Item 1. Description of Business.
General Overview
State Bank Financial Corporation (the "Company") is a bank holding company that was incorporated under the laws of the State of Georgia in January 2010 to serve as the holding company for State Bank and Trust Company (the "Bank" or "State Bank"). State Bank is a Georgia state-chartered bank that opened in October 2005. Between July 24, 2009 and December 31, 2017, we successfully completed 17 bank acquisitions totaling $6.0 billion in assets and $5.2 billion in deposits. State Bank principally operates through 32 full-service branches throughout seven of Georgia's eight largest metropolitan statistical areas, or MSAs.
In this report, unless the context indicates otherwise, all references to "we," "us," and "our" refer to State Bank Financial Corporation and our wholly-owned subsidiary, State Bank. Additionally, we refer to each of the financial institutions we have acquired collectively as the "Acquired Banks."
As a result of our acquisitions, we have transformed from a small community bank to a much larger commercial bank. We offer a variety of community banking services to individuals and businesses within our markets. Our product lines include loans to small and medium-sized businesses, lender finance loans, residential and commercial construction and development loans, commercial real estate loans, farmland and agricultural production loans, residential mortgage loans, home equity loans, consumer loans and a variety of commercial and consumer demand, savings and time deposit products. We also offer online banking and bill payment services, online cash management, safe deposit box rentals, debit card and ATM card services and the availability of a network of ATMs for our customers. In addition to the banking services noted above, we offer payroll and insurance services, through Altera Payroll and Insurance, a division of State Bank, to small and medium-size businesses. These services include fully automated human resources information system, payroll, benefits and labor management.
At December 31, 2017, our total assets were approximately $5.0 billion, our total loans receivable were approximately $3.5 billion, our total deposits were approximately $4.2 billion and our total shareholders' equity was approximately $641.6 million. The Company is headquartered at 3399 Peachtree Road, N.E., Suite 1900, Atlanta, Georgia 30326. State Bank's main office is located at 4219 Forsyth Road, Macon, Georgia 31210.
Our History and Growth
On July 24, 2009, State Bank raised approximately $292.1 million in gross proceeds (before expenses) from investors in a private offering of its common stock. Since that date and through October 2011, State Bank has acquired $3.9 billion in total assets and assumed $3.6 billion in deposits from the Federal Deposit Insurance Corporation (the "FDIC"), as receiver, in 12 different failed bank acquisition transactions.
Concurrent with each of our failed bank acquisitions, we entered into loss share agreements with the FDIC that covered certain of the acquired loans and other real estate owned. Historically, we have referred to loans subject to loss share agreements with the FDIC as “covered loans” and loans that were not subject to loss share agreements with the FDIC as “noncovered loans.” However, with the early termination of all of our loss share agreements as discussed below, we now segregate our loan portfolio into the following three categories:
(1) organic loans, which refers to loans not purchased in the acquisition of an institution or credit impaired portfolio,
(2) purchased non-credit impaired loans ("PNCI"), which refers to loans acquired in our acquisitions that did not show
signs of credit deterioration at acquisition, and
(3) purchased credit impaired loans ("PCI"), which refers to loans we acquired that, at acquisition, we determined it was
probable that we would be unable to collect all contractual principal and interest payments due.
All of the loans we acquired in our 12 FDIC assisted transactions, which we refer to as our failed bank transactions, and all of the loans acquired in our purchase of a loan portfolio from the FDIC in July 2014, were deemed purchased credit impaired loans at acquisition. The indemnification asset previously associated with the FDIC loss share agreements related to our failed bank transactions is referred to as the "FDIC receivable." The FDIC receivable was eliminated with the early termination of our loss share agreements discussed below.
On October 1, 2014, we closed on our acquisition of Atlanta Bancorporation, Inc. and its wholly-owned subsidiary bank, Bank of Atlanta. Atlanta Bancorporation, Inc. was immediately merged into the Company followed by the merger of Bank of Atlanta with and into State Bank. We paid approximately $25.2 million in cash for all of the outstanding shares of Atlanta Bancorporation. With the acquisition of Bank of Atlanta, we acquired one branch in midtown Atlanta and one branch in Duluth, Georgia. Shortly after the acquisition, our existing midtown Atlanta branch was closed and merged into Bank of Atlanta's midtown Atlanta branch.
On January 1, 2015, we completed our merger with Georgia-Carolina Bancshares, Inc., the holding company for First Bank of Georgia ("First Bank"). We paid approximately $88.9 million for all of the outstanding shares of Georgia-Carolina Bancshares, Inc. consisting of $31.8 million in cash and $57.0 million of our common stock. Immediately following the merger, First Bank, a Georgia state-chartered bank, became a wholly-owned subsidiary bank of the Company. With the acquisition of First Bank, we acquired three branches in Augusta, Georgia, two branches in Martinez, Georgia, one branch in Evans, Georgia and one branch in Thomson, Georgia. Additionally with the First Bank acquisition, we acquired four mortgage origination offices in Aiken, South Carolina; Augusta, Georgia; Savannah, Georgia and Pooler, Georgia. On July 24, 2015, First Bank merged with and into State Bank.
On May 21, 2015, we entered into an agreement with the FDIC to terminate our loss share agreements for all 12 of our FDIC-assisted acquisitions, resulting in a one-time after-tax charge of approximately $8.9 million, or $14.5 million pre-tax. All rights and obligations of the parties under the FDIC loss share agreements, including the clawback provisions and the settlement of historical loss share expense reimbursement claims, were eliminated under the early termination agreement. All future charge-offs, recoveries, gains, losses and expenses related to assets previously covered by FDIC loss share agreements will now be recognized entirely by us since the FDIC will no longer be sharing in such charge-offs, recoveries, gains, losses and expenses. Despite the termination of the loss share agreements, the terms of the purchase and assumption agreements for our FDIC-assisted acquisitions continue to provide for the FDIC to indemnify us against certain claims, including claims with respect to assets, liabilities or any affiliate not acquired or otherwise assumed by us and with respect to claims based on any action by directors, officers or employees of the failed banks for the term provided in the agreements.
On October 22, 2015, we closed on the acquisition of the equipment finance origination platform of Patriot Capital Corporation ("Patriot Capital"). Patriot Capital, which now operates as a division of State Bank, is a leading provider of equipment financing to the retail petroleum industry. Patriot Capital originates loans throughout the United States.
On December 31, 2016, we closed on our acquisition of NBG Bancorp, Inc. ("NBG Bancorp") and its wholly-owned subsidiary bank, The National Bank of Georgia ("National Bank of Georgia"). NBG Bancorp was immediately merged into the Company followed by the merger of National Bank of Georgia with and into State Bank. We paid approximately $77.9 million for all of the outstanding shares of NBG Bancorp consisting of $34.2 million in cash and $43.7 million of our common stock. With the acquisition of National Bank of Georgia, we acquired one branch in Athens, Georgia, one branch in Gainesville, Georgia, and a mortgage office in Athens, Georgia.
On December 31, 2016, we also closed on our acquisition of S Bankshares, Inc. ("S Bankshares") and its wholly-owned subsidiary bank, S Bank. S Bankshares was immediately merged into the Company followed by the merger of S Bank with and into State Bank. We paid approximately $12.6 million for all of the outstanding shares of S Bankshares consisting of $4.3 million in cash and $8.3 million of our common stock. With the acquisition of S Bank, we acquired four branches located in Savannah, Glennville, Reidsville and Hinesville, Georgia.
On September 30, 2017, we completed our acquisition of AloStar Bank of Commerce ("AloStar"), an Alabama banking corporation. State Bank Interim Corp., a wholly-owned subsidiary of State Bank, merged with and into AloStar with AloStar as the surviving bank and immediately thereafter, AloStar merged with and into State Bank, with State Bank as the surviving bank. We paid approximately $195.0 million in cash for all of the outstanding shares of AloStar. With the acquisition of AloStar, we acquired banking operations in Atlanta, Georgia and one branch in Birmingham, Alabama, which was closed on January 31, 2018.
Strategic Plan
As a result of our 12 FDIC-assisted acquisitions since July 2009, and the fair value discounts associated with each such acquisition, we anticipate that the realization of accretable discounts on the loans that we purchased will continue to be a material contributor to earnings over the next two years. (See below "Lending Activities-General" for an explanation of "accretable discounts"). We also plan to continue growing our loan portfolio organically over the coming year and to add additional clients to our cash management and payments business, including our payroll processing services. For the year ended December 31, 2017, we had organic loan growth of $275.3 million, or 13.2%, from 2016.
In addition to organic growth, we plan to seek other strategic opportunities, such as acquisitions of select loan portfolios, whole loans and loan participations from correspondent banks and specialty lenders, open bank acquisitions and acquisitions that leverage our expertise in failed bank transactions and distressed debt resolutions. We will also consider the purchase of select lines of business that we believe will complement our existing operations.
To achieve our goals, we have assembled an experienced senior management team, combining extensive market knowledge with an energetic and entrepreneurial culture. The members of our management team have close ties to, and are actively involved in, the communities in which we operate, which is critical to our relationship banking focus.
Our Market Area
Our primary market areas are Metropolitan Atlanta, Middle Georgia (including Macon), Greater Savannah, Athens, Gainesville and Augusta, Georgia. At December 31, 2017, we operated 32 full-service banking offices in the following counties in Georgia: Bibb, Chatham, Clarke, Cobb, Columbia, Dooly, Fulton, Gwinnett, Hall, Houston, Jones, Liberty, McDuffie, Richmond and Tattnall. We also operated a full-service banking office in Birmingham, Alabama which was closed on January 31, 2018.
The following table shows key deposit and demographic information about our market areas and our presence in these markets:
(1) Source: S&P Global Market Intelligence. This data is as of June 30, 2017 and the market information includes only retail branches for banks, thrifts, and savings banks and does not include credit unions.
(2) Source: Nielsen, as provided by S&P Global Market Intelligence. Demographic data is provided by Nielsen, based primarily on U.S. Census data. For non-census year data, Nielsen uses samples and projections to estimate the demographic data.
(3) Reflects new deposit lines of business assumed in our acquisitions of AloStar on September 30, 2017. Deposit data reflects deposits held by AloStar as of June 30, 2017.
Competition
The banking business is highly competitive, and we experience competition in our market areas from many other financial institutions. We offer a competitive suite of products coupled with personalized service. Delivery of customized product sets specifically designed to meet the needs of middle market businesses give us a competitive advantage with our target customers. Competition among financial institutions is based on interest rates offered on deposit accounts, structure, terms and interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of products and services rendered, the convenience of banking facilities, and, in the case of loans to commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, savings institutions, mortgage banking firms, consumer and commercial finance companies, securities brokerage firms, insurance companies, as well as super-regional, national and international financial institutions that operate in our market areas and elsewhere. In addition, we compete with payroll processing businesses in providing payroll services.
We compete with financial institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions, such as SunTrust, Bank of America, Wells Fargo, and BB&T. These institutions offer some services, such as extensive and established branch networks and more complex financial products, which we do not provide. In addition, many of our nonbank competitors are not subject to the same extensive governmental regulations applicable to bank holding companies and federally insured banks such as ours.
Lending Activities
General
We offer a range of lending services, including commercial and residential real estate mortgage loans, real estate construction loans, commercial and industrial loans, agriculture and consumer loans. Our customers are generally individuals, owner-managed businesses, farmers, professionals, real estate investors, other lenders, home builders, counties and municipalities within our market areas. We also offer equipment finance agreements, certain Small Business Administration loan programs, asset-based lending, and lender finance loans to customers nationally. At December 31, 2017, we had net total loans of $3.5 billion, representing 74.7% of our total earning assets.
We recorded the loans we acquired in each of our acquisitions at their estimated fair values on the date of each acquisition. We calculated the fair value of loans by discounting scheduled cash flows through the estimated maturity date of the loan, using estimated market discount rates that reflect the credit risk inherent in the loan. We refer to the excess cash flows expected at acquisition over the estimated fair value as the "accretable discount." The accretable discount for purchased non-credit impaired loans and purchased credit impaired loans is recognized as interest income and accretion income, respectively, over the remaining life of the loan. The "nonaccretable discount" is the difference, calculated at acquisition, between contractually required payments and the cash flows expected to be collected. We re-estimate our cash flow expectations for purchased credit impaired loans on a quarterly basis, which involves estimates of expected cash flows and significant judgment on timing of loan resolution. If our assumptions prove to be incorrect, our current allowance for loan and lease losses may not be sufficient, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio.
Real Estate Loans
Loans secured by real estate are the principal component of our loan portfolio. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Increases in interest rates, declines in occupancy rates, fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower's cash flow, creditworthiness and ability to repay the loan. When we make loans, we obtain a security interest in real estate whenever possible, in addition to any other available collateral, to increase the likelihood of the ultimate repayment of the loan. To control concentration risk, we monitor collateral type and industry concentrations within this portfolio.
•
Other Commercial Real Estate Loans. At December 31, 2017, other commercial real estate loans amounted to $1.3 billion, or 35.5%, of our loan portfolio. These loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each loan on an individual basis and attempt to determine the business risks and credit profile of each borrower.
•
Residential Real Estate Loans. We generally originate and hold certain first mortgage and traditional second mortgage residential real estate loans, adjustable rate mortgages and home equity lines of credit. We also originate fixed and adjustable rate residential real estate loans with terms of up to 30 years for third-party investors. At December 31, 2017, residential real estate loans amounted to $333.1 million, or 9.4%, of our loan portfolio, of which home equity loans totaled $89.0 million, or 26.7%, of the residential real estate loan portfolio.
•
Owner-Occupied Real Estate Loans. At December 31, 2017, owner-occupied real estate loans amounted to $399.4 million, or 11.3%, of our loan portfolio. These loans are underwritten based on the borrower’s ability to service the debt from income from the business, as cash flow from the business is considered the primary source of repayment.
Real Estate Construction and Development Loans
At December 31, 2017, real estate construction and development loans amounted to $452.0 million, or 12.8%, of our loan portfolio. We offer fixed and adjustable rate residential and commercial construction loans to builders and developers and to consumers who wish to build their own homes. Construction and development loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and usually on the subsequent leasing and/or sale of the property. Specific risks include, among others:
•
cost overruns;
•
mismanaged construction;
•
inferior or improper construction techniques;
•
economic changes or downturns during construction;
•
a downturn in the real estate market;
•
rising interest rates which may prevent sale of the property; and
•
failure to lease or sell completed projects in a timely manner.
We attempt to reduce the risks associated with construction and development loans by obtaining personal guarantees, as appropriate, monitoring the construction process, and by keeping the loan-to-value ratio of the completed project within regulations as promulgated by both the FDIC and the Georgia Department of Banking and Finance, subject to internal tolerance limits for exceptions.
We make residential land loans to both commercial entities and consumer borrowers for the purpose of financing land upon which to build a residential home. Residential land loans are reclassified as residential construction loans once construction of the residential home commences. These loans are further categorized as:
•
pre-sold commercial, which is a loan to a commercial entity with a pre-identified buyer for the finished home;
•
owner-occupied consumer, which is a loan to an individual who intends to occupy the finished home; and
•
nonowner-occupied commercial (speculative), which is a loan to a commercial entity intending to lease or sell the finished home.
We make commercial land loans to commercial entities for the purpose of financing land on which to build a commercial project. These loans are for projects that typically involve single and multi-use commercial buildings.
We make commercial construction loans to borrowers for the purpose of financing the construction of a commercial development. These loans are further categorized depending on whether the borrower intends (a) to occupy the finished development (owner-occupied) or (b) to lease or sell the finished development (nonowner-occupied). At issuance of the certificate of occupancy these loans are no longer considered construction loans.
Commercial, Financial and Agricultural
At December 31, 2017, commercial, financial and agricultural loans amounted to $973.4 million, or 27.6%, of our total loan portfolio. We make loans for commercial purposes in various lines of businesses, including the manufacturing, professional service, and crop production industries. Commercial, financial and agricultural loans also include loans to states and political subdivisions and equipment finance agreements originated through Patriot Capital, a division of State Bank. While these loans may have real estate as partial collateral, many are secured by various other assets of the borrower including but not limited to accounts receivable, inventory, furniture, fixtures, and equipment. Our underwriting and management of the credit take into consideration the fluid nature of receivables and inventory collateral, where appropriate. Our repayment analysis includes a consideration of the cash conversion cycle, historical cash flow coverage, the predictability of future cash flows, together with the overall capitalization of the borrower. We also participate in loan syndications of senior secured commercial loans either directly with the lead bank or through purchases in the secondary market. These loans are primarily to large publicly traded companies throughout the United States and are secured by all assets of the issuing company. These loans are underwritten to the same standards as our organic portfolio.
Commercial, financial and agricultural loans also include asset-based loans and lender finance loans. Asset-based loans are offered nationally to borrowers for working capital and are typically secured by certain business assets, which includes accounts receivable, inventory, machinery and equipment. These loans carry adjustable interest rates and typically have terms of 3 years.
Collateral securing asset-based loans is heavily monitored and is recalculated daily. Cash receipts of the borrower are received through a lockbox service and applied directly to the loan. Lender finance loans are loans to private lenders throughout the United States used to purchase finance receivables or extend finance receivables to the underlying borrowers and are secured primarily by the finance receivables owed to our borrowers. These loans are typically revolving lines of credit with variable interest rates and terms of 3 to 5 years.
Leases
At December 31, 2017 leases amounted to $52.4 million, or 1.5%, of our loan portfolio. Leases include purchased commercial, business purpose and municipal leases. For purchased leases, the stream of payments and a first security interest in the collateral is assigned to us. Our lease funding is based on a present value of the lease payments at a discounted interest rate, which is determined based on the credit quality of the lessee, the term of the lease compared to expected useful life, and the type of collateral. Types of collateral include, but are not limited to, medical equipment, rolling stock, franchise restaurant equipment and hardware/software. Servicing of purchased leases is primarily retained by the loan originator, as well as ownership of all residuals, if applicable. Lease financing is underwritten by our Specialized Finance Group using similar underwriting standards as would be applied to a secured commercial loan requesting high loan-to-value financing. Risks that are involved with lease financing receivables include credit underwriting and borrower industry concentrations.
Consumer
At December 31, 2017, consumer loans amounted to $66.9 million, or 1.9%, of our loan portfolio. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. We underwrite consumer loans based on the borrower's income, current debt level, personal financial statement composition, past credit and performance history and the availability and value of collateral. Consumer loan interest rates are both fixed and variable. Although we typically require monthly payments of interest and a portion of the principal on our loan products, we may offer consumer loans with a single maturity date when a specific source of repayment is available. Consumer loans not secured by real estate are generally considered to have higher risk because they may be unsecured, or, if they are secured, the value of the collateral may be more difficult to assess, more likely to decrease in value, and is more difficult to control, than real estate. During 2015, we began emphasizing the underwriting of consumer loans secured by cash value life insurance policies which we believe presents a lower collateral risk than other non-real estate secured consumer loans. We also purchase pools of retail installment contracts which are underwritten by our Specialized Finance Group. Servicing of purchased retail installment contracts is primarily retained by the loan originator.
Loan Approval
Certain credit risks are inherent in making loans. These credit risks include repayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. We employ consistent analysis and underwriting to examine credit information and prepare underwriting documentation. We monitor and approve exceptions to policy as required, and we also track and address document exceptions.
Our loan approval policy generally provides for all consumer and commercial relationship exposures less than $500,000 to be handled through a centralized underwriting group. We also have specific officer lending limits entrusted to senior sales leadership. Approval concurrence from experienced credit risk managers is required as the size of the transaction increases. Loans underwritten outside of our Centralized Underwriting Group are required to be post reported to our Loan Committees. Our Loan Committees include the Enterprise Risk Officer, President of State Bank, Chief Credit Officer, Senior Credit Officer, Regional Credit Officers, Director of Credit Administration, Retail/Business Banking Credit Manager and Director of the Commercial Financial Group. State Bank maintains an internal single borrower lending limit of $20.0 million and no more than $5.0 million may be unsecured. Internal policy has established lending authority up to $40.0 million for any relationship, of which no more than $10.0 million may be unsecured. During Credit Steering Committee meetings, loans with either (i) single transaction exposure (STE) greater than $10.0 million, (ii) non-real estate secured with STE greater than $5.0 million, (iii) Patriot Capital loans with STE greater than $500,000, (iv) SBA loans with gross STE greater than $2.0 million, (v) STE loans greater than $2.5 million with total credit exposure greater than $25.0 million or (vi) unsecured exposure greater than $1.0 million are post reported to our executive officers.
State Bank maintains a policy not to originate loans to any director, employee (officer or non-officer), or principal shareholder, or the related interests (as defined in Regulation O) of each. This prohibition does not apply to residential mortgage loans originated for sale in the secondary market to employees not designated as Regulation O officers. Certain of the Acquired
Banks previously extended loans from time to time to certain of their directors, their related interests and members of the immediate families of the directors, executive officers and employees of the Acquired Banks. These loans were made in the ordinary course of business on substantially the same terms, including interest rates, collateral and repayment terms, as those prevailing at the time for comparable transactions with persons not affiliated with the Acquired Banks, and did not involve more than the normal risk of collectability or present other unfavorable features. All loans made to previous Acquired Bank directors or executive officers, their related interests and members of the immediate families of the directors and executive officers who continued in a similar role at State Bank were paid off.
Credit Administration and Loan Review
Organic loans are rated at inception according to our credit grading system. Purchased credit impaired loans and purchased non-credit impaired loans are rated at acquisition date. Purchased non-credit impaired loans are subsequently managed and monitored in the same manner as organic loans. The credit rating for consumer loans and commercial loans with relationship debt less than $500,000 is generally determined by our Centralized Underwriting group. The credit rating for commercial loans is recommended by the relationship manager and ultimately determined by the applicable approval authority of the loan. It is the responsibility of the relationship manager to assess the accuracy of the credit ratings assigned to relationships with total credit exposure greater than $100,000 on a quarterly basis. The credit rating on loans less than $100,000 will remain unchanged unless the loan is part of a larger relationship or payment issues arise. As such, the primary review mechanism for managing these loans is the past due report. In our quarterly analysis of the allowance for loan and lease losses on organic and purchased non-credit impaired loans, loans that are less than $100,000 and are over 60 days past due are reclassified and are treated as substandard and are reserved for as a homogeneous pool, subject to the appropriate loss factor. A reassessment of a loan's credit rating may also be triggered by the noncompliance with financial or reporting covenants, review of financial information, or changes in the primary collateral securing the loan.
Our Credit Administration and Risk Departments assess portfolio trends, concentration risk, and other loan portfolio measurements to gauge the systemic risk that may be inherent in our lending practices and procedures. Our loan review activity is primarily coordinated by the Internal Loan Review Department. Our internal loan review is risk-based, concentrating on those areas with the highest perceived risk. For the year ended December 31, 2017, loans reviewed totaled $1.2 billion, representing 32.9% of recorded investment balances at year-end. The objective of each review was to assess the accuracy of our internal risk ratings; adherence to applicable regulations and bank policies; documentation exceptions; and potential loan administration deficiencies.
Lending Limits
Our lending activities are subject to a variety of lending limits imposed by federal and state law. In general, State Bank is subject to a legal limit on loans to a single borrower equal to 15% of the bank's capital and unimpaired surplus, or 25% if the loan is fully secured. This limit increases or decreases as the bank's capital increases or decreases. Based upon the capitalization of State Bank at December 31, 2017, our legal lending limits were approximately $76.5 million (15%) and $127.5 million (25%), and we maintained a relationship internal lending limit of $10.0 million (if unsecured) and $40.0 million (if secured). We may seek to sell participations in our larger loans to other financial institutions, which will allow us to manage the risk involved in these loans and to meet the lending needs of our customers requiring extensions of credit in excess of these limits.
Mortgage Banking Activity
We engage in mortgage banking as part of an overall strategy to deliver fixed and variable rate residential real estate loan products to customers. The loans are primarily originated for sale into the secondary market with servicing released, and are approved for purchase by a third party investor prior to closing. We also operate wholesale lending to facilitate the purchase of loans from qualified brokers and correspondents for resale in the secondary market. We bear minimal interest rate risk on these loans and only hold the loans temporarily until documentation can be completed to finalize the sale to the investor. In addition, we originate and hold certain first mortgage and traditional second mortgage residential real estate loans and adjustable rate mortgages in our residential real estate loan portfolio.
Deposit Products
We offer a full range of deposit products and services that are typically available in most banks and savings institutions, including checking accounts, commercial operating accounts, savings and money market accounts, individual retirement accounts and short-term to longer-term certificates of deposit. Transaction accounts and certificates of deposit are tailored to and offered at rates competitive to those offered in our primary market areas. We solicit accounts from individuals, businesses, associations, organizations and governmental authorities. We believe that our direct banking strategy will assist us in obtaining deposits from local customers in the future. We also offer certain accounts online at rates competitive to those offered by other online institutions.
Correspondent Banking
We offer a full slate of correspondent banking products to financial institutions across the nation, including liquidity management, Fed Funds accommodations, wholesale mortgage services and commercial real estate loan participations. We previously offered clearing services and exited that offering in the first quarter of 2018.
Treasury Management Services
We provide advanced treasury management tools and payment solutions to commercial customers. We have embraced market payment solutions to initiate deeper core operating relationships in targeted segments and industry verticals. Payment solutions for funds collection and concentration services include ACH origination, Electronic Bill Presentment and Payment (EBPP), Remote Deposit Capture, Remote Cash Deposit, retail and wholesale lockbox, and wire services. Our cash management accounts include enhanced analysis with complex grouping structures, targeted balance sweeps, zero balance accounts, and multiple entity grouping. Our disbursement services include ACH origination, wire services, enhanced on-line bill pay, person-to-person payments and bank-to-bank transfers. Our enhanced fraud controls include Positive Pay, ACH Decisioning, and IBM® Security Trusteer Rapport® malware protection. Our on-line cash management systems can be controlled and managed from multiple locations, through multiple access devices including mobile and desktop with around-the-clock access.
Payroll Services
In October 2012, we acquired substantially all of the assets of Altera Payroll, Inc., a payroll services company. The acquisition diversified our revenue beyond existing business lines and complements our other commercial banking services. Altera Payroll and Insurance, formed from the Altera Payroll acquisition, operates as a division of State Bank, in partnership with treasury services, to provide payroll services, human resources services, payroll cards and employee health insurance. Altera Payroll and Insurance also provides property and casualty insurance, employer liability insurance and workman's compensation through licensed insurance agents.
Employees
At December 31, 2017, we had 829 employees on a full-time equivalent basis.
Availability of Information
Our investor website can be accessed at www.statebt.com under "Investors." Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished to the Securities and Exchange Commission (the "SEC") pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our investor website under the caption "SEC Filings" promptly after we electronically file such materials with, or furnish such materials to, the SEC. No information contained on any of our websites is intended to be included as part of, or incorporated by reference into, this Annual Report on Form 10-K. Documents filed with the SEC are also available free of charge on the SEC's website at www.sec.gov.
SUPERVISION AND REGULATION
State Bank Financial Corporation and our subsidiary bank, State Bank, are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic conditions or new federal or state legislation may have on our business and earnings in the future.
The following discussion is not intended to be a complete list of all of the activities regulated by the banking laws or of the impact of those laws and regulations on our operations. It is intended only to briefly summarize some material provisions.
Legislative and Regulatory Initiatives to Address the Financial Crisis
Although the financial crisis has now passed, two notable legislative and regulatory responses - the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Basel III-based capital rules - will continue to have an impact on our operations.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law, which, among other things, changed the oversight and supervision of banks, bank holding companies, and other financial institutions, revised minimum capital requirements, created a new federal agency to regulate consumer financial products and services and implemented changes to corporate governance and compensation practices. Several provisions affect us, including:
•
Deposit Insurance Modifications. The Dodd-Frank Act modified the FDIC's assessment base upon which deposit insurance premiums are calculated. The new assessment base equals our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The FDIC has continued to modify some of the rules on assessments. The Dodd-Frank Act also permanently raised the standard maximum federal deposit insurance limits from $100,000 to $250,000.
•
Creation of New Governmental Authorities. The Dodd-Frank Act created various new governmental authorities such as the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (the “CFPB”), an independent regulatory authority housed within the Federal Reserve. The CFPB has broad authority to regulate the offering and provision of consumer financial products. The CFPB officially came into being on July 21, 2011, and rulemaking authority for a range of consumer financial protection laws (such as the Truth in Lending Act, the Electronic Funds Transfer Act and the Real Estate Settlement Procedures Act, among others) transferred from the Federal Reserve and other federal regulators to the CFPB on that date. The act gives the CFPB authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with these federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets for compliance with federal consumer laws will remain largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. The CFPB may participate in examinations of our subsidiary bank, which currently has assets of less than $10 billion, and could supervise and examine our other direct or indirect subsidiaries that offer consumer financial products or services. In addition, the act permits states to adopt consumer protection laws and regulations that are stricter than the regulations promulgated by the CFPB, and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against certain institutions.
The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” CFPB rules now in effect specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating a loan’s monthly payments. The rules also extend the requirement that creditors verify and document a borrower’s income and assets to include all information that creditors rely on in determining repayment ability. The rules also define “qualified mortgages,” imposing both underwriting standards - for example, a borrower’s debt-to-income ratio may not exceed 43% - and limits on the terms of such loans. Points and fees are subject to a relatively stringent cap, and payments that may be made in the course of closing a loan are limited as well. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.
•
Executive Compensation and Corporate Governance Requirements. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including the Company. The Dodd-Frank Act (1) grants shareholders of U.S. publicly traded companies an advisory vote on executive compensation; (2) enhances independence requirements for compensation committee members; (3) requires the SEC to adopt rules directing national securities exchanges to establish listing standards requiring all listed companies to adopt incentive-based compensation clawback policies for executive officers; and (4) provides the SEC with authority to adopt proxy access rules that would allow shareholders of publicly traded companies to nominate candidates for election as a director and have those nominees included in a company's proxy materials. The SEC has completed the bulk (although not all) of the rulemaking necessary to implement these provisions.
Separately, the Dodd-Frank Act requires several federal agencies, including the banking agencies and the SEC, to jointly issue a rule restricting incentive compensation arrangements at financial institutions, including bank holding companies and banks. The agencies proposed a rule in 2011, which was replaced with a new proposed rule in May 2016, but the rule has not yet been finalized.
Basel Capital Standards
Regulatory capital rules released in July 2013 to implement capital standards referred to as Basel III and developed by an international body known as the Basel Committee on Banking Supervision, impose higher minimum capital requirements for bank holding companies and banks. The rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. More stringent requirements are imposed on “advanced approaches” banking organizations-those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. The requirements in the rule began to phase in on January 1, 2015 for us. The requirements in the rule will be fully phased in by January 1, 2019.
The rule includes certain new and higher risk-based capital and leverage requirements than those previously in place. Specifically, the following minimum capital requirements apply to us:
•
a new common equity Tier 1 risk-based capital ratio of 4.5%;
•
a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);
•
a total risk-based capital ratio of 8% (unchanged from the former requirement); and
•
a leverage ratio of 4% (also unchanged from the former requirement).
Under the rule, Tier 1 capital is redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Accumulated other comprehensive income ("AOCI") is presumptively included in Common Equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of
this treatment of AOCI. We made this opt-out election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of our investment securities portfolio.
In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, we are required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.
In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.
Volcker Rule
Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.” Proprietary trading is, in general, trading in securities on a short-term basis for a banking entity's own account. Funds subject to the ownership and sponsorship prohibition are those not required to register with the SEC because they have only accredited investors or no more than 100 investors. In 2013, the federal banking agencies together with the SEC and the Commodity Futures Trading Commission, issued the final Volcker Rule regulations.
State Bank Financial Corporation
We own 100% of the outstanding capital stock of State Bank, and therefore we are required to be registered as a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"). As a result, we are primarily subject to the supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve (the "Federal Reserve") under the Bank Holding Company Act and the regulations promulgated under it. As a bank holding company located in Georgia, the Georgia Department of Banking and Finance also regulates and monitors our operations.
