankshares and with the business of Town Square Financial and Commonwealth Bank in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of Town Square Financial and Commonwealth Bank or result in decreased revenues resulting from any loss of customers. If Poage Bankshares is not able to successfully achieve these objectives, the anticipated benefits of the acquisitions may not be realized fully or at all or may take longer to realize than expected, adversely affecting the financial condition and results of operations of Poage Bankshares and the value of Poage Bankshares common stock.
Certain employees of Town Square Financial have not been and certain employees of Commonwealth Bank may not be employed by Poage Bankshares or Town Square after the acquisitions. In addition, employees of either company that Poage Bankshares has retained may elect to terminate their employment. Replacing such employees or tasking existing employees with such employees’ responsibilities could result in inconsistencies in standards, controls, procedures and policies that adversely affect the ability of both parties to maintain relationships with their respective customers and employees or the ability of Poage Bankshares to achieve the anticipated benefits of the acquisition.
Stockholder Activists Could Cause a Disruption to Poage Bankshares’ Business.
Certain institutional investors have indicated that they disagree with the strategic direction and capital allocation policies of Poage Bankshares and may seek representation on its Board of Directors through a director election contest. Poage Bankshares’ business, operating results or financial condition could be adversely affected by a director election contest and may result in, among other things:
· Increased operating costs, including increased legal expenses, insurance, administrative expenses and associated costs incurred in connection with director election contests;
· Uncertainties as to Poage Bankshares’ future direction could result in the loss of potential business opportunities and could (i) make it more difficult to attract, retain, or motivate qualified personnel, and (ii) strain relationships with investors and customers; and
· If an activist investor’s nominees are elected to the Board of Directors of Poage Bankshares, it may reduce or delay Poage Bankshares’ ability to effectively execute its current business strategy and to implement new strategies.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2014, the net book value of our offices was $8.0 million.
We believe that current facilities are adequate to meet our present and foreseeable needs, subject to possible future expansion.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any pending legal proceedings as a plaintiff or a defendant other than routine legal proceedings occurring in the ordinary course of business. At December 31, 2014, we were not involved in any legal proceedings, the outcome of which would be material to our financial condition or results of operations.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) Our shares of common stock are traded on the NASDAQ Capital Market under the symbol PBSK. The approximate number of holders of record of Poage Bankshares, Inc.’s common stock as of December 31, 2014 was 474. Certain shares of Poage Bankshares, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following table presents quarterly market information for Poage Bankshares, Inc. common stock for each quarter of the previous two fiscal years. Poage Bankshares, Inc. began trading on the NASDAQ Capital Market on September 13, 2011. The following information was provided by the NASDAQ Stock Market.
Dividend payments by Poage Bankshares, Inc. are dependent primarily on dividends it receives from Town Square, because Poage Bankshares, Inc. has no source of income other than dividends from Town Square, earnings from the investment of proceeds from the sale of shares of common stock retained by Poage Bankshares, Inc., and interest payments with respect to Poage Bankshares Inc.’s loan to the Employee Stock Ownership Plan. For more information on regulatory restrictions regarding the payment of dividends, see “Item 1 - Business-Supervision and Regulation-Dividends” and “-Holding Company Regulation-Permissible Activities.” For information regarding shares of Poage Bankshares common stock that is available for issuance under equity compensation plans, see “Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
Other than its employee stock ownership plan, Poage Bankshares, Inc. does not have any equity compensation plans that were not approved by stockholders.
(b) Not applicable.
(c) Issuer repurchases. The following table sets forth information in connection with repurchases of the Poage Bankshares’ common stock for the period January 1, 2014 through December 31, 2014. On June 14, 2013, the Board of Directors authorized the repurchase of up to 161,816 shares of Poage Bankshares common stock. Subsequently, on November 19, 2013, the Board of Directors terminated the June 14, 2013 repurchase authorization, and authorized the repurchase of up to 12,650 shares of Poage Bankshares common stock, pursuant to Securities and Exchange Commission rules regarding stock repurchases during the pendency of a merger transaction with Town Square Financial Corporation. The repurchase program commenced on or about November 21, 2013 and, in accordance with applicable Securities and Exchange Commission rules, terminated prior to the mailing of the proxy statement for the approval of the acquisition of Town Square Financial by its stockholders. On May 30, 2014, the Board of Directors authorized the repurchase of up to 195,244 shares of Poage Bankshares common stock. All shares indicated below were purchased pursuant to this repurchase authorization.
Poage Bankshares’ stock repurchases pursuant to the repurchase program is dependent on certain factors, including but not limited to, market conditions and prices, available funds and alternative uses of capital. The repurchase program may be carried out through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected historical financial and other data of Poage Bankshares for the years and at the dates indicated. The information at December 31, 2014 and 2013, and for the year ended December 31, 2014, for the three months ended December 31, 2013, and the year ended September 30, 2013 is derived in part from, and should be read together with, the audited consolidated financial statements and notes thereto of Poage Bankshares that appear in this Annual Report on Form 10-K. The information at September 30, 2013, 2012 and 2011 and the years ended September 30, 2012 and 2011 is derived in part from audited financial statements that do not appear in this Annual Report on Form 10-K.
Selected Financial and Other Data
(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.
(2) Represents net interest income as a percent of average interest-earning assets.
(3) Represents noninterest expense divided by the sum of net interest income and noninterest income.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We have historically operated as a traditional thrift institution headquartered in Ashland, Kentucky. Our principal business consists of attracting retail deposits from the general public in our market area and investing those deposits, together with funds generated from operations, and to a lesser extent, borrowings, in one- to four-family residential mortgage loans, commercial and multi-family real estate loans, commercial business loans, consumer loans, consisting primarily of automobile loans, home equity loans and lines of credit, and construction loans. Since the acquisition of Town Square Financial Corporation, our focus has moved towards commercial banking. We also purchase investment securities consisting primarily of securities issued by United States Government agencies and government sponsored entities, including obligations of state and political subdivisions and mortgage-backed securities. At December 31, 2014, we had total assets of $414.7 million, total deposits of $323.1 million and total equity of $68.2 million.
Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our results of operations also are affected by our provisions for loan losses, non-interest income and non-interest expense. Non-interest income currently consists primarily of service charges on deposit accounts, net gain on sales of securities and loans, income from company-owned life insurance and miscellaneous other income. Non-interest expense currently consists primarily of expenses related to compensation and employee benefits, occupancy and equipment, data processing, federal deposit insurance, foreclosed assets, advertising, professional and accounting fees, and other operating expenses.
Other than our loans for the construction of one- to four-family properties, we do not offer “interest only” mortgage loans (where the borrower pays only interest for an initial period, after which the loan converts to a fully amortizing loan) on one- to four-family residential properties. We also do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on his or her loan, resulting in an increased principal balance during the life of the loan. We do not offer “subprime loans” (i.e., loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (i.e., loans that generally target borrowers with better credit scores who borrow with alternative documentation, such as little or no verification of income).
Business Strategy
Highlights of our current business strategy include the following:
· Continuing to emphasize one- to four-family residential mortgage loans while increasing our holdings of such loans with adjustable rates. We have been primarily a one- to four-family residential mortgage lender to borrowers in our market area. As of December 31, 2014, $179.5 million, or 43.3%, of our total assets consisted of one- to four-family residential mortgage loans, compared to $135.2 million, or 46.7%, of total assets at December 31, 2013. We historically have held primarily fixed-rate loans in our one- to four-family residential mortgage loan portfolio. However, in order to better manage the interest rate sensitivity of our loan portfolio, in 2009 we began to increase our emphasis on adjustable-rate mortgage loan originations subject to demand for such loans in a lower interest rate environment. In addition, in fiscal year 2010, we began selling substantially all of our new fixed-rate one- to four-family residential mortgage loans through the FHLB-Cincinnati Mortgage Purchase Program.
· Increasing our origination of commercial real estate loans, commercial business loans, home equity loans and lines of credit, and other consumer loans. While we will continue to emphasize one- to four-family residential mortgage loans, we also intend to continue to increase our origination of nonresidential real estate loans, home equity loans and lines of credit, other consumer loans and commercial business loans in order to increase the yield of, and reduce the term to repricing of, our total loan portfolio. Between December 31, 2013 and December 31, 2014, commercial real estate loans increased $45.7 million, or 263.6%, commercial business loans increased $19.9 million, or 352.5%, home equity loans and lines of credit increased $2.0 million or 33.9%, and other consumer loans increased $5.2 million, or 44.3%. This growth is attributable to the acquisition of Town Square Financial Corporation. We expect each of these loan categories to continue to grow over the next three years. The additional capital raised in the stock offering increased our commercial real estate lending capacity by enabling us to originate more loans and loans with larger balances. See “Item 1 - Business-Town Square Bank-Lending Activities-Commercial Real Estate Lending.”
· Managing interest rate risk while enhancing to the extent practicable our net interest margin. During the last several years, we have taken steps that are intended to enhance our interest rate margin (in relation to what it would have been had we remained exclusively a residential lender) as well as our ability to manage our interest rate risk in the future. In particular, we have attempted to increase our holdings of nonresidential loans including commercial real estate loans, commercial business loans, and consumer loans, which generally have shorter terms to maturity and higher yields than fixed-rate one- to four-family mortgage loans, and which allows us to reinvest these funds into market-rate loans as interest rates change. Our portfolio of these types of loans increased significantly as a result of the acquisition of Town Square Financial Corporation. In addition, we have increased our origination of adjustable-rate one- to four-family residential loans and have developed a secondary market capability with the FHLB-Cincinnati so that we can sell our new fixed-rate one- to four-family mortgage loans that do not fit within our asset/liability management parameters.
· Increasing our “core” deposit base. We are seeking to build our core deposit base, with particular focus on NOW accounts and non-interest bearing demand accounts. We believe such core deposits not only have favorable cost and interest rate change resistance, but also allow us greater opportunity to connect with our customers and offer them other financial services and products. As part of this plan, we added a new branch office in Greenup in 2009 and installed ATMs at all of our retail offices. In addition, we added two branches in connection with our acquisition of Town Square Financial Corporation, which increased our core deposit base by approximately $26 million. We will continue to provide our high quality service and products, including our reward checking program, as well as competitive pricing to attract deposits.
· Expanding our banking relationships to a larger base of customers. We were established in 1889 and have been operating continuously since that time. As of June 30, 2014 (the latest date for which deposit market share information is available from the FDIC), our market share of deposits represented 17.74% of FDIC-insured deposits in Boyd, Greenup, Lawrence and Jessamine Counties in Kentucky, combined taking into account the acquisition of Town Square Bank. We will seek to expand our customer base, primarily through opportunistic acquisitions and organic growth, and offer our products and services to the new base of customers by using our recognized brand name and the goodwill developed over years of providing timely, efficient banking services.