Permitted Activities
Under the Bank Holding Company Act, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in, the following activities:
•
banking or managing or controlling banks;
•
furnishing services to or performing services for its subsidiaries; and
•
any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.
Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
•
factoring accounts receivable;
•
making, acquiring, brokering or servicing loans and usual related activities;
•
leasing personal or real property;
•
operating a nonbank depository institution, such as a savings association;
•
trust company functions;
•
financial and investment advisory activities;
•
conducting discount securities brokerage activities;
•
underwriting and dealing in government obligations and money market instruments;
•
providing specified management consulting and counseling activities;
•
performing selected data processing services and support services;
•
acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
•
performing selected insurance underwriting activities.
Our only subsidiary is State Bank. Additionally, we do not currently engage in other activities other than the management and control of State Bank, although we may choose to engage in other activities in the future. As a bank holding company, we also can elect to be treated as a "financial holding company," which would allow us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services and underwriting services, and engaging in limited merchant banking activities. We have not sought financial holding company status, but we may elect that status in the future as our business matures. If we were to elect in writing for financial holding company status, we would be required to be well capitalized and well managed, and each insured depository institution we control would also have to be well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act (discussed below).
The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company's continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.
Change in Control
Two statutes, the Bank Holding Company Act and the Change in Bank Control Act, together with regulations promulgated under them, require some form of regulatory review before any company acquires “control” of a bank or a bank holding company. Under the Bank Holding Company Act, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the management or policies of a bank or bank holding company. In guidance issued in 2008, the Federal Reserve has stated that it would not expect control to exist if a person acquires, in aggregate, less than 33% of the total equity of a bank or bank holding company (voting and nonvoting equity), provided such person’s ownership does not include 15% or more of any class of voting securities. Prior Federal Reserve approval is necessary before an entity acquires sufficient control to become a bank holding company. Natural persons, certain non-business trusts, and other entities are not treated as companies (or bank holding companies), and their acquisitions are not subject to review under the Bank Holding Company Act. State laws generally, including Georgia law, require state approval before an acquirer may become the holding company of a state bank.
Under the Change in Bank Control Act, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank's primary federal regulator must approve the change in control; at the bank level, only the bank's primary federal regulator is involved. Transactions subject to the Bank Holding Company Act are exempt from Change in Control Act requirements. For state banks, state laws, including that of Georgia, typically require approval by the state bank regulator as well.
Source of Strength
The Dodd-Frank Act confirmed a longstanding Federal Reserve policy that a bank holding company must serve as a source of financial strength to its subsidiary bank and to commit resources to support the bank in circumstances in which the bank holding company might not otherwise do so. If State Bank was to become "undercapitalized," we would be required to provide a guarantee of the Bank's plan to return to capital adequacy. (See "Bank Regulation-Prompt Corrective Action" below.) Additionally, under the Bank Holding Company Act, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary, other than a nonbank subsidiary of a bank, upon the Federal Reserve's determination that the activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of the bank holding company. Federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiaries if the agency determines that divestiture may aid the depository institution's financial condition. Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.
Dividends and Capital Requirements
The Federal Reserve imposes certain capital requirements on bank holding companies under the Bank Holding Company Act, including a minimum leverage ratio and minimum ratios of capital to risk-weighted assets. These requirements are essentially the same as those that apply to State Bank and are described above under “Basel Capital Standards” and below under "Bank Regulation-Prompt Corrective Action." Subject to our capital requirements and certain other restrictions, including the consent of the Federal Reserve, we are able to borrow money to make capital contributions to State Bank, and these loans may be repaid from dividends paid from State Bank to the Company.
Our ability to pay dividends depends on State Bank's ability to pay dividends to us, which is subject to regulatory restrictions as described below in "Bank Regulation-Dividends." The Federal Reserve imposes limits on dividends paid by a bank holding company, but because we have no operations apart from management of State Bank, the bank-level restrictions dictate our ability to make capital distributions. We are also able to raise capital for contribution to State Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.
Bank Regulation
State Bank operates as a state bank incorporated under the laws of the State of Georgia and is subject to examination by the Georgia Department of Banking and Finance and the FDIC. The deposits of State Bank are insured by the FDIC up to a maximum amount of $250,000.
The Georgia Department of Banking and Finance and the FDIC regulate or monitor virtually all areas of State Bank's operations, including:
•
security devices and procedures;
•
adequacy of capitalization and loss reserves;
•
loans;
•
investments;
•
borrowings;
•
deposits;
•
mergers;
•
issuances of securities;
•
payment of dividends;
•
interest rates payable on deposits;
•
interest rates or fees chargeable on loans;
•
establishment of branches;
•
corporate reorganizations;
•
maintenance of books and records; and
•
adequacy of staff training to carry on safe lending and deposit gathering practices.
These agencies and the federal and state laws applicable to State Bank’s operations extensively regulate various aspects of our banking business, including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of reserves on demand deposit liabilities, and the safety and soundness of our banking practices.
All insured depository institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate agency against each institution or affiliate as it deems necessary or appropriate. Insured depository institutions file quarterly call reports with their federal regulatory agency and their state supervisor, when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The FDIC and the other federal banking regulatory agencies also have issued standards for all insured depository institutions relating, among other things, to the following:
•
internal controls;
•
information systems and audit systems;
•
loan documentation;
•
credit underwriting;
•
interest rate risk exposure; and
•
asset quality.
Prompt Corrective Action
As an insured depository institution, State Bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the regulations under it, which set forth five capital categories, each with specific regulatory consequences. The following is a list of the criteria for each prompt corrective action category:
•
Well Capitalized - The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution:
•
has a total risk-based capital ratio of 10% or greater; and
•
has a Tier 1 risk-based capital ratio of 8% or greater; and
•
has a common equity Tier 1 risk-based capital ratio of 6.5% or greater; and
•
has a leverage capital ratio of 5% or greater; and
•
is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
•
Adequately Capitalized - The institution meets the required minimum level for each relevant capital measure. The institution may not make a capital distribution if it would result in the institution becoming undercapitalized. An adequately capitalized institution:
•
has a total risk-based capital ratio of 8% or greater; and
•
has a Tier 1 risk-based capital ratio of 6% or greater; and
•
has a common equity Tier 1 risk-based capital ratio of 4.5% or greater; and
•
has a leverage capital ratio of 4% or greater.
•
Undercapitalized - The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution:
•
has a total risk-based capital ratio of less than 8%; or
•
has a Tier 1 risk-based capital ratio of less than 6%; or
•
has a common equity Tier 1 risk-based capital ratio of less than 4.5% or greater; or
•
has a leverage capital ratio of less than 4%.
•
Significantly Undercapitalized - The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution:
•
has a total risk-based capital ratio of less than 6%; or
•
has a Tier 1 risk-based capital ratio of less than 4%; or
•
has a common equity Tier 1 risk-based capital ratio of less than 3% or greater; or
•
has a leverage capital ratio of less than 3%.
•
Critically Undercapitalized - The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.
If the FDIC determines, after notice and an opportunity for hearing, that the institution is in an unsafe or unsound condition, the FDIC is authorized to reclassify the institution to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.
If the institution is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, the rates the institution may pay on the brokered deposits will be limited. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the "national rate" paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity. The "national rate" is defined as a simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly by the FDIC. Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are higher than the "national rate" can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area. Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market areas.
Moreover, if the institution becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The institution also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless it is determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and the loss of its charter to conduct banking activities.
An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital, to the owners of the institution if following such a distribution the institution would be undercapitalized.
At December 31, 2017, State Bank's regulatory capital surpassed the levels required to be considered "well capitalized."
Transactions with Affiliates and Insiders
The Company is a legal entity separate and distinct from State Bank. Various legal limitations restrict State Bank from lending or otherwise supplying funds to the Company or its nonbank subsidiaries, if any. The Company and State Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.
Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit by a bank to any affiliate, including its holding company, and on a bank's investments in, or certain other transactions with, affiliates and on the amount of advances by a bank to third parties that are collateralized by the securities or obligations of any affiliates of the bank. Section 23A also applies to derivative transactions, repurchase agreements and securities lending and borrowing transactions that cause a bank to have credit exposure to an affiliate. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of State Bank's capital and surplus and, as to all affiliates combined, to 20% of State Bank's capital and surplus. Furthermore, within the foregoing limitations as to amount, each extension of credit or certain other credit exposures must meet specified collateral requirements. These limits apply to any transaction with a third party if the proceeds of the transaction benefit an affiliate of a bank. State Bank is forbidden to purchase low quality assets from an affiliate.
Section 23B of the Federal Reserve Act, among other things, prohibits a bank from engaging in certain transactions with certain affiliates unless the transactions are on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to such bank or its subsidiaries, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. If there are no comparable transactions, a bank’s (or one of its subsidiaries’) affiliate transaction must be on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, nonaffiliated companies. These requirements apply to all transactions subject to Section 23A as well as to certain other transactions.
The affiliates of a bank include any holding company of the bank, any other company under common control with the bank (including any company controlled by the same shareholders who control the bank), any subsidiary of the bank that is itself a bank, any company in which the majority of the directors or trustees also constitute a majority of the directors or trustees of the bank or holding company of the bank, any company sponsored and advised on a contractual basis by the bank or an affiliate, and any mutual fund advised by a bank or any of the bank's affiliates. Regulation W generally excludes all nonbank subsidiaries of banks from treatment as affiliates, except for subsidiaries engaged in certain nonbank financial activities or to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.
State Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Extensions of credit include derivative transactions, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions to the extent that such transactions cause a bank to have credit exposure to an insider. Any extension of credit to an insider:
•
must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties; and
•
must not involve more than the normal risk of repayment or present other unfavorable features.
In some circumstances, approval of an extension of credit to an insider must be approved by a majority of the disinterested directors. Extensions of credit to any one insider are capped at 10% of a bank's unimpaired capital and unimpaired surplus, with an additional 10% for loans secured by readily marketable collateral. Extensions of credit to all insiders are capped at 100% of unimpaired capital and unimpaired surplus. State Bank has a policy not to extend credit to its employees, directors, certain principal shareholders and their related interests.
In addition, State Bank may not purchase an asset from or sell an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the majority of disinterested directors.
Branching
Under current Georgia and federal law, we may open branch offices throughout Georgia with the prior approval of the Georgia Department of Banking and Finance and the FDIC. In addition, with prior regulatory approval, we will be able to acquire branches of existing banks located in Georgia. Furthermore, the Dodd-Frank Act authorizes a state or national bank to branch into any state as if they were chartered in that state.
Anti-Tying Restrictions
Under amendments to the Bank Holding Company Act and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that:
•
the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or its subsidiaries; or
•
the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to ensure the soundness of the credit extended.
Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products, and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.
Community Reinvestment Act
The Community Reinvestment Act requires a financial institution's primary regulator, which is the FDIC for State Bank, to evaluate the record of each financial institution in meeting the credit needs of the communities within the institution's assessment area, including low- and moderate-income neighborhoods and individuals. This record is considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately address the needs for bank products and services in low- and moderate-income communities and by low- and moderate-income individuals could result in the imposition of additional requirements and limitations on the institution. Additionally, the institution must publicly disclose the terms of various Community Reinvestment Act-related agreements. In its most recent CRA examination, State Bank was rated Satisfactory.
Financial Subsidiaries
Under the Gramm-Leach-Bliley Act (the "GLBA"), subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form "financial subsidiaries" that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank's equity investment in the financial subsidiary be deducted from the bank's assets and tangible equity for purposes of calculating the bank's capital adequacy. In addition, the GLBA imposes restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and nonbank affiliates. State Bank has no financial subsidiaries.
Consumer Protection Regulations
Activities of State Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by State Bank are subject to state usury laws and federal laws concerning interest rates. The loan operations of State Bank are also subject to federal laws applicable to credit transactions, such as:
•
the Truth-In-Lending Act and Regulation Z, governing disclosures of credit and servicing terms to consumer borrowers and including substantial new requirements for mortgage lending and servicing, as mandated by the Dodd-Frank Act;
•
the Home Mortgage Disclosure Act of 1975 and Regulation C, 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 communities they serve;
•
the Equal Credit Opportunity Act and Regulation B, prohibiting discrimination on the basis of race, color, religion, or other prohibited factors in extending credit;
•
the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act and Regulation V, as well as the rules and regulations of the FDIC governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;
•
the Fair Debt Collection Practices Act and Regulation F, governing the manner in which consumer debts may be collected by collection agencies; and
•
the Real Estate Settlement Procedures Act and Regulation X, which governs aspects of the settlement process for residential mortgage loans.
The deposit operations of State Bank are also subject to federal laws, such as:
•
the Federal Deposit Insurance Act, which, among other things, limits the amount of deposit insurance available per account to $250,000 and imposes other limits on deposit-taking;
•
the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
•
the Electronic Funds Transfer Act and Regulation E, which governs 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; and
•
the Truth in Savings Act and Regulation DD, which requires depository institutions to provide disclosures so that consumers can make meaningful comparisons about depository institutions and accounts.
Enforcement Powers
State Bank and its respective "institution-affiliated parties," including its respective managements, employees, agents, independent contractors and consultants, such as attorneys and accountants and others who participate in the conduct of the financial institution's affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Civil penalties may be as high as $1,375,000 a day for certain violations. Criminal penalties for some financial institution crimes have been increased to 20 years.
In addition, regulators have considerable flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies have expansive power to issue cease-and-desist orders. These orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts or take other actions as determined by the ordering agency to be appropriate.
The number of government entities authorized to take action against State Bank has expanded under the Dodd-Frank Act. The FDIC continues to have primary enforcement authority. The CFPB has back-up enforcement authority with respect to the consumer protection statutes above. Specifically, the CFPB may request reports from and conduct limited examinations of State Bank in conducting investigations involving the consumer protection statutes. Further, state attorneys general may bring civil actions or other proceedings under the Dodd-Frank Act or regulations against state-chartered banks, including State Bank. Prior notice to the CFPB and the FDIC would be necessary for a state civil action against State Bank.
Anti-Money Laundering
Financial institutions must maintain anti-money laundering programs governed by the Bank Secrecy Act, that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. Financial institutions are prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and "knowing your customer" in their dealings with foreign financial institutions, foreign customers and other high risk customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA PATRIOT Act, enacted in 2001 and renewed through 2019, as described below. Bank regulators routinely examine institutions for compliance with these obligations and are required immediately to consider compliance in connection with the regulatory review of applications. In recent years, several merger and acquisition transactions have been held up because of regulatory concerns about compliance with anti-money laundering requirements. The regulatory authorities have been active in imposing "cease and desist" orders and money penalty sanctions against institutions that have not complied with these requirements.
USA PATRIOT Act
The USA PATRIOT Act became effective on October 26, 2001, and amended the Bank Secrecy Act. The USA PATRIOT Act provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanisms for the U.S. government, including:
•
standards for verifying customer identification at account opening;
•
rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering;
•
reports of nonfinancial trades and businesses filed with the Treasury Department's Financial Crimes Enforcement Network for transactions exceeding $10,000; and
•
filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
The USA PATRIOT Act requires financial institutions to undertake enhanced due diligence of private bank accounts or correspondent accounts for non-U.S. persons that they administer, maintain or manage. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the USA PATRIOT Act, the Financial Crimes Enforcement Network (“FinCEN”) can send State Bank lists of the names of persons suspected of involvement in terrorist activities or money laundering. State Bank may be requested to search its records for any relationships or transactions with persons on those lists. If State Bank identifies any such relationships or transactions, it must report those relationships or transactions to FinCEN.
The Office of Foreign Assets Control
The Office of Foreign Assets Control ("OFAC"), which is an office in the U.S. Department of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with "enemies" of the United States, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If a bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze or block the transaction on the account. State Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. State Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. These checks are performed using software that is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.
Privacy, Data Security and Credit Reporting
Financial institutions are required to protect the confidentiality of the nonpublic personal information of individual customers and to disclose their policies for doing so. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. State Bank's policy is not to disclose any personal information unless permitted by law.
Recent cyber attacks against banks and other institutions that resulted in unauthorized access to confidential customer information have prompted the Federal banking agencies to issue several warnings and extensive guidance on cyber security. The agencies are likely to devote more resources to this part of their safety and soundness examination than they have in the past.
Like other lending institutions, State Bank uses credit bureau data in its underwriting activities. Use of that data is regulated under the Federal Credit Reporting Act on a uniform, nationwide basis. The act and its implementing regulation, Regulation V, cover credit reporting, prescreening, sharing of information between affiliates, and the use of credit data. The Fair and Accurate Credit Transactions Act of 2003 allows states to enact identity theft laws that are not inconsistent with the conduct required by the provisions of the act.
Payment of Dividends
The Company is a legal entity separate and distinct from its subsidiary, State Bank. While there are various legal and regulatory limitations under federal and state law on the extent to which State Bank can pay dividends or otherwise supply funds to the Company, the principal source of the Company's cash revenues is dividends from State Bank. The relevant federal and state regulatory agencies also have authority to prohibit a bank or bank holding company, which would include the Company and State Bank, from engaging in what, in the opinion of the regulatory body, constitutes an unsafe or unsound practice in conducting its business. The payment of dividends could, depending upon the financial condition of the subsidiary, be deemed to constitute an unsafe or unsound practice in conducting its business.
Under Georgia law, the prior approval of the Georgia Department of Banking and Finance is required before any cash dividends may be paid by a state bank if:
•
total classified assets at the most recent examination of the bank exceed 80% of the equity capital (as defined, which includes the allowance for loan and lease losses) of the bank;
•
the aggregate amount of dividends declared or anticipated to be declared in the calendar year exceeds 50% of the net profits (as defined) for the previous calendar year; and
•
the ratio of equity capital to adjusted total assets is less than 6%.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary policies of the United States Government and its agencies. The Federal Open Market Committee's monetary policies have had, and are likely to continue to have, an important effect on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects on the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. We cannot predict the nature or effect of future changes in monetary policies. In 2017, the Federal Open Market Committee raised the target range for the federal funds rate by 25 basis points three times, and indicated the potential for further gradual increases in the federal funds rate depending on the economic outlook.
Insurance of Accounts and Regulation by the FDIC
The deposits of State Bank are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The Dodd Frank Act permanently increased the maximum amount of deposit insurance for banks, savings associations and credit unions to $250,000 per account. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.
FDIC-insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.
The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a notice and hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, remain insured for a period of six months to two years, as determined by the FDIC.
Limitations on Incentive Compensation
In June 2010, the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency and the Office of Thrift Supervision issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization's incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization's ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization's board of directors.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not "large, complex banking organizations." These reviews will be tailored to each organization based on the scope and complexity of the organization's activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization's supervisory ratings, which can affect the organization's ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization's safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
The Dodd-Frank Act required the federal banking agencies, the SEC, and certain other federal agencies to jointly issue a regulation on incentive compensation. The agencies proposed such a rule in 2011, which reflected the 2010 guidance. However, the 2011 proposal was replaced with a new proposed rule in May 2016, which makes explicit that the involvement of risk management and control personnel includes not only compliance, risk management and internal audit, but also legal, human resources, accounting, financial reporting, and finance roles responsible for identifying, measuring, monitoring or controlling risk-taking. A final rule had not been adopted as of December 31, 2017.
Commercial Real Estate Guidance
In December 2015, the federal banking regulators released a statement entitled “Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending” (the “CRE Guidance”). In the CRE Guidance, the federal banking regulators (i) expressed concerns with institutions that ease commercial real estate underwriting standards, (ii) directed financial institutions to maintain underwriting discipline and exercise risk management practices to identify, measure and monitor lending risks, and (iii) indicated that they will continue to pay special attention to commercial real estate lending activities and concentrations going forward. The federal banking regulators previously issued guidance in December 2006, entitled “Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,” which stated that an institution is potentially exposed to significant commercial real estate concentration risk, and should employ enhanced risk management practices, where (1) total reported loans for construction, land development, and other land represent 100% or more of the institution's total capital; or (2) total commercial real estate loans represent 300% or more of the institution's total capital and the outstanding balance of such institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.
Proposed Legislation and Regulatory Action
New regulations and statutes are regularly proposed that contain wide-ranging provisions for altering the structures, regulations and competitive relationships of the nation's financial institutions. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.
Item 1A.
Item 1A. Risk Factors.
Our business is subject to certain risks, including those described below. If any of the events described in the following risk factors actually occurs, then our business, results of operations and financial condition could be materially adversely affected. More detailed information concerning these risks is contained in other sections of this report, including "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Risks Related to Our Business
Recessionary conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
Recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
Furthermore, the Board of Governors of the Federal Reserve System, in an attempt to help the overall economy, has among other things, kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. The Federal Reserve Board increased the target range for the federal funds rate by 25 basis points in
December 2017 and indicated the potential for further gradual increases in the target rate depending on the economic outlook. As the federal funds rate increases, market interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery.
The geographic concentration of our core markets in Georgia makes our business highly susceptible to a downturn in the local economy and depressed banking markets, which could materially and adversely affect us.
Unlike larger financial institutions that are more geographically diversified, our banking franchise is concentrated in Georgia. At December 31, 2017, approximately 64.6% of our loans were to borrowers located in Georgia. A deterioration in economic conditions in the loan or residential or commercial real estate markets in our Georgia market areas could have a material adverse effect on the quality of our loan portfolio, the demand for our products and services, the ability of borrowers to timely repay loans and the value of the collateral securing loans. In addition, if the population, employment or income growth in one of our core markets is negative or slower than projected, income levels, deposits and real estate development could be adversely impacted and we could be materially and adversely affected.
An adverse change in real estate market values may result in losses and otherwise adversely affect our profitability.
At December 31, 2017, approximately 69.1% of our loan portfolio was comprised of loans with real estate as a primary or secondary component of collateral. The real estate collateral in each loan provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. At December 31, 2017, approximately 48.3% of our loan portfolio consists of loans secured by commercial real estate, comprising $1.7 billion of total loans.
A decline in real estate values could impair the value of our collateral and our ability to sell the collateral upon any foreclosure. In the event of a default with respect to any of these loans, the amounts we receive on the sale of the collateral may be insufficient to recover the outstanding principal and interest on the loan. As a result, our profitability and financial condition may be adversely affected.
If we fail to effectively manage credit risk, our business and financial condition will suffer.
We must effectively manage credit risk. As a lender, we are exposed to the risk that our borrowers will be unable to repay their loans according to their terms, and that the collateral securing repayment of their loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers, including the risk that a borrower may not provide information to us about its business in a timely manner, and/or may present inaccurate or incomplete information to us, and risk relating to the value of collateral. In order to manage credit risk successfully, we must, among other things, maintain disciplined and prudent underwriting standards and ensure that our lenders follow those standards. The weakening of these standards for any reason, such as an attempt to attract higher yielding loans, a lack of discipline or diligence by our employees in underwriting and monitoring loans, the inability of our employees to adequately adapt policies and procedures to changes in economic or any other conditions affecting customers and the quality of our loan portfolio, may result in loan defaults foreclosures and additional charge-offs and may necessitate that we significantly increase our allowance for loan and lease losses, each of which could adversely affect our net income. As a result, our inability to manage credit risk could have a material adverse effect on our business, financial condition, or results of operations.
To the extent that we are unable to identify and consummate attractive acquisitions, or increase loans through organic loan growth, we may be unable to successfully implement our growth strategy, which could materially and adversely affect us.
A substantial part of our historical growth has been a result of acquisitions of other financial institutions and we intend to continue to grow our business through strategic acquisitions of banking franchises coupled with organic loan growth. Previous availability of attractive acquisition targets may not be indicative of future acquisition opportunities, and we may be unable to identify any acquisition targets that meet our investment objectives. To the extent that we are unable to find suitable acquisition candidates, an important component of our strategy may be lost. If we are able to identify attractive acquisition opportunities, we must generally satisfy a number of conditions prior to completing any such transaction, including obtaining certain bank regulatory approvals, which may involve time-consuming applications and discussions with regulators and which ultimately may not be granted. Additionally, any future acquisitions may not produce the revenue, earnings or synergies that we anticipated. As our purchased credit impaired loan portfolio, which produces substantially higher yields than our organic and purchased non-credit impaired loan portfolios, is paid down, we expect downward pressure on our income. For the year ended December 31, 2017, we recognized $34.1 million of accretion income, or 16.4% of our total interest income for the year, from
the realization of accretable discounts on our purchased credit impaired loans. If we are unable to replace our purchased credit impaired loans and the related accretion with a significantly higher level of new performing loans and other earning assets due to our inability to identify attractive acquisition opportunities, a decline in loan demand, competition from other financial institutions in our markets, stagnation or deterioration of economic conditions, or other conditions, our financial condition and earnings may be adversely affected.
Our strategic growth plan contemplates additional acquisitions, which could expose us to additional risks.
Our strategic growth plans contemplate additional organic growth and potential growth through additional acquisitions. To the extent that we are unable to increase loans through organic loan growth, or to identify and consummate attractive acquisitions, we may be unable to successfully implement our growth strategy, which could materially and adversely affect our financial condition and earnings.
We routinely evaluate opportunities to acquire additional financial institutions. As a result, we regularly engage in discussions or negotiations that, if they were to result in a transaction, could have a material effect on our operating results and financial condition, including short- and long-term liquidity.
Our acquisition activities could be material and could require us to use a substantial amount of common stock, cash, other liquid assets, and/or incur debt. In addition, if goodwill recorded in connection with our prior or potential future acquisitions were determined to be impaired, then we would be required to recognize a charge against our earnings, which could materially and adversely affect our results of operations during the period in which the impairment was recognized.
Our acquisition activities could involve a number of additional risks, including the risks of:
•
incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in management's attention being diverted from the operation of our existing business;
•
using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets;
•
incurring time and expense required to integrate the operations and personnel of the combined businesses, creating an adverse short-term effect on results of operations; and
•
losing key employees and customers as a result of an acquisition.
In addition, we may be unable to successfully:
•
maintain loan quality in the context of significant loan growth;
•
identify and expand into suitable markets;
•
attract significant deposits and capital to fund anticipated loan growth;
•
maintain adequate common equity and regulatory capital;
•
maintain adequate management personnel and systems to oversee such growth;
•
maintain adequate internal audit, loan review and compliance functions; and
•
implement additional policies, procedures and operating systems required to support such growth.
Failure to successfully address these and other issues related to our expansion could have a material adverse effect on our financial condition and results of operations, and could adversely affect our ability to successfully implement our business strategy.
Future acquisitions may be delayed, impeded, or prohibited due to regulatory issues.
Our future acquisitions, particularly those of financial institutions, are subject to approval by a variety of federal and state regulatory agencies. The process for obtaining these required regulatory approvals has become substantially more difficult in recent years. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to existing or new regulatory issues we have, or may have, with regulatory agencies, including, without limitation, issues related to anti-money laundering/Bank Secrecy Act compliance, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive, or abusive acts or practices regulations, Community Reinvestment Act issues, and other similar laws and regulations. We may fail to pursue, evaluate or complete strategic and competitively significant acquisition opportunities as a result of our inability, or perceived or anticipated inability, to obtain regulatory approvals in a timely manner, under reasonable conditions or at all. Difficulties associated with potential acquisitions that may result from these factors could have a material adverse effect on our business, and, in turn, our financial condition and results of operations.
We may be exposed to difficulties in combining the operations of acquired institutions into our own operations, which may prevent us from achieving the expected benefits from our acquisition activities.
We may not be able to fully achieve the strategic objectives and operating efficiencies that we anticipate in our acquisition activities. Inherent uncertainties exist in integrating the operations of an acquired institution. In addition, the markets in which we and our potential acquisition targets operate are highly competitive. We may lose existing customers, or the customers of an acquired institution, as a result of an acquisition. We also may lose key personnel from the acquired institution as a result of an acquisition. We may not discover all known and unknown factors when examining an institution for acquisition during the due diligence period. These factors could produce unintended and unexpected consequences. Undiscovered factors as a result of an acquisition could bring civil, criminal and financial liabilities against us, our management and the management of the institutions we acquire. In addition, if difficulties arise with respect to the integration process, the economic benefits expected to result from acquisitions might not occur. Failure to successfully integrate businesses that we acquire could have an adverse effect on our profitability, return on equity, return on assets, or our ability to implement our strategy, any of which in turn could have a material adverse effect on our business, financial condition and results of operations. These factors could contribute to our not achieving the expected benefits from our acquisitions within desired time frames, if at all.
Our business is subject to interest rate risk, and fluctuations in interest rates may adversely affect our earnings and capital levels and overall results.
The majority of our assets and liabilities are monetary in nature and, as a result, we are subject to significant risk from changes in interest rates. Changes in interest rates may affect our net interest income as well as the valuation of our assets and liabilities. Our earnings depend significantly on our net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. We expect to periodically experience "gaps" in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates move contrary to our position, this "gap" may work against us, and our earnings may be adversely affected.
When interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income. Additionally, an increase in the general level of interest rates may also, among other things, adversely affect our current borrower's ability to repay variable rate loans, the demand for loans and our ability to originate loans and decrease loan prepayment rates. Conversely, a decrease in the general level of interest rates, among other things, may lead to prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the general level of market interest rates may adversely affect our net yield on interest-earning assets, loan origination volume and our overall results.
Although our asset-liability management strategy is designed to control and mitigate exposure to the risks related to changes in the general level of market interest rates, those rates are affected by many factors outside of our control, including inflation, recession, unemployment, money supply, international disorder, instability in domestic and foreign financial markets and policies of various governmental and regulatory agencies, particularly the Board of Governors of the Federal Reserve. Adverse changes in the U.S. monetary policy or in economic conditions could materially and adversely affect us. We may not be able to accurately predict the likelihood, nature and magnitude of those changes or how and to what extent they may affect our business. We also may not be able to adequately prepare for or compensate for the consequences of such changes. Any failure to predict and prepare for changes in interest rates or adjust for the consequences of these changes may adversely affect our earnings and capital levels and overall results.
We could be subject to changes in tax laws, regulations and interpretations or challenges to our income tax provision.
We compute our income tax provision based on enacted tax rates in the jurisdictions in which we operate. Any change in enacted tax laws, rules or regulatory or judicial interpretations, or any change in the pronouncements relating to accounting for income taxes could adversely affect our effective tax rate, tax payments and results of operations. The taxing authorities in the jurisdictions in which we operate may challenge our tax positions, which could increase our effective tax rate and harm our financial position and results of operations. We are subject to audit and review by U.S. federal and state tax authorities. Any adverse outcome of such a review or audit could have a negative effect on our financial position and results of operations. In addition, changes in enacted tax laws, such as adoption of a lower income tax rate in any of the jurisdictions in which we operate, could impact our ability to obtain the future tax benefits represented by our deferred tax assets. In addition, the determination of our provision for income taxes and other liabilities requires significant judgment by management. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and could have a material adverse effect on our financial results in the period or periods for which such determination is made.
Any expansion into new lines of business might not be successful.
As part of our ongoing strategic plan, we will continue to consider expansion into new lines of business through the acquisition of third parties or through organic growth and development. There are substantial risks associated with such efforts, including risks that (a) revenues from such activities might not be sufficient to offset the development, compliance, and other implementation costs, (b) competing products and services and shifting market preferences might affect the profitability of such activities, and (c) our internal controls might be inadequate to manage the risks associated with new activities. Furthermore, it is possible that our unfamiliarity with new lines of business might adversely affect the success of such actions. If any such expansions into new product markets are not successful, there could be an adverse effect on our financial condition and results of operations.
We depend on our management team, and the loss of our senior executive officers or other key employees could impair our relationship with customers and adversely affect our business and financial results.
Our success largely depends on the continued service and skills of our existing senior executive management team, as well as other key employees, who have years of experience in the banking industry and have developed long-term customer relationships. Our growth strategy is built on our ability to retain our senior executive management team and other key employees with experience and business relationships within their respective segments. If we do not retain the services of these individuals or if we fail to adequately plan for the succession of such individuals, our customer relationships, results of operations and financial condition may be adversely affected.
We are subject to extensive regulation that could limit or restrict our activities and adversely affect our earnings.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies, including the Federal Reserve, the FDIC and the Georgia Department of Banking and Finance, among others. Our compliance with these regulations is costly and restricts our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. Our failure to comply with these requirements can lead to, among other remedies, administrative enforcement actions, termination or suspension of our licenses, rights of rescission for borrowers, and class action lawsuits. Many of these regulations are intended to protect depositors, the public and the FDIC rather than our shareholders. The burden of regulatory compliance has increased under current legislation and banking regulations and is likely to continue to have or may have a significant impact on the financial services industry. Legislative and regulatory changes, including increases in capital requirements, as well as changes in regulatory enforcement policies and capital adequacy guidelines, are increasing our costs of doing business and, as a result, may create an advantage for our competitors who may not be subject to similar legislative and
regulatory requirements. In addition, future regulatory changes, including changes to regulatory capital requirements, could have an adverse impact on our future results. Furthermore, the federal and state bank regulatory authorities who supervise us have broad discretionary powers to take enforcement actions against banks for failure to comply with applicable regulations and laws. If we fail to comply with applicable laws or regulations, we could become subject to enforcement actions that have a material adverse effect on our future results.
This and other potential changes in government regulation or policies could increase our costs of doing business and could adversely affect our operations and the manner in which we conduct our business.
The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.
In July 2013, the federal banking agencies published new regulatory capital rules based on the international standards, known as Basel III, that had been developed by the Basel Committee on Banking Supervision. The new rules raised the risk-based capital requirements and revised the methods for calculating risk-weighted assets, usually resulting in higher risk weights. The new rules became effective as applied to the Company and State Bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019. In November 2017, the federal banking agencies extended the transition provisions for certain items at the 2017 transition level indefinitely.
The Basel III-based rules increase capital requirements and include two new capital measurements that will affect us, a risk-based common equity Tier 1 ratio and a capital conservation buffer. Common Equity Tier 1 (CET1) capital is a subset of Tier 1 capital and is limited to common equity (plus related surplus), retained earnings and certain other items. Other instruments that have historically qualified for Tier 1 treatment, including noncumulative perpetual preferred stock, are consigned to a category known as Additional Tier 1 capital and must be phased out of CET1 over a period of nine years beginning in 2014. Tier 2 capital consists of instruments that have historically been placed in Tier 2, as well as cumulative perpetual preferred stock.
Beginning on January 1, 2015, our Basel III-based minimum risk-based capital requirements were (i) a CET1 ratio of 4.5%, (ii) a Tier 1 capital (CET1 plus Additional Tier 1 capital) of 6% (up from 4%) and (iii) a total capital ratio of 8% (unchanged from the former requirement). Our leverage ratio requirement will remain at the 4% level now required. These requirements remain in place today. Beginning in 2016, a capital conservation buffer began to phase in over three years, ultimately resulting in a requirement of 2.5% on top of the CET1, Tier 1 and total capital requirements, resulting in a required CET1 ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. As of January 1, 2018, our capital conservation buffer is 1.875%. Failure to maintain the buffer or to satisfy any of these three capital requirements will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions. While the final rules results in higher regulatory capital standards, it is not expected to significantly impact the Company and State Bank as our current capital levels far exceed those required under the new rules.
In addition to the higher required capital ratios and the new deductions and adjustments, the final rules increased the risk weights for certain assets, meaning that we will have to hold more capital against these assets. For example, commercial real estate loans that do not meet certain new underwriting requirements must be risk-weighted at 150%, rather than the former requirement of 100%. We will also be required to hold capital against short-term commitments that are not unconditionally cancelable. All changes to the risk weights took effect in full in 2015.
In addition, in the current economic and regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if we are unable to comply with such requirements. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, could result in management modifying our business strategy and could limit our ability to make distributions, including paying dividends or buying back our shares.
The federal banking agencies are implementing new liquidity standards that could result in our having to lengthen the term of our funding, restructure our business lines by forcing us to seek new sources of liquidity for them, and/or increase our holdings of liquid assets.
In 2014, the federal banking agencies adopted a "liquidity coverage ratio" requirement for banking holding companies with $250 billion or more in total assets or $10 billion or more in on-balance sheet foreign exposures and their subsidiary depository
institutions with $10 billion or more in total consolidated assets. The requirement calls for sufficient “high quality liquid assets” to meet liquidity needs for a 30 calendar day liquidity stress scenario. In 2016, the agencies proposed a net stable funding ratio for these institutions, which imposes a similar requirement over a one-year period. Neither the liquidity coverage standard nor the net stable funding standard apply directly to us, but the substance of the standards - adequate liquidity over a 30-day period and one-year periods - may inform the regulators’ assessment of our liquidity. We could be required to reduce our holdings of illiquid assets which could adversely affect our results of operations and financial condition. The U.S. regulators have not yet proposed a net stable funding ratio requirement.
The value of securities in our investment portfolio may decline in the future.
As of December 31, 2017, we owned $906.8 million of investment securities. The fair value of our investment securities may be adversely affected by market conditions, including changes in interest rates, and the occurrence of any events adversely affecting the issuer of particular securities in our investments portfolio. We analyze our securities on a quarterly basis to determine if an other-than-temporary impairment has occurred. The process for determining whether impairment is other-than-temporary usually requires complex, subjective judgments about the future financial performance of the issuer in order to assess the probability of receiving all contractual principal and interest payments on the security. Because of changing economic and market conditions affecting issuers, we may be required to recognize other-than-temporary impairment in future periods, which could have a material adverse effect on our business, financial condition or results of operations.
If our allowance for loan and lease losses and fair value adjustments with respect to acquired loans is not sufficient to cover actual loan losses, our earnings will be adversely affected.
Our success depends significantly on the quality of our assets, particularly loans. Like other financial institutions, we are exposed to the risk that our borrowers may not repay their loans according to their terms, and the collateral securing the payment of these loans may be insufficient to fully compensate us for the outstanding balance of the loan plus the costs to dispose of the collateral. As a result, we may experience significant loan losses that may have a material adverse effect on our operating results and financial condition.
We maintain an allowance for loan and lease losses with respect to our loan portfolio, in an attempt to cover loan losses inherent in our loan portfolio. In determining the size of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. We also make various assumptions and judgments about the collectability of our loan portfolio, including the diversification in our loan portfolio, the effect of changes in the economy on real estate and other collateral values, the results of recent regulatory examinations, the effects on the loan portfolio of current economic conditions and their probable impact on borrowers, the amount of charge-offs for the period and the amount of nonperforming loans and related collateral security.
The application of the acquisition method of accounting in our acquisitions has impacted our allowance for loan and lease losses. Under the acquisition method of accounting, all acquired loans were recorded in our consolidated financial statements at their fair values at the time of acquisition and the related allowance for loan and lease losses was eliminated because credit quality, among other factors, was considered in the determination of fair value. To the extent that our estimates of fair values are too high, we will incur losses associated with the acquired loans. The allowance associated with our purchased credit impaired loans reflects deterioration in cash flows since acquisition resulting from our quarterly re-estimation of cash flows which involves complex cash flow projections and significant judgment on timing of loan resolution.
If our analysis or assumptions prove to be incorrect, our current allowance may not be sufficient, and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Material additions to the allowance for loan and lease losses would materially decrease our net income and adversely affect our general financial condition.
In addition, federal and state regulators periodically review our allowance for loan and lease losses and may require us to increase our allowance for loan and lease losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan and lease losses or loan charge-offs required by these regulatory agencies could have a material adverse effect on our operating results and financial condition.
Finally, the measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us in 2020. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information
about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
We are exposed to higher credit risk by construction and development, other commercial real estate, and commercial, financial and agricultural lending.
Construction and development, commercial real estate, and commercial, financial and agricultural lending may involve higher credit risks than other forms of lending. At December 31, 2017, the following loan types accounted for the stated percentages of our total loan portfolio: real estate construction and development - 12.8%, other commercial real estate - 35.5%, and commercial, financial and agricultural - 27.6%.
Risk of loss on a construction and development loan depends largely upon whether our initial estimate of the property's value at completion of construction equals or exceeds the cost of the property construction (including interest), the availability of permanent take-out financing and the builder's ability to ultimately sell the property. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.
Other commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers' ability to repay their loans depends on successful development of their properties, in addition to the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period but have a balloon payment due at maturity. A borrower's ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.
Commercial, financial and agricultural loans are typically based on the borrowers' ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the assets securing the loans have the following characteristics: (a) they depreciate over time, (b) they are difficult to appraise and liquidate, and (c) they fluctuate in value based on the success of the business.
Construction and development loans, other commercial real estate loans, and commercial, financial and agricultural loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review and monitoring cannot eliminate all of the risks related to these loans.
During 2015 and 2016, the banking regulators issued several warnings about higher credit risk in commercial lending, particularly in commercial real estate loans. At December 31, 2017, our outstanding commercial real estate loans were equal to 334.8% of the Bank's total risk-based capital. Our commercial real estate level is considered to be a concentration by the banking regulators. The banking regulators are giving commercial real estate lending greater scrutiny, and require banks with concentrations in commercial real estate loans such as us to have an appropriate risk management framework consisting of (i) board and management oversight, (ii) portfolio management, (iii) market analysis, (iv) credit underwriting standards, (v) portfolio stress testing and sensitivity analysis and (vi) credit risk review function.
We face additional risks due to our mortgage banking activities that could negatively impact our net income and profitability.
We acquired mortgage banking operations in certain of our acquisitions, which in addition to our legacy mortgage banking operations, expose us to risks that are different from our retail and commercial banking operations. During higher and rising interest rate environments, the demand for mortgage loans and the level of refinancing activity tends to decline, which can lead to reduced volumes of business and lower revenues, which could negatively impact our earnings. While we have been experiencing historically low interest rates, the low interest rate environment likely will not continue indefinitely. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking operations also depends in large part on our ability to aggregate a high volume of loans and sell them in the secondary market at a gain. Thus, in
addition to our dependence on the interest rate environment, we are dependent upon (a) the existence of an active secondary market and (b) our ability to profitably sell loans into that market. If our level of mortgage production declines, the profitability will depend upon our ability to reduce our costs commensurate with the reduction of revenue from our mortgage operations. In addition, mortgages sold to third-party investors are typically subject to certain repurchase provisions related to borrower refinancing, defaults, fraud or other reasons stipulated in the applicable third-party investor agreements. If the fair value of a loan when repurchased is less than the fair value when sold, we may be required to charge such shortfall to earnings.
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
Our operations rely on the secure processing, storage and transmission of confidential and other sensitive business and consumer information on our computer systems and networks and third party providers. Under various federal and state laws, we are responsible for safeguarding such information. For example, our business is subject to the Gramm-Leach-Bliley Act which, among other things: (1) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (2) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (3) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Ensuring that our collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase our costs.
Although we take protective measures to maintain the confidentiality, integrity and availability of information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events that could have an adverse security impact. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or may originate internally from within our organization. Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified. In addition, the increasing reliance on technology systems and networks and the occurrence and potential adverse impact of attacks on such systems and networks, both generally and in the financial services industry, have enhanced government and regulatory scrutiny of the measures taken by companies to protect against cyber-security threats. As these threats, and government and regulatory oversight of associated risks, continue to evolve, we may be required to expend additional resources to enhance or expand upon the security measures we currently maintain.
In particular, information pertaining to us and our customers is maintained, and transactions are executed, on the networks and systems of us, our customers and certain of our third-party partners, such as our payment processing and online banking platforms. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our customers against fraud and security breaches and to maintain our clients’ confidence. While we have not experienced any material breaches of information security, such breaches may occur through intentional or unintentional acts by those having access or gaining access to our systems or our customers’ or counterparties’ confidential information, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions, as well as the technology used by our customers to access our systems. We cannot be certain that the security measures we or processors have in place to protect this sensitive data will be successful or sufficient to protect against all current and emerging threats designed to breach our systems or those of processors. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, a breach of our systems, or those of processors, could result in losses to us or our customers; loss of business and/or customers; damage to our reputation; the incurrence of additional expenses (including the cost of notification to consumers, credit monitoring and forensics, and fees and fines imposed by the card networks); disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability-any of which could have a material adverse effect on our business, financial condition and results of operations.
We depend on information technology and telecommunications systems of third-party servicers, and systems failures, interruptions or breaches of security involving these systems could have an adverse effect on our operations, financial condition and results of operations.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems, third-party servicers accounting systems and mobile and online banking platforms. We outsource some of our major systems, such as payment processing and online banking platforms. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to service our customers, compromise our efficiency, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. In addition, failure of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties could disrupt our operations or adversely affect our reputation.
It may be difficult for us to replace some of our third party vendors in a timely manner if they are unwilling or unable to provide us with these services in the future for any reason and if we are able to replace them, it may be at higher cost or create customer dissatisfaction. Any such events could have a material adverse effect on our business, financial condition or results of operations.
Our operations rely heavily on the secure processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. We also interact with and rely on financial counterparties and regulators. Each of these third parties may be targets of the same types of fraudulent activity, computer break-ins and other cyber security breaches described above or herein, and the cyber defense measures that they maintain to mitigate the risk of such activity may be different than our own and may be inadequate.
As a result of financial entities and technology systems becoming more interdependent and complex, a cyber incident, information breach or loss, or technology failure that compromises the systems or data of one or more financial entities could have a material impact on counterparties or other market participants, including ourselves. Although we review business continuity and backup plans for our vendors and take other safeguards to support our operations, such plans or safeguards may be inadequate. As a result of the foregoing, our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact.
Additionally, regulators expect financial institutions to be responsible for all aspects of their performance, including aspects which they delegate to third parties. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems, devices, or software that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
We may not be able to retain or develop a strong core deposit base or other low-cost funding sources.
We depend on checking, savings and money market deposit account balances and other forms of customer deposits as our primary source of funding for our lending activities. Our future growth will largely depend on our ability to retain and grow a strong deposit base. We derive liquidity through core deposit growth and maturity and sale of investment securities and loans. We acquired internet and correspondent banking operations in our acquisition of AloStar Bank of Commerce. These operations provide deposits which are more volatile and rate sensitive than our core deposits. Additionally, we have access to financial market borrowing sources on an unsecured and a collateralized basis for both short-term and long-term purposes including, but not limited to, the Federal Reserve and Federal Home Loan Banks, of which we are a member. If these funding sources are not sufficient or available, we may have to acquire funds through higher-cost sources. In addition, we must compete with other banks and financial institutions for deposits. If our competitors raise rates on their deposits, we may face deposit attrition or experience higher funding costs by increasing our deposit rates in order to maintain our customer deposit base. As of December 31, 2017, approximately 28.1% of our deposits were non-interest bearing. Higher funding costs will reduce our net interest margin, net interest income and net income. If we are unable to attract and retain core deposits, to obtain third party financing on favorable terms, or to have access to interbank or other liquidity sources, our cost of funds will increase, adversely affecting the ability to generate the funds necessary for our lending operations, reducing our net interest margin, net interest
income and net income. Any decline in available funding could adversely affect our ability to continue to implement our business strategy which could have a material adverse impact on our liquidity, business, financial condition, and results of operations.
We face strong competition for customers, which could prevent us from obtaining customers or may cause us to pay higher interest rates to attract customer deposits.
The banking business is highly competitive, and we experience competition in our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, as well as super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere. As customer preferences and expectations continue to evolve, technology has lowered barriers to entry and made it possible for banks to expand their geographic reach by providing services over the Internet and for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Because of this rapidly changing technology, our future success will depend in part on our ability to address our customers' needs by using technology. Customer loyalty can be easily influenced by a competitor's new products, especially offerings that could provide cost savings or a higher return to the customer. Moreover, this competitive industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation.
We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions, such as SunTrust Bank, Bank of America, Wells Fargo and BB&T. We also compete with regional and local community banks in our market. We may not be able to compete successfully with other financial institutions in our market, and we may have to pay higher interest rates to attract deposits, accept lower yields on loans to attract loans and pay higher wages for new employees, resulting in lower net interest margin and reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us. If we are unable to compete effectively with those banking or other financial services businesses, we could find it more difficult to attract new and retain existing clients and our net interest margin and net interest income could decline, which would adversely affect our results of operations and could cause us to incur losses in the future.
Future growth or operating results may require us to raise additional capital, but that capital may not be available or may be dilutive.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We may at some point need to raise additional capital to support our operations and any future growth.
Our ability to raise capital will depend on conditions in the capital markets, which are outside of our control and largely do not depend on our financial performance. Accordingly, we may be unable to raise capital when needed or on favorable terms. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These restrictions could negatively affect our ability to operate or further expand our operations through loan growth, acquisitions or the establishment of additional branches. These restrictions may also result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition, results of operations and the price of our common stock.
Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings.
The FDIC insures deposits at FDIC-insured depository institutions, such as State Bank, up to $250,000 per account. The amount of a particular institution's deposit insurance assessment is based on that institution's risk classification under an FDIC risk-based assessment system. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. As a result of recent FDIC assessment charges, banks are now assessed deposit insurance premiums based on the bank's average consolidated total assets less the sum of its average tangible equity, and the FDIC has modified certain risk-based adjustments, which increase or decrease a bank's overall assessment rate. This has resulted in increases to the deposit insurance assessment rates and thus raised deposit premiums for many insured depository institutions. If these increases are insufficient for the Deposit Insurance Fund to meet its funding requirements, further special assessments or increases in deposit insurance premiums may be required. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay higher FDIC premiums than the recent levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could reduce our profitability, may limit our ability to pursue certain business opportunities or otherwise negatively impact our operations.
We are subject to the Community Reinvestment Act and federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.
The Community Reinvestment Act, the Equal Credit Opportunity Act and the Fair Housing Act impose nondiscriminatory lending requirements on financial institutions. The FDIC, the Department of Justice, and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.
Any deficiencies in our financial reporting or internal controls could materially and adversely affect us, including resulting in material misstatements in our financial statements, and could materially and adversely affect the market price of our common stock.
If we fail to maintain effective internal controls over financial reporting, our operating results could be harmed and it could result in a material misstatement in our financial statements in the future. Inferior controls and procedures or the identification of accounting errors could cause our investors to lose confidence in our internal controls and question our reported financial information, which, among other things, could have a negative impact on the trading price of our common stock. Additionally, we could become subject to increased regulatory scrutiny and a higher risk of shareholder litigation, which could result in significant additional expenses and require additional financial and management resources.
The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in this report, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider "critical" because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures.
We face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations and corresponding enforcement proceedings.
The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (which we refer to as the “PATRIOT Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and to file suspicious activity and currency transaction reports as appropriate. FinCEN, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the OFAC. Federal and state bank regulators also have focused on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations. Sanctions that the regulators have imposed on banks that have not complied with all requirements have been especially severe. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.
We must respond to rapid technological changes, and these changes may be more difficult or expensive than anticipated.
We will have to respond to future technological changes. Specifically, if our competitors introduce new banking products and services embodying new technologies, or if new banking industry standards and practices emerge, then our existing product and service offerings, technology and systems may be impaired or become obsolete. Further, if we fail to adopt or develop new technologies or to adapt our products and services to emerging industry standards, then we may lose current and future customers, which could have a material adverse effect on our business, financial condition and results of operations. The financial services industry is changing rapidly, and to remain competitive, we must continue to enhance and improve the functionality and features of our products, services and technologies. These changes may be more difficult or expensive than we anticipate.
We are subject to losses due to the errors or fraudulent behavior of employees or third parties.
We are exposed to many types of operational risk, including the risk of fraud by employees and outsiders, clerical record-keeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially adversely affected if one of our employees causes a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. When we originate loans, we rely upon information supplied by loan applicants and third parties, including the information contained in the loan application, property appraisal and title information, if applicable, and employment and income documentation provided by third parties. If any of this information is misrepresented and such misrepresentation is not detected prior to loan funding, we generally bear the risk of loss associated with the misrepresentation. Any of these occurrences could result in a diminished ability of us to operate our business, potential liability to customers, reputational damage and regulatory intervention, which could negatively impact our business, financial condition and results of operations.
We may be adversely affected by the lack of soundness of other financial institutions.
Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial institutions, or the financial services industry generally, may lead to market-wide liquidity problems and losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions.
There is uncertainty surrounding the potential legal, regulatory and policy changes by the current presidential administration in the U.S. that may directly affect financial institutions and the global economy.
The current presidential administration has indicated that it would like to see changes made to certain financial reform regulations, including the Dodd-Frank Act, which has resulted in increased regulatory uncertainty, and we are assessing the potential impact on financial and economic markets and on our business. Changes in federal policy and at regulatory agencies
are expected to occur over time through policy and personnel changes, which could lead to changes involving the level of oversight and focus on the financial services industry. The nature, timing and economic and political effects of potential changes to the current legal and regulatory framework affecting financial institutions remain highly uncertain. At this time, it is unclear what laws, regulations and policies may change and whether future changes or uncertainty surrounding future changes will adversely affect our operating environment and therefore our business, financial condition and results of operations.
Risks Related to the Acquisition of our Acquired Banks
We are subject to risks related to our acquisition transactions.
The ultimate success of our past acquisition transactions and any acquisitions (whether FDIC-assisted or unassisted transactions) in which we may participate in the future, will depend on a number of factors, including our ability:
•
to fully integrate, and to integrate successfully, the branches acquired into our operations;
•
to limit the outflow of deposits held by our new customers in the acquired branches and to successfully retain and manage interest-earning assets (loans) acquired;
•
to retain existing deposits and to generate new interest-earning assets in the geographic areas previously served by the acquired banks;
•
to effectively compete in new markets in which we did not previously have a presence;
•
to control the incremental noninterest expense from the acquired operations in a manner that enables us to maintain a favorable overall efficiency ratio;
•
to retain and attract the appropriate personnel to staff the acquired operations;
•
to earn acceptable levels of interest and noninterest income, including fee income, from the acquired operations; and
•
to reasonably estimate cash flows for acquired loans to mitigate exposure greater than estimated losses at the time of acquisition.
As with any acquisition involving a financial institution there may be higher than average levels of service disruptions that would cause inconveniences to our new or existing customers or potentially increase the effectiveness of competing financial institutions in attracting our customers. We anticipate challenges and opportunities because of the unique nature of each acquisition. Integration efforts will also likely divert our management's attention and resources. We may be unable to integrate acquired branches or their personnel successfully, and the integration process could result in the loss of key employees, the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of our acquisition transactions. We may also encounter unexpected difficulties or costs during the integration that could adversely affect our results of operation and financial condition, perhaps materially. Additionally, we may be unable to achieve results in the future similar to those achieved by our existing banking business, to compete effectively in the market areas previously served by the acquired branches or to manage effectively any growth resulting from our acquisition transactions.
The accounting for loans acquired in connection with our acquisitions is based on numerous subjective determinations that may prove to be inaccurate and have a negative impact on our results of operations.
The loans we acquired in connection with our acquisitions have been recorded at their estimated fair value on the respective acquisition date without a carryover of the related allowance for loan and lease losses. In general, the determination of estimated fair value of acquired loans requires management to make subjective determinations regarding discount rate, estimates of losses on defaults, market conditions and other factors that are highly subjective in nature. Although we have recorded fair value adjustments based on our estimates at the date of acquisition, the loans we acquired may become impaired or may further deteriorate in value, resulting in additional losses and charge-offs to the loan portfolio. The fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs that we make to our loan portfolio and consequently reduce our capital. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our results of operations and financial condition even if other favorable events occur.
Loans we acquired in connection with acquisitions that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These purchased credit impaired loans, like purchased non-credit impaired loans, acquired in connection with our acquisitions, have been recorded at their estimated fair value on the respective acquisition date, based on subjective
determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan and lease losses. We evaluate these loans quarterly to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of any previously-recorded provision for loan and lease losses and related allowance for loan and lease losses, and then as a prospective increase in the accretable discount on the purchased credit impaired loans. Because the accounting for these loans is based on subjective measures that can change frequently, we may experience fluctuations in our net interest income and provisions for loan losses attributable to these loans. These fluctuations could negatively impact our results of operations.
Risks Related to Our Common Stock
Shares of our common stock are subject to dilution.
At February 22, 2018, we had 39,012,378 shares of common stock issued and outstanding and warrants outstanding to purchase another 52,904 shares of our common stock. Our outstanding shares of common stock include 977,662 shares of restricted stock. In addition, we have 1,759,651 unallocated shares under our 2011 Omnibus Equity Compensation Plan, as amended, that remain available for future grants. If we issue additional shares of common stock in the future and do not issue those shares to all then-existing common shareholders proportionately to their interests, the issuance will result in dilution to each shareholder by reducing the shareholder's percentage ownership of the total outstanding shares of our common stock.
The market price of our common stock may be volatile, which could cause the value of an investment in our common stock to decline.
The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:
•
general market conditions;
•
domestic and international economic factors unrelated to our performance;
•
actual or anticipated fluctuations in our quarterly operating results;
•
changes in or failure to meet publicly disclosed expectations as to our future financial performance;
•
downgrades in securities analysts' estimates of our financial performance or lack of research and reports by industry analysts;
•
changes in market valuations or earnings of similar companies;
•
any future sales of our common stock or other securities; and
•
additions or departures of key personnel.
The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These types of broad market fluctuations may adversely affect the trading price of our common stock. In the past, shareholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management's attention and resources and harm our business or results of operations.
We may issue shares of preferred stock that would adversely affect the rights of our common shareholders.
Our authorized capital stock includes 2,000,000 shares of preferred stock of which no preferred shares are issued or outstanding. Our board of directors, in its sole discretion, may designate and issue one or more series of preferred stock from the authorized and unissued shares of preferred stock. Subject to limitations imposed by law or our articles of incorporation, our board of directors is empowered to determine:
•
the designation of, and the number of, shares constituting each series of preferred stock;
•
the dividend rate for each series;
•
the terms and conditions of any voting, conversion and exchange rights for each series;
•
the amounts payable on each series on redemption or our liquidation, dissolution or winding-up;
•
the provisions of any sinking fund for the redemption or purchase of shares of any series; and
•
the preferences and the relative rights among the series of preferred stock.
We could issue preferred stock with voting and conversion rights that could adversely affect the voting power of the shares of our common stock and with preferences over the common stock with respect to dividends and in liquidation.
Our securities are not FDIC-insured.
Our securities, including our common stock, are not savings or deposit accounts or other obligations of State Bank, are not insured by the Deposit Insurance Fund, the FDIC or any other governmental agency and are subject to investment risk, including the possible loss of principal.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
The Company is headquartered at 3399 Peachtree Road, N.E., Suite 1900, Atlanta, Georgia 30326 and State Bank's main office is located at 4219 Forsyth Road, Macon, Georgia 31210. We lease the Company's main office and own State Bank's main office location. We currently operate 31 additional full-service branches located in Bibb, Chatham, Clarke, Cobb, Columbia, Dooly, Fulton, Gwinnett, Hall, Houston, Jones, Liberty, McDuffie, Richmond, and Tattnall counties in Georgia and one full-service branch in Birmingham, Alabama. We lease five of our Georgia branches, one full-service branch in Birmingham, Alabama, and own the remaining locations.
Item 3.
Item 3. Legal Proceedings.
In the ordinary course of operations, we may be party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.
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.
Market Information and Holders of Record
On April 14, 2011, our common stock became listed on The NASDAQ Capital Market under the symbol "STBZ".
The following table shows the high and low sales prices for shares of our common stock reported by the NASDAQ Capital Market and the dividends we paid per common share for the periods indicated:
At February 22, 2018, we had 39,012,378 shares of common stock issued and outstanding and approximately 489 shareholders of record.
Dividends
Our ability to pay dividends depends on the ability of our subsidiary bank to pay dividends to us. Under Georgia law, the prior approval of the Georgia Department of Banking and Finance is required before State Bank may pay any cash dividends if:
•
total classified assets at the Bank's most recent examination exceed 80% of equity capital (which includes the allowance for loan and lease losses);
•
the aggregate amount of dividends declared or anticipated to be declared in the calendar year exceeds 50% of the net profits for the previous calendar year; or
•
the Bank's ratio of equity capital to adjusted total assets is less than 6%.
As noted in the above table, we paid cash dividends totaling $.56 per common share in both 2017 and 2016. On February 7, 2018, we declared a quarterly dividend of $.20 per common share to be paid on March 13, 2018 to shareholders of record of our common stock as of March 5, 2018.
Unregistered Sales of Equity Securities
On November 6, 2017, we issued 3,272 shares of our common stock in a cashless exchange for a warrant to purchase 5,000 shares of our common stock. Pursuant to the terms of the warrant, the holder of the warrant used the amount by which 743 shares were deemed to be "in the money" as consideration for the $10.00 per share exercise price for the 3,272 shares we issued, and the entire warrant was canceled in the exchange. The shares issued were exempt from registration under Section 3(a)(9) of the Securities Act of 1933, as amended, because we exchanged the shares with our existing security holder exclusively, and no commission or other remuneration was paid or given directly or indirectly for soliciting the exchange.
Repurchases of Common Stock
The following table provides information regarding the Company's purchase of common stock during the three months ended December 31, 2017:
(1) Represents shares of the Company's common stock acquired by the Company in connection with satisfaction of tax
withholding obligations on vested restricted stock.
(2) On February 10, 2016, the board of directors authorized the repurchase of up to 1.5 million shares of the Company's outstanding common stock. On February 25, 2016, the Company announced it entered into a written trading plan with a broker for the purpose of purchasing up to 1.5 million shares of the Company's outstanding common stock in accordance with the guidelines specified in Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. On February 9, 2018, the Company extended this existing written trading plan for an additional year. The trading plan will now expire on the earlier of (a) February 24, 2019, (b) the date on which the maximum aggregate number of shares authorized to be repurchased has been repurchased, or (c) after written notice by the broker or the Company as specified in the trading plan. To date, 270,715 shares have been repurchased by the Company under the plan.
Stock Performance Graph
The following stock performance graph and related information shall not be deemed "soliciting material" or to be "filed" with the SEC, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended, nor shall such information be incorporated by reference into any future filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, except to the extent the Company specifically incorporates it by reference into such filing. The stock performance graph represents past performance and should not be considered an indication of future performance.
The stock performance graph compares the cumulative annual shareholder return over the past five years on the Company's common stock, assuming an investment of $100 on December 31, 2012 and the reinvestment of dividends thereafter, with the cumulative total return of such an amount on the SNL U.S. Bank Index and the common stocks reported in the NASDAQ Composite Index. The SNL U.S. Bank Index was made up of 320 U.S. bank stocks as of December 31, 2017. The NASDAQ Composite Index is a market capitalization-weighted index and includes all domestic and international based common type stocks listed on The NASDAQ Stock Market.
(1) Total return includes reinvestment of dividends.
Item 6.
Item 6. Selected Financial Data.
The following table provides selected historical consolidated financial information at the dates indicated and for the periods presented. This data should be read in conjunction with the consolidated financial statements and the notes thereto in Item 8, the information contained in this Item 6, including Table 2 below, "Non-GAAP Measure Reconciliation", and with "Management's Discussion and Analysis of Results of Operations and Financial Condition" contained in Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the "Cautionary Note Regarding Forward-Looking Statements" at the beginning of this report.
Introduction
The Company is a bank holding company that was incorporated under the laws of the State of Georgia in January 2010 to serve as the holding company for State Bank. State Bank is a Georgia state-chartered bank that opened in October 2005. From October 2005 until July 23, 2009, State Bank operated as a small community bank from two branch offices located in Dooly County.
On July 24, 2009, State Bank raised approximately $292.1 million in gross proceeds (before expenses) from investors in a private offering of its common stock. In connection with the private offering, the FDIC and the Georgia Department of Banking and Finance approved the Interagency Notice of Change in Control application filed by our new management team, which took control of State Bank on July 24, 2009. As a result of our private offering and acquisition, we were transformed from a small community bank to a much larger commercial bank.