· Maintaining strong asset quality. We have emphasized maintaining strong asset quality by following conservative underwriting guidelines, sound loan administration, and focusing on loans secured by real estate located within our primary market area. Our nonperforming assets totaled $5.2 million, or 1.3% of total assets at December 31, 2014. Our nonperforming loans totaled $3.4 million, or 1.1% of total loans at December 31, 2014.
Critical Accounting Policy
We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on income or on the carrying value of certain assets, to be critical accounting policies. We consider the following to be our critical accounting policy:
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.
A loan is impaired when full payment under the terms of the loan is not expected. Commercial and non-residential real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Accounting for Business Combination: During 2014, the Company completed its acquisition of Town Square Financial Corporation. The transaction was accounted for in accordance with the acquisition method as outlined in ASC Topic 805, Business Combinations and ASC Topic 310, Receivables. The acquisition method requires: a) identification of the entity that obtains control of the acquired; b) determination of the acquisition date; c) recognition and measurement of the identifiable assets acquired and liabilities assumed at fair value; and d) recognition and measurement of goodwill or bargain purchase gain.
Acquired loans are recorded at their estimated fair values, which includes a credit component, and the allowance for loan losses is not carried over. Loans with evidence of credit deterioration since origination are accounted under ASC 310-30. Under this guidance, the Company estimates the amount and timing of expected cash flows in excess of the amount paid, which is recorded as interest income over the remaining life (accretable yield). The excess of the contractual principal and interest over the expect cash flow is not recorded (non-accretable difference). Loans with no evidence of credit deterioration are recorded at their estimated fair value, with the difference between fair value and amortized cost amortized or accreted into income using the interest method. Credit deterioration post acquisition is recorded as provision expense.
Discounts or premiums on other financial instruments are also amortized or accreted into income over the life using the income method.
Comparison of Financial Condition at December 31, 2014 and December 31, 2013
At December 31, 2014, the Poage Bankshares’ assets totaled $ 414.7 million, an increase of $125.5 million, or 43.4% from $289.2 million at December 31, 2013. The increase was attributed primarily to the acquisition of Town Square Financial Corporation.
Cash and Cash equivalents increased by $10.3 million, or 153.8% to $17.0 million at December 31, 2014 from $6.7 million at December 31, 2013, primarily due to the acquisition of Town Square Financial Corporation and the sale of $19.7 million in available for sale securities.
Loans held for sale increased $405,000, or 131.9%, to $712,000 at December 31, 2014 from $307,000 at December 31, 2013.
Loans receivable, net, increased $124.9 million, or 70.5%, to $302.0 million at December 31, 2014 from $177.1 million at December 31, 2013. Non-performing loans increased $2.5 million, or 270.0%, from $926,000 at December 31, 2013 to $3.4 million at December 31, 2014. These increases were primarily due to the acquisition of Town Square Financial Corporation.
Securities available for sale decreased by $20.8 million, or 24.2%, to $65.3 million at December 31, 2014 from $86.1 million at December 31, 2013. This decrease is due to $41.0 million in sales, calls, regular maturities and principal payments partially offset by an increase of securities totaling $14.7 million attributable to the acquisition of Town Square Financial Corporation and purchases totaling $3.9 million.
Deposits increased $113.7 million, or 54.3%, to $323.1 million at December 31, 2014 from $209.4 million at December 31, 2013. The increase was primarily attributable to the acquisition of Town Square Financial Corporation.
Federal Home Loan Bank advances decreased $2.0 million, or 10.1%, to $18.0 million at December 31, 2014 from $20.0 million at December 31, 2013. This decrease in borrowings was primarily due to $82.0 million in regular principal payments and maturities offset by $65.0 million in advances and $15.0 million in borrowings acquired from Town Square Financial Corporation.
Other borrowings increased by $2.7 million to $2.7 million at December 31, 2014 from $0 at December 31, 2013 as a result of the assumption of $4.0 million of subordinated debt assumed in conjunction with acquisition of Town Square Financial Corporation. In December 2006, Town Square Statutory Trust I, a trust formed by Town Square Financial Corporation, closed a pooled private offering of 4,124 trust preferred securities with a liquidation amount of $1,000 per security. The subordinated debt of $2.7 million is shown as a liability. The investment in common stock of the trust is $124,000 and is included in other assets. The subordinated debt has a variable rate of interest equal to the three month London Interbank Offered Rate (LIBOR) plus 1.83%, which was 2.07% at December 31, 2014.
Total shareholders’ equity increased by $10.5 million to $68.2 million at December 31, 2014, compared to $57.7 million at December 31, 2013. The increase resulted primarily from the issuance of common stock to acquire Town Square Financial Corporation of $7.6 million, net of issuance costs, and an increase in other comprehensive income of $1.3 million, net income of $1.8 million for the year ended December 31, 2014, offset by the payment of cash dividends totaling $702,000 and repurchase of stock totaling $410,000.
Comparison of Operating Results for the Years Ended December 31, 2014 and December 31, 2013
General. Net income increased $284,000, or 18.2%, to $1.8 million for the year ended December 31, 2014 from net income of $1.6 for the year ended December 31, 2013. The increase reflected an increase in net interest income of $5.9 million, or 62.3%, to $15.4 million for the year ended December 31, 2014 from $9.5 million for the year ended December 31, 2013, and increase in non-interest income of $555,000, or 25.5%, to $2.7 million for the year ended December 31, 2014 from $2.2 million for the year ended December 31, 2013 offset by an increase in non-interest expense of $5.9 million, or 63.8%, to $15.2 million for the year ended December 31, 2014 from $9.3 million for the year ended December 31, 2013.
Interest Income. Interest income increased $6.0 million, or 51.8%, to $17.6 million for the year ended December 31, 2014 from $11.6 million for the year ended December 31, 2013.
Interest income on loans increased $6.1 million, or 63.6%, to $15.7 million for the year ended December 31, 2014 from $9.6 million for the year ended December 31, 2013. The average yields on loans increased to 5.68% for the year ended December 31, 2014, compared to 5.45% for the year ended December 31, 2013 and the average balance of loans increased to $275.6 million for the year ended December 31, 2014 from $175.5 million for the year ended December 31, 2013. Interest income on investment securities decreased $106,000, or 14%, to $1.8 million for the year ended December 31, 2014 from $1.9 million for the year ended December 31, 2013, reflecting a decrease in the average balance of such securities to $77.1 million at December 31, 2014 from $92.9 million at December 31, 2013 offset by an increase in the average yield to 2.35% for the year ended December 31, 2014, from 2.07% for the year ended December 31, 2013. This increase in yield is due to investing in mortgage backed securities.
Interest Expense. Interest expense increased $82,000, or 3.9%, to $2.2 million for the year ended December 31, 2014 from $2.1 million for the year ended December 31, 2013. The increase reflected an increase in the average balance on interest bearing deposits to $264.6 million at December 31, 2014 from $217.1 million at December 31, 2013, offset by a decrease in the rate paid on such deposits to 0.65% for the year ended December 31, 2014 from 0.77% for the year ended December 31, 2013. Interest expense on FHLB-Cincinnati advances and subordinated debenture increased $35,000, or 8.3% to $455,000 for the year ended December 31, 2014 from $420,000 for the year ended December 31, 2013. This increase was due to an increase of $12.7 million in the average balance of these borrowings offset by a 16 basis point decrease to 0.74% from 0.90% in the average rate paid on these borrowings.
Interest expense on certificates of deposit increased $7,000, or 0.47%, to $1.5 million for the year ended December 31, 2014 from $1.5 million for the year ended December 31, 2013. This slight increase reflected and increase in the average balance of such certificates to $156.4 million from $130.6 million offset by a decrease in the average rate paid on certificates of deposits to 0.96% for the year ended December 31, 2014 from 1.15% for the year ended December 31, 2013. Interest expense on money market deposits, savings, NOW and demand deposits increased $40,000, or 24.5%, to $203,000 for the year ended December 31, 2014 from $163,000 for the year ended December 31, 2013. The increase reflected an increase in the average balance of these deposits to $108.2 million at December 31, 2014 from $86.5 million at December 31, 2013. The average rate paid on these deposits remained unchanged at 0.19% for the year ended December 31, 2014 and 0.19% for the year ended December 31, 2013.
Net Interest Income. Net interest income increased $5.9 million, or 62.3%, to $15.4 million for the year ended December 31, 2014 from $9.5 million for the year ended December 31, 2013. The interest rate spread increased to 4.01% from 3.21%, along with an increase in the ratio of the average interest earning assets to average interest bearing liabilities to 127.56% from 121.52%. Net interest margin increased to 4.16% from 3.37%. The increase in interest rate spread and net interest margin was largely due to the acquisition of Town Square Financial .
Provision for Loan Losses. Provision for loan losses increased $398,000, or 375.5%, to $504,000 for the year ended December 31, 2014 from $106,000 for the year ended December 31, 2013. The provisions for each period were based on management’s quarterly calculations and evaluation of trends in the portfolio to insure the allowance is adequate.
Noninterest Income. Noninterest income increased $555,000, or 25.5%, to $2.7 million for the year ended December 31, 2014 from 2.2 million for the year ended December 31, 2013. The increase in noninterest income was primarily attributable to an increase in service charges on deposits of $885,000, or 155.0%, to $1.5 million for the year ended December 31, 2014 from $571,000 for the year ended December 31, 2013, and an increase in gains on sales of securities of $210,000, or 954.5%, to $232,000 for the year ended December 31, 2014, from $22,000 for the year ended December 31, 2013, offset by a decrease in recovery on fictitious loans to $0 for the year ended December 31, 2014 from $753,000 from the year ended December 31, 2013.
Noninterest Expense. Noninterest expense increased $5.9 million, or 63.8%, to $15.2 million for the year ended December 31, 2014 from $9.3 million for the year ended December 31, 2013. This increase was due largely to an increase in salaries and employee benefits of $2.4 million, an increase in data processing expense of $916,000 and an early termination fee of $872,000 attributable to the acquisition of Town Square Financial Corporation.
Provision for Income Taxes. The provision for income taxes was $612,000 for the year ended December 31, 2014 compared to $738,000 for the year ended December 31, 2013. Poage Bankshares’ effective tax rate for the year ended December 31, 2014 was 24.9% compared to 32.09% for the year ended December 31, 2013. This decrease in income tax expense and effective tax rate is primarily due to non-taxable proceeds from life insurance collected for the year ended December 31, 2014 and approximately $327,000 of expenses relating to the merger with Town Square Financial Corporation that were not deductible for income tax purposes in 2013.