Between July 24, 2009 and December 31, 2017, we successfully completed 17 bank acquisitions totaling $6.0 billion in assets and $5.2 billion in deposits. The acquisitions included 12 different failed bank transactions in which we acted as the assuming institution from the FDIC, which we refer to as our FDIC-assisted transactions or failed bank transactions. Concurrently with each of the failed bank transactions, we entered into loss share agreements with the FDIC that covered certain of the acquired loans and other real estate owned. Our acquisitions also include the acquisition of Atlanta Bancorporation, Inc. and its wholly-owned subsidiary bank, Bank of Atlanta, in October 2014, the acquisition of Georgia-Carolina Bancshares, Inc., the holding company for First Bank of Georgia ("First Bank"), in January 2015, the acquisition of NBG Bancorp, Inc. and its wholly-owned subsidiary bank, The National Bank of Georgia, in December 2016, the acquisition of S Bankshares, Inc. and its wholly-owned subsidiary bank, S Bank, in December 2016, and the acquisition of AloStar Bank of Commerce ("AloStar") in September 2017.
We are now operating 32 full-service branches throughout seven of Georgia's eight largest MSAs. At December 31, 2017, our total assets were approximately $5.0 billion, our total loans receivable were approximately $3.5 billion, our total deposits were approximately $4.2 billion and our total shareholders' equity was approximately $641.6 million.
During the second quarter of 2015, we entered into an agreement with the FDIC to terminate our loss share agreements for all 12 of our FDIC-assisted acquisitions, resulting in a one-time after-tax charge of approximately $8.9 million, or $14.5 million pre-tax. All rights and obligations of the parties under the FDIC loss share agreements, including the clawback provisions and the settlement of historic loss share expense reimbursement claims, were eliminated under the early termination agreement. All future charge-offs, recoveries, gains, losses and expenses related to assets previously covered by FDIC loss share agreements will now be recognized entirely by us since the FDIC will no longer be sharing in such charge-offs, recoveries, gains, losses and expenses.
Historically, we have referred to loans subject to loss share agreements with the FDIC as “covered loans” and loans that are not subject to loss share agreements with the FDIC as “noncovered loans.” With the early termination of all of our loss share agreements as discussed above, we now segregate our loan portfolio into the following three categories:
(1) organic loans, which refers loans not purchased in the acquisition of an institution or credit impaired portfolio,
(2) purchased non-credit impaired loans ("PNCI"), which refers to loans acquired in our acquisitions that did not show
signs of credit deterioration at acquisition, and
(3) purchased credit impaired loans ("PCI"), which refers to loans we acquired that, at acquisition, we determined it was
probable that we would be unable to collect all contractual principal and interest payments due.
Overview
The following provides an overview of the major factors impacting our financial performance in 2017 as well as information on certain important recent events.
•
Our income before income taxes for the year ended December 31, 2017 was $87.6 million, an increase of $13.8 million, or 18.8%, compared to $73.8 million for 2016.
•
Our net income for the year ended December 31, 2017 was $46.6 million, or $1.19 per diluted share, compared to net income of $47.6 million for 2016, or $1.28 per diluted share. Net income for the year ended December 31, 2017 includes the impact of a $10.7 million non-cash tax expense resulting from the enactment of the "Tax Cuts and Jobs Act" in December 2017 and merger election-related revaluation of our net deferred tax assets.
•
Our net interest income on a taxable equivalent basis was $193.4 million for 2017, an increase of $37.2 million, or 23.8%, from 2016. Our interest income increased $43.1 million in 2017, primarily as a result of an increase of $48.2 million in interest income on loans and an increase of $3.6 million in interest income on investment securities which was partially offset by a $9.2 million decline in accretion income.
•
We completed our acquisition of AloStar Bank of Commerce on September 30, 2017.
•
We experienced strong loan growth in 2017, with total organic loans of $2.4 billion at December 31, 2017, an increase of $275.3 million, or 13.2%, from 2016.
•
The accretable discount on purchased credit impaired loans, which represents the excess cash flows expected at acquisition over the estimated fair value of the loans, decreased $11.4 million to $57.9 million at December 31, 2017, compared to $69.3 million at December 31, 2016. The decrease is primarily a result of $34.1 million in accretion income recognized on purchased credit impaired loans, partially offset by additions from acquisitions of $11.7 million and transfers from nonaccretable to accretable discount of $11.1 million during 2017.
•
Our asset quality remained solid at December 31, 2017 with a ratio of nonperforming assets to total loans plus other real estate owned of .39% and a ratio of nonperforming loans to total loans of .37%.
•
Our cost of funds remained low as the average cost of funds was 42 basis points for the year ended December 31, 2017, compared to 33 basis points for the year ended December 31, 2016. This compares favorably to the 75 basis point increase in the Federal Funds target rate during 2017.
•
The Company's capital ratios exceeded all regulatory "well capitalized" guidelines, with a Tier 1 leverage ratio of 11.24%, CET1 and Tier 1 risk-based capital ratios of 12.61% and a Total risk-based capital ratio of 13.28% at December 31, 2017.
•
In 2017, we paid cash dividends totaling $.56 per common share to our shareholders.
•
On February 7, 2018, we declared a quarterly dividend of $.20 per common share to be paid on March 13, 2018 to shareholders of record of our common stock as of March 5, 2018.
Critical Accounting Policies
In preparing financial statements, management is required to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. The accounting principles and methods we use conform with accounting principles generally accepted in the United States and general banking practices. Estimates and assumptions most significant to us relate primarily to the calculation of the allowance for loan and lease losses, the accounting for acquired loans, the valuation of goodwill and income taxes. These significant estimates and assumptions are summarized in the following discussion and are further analyzed in the notes to the consolidated financial statements.
Acquisition Accounting
We determined the fair value of our acquired assets and liabilities in accordance with accounting requirements for fair value measurement and acquisition transactions as promulgated in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), ASC Topic 805, Business Combinations (ASC 805), and ASC Topic 820, Fair Value Measurements and Disclosures. The determination of the initial fair values on loans and other real estate purchased in an acquisition require significant judgment and complexity. All identifiable assets acquired, including loans, are recorded at fair value. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic No. 820. These fair value estimates associated with the purchased loans include estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.
Where a loan exhibits evidence of credit deterioration since origination and it is probable at the acquisition date that we will not collect all principal and interest payments in accordance with the terms of the loan agreement, we account for the loan under ASC 310-30, as a purchased credit impaired loan. We account for our purchased credit impaired loans by dividing them into two categories, either: (1) specifically-reviewed loans or, (2) loans accounted for as part of a loan pool. We create loan pools by grouping loans with similar risk characteristics with the intent of creating homogeneous pools based on a combination of various factors including product type, cohort, risk classification and term. Loans accounted for in pools remain in the assigned pool until they are resolved. Any gains or losses are deferred and retained in the pool until the pool closes, which is either when all the loans are resolved or the pool’s recorded investment reaches zero.
Allowance for Loan and Lease Losses (ALLL)
The ALLL represents the amount considered adequate by management to absorb losses inherent in the loan portfolio at the balance sheet date. The ALLL is adjusted through provisions for loan losses charged or credited to operations. The provisions are generated through loss analyses performed on organic loans, estimated additional losses arising on PNCI loans subsequent to acquisition and impairment recognized as a result of decreased expected cash flows on PCI loans due to further credit deterioration since the previous quarterly cash flow re-estimation. The ALLL consists of both specific and general components. Individual loans are charged off against the ALLL when management determines them to be uncollectible. Subsequent recoveries, if any, of loans previously charged-off are credited to the ALLL.
All known and inherent losses that are both probable and reasonable to estimate are recorded. While management utilizes available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance. Such agencies may require adjustments to the ALLL based on their judgment about information available at the time of their examination.
We assess the adequacy of the ALLL quarterly with respect to organic and purchased loans. The assessment begins with a standard evaluation and analysis of the loan portfolio. All loans are consistently graded and monitored for changes in credit risk and possible deterioration in the borrower’s ability to repay the contractual amounts due under the loan agreements.
Allowance for loan and lease losses for organic loans
The ALLL for organic loans consists of two components:
(1)
a specific amount against identified credit exposures that we believe it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreements; and
(2)
a general amount, which is based on historical losses that are then adjusted for qualitative factors representative of various economic indicators and risk characteristics of the loan portfolio.
Management establishes the specific amount by examining impaired loans. The majority of our impaired loans are collateral dependent; therefore, nearly all of the specific allowances are calculated based on the fair value of the collateral less disposal costs, if applicable.
Management establishes the general amount by reviewing the remaining loan portfolio (excluding those impaired loans discussed above) and incorporating allocations based on historical losses. The calculation of the general amount is subjected to qualitative factors that are somewhat subjective. The qualitative testing attempts to correlate the historical loss rates with current economic factors and current risks in the portfolio. The qualitative factors consist of but are not limited to:
•economic factors including changes in the local or national economy;
•the depth of experience in lending staff, credit administration and internal loan review;
•asset quality trends; and
•seasoning and growth rate of the portfolio segments.
After assessing the applicable factors, the remaining amount is evaluated based on management's experience and the level of the organic ALLL is compared with historical trends and peer information as a reasonableness test.
Allowance for loan and lease losses for purchased loans
Purchased loans are initially recorded at their acquisition date fair values. The carryover of ALLL is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for purchased loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, default rates, loss severity, collateral values, discount rates, payment speeds, prepayment risk and liquidity risk.
We maintain an ALLL on purchased loans based on credit deterioration subsequent to the acquisition date. Purchased credit impaired loans are accounted for under ASC 310-30. Management establishes an allowance for credit deterioration subsequent to the date of acquisition by re-estimating expected cash flows on a quarterly basis with any decline in expected cash flows recorded as impairment in the provision for loan losses. Impairment is measured as the excess of the recorded investment in a loan over the present value of expected future cash flows discounted at the pre-impairment accounting yield of the loan. For any increases in cash flows expected to be collected, we first reverse any previously recorded ALLL, then adjust the amount of accretable yield recognized on a prospective basis over the loan’s remaining life.
For purchased loans that are not deemed purchased credit impaired loans at acquisition, also referred to as purchased non-credit impaired loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. We review goodwill for impairment annually, or more frequently if deemed necessary, as goodwill is deemed to have an indefinite life. On our annual assessment date, December 31, we performed a qualitative assessment of whether it was more likely than not that the fair value exceeded carrying value. Based on this assessment, we determined that it was more likely than not that the fair value exceeded its carrying value, resulting in no impairment to goodwill.
Income Taxes
Income Tax Expense. The calculation of our income tax expense requires significant judgment and the use of estimates. We periodically assess tax positions based on current tax developments, including enacted statutory, judicial, regulatory and industry guidance. In analyzing our overall tax position, we consider the amount and timing of recognizing income tax liabilities and benefits. In applying the tax and accounting guidance to the facts and circumstances, we adjust income tax balances appropriately through the income tax provision. We maintain reserves for income tax uncertainties at levels we believe are adequate to absorb probable payments. Actual amounts paid, if any, could differ significantly from these estimates.
Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We assess deferred tax assets based on expected realizations, and we establish a valuation allowance in situations where it is more likely than not that a deferred tax asset is not realizable. Management has reviewed all evidence, both positive and negative, and concluded that no valuation allowance against the net deferred tax asset is needed at December 31, 2017.
Results of Operations
Net Income
We reported net income of $46.6 million, $47.6 million, and $28.4 million for December 31, 2017, 2016, and 2015, respectively. Diluted earnings per common share was $1.19, $1.28, and $.77 for December 31, 2017, 2016, and 2015, respectively.
Net Interest Income (Taxable Equivalent)
Net interest income, which is our primary source of earnings, is the difference between interest earned on interest-earning assets, as well as accretion income on purchased credit impaired loans, and interest incurred on interest-bearing liabilities. Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates.
2017 compared to 2016
Our net interest income on a taxable equivalent basis was $193.4 million for 2017, an increase of $37.2 million, or 23.8%, from 2016. This increase was primarily attributable to increases in average loans, excluding purchased credit impaired loans, of $687.5 million and investment securities of $39.3 million compared to the year ended December 31, 2016. A decrease of $9.2 million in accretion income on purchased credit impaired loans and an increase of $571.1 million in average interest-bearing deposits, compared to the year ended December 31, 2016, partially offset the impact of the increases in average loans, excluding purchased credit impaired loans, and investment securities.
Our net interest spread on a taxable equivalent basis, which is the difference between the yields earned on average earning assets and the rates paid on average interest-bearing liabilities, was 4.50% for both 2017 and 2016. Our net interest margin on a taxable equivalent basis, which is net interest income divided by average interest-earning assets, was 4.70% for 2017, compared to 4.68% for 2016, an increase of two basis points.
The yield on average earning assets was 5.08% for 2017, compared to 4.96% for 2016, an increase of 12 basis points, driven primarily by an increase in our yield on loans, excluding purchased credit impaired loans. Our yield on loans, excluding purchased credit impaired loans, was 5.22% for 2017, compared to 4.66% for 2016, an increase of 56 basis points. The increase primarily resulted from a combination of variable rate loans repricing due to increases in index rates and accretion of purchase accounting discounts on purchased non-credit impaired loans. The yield on our investment portfolio was 2.38% for 2017 and 2.08% for 2016. The increase of 30 basis points was primarily driven by variable rate securities repricing due to increases in index rates and the reinvestment of cash flows from securities into higher yielding bonds as market rates have increased. Our yield on purchased credit impaired loans was 22.05% for 2017, compared to 32.66% for 2016, a decrease of 1,061 basis points. The yield on our purchased credit impaired loans can vary significantly from period to period depending largely on the timing of loan pool closings for our purchased credit impaired loans that are accounted for in pools and the timing of customer payments. The decrease in our yield on purchased credit impaired loans in 2017 was primarily due to a decrease in gains on loan pool closings of $6.3 million, as well as the lower yield on the portfolios acquired in our recent acquisitions.
The average rate on interest-bearing liabilities was .58% for 2017, an increase of 12 basis points from 2016. The average rate paid on interest-bearing deposits was .58% for 2017, an increase of 12 basis points from 2016. This is primarily due to an increase in the rate paid on savings and money market accounts acquired in our recent acquisitions, a shift in the mix of interest-bearing deposits to savings and money market accounts, and the assumption of higher-yielding internet time deposits in our acquisition of AloStar. Also contributing to the increase in the rate paid on interest-bearing liabilities was an increase in the volume of other borrowings and a 25 basis point increase in the related rate on other borrowings compared to 2016. Our cost of funds was 42 basis points for 2017, an increase of nine basis points from 2016.
2016 compared to 2015
Our net interest income on a taxable equivalent basis was $156.2 million for 2016, an increase of $5.0 million, or 3.3%, from 2015. This increase was primarily attributable to increases in average loans, excluding purchased credit impaired loans, of $287.1 million and investment securities of $68.2 million compared to the year ended December 31, 2015. A decrease of $6.5 million in accretion income on purchased credit impaired loans, a decline in the yield on average loans, excluding purchased credit impaired loans, of 17 basis points and an increase in average interest-bearing deposits of $25.4 million compared to the year ended December 31, 2015 partially offset the impact of the increases in average loans, excluding purchased credit impaired loans, and investment securities.
Our net interest spread on a taxable equivalent basis, which is the difference between the yields earned on average earning assets and the rates paid on average interest-bearing liabilities was 4.50% for 2016, compared to 4.64% for 2015, a decrease of 14 basis points. Our net interest margin on a taxable equivalent basis, which is net interest income divided by average interest-earning assets, was 4.68% for 2016, compared to 4.78% for 2015, a decrease of 10 basis points.
The yield on average earning assets was 4.96% for 2016, compared to 5.03% for 2015, a decrease of seven basis points, driven primarily by a decline in our yield on loans, excluding purchased credit impaired loans. Our yield on loans, excluding purchased credit impaired loans, was 4.66% for 2016, compared to 4.83% for 2015, a decrease of 17 basis points. The decrease primarily resulted from a combination of payoffs of higher-yielding loans and new lower-yielding loan originations. The decrease in yield on loans, excluding purchased credit impaired loans, was partially offset by increases in the yields on purchased credit impaired loans and investment securities. Our yield on purchased credit impaired loans was 32.66% for 2016, compared to 28.41% for 2015, an increase of 425 basis points. The yield on our purchased credit impaired loans can vary significantly from period to period depending largely on the timing of loan pool closings for our purchased credit impaired loans that are accounted for in pools and the timing of customer payments. The increase in our yield on purchased credit impaired loans in 2016 was primarily due to gains on loan pool closings of $6.4 million in relation to average purchased credit impaired loans. The yield on our investment portfolio was 2.08% for 2016 and 1.84% for 2015. The increase of 24 basis points was primarily driven by variable rate securities repricing due to changes in index rates.
The average rate on interest-bearing liabilities was 0.46% for 2016, an increase of seven basis points from 2015. The average rate paid on interest-bearing deposits was 0.46% for 2016, an increase of eight basis points from 2015. This increase was primarily due to the increase in amortization on our interest rate caps of $625,000, as well as a $537,000 reduction in amortization of time deposit premiums acquired in our acquisitions of First Bank of Georgia and Bank of Atlanta. Also contributing to the increase was a local time deposit special run during the fourth quarter of 2015 and the first quarter of 2016 as part of management's strategy to grow new retail deposits. Our cost of funds was 33 basis points for 2016, an increase of five basis points from 2015.
Average Balances, Net Interest Income, Yields and Rates
The following table shows our average balance sheet and our average yields on assets and average costs of liabilities for the periods indicated (dollars in thousands). We derive these yields by dividing income or expense by the average balance of the corresponding assets or liabilities, respectively. We have derived average balances from the daily balances throughout the periods indicated.
(1) Reflects taxable equivalent adjustments using the statutory tax rate of 35% in adjusting interest on tax-exempt securities to a fully taxable basis. The taxable equivalent adjustments included above are $0, $4,000 and $39,000 for 2017, 2016 and 2015, respectively.
(2) Includes average nonaccrual loans of $9.7 million, $8.9 million and $5.6 million for 2017, 2016 and 2015, respectively.
(3) Reflects taxable equivalent adjustments using the statutory tax rate of 35% in adjusting tax-exempt loan interest income to a fully taxable basis. The taxable equivalent adjustments included above are $576,000, $562,000 and $515,000 for 2017, 2016 and 2015, respectively.
Rate/Volume Analysis on a Taxable Equivalent Basis
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volumes. The following table reflects the effect that varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented (dollars in thousands):
(1) Amounts shown as increase (decrease) due to changes in either volume or rate include an allocation of the amount that reflects the interaction of volume and rate changes. This allocation is based on the absolute dollar amounts of change due solely to changes in volume or rate.
Provision for Loan and Lease Losses
The provision for loan and lease losses is the amount of expense that, based on our judgment, is required to maintain the allowance for loan and lease losses (ALLL) at an adequate level to absorb probable losses inherent in the loan portfolio at the balance sheet date and that, in management's judgment, is appropriate under GAAP. The determination of the amount of the ALLL is complex and involves a high degree of judgment and subjectivity. Our determination of the amount of the allowance and corresponding provision for loan losses considers ongoing evaluations of the credit quality and level of credit risk inherent in various segments of the loan portfolio and of individually significant credits, levels of nonperforming loans and charge-offs, statistical trends and economic and other relevant factors. Please see the section entitled "Allowance for Loan and Leases Losses (ALLL)" under "Balance Sheet Review" for a description of the factors we consider in determining the amount of periodic provision expense to maintain this allowance.
Organic Loans
We recorded a provision for loan and lease losses related to organic loans of $5.0 million, $3.1 million and $2.9 million, for the years ended December 31, 2017, 2016 and 2015, respectively. The amount of provision for loan and lease losses recorded for organic loans was the amount required such that the total allowance for loan and lease losses reflected the appropriate balance, in management’s opinion, to sufficiently cover probable losses in the organic loan portfolio. This determination includes, but is not limited to, factors such as loan growth, asset quality, changes in loan portfolio composition, and national and local economic conditions.
Purchased Non-Credit Impaired Loans
We did not record an ALLL at acquisition for our purchased non-credit impaired loans because the loans were recorded at fair value based on a discounted cash flow methodology at the date of each respective acquisition. Subsequent to the purchase date, the ALLL for purchased non-credit impaired loans is evaluated quarterly similar to the method described above for organic loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses. For the year ended December 31, 2017, the activity in our ALLL on purchased non-credit impaired loans included charge-offs of $670,000 and recoveries of $87,000 with a provision for loan and leases losses of $1.1 million, resulting in a $995,000 ending allowance on purchased non-credit impaired loans at December 31, 2017. For the year ended December 31, 2016, the activity in our ALLL on purchased non-credit impaired loans included charge-offs of $223,000 and recoveries of $63,000 with a provision for loan and leases losses of $546,000, resulting in a $439,000 ending allowance on purchased non-credit impaired loans at December 31, 2016. For the year ended December 31, 2015, activity in our ALLL on purchased non-credit impaired loans included charge-offs of $48,000 and recoveries of $7,000 with a provision for loan and lease losses of $94,000, resulting in a $53,000 ending allowance on purchased non-credit impaired loan at December 31, 2015.
Purchased Credit Impaired Loans
Similar to our purchased non-credit impaired loans, we did not record an ALLL at acquisition for our purchased credit impaired loans as the loans were recorded at fair value based on a discounted cash flow methodology at the date of each respective acquisition. We re-estimate expected cash flows on our purchased credit impaired loans on a quarterly basis and we record a provision for loan and lease losses during the period for any decline in expected cash flows. Conversely, any improvement in expected cash flows is recognized prospectively as an adjustment to the yield on the purchased credit impaired loan once any previously recorded impairment is recaptured. Before the early termination of our loss share agreements with the FDIC, we recorded the amount of provision for formerly covered assets through the FDIC receivable for loss share agreements. Now that our loss share agreements have been terminated, the impact of any provision related to formerly covered assets will not be offset by changes in the FDIC receivable for loss share agreements, which may result in greater volatility. We recorded a negative provision for loan and lease losses related to purchased credit impaired loans of $71,000 for the year ended December 31, 2017, a negative provision of $3.4 million for the year ended December 31, 2016 and a provision of $535,000 for the year ended December 31, 2015.
Noninterest Income
Noninterest income for 2017 totaled $39.8 million, up $456,000 from 2016. Noninterest income for 2016 totaled $39.3 million, up $19.2 million from 2015. The following table presents the components of noninterest income for the periods indicated (dollars in thousands):
2017 compared to 2016
Service charges on deposits increased $751,000, or 13.8%, in 2017 from 2016. The increase in service charges on deposits was primarily a result of our acquisitions of NBG Bancorp, Inc., S Bankshares, Inc. and AloStar. Mortgage banking income decreased $1.0 million, or 7.9% in 2017 from 2016. The decrease in mortgage banking income was primarily a result of decreased production of loans and a shift in loans produced from retail to wholesale which provides smaller gains on sale. SBA income was $6.5 million in both 2017 and 2016. Payroll and insurance income increased $473,000, or 8.4%, in 2017 from 2016. This increase was attributable to an increase in commissions on new insurance policies written.
Other noninterest income increased $1.7 million, or 43.0%, in 2017 from 2016, attributable, in part, to increases of $702,000 in prepayment fees and $324,000 on gain on sale of equipment finance loans. The increase was also attributable to $745,000 in fee income on our asset based lending portfolio that we acquired in 2017. Loss on sale of investment securities was $1.5 million in 2017 compared to a gain of $489,000 in 2016. The loss in 2017 was a result of an opportunistic portfolio restructuring in which we sold certain lower yielding securities in a loss position and reinvested the proceeds into higher yielding securities.
2016 compared to 2015
Mortgage banking income increased $1.1 million, or 9.5% in 2016 from 2015. The increase in mortgage banking income was primarily a result of increased gains on sale of loans. SBA income was $6.5 million in 2016, compared to $5.5 million in 2015. The $919,000, or 16.6%, increase in SBA income was due to increases of $1.1 million on gains on sale of loans and $378,000 in fee income, partially offset by unfavorable fair value adjustments on SBA servicing rights of $512,000.
Payroll and insurance income increased $916,000, or 19.5%, in 2016 from 2015. This increase was attributable to an increase in the number of payroll customers compared to 2015. Prepayment fees increased $2.4 million, or 74.7%, in 2016 from 2015, resulting from a drop off in the number of fixed rate loans that were paid off early which had increased during the first half of 2015. Other noninterest income increased $168,000, or 4.3%, in 2016 from 2015, attributable in part to writedowns and losses totaling $747,000 on premises and equipment primarily associated with closed branches disposed of or transferred to OREO during 2015. The increase in other noninterest income for 2016 also results from fee income and gains on sale of equipment finance loans totaling $1.3 million and the mark-to-market on interest rate swaps and hedged assets improving by $414,000 compared to 2015.
Noninterest income includes the amortization of the FDIC receivable for loss share agreements, which represents amortization expense on the FDIC receivable for loss share agreements. The $16.5 million decrease in the amortization of the FDIC receivable for loss share agreements in 2016 from 2015, mainly resulted from our ceasing to amortize the FDIC receivable when we terminated our loss share agreements with the FDIC in the second quarter of 2015.
Noninterest Expense
Noninterest expense for 2017 totaled $138.8 million, up $17.9 million from 2016. Noninterest expense totaled $120.9 million for 2016, down $2.5 million from 2015. The following table presents the components of noninterest expense for the periods indicated (dollars in thousands):
2017 compared to 2016
Salaries and employee benefits increased $13.1 million, or 16.6%, to $91.8 million in 2017 from 2016. Occupancy and equipment increased $1.2 million, or 9.9%, to $13.4 million in 2017 from 2016. The increases in salaries and employee benefits and occupancy and equipment were largely attributable to additional personnel and facilities acquired in our acquisitions of NBG Bancorp, Inc., S Bankshares, Inc. and AloStar. Data processing increased $1.7 million, or 19.8%, to $10.2 million in 2017 from 2016. The increase in data processing was primarily related to investments in our infrastructure and our acquisitions of NBG Bancorp, Inc., S Bankshares, Inc. and AloStar.
Legal and professional fees decreased $319,000, or 6.8% in 2017 from 2016, primarily due to a support system project started in the last half of 2016 that was completed in the first quarter of 2017.
Merger-related expenses increased $1.4 million, or 34.6%, to $5.3 million for 2017 from $4.0 million in 2016. Merger-related expenses in 2017 were directly related to our acquisition of AloStar and the integrations of NBG Bancorp, Inc. and S Bankshares, Inc. The merger-related expenses in 2016 were directly related to our acquisitions of NBG Bancorp, Inc. and S Bankshares, Inc.
Our FDIC deposit insurance premiums and other regulatory fees decreased $44,000 or 2.5% in 2017 from 2016, due to a reduction in assessment rates beginning in the third quarter of 2016 as the Deposit Insurance Fund Reserve Ratio exceeded 1.15%, partially offset by an increase in our assessment base during 2017.
Amortization of intangibles increased $713,000, or 33.9%, to $2.8 million in 2017 from 2016, primarily due to an increase in amortization of intangibles related to our acquisition of NBG Bancorp, Inc. and S Bankshares, Inc.
2016 compared to 2015
Salaries and employee benefits decreased $4.5 million, or 5.4%, to $78.8 million in 2016 from 2015. The decrease was attributable to reduction in staffing in certain support areas as a result of efficiency initiatives announced in the third quarter of 2015. The efficiency initiatives resulted in severance costs of $3.8 million for 2015 with no such amounts in 2016. The decrease in severance costs for 2016 and staffing reductions in certain support areas were partially offset by staff additions in our SBA and equipment finance lending areas and increased commission expense related to our increase in mortgage and SBA production volumes during the same period.
Legal and professional fees decreased $376,000, or 7.4% in 2016 from 2015, primarily due to reductions in payments to certain vendors associated with our efficiency initiatives, lower spending related to infrastructure needed to support assets previously covered under our loss share agreements with the FDIC, which were terminated in the second quarter of 2015, and lower employee recruiting fees during 2016. These reductions were partially offset by costs incurred in connection with a support system project during the last half of 2016.
Merger-related expenses increased $2.2 million, or 129.0%, to $4.0 million for 2016 from $1.7 million in 2015. Merger-related expenses in 2016 were directly related to our acquisitions and integrations of NBG Bancorp, Inc. and S Bankshares, Inc. The merger-related expenses in 2015 were directly related to our acquisitions and integrations of Bank of Atlanta and First Bank of Georgia.
Our FDIC deposit insurance premiums and other regulatory fees decreased $356,000, or 17.0%, in 2016 from 2015, due to a reduction in assessment rates beginning with in third quarter of 2016 as the Deposit Insurance Fund Reserve Ratio exceeded 1.15%. Loan collection costs and OREO activity includes rental fees on OREO properties as well as gains and losses on OREO, which may result in a net benefit to expense. Loan collection costs and OREO activity increased $1.0 million, or 63.7%, to negative $579,000 in 2016 from 2015. The increase is attributable to a $2.5 million decrease in gains in sales of OREO, partially offset by a net reduction of $1.5 million in loan collection expenses and rental fees for 2016.
Amortization of intangibles increased $298,000, or 16.5%, to $2.1 million in 2016 from 2015, primarily due to an increase in amortization of intangibles related to the Patriot Capital acquisition.
Income Taxes
Our provision for income taxes was $41.0 million, $26.2 million, and $15.4 million in 2017, 2016, and 2015, respectively.
Our effective income tax rates were 46.8%, 35.5% and 35.2% for 2017, 2016 and 2015, respectively. The increase in income taxes and the effective tax rate for 2017 compared to 2016 was primarily attributable to a provisional $8.1 million revaluation of our deferred tax assets resulting from a reduction in the federal corporate tax rate to 21%, effective January 1, 2018, under the Tax Cuts and Jobs Act. The ultimate impact of the Tax Cuts and Jobs Act may differ from this provisional amount due to changes in management's interpretations and assumptions, as well as additional regulatory guidance that may be issued. The provisional amount is expected to be finalized when the 2017 federal tax return is filed in 2018. Also contributing to the increase was $2.5 million in tax expense related to our election to treat the acquisition of AloStar as an acquisition of assets rather than an acquisition of stock for tax purposes. Our effective income tax rate for 2018 is estimated to be between 22% and 24%. The effective tax rates for all periods were affected by various factors including amounts of non-taxable income, non-deductible expenses and tax credits. A reconciliation between the income tax expense and the amounts computed by applying the statutory federal income tax rate for the years ended December 31, 2017, 2016 and 2015 is included in Note 21 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Fourth Quarter Results
Net income for the fourth quarter of 2017 was $5.4 million, or $.14 per diluted common share, compared to $14.4 million, or $.37 per diluted common share, in the third quarter of 2017.
Net interest income was $58.0 million for the fourth quarter of 2017, compared to $44.3 million for the third quarter of 2017. The increase in net interest income of $13.7 million was primarily a result of a $11.5 million increase in interest income on loans. Interest expense increased $2.2 million in the fourth quarter as compared to the third quarter. The increases in interest income on loans and interest expense was primarily due to our acquisition of AloStar, which was completed on September 30, 2017.
Our provision for loan and lease loss expense was $2.8 million for the fourth quarter of 2017, compared to $415,000 for the third quarter of 2017. The increase was largely driven by a $798,000 provision for loan and lease losses on purchased credit impaired loans in the fourth quarter of 2017, compared to a negative provision of $885,000 in the third quarter of 2017. The increase in provision for loan and lease losses on purchased credit impaired loans was primarily related to a decline in expected cash flows on a small number of purchased credit impaired loans.
Total noninterest income was $10.1 million for the fourth quarter of 2017, compared to $9.7 million for the third quarter of 2017. The increase was primarily due to an increase in SBA income of $402,000 in the fourth quarter related to increased gains on sale of SBA loans. Other noninterest income increased $1.5 million in the fourth quarter of 2017 compared to the third quarter of 2017 due primarily to increased prepayment fees of $683,000 and asset based lending loan fees of $745,000. Loss on sale of investment securities was $1.5 million for the fourth quarter of 2017, compared to a gain of $3,000 for the third quarter of 2017. The loss for the fourth quarter was attributable to an opportunistic portfolio restructuring where certain lower yielding securities in a loss position were sold and reinvested into higher yielding securities.
Total noninterest expense was $40.7 million for the fourth quarter of 2017, compared to $31.6 million for the third quarter of 2017, an increase of $9.1 million. The increase is largely attributable to increases in salaries and employee benefits of $5.0 million and merger-related expenses of $2.5 million, primarily related to our acquisition of AloStar.
Balance Sheet Review
General
At December 31, 2017, we had total assets of approximately $5.0 billion, consisting principally of $2.3 billion in net organic loans, $989.7 million in net purchased non-credit impaired loans, $171.9 million in net purchased credit impaired loans, $906.8 million in investment securities and $230.9 million in cash and cash equivalents. Our liabilities at December 31, 2017 totaled $4.3 billion, consisting principally of $4.2 billion in deposits. At December 31, 2017, our shareholders' equity was $641.6 million.
At December 31, 2016, we had total assets of approximately $4.2 billion, consisting principally of $2.1 billion in net organic loans, $562.9 million in net purchased non-credit impaired loans, $155.6 million in net purchased credit impaired loans, $914.2 million in investment securities and $149.6 million in cash and cash equivalents. Our liabilities at December 31, 2016 totaled $3.6 billion, consisting principally of $3.4 billion in deposits. At December 31, 2016, our shareholders' equity was $613.6 million.
Investments
Our investment portfolio consists of U.S. Government sponsored agency mortgage-backed securities, nonagency mortgage-backed securities, U.S. Government agency securities, municipal securities, corporate bonds and asset-backed securities. The composition of our portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of revenue. The portfolio also provides a balance to interest rate risk, while providing a vehicle for the investment of available funds, furnishing liquidity and supplying securities to pledge as required collateral. At December 31, 2017, we had $874.0 million in our available-for-sale investment securities portfolio representing approximately 17.6% of our total assets, compared to $847.2 million, or 20.1% of total assets, at December 31, 2016. Our increased investment in securities available-for-sale totaling $26.8 million, or 3.2%, compared to December 31, 2016 was primarily due to reinvestment of proceeds from paydowns on held-to-maturity securities into available-for-sale securities. Management also continued to invest excess cash to receive a higher return on liquid assets. The securities we purchased had short durations and no material impact on our overall liquidity or interest rate risk profile.
At December 31, 2017, we had $32.9 million in held-to-maturity securities compared to $67.1 million at December 31, 2016. The decreased investment in securities held-to-maturity totaling $34.2 million, or 51.0%, compared to December 31, 2016 was primarily due to paydowns on existing securities, partially offset by additional purchases of held-to-maturity securities.
At December 31, 2017, $69.6 million, or 7.7%, of our investment securities were invested in securities of U.S. Government agencies, compared to $88.6 million, or 9.7%, at December 31, 2016. U.S. Government agency securities consist of debt obligations issued by the Government Sponsored Enterprises or collateralized by loans that are guaranteed by the SBA and are, therefore, backed by the full faith and credit of the U.S. Government. At December 31, 2017, $575.8 million, or 63.5%, of our investment securities were invested in agency mortgage-backed securities, compared to $529.3 million, or 57.9%, as of December 31, 2016. Agency mortgage-backed securities are securities that have been developed by pooling a number of real estate mortgages and are principally issued by "quasi-federal" agencies such as Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac). The contractual monthly cash flows of principal and interest are guaranteed by the issuing agencies. Although investors generally assume the federal government will support these agencies, it is under no obligation to do so. Other agency mortgage-backed securities are issued by Government National Mortgage Association (Ginnie Mae), which is a federal agency, and are guaranteed by the U.S. Government. The actual maturities of these mortgage-backed securities will differ from their contractual maturities because the loans underlying the securities can prepay.
At December 31, 2017, $118.7 million, or 13.1% of our investment securities were invested in nonagency mortgage-backed securities, compared to $154.0 million, or 16.8%, at December 31, 2016. The underlying collateral consists of mortgages originated prior to 2006 with the majority being 2004 and earlier. None of the collateral is subprime and we own the senior tranche of each bond.
At December 31, 2017, $22.7 million, or 2.5%, of our investment securities were invested in asset-backed securities, compared to $56.8 million, or 6.2%, as of December 31, 2016. Asset-backed securities currently consist of highly-rated collateralized loan obligations. At December 31, 2017, $120.0 million, or 13.2%, of our investment securities were invested in corporate securities, compared to $85.2 million, or 9.3%, at December 31, 2016. Corporate securities currently consist of short duration debt. We evaluate and underwrite each issuer prior to purchase and periodically review the issuers after purchase.
The following tables are a summary of our investment portfolio at the dates indicated (dollars in thousands):
The following table shows contractual maturities and yields on our investments in debt securities at and for the period presented (dollars in thousands):
(1) The amortized cost and fair value of investments in debt securities are presented based on contractual maturities. Actual cash flows may differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.
(2) Average yields are based on amortized cost and presented on a fully taxable equivalent basis using a tax rate of 35%.
Loans
We had total net loans outstanding, including organic and purchased loans, of $3.5 billion at December 31, 2017 and $2.8 billion at December 31, 2016. Loans secured by real estate, consisting of commercial or residential property, are the principal component of our loan portfolio. Even if the principal purpose of the loan is not to finance real estate, when reasonable, we may obtain a security interest in the real estate in addition to any other available collateral to increase the likelihood of ultimate repayment or collection of the loan.
Organic Loans
Our organic loans increased $275.3 million, or 13.2%, to $2.4 billion at December 31, 2017 from December 31, 2016. The $275.3 million increase was a result of stable economic conditions within our markets, leading to increased loan demand which included approximately $1.8 billion in loan fundings, offset by approximately $1.6 billion in paydowns. Also contributing to organic loan growth was the reclassification of purchased non-credit impaired and purchased credit impaired loans to organic loans, as these loans renewed and met our current underwriting standards.
Purchased Non-Credit Impaired Loans
Purchased non-credit impaired loans were $990.7 million at December 31, 2017, an increase of $427.4 million, or 75.9%, from December 31, 2016. The increase was attributed to $641.0 million in purchased non-credit impaired loans acquired from AloStar offset by $213.6 million in loan paydowns or payoffs.
Purchased Credit Impaired Loans
Our purchased credit impaired loans increased $15.0 million, or 9.3%, to $175.6 million at December 31, 2017 from December 31, 2016. The increase was attributed to $77.6 million in purchased credit impaired loans acquired from AloStar offset by $62.6 million in loan paydowns or payoffs.
The following tables summarizes the composition of our loan portfolio at the dates indicated (dollars in thousands):
Maturities and Sensitivity of Loans to Changes in Interest Rates
Information included in the following tables is based on the contractual maturities of individual loans, including loans that may be subject to renewal at their contractual maturities. Renewal of these loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because some borrowers have the right to prepay obligations without prepayment penalties.
The following table summarizes the maturity distribution of our held for investment loan portfolio by type (dollars in thousands):
The following table summarizes loans held for investment with maturity dates after one year and their interest rate characteristics (dollars in thousands):
Allowance for Loan and Lease Losses (ALLL)
The ALLL represents the amount that management believes is necessary to absorb probable losses inherent in the loan portfolio at the balance sheet date and involves a high degree of judgment and complexity. The ALLL is critical to the portrayal and understanding of our financial condition, liquidity and results of operations. The determination and application of the ALLL accounting policy involves judgments, estimates and uncertainties that are subject to change. Changes in these assumptions, estimates or the conditions surrounding them may have a material impact on our financial condition, liquidity and results of operations.
At December 31, 2017, our total ALLL for the loan portfolio was $28.8 million, an increase of $2.2 million compared to December 31, 2016. The ALLL reflected $4.0 million of net charge-offs and a $6.1 million provision for loan and lease losses on our total loan portfolio for the year ended December 31, 2017.
Organic loans
The ALLL on our organic loan portfolio is determined based on factors such as changes in the nature and volume of the portfolio, overall portfolio quality, delinquency trends, adequacy of collateral, loan concentrations, specific problem loans and economic conditions that may affect the borrower's ability to pay. The ALLL for organic loans consists of two components: a specific reserve and a general reserve. The specific reserve relates to loans that are individually evaluated for impairment and represents identified credit exposures that we believe it is probable that, based on current performance of the borrower and the underlying collateral, we will be unable to collect all amounts due according to the contractual terms of the loan. The general reserve is based on historical loss experience adjusted for current economic factors and relates to non-impaired loans. Historical losses are adjusted by a qualitative analysis that reflects several key economic indicators such as gross domestic product, unemployment and core inflation as well as asset quality trends, interest rate risk and unusual events or significant changes in personnel, policies and procedures. The qualitative analysis requires judgment by management and is subject to ongoing validation. The provision for loan and lease losses will be affected by the loss potential of impaired loans and trends in the delinquency of loans, nonperforming loans and net charge-offs, which may be more than our historical experience.
At December 31, 2017, our organic ALLL was $24.0 million, an increase of $3.0 million compared to December 31, 2016. The increase in our organic ALLL at December 31, 2017 is primarily from $2.1 million of net charge-offs partially offset by a $5.0 million provision for loan and lease losses charged to expense for the year ended December 31, 2017.
Purchased Non-Credit Impaired Loans
In accordance with the accounting guidance for business combinations, there was no allowance for loan and lease losses brought forward on any purchased non-credit impaired loan at acquisition, as we adjusted the unpaid principal balance of such loans to reflect credit discounts representing the principal losses expected over the life of the loans which was a component of the initial fair value. This adjustment is accreted into earnings as a yield adjustment, using the effective yield method, over the remaining life of each loan. After the acquisition date, the method used to evaluate the sufficiency of the credit discount is similar to the method we use for organic loans, and if necessary, we recognize additional reserves in the allowance for loan and lease losses. Any provision for loan and lease losses will be affected by the loss potential of impaired loans and trends in the delinquency of loans, nonperforming loans and net charge-offs, which may be more than our historical experience.
At December 31, 2017, our purchased non-credit impaired ALLL was $995,000, an increase of $556,000 compared to December 31, 2016. The increase in our purchased non-credit impaired ALLL at December 31, 2017 is primarily due to the calculated ALLL exceeding the remaining discount on certain credits and loan pools.
Purchased Credit Impaired Loans
In accordance with the accounting guidance for business combinations, there was no allowance for loan and lease losses brought forward on any purchased credit impaired loans at acquisition, as we adjusted the loan balances to fair value based on a discounted cash flow methodology that involves assumptions and judgments related to credit risk, default rates, loss severity, collateral values, discounts rates, payment speeds, prepayment risk, and liquidity risk. We then determined which purchased credit impaired loans would be placed into homogeneous risk pools and which would be specifically reviewed as part of the quarterly cash flow re-estimation process.
We maintain an allowance for loan and lease losses on purchased credit impaired loans subsequent to the acquisition date which represents management's estimates of the potential impairment of the purchased credit impaired loans or pools of loans based on expected future cash flows, which is re-estimated on a quarterly basis. If a loan is placed in a pool, the overall performance of the pool will determine if any future ALLL is required. Typically, decreased estimated cash flows result in impairment, while increased estimated cash flows result in a full or partial reversal of previously recorded impairment and, potentially, the calculation of a higher effective yield. The potentially higher yield is recorded as "loan accretion" on our consolidated statements of income. If actual losses exceed the estimated losses, we record a provision for loan and lease losses on purchased credit impaired loans as an expense on our consolidated statements of income. If actual losses are less than our previously estimated losses, we reduce the purchased credit impaired ALLL by recording a negative provision for loan and lease losses up to the amount of the ALLL previously recorded. Before the early termination of our FDIC loss share agreements in the second quarter of 2015, we recorded the provision for loan and lease losses on purchased credit impaired loans covered by loss share agreements with the FDIC net of the amount that we expected to recover under the related FDIC loss share agreements.
At December 31, 2017, our purchased credit impaired ALLL was $3.7 million, a decrease of $1.4 million compared to December 31, 2016. The decrease in the purchased credit impaired ALLL was primarily due to a decrease in the balance of our purchased credit impaired loan portfolio of $62.6 million, excluding the purchased credit impaired loans acquired from AloStar. The loans acquired from AloStar were recorded at fair value at the acquisition date of September 30, 2017 with no related ALLL. The overall purchased credit impaired loan portfolio continues to perform better than our initial projections at the applicable acquisition dates, although the performance is not uniform across all asset classes within specifically reviewed loans and loan pools. The provision for loan and lease losses charged to expense was negative $71,000 in 2017, compared to a negative provision of $3.4 million in 2016. The increase in provision expense was primarily attributed to net charge-offs partially offset by improved cash flow expectations during 2017.
The following table summarizes the activity in our ALLL related to our organic loans for the years presented (dollars in thousands):
Our purchased non-credit impaired portfolio was established in the fourth quarter of 2014 and we did not have any charge-off or recovery activity on the purchased non-credit impaired portfolio until 2015. The following table summarizes the activity in our ALLL related to our purchased non-credit impaired loans for the years presented (dollars in thousands):
The following table summarizes the activity in our ALLL related to our purchased credit impaired loans for the years presented (dollars in thousands):
Allocation of Allowance for Loan and Lease Losses
The following table presents the allocation of the ALLL for organic loans and the percentage of the total amount of organic loans in each loan category listed at the dates indicated (dollars in thousands):
Our purchased non-credit impaired loans portfolio was established in the fourth quarter of 2014. We did not record an ALLL for purchased non-credit impaired loans in 2014. The following table presents the allocation of the ALLL for purchased non-credit impaired loans and the percentage of the total amount of purchased non-credit impaired loans in each loan category listed at the dates indicated (dollars in thousands):
The following table presents the allocation of the ALLL on our purchased credit impaired loans and the percentage of the total amount of purchased credit impaired loans in each loan category listed at the dates indicated (dollars in thousands):
Nonperforming Assets
Nonperforming assets consist of nonaccrual loans, troubled debt restructurings, and other real estate owned. For organic and purchased non-credit impaired loans, management continuously monitors loans and transfers loans to nonaccrual status when they are 90 days past due.
We do not consider our purchased credit impaired loans, which showed evidence of deteriorated credit quality at acquisition, to be nonperforming assets as long as their cash flows and the timing of such cash flows continue to be estimable and probable of collection. Therefore, interest income is recognized through accretion of the difference between the carrying value of these loans and the present value of expected future cash flows. As a result, management has excluded purchased credit impaired loans from the table in this section.
Non purchased credit impaired loans that are (a) $500,000 or greater or (b) less than $500,000 and 180 days or more past due, that have been placed on nonaccrual are considered impaired and are valued at either the observable market price of the loan, the present value of expected future cash flows or, if collateral dependent, the fair value of the collateral less estimated costs to sell. The majority of these loans are collateral dependent and, therefore, are valued using the fair value of collateral. The fair value of collateral is determined through a review of the appraised value and an assessment of the recovery value of the collateral through discounts related to various factors noted below. When a loan reaches nonaccrual status, we review the appraisal on file and determine if the appraisal is current and valid. A current appraisal is one that has been performed in the last twelve months, and a valid appraisal is one that we believe accurately and appropriately addresses current market conditions. If the appraisal is more than twelve months old or if market conditions have deteriorated since the last appraisal, we will order a new appraisal. In addition, we require a new appraisal at the time of foreclosure or repossession of the underlying collateral. Upon determining that an appraisal is both current and valid, management assesses the recovery value of the collateral, which involves the application of various discounts to the market value. These discounts may include the following: length of time to market and sell the property, as well as expected maintenance costs, insurance and taxes and real estate commissions on sale.
For nonaccrual organic impaired loans, we will record either a specific allowance or a charge-off against the ALLL if an impairment analysis indicates a collateral deficiency. For nonaccrual purchased non-credit impaired loans, if an impairment analysis indicates a collateral deficiency, a specific allowance or charge-off against the ALLL is recorded only if the collateral
deficiency exceeds the fair value mark recognized at acquisition. The ALLL is evaluated quarterly to ensure it is sufficient to absorb all estimated credit losses in the loan portfolio given the facts and circumstances as of the evaluation date.
Loans, excluding purchased credit impaired loans, that are nonperforming remain on nonaccrual status until the factors that previously indicated doubtful collectability on a timely basis no longer exist. Specifically, we look at the following factors before returning a nonperforming loan to performing status: documented evidence of debt service capacity; adequate collateral; and a minimum of six months of satisfactory payment performance.
Loan modifications on organic and purchased non-credit impaired loans constitute a troubled debt restructuring if we, for economic or legal reasons related to the borrower's financial difficulties, grant a concession to the borrower that we would not otherwise consider. For loans that are considered troubled debt restructurings, we either compute the present value of expected future cash flows discounted at the original loan's effective interest rate or we may measure impairment based on the observable market price of the loan or the fair value of the collateral when the troubled debt restructuring is deemed collateral dependent. We record the difference between the carrying value and fair value of the loan as a charge-off or valuation allowance, as the situation may warrant.
Loan modifications on purchased credit-impaired loans accounted for within a pool under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, do not result in the removal of the loan from the pool even if the modification of the loan would otherwise be considered a troubled debt restructuring. At December 31, 2017, we did not have any purchased credit impaired loans classified as troubled debt restructurings.
Other real estate owned (OREO) consists of real estate acquired through foreclosure or a deed in lieu of foreclosure in satisfaction of a loan, OREO acquired in a business acquisition, and banking premises no longer used for a specific business purpose. Real estate obtained in satisfaction of a loan is initially recorded at the lower of the principal investment in the loan or the fair value of the collateral less estimated costs to sell at the time of foreclosure with any excess in loan balance charged against the allowance for loan and lease losses. OREO acquired in a business acquisition is recorded at fair value on Day 1 of the acquisition. Banking premises no longer used for a specific business purpose is transferred into OREO at the lower of its carrying value or fair value less estimated costs to sell with any excess in the carrying value charged to noninterest expense. For all fair value estimates of real estate properties, management considers a number of factors such as appraised values, estimated selling prices, and current market conditions. Management periodically reviews the carrying value of OREO for impairment and adjusts the values as appropriate through noninterest expense. At December 31, 2017, OREO totaled $895,000, a decrease of $10.0 million from December 31, 2016. The decrease is mainly attributed to $10.6 million in sales of OREO, partially offset by $1.5 million of OREO acquired through foreclosure of loans receivable.
The following tables set forth our nonperforming assets at the years indicated (dollars in thousands):
Nonperforming assets, defined as nonaccrual loans, troubled debt restructurings and other real estate owned, totaled $13.9 million, or .4% of total loans and other real estate owned, at December 31, 2017, compared to $20.5 million, or .7% at December 31, 2016. The $6.6 million decrease in nonperforming assets is primarily due to a $10.0 million decrease of in OREO, partially offset by the migration of a small group of credits to nonperforming loans.
At December 31, 2017 and 2016, we did not have any organic or purchased non-credit impaired loans greater than 90 days past due and still accruing interest. At December 31, 2017 and 2016, a considerable portion of our purchased credit impaired loans were past due, including many that were 90 days or greater past due; however, as noted above, under ASC 310-30, our purchased credit impaired loans are classified as performing, even though they are contractually past due, as long as their cash flows and the timing of such cash flows are estimable and probable of collection.
The amount of interest that would have been recorded on organic and purchased non-credit impaired nonaccrual loans, had the loans not been classified as nonaccrual, totaled approximately $761,000 for 2017. Interest income recognized on organic and purchased non-credit impaired nonperforming loans was approximately $9,000 for 2017.
Potential problem loans are organic and purchased non-credit impaired loans which management has serious doubts as to the ability of the borrowers to comply with the present loan repayment terms. Management classifies potential problem loans as "Substandard" or "Doubtful". Potential problem loans not included in the nonperforming assets table above totaled $13.9 million, or .4% of total organic and purchased non-credit impaired loans outstanding, at December 31, 2017.
Deferred Tax Assets
At December 31, 2017, we had $15.6 million in net deferred tax assets. Deferred tax assets are subject to an evaluation of whether it is more likely than not that they will be realized. In making such judgments, significant weight is given to evidence that can be objectively verified. Although realization is not assured, management believes the recorded deferred tax assets are fully recoverable based on taxable income in carryback years and the current forecast of taxable income that is sufficient to realize the net deferred tax assets during periods through which losses may be carried forward. The amount of taxable income available in the carryback years is approximately $114.9 million. If we are unable to demonstrate that we can continue to generate sufficient taxable income in the near future, then we may not be able to conclude it is more likely than not that the benefits of the deferred tax assets will be fully realized and we may be required to recognize a valuation allowance against our deferred tax assets with a corresponding decrease in income.
Deposits
Total deposits at December 31, 2017 were $4.2 billion, an increase of $812.0 million from December 31, 2016. The increase was largely due to $705.6 million of deposits assumed in our acquisitions of AloStar and organic deposit growth of $106.4 million. Interest rates paid on specific deposit types are determined based on (i) interest rates offered by competitors, (ii) anticipated amount and timing of funding needs, (iii) availability and cost of alternative sources of funding, and (iv) anticipated future economic conditions and interest rates. We regard our deposits as attractive sources of funding because of their stability and relative cost. Deposits are an important part of our overall client relationship, which provide us opportunities to cross sell other services.
The change in our overall deposit mix continued its trend through 2017, as we grew our noninterest-bearing deposits to $1.2 billion, representing 28.1% of total deposits. Of the $206.7 million increase from December 31, 2016 to December 31, 2017, $102.7 million was assumed in our acquisition of AloStar and $104.0 million was attributable to organic growth. Average noninterest-bearing deposits increased $168.7 million, or 19.8%, for the year ended December 31, 2017 compared to the same period in 2016.
Our interest-bearing transaction accounts increased $23.8 million from December 31, 2016 to December 31, 2017, of which $3.9 million were assumed in our acquisition of AloStar and $19.9 million was attributable to organic growth. Interest-bearing deposits in savings and money market accounts increased $333.4 million from December 31, 2016, primarily resulting from $293.6 million assumed in our acquisition of AloStar and $39.8 million attributable to organic growth.
Time deposits, excluding brokered and wholesale, increased $248.3 million during 2017, primarily due to our acquisition of AloStar, offset by net contraction of organic time deposits totaling $57.1 million.
Our continued focus on growing low cost deposit relationships resulted in an average cost of funds of 42 basis points for the year ended December 31, 2017, compared to 33 basis points for the year ended December 31, 2016. This is primarily due to an increase in the rate paid on savings and money market accounts acquired in our recent acquisitions, a shift in the mix of interest-bearing deposits to savings and money market accounts, and the assumption of higher-yielding internet time deposits in our acquisition of AloStar.
The following table shows the composition of deposits at the dates indicated (dollars in thousands):
The maturity distribution of our time deposits of $250,000 or greater is as follows (dollars in thousands):
The following table shows the average balance amounts and the average rates paid on deposits held by us for the periods presented (dollars in thousands):
Capital Resources
We maintain an adequate capital base to support our activities in a safe manner while at the same time attempting to maximize shareholder returns. At December 31, 2017, shareholders' equity was $641.6 million, or 12.9% of total assets, compared to $613.6 million, or 14.5% of total assets, at December 31, 2016. The primary factors affecting changes in shareholders' equity was our net income, offset by dividends declared during the year ended December 31, 2017.
Federal regulations impose minimum regulatory capital requirements on all institutions with deposits insured by the FDIC. The Federal Reserve Board imposes similar capital regulations on bank holding companies. On January 1, 2015, the U.S. Basel III final rule replaced the existing Basel I-based approach for calculating risk-weighted assets. Basel III introduced a new minimum ratio of common equity Tier 1 capital (CET1) and raised the minimum ratios for Tier 1 capital, total capital, and Tier 1 leverage. The final rule emphasizes common equity Tier 1 capital and implements strict eligibility criteria for regulatory capital instruments and changed the methodology for calculating risk-weighted assets to enhance risk sensitivity. The methods for calculating the risk-based capital ratios have changed and will change as the provisions of the Basel III final rule related to the numerator (capital) and denominator (risk-weighted assets) are fully phased in by January 1, 2019. The ongoing methodological changes will result in differences in the reported capital ratios from one reporting period to the next that are independent of applicable changes in the capital base, asset composition, off-balance sheet exposures or risk profile. In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. Implementation of the new capital and liquidity standards did not and are not expected to significantly impact the Company or State Bank in the near term because our current capital levels materially exceed those required under the new rules.
The minimum regulatory capital ratios and ratios to be considered well-capitalized under prompt corrective action provisions at the dates indicated are presented in the table below:
(1) The prompt corrective action provisions are only applicable at the bank level.
At December 31, 2017 and 2016, the Company and State Bank exceeded all regulatory capital adequacy requirements to which they were subject. The following table shows the regulatory capital ratios for both the Company and State Bank at the dates indicated:
At December 31, 2017, the leverage ratios for both the Company and State Bank decreased compared to December 31, 2016, primarily due to increase in our average assets related to our recent acquisitions and organic growth. At December 31, 2017, Tier 1 and Total Risk-Based Capital ratios declined for both the Company and State Bank compared to December 31, 2016 as a result of the increase in risk-weighted assets during the year ended December 31, 2017. The increase in risk-weighted assets was attributable to the assets acquired from AloStar and organic loan growth.
Regulatory policy statements generally provide that bank holding companies should pay dividends only out of current operating earnings and that the level of dividends must be consistent with current and expected capital requirements. Dividends received from State Bank have been our primary source of funds available for the payment of dividends to our shareholders. Federal and state banking laws and regulations restrict the amount of dividends subsidiary banks may distribute without prior regulatory approval. At December 31, 2017, State Bank had no capacity to pay dividends to the Company without prior regulatory approval. In 2018, State Bank expects to have the capacity to pay $24.0 million in dividends to the Company without prior regulatory approval.
At December 31, 2017, the Company had $55.1 million in cash and due from bank accounts, which could be used for additional capital as needed by State Bank, payment of holding company expenses, payment of dividends to shareholders or for other corporate purposes. On February 7, 2018, we declared a quarterly dividend of $.20 per common share to be paid on March 13, 2018 to shareholders of record of our common stock as of March 5, 2018.
We currently have a level of capitalization that will support significant growth, and the long term management of our capital position is an area of significant strategic focus. We actively seek and regularly evaluate opportunities to acquire additional financial institutions as well as acquisitions that would complement or expand our present product capabilities. In accordance with this approach, we closed on mergers with Georgia-Carolina Bancshares, Inc. in 2015, NBG Bancorp, Inc. and S Bankshares, Inc. in 2016, and AloStar in 2017. We also purchased Boyett Agency, LLC, an independent insurance agency, and the equipment finance origination platform of Patriot Capital Corporation in 2015. To the extent that we are unable to appropriately leverage our capital with organic growth and acquisitions, we will actively consider alternative means of normalizing our level of capitalization, including increasing our quarterly dividend, paying a special dividend and/or repurchasing shares (including purchases under the Rule 10b-18 plan we announced on February 11, 2016, which the Company extended through February 24, 2019).
Off-Balance Sheet Arrangements
Commitments to extend credit are agreements to lend to a customer as long as the customer has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses, which may require the payment of a fee by the borrower. At December 31, 2017, unfunded commitments to extend credit were $979.6 million. A significant portion of the unfunded commitments related to commercial and residential real estate construction, commercial lines of credit and consumer equity lines of credit. Based on experience, we anticipate a significant portion of these lines of credit will not be funded. We evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.
At December 31, 2017, there were commitments totaling approximately $17.4 million under letters of credit. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Because most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.
Except as disclosed in Note 19 to our consolidated financial statements located in Part II, Item 8 of this Annual Report on Form 10-K, we are not involved in off-balance sheet contractual relationships or commitments, unconsolidated related entities that have off-balance sheet arrangements, or other off-balance sheet transactions that could result in liquidity needs that significantly impact earnings.
Contractual Obligations
In the normal course of business, we have various outstanding contractual obligations that will require future cash outflows. The following table presents our largest contractual obligations (dollars in thousands):
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds to meet the operating, capital and strategic needs of the Company and State Bank. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control when we make investment decisions. Net deposit inflows and outflows, however, are far less predictable and are not subject to the same degree of certainty.
The asset portion of the balance sheet provides liquidity primarily through scheduled payments, maturities and repayments of loans and investment securities. Cash and short-term investments such as federal funds sold and maturing interest-bearing deposits with other banks are also sources of funding.
At December 31, 2017, our liquid assets, which consist of cash and amounts due from banks, interest-bearing deposits in other financial institutions and federal funds sold, amounted to $230.9 million, or 4.7% of total assets, compared to $149.6 million, or 3.5% of total assets at December 31, 2016. The increase in our liquid assets was primarily due to deposit growth. Our available-for-sale securities at December 31, 2017 amounted to $874.0 million, or 17.6% of total assets, compared to $847.2 million, or 20.1% of total assets at December 31, 2016. Investment securities with an aggregate fair value of $116.1 million and $368.3 million at December 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits and repurchase agreements. The increase in our unpledged securities was due to investment of excess cash and reductions in pledging requirements as a result of implementation of a new Georgia Secure Deposit Program that reduced pledging requirements for qualified participating banks.
The liability portion of the balance sheet serves as our primary source of liquidity. We plan to meet our future cash needs through the generation of deposits. Customer deposits, excluding brokered deposits, have historically provided a sizeable source of relatively stable and low-cost funds. At December 31, 2017, customer deposits, excluding brokered deposits. were 116.2% of net loans, compared with 119.7% at December 31, 2016. We maintain nine federal funds lines of credit with correspondent banks totaling $200.0 million. We are also a member of the Federal Home Loan Bank of Atlanta (FHLB), from whom we can borrow for leverage or liquidity purposes. The FHLB requires that securities and qualifying loans be pledged to secure any advances. At December 31, 2017, we had no advances from the FHLB and a remaining credit availability of $150.9 million. In addition, we maintain a line with the Federal Reserve Bank's discount window of $535.3 million secured by certain loans from our loan portfolio.
Asset/Liability Management
Market risk is the risk of loss from adverse changes in market prices and rates, which principally arise from interest rate risk inherent in our lending, investing, deposit gathering and borrowing activities. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business. Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities to minimize potentially adverse effects on earnings from changes in market interest rates. Our Risk Committee monitors and considers methods of managing exposure to interest rate risk and is
responsible for maintaining the level of interest rate sensitivity of our interest-sensitive assets and liabilities within Board-approved limits.
Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time-frame that minimizes the changes in net interest income.
In the event of a shift in interest rates, management may take certain actions intended to mitigate negative impacts on net interest income or to maximize positive impacts on net interest income. These actions may include, but are not limited to, restructuring of interest-earning assets and interest-bearing liabilities, seeking alternative funding sources or investment opportunities, modifying the pricing or terms of loans and deposits, and using derivatives.
Through the use of derivatives designated as hedging instruments, we are able to efficiently manage the interest rate risk identified in specific assets and liabilities on our balance sheet. At December 31, 2017, we had interest rate swaps and caps, designated as hedging instruments, with aggregate notional amounts of $141.9 million and $200.0 million, respectively. The fair value of these derivative financial assets was $2.0 million at December 31, 2017, compared to $1.8 million at December 31, 2016 and the fair value of these derivative financial liabilities was $116,000 at December 31, 2017, compared to $641,000 at December 31, 2016. Note 13 to the consolidated financial statements located in Part II, Item 8 of this Annual Report on Form 10-K provides additional information on these contracts.
We regularly review our exposure to changes in interest rates. Among the factors we consider are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. Typically, our Risk Committee reviews, on at least a quarterly basis, our interest rate risk position. The primary tool used to analyze our interest rate risk and interest rate sensitivity is an earnings simulation model.
This earnings simulation model projects a baseline net interest income (assuming no changes in interest rate levels) and estimates changes to that baseline net interest income resulting from changes in interest rate levels. We rely primarily on the results of this model in evaluating our interest rate risk. This model incorporates a number of additional factors including: (1) the expected exercise of call features on various assets and liabilities, (2) the expected rates at which various rate-sensitive assets and rate-sensitive liabilities will reprice, (3) the expected growth in various interest-earning assets and interest-bearing liabilities and the expected interest rates on new assets and liabilities, (4) the expected relative movements in different interest rate indexes which are used as the basis for pricing or repricing various assets and liabilities, (5) existing and expected contractual cap and floor rates on various assets and liabilities, (6) expected changes in administered rates on interest-bearing transaction, savings, money market and time deposit accounts and the expected impact of competition on the pricing or repricing of such accounts, (7) cash flow and accretion expectations from purchased credit impaired loans, and (8) other relevant factors. Inclusion of these factors in the model is intended to more accurately project our expected changes in net interest income resulting from interest rate changes. We typically model our changes in net interest income assuming interest rates go up 100 basis points, up 200 basis points, down 100 basis points and down 200 basis points. We also model more extreme rises in interest rates (e.g. up 500 basis points). For purposes of this model, we have assumed that the changes in interest rates are instantaneously shocked up or down. While we believe this model provides a reasonably accurate projection of our interest rate risk, the model includes a number of assumptions and predictions which may or may not be correct and may impact the model results. These assumptions and predictions include inputs to compute baseline net interest income, growth rates, expected changes in administered rates on interest-bearing deposit accounts, competition and a variety of other factors that are difficult to accurately predict. Accordingly, there can be no assurance the earnings simulation model will accurately reflect future results.