Comparison of Operating Results for the Three Months Ended December 31, 2013 and December 31, 2012
General. Net income decreased $594,000, or 136.9%, to a loss of $160,000 for the three months ended December 31, 2013 from net income of $434,000 for the three months ended December 31, 2012. The decrease reflected a decrease in non-interest income of $101,000 to $274,000 for the three months ended December 31, 2013 from $365,000 for the three months ended December 31, 2012 and an increase in non-interest expense of $724,000, to $2.8 million for the three months ended December 31, 2013 from $2.1 million for the three months ended December 31, 2012 offset by an increase in net interest income of $86,000 for the three months ended December 31, 2013.
Interest and Dividend Income. Interest and dividend income decreased $160,000, or 5.3%, to $2.9 million for the three months ended December 31, 2013 from $3.0 million for the three months ended December 31, 2012.
Interest income on loans decreased $217,000, or 8.5%, to $2.3 million for the three months ended December 31, 2013 from $2.6 million for the three months ended December 31, 2012. The average yields on loans decreased to 5.28% for the three months ended December 31, 2013, compared to 5.70% for the three months ended December 31, 2012 and the average balance of loans decreased to $177.0 million for the three months ended December 31, 2013 from $179.2 million for the three months ended December 31, 2012. Interest income on investment securities increased $68,000, or 14%, to $524,000 for the three months ended December 31, 2013 from $456,000 for the three months ended December 31, 2012, reflecting a decrease in the average balance of such securities to $88.4 million at December 31, 2013 from $96.7 million at December 31, 2012 offset by an increase in the average yield to 2.37% for the three months ended December 31, 2013, from 1.89% for the three months ended December 31, 2012. This increase in yield is due to increased investment in mortgage backed securities.
Interest Expense. Interest expense decreased $246,000, or 34.7%, to $462,000 for the three months ended December 31, 2013 from $708,000 for the three months ended December 31, 2012. The decrease reflected a decrease in the average rate paid on deposits to 0.71% for the three months ended December 31, 2013 from 1.02% for the three months ended December 31, 2012, as well as a decrease in the average balance of such deposits to $206.6 million from $228.6 million for the same periods. Interest expense on FHLB-Cincinnati advances decreased $31,000, or 24.6%, to $95,000 for the three months ended December 31, 2013 from $126,000 for the three months ended December 31, 2012. This decrease was due to a 73 basis point decrease in the average rate paid on these borrowings.
Interest expense on certificates of deposit decreased $146,000, or 30.7%, to $329,000 for the three months ended December 31, 2013 from $475,000 for the three months ended December 31, 2012. This decrease reflected a decrease in the average rate paid on certificates of deposits to 1.07% for the three months ended December 31, 2013 from 1.35% for the three months ended December 31, 2012, as well as a decrease in the average balance of such certificates to $123.1 million from $140.5 million. Interest expense on money market deposits, savings, NOW and demand deposits decreased $69,000, or 64.5%, to $38,000 for the three months ended December 31, 2013 from $107,000 for the three months ended December 31, 2012. The decrease reflected a decrease in the average rate paid on these deposits to 0.18% for the three months ended December 31, 2013 from 0.49% for the three months ended December 31, 2012, as well as a decrease in the average balance of such deposits to $83.4 million from $88.1 million.
Net Interest Income. Net interest income increased $86,000, or 3.7%, to $2.4 million for the three months ended December 31, 2013 from $2.3 million for the three months ended December 31, 2012. Our interest rate spread increased to 3.38% from 2.94%, along with an increase in the ratio of our average interest earning assets to average interest bearing liabilities to 122.33% from 121.13%. Our net interest margin increased to 3.54% from 3.12%. The increase in our interest rate spread and net interest margin was largely due to the decline in interest paid on deposits.
Provision for Loan Losses. We did not record provision for loan losses for the three months ended December 31, 2013 or 2012. The provisions for each period were based on management’s quarterly calculations and evaluation of trends in the portfolio to insure the allowance is adequate.
Noninterest Income. Noninterest income decreased $101,000, or 26.9%, to $274,000 for the three months ended December 31, 2013. The decrease in noninterest income was primarily attributable to a decrease of $95,000 in gains on mortgage banking activity to $66,000 for the three months ended December 31, 2013 from $161,000 for the three months ended December 31, 2012.
Noninterest Expense. Noninterest expense increased $724,000, or 34.2%, to $2.8 million for the three months ended December 31, 2013. This increase was due largely to an increase in salaries and employee benefits of $267,000 due to an increase in the number of employees as well as the expense related to the adoption of stock based compensation plans during April and May of 2013 of $132,000 for the three months ended December 31, 2013 as well as an increase in professional fees of $340,000 for the three months ended December 31, 2013 to $514,000 related to the pending merger with Town Square Financial. We expect to incur additional expense in connection with the additional employees resulting from the acquisition.
Provision for Income Taxes. The provision for income taxes was $16,000 for the three months ended December 31, 2013 compared to $161,000 for the three months ended December 31, 2012. Poage Bankshares’ effective tax rate for the three months ended December 31, 2013 and 2012 were (11.11)% and 27.06%, respectively. This decrease in income tax expense and effective tax rate is due to incurring an operating loss for the three months ended December 31, 2013. The operating loss resulted from approximately $327,000 of expenses relating to the acquisition of Town Square Financial that are not deductible for income tax purposes.
Comparison of Operating Results for the Years Ended September 30, 2013 and September 30, 2012
General. Net income increased $728,000, or 51.0%, to $2.2 million for the year ended September 30, 2013 from $1.6 million for the year ended September 30, 2012. The increase reflected an increase in non-interest income of $824,000 to $2.3 million for the year ended September 30, 2013 from $1.4 million for the year ended September 30, 2012, partially offset by a decrease in net interest income of $308,000 and an increase in non-interest expense of $410,000 for the year ended September 30, 2013.
Interest and Dividend Income. Total interest and dividend income decreased $1.2 million, or 9.2%, to $11.8 million for the year ended September 30, 2013 from $13.0 million for the year ended September 30, 2012. This decrease was primarily due to a $778,000 decrease in interest income on loans, as well as a decrease of $246,000 in interest income from taxable securities, and a $201,000 decrease in interest income on tax-exempt securities. The average balance of loans during fiscal year 2013 decreased $5.4 million to $176.1 million, while the average yield on loans decreased by 27 basis points to 5.55% for fiscal year 2013 from 5.82% for fiscal year 2012. The decrease in yield reflected the generally lower interest rate environment. The decrease in income from investment securities reflected a decrease in the average yield on investment securities by 45 basis points to 1.95% for fiscal year 2013 from 2.40% for fiscal year 2012 and a $1.0 million decrease in average balance of securities to $94.9 million from $95.9 million.
Interest Expense. Total interest expense decreased $925,000, or 28.4%, to $2.3 million for the year ended September 30, 2013 from $3.3 million for the year ended September 30, 2012. Interest expense on deposit accounts decreased $769,000, or 29.1%, to $1.9 million for the year ended September 30, 2013 from $2.6 million for the year ended September 30, 2012. The decrease was primarily due to a 30 basis point decrease in the average cost of deposits to 0.84% in fiscal year 2013 from 1.14% for fiscal year 2012, reflecting the declining interest rate environment as well as a $9.8 million, or 4.2%, decrease in the average balance of interest-bearing deposits to $222.6 million for fiscal year 2013 from $232.4 million for fiscal year 2012.
Interest expense on FHLB-Cincinnati advances decreased $156,000 to $451,000 for the year ended September 30, 2013 from $607,000 for the year ended September 30, 2012. The average balance of advances decreased $5.0 million to $15.3 million for fiscal year 2013 from $20.3 million for fiscal year 2012, while the average cost of advances decreased by 6 basis points to 2.94% for fiscal year 2013 from 3.00% for fiscal year 2012.
Net Interest Income. Net interest income decreased $308,000 or 3.2%, to $9.4 million for the year ended September 30, 2013 from $9.7 million for the year ended September 30, 2012. The increase reflected a slight increase in our interest rate spread to 3.09% in fiscal year 2013 from 3.01% in fiscal year 2012, and a slight increase in our net interest margin to 3.27% in fiscal year 2013 from 3.22% in fiscal year 2012.
Provision for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
We evaluate the allowance for loan losses on a regular basis and the provision is based upon our periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The factors we considered in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
Groups of loans with similar loan characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, we do not separately identify individual consumer and residential loans for impairment measurements.
Due to the fact that commercial loans are a relatively new product line for Town Square and considering little historical loss basis exists, we have made qualitative adjustments to the allowance for loan losses to account for the fact that this is a new product line. At the time of the first of these commercial loan originations, peer data provided an industry average of approximately 2% which was applied to the commercial loan portfolio in the allowance for loan loss calculation. Over time, the continued lack of historical loss in this product line allowed some reduction of the calculation percentage. As economic conditions, unemployment and limited growth in the local economy have worsened, these and other qualitative factors were considered in continuing adjustments to the allowance for loan losses for commercial loans, which was 3.1% of the portfolio at September 30, 2013 with no loss to date. In addition, minimal loss history is available for the consumer loan portfolio, which was 10.1% of the portfolio at September 30, 2013.
A provision of $106,000 was recorded for the year ended September 30, 2013, a decrease of $796,000, or 88.2%, from the provision of $902,000 for the year ended September 30, 2012. The provision for loan losses for the year ended September 30, 2013 reflected net charge-offs of $121,000 compared to net charge-offs of $556,000 for fiscal year 2012. The allowance for loan losses was $2.0 million, or 1.1% of total loans at September 30, 2013 and September 30, 2012. Total nonperforming loans were $718,000 at September 30, 2013 compared to $1.3 million at September 30, 2012. At September 30, 2013 and September 30, 2012, we had no impaired loans. As a percentage of nonperforming loans, the allowance for loan losses was 277.0% at September 30, 2013 compared to 153.2% at September 30, 2012.
To the best of our knowledge, the allowance for loan losses reflects the estimate we believe to be appropriate to cover incurred probable losses, which were inherent in the loan portfolio at September 30, 2013 and September 30, 2012.
Noninterest Income. Noninterest income increased $975,000, or 75.5%, to $2.3 million for the year ended September 30, 2013 from $1.3 million for the year ended September 30, 2012. The increase in noninterest income was primarily attributable to an insurance recovery of $824,000 related to previously written off fictitious loans.
Noninterest Expense. Noninterest expense increased $410,000, or 5.1%, to $8.5 million for the year ended September 30, 2013 compared to $8.1 million for the year ended September 30, 2012. This increase was due largely to an increase in salaries and employee benefits to $4.3 million for the year ended September 30, 2013 from $4.2 million for the year ended September 30, 2012 as well as an increase in other expenses of $239,000 to $1.1 million for the year ended September 30, 2013 compared to $909,000 for the year ended September 30, 2012. Personnel expenses will continue to increase as we continue to build our management and administrative teams.
Provision for Income Taxes. Income tax expense was $883,000 for the year ended September 30, 2013 compared to $407,000 for the year ended September 30, 2012. The effective tax rate as a percent of pre-tax income was 29.0% and 20.5% for the years ended September 30, 2013 and 2012, respectively. This increase in the effective tax rate was due to the decrease in tax exempt interest income in the amount of $201,000, or 25.2%.
Analysis of Net Interest Income
Net interest income represents the difference between the income we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them.
The following tables set forth average balance sheets, average yields and costs, and certain other information at the dates and for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the tables as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income.
Rate/Volume Analysis
The following tables present, for the periods indicated, the dollar amount of changes in interest income and interest expense for the major categories of Town Square’s interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of these tables, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Management of Market Risk
Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates.
Our Board of Directors is responsible for the review and oversight of our asset/liability strategies. Our Board of Directors has also established an Asset/Liability Management Committee consisting of senior management. This committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.
Among the techniques we are currently using to manage interest rate risk are: (i) increasing our portfolio of adjustable-rate one- to four-family residential loans, subject to demand for such loans in a lower interest rate environment, while endeavoring to sell a large portion of the fixed rate; (ii) increasing our origination of commercial and multifamily residential real estate, commercial business and motor vehicle and other consumer loans as they generally reprice more quickly than residential mortgage loans that we originate to the FHLB-Cincinnati; (iii) maintaining a strong capital position, which provides for a favorable level of interest-earning assets relative to interest-bearing liabilities; and (iv) emphasizing less interest rate sensitive and lower-costing “core deposits.” We also maintain a portfolio of short-term or adjustable-rate assets and from time to time have used fixed-rate FHLB-Cincinnati advances and brokered deposits to extend the term to repricing of our liabilities.
Depending on market conditions, from time to time we place more emphasis on enhancing net interest margin rather than matching the interest rate sensitivity of our assets and liabilities. In particular, we believe that the increased net interest income resulting from a mismatch in the maturity of our assets and liabilities portfolios can, during periods of stable or declining interest rates, provide high enough returns to justify increased exposure to sudden and unexpected increases in interest rates. As a result of this philosophy, our results of operations and the economic value of our equity will remain vulnerable to increases in interest rates and to declines due to differences between long and short-term interest rates.
An important measure of interest rate risk is the amount by which the economic value of equity of an institution’s cash flow from assets, liabilities and off balance sheet items changes in the event of a range of assumed changes in market interest rates. We have utilized the Sterne Agee Bank Earnings Report (SABER) to provide an analysis of estimated changes in our EVE under the assumed instantaneous changes in the United States treasury yield curve. The financial model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of the EVE.
Set forth below is an analysis of the changes to the economic value of our equity (“EVE”) that would occur December 31, 2014 in the event of designated changes in the United States treasury yield curve. At December 31, 2014, the economic value of our equity exposure related to these hypothetical changes in market interest rates was within the current guidelines we have established.
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. The EVE analysis incorporates all cash flows over the estimated remaining life of all balance sheet items and off balance sheet items. The EVE of the balance sheet is the discounted present value of assets and derivative cash flows minus discounted value of liability cash flows at a point in time and is a measure of longer term interest rate risk. The results of the model are dependent on assumptions concerning the timing and variability of cash flows along with projected prepayments and deposit decay rates.
Our policies do not permit hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage backed securities.
Liquidity and Capital Resources
Our primary sources of funds are deposits and the proceeds from principal and interest payments on loans and investment securities. We also utilize Federal Home Loan Bank advances. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Poage Bankshares generally manage the pricing of its deposits to be competitive within its market and to increase core deposit relationships.
Liquidity management is both a daily and long-term responsibility of management. We adjust our investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and investment securities, and (iv) the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits, federal funds sold, and short and intermediate-term investment securities. If we require funds beyond our ability to generate them internally, we have additional borrowing capacity with the FHLB-Cincinnati. At December 31, 2014, we had $18.0 million in advances from the FHLB-Cincinnati and an additional borrowing capacity of $90.2 million.
Town Square is subject to various regulatory capital requirements administered by its primary federal regulator, the OCC. Failure to meet the minimum regulatory capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that if undertaken, could have a direct material effect on Town Square and the consolidated financial statements. Under the regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, Town Square must meet specific capital guidelines involving quantitative measures of Town Square’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.
Town Square’s capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Town Square to maintain minimum amounts and ratios of total risk-based capital and Tier 1 capital to risk-weighted assets (as defined in the regulations), Tier 1 capital to adjusted total assets (as defined), and tangible capital to adjusted total assets (as defined).
As of December 31, 2014, based on the most recent notification from the OCC, Town Square was categorized as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the most recent notification that management believes have changed Town Square’s prompt corrective action category.
Off-Balance Sheet Arrangements. In the normal course of operations, Poage Bankshares engages in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in its financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.
Impact of Inflation and Changing Prices
Our consolidated financial statements and related notes have been prepared in accordance with U.S. GAAP. U.S. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding market risk, see “Item 7 - Management’s Discussion and Analysis of Financial Conditions and Results of Operation.”
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Poage Bankshares, Inc.
Ashland, Kentucky
We have audited the accompanying consolidated balance sheets of Poage Bankshares, Inc. (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for the year ended December 31, 2014, the three months ended December 31, 2013 and the year ended September 30, 2013. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2014 and 2013, and the results of its operations and its cash flows for the year ended December 31, 2014, three month period ended December 31, 2013 and year ended September 30, 2013, in conformity with U.S. generally accepted accounting principles.
/s/ Crowe Horwath LLP
Louisville, Kentucky
March 31, 2015
POAGE BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 2014 and 2013
(Dollar amounts in thousands except per share data)
See Notes to Consolidated Financial Statements.
POAGE BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31, 2014, Three months ended December 31, 2013 and Year ended September 30, 2013
(Dollar amounts in thousands except per share data)
See Notes to Consolidated Financial Statements.
POAGE BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2014, Three months ended December 31, 2013 and Year ended September 30, 2013
(Dollar amounts in thousands except per share data)
See Notes to Consolidated Financial Statements.
POAGE BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Year ended December 31, 2014, Three months ended December 31, 2013 and Year ended September 30, 2013
(Dollar amounts in thousands except per share data)
See Notes to Consolidated Financial Statements.
POAGE BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, 2014, Three months ended December 31, 2013 and Year ended September 30, 2013
(Dollar amounts in thousands except per share data)
See Notes to Consolidated Financial Statements.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: The consolidated financial statements include Poage Bankshares, Inc. (the “Company”) and the Company’s wholly owned subsidiary, Town Square Bank (the “Bank”) (which was formerly operated under the name “Home Federal Savings and Loan Association”). The Company’s principal business is the business of the Bank. Inter-company transactions and balances are eliminated in consolidation.
The Bank is a federally chartered savings and loan association. The Bank currently serves the financial needs of communities in its market area through its main office located in Ashland, Kentucky and its branch offices located in Flatwoods, South Shore, Louisa, Cannonsburg, Catlettsburg, Nicholasville and Greenup, Kentucky. The Bank also has a loan production office in the Cincinnati, Ohio area. The Bank’s business involves attracting deposits from the general public and using such deposits, together with other funds, to originate one-to-four family residential mortgage loans, commercial and multi-family real estate, construction loans primarily in its market area which includes the Kentucky counties of Boyd, Greenup, Jessamine and Lawrence and the Ohio counties of Scioto and Lawrence.
Change of Accounting Year: On August 24, 2013 the Board of Directors of the Company amended the Company’s bylaws to change the Company’s year end from September 30 of each year to December 31.
Subsidiary name change: The Board of Directors of Home Federal Savings and Loan Association elected to amend the charter to change the institution’s name from “Home Federal Savings and Loan Association” to “Town Square Bank.” The name change was effective as of June 25, 2014.
Reorganization: The Board of Directors of Home Federal Savings and Loan Association adopted a Plan of Conversion on December 21, 2010 (the “Plan”) from a federally chartered mutual savings association to a federally chartered stock savings association (“the Conversion”). The Conversion was accomplished through the amendment of the Association’s charter and the sale of common stock in an amount equal to the market value of the Association. A subscription offering the shares of the Association’s common stock was offered to the Association’s depositors, and second, to the Association’s tax-qualified employee benefit plans. No shares in the subscription were offered for sale to the general public.
On September 12, 2011, the conversion from a mutual savings association to a federally chartered stock savings association was completed. A new holding company, Poage Bankshares, Inc., was established as part of the conversion. The public offering was consummated through the sale and issuance by the Company of 3,372,375 shares of common stock at $10 per share. Net proceeds of $32.0 million were raised in the stock offering, after deduction of conversion costs of $1.7 million and excluding $2.7 million which was loaned by the Company to a trust for the Employee Stock Ownership Plan (the ESOP), enabling it to finance the purchase of 269,790 shares of common stock in the offering.
Voting rights are held and exercised exclusively by the stockholders of the new holding company. Deposit account holders continue to be insured by the FDIC.
A liquidation account was established in the amount of $29 million which represented the Association’s retained earnings as of the latest statement of financial condition contained in the final prospectus utilized in connection with the Conversion. The liquidation account will be maintained for the benefit of eligible depositors who continue to maintain their accounts at the Association after the Conversion. The liquidation account will be reduced annually to the extent that eligible depositors have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the event of a complete liquidation, each eligible depositor will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for accounts then held. The Association may not declare, pay a dividend on, or repurchase any of its capital stock, if the effect thereof would cause retained earnings to be reduced below the liquidation account amount or regulatory capital requirements. Any repurchases of the Company’s common stock will be conducted in accordance with applicable laws and regulations.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.
Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions with maturities fewer than 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, federal funds purchased and sold, and repurchase agreements.
Securities: Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.
Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the contractual life of the loan using the level-yield method without anticipating prepayments.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Real estate loans and commercial and industrial loans are charged off on a case by case basis at such time that management determines the loan to be uncollectible. Past due status of all loan types is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. All loan types are moved to non-accrual status in accordance with the Company’s policy, typically after 90 days of non-payment.
All interest accrued but not received for all loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. All types of loans are returned to accrual status when all the principal and interest are brought current and the loan has been performing according to the contractual terms for a period of not less than 6 months.