The following table presents the earnings simulation model's projected impact of a change in interest rates on the projected baseline net interest income for the 12-month period commencing January 1, 2018. Based on the simulation run at December 31, 2017, annual net interest income would be expected to increase approximately 5.82%, if rates increased from current rates by 100 basis points. If rates increased 200 basis points from current rates, net interest income is projected to increase approximately 11.52%. If rates decreased 100 basis points from current rates, net interest income is projected to decrease approximately 8.10%. The change in interest rates assumes parallel shifts in the yield curve and does not take into account changes in the slope of the yield curve. The slight decrease in asset sensitivity at December 31, 2017 was primarily due to an increase of more rate sensitive deposits.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The information required by Item 305 of Regulation S-K is contained in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the Company's December 31, 2017 Annual Report on Form 10-K under the heading "Asset/Liability Management", which information is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data.
Selected Quarterly Financial Data (Unaudited)
Selected Quarterly Financial Data (Unaudited) (Continued)
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of State Bank Financial Corporation (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017, utilizing the framework established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As permitted, management excluded from its assessment of internal control over financial reporting the AloStar Bank of Commerce acquisition made during 2017, which is described in Note 2 to the Consolidated Financial Statements. The total assets and total interest income from this acquisition comprised approximately 15.7% of total consolidated assets at December 31, 2017 and approximately 7.8% of total consolidated interest income for the year ended December 31, 2017. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2017 is effective.
Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s independent registered public accounting firm, Dixon Hughes Goodman LLP, has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. The report, which expresses an unqualified opinion on the Company’s internal control over financial reporting as of December 31, 2017, is included in this Report on Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
State Bank Financial Corporation
Opinion on Internal Control Over Financial Reporting
We have audited State Bank Financial Corporation and Subsidiary (the “Company”)’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, State Bank Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of State Bank Financial Corporation as of December 31, 2017 and 2016 and for each of the three years in the period ended December 31, 2017, and our report dated February 23, 2018, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Management’s Annual Report on Internal Control Over Financial Reporting, the scope of management’s assessment of internal control over financial reporting as of December 31, 2017 has excluded AloStar Bank of Commerce acquired on September
30, 2017. Accordingly, we have also excluded AloStar bank of Commerce from the scope of our audit of internal control over financial reporting. AloStar Bank of Commerce comprised approximately 15.7% of total consolidated assets at December 31, 2017 and approximately 7.8% of total consolidated interest income for the year ended December 31, 2017.
/s/ Dixon Hughes Goodman LLP
Atlanta, Georgia
February 23, 2018
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
State Bank Financial Corporation:
Opinion on the Financial Statements
We have audited the accompanying balance sheets of State Bank Financial Corporation and Subsidiary (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017 and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2017, based on Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Dixon Hughes Goodman LLP
We have served as the Company's auditor since 2009.
Atlanta, Georgia
February 23, 2018
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Financial Condition
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Income
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
Consolidated Statements of Shareholders' Equity
(Dollars in thousands, except per share amounts)
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of State Bank Financial Corporation and Subsidiary (the "Company") include the financial statements of State Bank Financial Corporation and its wholly-owned subsidiary, State Bank and Trust Company (the "Bank" or "State Bank"). All intercompany transactions and balances have been eliminated in consolidation. Certain reclassifications of prior year amounts have been made to conform with the current year presentations. These reclassifications had no impact on prior years' net income, as previously reported.
State Bank and Trust Company was organized as a Georgia-state chartered bank, which opened October 4, 2005. The Bank is primarily regulated by the FDIC and undergoes periodic examinations by this regulatory authority. On July 24, 2009, State Bank and Trust Company closed on investment agreements under which new investors infused $292.1 million, gross (before expenses), of additional capital into the Bank, which resulted in a successor entity. This significant recapitalization resulted in a change of control and a new basis of accounting was applied. At the annual shareholders' meeting held March 11, 2010, approval was granted through proxy vote for the formation of a bank holding company. The required regulatory approval was obtained in July 2010 and the holding company reorganization was completed July 23, 2010.
Between July 24, 2009 and December 31, 2017, the Company successfully completed 17 bank acquisitions totaling $6.0 billion in assets and $5.2 billion in deposits. The acquisitions include the Company's acquisitions of NBG Bancorp, Inc. and S Bankshares, Inc., the holding companies for The National Bank of Georgia and S Bank, respectively, both of which closed on December 31, 2016. The acquisitions also include the Bank's acquisition of AloStar Bank of Commerce, which closed on September 30, 2017.
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to prevailing practices within the financial institutions industry. The following is a summary of the significant accounting policies that the Company follows in presenting its consolidated financial statements.
Nature of Business
State Bank Financial Corporation is a bank holding company whose primary business is conducted through 32 full-service branch offices of State Bank and Trust Company, its wholly-owned banking subsidiary. Through the Bank, the Company operates a full service banking business and offers a broad range of commercial and retail banking products to its customers throughout seven of Georgia's eight largest MSAs. The Company is subject to regulations of certain federal and state agencies and is periodically examined by those regulatory agencies.
Basis of Presentation
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenue and expenses for the period. Actual results could differ significantly from those estimates.
Significant estimates include the allowance for loan and lease losses, the valuation of other real estate owned, the amount and timing of expected cash flows from purchased credit impaired loans, the fair value of investment securities and other financial instruments, and the valuation of goodwill.
A substantial portion of the Company's loans are secured by real estate located in its market area. Accordingly, the ultimate collectability of a substantial portion of the Company's loan portfolio is susceptible to changes in the real estate market conditions.
As defined by authoritative guidance, segment disclosures require reporting information about a company's operating segments using a “management approach.” Reportable segments are identified as those revenue-producing components for which separate financial information is produced internally and which are subject to evaluation by the chief operating decision maker in deciding how to allocate resources to segments. The Company operates as one reportable segment.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash and Cash Equivalents
Cash and cash equivalents, as presented in the consolidated financial statements, includes cash on hand, cash items in process of collection, federal funds sold, and interest-bearing deposits with other financial institutions with maturities less than 90 days.
Investments
Management determines the appropriate classifications of investment securities at the time of purchase and reevaluates such designation as needed. At December 31, 2017 and 2016, the Company classified all of its investment securities as either available-for-sale or held-to-maturity. Investment securities available-for-sale are reported at fair value, as determined by independent quotations. Investment securities held-to-maturity represent those securities management has the positive intent and ability to hold to maturity and are reported at amortized cost. Purchase premiums and discounts on investment securities are amortized and accreted to interest income using the effective interest rate method over the remaining lives of the securities, taking into consideration assumed prepayment patterns. Realized gains and losses are derived using the specific identification method for determining the cost of securities sold and are recognized on the trade date.
The Company reclassified certain of its investment securities available-for-sale to held-to-maturity during the year ended December 31, 2016. The difference between book value and fair value at the date of transfer will continue to be reported in a separate component of accumulated other comprehensive income (loss), and will be amortized into income over the remaining life of the securities as an adjustment of yield. The difference between fair value at the date of transfer and par value is being amortized back to par value over the remaining life of the security as an adjustment to yield.
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. In connection with the assessment for other-than-temporary impairment of investment securities, management obtains fair value estimates by independent quotations, assesses current credit ratings and related trends, reviews relevant delinquency and default information, assesses expected cash flows and coverage ratios, assesses the relative strength of credit support from less senior tranches of the securities, reviews average credit score data of underlying mortgages, and assesses other current data. The severity and duration of impairment and the likelihood of potential recovery of impairment is considered along with the intent and ability to hold any impaired security to maturity or recovery of carrying value.
Unrealized losses, other than those determined to be other-than-temporary, and unrealized gains on available-for-sale are excluded from net income and are reported, net of tax, in other comprehensive income and in accumulated other comprehensive income (loss), a separate component of shareholders' equity. A decline in the market value of any security below cost that is deemed other-than-temporary results in a charge to earnings and the establishment of a new cost basis for that security. At December 31, 2017 and 2016, the Company did not have any securities with other than temporary impairment.
Investment in stock of the Federal Home Loan Bank ("FHLB") is required of every federally insured financial institution which utilizes the FHLB's services. The investment in FHLB stock is included in "other assets" at its original cost basis, as cost approximates fair value since there is no readily determinable market value for such investments given the redemptive provision of the FHLB. The Company acquired Federal Reserve Bank ("FRB") stock in its acquisition of NBG Bancorp, Inc. The investment in FRB stock is included in "other assets" at its original cost basis, as cost approximates fair value since there is no readily determinable market value for such investments.
Organic Loans
Organic loans, defined as loans not purchased in the acquisition of an institution or credit impaired portfolio, are loans management has the intent and ability to hold for the foreseeable future, until maturity, or until payoff. Organic loans are reported at their principal amounts outstanding, net of unearned income, deferred loan fees and origination costs, and unamortized premiums or discounts on purchased participation loans. Interest income is recognized using the simple interest method on the daily balance of the principal amount outstanding. Unearned income, primarily arising from deferred loan fees net of certain origination costs, is recognized as an adjustment of the related loan yield.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Past due status is based on the contractual terms of the loan agreement. Generally, the accrual of interest income is discontinued and loans are placed on nonaccrual status when reasonable doubt exists as to the full, timely collection of interest or principal or when they reach 90 days past due. Interest previously accrued but not collected is reversed against current period interest income when such loans are placed on nonaccrual status. Interest on nonaccrual loans when ultimately collected is recorded as a principal reduction. Nonaccrual loans are returned to accrual status when all principal and interest amounts contractually due are brought current. In addition, the future payments must be reasonably assured along with a period of at least six months of repayment performance by the borrower depending on the contractual payment terms. When it has been determined that a loan cannot be collected in whole or in part, then the uncollectible portion is charged-off.
The Company considers an organic loan impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Additionally, loans for which the terms have been modified and for which (i) the borrower is experiencing financial difficulties and (ii) a concession has been granted to the borrower by the Company are considered troubled debt restructurings ("TDRs") and are included in impaired loans. The Company's policy requires that impaired loans be individually evaluated for impairment if either 1) contractual balances are $500,000 and greater or 2) less than $500,000 and 180 day past due or greater. Loans are reviewed for impairment based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or the loan's observable market price, or the fair value of the collateral less disposal costs, as applicable, if the loan is collateral dependent. The Company's policy requires that large pools of smaller balance homogeneous loans, such as consumer, residential and installment loans, be collectively evaluated for impairment by the Company. Impairment losses are included in the allowance for loan and lease losses through a provision charge to earnings. All loans considered impaired are placed on nonaccrual status in accordance with policy. The interest portion of cash receipts on impaired loans are recorded as income when received unless full recovery of principal is in doubt whereby cash received is recorded as a reduction to the Company's recorded investment in the loan.
All organic impaired loans are reviewed at least quarterly. Reviews may be performed more frequently if material information is available before the next scheduled quarterly review. Existing valuations are reviewed to determine if additional discounts or new appraisals are required. The discounts may include the following: length of time to market and sell the property, as well as expected maintenance costs, insurance and taxes and real estate commissions on sale.
Purchased Loans
Purchased non-credit impaired loans ("PNCI loans")
Loans acquired without evidence of deterioration in credit quality since origination, referred to as purchased non-credit impaired loans, are initially recorded at estimated fair value on the acquisition date. Premiums and discounts created when the loans are recorded at their estimated fair values at acquisition are amortized or accreted over the remaining term of the loan as an adjustment to the related loan's yield.
The Company accounts for performing loans acquired in business combinations using the contractual cash flows method whereby premiums and discounts are recognized using the interest method. There is no allowance for loan and lease losses established at the acquisition date for purchased loans. Following the acquisition of these loans, the policies regarding nonaccrual and impaired loan status is consistent with that described above for organic loans. A provision for loan losses is recorded should there be deterioration in these loans subsequent to the acquisition.
Purchased credit impaired loans ("PCI loans")
Purchased credit impaired loans, defined as acquired loans, which at acquisition, management determined it was probable that the Company would be unable to collect all contractual principal and interest payments due, are recorded at fair value at the date of acquisition. The fair values of loans with evidence of credit deterioration are recorded net of a nonaccretable discount and, if appropriate, an accretable discount. The nonaccretable discount, which is excluded from the carrying amount of acquired loans, is the difference between the contractually required payments and the cash flows expected to be collected at acquisition. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized in interest income over the remaining life of the loan when there is reasonable expectation about the amount and timing of such cash flows. The difference between actual prepayments and expected prepayments does not affect the nonaccretable discount. Subsequent decreases to the expected cash flows will result in a provision for loan losses. Subsequent increases in the amount of cash expected to be collected from the borrower results in the reversal of any previously-recorded provision for loan and lease losses and related allowance for loan and lease losses, and then as a prospective increase in the accretable discount on the purchased credit impaired loans.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All loans acquired in failed bank transactions are considered to have evidence of credit deterioration, as limited due diligence is afforded which does not allow a sufficient detailed review to classify the acquired loans into credit deterioration and performing categories.
At the time of acquisition, purchased credit impaired loans are either accounted for as specifically-reviewed or as part of a loan pool. Loan pools are created by grouping loans with similar risk characteristics, the intent being to create homogeneous pools. Loans are grouped into pools based on a combination of various factors including product type, cohort, risk classification and term. Loans remain in the assigned pool until the individual pools have resolved. Gains and losses on individual loans within pools are deferred and retained in the pools until the pool closes, which is either when all the loans are resolved or the pool’s aggregate recorded investment reaches zero.
Allowance for Loan and Lease Losses ("ALLL")
The ALLL represents the amount considered adequate by management to absorb losses inherent in the loan portfolio at the balance sheet date. The ALLL is adjusted through provisions for loan losses charged or credited to operations. The provisions are generated through loss analyses performed on organic loans, estimated additional losses arising on PNCI loans subsequent to acquisition and impairment recognized as a result of decreased expected cash flows on PCI loans due to further credit deterioration since the previous quarterly cash flow re-estimation. The ALLL consists of both specific and general components. Individual loans are charged off against the ALLL when management determines them to be uncollectible. Subsequent recoveries, if any, of loans previously charged-off are credited to the ALLL.
All known and inherent losses that are both probable and reasonable to estimate are recorded. While management utilizes available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance. Such agencies may require adjustments to the ALLL based on their judgment about information available at the time of their examination.
The Company assesses the adequacy of the ALLL quarterly with respect to organic and purchased loans. The assessment begins with a standard evaluation and analysis of the loan portfolio. All loans are consistently graded and monitored for changes in credit risk and possible deterioration in the borrower’s ability to repay the contractual amounts due under the loan agreements.
Allowance for loan and lease losses for organic loans:
The ALLL for organic loans consists of two components:
(1)a specific amount against identified credit exposures where it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreements; and
(2)a general amount based upon historical losses that are then adjusted for qualitative factors representative of various economic indicators and risk characteristics of the loan portfolio.
Management establishes the specific amount by examining impaired loans. The majority of the Company's impaired loans are collateral dependent; therefore, nearly all of the specific allowances are calculated based on the fair value of the collateral less disposal costs, if applicable.
Management establishes the general amount by reviewing the remaining loan portfolio (excluding those impaired loans discussed above) and incorporating allocations based on historical losses. The calculation of the general amount is subjected to qualitative factors that are somewhat subjective. The qualitative testing attempts to correlate the historical loss rates with current economic factors and current risks in the portfolio. The qualitative factors consist of but are not limited to:
(1)economic factors including changes in the local or national economy;
(2)the depth of experience in lending staff, credit administration and internal loan review;
(3)asset quality trends; and
(4)seasoning and growth rate of the portfolio segments.
After assessing the applicable factors, the remaining amount is evaluated based on management's experience and the level of the organic ALLL is compared with historical trends and peer information as a reasonableness test.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance for loan and lease losses for purchased loans:
Purchased loans are initially recorded at their acquisition date fair values. The carryover of allowance for loan and lease losses is prohibited as any credit losses in the loans are included in the determination of the fair value of the loans at the acquisition date. Fair values for purchased loans are based on a discounted cash flow methodology that involves assumptions and judgments as to credit risk, default rates, loss severity, collateral values, discount rates, payment speeds, prepayment risk and liquidity risk.
The Company maintains an ALLL on purchased loans based on credit deterioration subsequent to the acquisition date. For purchased credit impaired loans accounted for under ASC 310-30, management establishes an allowance for credit deterioration subsequent to the date of acquisition by quarterly re-estimating expected cash flows with any decline in expected cash flows recorded as impairment in the provision for loan losses. Impairment is measured as the excess of the recorded investment in a loan over the present value of expected future cash flows discounted at the pre-impairment accounting yield of the loan. For any increases in cash flows expected to be collected, the Company first reverses only previously recorded ALLL, then adjusts the amount of accretable yield recognized on a prospective basis over the loan’s remaining life.
For purchased loans that are not deemed impaired at acquisition, also referred to as purchased non-credit impaired loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the asset. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary, additional reserves are recognized in the allowance for loan and lease losses.
Loans Held-for-Sale
Loans held-for-sale include the majority of originated residential mortgage loans and certain Small Business Administration ("SBA") loans, which the Company has the intent and ability to sell.
Mortgage Loans Held-for-Sale
The Company has elected to record mortgage loans held-for-sale at fair value under the fair value option. The fair value of committed residential mortgage loans held-for-sale is determined by outstanding commitments from investors and the fair value of uncommitted loans is based on current delivery prices in the secondary mortgage market. Net origination fees and costs are recognized in earnings at the time of origination for residential mortgage loans held-for-sale.
Gains and losses on mortgage loan sales are recognized based on the difference between the net sales proceeds, including the estimated value associated with servicing assets or liabilities, and the net carrying value of the loans sold. Adjustments to reflect unrealized gains and losses resulting from changes in fair value of residential mortgage loans held-for-sale, as well as realized gains and losses at the sale of the residential mortgage loans, are classified on the consolidated statements of income as noninterest income - mortgage banking income.
The loan sales agreements generally require that we repurchase or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. In addition to these conditions, our loan sale contracts define a condition in which the borrower defaults during a short period of time, typically 120 days to one year, as an Early Payment Default ("EPD"). In the event of an EPD, we are required to return the premium paid by the investor for the loan as well as certain administrative fees, and in certain situations repurchase the loan or indemnify the investor. Any losses related to loans previously sold are charged against our recourse liability for mortgage loans previously sold. The recourse liability is based on historical loss experience adjusted for current information and events when it is probable that a loss will be incurred.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SBA Loans Held-for-Sale
SBA loans held-for-sale are recorded at the lower of cost or market. Any loans subsequently transferred to the held for investment portfolio are transferred at the lower of cost or market at that time. For SBA loans, fair value is determined on an individual loan basis primarily based on loan performance and available market information. Origination fees and costs for SBA loans held-for-sale are capitalized as part of the basis of the loan and are included in the calculation of realized gains and losses upon sale. Gains and losses are classified on the consolidated statements of income as noninterest income - SBA income. All SBA loan sales are executed on a servicing retained basis - refer to SBA Servicing Rights below for more information.
Other Real Estate Owned ("OREO")
Other real estate owned consists of real property (a) acquired through mergers and acquisitions, (b) acquired through foreclosure in satisfaction of loans receivable, and (c) banking premises formerly, but no longer, used for a specific business purpose. Other real estate is distinguished between organic, purchased non-credit impaired, or purchased credit impaired, consistent with the categories, respectively, at time of transfer.
Real property acquired through mergers and acquisitions are recorded at fair value on Day 1 of the acquisition. Real estate acquired through foreclosure of loans, consisting of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, is reported on an individual asset basis at the lower of cost or fair value, less costs to sell with any excess in loan balance charged against the allowance for loan and lease losses. Banking premises no longer used for a specific business purposes is transferred into OREO at the lower of its carrying value or fair value, less estimated costs to sell with any excess in carrying value charged to noninterest expense.
For all fair value estimates of the real estate properties, fair value is determined on the basis of current appraisals, comparable sales, current market conditions, and other estimates of value obtained principally from independent sources. Management periodically reviews the carrying value of OREO for subsequent declines in fair value and adjusts the values as appropriate through noninterest expense. Gains or losses recognized on the disposition of the properties are recorded on the consolidated statements of income as "loan collection costs and OREO activity". Costs of improvements to real estate are capitalized, while costs associated with holding the real estate are charged to income.
Prior to termination of the Company's loss share agreements with the FDIC in May 2015, OREO formerly covered under the agreements were reported exclusive of expected reimbursement cash flows from the FDIC. Subsequent adjustments to the estimated recoverable value of the other real estate resulted in a reduction of other real estate and a charge to other expense. The FDIC receivable was increased for the estimated amount to be reimbursed, with a corresponding offsetting amount recorded to other expense. Costs associated with holding the formerly covered other real estate were charged to noninterest expense, net of any expected reimbursements from the FDIC relating to previously covered external expenses.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation, which is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets range from 10 to 39 years for buildings and improvements and 3 to 15 years for furniture, fixtures, and equipment. Costs of improvements are capitalized and depreciated, while operating expenses are charged to current earnings.
Goodwill and Other Intangibles, Net
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill and other intangibles deemed to have an indefinite life are not amortized but instead are subject to review for impairment annually, or more frequently if deemed necessary. Also in connection with business combinations, the Company records core deposit intangibles, representing the value of the acquired core deposit base, and other identifiable intangible assets. Core deposit intangibles and other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives ranging up to 10 years.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SBA Servicing Rights
All sales of SBA loans, consisting of the guaranteed portion, are executed on a servicing retained basis. The standard sale structure under the SBA Secondary Participation Guaranty Agreement provides for the Company to retain a portion of the cash flow from the interest payment received on the loan. This cash flow is commonly known as a servicing spread. For any guaranteed loans sold at a premium, SBA regulations require the lender to keep a minimum 100 basis points in servicing spread which includes a minimum service fee of 40 basis points and a minimum premium protection fee of 60 basis points. The servicing spread is recognized as a servicing asset to the extent the spread exceeds adequate compensation for the servicing function. The fair value of the servicing asset is measured on a recurring basis at the present value of future cash flows using market-based discount assumptions. The future cash flows for each asset are based on their unique characteristics and market-based assumptions for prepayment speeds, default and voluntary prepayments. For non-guaranteed portions of servicing assets, future cash flows are estimated using loan specific assumptions for losses and recoveries. Adjustments to fair value are recorded as a component of "SBA income" on the consolidated statements of income.
Servicing fee 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.
Derivative Instruments and Hedging Activities
Interest Rate Swaps and Caps
The Company enters into derivative financial instruments to manage interest rate risk, facilitate asset/liability management strategies and manage other exposures. These instruments may include interest rate swaps and interest rate caps and floors. All derivative financial instruments are recognized on the consolidated statements of financial condition as other assets or other liabilities, as applicable, at estimated fair value. The Company enters into master netting agreements with counterparties and/or requires collateral to cover exposures. In most cases, counterparties post at a zero threshold regardless of rating.
Interest rate swaps are agreements to exchange interest payments based upon notional amounts. Interest rate swaps subject the Company to market risk associated with changes in interest rates, as well as the credit risk that the counterparty will fail to perform. Option contracts involve rights to buy or sell financial instruments on a specified date or over a period at a specified price. These rights do not have to be exercised. Some option contracts such as interest rate caps, involve the exchange of cash based on changes in specified indices. Interest rate caps are contracts to hedge interest rate increases based on a notional amount. Interest rate caps subject the Company to market risk associated with changes in interest rates, as well as the credit risk that the counterparty will fail to perform.
Derivative financial instruments are designated, based on the exposure being hedged, as either fair value or cash flow hedges. Fair value hedge relationships mitigate exposure to the change in fair value of an asset, liability or firm commitment. Under the fair value hedging model, gains or losses attributable to the change in fair value of the derivative instrument, as well as the gains and losses attributable to the change in fair value of the hedged item, are recognized in other noninterest income in the period in which the change in fair value occurs. Hedge ineffectiveness is recognized as other noninterest income to the extent the changes in fair value of the derivative do not offset the changes in fair value of the hedged item. The corresponding adjustment to the hedged asset or liability is included in the basis of the hedged item, while the corresponding change in the fair value of the derivative instrument is recorded as an adjustment to other assets or other liabilities, as applicable. Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. For cash flow hedge relationships, the effective portion of the gain or loss related to the derivative instrument is recognized as a component of accumulated other comprehensive income (loss). The ineffective portion of the gain or loss related to the derivative instrument, if any, is recognized in earnings as other noninterest income during the period of change. Amounts recorded in accumulated other comprehensive income (loss) are recognized in earnings in the period or periods during which the hedged item impacts earnings.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company formally documents all hedging relationships between hedging instruments and the hedged items, as well as its risk management objective and strategy for entering into various hedge transactions. Methodologies related to hedge effectiveness and ineffectiveness are consistent between similar types of hedge transactions and typically include (i) statistical regression analysis of changes in the cash flows of the actual derivative and a perfectly effective hypothetical derivative, and (ii) statistical regression analysis of changes in the fair values of the actual derivative and the hedged item. The Company performs retrospective and prospective effectiveness testing using quantitative methods and does not assume perfect effectiveness through the matching of critical terms. Assessments of hedge effectiveness and measurements of hedge ineffectiveness are performed at least quarterly for ongoing effectiveness.
Hedge accounting is discontinued prospectively when (i) a derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item, (ii) a derivative expires or is sold, terminated or exercised, (iii) we elect to discontinue the designation of a derivative as a hedge, or (iv) in a cash flow hedge, a derivative is de-designated because it is not probable that a forecasted transaction will occur. If a derivative that qualifies as a fair value or cash flow hedge is terminated or the designation removed, the realized or then unrealized gain or loss is recognized in income over the life of the hedged item (fair value hedge) or in the period in which the hedged item affects earnings (cash flow hedge). Immediate recognition in earnings is required upon sale or extinguishment of the hedged item (fair value hedge) or if it is probable that the hedged cash flows will not occur (cash flow hedge). Derivatives continued to be held after hedge accounting ceases are carried at fair value on the consolidated statements of financial condition with changes in fair value including in earnings.
Mortgage Derivatives
The Company enters derivative financial instruments to manage interest rate risk and pricing risk associated with is mortgage banking activities. These instruments may include interest rate lock commitments and forward commitments. All mortgage derivatives are recognized on the consolidated statements of financial condition as other assets or other liabilities, as applicable, at estimated fair value and are not accounted for as hedges. Interest rate lock commitments are agreements to fund fixed-rate mortgage loans to customers. Forward commitments are agreements to sell fixed-rate mortgage loans to investors. Changes in fair value are recognized as a component of "mortgage banking income" on the consolidated statements of income.
Bank-Owned Life Insurance ("BOLI")
The Company has purchased life insurance policies on certain key executives. Bank-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 that is probable at settlement. Increases to cash surrender values are recorded as "Bank-owned life insurance income" on the consolidated statements of income. The Company has entered into a split dollar agreement with certain of its executives whereby the executive’s designated beneficiary will receive a portion of the death benefit upon the executive officer’s death. The Company uses the cost of insurance method whereby a liability is recorded relating to the benefit provided that extends to post-retirement periods.
Share-Based Compensation
The Company has an equity compensation plan providing for the grant of equity awards, which is described more fully in Note 16. The Company uses the fair value method of recognizing expense for share-based compensation, whereby compensation cost is measured at the grant date based on the value of the award and is recognized on a straight-line basis over the vesting period. Compensation expense relating to equity awards is reflected in net income as part of "salaries and employee benefits" on the consolidated statements of income.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies by jurisdiction and entity in making this assessment. Interest and penalties related to the Company’s tax positions are recognized as a component of the income tax provision.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comprehensive Income
In addition to net income for the period, comprehensive income for the Company consists of changes in unrealized holding gains and losses on investments classified as available-for-sale, changes in unamortized or unaccreted premiums or discounts on investment securities available-for-sale transferred to held-to-maturity and changes in fair value of the effective portion of derivative financial instruments designated as cash flow hedges. The changes are reported net of income taxes and reclassification adjustments.
Acquisitions
Accounting principles generally accepted in the United States of America ("US GAAP") require that the acquisition method of accounting, formerly referred to as the purchase method, be used for all business combinations and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date.
Basic and Diluted Earnings Per Share
Basic earnings per share is calculated using the two-class method to determine income attributable to common shareholders. Unvested share-based payment awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Net income attributable to common shareholders is then divided by the weighted average common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income of the Company. Diluted earnings per share is computed by dividing net income attributable to common shareholders by the total of the weighted average number of shares outstanding plus the dilutive effect of the outstanding options and warrants.
Adoption of New Accounting Standards
ASU 2018-02 - In February 2018, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this Update allow for a reclassification of stranded tax effects resulting from the Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. The amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted and the Company elected to early adopt this guidance effective December 31, 2017. The adoption resulted in a reclassification of stranded tax effects of $453,000 from accumulated other comprehensive income (loss) to retained earnings.
ASU 2016-05 - In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships. The amendments in this Update clarify that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments in this update are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted and the amendments can be adopted either on a prospective basis or a modified retrospective basis. The Company adopted the amendments in this ASU effective January 1, 2017. The adoption did not have a material impact on our consolidated financial statements.
Recent Accounting Pronouncements
ASU 2017-12 - On August 28, 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of this ASU is to better align a company’s risk management activities and financial reporting for hedging relationships with the economic objectives of those activities, simplify the hedge accounting requirements, and improve the disclosures of hedging arrangements. The ASU is effective for annual reporting periods, including interim periods within those annual reporting periods, beginning after December 15, 2018. Early adoption is
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
permitted, including adoption in any interim period. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. The Company is still reviewing the impact of adoption of this guidance.
ASU 2017-09 - On May 10, 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting. This Update amends the scope of modification accounting for share-based payment arrangements. It provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718, Compensation-Stock Compensation. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. The ASU is effective for annual reporting periods, including interim periods within those annual reporting periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. The guidance is not expected to have a significant impact on the Company's financial position, results of operations or disclosures.
ASU 2017-08 - In March 2017, FASB issued ASU No. 2017-08, Receivables - Nonrefundable Fees and Other Costs (Topic 310-20): Premium Amortization on Purchased Callable Debt Securities. The ASU shortens the amortization period for certain callable debt securities held at a premium. The premium on individual callable debt securities shall be amortized to the earliest call date. This guidance does not apply to securities for which prepayments are estimated on a large number of similar loans where prepayments are probable and reasonably estimable. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. This update should be adopted on a modified retrospective basis with a cumulative-effect adjustment to retained earnings on the date of adoption. The guidance is not expected to have a significant impact on the Company's financial position, results of operations or disclosures.
ASU 2017-04 - In January 2017, FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for goodwill impairment tests performed on testing dates after January 1, 2017. The guidance is not expected to have a significant impact on the Company's financial positions, results of operations or disclosures.
ASU 2017-01 - In January 2017, FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The ASU clarifies the definition of a business to assist with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance is not expected to have a significant impact on the Company's financial positions, results of operations or disclosures.