Concentration of Credit Risk: Most of the Company’s business activity is with customers located within a 50 mile radius of its home office. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in the immediate area. The Company held common stock of the FHLB totaling $2.9 million at December 31, 2014 and 2.0 million at December 31, 2013, and other deposits totaling $1.5 million at December 31, 2014 and $1.4 million at December 31, 2013.
Purchased Credit Impaired Loans: The Company purchases groups of loans, some of which have shown evidence of credit deterioration since origination. These purchased credit impaired loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance for loan losses.
Such purchased credit impaired loans are accounted for individually or aggregated into pools of loans based on common risk characteristics such as, credit score, loan type, and date of origination. The Company estimates the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. If a loan is categorized as loss under the regulatory definitions of loan classifications, the loan is immediately charged off. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The allowance for loan losses reflects the estimate management believes to be appropriate to cover incurred probable losses which are inherent in the loan portfolio at December 31, 2014 and 2013.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors.
A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified at the borrower’s request, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for all commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.
Troubled debt restructurings are individually evaluated for impairment and included in the separately identified impairment disclosures. TDRs are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, the Company determines the amount of the allowance on that loan in accordance with the accounting policy for the allowance for loan losses on loans individually identified as impaired.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The general component of the allowance covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified as having differing risk characteristics:
Real estate loans: Loans secured by real estate represent the lowest risk of loans for the Company. The majority of loans in this segment are loans secured by the borrower’s principal residence; however, there are also loans secured by apartment buildings, non-owner occupied property, commercial real estate, or construction and land development projects. They include fixed and floating rate loans as well as loans for commercial purposes or consumer purposes. Borrowers with loans in this category, whether for commercial or consumer purposes, tend to make their payments timely as they do not want to risk foreclosure and loss of the primary residence.
Commercial and industrial loans: These loans to businesses do not have real estate as the underlying collateral. Instead of real estate, collateral could be business assets such as equipment or accounts receivable or the personal guarantee of one or more guarantors. These loans generally present a higher level of risk than loans secured by real estate because in the event of default by the borrower, the business assets must be liquidated and/or guarantors pursued for deficit funds. Business assets are worth more while they are in use to produce income for the business and worth significantly less if the business is no longer in operation. For this reason, the Company discounts the value on these types of collateral prior to meeting the Company’s loan-to-value policy limits.
Consumer loans: Consumer loans are generally loans to borrowers for non-business purposes. They can be either secured or unsecured. Consumer loans are generally small in the individual amount of principal outstanding and are repaid from the borrower’s private funds earned from employment. Consumer lending risk is very susceptible to local economic trends. If there is a consumer loan default, any collateral that may be repossessed is generally not well maintained and has a diminished value. For this reason, consumer loans tend to have higher overall interest rates to cover the higher cost of repossession and charge-offs. However, due to their smaller average balance per borrower, consumer loans are collectively evaluated for impairment in determining the appropriate allowance for loan losses.
Servicing Rights: Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts when available or, alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing rights are included in the other assets line item of the balance sheet.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. No valuation allowance was required at December 31, 2014 or 2013. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Servicing fee income which is reported on the income statement as other income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal; or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 50 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 10 years.
Federal Home Loan Bank (FHLB) Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Company Owned Life Insurance: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is 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.
Goodwill and Other Intangible Assets: Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selected December 31 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions are amortized on an accelerated method over their estimated useful lives, which range from 7 to 10 years.
Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial 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 when they are funded.
Stock-Based Compensation: Compensation cost is recognized for restricted stock awards issued to employees over the required service period, generally defined as the vesting period. The fair value of restricted stock awards is estimated by using the market price of the Company’s common stock at the date of grant. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
The Company recognizes interest and/or penalties related to income tax matters in income tax expense. There were no such expenses recognized in the year ended December 31, 2014, the three months ended December 31, 2013 and, the year ended September 30, 2013.
Retirement Plans: Employee 401(k) and profit sharing plan expense is the amount of matching contributions. The Bank participates in the Pentegra Defined Benefit Pension Plan for Financial Institutions. This plan covers eligible employees who were employed by the Bank prior to January 1, 2007. Employees hired subsequent to that date are not eligible to participate. The employees hired prior to January 1, 2007 continue to earn benefits under the plan. It is the policy of the Association to fund the amount that is determined by annual actuarial valuations.
Comprehensive Income (Loss): Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
Loss Contingencies: 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. Management does not believe there now are such matters that will have a material effect on the financial statements.
Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements. The Bank is required to maintain reserve funds in cash or on deposit with a designated depository financial institution. The required reserve at December 31, 2014 was $623,000, at December 31, 2013 was $663,000.
Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve 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 the estimates.
Employee Stock Ownership Plan: The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of shareholders’ equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest.
Earnings Per Common Share: Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. ESOP shares are considered outstanding for this calculation unless unearned. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Segment Reporting: The Company has one reportable segment: banking. While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.
Adoptions of New Accounting Standards: In July 2013, the FASB amended existing guidance related to the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. These amendments provide that an unrecognized tax benefit, or a portion thereof, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date to settle any additional income taxes that would result from disallowance of a tax position, or the tax law does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented as a liability. These amendments are effective for interim and annual reporting periods beginning after December 15, 2013. Early adoption and retrospective application is permitted. Adoption of this standard did not have an impact on the Company’s operations or financial position.
Newly Issued Accounting Standard Not Yet Effective: In May 2014 the FASB amended existing guidance related to revenue from contracts with customers. This amendment supersedes and replaces nearly all existing revenue recognition guidance, including industry-specific guidance, establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue. In addition, this amendment specifies the accounting for some costs to obtain or fulfill a contract with a customer.
These amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The amendments should be applied retrospectively to all periods presented or retrospectively with the cumulative effect recognized at the date of initial application. The Company is currently evaluating the impact of this new accounting standard on the consolidated financial statements.
NOTE 2 - ADJUSTMENT FOR FICTITIOUS LOANS
On November 26, 2012, the Company determined that it was required to record a loss, for certain fraudulent loans in the aggregate amount of $950,000 including accrued interest of $127,000 which, net of tax, was a loss of $627,000. The loss related to the creation of fictitious loans by a former employee of the Company’s subsidiary and was discovered by management while in the process of upgrading the Company’s lending controls and procedures.
The Company reported this event to its blanket bond insurance provider and the blanket bond insurance provider paid the Bank $824,000 in exchange for the assignment by the Company and the Bank of all claims, rights and causes of action which they could have asserted against the employee and any other person or entities which are or may be liable to the Company and the Bank related to the losses suffered, and the general release by the Company and the Bank of the blanket bond insurer and its affiliates. The Company recorded this payment during the quarter ending June 30, 2013 as recovery for the previously recognized losses, resulting in a non-recurring increase in non-interest income for the quarter and year ended September 30, 2013.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES AVAILABLE FOR SALE
The following table summarizes the amortized cost and fair value of securities available for sale at December 31, 2014 and 2013, and September 30, 2013 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) and gross unrecognized gains and losses:(in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES AVAILABLE FOR SALE (Continued)
The proceeds from sales of securities and the associated gross gains and losses are listed below (in thousands):
The provision for income taxes related to net realized gains and losses was $79,000 and $7,000 for the years ended December 31, 2014 and September 30, 2013, respectively, based on an income tax rate of 34%.
The amortized cost and fair value of the securities portfolio at December 31, 2014 are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
Securities pledged at December 31, 2014 and 2013 had a carrying amount of $10.8 million and $8.5 million, respectively, and were pledged to secure public deposits and repurchase agreements.
At December 31, 2014 and 2013, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of equity.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES AVAILABLE FOR SALE (Continued)
The following table summarizes the securities with unrealized losses at December 31, 2014 and 2013.aggregated by major security type and length of time in a continuous unrealized loss position:
Unrealized losses on bonds have not been recognized into income because the issuers of the bonds are of high credit quality, management does not intend to sell and it is not more likely than not that management would be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value is expected to recover as the bonds approach maturity.
As of December 31, 2014, the Company’s security portfolio consisted of 73 securities, 18 of which were in an unrealized loss position.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement, and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS
Loans at December 31, 2014 and 2013 were as follows (in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
The following tables present the balance in the allowance for loan losses and recorded investment in loans by portfolio segment based on impairment method as of December 31, 2014 and 2013. Accrued interest receivable and net deferred loan fees are not considered significant and therefore are not included in the loan balances presented in the table below (in thousands):
December 31, 2014	
December 31, 2013
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
The following table presents the activity in the allowance for loan losses by portfolio segment for the periods indicated was as follows (in thousands):
As of December 31, 2014, there were $4.1 million of purchased credit impaired loans which were acquired in a business combination completed on March 18, 2014. Impaired loans averaged $751,000 for the year ended December 31, 2014 and there were no impaired loans as of December 31, 2013 and September 30, 2013.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
Nonaccrual loans and loans past due 90 days still on accrual consist of smaller balance homogeneous loans that are collectively evaluated for impairment.
The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2014 and 2013 (in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
The following table presents the aging of the recorded investment in past due loans as of December 31, 2014 and 2013 by class of loans. Non-accrual loans of $3.4 million and $926,000 as of December 31, 2014 and 2013 respectively, are included in the tables below and have been categorized based on their payment status (in thousands):
Troubled Debt Restructurings:
As of December 31, 2014, the Company has a recorded investment in two troubled debt restructurings which totaled $218,000. There were no troubled debt restructuring at December 31, 2013. A less than market rate and extended term was granted as concessions for both troubled debt restructurings. No additional charge-off or provision has been made for the loan relationships. No additional commitments to lend have been made to the borrower.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
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 includes all non-homogeneous loans, such as commercial and commercial real estate loans. The analysis for residential real estate and consumer loans primarily includes review of past due status. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
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.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
$3.0 million PCI loans are included in substandard disclosure above for the period ended December 31, 2014. There were no PCI loans for the period ended December 31, 2013.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (Continued)
The Company holds purchased loans without evidence of credit quality deterioration and purchased loans for which there was, at their acquisition date, evidence of deterioration of credit quality since their origination and it was probable, at acquisition, that all contractually required payments would not be collected. A summary of non-impaired purchased loans and credit-impaired purchased loans with the carrying amount of those loans is as follows at December 31, 2014. (in thousands)
For those purchased loans disclosed above, the Company did not increase the allowance for loan losses for the year ended December 31, 2014. There were no purchased credit impaired loans as of December 31, 2013.
The following table presents the composition of the acquired loans at December 31, 2014 (in thousands):
The following table presents the purchased loans that are included within the scope of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality as of December 31, 2014 (in thousands):
The Company adjusted interest income to recognize $285,000 for the year ended December 31, 2014 of accretable yield on credit-impaired purchased loans.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate fair value:
Securities: The fair values for securities are determined by quoted market prices, if available (Level 1). If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments (Level 2). This includes the use of “matrix pricing” used to value debt securities absent the exclusive use of quoted prices. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3). As of December 31, 2014 and 2013, all securities were classified as a level 2 fair value.
Other Real Estate Owned: Commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Appraisals for real estate properties classified as other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank’s management. The appraisal values are discounted to allow for selling expenses and fees, and the discounts range from 5% to 10%.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - FAIR VALUE (Continued)
Assets and liabilities measured at fair value on a recurring basis, at December 31, 2014 and 2013, are as follows (in thousands):
There were no transfers between Level 1 and Level 2.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - FAIR VALUE (Continued)
Assets measured at fair value on a non-recurring basis at December 31, 2014 and 2013 are summarized below (in thousands):
Commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Appraisals for real estate properties classified as other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank’s management. The appraisal values are discounted to allow for selling expenses and fees, and the discounts range from 5% to 10%.
At December 31, 2014, other real estate owned recorded at fair value had a net carrying amount of $187,000 made up of the outstanding balance of $244,000 net of a valuation allowance of $57,000. At December 31, 2013, other real estate owned recorded at fair value had a net carrying amount of $296,000 made up of the outstanding balance of $454,000, net of a valuation allowance of $158,000. There were no writedowns for the year ended December 31, 2014 or three months period ended December 31, 2013.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - FAIR VALUE (Continued)
The carrying amounts and estimated fair values of financial instruments, at December 31, 2014 and 2013 are as follows (in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - FAIR VALUE (Continued)
The methods and assumptions, not previously presented, used to estimate fair value is described as follows:
Cash and Cash Equivalents
The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
FHLB Stock
It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
Loans
Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors in a Level 2 classification.
Deposits
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are by definition equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
FHLB Advances
The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
Accrued Interest Receivable/Payable
The carrying amounts of accrued interest approximate fair value and are classified by level consistent with the level of the related assets or liabilities.
Off-balance Sheet Instruments
Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LOAN SERVICING
Mortgage loans serviced for others are not reported as assets. The principal balance of these loans at December 31, 2014 and 2013 were $36,988,000 and $32,862,000, respectively. Custodial escrow balances maintained in connection with serviced loans were $108,000 and $66,000, at December 31, 2014 and 2013, respectively.
Activity for loan servicing rights during the period and year ends was as follows (in thousands):
There was no valuation allowance for servicing rights at December 31, 2014 and 2013. The fair value of servicing rights is estimated to be $383,000, $321,000 and $310,000 at year-end December 31, 2014 and 2013 and September 30, 2013, respectively. Fair value at December 31, 2014 was determined using a discount rate of 8%, prepayment speeds ranging from 201% to 288%, depending on the stratification of the specific right and a weighted average default rate of 0%. Fair value at September 30, 2013 was determined using a discount rate of 8%, prepayment speeds ranging from 213% to 399%, depending on the stratification of the specific right and a weighted average default rate of 0%. There was no fair value valuation performed for December 31, 2013.
The weighted average amortization period is 7.2 years.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2014 and 2013 were as follows (in thousands):
Depreciation expense was $569,000, $147,000 and $414,000 for the year ended December 31, 2014, the three months ended December 31, 2013 and the year ended September 30. 2013, respectively.
Operating Leases: The Company leases one branch property and an operations center under operating leases. The Company purchased the Nicholasville branch, which was previously rented, in November 2014. Rent expense was $159,485, $15,389, and $42,492 for the year ended December 31, 2014, the three months ended December 31, 2013 and the year ended September 30, 2013, respectively. Rent commitments, before considering renewal options that generally are present, were $79,524 for 2015 and $25,524 per year for 2016, 2017, 2018 and 2019.
NOTE 8 - GOODWILL AND INTANGIBLE ASSETS
Goodwill: The change in goodwill during the year is as follows (in thousands):
Acquired intangible assets were as follows at year-end (in thousands):
Aggregate amortization expense was $264,000 for 2014. Estimated amortization expense for each of the next five years:
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - DEPOSITS
Time deposits that meet or exceed the FDIC Insurance limit of $250,000 at year-end 2014 and 2013 were $66.4 million and $37.2 million, respectively.
Scheduled maturities of time deposits for the next five years were as follows (in thousands):
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES
At December 31, 2014 and 2013, advances from the Federal Home Loan Bank were as follows:
Rates on advances were as follows:
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES (Continued)
Each advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances were collateralized by all of the Bank’s one to four family first mortgage loans under a blanket lien arrangement at December 31, 2014 and 2013 and the Company’s FHLB stock. Based on this collateral and the Company’s holdings of FHLB stock, the Bank is eligible to borrow an additional $90,159,474 at December 31, 2014.
Payments contractually required over the next five years as of December 31, 2014 (in thousands):
NOTE 11 - SUBORDINATED DEBENTURES
In December 2006, Town Square Statutory Trust I, a trust formed by the Town Square Financial Corporation, closed a pooled private offering of 4,000 trust preferred securities with a liquidation amount of $1,000 per security. The Company issued $4,124,000 of subordinated debentures to the trust in exchange for ownership of all of the common security of the trust and the proceeds of the preferred securities sold by the trust. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. The Company’s investment in the common stock of the trust was $124,000 and is included in other assets.
The Company may redeem the subordinated debentures, in whole or in part, in a principal amount with integral multiples of $1,000, on or after December 22, 2012 at 100% of the principal amount, plus accrued and unpaid interest. The subordinated debentures mature on December 22, 2036. The subordinated debentures are also redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust indenture. The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed five consecutive years.
The subordinated debentures may be included in Tier I capital (with certain limitations applicable) under current regulatory guidelines and interpretations. The subordinated debentures have a variable rate of interest equal to the three month London Interbank Offered Rate (LIBOR) plus 1.83%, which was 2.07% at year-end 2014.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - BENEFIT PLANS
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (“The Pentegra DB Plan”), a tax-qualified defined-benefit pension plan. The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413C and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
Funded Status (Market value of plan assets divided by funding target) as of July 1,
*Market value of plan assets reflects any contributions received through December 31, 2014.
**Market value of plan assets reflects any contributions received through September 30, 2013.
Employer Contributions
Total contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $190.8 million and $135.2 million for the plan years ending June 30, 2014 and June 30, 2013, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan.
The following contributions were paid by the Bank during the fiscal year ending December 31, 2014, three months ended December 31, 2013 and the fiscal year ending September 30, 2013 (in thousands):
This plan was “frozen” as of February 1, 2013. Contributions will be limited to sustaining earned participant benefits.
401(k) Plan: A 401(k) benefit plan allows employee contributions up to 15% of their compensation, which are matched equal to 50% of the first 6% of the compensation contributed. Expense for the year ended December 31, 2014, three months ended December 31, 2013 and for the years ended September 30, 2013 was $60,000, $11,000, and $46,000, respectively.
Deferred Compensation Plan: A deferred compensation plan covers all directors and certain executive officers. Under the plan, the Bank pays each participant, or their beneficiary, the amount of fees deferred plus interest over 20 years, beginning with the individual’s termination of service. A liability is accrued for the obligation under these plans. In January 2003, the Bank adopted a non-contributory retirement plan which provides benefits to directors and certain key officers. The Company’s obligations under the plan have been informally funded through the purchase of single premium key man life insurance of which the Company is the beneficiary. The expense incurred for the deferred compensation for the year ended December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013 was $157, $47 and $181, respectively resulting in a deferred compensation liability of $1.5 million and $1.4 million at December 31, 2014 and 2013, respectively. The cash surrender value of the key man life insurance policies totaled $6.8 million and $6.9 million at December 31, 2014 and 2013, respectively.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - INCOME TAXES
The provision for income taxes consists of the following (in thousands):
The following tabulation reconciles the federal statutory tax rate of 34% to the effective rate of taxes provided for income taxes (in thousands):
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - INCOME TAXES (Continued)
The components of the Company’s net deferred tax asset as of December 31, 2014 and 2013 are summarized as follows (in thousands):
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - INCOME TAXES (Continued)
Management evaluated whether a valuation allowance was necessary based on taxes paid in prior periods and recoverable, projected future income, projected future reversals of deferred tax items, and tax planning strategies. Based on its assessments, management concluded that it was more likely than not that all deferred tax assets could be realized based primarily on current taxes paid and recoverable and projected reversals of deferred tax liabilities, as well as future income. As such, no valuation allowance was recorded as of December 31, 2014 or 2013.
The Company is subject to U.S. federal income tax. The Company is no longer subject to examination by taxing authorities for years before September 30, 2010.
The Company had no unrecognized tax benefits at December 31, 2014 or 2013. No change in unrecognized tax benefits is expected in the next twelve months.
Retained earnings at December 31, 2014 and 2013 included approximately $2,341,000, for which no provision for federal income taxes has been made. This amount represents the tax bad debt reserve at September 30, 1987, which is the end of the Bank’s base year for purposes of calculating the bad debt deduction for tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 2014 and 2013 was approximately $796,000.
NOTE 14 - RELATED-PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates at December 31, 2014 and 2013 were as follows (in thousands):
Deposits from principal officers, directors, and their affiliates at December 31, 2014 and 2013 were $3,616,000 and $3,127,000, respectively.
During the year ended December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013, the Company paid approximately $3,800, $7,000 and $32,000, respectively, to a principal officer who is a Certified Residential Real Estate Appraiser for appraisals performed on real estate properties that were used as collateral on loans extended to customers. The appraisals are validated through an internal validation process and once a property is foreclosed upon or the loan is deemed impaired, an appraisal from an outside party is obtained.
NOTE 15 - REGULATORY CAPITAL MATTERS
The Bank is subject to various regulatory capital requirements administered by its primary federal regulator, the Office of the Comptroller of the Currency (OCC). Failure to meet the minimum regulatory capital requirements can initiate certain mandatory, and possible additional discretionary actions by regulators, that if undertaken, could have a direct material effect on the Bank and the consolidated financial statements. Under the regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Management believes as of December 31, 2014, the Bank meets all capital requirements to which it is subject.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - REGULATORY CAPITAL MATTERS (Continued)
The Bank’s capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of: total risk-based capital and Tier I capital to risk-weighted assets (as defined in the regulations) and Tier I capital to adjusted total assets (as defined).
As of December 31, 2014, based on the most recent notification from the OCC, the Bank was categorized as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the most recent notification that management believes have changed the Association’s prompt corrective action category.
Actual and required capital amounts (in thousands) and ratios for the Company are presented below at December 31, 2014 and 2013:
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - REGULATORY CAPITAL MATTERS (Continued)
Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. As of December 31, 2014, the Company could, without prior approval, declare dividends of approximately $4,284,000, plus and 2015 retained profits.
NOTE 16 - LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES
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 to credit loss 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 at exercise of the commitment.
The contractual amounts of financial instruments with off-balance-sheet risk at December 31, 2014 and 2013 were as follows (in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - ESOP PLAN
Effective January 1, 2011, the company adopted an Employee Stock Ownership Plan (“ESOP”) for eligible employees. The ESOP borrowed $2.7 million from the Company and used those funds to acquire 269,790 shares issued by the Company in its initial public offering. The shares were acquired at a price of $10.00 per share.
The debt is secured by the shares purchased with the debt proceeds and will be repaid by the ESOP over the 20-year term of the debt with funds from Town Square’s contributions to the ESOP and dividends payable on shares, if any. The interest rate on the ESOP loan adjusts annually and is the prime rate on the first business day of the calendar year, as published in The Wall Street Journal.
Shares purchased by the ESOP are held by a trustee in an unallocated suspense account and shares are released annually from the suspense account on a pro-rata basis as principal and interest payments are made by the ESOP to the Company. The trustee allocates the shares released among participants on the basis of each participant’s proportional share of compensation relative to all participants. Total ESOP shares may be reduced as a result of employees leaving the Company; shares that have previously been released to those exiting employees may be removed from the plan and transferred to that employee. As shares are committed to be released from the suspense account, the Company reports compensation expense based on the average fair value of shares committed to be released with a corresponding credit to shareholders’ equity.
Compensation expense recognized for the year ended December 31, 2014, three months ended December 31, 2013 and the year ended September 30, 2013 was $195,000, $48,000 and $191,000, respectively.
Shares held by the ESOP at December 31, 2014 and 2013 were as follows (in thousands):
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - EARNINGS PER SHARE
The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participating rights in undistributed earnings. The factors used in the earnings per computation follow (dollars in thousands):
There were no potentially dilutive securities outstanding as of December 31, 2014 or 2013 or September 30, 2013. Stock options of 299,500, 300,000 and 290,000 shares of common stock were not considered in computing diluted earnings per common share for December 31, 2014 or 2013 or September 30, 2013, respectively, because they were antidilutive.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - STOCK REPURCHASE PROGRAM
On December 18, 2012, the Board of Directors of the Company authorized a stock repurchase program pursuant to which the Company intended to purchase up to 168,619 of its issued and outstanding shares of common stock, which represented approximately 5.0% of the Company’s issued and outstanding shares. All repurchased shares are held by the Company as authorized but unissued shares. On June 11, 2013, the Board of Directors of the Company terminated the Company’s existing stock repurchase program, under which the Company had previously purchased a total of 136,046 shares of its common stock at a weighted average price of $14.51 per share.
On June 11, 2013, the Board of Directors of the Company authorized a stock repurchase program pursuant to which the Company intended to purchase up to 161,816 of its issued and outstanding shares of common stock, which represented approximately 5.0% of the Company’s issued and outstanding shares. All repurchased shares are held by the Company as authorized but unissued shares. The repurchase program commenced on June 14, 2013. On November 20, 2013, the Board of Directors of the Company terminated the Company’s existing stock repurchase program, under which the Company had previously purchased a total of 18,961 shares of its common stock at a weighted average price of $15.00 per share.
On November 20, 2013, the Board of Directors of the Company authorized a program to repurchase, from time to time and subject to market conditions, up to 12,650 shares of Company outstanding common stock through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan that will be adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934 (the “Third Repurchase Program”). The Third Repurchase Program commenced on November 21, 2013 and terminated prior to the mailing of the proxy statement for the approval of Poage Bankshare’s acquisition of Town Square Financial Corporation to its stockholders. On May 30, 2014, the Board of Directors authorized the repurchase of up to 195,244 shares of Poage Bankshares common stock. The Company has repurchased 5,000 shares of its common stock at a weighted average price of $14.20 per share under the Plan.
NOTE 20 - STOCK BASED COMPENSATION
On January 8, 2013, the shareholders of Poage Bankshares, Inc. approved the Poage Bankshares, Inc. 2013 Equity Incentive Plan (the “Plan”) for employees and directors of the Company. The Plan authorizes the issuance of up to 472,132 shares of the Company’s common stock, with no more than 134,895 of shares as restricted stock awards and 337,237 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Plan may not be less than the fair value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted.
On April 16, 2013, the compensation committee of the board of directors approved the issuance of 134,895 shares of restricted stock to its directors and officers. In addition, on May 10, 2013, the compensation committee of the board of directors approved the issuance of 300,000 stock options to its directors and officers. An additional 20,000 stock option shares were issued on March 19, 2014 as a result of the acquisition of Town Square Financial Corporation by Poage Bankshares, Inc. All stock options and restricted stock awards vest ratably over five years. Stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - STOCK BASED COMPENSATION (Continued)
The following table summarizes stock option activity for the year ended December 31, 2014 and three months ended December 31, 2013:
The fair value for each option grant is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the following assumptions. The Company uses the U.S. Treasury yield curve in effect at the time of the grant to determine the risk-free interest rate. The expected dividend yield is estimated using the projected annual dividend level and recent stock price of the Company’s common stock at the date of grant. Expected stock volatility is based on historical volatilities of the Company’s common stock. The expected term of the options is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable.
The weighted-average assumptions used in the Black-Scholes-Merton option pricing model to determine the fair value of options granted was as follows:
Stock options are assumed to be earned ratably over their respective vesting periods and charged to compensation expense based upon their grant date fair value and the number of options assumed to be earned. 57,950 options were vested during the year ended December 31, 2014. Stock-based compensation expense for stock options included in salaries and benefits for the year ended December 31, 2014 was $142,000. Stock-based compensation expense for vested and non-vested stock options for the three months ended December 31, 2013 was $31,000. Total unrecognized compensation cost related to vested and non-vested stock options was $386,000 at December 31, 2014 and, $535,000 at December 31, 2013 and is expected to be recognized over a weighted average period of 4.5 years.
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - STOCK BASED COMPENSATION (Continued)
The following table summarizes non-vested restricted stock activity for the year ended December 31, 2014 and three months ended December 31, 2013:
The fair value of the restricted stock awards is amortized to compensation expense over the vesting period (generally five years) and is based on the market price of the Company’s common stock at the date of the grant multiplied by the number of shares granted that are expected to vest. Stock-based compensation expense for the restricted stock included in salaries and benefits for the year ended December 31, 2014 was $487,000. The weighted average grant date fair value was $15.10 per award. Stock-based compensation expense for the vested and non-vested restricted stock for the three months ended December 31, 2013 was $100,000. Unrecognized compensation expense for vested and non-vested restricted stock awards was $1,264,000 at December 31, 2014 and is expected to be recognized over a weighted-average period of 4.5 years.
NOTE 21 - BUSINESS COMBINATION
On March 18, 2014, the Company acquired 100% of Town Square Financial, a bank holding company for Town Square Bank, Inc. in exchange for cash and common shares of the Company’s stock. Under the terms of the Merger Agreement, 55% of the outstanding shares of Town Square Financial common stock were converted into 2.3289 shares of Poage common stock for each share of Town Square Financial common stock. Each of the remaining 45% of the outstanding shares of Town Square Financial common stock was exchanged for $33.86 in cash. Town Square Financial shareholders received approximately 557,621 shares of Company common stock and an aggregate of $6.6 million in cash. The fair value of the common stock issued as part of the consideration paid for Town Square Financial was determined based on the average of the daily closing sales prices of a share of Poage Common Stock as reported on the NASDAQ Capital Market for the five (5) consecutive trading days immediately preceding the acquisition date. Town Square Financial was a registered bank holding company engaged in commercial banking and financial services through its wholly owned subsidiary, Town Square Bank, a Kentucky chartered bank headquartered in Ashland, Kentucky.
Town Square Bank’s business consisted primarily of accepting savings accounts and certificates of deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in first lien one-to-four family mortgage loans, commercial and multi-family real estate loans, commercial and industrial loans, consumer loans, consisting primarily of automobile loans, and construction loans. With the acquisition the Company expanded its customer base in in the eastern and central Kentucky area with an institution that shares its community banking orientation and enjoys a favorable reputation in the community. Town Square Bank also purchased investment securities consisting primarily of mortgage-backed securities issued by United States Government agencies and government-sponsored enterprises, and obligations of state and political subdivisions. Town Square Bank offered a variety of deposit accounts, including NOW and demand accounts, certificates of deposits, money market accounts and individual retirement accounts, as well as credit cards for both personal and business purposes. Town Square Bank had three branches located in Boyd County, Kentucky and one branch in Jessamine County, Kentucky.
Acquisition costs of $1.2 million are included in the Company’s consolidated statement of income for the year ended December 31, 2014. The Company has determined that the acquisition constitutes a business acquisition as defined by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations. Accordingly, the assets acquired and liabilities assumed are presented at their estimated fair values as required by the accounting guidance. Fair values were determined based on the requirements of ASC Topic 820, Fair Value Measurements.
In many cases, the determination of these fair values required management to make estimates about discount rates, future expected cash flows, market conditions and other future events which are highly subjective in nature and are subject to change. The assets acquired and liabilities assumed in the transaction are presented at estimated fair value on the Acquisition Date.
The following is a description of the methods used to determine the fair values of significant assets and liabilities at the Acquisition Date presented above.
Cash and Due from Banks and Interest-bearing Deposits in Banks- The Company acquired $8.1 million in cash and cash equivalents. The carrying amount of these assets, adjusted for any cash items deemed uncollectible by management, was determined to be a reasonable estimate of fair value based on their short-term nature.
Investment Securities- The Company acquired $14.7 million in securities at fair value. Federal Home Loan Bank stock totaling $727,600 and Bankers Bank of Kentucky stock totaling $240,000 was acquired at cost, as it is not practicable to determine its fair value because of restrictions on its marketability.
Loans- The Company acquired approximately $117.5 million in loans with and without evidence of credit quality deterioration. The loans acquired consist of residential real estate, commercial real estate, real estate construction, commercial and consumer loans.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - BUSINESS COMBINATION (Continued)
At the acquisition date, the Company recorded $112.0 million of loans without evidence of credit quality deterioration and $5.5 million of purchased credit-impaired loans subject to nonaccretable difference of $3.9 million. The acquired loans were deemed impaired at the acquisition date if the Company did not expect to receive all contractually required cash flows due to concerns about credit quality. Fair values for loans were based on discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting current market rates for new originations of comparable loans adjusted for the risk inherent in the cash flow estimates. Certain loans that were determined to be collateral dependent were valued based on the fair value of the underlying collateral. These estimates were based on the most recently available real estate appraisals with certain adjustments made based on the type of property, age of appraisal, current status of the property and other related factors to estimate the current value of the collateral. (in thousands)
The composition of the acquired loans at March 18, 2014 follows (in thousands):
Loans purchased in the acquisition are accounted for using one of two following accounting standards:
· ASC Topic 310-20 is used to value loans that have not demonstrated post origination credit quality deterioration and the acquirer expect to collect all contractually required payments from the borrower. For these loans, the difference between fair value of the loan at acquisition and the amortized cost of the loan would be amortized or accreted into income using the interest method.