ASU 2016-13 - In June 2016, FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU changed the credit loss model on financial instruments measured at amortized cost, available for sale securities and certain purchased financial instruments. Credit losses on financial instruments measured at amortized cost will be determined using a current expected credit loss model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. Purchased financial assets with more-than-insignificant credit deterioration since origination ("PCD assets") measured at amortized cost will have an allowance for credit losses established at acquisition as part of the purchase price. Subsequent increases or decreases to the allowance for credit losses on PCD assets will be recognized in the income statement. Interest income should be recognized on PCD assets based on the effective interest rate, determined excluding the discount attributed to credit losses at acquisition. Credit losses relating to available-for-sale debt securities will be recognized through an allowance for credit losses. The amount of the credit loss is limited to the amount by which fair value is below amortized cost of the available-for-sale debt security. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted and if early adopted, all provisions must be adopted in the same period. The amendments should be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the period adopted. A prospective approach is required for securities with other-than-temporary impairment recognized prior to adoption. The Company is still reviewing the impact of the adoption of this guidance
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and has established a cross-functional implementation team. The Company expects the allowance for credit losses to increase upon adoption with a corresponding adjustment to retained earnings. The ultimate amount of the increase will depend on the portfolio composition, credit quality, economic conditions and reasonable and supportable forecasts at that time.
ASU 2016-02 - In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). The new standard requires the recognition of assets and liabilities arising from the lease transactions on the balance sheet and the disclosure of key information about leasing arrangements. Accordingly, a lessee will recognize a lease asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation. Both the asset and liability will initially be measured at the present value of the future minimum lease payments over the lease term. Subsequent measurement, including the presentation of expenses and cash flows, will depend on the classification of the lease as either a finance or an operating lease. Initial costs directly attributable to negotiating and arranging the lease will be included in the asset. For leases with a term of 12 months or less, a lessee can make an accounting policy election by class of underlying asset to not recognize an asset and corresponding liability. Lessees will also be required to provide additional qualitative and quantitative disclosures regarding the amount, timing and uncertainty of cash flows arising from leases. These disclosures are intended to supplement the amounts recorded in the financial statements and provide additional information about the nature of an organization’s leasing activities. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees are required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company expects to elect the package of practical expedients that allows it to not reassess whether any expired or existing contracts represent leases, the lease classification of any expired or existing lease and initial direct costs for any existing or expired leases. The Company expects this standard will have a material impact on its financial statements through gross-up of the balance sheet for lease assets and liabilities. However, no material change to lease expense recognition is expected.
ASU 2016-01 - In January 2016, FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU (i) require equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. The accounting guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is prohibited except for the presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk which may be early adopted. The guidance is not expected to have a significant impact on the Company's financial position, results of operations or disclosures.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ASU 2014-09, Revenue from Contracts with Customers (Topic 606), ASU 2015-14 Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, ASU 2016-08 Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10 Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, ASU 2016-11 Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting, ASU 2016-12 Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and ASU 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers - In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The new guidance, which does not apply to financial instruments, provides that revenue should be recognized for the transfer of goods and services to customers in an amount equal to the consideration it receives or expects to receive. The guidance also includes expanded disclosure requirements that provides comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company currently plans to adopt the guidance using the modified retrospective method and without electing any of the practical expedients available. The Company has performed an analysis of the guidance and it is not expected to have a significant impact on the Company's financial position or results of operations but will increase disclosures of revenue.
NOTE 2: ACQUISITIONS
Acquisition of AloStar Bank of Commerce
On September 30, 2017, State Bank completed its acquisition of AloStar Bank of Commerce ("AloStar"). State Bank Interim Corp., a wholly-owned subsidiary of State Bank, merged with and into AloStar, immediately followed by the merger of AloStar with and into State Bank. Under the terms of the merger agreement, each share of AloStar common stock was converted into the right to receive $24.26 in cash. Total consideration paid was approximately $195.0 million.
The merger of AloStar was accounted for under the acquisition method of accounting. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Goodwill of $7.1 million was generated from the acquisition, none of which is expected to be deductible for income tax purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the assets acquired and liabilities assumed and the consideration payable by the Company at the acquisition date (dollars in thousands):
Explanation of fair value adjustments
(a)
Adjustment reflects the loss on certain securities that were sold immediately following the closing that was deemed to be a more accurate representation of fair value.
(b)
Adjustment reflects the fair value adjustment based on the State Bank's evaluation of the acquired loan portfolio and includes the adjustment to eliminate the recorded allowance for loan and lease losses.
(c)
Adjustment reflects the fair value adjustment to record the estimated core deposit intangible.
(d)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired other assets.
(e)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired deposits.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents certain pro forma information as if AloStar had been acquired on January 1, 2015 (dollars in thousands, except per share amounts). These results combine the historical results of AloStar in the Company's consolidated statements of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2015. Merger-related costs are not included in the pro forma statements below.
The following is a summary of the purchased credit impaired loans acquired in the AloStar transaction on September 30, 2017 (dollars in thousands):
On September 30, 2017, the fair value of the purchased non-credit impaired loans acquired in the AloStar transaction was $641.0 million. The gross contractual amounts receivable of the purchased non-credit impaired loans at acquisition was $707.0 million, of which $9.3 million was the amount of contractual cash flows not expected to be collected.
Acquisition of NBG Bancorp, Inc. and The National Bank of Georgia
On December 31, 2016 the Company completed its acquisition of NBG Bancorp, Inc. ("NBG Bancorp"), the holding company for The National Bank of Georgia ("National Bank of Georgia"), a national banking association. NBG Bancorp was immediately merged into the Company followed by the merger of National Bank of Georgia with and into State Bank. Under the terms of the merger agreement, each share of NBG Bancorp, Inc. common stock was converted into the right to receive either $45.45 in cash or 2.1642 shares of the Company's common stock. Elections by NBG Bancorp shareholders were prorated such that 50% of NBG Bancorp's shares were exchanged for cash and 50% were exchanged for Company common stock. The elections by NBG Bancorp's shareholders were made subsequent to merger completion and the final merger consideration was distributed in February 2017. Total consideration paid was approximately $77.9 million, consisting of $34.2 million in cash and $43.7 million in the Company's common stock.
The merger of NBG Bancorp, Inc. was accounted for under the acquisition method of accounting, using pushdown accounting. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Goodwill of $36.6 million was generated from the acquisition, none of which is expected to be deductible for income tax purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the assets acquired and liabilities assumed and the consideration paid by the Company at the acquisition date (dollars in thousands):
Explanation of fair value adjustments
(a)
Adjustment reflects the elimination of a deposit account The National Bank of Georgia held with State Bank.
(b)
Adjustment reflects the loss on certain securities that were sold immediately following close that was deemed to be a more accurate representation of fair value.
(c)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired loan portfolio and includes the adjustment to eliminate the recorded allowance for loan and lease losses.
(d)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired other real estate owned portfolio.
(e)
Adjustment reflects the fair value adjustment to record the estimated core deposit intangible.
(f)
Adjustment reflects the fair value adjustment based on appraised values.
(g)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired other assets.
(h)
Adjustment reflects the elimination of a deposit account The National Bank of Georgia held with State Bank and the fair value adjustment based on State Bank's evaluation of acquired deposits.
(i)
Adjustment arises since the rates on acquired FHLB advances were lower than the rates available on similar borrowings. Subsequent to the NBG Bancorp acquisition all FHLB advances were paid off.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the impact of the merger with NBG Bancorp, Inc. (excluding the impact of merger-related expenses) from the acquisition date of December 31, 2016 (dollars in thousands, except per share amounts). The table also presents certain pro forma information as if NBG Bancorp, Inc. had been acquired on January 1, 2015. These results combine the historical results of NBG Bancorp, Inc. in the Company's consolidated statements of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2015. Merger-related costs are not included in the pro forma statements below.
The following is a summary of the purchased credit impaired loans acquired in the NBG Bancorp, Inc. transaction on December 31, 2016 (dollars in thousands):
On December 31, 2016, the fair value of the purchased non-credit impaired loans acquired in the NBG Bancorp, Inc. transaction was $317.9 million. The contractual balance of the purchased non-credit impaired loans at acquisition was $350.0 million, of which $4.4 million was the amount of contractual cash flows not expected to be collected.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquisition of S Bankshares, Inc. and S Bank
On December 31, 2016 the Company completed its acquisition of S Bankshares Inc. ("S Bankshares"), the holding company for S Bank, a Georgia state-chartered bank. S Bankshares was immediately merged into the Company followed by the merger of S Bank with and into State Bank. Under the terms of the merger agreement, each share of S Bankshares, Inc. common stock was converted into the right to receive either $56.70 in cash or 2.7444 shares of the Company's common stock. Elections by S Bankshares shareholders were prorated such that 60% of S Bankshares' shares were exchanged for Company common stock and 40% were exchanged for cash. Total consideration paid was approximately $12.6 million, consisting of $4.3 million in cash and $8.3 million in the Company's common stock.
The acquisition of S Bankshares Inc. was accounted for under the acquisition method of accounting, using pushdown accounting. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Goodwill of $4.1 million was generated from the acquisition, none of which is expected to be deductible for income tax purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the assets acquired and liabilities assumed and the consideration paid by the Company at the acquisition date (dollars in thousands):
Explanation of fair value adjustments
(a)
Adjustment reflects the loss on certain securities that were sold immediately following close that was deemed to be a more accurate representation of fair value.
(b)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired loan portfolio and includes the adjustment to eliminate the recorded allowance for loan and lease losses.
(c)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired other real estate owned portfolio.
(d)
Adjustment reflects the fair value adjustment to record the estimated core deposit intangible.
(e)
Adjustment reflects the fair value adjustment based on appraised values.
(f)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired other assets.
(g)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired deposits.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the impact of the merger with S Bankshares Inc. (excluding the impact of merger-related expenses) from the acquisition date of December 31, 2016 (dollars in thousands, except per share amounts). The table also presents certain pro forma information as if S Bankshares Inc. had been acquired on January 1, 2015. These results combine the historical results of S Bankshares Inc. in the Company's consolidated statements of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2015. Merger-related costs are not included in the pro forma statements below.
The following is a summary of the purchased credit impaired loans acquired in the S Bankshares Inc. transaction on December 31, 2016 (dollars in thousands):
On December 31, 2016, the fair value of the purchased non-credit impaired loans acquired in the S Bankshares Inc. transaction was $67.3 million. The contractual balance of the purchased non-credit impaired loans at acquisition was $77.0 million, of which $1.3 million was the amount of contractual cash flows not expected to be collected.
Acquisition of Patriot Capital Corporation's Equipment Finance Group
On October 22, 2015, State Bank announced the purchase of the equipment financing origination platform of Patriot Capital Corporation. The acquisition was not material to the financial results of State Bank. Goodwill of $5.3 million and other intangibles of $2.1 million were recorded in the acquisition. None of the goodwill is expected to be deductible for income tax purposes.
Acquisition of Boyett Agency, LLC
On February 26, 2015, State Bank entered into an Asset Purchase Agreement with Boyett Agency, LLC an independent insurance agency, pursuant to which State Bank acquired substantially all of the assets of Boyett Agency, LLC. The acquisition was not material to the financial results of State Bank. Goodwill of $539,000 and other intangibles of $319,000 were recorded in the acquisition. None of the goodwill is expected to be deductible for income tax purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquisition of Georgia-Carolina Bancshares Inc. and First Bank of Georgia
On January 1, 2015, the Company completed its merger with Georgia-Carolina Bancshares, Inc., the holding company for First Bank. In the merger, First Bank, a Georgia-state-chartered bank, became a wholly-owned subsidiary bank of the Company. Under the terms of the merger agreement, each share of Georgia-Carolina Bancshares, Inc. common stock was converted into the right to receive $8.85 in cash and .794 shares of the Company's common stock. Total consideration paid was approximately $88.9 million, consisting of $31.8 million in cash and $57.0 million in the Company's common stock. On July 24, 2015, First Bank merged with and into State Bank.
The merger of Georgia-Carolina Bancshares was accounted for under the acquisition method of accounting, using pushdown accounting. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Goodwill of $19.9 million was generated from the acquisition, none of which is expected to be deductible for income tax purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the assets acquired and liabilities assumed and the consideration paid by the Company at the acquisition date (dollars in thousands):
Explanation of fair value adjustments
(a)
Adjustment reflects the gain on certain securities that were sold immediately following close that was deemed to be a more accurate representation of fair value.
(b)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired loan portfolio and includes the adjustment to eliminate the recorded allowance for loan and lease losses.
(c)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of the acquired other real estate owned portfolio.
(d)
Adjustment reflects the fair value adjustment to record the estimated core deposit intangible.
(e)
Adjustment reflects the fair value adjustment based on appraised values.
(f)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired other assets.
(g)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of acquired deposits.
(h)
Adjustment reflects the fair value adjustment based on State Bank's evaluation of other liabilities and to record certain liabilities directly attributable to the acquisition.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the impact of the merger with Georgia-Carolina Bancshares, Inc. (excluding the impact of merger-related expenses) from the acquisition date of January 1, 2015 through December 31, 2015 (dollars in thousands, except per share amounts). The table also presents certain pro forma information as if Georgia-Carolina Bancshares, Inc. had been acquired on January 1, 2015. These results combine the historical results of Georgia-Carolina Bancshares, Inc. in the Company's consolidated statements of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2015. Merger-related costs of $1.7 million are included in the Company's consolidated statements of income for the year ended December 31, 2015 and are not included in the pro forma statements below.
The following is a summary of the purchased credit impaired loans acquired in the Georgia-Carolina Bancshares, Inc. transaction on January 1, 2015 (dollars in thousands):
On January 1, 2015, the fair value of the purchased non-credit impaired loans acquired in the Georgia-Carolina Bancshares, Inc. transaction was $292.4 million. The contractual balance of the purchased non-credit impaired loans at acquisition was $355.0 million, of which $6.4 million was the amount of contractual cash flows not expected to be collected.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3: INVESTMENT SECURITIES
The amortized cost and fair value of securities classified as available-for-sale are as follows (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and estimated fair value of available-for-sale debt securities by contractual maturities are summarized in the table below (dollars in thousands):
(1) Actual cash flows may differ from contractual maturities as borrowers may prepay obligations without prepayment penalties.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables provide information regarding securities with unrealized losses (dollars in thousands):
At December 31, 2017, the Company held 129 investment securities that were in an unrealized loss position. Market changes in interest rates and credit spreads may result in temporary unrealized losses as market prices of securities fluctuate. The Company reviews its investment portfolio on a quarterly basis for indications of other than temporary impairment ("OTTI"). The severity and duration of impairment and the likelihood of potential recovery of impairment is considered along with the intent and ability to hold any impaired security to maturity or recovery of carrying value. More specifically, when analyzing the nonagency portfolio, the Company uses cash flow models that estimate cash flows on security-specific collateral and the transaction structure. Future expected credit losses are determined by using various assumptions, the most significant of which include current default rates, prepayment rates and loss severities. Credit information is available and modeled at the loan level underlying each security during the OTTI analysis; the Company also considers information such as loan to collateral values, FICO scores and geographic considerations, such as home price appreciation or depreciation. These inputs are updated quarterly or as changes occur to ensure that the most current credit and other assumptions are utilized in the analysis. If, based on the analysis, the Company does not expect to recover the entire amortized cost basis of the security, the expected cash flows are discounted at the security's initial effective interest rate to arrive at a present value amount. OTTI credit losses reflect the difference between the present value of cash flows expected to be collected and the amortized cost basis of these securities. At December 31, 2017, there was no intent to sell any of the available-for-sale securities in an unrealized loss position, and it is more likely than not the Company will not be required to sell these securities. Furthermore, the present value of cash flows
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
expected to be collected exceeded the Company's amortized cost basis of the investment securities; therefore, these securities are not deemed to be other than temporarily impaired.
Sales and calls of securities available-for-sale are summarized in the following table (dollars in thousands):
The composition of investment securities reflects the strategy of management to maintain an appropriate level of liquidity while providing a relatively stable source of revenue. The securities portfolio may at times be used to mitigate interest rate risk associated with other areas of the balance sheet while also providing a means for the investment of available funds, providing liquidity and supplying investment securities that are required to be pledged as collateral against specific deposits and for other purposes. Investment securities with an aggregate fair value of $116.1 million and $368.3 million at December 31, 2017 and 2016, respectively, were pledged to secure public deposits and repurchase agreements.
NOTE 4: LOANS
Loans, in total, are summarized as follows (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Organic loans, which we define as loans not purchased in the acquisition of an institution or credit impaired portfolio, are summarized as follows (dollars in thousands):
(1) Includes net deferred loan fees that totaled approximately $9.3 million and $7.0 million at December 31, 2017 and 2016, respectively.
Purchased non-credit impaired loans ("PNCI loans"), net of related discounts, are summarized as follows (dollars in thousands):
(1) Includes net discounts that totaled approximately $12.7 million and $10.5 million at December 31, 2017 and 2016, respectively.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Purchased credit impaired loans ("PCI loans"), net of related discounts, are summarized as follows (dollars in thousands):
Changes in the carrying value of net purchased credit impaired loans are presented in the following table (dollars in thousands):
Purchased credit impaired loans are initially recorded at fair value at the acquisition date. Subsequent decreases in the amount of cash expected to be collected from the borrower results in a provision for loan and lease losses and an increase in the allowance for loan and lease losses. Subsequent increases in the amount of cash expected to be collected from the borrower results in the reversal of any previously-recorded provision for loan and lease losses and related allowance for loan and lease losses, and then as a prospective increase in the accretable discount on the purchased credit impaired loans. The accretable discount is accreted into interest income over the estimated life of the related loan on a level yield basis.
Changes in the value of the accretable discount are presented in the following table for the periods presented (dollars in thousands):
The accretable discount changes over time as the purchased credit impaired loan portfolios season. The change in the accretable discount is a result of the Company's review and re-estimation of loss assumptions and expected cash flows on acquired loans.
At December 31, 2017 and 2016, loans with a carrying value of $3.1 billion and $2.5 billion, respectively, were pledged for lines of credit with the FHLB and FRB. At December 31, 2017 and 2016, in accordance with Company policy, there were no loans to executive officers, directors and/or their affiliates. At December 31, 2017, consumer mortgage loans secured by residential real estate properties totaling $49,000 were in formal foreclosure proceedings.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5: ALLOWANCE FOR LOAN AND LEASE LOSSES (ALLL)
The following table summarizes the Company’s loan loss experience on the total loan portfolio as well as the breakdown between the organic, purchased non-credit impaired, and purchased credit impaired portfolios for the periods presented (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment and Class Risk Descriptions
Each of our portfolio segments and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of our loan portfolio. Management has identified the most significant risks associated with segments and classes as described below. While the list is not exhaustive, it provides a description of the risks that management has determined are the most significant.
Real Estate Loans
Loans secured by real estate are the principal component of our loan portfolio. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Increases in interest rates, decline in occupancy rates, fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower's cash flow, creditworthiness and ability to repay the loan. When we make new real estate loans, we typically obtain a security interest in the real estate, as well as other available credit enhancements, to increase the likelihood of the ultimate repayment of the loan. To control concentration risk, we monitor collateral type concentrations within this portfolio.
In addition to these common risks for the majority of our real estate loans, additional risks are inherent in certain of our classes of real estate loans which are addressed below:
Commercial Real Estate
Commercial real estate loans consist of commercial construction and land development loans and other commercial real estate loans. Commercial construction and land development loans are highly dependent upon the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and lots that our customers are developing. Construction and development loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends upon the ultimate completion of the project and usually on the subsequent lease-up and/or sale of the property. Additionally, deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.
Other commercial real estate loans consist primarily of loans secured by other nonfarm nonresidential properties such as retail, office and hotel/motel and multifamily housing. These loans typically have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine the business risks and credit profile of each borrower. The primary risk associated with loans secured with income-producing property is the inability of that property to produce adequate cash flow to service the debt. High unemployment, generally weak economic conditions and/or an oversupply in the market may result in our customer having difficulty achieving adequate occupancy rates.
Residential Real Estate
Residential real estate loans are typically to individuals and are secured by owner-occupied and investor-owned 1-4 family residential property. We generally originate and hold certain first mortgages and traditional second mortgages, adjustable rate mortgages and home equity lines of credit. We also originate and sell fixed and adjustable rate residential real estate loans in the secondary market. Significant and rapid declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the current market value of the collateral.
Owner-Occupied Real Estate
Owner-occupied loans consist of loans secured by nonfarm nonresidential properties, such as office and industrial properties, churches, convenience stores and restaurants occupied by an affiliated tenant. Loan repayment is primarily dependent on the ability of the operating company to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. Adverse changes in the business's results, specifically declines in cash flows, could jeopardize the ability for the loan to be serviced in accordance with the contractual terms.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commercial, Financial & Agricultural Loans
Commercial, financial and industrial loans include loans to individuals and businesses for commercial purposes in various lines of business, including the manufacturing, professional service, and crop production industries. This segment also includes loans to states and political subdivisions, as well as equipment finance agreements, asset-based loans and lender finance loans. Repayment is primarily dependent on the ability of the borrower to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a borrower's business results are significantly unfavorable versus the original projections, the ability for the loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans may be partially secured by real estate, they are generally considered to have greater collateral risk than first or second mortgages on real estate because these loans may be unsecured or, if they are secured, the value of the non-real estate collateral may be difficult to assess and less marketable than real estate, and the control of the collateral is more at risk.
Leases
Leases include purchased commercial, business purpose and municipal leases. The stream of payments and a first security interest in the collateral is assigned to us. Our lease funding is based on a present value of the lease payments at a discounted interest rate, which is determined based on the credit quality of the lessee, the term of the lease compared to expected useful life, and the type of collateral. Types of collateral include, but are not limited to, medical equipment, rolling stock, franchise restaurant equipment and hardware/software. Servicing of purchased leases is primarily retained by the loan originator, as well as ownership of all residuals, if applicable. Lease financing is underwritten using similar underwriting standards as would be applied to a secured commercial loan requesting high loan-to-value financing. Risks that are involved with lease financing receivables are credit underwriting and borrower industry concentrations.
Consumer Loans
The consumer loan portfolio includes loans to individuals for personal, family and household purposes, including secured and unsecured installment loans and revolving lines of credit. Consumer loans not secured by real estate are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value, and is more difficult to control, than real estate. Consumer loans may be secured by cash value life insurance policies which presents a lower collateral risk than other non-real estate secured consumer loans.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the allowance for loan and lease losses on organic loans is detailed as follows by portfolio segment for the periods presented (dollars in thousands):
The following table presents the balance of organic loans and the allowance for loan and lease losses based on the method of determining the allowance at the dates indicated (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the allowance for loan and lease losses on purchased non-credit impaired loans is detailed as follows by portfolio segment for the periods presented (dollars in thousands):
The following table presents the balance of purchased non-credit impaired loans and the allowance for loan and lease losses based on the method of determining the allowance at the date indicated (dollars in thousands).
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Activity in the allowance for loan and lease losses on purchased credit impaired loans is detailed as follows by portfolio segment for the periods presented (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the balance of purchased credit impaired loans and the allowance for loan and lease losses based on the method of determining the allowance at the dates indicated (dollars in thousands):
For each period indicated, a significant portion of the Company's purchased credit impaired loans were past due, including many that were 90 days or more past due; however, such delinquencies were included in the Company's performance expectations in determining the fair values of purchased credit impaired loans at each acquisition and at subsequent valuation dates. All purchased credit impaired loan cash flows and the timing of such cash flows continue to be estimable and probable of collection and thus accretion income continues to be recognized on these assets. As such, the referenced purchased credit impaired loans are not considered nonperforming assets.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired loans, segregated by class of loans, are presented in the following table (dollars in thousands):
(1) Includes loans with SBA guaranteed balances of $5.7 million and $3.0 million at December 31, 2017 and December 31, 2016, respectively.
The following table presents information related to the average recorded investment and interest income recognized on impaired loans for the periods presented (dollars in thousands):
(1) The average recorded investment for troubled debt restructurings was $2.8 million, $6.0 million and $3.5 million for the years ended December 31, 2017, 2016 and 2015, respectively.
(2) The total interest income recognized on troubled debt restructurings was $8,000, $24,000 and $82,000 for the years ended December 31, 2017, 2016, 2015, respectively.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the recorded investment in nonaccrual loans by loan class at the dates indicated (dollars in thousands):
The following table presents an analysis of past due organic loans, by class of loans, at the dates indicated (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents an analysis of past due purchased non-credit impaired loans, by class of loans, at the dates indicated (dollars in thousands):
The following table presents an analysis of past due purchased credit impaired loans, by class of loans, at the dates indicated (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Asset Quality Grades:
The Company assigns loans into risk categories based on relevant information about the ability of borrowers to pay their debts, such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. A loan’s risk grade is assigned at inception based upon the strength of the repayment sources and reassessed periodically throughout the year. Loans over certain dollar thresholds identified as having weaknesses are subject to more frequent review. In addition, the Company’s internal loan review department provides an ongoing, comprehensive, and independent assessment of credit risk within the Company.
Loans are graded on a scale of 1 to 9. Pass grades are from 1 to 4. Descriptions of the general characteristics of grades 5 and above are as follows:
Watch (Grade 5)-Loans graded Watch are pass credits that have not met performance expectations or that have higher inherent risk characteristics warranting continued supervision and attention.
OAEM (Grade 6)-Loans graded OAEM (other assets especially mentioned) have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Company's credit position at some future date. OAEM loans are not adversely classified and do not expose the institution to sufficient risk to warrant adverse classification.
Substandard (Grade 7)-Loans classified as substandard are inadequately protected by the current sound worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful (Grade 8)-Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss (Grade 9)-Loans classified as loss are considered uncollectible and have little value to the Company and their continuance as an active relationship is not warranted.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the risk grades of the organic loan portfolio, by class of loans, at the dates indicated (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the risk grades of the purchased non-credit impaired loan portfolio, by class of loans, at the dates indicated (dollars in thousands):
Classifications on purchased credit impaired loans are based upon the borrower's ability to pay the current unpaid principal balance without regard to the net carrying value of the loan on the Company's balance sheet. Because the values shown in the table below are based on each loan's estimated cash flows, any expected losses should be covered by a combination of the specific reserves established in the allowance for loan and lease losses on purchased credit impaired loans plus the discounts to the unpaid principal balances reflected in the recorded investment of each loan.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the risk grades of the purchased credit impaired loan portfolio, by class of loans, at the dates indicated (dollars in thousands):
Troubled Debt Restructurings (TDRs)
Total troubled debt restructurings were $1.5 million and $5.0 million at December 31, 2017 and 2016, respectively. There was no related allowance for loan and lease losses at December 31, 2017 and $148,000 at December 31, 2016. At December 31, 2017 and 2016, there were no commitments to extend credit to a borrower with an existing troubled debt restructuring. Purchased credit impaired loans modified post-acquisition are not removed from their accounting pools and accounted for as TDRs, even if those loans would otherwise be deemed TDRs.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides information on troubled debt restructured loans that were modified during the periods presented (dollars in thousands):
(1) The pre-modification and post-modification recorded investments represent amounts at the date of loan modifications. Since the modifications on these loans have been only interest rate concessions and payment term extensions, not principal reductions, the pre-modification and post-modification recorded investment amounts are the same.
During the years ended December 31, 2017, 2016, and 2015, there were no TDRs that subsequently defaulted within twelve months of their modification dates.
NOTE 6: PREMISES & EQUIPMENT
Premises and equipment are summarized as follows (dollars in thousands):
Depreciation expense for premises and equipment was $3.7 million, $3.5 million, and $3.8 million for the years ended December 31, 2017, 2016, and 2015, respectively.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Leases
The Company has various operating leases on office locations with lease terms that range up to 8 years. These noncancelable operating leases are subject to renewal options and some leases provide for periodic rate adjustments according to the terms of the agreements.
Future minimum lease commitments under all noncancelable operating leases with terms of one year or more, excluding any renewal options, are as follows (dollars in thousands):
(1) The total future minimum lease commitments have not been reduced by minimum sublease rentals of $3.4 million due in the future from noncancelable subleases.
Rent expense was $3.5 million, $3.2 million, and $3.1 million, for the years ended December 31, 2017, 2016, and 2015, respectively.
NOTE 7: GOODWILL & OTHER INTANGIBLE ASSETS
Changes to the carrying amounts of goodwill and identifiable intangible assets are presented in the table below (dollars in thousands):
The Company evaluates goodwill for impairment on at least an annual basis and more frequently if an event occurs or circumstances indicate carrying value exceeds fair value. At December 31, 2017, the Company performed a qualitative assessment to determine if it was more likely than not that the fair value exceeded carrying value. The qualitative assessment indicated that it was more likely than not that the fair value exceeded its carrying value, resulting in no impairment.
Amortization expense of $2.8 million, $2.1 million, and $1.8 million was recorded on total intangibles for the years ended December 31, 2017, 2016, and 2015, respectively.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amortization expense for core deposit and other intangibles for the next five years is expected to be as follows (dollars in thousands):
NOTE 8: SBA SERVICING RIGHTS
All sales of SBA loans, consisting of the guaranteed portion, are executed on a servicing retained basis. These loans, which are partially guaranteed by the SBA, are generally secured by business property such as real estate, inventory, equipment, and accounts receivable. During the years ended December 31, 2017, 2016 and 2015 the Company sold SBA loans with unpaid principal balances totaling $50.3 million, $53.7 million and $42.1 million, respectively, and recognized $5.3 million, $5.4 million and $4.4 million, respectively, in gains on the loan sales. The Company retains the related loan servicing rights and receives servicing fees on the sold loans. Both the servicing fees and the gains on sales of loans are recorded in SBA income on the consolidated statements of income. SBA servicing fees totaled $1.7 million, $1.3 million and $978,000 for the years ended December 31, 2017, 2016 and 2015, respectively. At December 31, 2017 and 2016, the Company serviced SBA loans for others with unpaid principal balances totaling $185.6 million and $142.1 million, respectively.
The table below summarizes the activity in the SBA servicing rights asset for the period presented (dollars in thousands):
A summary of the key characteristics, inputs and economic assumptions used to estimate the fair value of the Company's SBA servicing rights asset are as follows (dollars in thousands):
The risk inherent in the SBA servicing rights asset includes prepayments at different rates than anticipated or resolution of loans at dates not consistent with the estimated expected lives. These events would cause the value of the servicing asset to decline at a faster or slower rate than originally anticipated.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information about the SBA loans serviced by the Company at and for the periods presented is as follows (dollars in thousands):
NOTE 9: FDIC RECEIVABLE FOR LOSS SHARE AGREEMENTS
On May 21, 2015, State Bank entered into an agreement with the FDIC to terminate loss share coverage on all 12 of its FDIC-assisted acquisitions which occurred in 2009, 2010, and 2011. The termination resulted in the elimination of both the FDIC receivable for loss share agreements and the associated clawback liability.
The following table presents a summary of the calculation of the loss recognized as a result of the termination of the FDIC loss share agreements, including the clawback provisions and settlement of historic loss share and expense reimbursement claims (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table documents changes in the carrying value of the FDIC receivable for loss share agreements relating to purchased credit impaired loans and acquired other real estate owned previously covered under loss share agreements with the FDIC for the periods indicated (dollars in thousands):
NOTE 10: DEPOSITS
Deposits are summarized as follows (dollars in thousands):
Overdrawn deposit accounts reclassified as loans were $393,000 and $390,000 at December 31, 2017 and 2016, respectively.
The scheduled maturities of time, brokered, and wholesale deposits were as follows (dollars in thousands):
The Company had $18.2 million in brokered deposits at December 31, 2017, and had $14.3 million in brokered deposits at December 31, 2016.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11: SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
The Company utilizes securities sold under repurchase agreements to facilitate the needs of our customers. Securities sold under repurchase agreements consist of balances in the transaction accounts of commercial customers swept nightly to an overnight investment account and are collateralized with investment securities having a market value no less than the balance borrowed. The agreements bear interest rates determined by the Company. The investment securities pledged are subject to market fluctuations as well as prepayments of principal. The Company monitors the risk of the fair value of its pledged collateral falling below the balance of the repurchase agreements on a daily basis and may be required to provide additional collateral. Securities pledged as collateral are maintained with our safekeeping agent.
At December 31, 2017 and 2016, securities sold under repurchase agreements were $25.2 million and $25.7 million, respectively. These securities sold under repurchase agreements had a weighted average interest rate of .12% for both periods, all of which mature on an overnight and continuous basis. At December 31, 2017 and 2016, investment securities pledged for the outstanding repurchase agreements consisted of U.S. government sponsored agency mortgage-backed securities.