· ASC Topic 310-30 is used to value loans with post origination credit quality deterioration. For these loans, it is probable the acquirer will be unable to collect all contractually required payments from the borrower. Under ASC 310-30, the expected cash flows that exceed the initial investment in the loan (fair value) represent the “accretable yield,” which is recognized as interest income on a level-yield basis over the expected cash flow periods of the loans. The excess of the loan’s contractual principal and interest over the expected cash flows is the nonaccretable difference.
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - BUSINESS COMBINATION (Continued)
The following table presents the purchased loans that are included within the scope of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality as of March 18, 2014. (in thousands)
Core Deposit Intangible- This intangible asset represents the value of the relationships that Town Square Bank had with its deposit customers. The fair value of this intangible asset will be estimated based on a discounted cash flow methodology that gave appropriate consideration to the type of deposit, deposit retention, cost of the deposit base, and net maintenance cost attributable to customer deposits.
Deposits - The Company assumed $117.1 million in deposits at estimated fair value. Savings accounts and demand deposit accounts totaled $66.1 million, while certificates of deposit had face value of $50.7 million. The Company recorded a premium associated with the certificates of deposit of $327,465 due to the interest rates associated with the time deposits, which caused those deposits to be valued at $51.0 million.
PRO FORMA INFORMATION (Unaudited)
The following table presents pro forma information as if the acquisition had occurred at the beginning of the periods presented (January 1, in this case.) The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effected on the assumed dates. (in thousands)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - BUSINESS COMBINATION (Continued)
The Company paid approximately $14.4 million ($6.6 million in cash and $7.8 million in stock) for Town Square Financial. A summary of the net assets acquired as of March 18, 2014 follows (in thousands):
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 - HOLDING COMPANY ONLY FINANCIAL STATEMENTS
The following balance sheets, statements of operations and comprehensive income (loss) and statements of cash flows for Poage Bankshares, Inc. should be read in conjunction with the consolidated financial statements and notes thereto.
BALANCE SHEETS
December 31, 2014 and 2013
(In Thousands)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 - HOLDING COMPANY ONLY FINANCIAL STATEMENTS (Continued)
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2014,
Three months ended December 31, 2013 and
Year ended September 30, 2013
(In thousands)
(Continued)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 - HOLDING COMPANY ONLY FINANCIAL STATEMENTS (Continued)
STATEMENTS OF CASH FLOWS
Year ended December 31, 2014, Three months ended December 31, 2013 and
Year ended September 30, 2013
(In Thousands)
POAGE BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following is changes in Accumulated Other Comprehensive Income (Loss) by component, net of tax for the year ended December 31, 2014 and three months ended December 31, 2013 (in thousands):
NOTE 24 - PENDING BUSINESS COMBINATION
On September 9, 2014, the Company and Commonwealth Bank, FSB (“Commonwealth”) issued a joint press release announcing that they have entered into a definitive agreement for the Company to acquire Commonwealth in a conversion merger transaction. Under the terms of the definitive agreement, which has been approved by the Boards of Directors of both institutions, Commonwealth will convert from a federally-chartered mutual savings association to a federally- chartered stock savings association and issue all of its outstanding shares of common stock to the Company.
Commonwealth Bank is a federally chartered mutual savings association with one office, located in Mt. Sterling, Kentucky. Commonwealth Bank is a traditional community bank that provides financing primarily for home ownership and that offers traditional savings opportunities for customers in the local community. As of September 30, 2014, Commonwealth had assets of $19.3 million and equity of $1.7 million (unaudited).
In connection with the acquisition and in accordance with a related Plan of Conversion Merger (the “Plan”), the Company will offer newly issued shares of its common stock in a subscription offering, on a priority basis, first to eligible depositors of Commonwealth as of the close of business on July 31, 2013, and then to other eligible members of Commonwealth. If any shares remain unsold in the subscription offering, the Company will offer those shares in a community offering and, if necessary, in a syndicated community offering. The amount of stock that the Company will issue and sell will be based on an independent appraisal of Commonwealth. Following the completion of the stock offering, Commonwealth will merge with and into Town Square Bank, with Town Square Bank as the surviving institution. The transaction is expected to close in the second quarter of 2015, subject to regulatory approval, the approval of Commonwealth’s members and the satisfaction of other customary closing conditions.
(Continued)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2014 (the “Evaluation Date”). Based upon that evaluation, the Chief Executive Officers and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective, in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in our periodic SEC filings.
(b) Management’s Report on Internal Control over Financial Reporting
Poage Bankshares’ management is responsible for establishing and maintaining adequate internal control over financial reporting. Poage Bankshares’ system of internal control over financial reporting is designed under the supervision of management, including our Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of Poage Bankshares’ consolidated financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles (“GAAP”).
Our internal control over financial reporting includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;
• provide reasonable assurance that our transactions are recorded as necessary to permit preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and our directors; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Further, because of changes in conditions, effectiveness of internal controls over financial reporting may vary over time. Our system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.
As of December 31, 2014, management assessed the effectiveness of Poage Bankshares’ internal control over financial reporting based upon the framework established in Internal Control-1992 Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based upon its assessment, management believes that Poage Bankshares’ internal control over financial reporting as of December 31, 2014 is effective using these criteria. This annual report does not include an attestation report of Poage Bankshares’ registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by Poage Bankshares’ registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit Poage Bankshares (as a smaller reporting company) to provide only management’s report in this annual report.
(c) Changes in internal controls.
There were no significant changes made in our internal control over financial reporting during the Company’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 of Form 10-K appears under the caption “Proposal I-Election of Directors” in the Proxy Statement for the Company’s 2015 Annual Meeting of Stockholders (the “Proxy Statement”) and is hereby incorporated by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K appears under the caption “Executive Compensation” in the Proxy Statement and is hereby incorporated by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 of Form 10-K appears under the caption “Voting Securites and Principal Holders” in the Proxy Statement and is hereby incorporated by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by Item 13 of Form 10-K appears under the caption “Proposal I-Election of Directors” in the Proxy Statement and is hereby incorporated by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 10 of Form 10-K appears under the caption “Proposal III-Ratification of Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement and is hereby incorporated by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following documents are filed as item 8 of this Form 10-K.
(A) Report of Independent Registered Public Accounting Firm
(B) Consolidated Balance Sheets - at December 31, 2014 and December 31, 2013
(C) Consolidated Statements of Operations - Year ended December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013
(D) Consolidated Statements of Comprehensive Income (Loss) - Year end December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013 and 2012
(E) Consolidated Statements of Changes In Shareholder’ Equity - Year ended December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013
(F) Consolidated Statements of Cash Flows - Year ended December 31, 2014, three months ended December 31, 2013 and year ended September 30, 2013
(G) Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
None.
(b) Not applicable.
(c) Not applicable.
(a)(3) Exhibits
3.1 Articles of Incorporation of Poage Bankshares, Inc.*
3.2 Bylaws of Poage Bankshares, Inc.**
Form of Common Stock Certificate of Poage Bankshares, Inc.*
10.1 Form of Employee Stock Ownership Plan*
10.2 Employment Agreement, dated April 26, 2012, by and between Ralph E. Coffman, Jr. and Home Federal Savings and Loan Association***
10.3 Employment Agreement dated May 1, 2011, by and among Miles R. Armentrout, Poage Bankshares, Inc. and Home Federal Savings and Loan Association****
10.4 Three Year Change in Control Agreement, dated September 12, 2011, by and between James W. King and Home Federal Savings and Loan Association.*
10.5 Life Insurance Endorsement Method Split Dollar Plan Agreement, dated April 29, 2003, by and between James W. King and Home Federal Savings and Loan Association.*
10.6 Form of Director Supplemental Retirement Plan Agreement.*
10.7 Form of Executive Supplemental Retirement Plan Agreement.*
10.8 Form of Amendment to the Executive Supplemental Retirement Plan Agreement.*
10.9 Poage Bankshares, Inc. 2014 Equity Incentive Plan*****
10.10 Agreement and Plan of Merger, dated as of October 21, 2013, by and among Poage, Bankshares, Inc., Poage Merger Subsidiary, Inc. and Home Federal Savings and Loan Association, and Town Square Financial Corporation and Town Square Bank.******
10.11 Employment Agreement, dated March 18, 2014, by and between Bruce VanHorn and Home Federal Savings and Loan Association *******
Subsidiaries of registrant
Consent of Crowe Horwath LLP
31.1 Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of President and Chief Executive Officer and Chief Financial Officer pursuant to 18 USC Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of December 31, 2014 and 2013, (ii) the Consolidated Statements of Operations for the year ended December 31, 2014, three months ended December 31, 2013, and the year ended September 30, 2013, (iii) the Consolidated Statements of Comprehensive Income (Loss) for the year ended December 31, 2014, three months ended December 31, 2013, and the year ended September 30, 2013, (iv) the Consolidated Statements of Changes in Shareholders’ Equity for the year ended December 31, 2014, three months ended December 31, 2013, and the year ended September 30, 2013, (v) the Consolidated Statements of Cash Flows for the year ended December 31, 2014, three months ended December 31, 2013, and the year ended September 30, 2013, and (vi) the Notes to the Consolidated Financial Statements.
*
Incorporated by reference to the Registration Statement on Form S-1 of Poage Bankshares, Inc. (File No. 333-172192, originally filed with the Securities and Exchange Commission on February 11, 2011, and as subsequently amended).
** Incorporated by reference to the Current Report on Form 8-K of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on August 29, 2013).
*** Incorporated by reference to the Current Report on Form 8-K of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on April 30, 2012).
**** Incorporated by reference to the Current Report on Form 8-K of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on June 27, 2012).
***** Incorporated by reference to the Definitive Proxy Statement on Schedule 14A of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on January 1, 2013).
****** Incorporated by reference to the Current Report on Form 8-K of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on October 21, 2013).
******* Incorporated by reference to the Current Report on Form 8-K of Poage Bankshares, Inc. (File No. 001-35295, filed with the Securities and Exchange Commission on March 18, 2014).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Poage Bankshares, Inc.
Date: April 2, 2015
/s/ R. E. Coffman, Jr.
R. E. Coffman, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.