The Company assumed $2.0 million in federal funds purchased at December 31, 2016 through its acquisition of S Bankshares. These federal funds purchased carried a rate of 1.25% at December 31, 2016 and were paid off in January of 2017. At December 31, 2017, the Company had no federal funds purchased.
NOTE 12: OTHER BORROWINGS
The Company has several participation agreements with various provisions regarding collateral position, pricing and other matters where the junior participation interests were sold. The terms of the agreements do not convey proportionate ownership rights with equal priority to each participating interest and entitle the Company to receive principal and interest payments before other participating interest holders. Given the participations sold do not qualify as participating interests, they do not qualify for sale treatment in accordance with generally accepted accounting principles. As a result, the Company recorded the transactions as secured borrowings. The balance of the secured borrowings was $398,000 at December 31, 2017 and 2016, respectively. The loans are recorded at their gross balances outstanding and are included in organic loans on the consolidated statements of financial condition.
The Company assumed $47.0 million in FHLB borrowings at December 31, 2016 through its acquisitions of NBG Bancorp and S Bankshares. These borrowings were paid off in January of 2017. At December 31, 2017, the Company had no FHLB borrowings.
NOTE 13: DERIVATIVES INSTRUMENTS & HEDGING ACTIVITIES
Interest Rate Swaps and Caps
Risk Management Objective of Interest Rate Swaps and Caps
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedging relationship. The Company's hedging strategies involving interest rate derivatives are classified as either Fair Value Hedges or Cash Flow Hedges, depending upon the rate characteristic of the hedged item.
Fair Value Hedge: As a result of interest rate fluctuations, fixed-rate assets and liabilities will appreciate or depreciate in fair value. When effectively hedged, this appreciation or depreciation will generally be offset by fluctuations in the fair value of the derivative instruments that are linked to the hedged assets and liabilities. This strategy is referred to as a fair value hedge.
Cash Flow Hedge: Cash flows related to floating-rate assets and liabilities will fluctuate with changes in an underlying rate index. When effectively hedged, the increases or decreases in cash flows related to the floating rate asset or liability will generally be offset by changes in cash flows of the derivative instrument designated as a hedge. This strategy is referred to as a cash flow hedge.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit and Collateral Risks for Interest Rate Swaps and Caps
The Company manages credit exposure on interest rate swap and cap transactions by entering in bilateral credit support agreement with each counterparty. The credit support agreements require collateralization of exposures beyond specified minimum threshold amounts. The details of these agreements, including the minimum thresholds, vary by counterparty. Refer to Note 14, Balance Sheet Offsetting, for more information on collateral pledged and received under these agreements.
The Company’s agreements with its interest rate swap and cap counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivative counterparties also include provisions that if not met, could result in the Company being declared in default. If the Company were to be declared in default, the counterparty could terminate the derivative positions and the Company and the counterparty would be required to settle their obligations under the agreements. At December 31, 2017, the Company had no derivatives in a net liability position under these agreements.
Mortgage Derivatives
Risk Management Objective of Mortgage Lending Activities
The Company also maintains a risk management program to manage interest rate risk and pricing risk associated with its mortgage lending activities. The risk management program includes the use of forward contracts and other derivatives that are recorded in the financial statements at fair value and are used to offset changes in value of the mortgage inventory due to changes in market interest rates. As a normal part of our operations, we enter into derivative contracts to economically hedge risks associated with overall price risk related to interest rate lock commitments ("IRLCs") and mortgage loans held-for-sale for which the fair value option has been elected. Fair value changes occur as a result of interest rate movements as well as changes in the value of the associated servicing. Derivative instruments used include forward sale commitments and IRLCs.
Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. It is the Company's practice to enter into forward commitments for the future delivery of mortgage loans in order to economically hedge the effect of changes in interest rates resulting from interest rate lock commitments.
Credit and Collateral Risks for Mortgage Lending Activities
The Company’s underlying risks are primarily related to interest rates and forward sales commitments entered into as part of its mortgage banking activities. Forward sales commitments are contracts for the delayed delivery or net settlement of an underlying instrument, such as a mortgage loan, in which the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. These hedges are used to preserve the Company’s position relative to future sales of mortgage loans to third parties in an effort to minimize the volatility of the expected gain on sale from changes in interest rate and the associated pricing changes.
Derivative Fair Values
The table below presents the fair values of the Company's derivatives at the dates indicated (dollars in thousands):
(1) All asset derivatives are located in "Other Assets" on the consolidated statements of financial condition and all liability derivatives are located in "Other Liabilities" on the consolidated statements of financial condition.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Derivatives Designated as Hedging Instruments
Fair Value Hedges
The Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps, designated as fair value hedges, involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed payments over the life of the agreements without the exchange of the underlying notional amount. The gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings. At December 31, 2017, the Company had 84 interest rate swaps with an aggregate notional amount of $141.9 million, designated as fair value hedges associated with the Company's fixed rate loan program.
The table below presents the effect of the Company's derivatives in fair value hedging relationships for the periods presented (dollars in thousands):
The Company recognized net (losses) gains of $(50,000), $183,000, and $(141,000) during the years ended December 31, 2017, 2016, and 2015, respectively, related to hedge ineffectiveness on the fair value swaps. The Company also recognized a net reduction in interest income of $912,000, $1.8 million, and $2.3 million for the years ended December 31, 2017, 2016, and 2015, respectively, related to the fair value hedges, which includes net settlements on derivatives and any amortization adjustment of the basis in the hedged items. Terminations of derivatives and related hedged items for interest rate swap agreements prior to their original maturity date resulted in the recognition of net losses of $65,000, $118,000, and $492,000 in interest income for the years ended December 31, 2017, 2016, and 2015, respectively, related to the unamortized basis in the hedged items.
Cash Flow Hedges
The Company uses interest rate caps as part of its interest rate risk management strategy. Interest rate caps, designated as cash flow hedges, involve the payment of a premium to a counterparty based on the notional size and cap strike rate. The Company's current cash flow hedges are for the purpose of capping the interest rates paid on deposits, which protects the Company in a rising rate environment. The caps were purchased during the first quarter of 2013 to hedge the variable cash outflows associated with these liabilities; they originally had a five-year life and notional value of $200.0 million.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (AOCI) and is subsequently reclassified into earnings in the period the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of derivatives that qualify as cash flow hedges is recognized directly in earnings. No hedge ineffectiveness was recognized on the Company's cash flow hedges during the years ended December 31, 2017, 2016, or 2015.
Amounts reported in AOCI related to derivatives are reclassified to interest expense as the interest rate cap premium is amortized over the life of the cap. During the next twelve months, $88,000 is expected to be reclassified as a decrease to net interest income.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below presents the effect of the Company's derivatives in cash flow hedging relationships for the periods presented (dollars in thousands):
Derivatives Not Designated as Hedging Instruments
Interest Rate Swaps
At December 31, 2017, the Company had no interest rate swaps that were not designated as fair value hedges associated with the Company's fixed rate loan program. The income statement effect from the derivatives not designated as hedging instruments was net losses of $124,000, $51,000, and $147,000 during the years ended December 31, 2017, 2016, and 2015 respectively.
Mortgage Derivatives
Mortgage derivative fair value assets and liabilities are recorded in "Other Assets" and "Other Liabilities", respectively, on the consolidated statements of financial condition. At December 31, 2017, the fair value of mortgage derivative assets was $616,000 and the fair value of mortgage derivative liabilities was $238,000. At December 31, 2016, the fair value of mortgage derivative assets was $1.4 million and the fair value of mortgage derivative liabilities was $459,000.
At December 31, 2017, the Company had approximately $36.3 million of interest rate lock commitments and $55.8 million of forward commitments for the future delivery of residential mortgage loans. The net gain (loss) related to interest rate lock commitments used for risk management was $78,000, $(280,000) and $347,000 for the years ended December 31, 2017, 2016, and 2015, respectively. The net (loss) gain for forward commitments related to these mortgage loans was $(603,000), $819,000, and $(34,000) for the years ended December 31, 2017, 2016, and 2015, respectively.
The table below presents the effect of the Company's derivatives not designated as hedging instruments for the periods presented (dollars in thousands):
NOTE 14: BALANCE SHEET OFFSETTING
Certain financial instruments, including repurchase agreements and derivatives (interest rate swaps and caps), may be eligible for offset in the consolidated statements of financial condition and/or subject to master netting arrangements or similar agreements; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below presents information about the Company’s financial instruments that are eligible for offset in the consolidated statements of financial condition at the dates presented (dollars in thousands):
(1) The application of collateral cannot reduce the net amount below zero; therefore, excess collateral received/posted is not reflected in this table. All positions are fully collateralized.
NOTE 15: STOCK WARRANTS
The Company has outstanding warrants purchased by current and former executive officers, directors and certain members of senior management. Warrant holders have the right to purchase one share of the Company's common stock at strike prices ranging from $5.00 to $11.21 per share through the ten-year contractual period. The warrants were fully exercisable as of the purchase date. During 2017 and 2016, no new warrants were issued.
The following table represents the activity related to stock warrants:
NOTE 16: SHARE-BASED COMPENSATION
The Company maintains an incentive compensation plan that includes share-based compensation. The State Bank Financial Corporation 2011 Omnibus Equity Compensation Plan (the "Plan") was approved by the Company's shareholders in 2011 and authorizes up to 3,160,000 shares of stock for issuance in accordance with the Plan terms. The Plan provides for the granting of Incentive Stock Options, Non-Qualified Stock Options, Performance Awards, Restricted Stock, Restricted Stock Units, Stock Appreciation Rights, Bonus Stock and Stock Awards, or any combination of the foregoing, as the Independent Directors Committee serving as the Compensation Committee determines is best suited to the circumstances of the particular individual.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock Option Awards
Option awards are granted with an exercise price equal to or greater than the market price of the Company's common stock at the date of grant. The options include a vesting period, usually three years, and a ten-year contractual period. Certain option grants provide for accelerated vesting if there is a change in control of the Company or certain other conditions are met, as defined in the Plan document. At all times during the term of the Plan, the Company shall retain the number of shares required to satisfy option exercises as authorized and unissued shares in the Company's treasury. Currently, the Company has a sufficient number of shares allocated to satisfy expected share option exercises.
During the periods ended December 31, 2016 and 2015 there was no stock option activity. There was no compensation expense recognized related to stock options for the years ended December 31, 2017, 2016 or 2015, as all options were vested in 2013.
The following table represents a summary of the activity related to stock options:
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2017. This amount changes based on changes in the market value of the Company’s stock. The intrinsic value of options exercised during 2017 was $378,000.
Restricted Stock Awards
The Company has issued both time-based and performance-based shares of restricted stock to certain officers and independent directors under the Plan. The Plan allows for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The holders of the restricted stock receive dividends, if applicable, and have the right to vote the shares. The fair value of the restricted stock awarded under the Plan is recorded as unearned share-based compensation.
The unearned compensation related to time-based shares of restricted stock is amortized to compensation expense over the vesting period, generally five years. The total share-based compensation expense for these awards is determined based on the market price of the Company's common stock at the date of grant applied to the total number of shares granted and is amortized over the vesting period.
The performance-based shares of restricted stock entitle the recipient to receive shares of the Company’s common stock upon the achievement of performance goals that are specified in the award agreement over a specified performance period. The unearned compensation related to performance-based shares of restricted stock is amortized to compensation expense over the vesting period, generally ten years. The total share-based compensation expense for these awards is determined based on the market price of the Company's common stock at the date of grant applied to the total number of shares granted and is amortized over the vesting period. During 2015, the Company issued 558,000 performance-based shares of restricted stock with a ten year performance period, of which 92,000 were subsequently forfeited. There were no performance shares granted during the years ended December 31, 2017 and 2016.
Compensation expense recognized in the Company's consolidated statements of income for restricted stock was $3.8 million, $3.9 million and $3.6 million for the years ended December 31, 2017, 2016 and 2015, respectively. The total recognized tax benefit related to the share-based compensation was $2.5 million, $1.8 million and $1.4 million for 2017, 2016 and 2015, respectively. Total unrecognized compensation cost related to unvested share-based compensation was $10.5 million at December 31, 2017 and is expected to be recognized over a weighted-average period of 3.4 years.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table represents a summary of the unvested restricted stock award activity:
Restricted stock awards of 146,254 shares, 85,575 shares, and 664,706 shares, respectively, were granted during 2017, 2016 and 2015 with a weighted-average grant date fair value of $27.10, $19.81 and $19.33, respectively.
NOTE 17: EMPLOYEE BENEFIT PLAN
The Company offers a defined contribution 401(k) Profit Sharing Plan (the "401(k) Plan”) that covers substantially all employees meeting certain eligibility requirements. The 401(k) Plan allows employees to make pre-tax or Roth after-tax salary deferrals to the 401(k) Plan and the Company matches these employee contributions on a basis equal to a uniform percentage of the salary deferrals. During 2017, 2016 and 2015, the Company matched employee contributions dollar-for-dollar up to 5% of eligible compensation, subject to 401(k) Plan and regulatory limits. Participants receive matching contributions the first quarter after completing three months of service and matching contributions made after January 1, 2013 are fully vested, regardless of years of service. Compensation expense related to the 401(k) Plan totaled $2.6 million, $2.3 million, and $2.2 million in 2017, 2016 and 2015, respectively.
NOTE 18: REGULATORY MATTERS
Regulatory Capital Requirements
The Company and State Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company and State Bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and State Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Measures of regulatory capital are an important tool used by regulators to monitor the financial health of financial institutions. The primary quantitative measures used to gauge capital adequacy are the Common Equity Tier 1, Tier 1, Total Capital Ratios to risk-weighted assets (risk-based capital ratios) and the ratio of Tier 1 capital to average total assets (leverage ratio). Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the Company and State Bank.
Beginning on January 1, 2015, the Company and State Bank became subject to the provisions of the Basel III final rule that governs the regulatory capital calculation, including transitional, or phase-in, provisions. The methods for calculating the risk-based capital ratios will change as the provisions of the Basel III final rule related to the numerator (capital) and denominator (risk-weighted assets) are fully phased in on January 1, 2019. The ongoing methodological changes will result in differences in the reported capital ratios from one reporting period to the next that are independent of applicable changes in the capital base, asset composition, off-balance sheet exposures or risk profile.
Beginning on January 1, 2016, the Company and State Bank must maintain a capital conservation buffer to avoid restrictions on capital distributions or discretionary bonus payments. This buffer must consist solely of Common Equity Tier 1 Capital, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital) in addition to the minimum risk-based capital requirements. The capital conservation buffer required for 2017 is common equity equal to 1.25% of risk-weighted assets and will increase by .625% per year until reaching 2.5% beginning January 1, 2019.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The minimum regulatory capital ratios and ratios to be considered well-capitalized under prompt corrective action provisions at the dates indicated are presented in the table below:
(1) The prompt corrective action provisions are only applicable at the bank level.
At December 31, 2017 and 2016, the Company and State Bank exceeded all regulatory capital adequacy requirements to which they were subject.
The Company's regulatory ratios at the dates indicated are presented in the table below (dollars in thousands):
State Bank's regulatory ratios at the dates indicated are presented in the table below (dollars in thousands):
Regulatory Restrictions on Dividends
Regulatory policy statements provide that generally bank holding companies should pay dividends only out of current operating earnings and that the level of dividends must be consistent with current and expected capital requirements. Dividends received from State Bank have been the primary source of funds available for the declaration and payment of dividends to the Company's common shareholders.
Federal and state banking laws and regulations restrict the amount of dividends State Bank may distribute without prior regulatory approval. At December 31, 2017, State Bank had no capacity to pay dividends to the Company without prior regulatory approval.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2017, the Company had $55.1 million in cash and due from bank accounts, which can be used for additional capital as needed by the subsidiary bank, payment of holding company expenses, payment of dividends to shareholders or for other corporate purposes.
Other Regulatory Matters
The Company had required reserve balances at the Federal Reserve Bank of $29.6 million and $16.2 million at December 31, 2017 and 2016, respectively.
NOTE 19: COMMITMENTS AND CONTINGENT LIABILITIES
Commitments
In order to meet the financing needs of its customers, the Company maintains financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit and standby letters of credit and involve, to varying degrees, elements of credit, interest rate and/or liquidity risk. Such financial instruments are recorded when they are funded and the related fees are generally recognized when collected.
Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed maturity dates or other termination clauses with required fee payments. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The amount of collateral required, if deemed necessary upon extension of credit, is determined on a case by case basis by management through credit evaluation of the customer.
Standby letters of credit are commitments guaranteeing performance of a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements. In order to minimize its exposure, the Company's credit policies govern the issuance of standby letters of credit.
The Company's exposure to credit loss is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.
A summary of the Company's commitments is as follows (dollars in thousands):
The fixed rate loan commitments have maturities ranging from one month to thirteen years. Management takes appropriate actions to mitigate interest rate risk associated with these fixed rate commitments through various measures including, but not limited to, the use of derivative financial instruments.
Contingent Liabilities
Mortgage loan sales agreements contain covenants that may, in limited circumstances, require the Company to repurchase or indemnify the investors for losses or costs related to the loans the Company has sold. As a result of the potential recourse provisions, the Company established a recourse liability for mortgage loans held-for-sale. The recourse liability was $297,000 and $306,000 at December 31, 2017 and 2016, respectively.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Furthermore, in the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material effect on the Company's financial statements.
NOTE 20: FAIR VALUE
Overview
Fair value measurements are determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, the Financial Accounting Standards Board's Accounting Standards Codification Topic 820 ("ASC 820") Fair Value Measurements and Disclosures establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).
Fair Value Hierarchy
Level 1
Valuation is based on inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2
Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as interest rates, yield curves observable at commonly quoted intervals, and other market-corroborated inputs.
Level 3
Valuation is generated from techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's valuation process. For the years ended December 31, 2017 and 2016, there were no transfers between levels.
Fair Value Option
ASC 820 allows companies to report selected financial assets and liabilities at fair value using the fair value option. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. The Company records mortgage loans held-for-sale at fair value under the fair value option, which allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to hedge them without the burden of complying with the requirements for hedge accounting. See Note 1, Summary of Significant Accounting Policies.
Financial Assets and Financial Liabilities Measured on a Recurring Basis
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company uses the following methods and assumptions in estimating the fair value of its financial assets and financial liabilities on a recurring basis:
Investment Securities Available-for-Sale
At December 31, 2017, the Company's investment portfolio primarily consisted of U.S. government agency mortgage-backed securities, nonagency mortgage-backed securities, U.S. government securities, municipal securities, asset-backed securities, and corporate securities. Fair values for U.S. Treasury and equity securities are determined by obtaining quoted prices on nationally recognized securities exchanges utilizing Level 1 inputs. Other securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs. The fair value of other securities classified as available-for-sale are determined using widely accepted valuation techniques including matrix pricing and broker-quote-based applications. Inputs may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other relevant items. The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness and to ensure such prices are aligned with traditional pricing matrices. From time to time, the Company validates the appropriateness of the valuations provided by the independent pricing service to prices obtained from an additional third party or prices derived using internal models.
Hedged Loans
Loans involved in fair value hedges are recorded at fair value on a recurring basis. The estimated fair value is determined using Level 2 inputs consistent with the valuation methodology for interest rate swaps discussed below. The Company does not record other loans held for investment at fair value on a recurring basis.
Mortgage Loans Held-for-Sale
Mortgage loans held-for-sale are recorded at fair value on a recurring basis. The estimated fair value is determined using Level 2 inputs based on observable data such as the existing forward commitment terms or the current market value of similar loans. After origination and prior to sale, the mortgage loans held-for-sale accrue interest income, recorded in "interest income" on the consolidated statements of income, based on the contractual terms of the loans. Refer to Note 1, Summary of Significant Accounting Policies, for more information on the accounting for mortgage loans held-for-sale.
At December 31, 2017 and 2016, the aggregate fair value of the mortgage loans held-for-sale was $25.8 million and $35.8 million, respectively. At December 31, 2017 and 2016, the contractual balance including accrued interest was $25.2 million and $35.6 million, respectively, with a fair value mark totaling $544,000 and $209,000, respectively. None of the loans were 90 days or more past due or on nonaccrual at December 31, 2017 or 2016. The gain (loss) recognized for the change in fair value of the mortgage loans held-for-sale, included in "mortgage banking income" on the consolidated statements of income, was $334,000, $(757,000) and $182,000 for the years ended December 31, 2017, 2016 and 2015, respectively.
Derivative Financial Instruments
Swaps and Caps
The Company uses interest rate swaps to provide longer-term fixed rate funding to its customers and interest rate caps to mitigate the interest rate risk on its variable rate liabilities. The majority of these derivatives are traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilizes the exchange price or dealer market price for the particular derivative contract. Therefore, these derivative contracts are classified as Level 2. The Company utilizes an independent third party valuation company to validate the dealer prices. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are considered to have been derived utilizing Level 3 inputs.
The Company evaluates the credit risk of its counterparties as well as that of the Company. The Company has considered factors such as the likelihood of default by the Company and its counterparties, its net exposures, and remaining contractual life, among other things, in determining if any fair value adjustments related to credit risk are required. Counterparty exposure is evaluated by netting positions that are subject to master netting arrangements, as well as considering the amount of collateral securing the position. The Company reviews its counterparty exposure on a regular basis, and, when necessary, appropriate business actions are taken to adjust the exposure. The Company also utilizes this approach to estimate its own credit risk on
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
derivative liability positions. To date, the Company has not realized any losses due to a counterparty's inability to pay any net uncollateralized position.
Mortgage Derivatives
Mortgage derivatives include interest rate lock commitments to originate residential mortgage loans held-for-sale. The Company relies on an internal valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held-for-sale. The model groups the interest rate lock commitments by interest rate and term, applies an estimated pull-through rate based on historical experience, and then multiplies by quoted investor prices which were determined to be reasonably applicable to the loan commitment group based on interest rate, term, and rate lock expiration date of the loan commitment group. While there are Level 2 and 3 inputs used in the valuation model, the Company has determined that the majority of the inputs significant in the valuation of the interest rate lock commitments fall within Level 3 of the fair value hierarchy. Changes in the fair values of these derivatives are included in "mortgage banking income" on the consolidated statements of income.
Mortgage derivatives also include forward commitments to sell residential mortgage loans to various investors when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitment to fund loans. The Company also relies on an internal valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available (Level 2). Changes in the fair values of these derivatives are included in "mortgage banking income" on the consolidated statements of income.
SBA Servicing Rights
The Company has the rights to service a portfolio of SBA loans. The SBA servicing rights are measured at fair value when loans are sold on a servicing retained basis. The servicing rights are subsequently measured at fair value on a recurring basis utilizing Level 3 inputs. Management uses a model operated and maintained by a third party to calculate the present value of future cash flows using the third party's market-based assumptions. The future cash flows for each asset are based on the asset's unique characteristics and the third party's market-based assumptions for prepayment speeds, default and voluntary prepayments. For non-guaranteed portions of servicing assets, future cash flows are estimated using loan specific assumptions for losses and recoveries. Adjustments to fair value are recorded as a component of "SBA income" on the consolidated statements of income.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables present the financial assets and financial liabilities measured at fair value on a recurring basis at the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables present a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (level 3) for the periods presented (dollars in thousands):
(1) Fair value adjustments are recorded as a component of "SBA income" on the consolidated statements of income.
(1) Total gain (loss) on the change in fair value, recorded as a component of "mortgage banking income" on the consolidated statements of income was $61,000, $(36,000) and $153,000, respectively for the years ended December 31, 2017, 2016 and 2015.
Financial Assets Measured on a Nonrecurring Basis
The Company uses the following methods and assumptions in estimating the fair value of its financial assets on a nonrecurring basis:
Impaired Loans
Loans, excluding purchased credit impaired loans, are considered 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. The fair values of impaired loans are measured on a nonrecurring basis and are based on the underlying collateral value of each loan if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 inputs that are based on observable market data such as an appraisal. Updated appraisals are obtained on at least an annual basis. Level 3 inputs are based on the Company's customized discounting criteria when management determines the fair value of the collateral is further impaired.
The following table presents financial assets measured at fair value on a nonrecurring basis at the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired loans, excluding purchased credit impaired loans, that are measured for impairment using the fair value of collateral for collateral dependent loans had recorded investments of $13.0 million and $9.6 million with respective valuation allowances of $1.2 million and $831,000 at December 31, 2017 and 2016, respectively.
Nonfinancial Assets Measured on a Nonrecurring Basis
The Company uses the following methods and assumptions in estimating the fair values of its nonfinancial assets on a nonrecurring basis:
Other Real Estate Owned
Other real estate owned ("OREO") consists of real estate acquired through foreclosure or a deed in lieu of foreclosure in satisfaction of a loan, OREO acquired in a business acquisition, and banking premises no longer used for a specific business purpose. Real estate obtained in satisfaction of a loan is initially recorded at the lower of the principal investment in the loan or the fair value of the collateral less estimated costs to sell at the time of foreclosure with any excess in loan balance charged against the allowance for loan and lease losses. OREO acquired in a business acquisition is recorded at fair value on Day 1 of the acquisition. Banking premises no longer used for a specific business purpose is transferred into OREO at the lower of its carrying value or fair value less estimated costs to sell with any excess in the carrying value charged to noninterest expense. For all fair value estimates of the real estate properties, management considers a number of factors such as appraised values, estimated selling prices, and current market conditions, resulting in a Level 3 classification. Management periodically reviews the carrying value of OREO for impairment and adjusts the values as appropriate through noninterest expense.
The following table presents nonfinancial assets measured at fair value on a nonrecurring basis at the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):
The following table is a reconciliation of the fair value measurement of other real estate owned disclosed in accordance with ASC Topic 820, Fair Value Measurements and Disclosures, to the amount recorded on the consolidated statements of financial condition (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unobservable Inputs for Level 3 Fair Value Measurements
The following tables provide information describing the unobservable inputs used in Level 3 fair value measurements at the dates indicated (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value of Financial Assets and Financial Liabilities
The following table includes the estimated fair value of the Company's financial assets and financial liabilities (dollars in thousands). The methodologies for estimating the fair value of financial assets and financial liabilities measured on a recurring and nonrecurring basis are discussed above. The methodologies for estimating the fair value for other financial assets and financial liabilities are discussed below. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies; however, considerable judgment is required to interpret market data in order to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation techniques may have a material effect on the estimated fair value amounts at December 31, 2017 and 2016.
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short maturity of these instruments.
Investment Securities Held-to-Maturity
Fair values are determined using quoted market prices or dealer quotes in the same manner as investment securities available-for-sale.
Organic and Purchased Non-Credit Impaired Loans
Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturities using estimated market discount rates that reflect observable market information incorporating the credit, liquidity, yield, and other risks inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Purchased Credit Impaired Loans
Purchased credit impaired loans are recorded at fair value at the date of acquisition. The fair values of loans with evidence of credit deterioration are recorded net of a nonaccretable discount and an accretable discount. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases to the expected cash flows results in a reversal of the provision for loan and lease losses to the extent of prior changes or a reclassification of the difference from the nonaccretable to accretable discount with a positive impact on the accretable discount.
Accrued Interest Receivable and Accrued Interest Payable
The carrying amounts are a reasonable estimate of fair values.
Federal Home Loan Bank Stock
Federal Home Loan Bank stock, classified as a restricted equity security, is considered a Level 3 asset as little or no market activity exists for the security; therefore, the security's value is not market observable and is carried at original cost basis as cost approximates fair value.
Deposits
The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, interest-bearing deposits, and savings and money market deposits, is equal to the amount payable on demand. The fair value of time deposits is estimated by discounting the expected life. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Federal Funds Purchased and Securities Sold Under Repurchase Agreements
The fair value of federal funds purchased and securities sold under agreements to repurchase approximates the carrying amount because of the short maturity of these borrowings.
FHLB Borrowings
The carrying amount approximates fair value because of the short maturity of these instruments.
Notes Payable
Notes payable are variable rate subordinated debt for which performance is based on the underlying notes receivable interest rates adjust according to market value; therefore, the carrying amount approximates fair value.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21: INCOME TAXES
The components of income tax expense were as follows (dollars in thousands):
Income tax expense differed from amounts computed by applying the Federal statutory rate of 35% to income before income taxes due to the following factors (dollars in thousands):
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21% effective January 1, 2018. At the enactment date, the Company revalued its deferred tax assets and liabilities based upon the newly enacted statutory rate of 21%, which is the rate at which these assets and liabilities are expected to reverse, and recognized provisional tax expense of $8.1 million. The ultimate impact of the Tax Cuts and Jobs Act may differ from this provisional amount due to changes in management's interpretations and assumptions, as well as additional regulatory guidance that may be issued. The provisional amount is expected to be finalized when the 2017 federal tax return is filed in 2018. The Company elected to treat its acquisition of AloStar as an acquisition of assets rather than an acquisition of stock for tax purposes. This election resulted in tax expense of $2.5 million to remeasure the deferred tax assets and liabilities related to the acquisition.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the net deferred tax asset included in other assets in the accompanying consolidated statement of financial condition are as follows (dollars in thousands):
Based on management’s belief that it is more likely than not that all net deferred tax asset benefits will be realized, there was no valuation allowance at either December 31, 2017 or 2016. At December 31, 2017 and 2016, the Company had Federal and State tax net operating loss carryforwards, related to the Bank of Atlanta and S Bank acquisitions, of approximately $16.3 million and $17.2 million, respectively. The loss carryforwards can be deducted annually from future taxable income through 2036, subject to an annual limitation of approximately $1.0 million. Currently, tax years 2014 to present are open for examination by Federal and State taxing authorities.
NOTE 22: EARNINGS PER SHARE
The Company has granted stock compensation awards with nonforfeitable dividend rights which are considered participating securities. As such, earnings per share is calculated using the two-class method. Basic earnings per share is calculated by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period which excludes the participating securities. Diluted earnings per share includes the dilutive effect of additional potential common shares from stock compensation awards and warrants. There were no anti-dilutive securities excluded from the computation of earnings per share in the periods presented.
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Earnings per share have been computed based on the following weighted average number of common shares outstanding (dollars in thousands, except per share data):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23: ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income, or AOCI, is reported as a component of shareholders' equity. AOCI can include, among other items, unrealized holding gains and losses on investment securities available-for-sale, unrealized gains and losses on investment securities available-for-sale transferred to held-to-maturity and gains and losses on derivative instruments that are designated as, and qualify as, cash flow hedges. The components of AOCI are reported net of related tax effects.
The components of AOCI and changes in those components are as follows (dollars in thousands):
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications from AOCI into income for the periods presented are as follows (dollars in thousands):
NOTE 24: CONDENSED FINANCIAL INFORMATION OF STATE BANK FINANCIAL CORPORATION (PARENT COMPANY ONLY FINANCIAL STATEMENTS)
STATE BANK FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Disclosure Controls and Procedures
Based on our management's evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Management's Report on Internal Control Over Financial Reporting
Management's Report on Internal Control Over Financial Reporting is set forth on page 82 of this Annual Report on Form 10-K and is incorporated herein by reference.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting during our fourth quarter of fiscal year 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Information required by Item 10 is hereby incorporated by reference from our proxy statement to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation.
Information required by Item 11 is hereby incorporated by reference from our proxy statement to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information required by Item 12 is hereby incorporated by reference from our proxy statement to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information required by Item 13 is hereby incorporated by reference from our proxy statement to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 14.
Item 14. Principal Accounting Fees and Services.
Information required by Item 14 is hereby incorporated by reference from our proxy statement to be filed with the SEC not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
A list of financial statements filed herewith is contained in Part II, Item 8, "Financial Statements and Supplementary Data," above of this Annual Report on Form 10-K and is incorporated by reference herein. The financial statement schedules have been omitted because they are not required, not applicable or the information has been included in our consolidated financial statements.
*Management compensatory plan or arrangement.
^Schedules and similar attachments have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant will furnish supplementally a copy of any omitted schedule or similar attachment to the SEC upon request.
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.
STATE BANK FINANCIAL CORPORATION
Date:
February 23, 2018
By:
/s/ J. Thomas Wiley, Jr.
J. Thomas Wiley, Jr.
Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints J. Thomas Wiley, Jr., his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX