Item 1B.
UNRESOLVED STAFF COMMENTS
There were no unresolved comments received from the SEC regarding COB’s periodic or current reports within the 180 days prior to December 31, 2013.
The principal executive and administrative offices of COB are located in an office building at 1017 E. Morehead Street, Suite 200, Charlotte, NC 28203. We also maintain administrative offices in Asheboro, Hickory and Greensboro, North Carolina. The Bank has three other facilities in Asheboro containing administrative and operational functions.
The Bank operates 53 branches in Archdale, Asheboro (three branches), Belmont, Biscoe, Boone, Burlington, Charlotte (two branches), China Grove, Cornelius, Dallas, Ellerbe, Gastonia, Graham, Granite Falls, Greensboro (two branches), Hickory (five branches), Hillsborough, Hudson, Jamestown, Kannapolis, Laurinburg, Lenoir (two branches), Matthews, Millers Creek, Mooresville, Morganton, Mt. Holly, Newton (two branches), Ramseur, Randleman, Rockingham (two branches), Salisbury (two branches), Seagrove, Siler City, Southern Pines, Stanley, Statesville, Taylorsville, Trinity, West Jefferson, and Wilkesboro, North Carolina.
In total, 44 of our branches are owned and 9 are leased facilities, with 3 of the owned branches situated on land that is leased. Of our administrative and operational facilities, four of the facilities are owned and three are leased.
Item 3.
Item 3.
LEGAL PROCEEDINGS
From time to time, we are subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against us incident to the operation of our business. In management's opinion, there are no proceedings pending to which we are a party or to which our property is subject, which, if determined adversely to us, would be material in relation to our shareholder's equity or financial condition. In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities or other parties.
Item 4.
Item 4.
MINE SAFETY DISCLOSURES
Not Applicable.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Prices and Dividend Policies
COB’s common stock is traded on The Nasdaq Capital Market under the symbol “COB.”
The range of sale prices for the years 2013 and 2012 is set forth in the table below and is based upon information obtained from Nasdaq. As of the close of business on February 28, 2014, there were approximately 4,500 registered shareholders according to the records maintained by our transfer agent.
We are restricted from paying dividends on stock as described in item 1, Regulation and Supervision-Dividend Restrictions of this Report.
FIVE-YEAR STOCK PERFORMANCE TABLE
Performance Graph
The following graph and table compares the cumulative total shareholder return of COB common stock for the five-year period ended December 31, 2013 with the SNL Southeast Bank Index and the Russell 3000 Stock Index, assuming an investment of $100 at the beginning of the period and the reinvestment of dividends.
CommunityOne Bancorp
Item 6.
Item 6.
SELECTED FINANCIAL DATA
The tables below set forth selected consolidated financial data as of the dates or for the periods indicated. This data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis of the financial condition and results of operations of COB represents an overview of the consolidated financial conditions and results of operations of COB for each of the last three years. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes presented in Item 8 of this Report. Results of operations for the periods included in this review are not necessarily indicative of results to be obtained during any future period.
Important Note Regarding Forward-Looking Statements
This Report contains information, including information incorporated by reference in this Report, that we believe are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to COB’s financial condition, results of operations, plans, objectives, future performance or business. They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this Report, or the documents incorporated by referenced in it, including Item 1.A “Risk Factors.” When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to us at the time. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Forward-looking statements contained in this Report are based on current expectations, estimates and projections about COB’s business, management’s beliefs and assumptions made by management based on the information available to management at the time these disclosures were prepared. These statements are not guarantees of COB’s future performance or results and involve certain risks, uncertainties and assumptions called "Future Factors", which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. Future Factors include, without limitation:
•
financial and management resources in the amount, at the times and on the terms required to support our future business;
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adverse changes in financial performance or condition of COB's borrowers, which could affect repayment of such borrowers' outstanding loans;
•
credit losses and material changes in the quality of our loan portfolio;
•
new declines in the value of our OREO;
•
the inaccuracy of assumptions underlying the establishment of our ALL;
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reducing costs and expenses;
•
less favorable general economic conditions, either nationally or regionally; resulting in, among other things, a reduced demand for credit or other services;
•
a new slowdown in the housing markets, or an increase in interest rates, either of which may reduce demand for mortgages;
•
changes in interest rates, spreads on earning assets and interest-bearing liabilities, the shape of the yield curve and interest rate sensitivity;
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a prolonged period of low interest rates;
•
loss of one or more members of executive management;
•
rapid technological development and changes;
•
disruptions in or manipulations of our operating systems;
•
increased competitive pressures in the banking industry or in COB's markets;
•
increasing price and product/service competition by competitors;
•
changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
•
the outcome of legislation and regulation affecting the financial services industry, including COB, including the continued effects resulting from the implementation of the Dodd-Frank Act;
•
changes in accounting principles and standards;
•
the effect of any mergers, acquisitions or other transactions to which we or our subsidiaries may from time to time be a party; and
•
COB's success at managing the risks involved in the foregoing.
All forward-looking statements speak only as of the date on which such statements are made, and COB undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.
Important Factors Impacting Comparability of Results
We have accounted for our purchase of Granite Corp. using the acquisition method of accounting as of October 21, 2011, the acquisition date. The results of our operations for the years ended December 31, 2013 and 2012 include the results of Granite Corp. for the entire year, while the results of our operations for the year ended December 31, 2011 include the results of Granite Corp. for the 71 day period from October 21, 2011 through December 31, 2011. Our balance sheets as of December 31, 2013, 2012 and 2011 includes the assets, liabilities and equity of Granite Corp.
Executive Overview
Background
We are a bank holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne Bank, N.A., or the "Bank," a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers through operations located throughout central, southern and western North Carolina.
In addition to the Bank, we own FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities. COB also owned Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012.
The Bank holds the stock of First National Investor Services, Inc., which holds deeds of trust for the Bank. The Bank had also owned Dover Mortgage, which had previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012.
We earn revenue primarily from interest on loans and securities investments, gains on the sale of mortgage loans, and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provision for loan losses and write-downs in the value of our OREO, and other operating costs such as: salaries and employee benefits, occupancy, data processing expenses and tax expense.
2013 Goals and Results
Our four core goals for 2013 were to (1) successfully complete the merger of the Bank and Bank of Granite during the second quarter of 2013, (2) continue to reduce problem asset levels and increase asset quality, (3) return the company to profitability in the second half of 2013, and (4) continue efforts to restore COB and its subsidiaries to a satisfactory condition. We executed each of these strategies during the year and achieved each of these goals.
We completed the merger of the Bank and Bank of Granite effective June 8, 2013. Merger of the two banks enabled us to consolidate overlapping branches and ATM networks, complete the consolidation of operational functions, and complete the merger-related expense, all of which delivered expense synergies in the third quarter of 2013. The bank merger also allowed us to better serve customers by having one brand and product set marketed throughout our footprint. We also changed the name of our holding company to CommunityOne Bancorp and changed our stock symbol effective July 1, 2013.
We continued to aggressively resolve our legacy credit issues during 2013. Nonperforming assets decreased by $79.0 million or 55% during 2013, from $142.6 million to $63.6 million. Classified loans decreased by $57.0 million or 37%, and OREO and property acquired in settlement of loans decreased $34.7 million or 55%. Our nonperforming asset ratio declined from 6.6% as of December 31, 2012 to 3.2% as of December 31, 2013 and our classified asset to Bank Tier 1 Capital and ALL ratio declined from 121% as of December 2012 to 70% as of December 31, 2013 - exceeding our goal. The resolution of these assets was accomplished at low cost, with net charge-offs of 26 basis points of average loans. More importantly, our performing loan portfolio is experiencing declining levels of delinquencies, 68 bps at December 31, 2013, as a result of the disciplined credit administration we have put in place since the Recapitalization.
The achievement of these first two goals, along with other strategies to increase net interest margin, increase noninterest income and reduce noninterest expense, enabled us to return to profitability in the second half of 2013. We earned $6.3 million during the second half of 2013 and the Bank was profitable for the full year, with net income of $0.3 million. In addition to the completion of the merger and realization of merger synergies, factors that contributed to our return to profitability include prudent deployment of excess cash positions into higher yielding loans and securities, growth in our performing commercial and mortgage loan portfolios, continued reductions in nonperforming assets and additional reductions in the cost of our interest-bearing deposits, and a successful expense reduction effort primarily focused on our branch, vendor, legal and insurance costs.
Finally, we substantially restored COB and its subsidiaries to a satisfactory condition. In this connection, the FDIC terminated its cease and desist order with the Bank of Granite, effective February 27, 2013. The termination of this action allowed Bank of Granite
to merge with the Bank on June 8, 2013, at which time the OCC also terminated the Consent Order with the Bank, effective June 10, 2013. Lastly, the Federal Reserve Board terminated the Written Agreement with COB on November 7, 2013.
Our regulators were not the only entities that recognized our progress to return to satisfactory condition. As a result of our successful efforts to enhance our BSA/AML program, and to comply with the Bank Secrecy Act and related laws and regulations, the deferred prosecution agreement that the Bank had entered into with the U.S. Attorneys’ Office for the Western District of North Carolina and the U.S. Department of Justice in connection with the Recapitalization in order to settle a potential claim relating to a Bank customer that was under indictment for and was subsequently convicted of securities fraud, wire fraud and money laundering relating to a suspected Ponzi scheme, also was terminated and the related court case was dismissed on September 27, 2013.
Goals for 2014
Looking forward to 2014, we have four key objectives for our company: (1) grow loans; (2) grow core deposits; (3) invest in new businesses while maintaining our focus on expenses; and (4) resolve our remaining credit issues.
With respect to the first goal, we have several initiatives underway directed at loan growth throughout our commercial, consumer and mortgage lines of business, with a target to increase our loans to deposits ratio from 69% at December 31, 2013 to the mid-70% range by December 31, 2014.
We also expect to emphasize growing our core deposits by 3%, focusing on expanding our relationships with existing customers as well as attracting new customers. We are investing in enhanced treasury management products and services to attract and retain commercial deposit customers, supported by managers experienced in designing and selling cash management services. These products and services are targeted primarily for our small and medium sized commercial customers. We also are investing in expanding our on-line and mobile banking services so that our small business and consumer customers may have more convenient ways to transact business with us.
While investment in needed infrastructure and in our strategic initiatives is critical to our success, we intend to make sure that we maintain control over our expenses, targeting a core noninterest expense to average assets ratio of 3.5% during 2014. We expect to achieve that goal by targeting a 4% reduction in baseline expenses which will allow us to reinvest in our loan and deposit growth strategies. To that end, we have announced the closing of three branches - Biscoe, Dallas, and Enochville - effective April 2014. We also expect to continue to work with our vendors to reduce operating expenses throughout the year.
Finally, we are continuing our focused efforts to resolve our remaining legacy credit issues. Our goal is to reduce our classified assets by an additional $40 million during the year. Achievement of this goal will reduce our nonperforming assets ratio to 2.3% by December 31, 2014 and our ratio of classified assets to Bank Tier 1 capital and ALL from 70% to 45% by the same date.
Results of Operations
Our net loss after tax from continuing operations for 2013 was $1.5 million, a significant improvement over 2012's loss of $40.0 million. Over the final two quarters of 2013, we recorded consecutive quarters of profitability and earned $6.3 million in net income after taxes. The $38.5 million improvement in our net loss after tax from continuing operations in 2013 over 2012 is primarily driven by $13.5 million in reduced provision for loan losses, a $23.7 million in reduced OREO expenses and $3.1 million in increased net interest income. Diluted loss per common share from continuing operations declined from $1.87 in 2012 to $0.07 in 2013, as a result of the substantial improvement in net loss from continuing operations.
During 2013, net interest income grew 5% to $64.4 million, from $61.3 million in 2012. We improved our net interest margin to 3.44% in 2013 from 2.95% in 2012, as we successfully reduced the cost of interest-bearing deposits from 0.79% in 2012 to 0.53% in 2013, reduced the level of nonperforming loans by 56%, and reduced our average balances of low yielding cash equivalents by increasing our average investment securities balances by 24%. Noninterest income, excluding securities gains, declined $0.2 million, or 1%, in 2013, from $17.8 million in 2012 to $17.6 million in 2013. Increases in mortgage loan sales income and trust and investment services were partially offset by a decrease in service charge income.
Core earnings, a non-GAAP measure that excludes taxes, credit related costs and nonrecurring income and expense, increased $5.5 million in 2013 to $10.4 million, as compared to $4.9 million in 2012 and a loss of $11.6 million in 2011. The primary drivers of the increase in 2013 were $3.1 million in increased net interest income described above and $2.6 million in reduced core expenses, mostly as a result of the bank merger in June 2013, branch closures and other continuing cost reduction efforts.
Return on average assets improved in 2013 to (0.07)%, compared to (1.75)% in 2012 and (6.88)% in 2011. Return on average shareholders' equity was (1.73)% in 2013, compared to (34.88)% in 2012. Return on average equity was not a meaningful measure in 2011, as the Company had negative average equity for the year. In 2013, return on average tangible assets (calculated by deducting average goodwill and core deposit premiums from average assets) amounted to (0.07)%, improved from (1.76)% and (6.92)% in 2012 and 2011, respectively. Return on average tangible equity (calculated by deducting average goodwill and core deposit premiums from
average equity) was (2.00)% in 2013, improved from (39.09)% in 2012. Again, this measure was not meaningful in 2011 because of the Company's negative average equity for the year.
Net Interest Income
Our largest source of revenue is net interest income. Net interest income represents the difference between interest and fees on interest-earning assets, principally loans and investments, and interest expense on interest-bearing liabilities, principally customer deposits. Net interest income is affected by changes in interest rates and spreads and changes in the average balances and mix of interest-earning assets and interest-bearing liabilities.
Table 1 sets forth for the periods indicated information with respect to COB’s average balances of assets and liabilities, as well as the total dollar amounts of interest income (taxable equivalent basis) from earning assets and interest expense on interest-bearing liabilities, resultant rates earned or paid, net interest income, net interest spread and net yield on earning assets. Net interest spread refers to the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. Net yield on earning assets, or net interest margin, refers to net interest income divided by average earning assets and is influenced by the level and relative mix of earning assets and interest-bearing liabilities.
Table 1
Average Balance Sheet and Net Interest/Dividend Income Analysis
Fully Taxable Equivalent Basis
(1)
The fully tax equivalent basis is computed using a federal tax rate of 35%.
(2)
Average loan balances include nonaccruing loans and loans held for sale.
(3)
Average balances include market adjustments to fair value for securities available-for-sale and loans held for sale.
(4)
Net yield on earning assets is computed by dividing net interest income by average earning assets.
(5)
Earning asset yield minus interest-bearing liabilities rate.
Net interest income (on a non tax equivalent basis) was $64.4 million in 2013, compared to $61.3 million in 2012. This increase of $3.1 million, or 5%, resulted primarily from an increase in the net yield on earning assets, or net interest margin, to 3.44% in 2013 from 2.95% in 2012, partially offset by a 10% decrease in the level of average earning assets during the same period. There were two primary drivers of this 49 basis point increase in net interest margin in 2013. The first driver was a decrease in the cost and amount of interest-bearing liabilities as a result of COB's efforts to decrease its reliance on higher cost time deposits. The second driver was an increase in yield on earning assets, which was positively impacted by the deployment of funds from low-yielding cash equivalents into higher yielding investment securities whose average balances rose by $111.4 million during 2013. These improvements were partially offset by the impact of the continued low interest rate environment on average loan yields, which declined by 0.12% during the year, and a decrease in average loans, which fell 7% in 2013.
In 2012, the increase in net interest income of $21.7 million, or 55% from 2011, resulted primarily from a 19% increase in the level of average earning assets accompanied by an increase in the net yield on earning assets, or net interest margin, from 2.29% in 2011 to 2.95% in 2012. Both of these were primarily as a result of the impact of the acquisition of Granite Corp. on October 21, 2011.
On a taxable equivalent basis, the changes in net interest income were a $3.2 million increase in 2013 and an increase of $21.5 million for 2012, reflecting changes in the levels of and relative mix of taxable and non-taxable earning assets in each year.
In 2013, the net interest spread increased by 49 basis points from 2.87% in 2012, to 3.36% in 2013, reflecting the net effect of an increase in the average total yield on earning assets and a decrease in the average rate paid on interest-bearing liabilities, or cost of funds. The yield on earning assets increased by 25 basis points, from 3.75% in 2012 to 4.00% in 2013, while the decrease in the cost of funds was 24 basis points, from 0.88% to 0.64%. In 2012, the 58 basis point increase in net interest spread resulted from an 11 basis point increase in the yield on earning assets and a 47 basis point decrease in the cost of funds, primarily the cost of deposits.
Changes in the net interest margin and net interest spread tend to correlate with movements in interest rates. There are variations, however, in the degree and timing of rate changes for the different types of earning assets and interest-bearing liabilities.
Table 2 analyzes net interest income on a taxable equivalent basis, as measured by volume and rate variances. The table reflects the extent to which changes in the interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate) and changes in rate (changes in rate multiplied by prior year volume).
Table 2
Volume and Rate Variance Analysis
Provision for Loan Losses
The provision for (recovery of) loan loss is the charge against (addition to) earnings added to (subtracted from) the ALL each year to provide a level of allowance considered appropriate to absorb probable losses inherent in the loan portfolio. The amount of each year’s charge (addition) is affected by several considerations, including management’s evaluation of various risk factors in determining the adequacy of the allowance (see “Asset Quality” below), loan composition, actual loan loss experience and loan portfolio growth.
The provision for loan losses has declined substantially over the past three years primarily as a result of improved loss experience and reductions in the amount of nonperforming loans. The provision for loan losses was $0.5 million in 2013, $14.0 million in 2012 and $67.4 million in 2011. These changes in the level of the provision for loan losses are discussed and analyzed in detail as part of the discussions in the “Asset Quality” section.
Noninterest Income
Noninterest income, excluding discontinued operations, was $20.4 million in 2013, a decline of $1.6 million from 2012. The decrease was primarily caused by a decline in securities gains of $1.3 million, from $4.1 million in 2012 to $2.8 million in 2013. Core noninterest income, a non-GAAP measure that excludes nonrecurring items like securities gains and losses, fell $0.2 million in 2013. Loan sales income from the sale of mortgage loans to Fannie Mae was higher by $0.3 million in 2013 compared to 2012 as we sold loans to Fannie Mae for the full year in 2013 versus a partial year in 2012. Service charges on deposit accounts decreased $0.4 million in 2013, primarily as a result of a one-time 60 day fee waiver given to customers at the Bank as part of the product conversion completed in February of 2013, and the impact of changes to NSF policies and overdraft protection products beginning in the second half of 2012.
In 2012, noninterest income was $22.0 million, essentially unchanged from 2011. Core noninterest income, which excluded securities gains, loss on fair value swap and gain on extinguishment of debt in 2012 and 2011, grew $4.5 million, or 34%, in 2012, from $13.4 million in 2011 to $17.9 million in 2012. This growth is attributable in part to the addition of a full year's results of Granite in 2012, and to $2.1 million of loan sales income from the sale of mortgage loans to Fannie Mae following the resumption of sales of loans to Fannie Mae in the second quarter of 2012. Service charges on deposit accounts increased $0.9 million in 2012, primarily because our 2012 results include a full year of Granite's operations. These increases in core noninterest income were offset by a $3.2 million decline in non-core securities gains in 2012 to $4.1 million, from $7.3 million in 2011.
Table 3
Noninterest Income
(1) Non-GAAP Measure
Noninterest Expense
Noninterest expense, excluding discontinued operations, was well controlled in 2013, declining $25.7 million, or 23%, from 2012. The decline was primarily the result of a $23.7 million decrease in OREO expenses on lower OREO balances and continued stabilization in local real estate markets, as well as a $2.2 million decrease in professional fees, as a result of legal and vendor expenses reduced after the completion of the Recapitalization and Merger.
As a result of the level of legacy problem assets, actions taken to dispose of those assets and actions taken to restructure the balance sheet, there have been a significant number of non-core items within our noninterest expense in the last three years. Core noninterest expense, which excludes the non-core items of other real estate expense, loan collection expense, merger-related expense, mortgage and litigation accruals, rebranding expense, branch closure and restructuring expense, loss on sales of loans held for sale, and prepayment penalty on borrowings, the core noninterest expense ("Core NIE"), was $71.7 million in 2013, a decrease of $2.5 million, or 3%, from $74.2 million in 2012. On a comparative basis, core noninterest expense as a percent of average assets was 3.50% in 2013, slightly higher than 3.24% in 2012.
Noninterest expense, excluding discontinued operations, declined $14.8 million, or 12%, from 2011 to 2012. The decline was primarily the result of a $23.5 million decrease in OREO expenses on lower OREO balances and improvements in local real estate markets, as well as a $3.2 million decrease in FDIC insurance assessments based on the improved capital position of the Bank following the Recapitalization. These declines were partially offset by a $12.3 million increase in personnel expense, as well as increases in net occupancy expense and furniture, equipment and data processing expense, primarily because our results for 2012 include a full year of Granite's operations, whereas 2011’s results included only the period from October 21, 2011 through December 31, 2011. In addition, merger-related expenses increased $2.0 million in 2012, to $3.2 from $1.2 million in 2011. Merger-related expenses in 2012 include the costs associated with merging information systems, severance for displaced employees, consolidated branch closure costs, and other merger-related professional services.
Excluding the same non-core items referenced above, core noninterest expense increased $9.7 million in 2012 to $74.2 million, from $64.5 million in 2011, primarily as a result of the addition of a full year of Granite expenses in 2012. Core noninterest expense to average assets decreased slightly in 2012 to 3.24% from 3.37% in 2011.
Table 4
Noninterest Expense
(1) Non-GAAP Measure
Provision for Income Taxes
Excluding discontinued operations, COB had an income tax expense totaling $1.3 million for the year ended 2013 compared to an income tax benefit of $1.0 million for the same period in 2012. The change resulted primarily from the reduction of deferred tax liabilities during the year, offset by an increase in the deferred tax assets arising from declines in the market value of available-for-sale securities for which no valuation allowance is required. Because we maintain a valuation allowance for net deferred tax assets equal to the gross deferred tax asset (less deferred tax assets for which no valuation allowance is required, net of any deferred tax liabilities), increases in our net deferred tax assets resulted in an increase to the required valuation reserve and a corresponding increase in income tax expense. COB’s income tax expense as a percentage of loss before income taxes, excluding discontinued operations, was 844% for the year ended December 31, 2013, compared to an income tax benefit of 2.5% for the same period ended 2012.
Excluding discontinued operations, COB had an income tax benefit totaling $1.0 million for the year ended 2012 compared to an income tax expense of $0.6 million for the same period in 2011. The change resulted primarily from the impact of the change in the market value of available-for-sale securities relating to our tax strategy for securities with losses on our net deferred tax assets, and a reduction in the corresponding valuation allowance that was recorded as income tax benefit. COB’s income tax benefit as a percentage of loss before income taxes, excluding discontinued operations, was 2.5% for the year ended December 31, 2012, compared to provision for income tax of 0.5% for the same period ended 2011.
On a quarterly basis, the net deferred tax assets are evaluated to determine the amount of net deferred tax assets that are realizable in the foreseeable future. In assessing whether net deferred tax assets will be realized, management considers whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized. The ultimate realization of net deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. After evaluating the positive and negative evidence to support the realization of the net deferred tax assets under current guidance, we continue to believe there is insufficient positive evidence to support a conclusion that it is more likely than not that all of this asset will be realized in the foreseeable future. Consequently, we maintained a valuation allowance for the amount for which it has been determined that realization is not more-likely-than-not. For deferred tax assets associated with unrealized losses on investment securities, for which we have the capability and intent to hold until maturity and thus not incur the unrealized loss, we have concluded that it is not necessary to maintain a valuation allowance. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense in continuing operations or other comprehensive income, as appropriate.
Liquidity
Liquidity for COB refers to its continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds to COB for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks (b) the outstanding balance of federal funds sold (c) the market value of unpledged investment securities and (d) availability under lines of credit. At December 31, 2013, the total amount of these four items was $525.1 million, or 27% of total assets, a decrease of $203.2 million from $728.3 million, or 34% of total assets, at December 31, 2012. COB could also access $301.8 million of additional borrowings under credit lines by pledging additional collateral.
Consistent with the general approach to liquidity, loans and other assets of COB are funded primarily by local core deposits. A stable deposit base, supplemented by FHLB advances and a modest amount of brokered time deposits, has been sufficient to meet the Bank's loan demands. During 2013, liquidity was used to grow the loan portfolio by $30.1 million and to reduce the amount of higher cost time deposits by $180.9 million, offset by a reduction in OREO assets of $34.7 million. During 2013, we were able to grow our loans to deposits ratio from 62% at year-end 2012 to 69% at year-end 2013.
Contractual Obligations
Under existing contractual obligations, we will be required to make payments in future periods. Table 5 presents aggregated information about the payments due under such contractual obligations at December 31, 2013. Benefit plan payments cover estimated amounts due through 2023.
Table 5
Contractual Obligations
Commitments, Contingencies and Off-Balance Sheet Risk
In the normal course of business, various commitments are outstanding that are not reflected in the consolidated financial statements. Significant commitments at December 31, 2013 are discussed below.
Commitments by the Bank to extend credit and undisbursed advances on customer lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. At December 31, 2013, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $225.6 million. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee. Since many commitments expire without being fully drawn, the total commitment amounts do not necessarily represent future cash requirements. COB evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on the credit evaluation of the borrower.
The Bank issues standby letters of credit whereby each guarantees the performance of a customer to a third party if a specified triggering event or condition occurs. The guarantees generally expire within one year and may be automatically renewed depending on the terms of the guarantee. All standby letters of credit provide for recourse against the customer on whose behalf the letter of credit was issued, and this recourse may be further secured by a pledge of assets. The maximum potential amount of undiscounted future payments related to standby letters of credit was $0.7 million at December 31, 2013 and $0.9 million at December 31, 2012.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The fair value of these commitments was not considered material.
COB does not have any special purpose off-balance sheet financing.
From time to time, we are subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against us incident to the operation of our business. In management's opinion, there are no proceedings pending to which we are a party or to which our property is subject, which, if determined adversely to us, would be material in relation to our shareholder's equity or financial condition. In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities or other parties.
Asset/Liability Management and Interest Rate Sensitivity
One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps; however, this method addresses only the magnitude of timing differences and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, at least quarterly, earnings projections based on a range of interest rate scenarios in order to more accurately measure interest rate risk. For additional information, see Item 7A.
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The objective of COB’s asset/liability management function is long-term maximization of net interest income within COB risk guidelines. This objective is accomplished through management of our balance sheet composition, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.
The goal of liquidity management is to provide adequate funds to meet changes in loan demand or unexpected deposit withdrawals. This is accomplished by maintaining liquid assets in the form of investment securities, maintaining sufficient unused borrowing capacity and achieving consistent growth in core deposits.
Management considers interest rate risk COB’s most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of our net interest income is largely dependent upon the effective management of interest rate risk.
To identify and manage its interest rate risk, we employ an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management projections for activity levels in each of the product lines offered by the Bank. Assumptions are inherently uncertain and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted. Actual results may differ from simulated results due to timing, magnitude, and frequency of interest changes as well as changes in market conditions and management strategies.
COB’s Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk. The banks’ current interest rate risk position is determined by measuring the anticipated change in net interest income over a 24-month horizon assuming a ramped increase or decrease in all interest rates equally over the 24 month time horizon. The following table shows COB’s estimated net interest income profile for the 12-month period beginning December 31, 2013.
ALCO also monitors the sensitivity of COB’s economic value of equity (“EVE”) due to sudden and sustained changes in market rates. The EVE ratio, measured on a static basis at the current period end, is calculated by dividing the economic value of equity by the economic value of total assets. ALCO monitors the change in EVE on a percentage change basis.
The following table estimates changes in EVE for given changes in interest rates as of December 31, 2013.
We are in compliance with our internal policy on both changes in net interest income and on changes to EVE as of December 31, 2013 in a higher rate environment. We are in compliance with our policy on changes to net interest income but slightly over policy on changes to EVE as of December 31, 2013 in a lower rate environment which management believes is an unlikely scenario at the current low level of interest rates. We consider our risks to changes in interest rates to be moderate.
Item 8.
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
QUARTERLY FINANCIAL INFORMATION
The following table sets forth, for the periods indicated, certain of our consolidated quarterly financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with our consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.
Quarterly Financials
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors
CommunityOne Bancorp and Subsidiaries
Charlotte, North Carolina
We have audited the accompanying consolidated balance sheets of CommunityOne Bancorp and Subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CommunityOne Bancorp and Subsidiaries as of December 31, 2013 and 2012 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CommunityOne Bancorp and Subsidiaries internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 7, 2014 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ Dixon Hughes Goodman LLP
Charlotte, North Carolina
March 7, 2014
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors
CommunityOne Bancorp and Subsidiaries
Charlotte, North Carolina
We have audited CommunityOne Bancorp and Subsidiaries' (the “Company”) internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, CommunityOne Bancorp and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of CommunityOne Bancorp and Subsidiaries as of December, 31, 2013 and 2012 and for each of the years in the three year period ended December 31, 2013, and our report dated March 7, 2014 expressed an unqualified opinion on those consolidated financial statements.
We do not express an opinion or any other form of assurance on management’s statement referring to compliance with designated laws and regulations related to safety and soundness.
/s/ Dixon Hughes Goodman LLP
Charlotte, North Carolina
March 7, 2014
CommunityOne Bancorp and Subsidiaries
Consolidated Balance Sheets
See accompanying notes to consolidated financial statements.
CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Operations
See accompanying notes to consolidated financial statements.
CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Comprehensive Loss
See accompanying notes to consolidated financial statements.
CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Shareholders’ Equity
See accompanying notes to consolidated financial statements.
CommunityOne Bancorp and Subsidiaries
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
CommunityOne Bancorp and Subsidiaries
Notes to Consolidated Financial Statements
1. Nature of Operations and Basis of Presentation
Nature of Operations/Consolidation
CommunityOne Bancorp, or "COB" or the "Company"(which also refers to us and our subsidiaries on a consolidated basis), is a bank holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne Bank, N.A., or the "Bank," a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment management and trust services, to individual and business customers through operations located throughout central, southern and western North Carolina.
In addition to the Bank, we own FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities. COB also owned Granite Mortgage, Inc., which ceased mortgage operations in 2009 and filed for Chapter 11 bankruptcy on February 15, 2012.
The Bank holds the stock of First National Investor Services, Inc., which holds deeds of trust for the Bank. The Bank had also owned Dover Mortgage, which had previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011 and filed for Chapter 11 bankruptcy on February 15, 2012.
Our shareholders approved an amendment in our articles of incorporation to change our name from FNB United Corp. to CommunityOne Bancorp on June 20, 2013. This change, along with a change in our stock symbol from FNBN to COB, was implemented on July 1, 2013.
Basis of Presentation
The accounting and reporting policies of COB are in accordance with U.S. generally accepted accounting principles (“GAAP”). All significant intercompany balances and transactions have been eliminated.
Use of Estimates
We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these consolidated financial statements in conformity with GAAP. Actual results could differ from those estimates. Material estimates subject to change in the near term include, among other items, the allowances for loan losses (“ALL”), the carrying value of other real estate owned (“OREO”), the carrying value of investment securities, the carrying value of purchased impaired loans and the realization of deferred tax assets.
Reclassification
Certain reclassifications have been made to the prior period consolidated financial statements to place them on a comparable basis with the current period consolidated financial statements. These reclassifications have no effect on net loss or shareholders’ equity as previously reported.
Business Combinations
Business combinations are accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations. Under the acquisition method, the acquiring entity in a business combination recognizes 100% of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the statement of operations from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred.
Business Segments
We report business segments in accordance with accounting guidance. Business segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The guidelines require that a public enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the way that the business segments were determined and other items. We have only one business segment.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include the balance sheet captions: cash and due from banks, and interest-bearing bank balances.
Investment Securities
Investment securities are categorized and accounted for as follows:
•
Available-for-sale securities - Debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value, with unrealized gains and losses, net of related tax effect, included as an item of accumulated other comprehensive income and reported as a separate component of shareholders’ equity.
•
Held-to-maturity securities - Debt securities that COB has the positive intent and ability to hold to maturity are reported at amortized cost.
We intend to hold securities classified as available-for-sale securities for an indefinite period of time but may sell them prior to maturity. All other securities, which COB has the positive intent and ability to hold to maturity, are classified as held-to-maturity securities. At December 31, 2013, we have securities with an amortized cost of $151.8 million in the held-to-maturity portfolio and at December 31, 2012, we had no such securities.
A decline, which is deemed to be other than temporary, in the market value of any available-for-sale or held-to-maturity security to a level below cost results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established.
Our policy regarding other than temporary impairment (“OTTI”) of investment securities requires continuous monitoring of those securities. The evaluation includes an assessment of both qualitative and quantitative measures to determine whether, in management’s judgment, the investment is likely to recover its original value. If the evaluation concludes that the investment is not likely to recover its original value, the unrealized loss is reported as an OTTI, and the loss is recorded in the Consolidated Statements of Operations.
For debt securities, an impairment loss is recognized in earnings only when (1) we intend to sell the debt security; (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or (3) we do not expect to recover the entire amortized cost basis of the security. In situations where we intend to sell or when it is more likely than not that we will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as a component of other comprehensive loss, net of deferred taxes.
Interest income on debt securities is adjusted using the level yield method for the amortization of premiums and accretion of discounts. The adjusted cost of the specific security is used to compute gains or losses on the disposition of securities on a trade date basis.
Loans Held for Sale
In the second quarter of 2012, we re-entered the business of originating residential mortgage loans, through our branch mortgage channel under various loan programs, which were sold in the secondary market. At December 31, 2013 and December 31, 2012, loans held for sale consist of such residential mortgage loans which have not yet been sold. The loans held for sale are carried at the aggregate lower of cost or fair value less estimated costs to sell.
Loans are generally sold without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in mortgage loan income.
Loans Held for Investment
Loans held for investment are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income. COB reports its loan portfolio by segment and classes, which are disaggregations of portfolio segments. COB's portfolio segments are: Commercial and agricultural, Real estate, and Consumer loans. The Commercial and agricultural loan and Consumer loan portfolios are not further segregated into classes. The classes within the Real estate portfolio
segment include Real estate - construction and Real estate mortgage, broken into 1-4 family residential mortgage and Commercial real estate mortgage loans.
Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the life of the loan as an adjustment of interest income. The premium or discount on purchased loans is amortized over the expected life of the loans and is included in interest and fees on loans.
All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. When we cannot reasonably expect full and timely repayment of its loan, the loan is placed on nonaccrual.
All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. A debt is "well-secured" if collateralized by liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full; or by the guarantee of a financially responsible party. A debt is "in process of collection" if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action that are reasonably expected to result in repayment of the debt or its restoration to a current status.
Loans that are less than 90 days delinquent may also be placed on nonaccrual, if approved, due to deterioration in the borrower’s financial condition that could result in less than full repayment.
For all loan classes, a nonaccrual loan may be returned to accrual status when we can reasonably expect continued timely payments until payment in full. All prior arrearage does not have to be eliminated, nor do all previously charged off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met: (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.
At the time a loan is placed on nonaccrual, all accrued, unpaid interest is charged off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable. Charge-offs of accrued and unpaid interest are taken against the current year's interest income. They are not charged to the current ALL.
For all classes within all loan portfolios, cash receipts received on nonaccrual loans are applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income.
Charge-off of Uncollectible Loans - For all loan classes, as soon as any loan becomes uncollectible, the loan will be charged down or charged off as follows:
•
If unsecured, the loan must be charged off in full.
•
If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral.
Loans should be considered uncollectible when:
•
No regularly scheduled payment has been made within four months, or
•
The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.
Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectible.
Impaired Loans - An impaired loan is one for which COB will not be repaid all principal and interest due per the terms of the original contract or within reasonably modified contracted terms. If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract. All loans meeting the definition of Doubtful are considered impaired.
When a loan in any class has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan changes over time. A specific reserve is established as a component of the ALL when a loan has been determined to be impaired. After three months, specific reserves are considered for charge off. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan’s expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, COB recalculates the
impairment and appropriately adjusts the specific reserve. Similarly, if COB measures impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, COB will adjust the specific reserve if there is a significant change in either of those bases.
When a loan within any class is impaired and principal and interest is in doubt when contractually due, interest income is not recognized. Cash receipts received on nonaccruing impaired loans within any class are generally applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.
Acquired Loans
In addition to originating loans, we also purchase loans. At acquisition, purchased loans are designated as either purchased contractual loans ("PC loans") or purchased impaired loans ("PI loans"). PC loans are acquired loans where management believes it is probable that it will receive all principal as of the date of acquisition. These loans are accounted for under the contractual cash flow method, under ASC 310-20. Any discount or premium paid on PC loans is recorded in interest income using the effective yield method over the expected life of the loans.
PI loans are acquired loans where management believes, at acquisition date, it is probable that all principal on the acquired loans will not be received. PI loans are placed in homogeneous risk-based pools, based on such factors as purpose and/or type of loan, and are treated in the aggregate where accounting for projected cash flows is performed, as allowed under ASC 310-30. The fair value of the loan pool is the present value of expected future cash flows at the acquisition date. The difference between the expected cash flows and the fair value is known as the accretable yield which is recognized as interest income over the remaining life of each PI loan pool when there is a reasonable expectation about the timing and amount of such cash flows.
Once a PI loan pool is established the individual loans within each pool do not change. As management obtains new information related to changes in expected principal loss and expected cash flows, by pool, we record either an increase in yield when new expected cash flows increase, an allowance for loan losses when new expected cash flows decline, or a decrease in yield when there is only a timing difference in expected cash flows.
PI loans that meet the criteria for nonaccrual of interest at the time of acquisition may be considered performing upon and subsequent to acquisition, regardless of whether the customer is contractually delinquent, if the timing and expected cash flows on such loans can be reasonably estimated and if collection of the new carrying value of such loans is expected.
Loans acquired in the Merger ("Granite Purchased Loans") included PI loans and PC loans. Loans designated as PC loans included performing revolving consumer and performing revolving commercial loans on acquisition date.
At December 31, 2013 and December 31, 2012 an ALL of $5.6 million and $5.4 million, respectively, was required for the acquired Granite loans. In addition, the acquired Granite loans are recorded on an accruing basis. We recorded $16.0 million, $20.5 million and $4.8 million in accretable yield during 2013, 2012 and 2011, respectively, on the Granite loans.
Allowance for Loan Losses
COB's ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses to be incurred as of the balance sheet date. Management assesses COB's ALL quarterly. This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk. The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group. For purposes of the ALL, we have grouped our loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income. Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines. Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary if economic or other conditions differ substantially from the assumptions used.
Historical Loss Rates: Historical loss rates are calculated by associating losses to the risk-graded pool to which they relate for each of the previous eight quarters. Then, using a look back period consisting of the twenty most recent quarters, loss factors are calculated for each risk-graded pool using a simple average. This represents a change in methodology which began in the third quarter of 2013. Previously, we used a look back period beginning in the third quarter of 2006 and a weighted average of losses. The impact of this change was immaterial to the financial statements of the Company.
Q&E Loss Factors: In addition to our ability to use our own historical loss data and migration between risk grades, we have a rigorous process for computing the qualitative factors that impact the ALL. The methodology incorporates various internal and
external qualitative and environmental factors as described in the Interagency Policy Statement on the Allowance for Loan and Lease Losses dated December 2006. Some factors are quantifiable, such as concentration, growth, delinquency, and nonaccrual risk by loan type, while other factors are qualitative in nature, such as staff competency, competition within our markets and economic and regulatory changes impacting the loans held for investment, and are determined on the basis of management observation, judgment, and experience. A committee, independent of the historical loss migration team, reviews risk factors that may impact the ALL. The factors utilized by COB for all loan classes are as follows:
a)
Standard - Accounts for inherent uncertainty in using the past as a predictor of the future. Particularly, this factor will be used to make adjustments when historical loss data over the look back period is above or below the loss experienced over more recent periods, causing the model to over or under predict the potential losses currently in the portfolio. Uniform across all segments.
b)
Volume - Accounts for historical growth characteristics of the portfolio over the loss recognition period.
c)
Terms - Measures risk derived from granting terms outside of policy and underwriting guidelines.
d)
Staff - Reflects staff competence in various types of lending.
e)
Delinquency - Reflects increased risk deriving from higher delinquency rates.
f)
Nonaccrual - Reflects increased risk of loans with characteristics that merit nonaccrual status.
g)
Migration - Accounts for the changing level of risk inherent in loans as they migrate into, or away from, more adverse risk grades.
h)
Concentration - Measures increased risk derived from concentration of credit exposure in particular industry segments within the portfolio.
i)
Production - Measures impact of efforts towards expanding credit exposure and potential risk derived from new loan production.
j)
Process - Measures increased risk derived from more demanding processing requirements directed towards risk mitigation.
k)
Economic - Impact of general and local economic factors and effect is felt uniformly across pools.
l)
Competition - Measures risk associated with Bank's response to competitors’ relaxed credit requirements.
m)
Regulatory and Legal - Measures risk from exposure to regulations, legislation, and legal code that result in increased risk of loss.
Each pool is assigned an adjustment to the potential loss percentage by assessing its characteristics against each of the factors listed above.
Calculation and Summary: A general reserve amount for each loan pool is calculated by adding the historical loss rate to the total Q&E factors, and applying the combined percentage to the pool loan balances.
Reserves are generally divided into three allocation segments:
1.
Individual Reserves. These are calculated against loans evaluated individually and deemed most likely to be impaired. Management determines which loans will be considered for potential impairment review. This does not mean that an individual reserve will necessarily be calculated for each loan considered for impairment, only for those noted during this process as likely to have a loss. Loans to be considered will generally include:
•
All commercial loans classified substandard or worse
•
Any other loan in a nonaccrual status
•
Any loan, consumer or commercial, that has already been modified such that it meets the definition of Troubled Debt Restructurings (“TDR”)
•
Any loan for which the customer has filed Bankruptcy when the customer does not reaffirm the debt.
The individual reserve must be verified at least quarterly, and recalculated whenever additional relevant information becomes available. All information related to the calculation of the individual reserve, including internal or external collateral valuations, assumptions, calculations, etc. must be documented.
Individual reserve amounts are not carried indefinitely.
•
When the amount of the actual loss becomes reasonably quantifiable the amount of the loss should be charged off against the ALL, whether or not all liquidation and recovery efforts have been completed.
•
If the total amount of the individual reserve that will eventually be charged off cannot yet be determined, but some portion of the individual reserve can be viewed as an imminent loss, that smaller portion can be charged off against the
ALL and the individual reserve reduced by a corresponding amount. It is acceptable to retain an estimate of remaining loss as a “special reserve” only when the estimate is not reasonably quantifiable.
•
Impaired loans with a de minimis balance are not individually evaluated for individual reserve but they are included in the formula reserve calculation.
2.
Formula Reserves. Formula reserves are held against loans evaluated collectively. Loans are grouped by type or by risk grade, or some combination of the two. Loss estimates are based on historical loss rates for each respective loan group.
Formula reserves represent COB’s best estimate of losses that may be inherent, or embedded, within the group of loans, even if it is not apparent at this time which loans within any group or pool represent those embedded losses.
3.
Unallocated Reserves. If individual reserves represent estimated losses tied to any specific loan, and formula reserves represent estimated losses tied to a pool of loans but not yet to any specific loan, then unallocated reserves represent an estimate of losses that are expected, but are not yet tied to any loan or group of loans. Unallocated reserves are generally the smallest of the three overall reserve segments and are set based on qualitative factors.
All information related to the calculation of the three segments including data analysis, assumptions, calculations, etc. are documented. Assigning specific individual reserve amounts, formula reserve factors, or unallocated amounts based on unsupported assumptions or conclusions is not permitted.
COB lends primarily in North Carolina. As of December 31, 2013, a substantial majority of the principal amount of the loans held for investment in its portfolio was to businesses and individuals in North Carolina. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the adequacy of the ALL. Management believes the ALL is adequate to cover estimated losses on loans at each balance sheet date.
In addition, as an integral part of the examination process, the OCC periodically reviews the Bank's ALL. The OCC may require the Bank to recognize adjustments to the allowance based on its judgment about information available to it at the time of its examination.
Other Real Estate Owned
Other real estate owned, or OREO, represents properties acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale. The property is initially carried at fair value based on recent appraisals, less estimated costs to sell. Declines in the fair value of properties included in OREO below carrying value are recognized by a charge to income.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets as follows: buildings and improvements, 10 to 50 years, and furniture and equipment, 3 to 10 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated life of the improvement or the term of the lease.
Intangible Assets
Goodwill arises from business combinations and represents the excess of the purchase price over the fair value of the net assets and other identifiable intangible assets acquired. Goodwill and other intangible assets deemed to have indefinite lives generated from purchase business combinations are not subject to amortization and are instead assessed for impairment no less than annually. Impairment exists when the carrying value of the goodwill exceeds its implied fair value. Impairment charges are included in noninterest expense in the statements of operations.
Intangible assets with estimable useful lives are amortized over such useful lives to their estimated residual values. Core deposit intangible assets, which we refer to as CDI, is recognized apart from goodwill at the time of acquisition based on market valuations prepared by independent third parties. In preparing such valuations, the third parties consider variables such as deposit servicing costs, attrition rates, and market discount rates. CDI assets are amortized to expense over their useful lives, which we have estimated to range from 8 to 10 years. CDI is reviewed for impairment quarterly or earlier if events or changes in circumstances indicate that their carrying values may not be recoverable. If the recoverable amount of CDI is determined to be less than its carrying value, we would then measure the amount of impairment based on an estimate of the intangible asset's fair value at that time. If the fair value is below the carrying value, the intangible asset is reduced to such fair value and the impairment is recognized as noninterest expense in the statements of operations.
Mortgage Servicing Rights (“MSRs”)
The rights to service mortgage loans for others are included in other assets in the consolidated balance sheet. MSRs are recorded at fair value on an ongoing basis, with changes in fair value recorded in the results of operations. A fair value analysis of MSRs is performed on a quarterly basis. The Bank resumed the sale of mortgage loans to Fannie Mae beginning in the second quarter of 2012, following Fannie Mae's approval of the Bank as a Seller Servicer.
Income Taxes
Income tax expense includes both a current provision based on the amounts computed for income tax return purposes and a deferred provision that results from application of the asset and liability method of accounting for deferred taxes. Under the asset and liability method, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of COB's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Management’s determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax assets. In evaluating the positive and negative evidence to support the realization of the asset under current guidance, given our current financial results and current economic conditions, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future. Examinations of the income tax returns or changes in tax law may impact COB’s tax liabilities and resulting provisions for income taxes.
A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset 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. In making such judgments, significant weight is given to evidence that can be objectively verified. As a result of significant credit losses, COB continues to be in a three-year cumulative pre-tax loss position as of December 31, 2013. A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome. COB’s estimate of the realization of its deferred tax assets was based on the scheduled reversal of deferred tax liabilities and taxable income available in prior carry back years and estimated unrealized losses in the available-for-sale investment portfolio. COB did not consider future taxable income in determining the realizability of its deferred tax assets. COB expects its income tax expense (benefit) will be negligible for the next several quarters until profitability has been restored for a reasonable time and such profitability is considered sustainable. At that time, the valuation allowance would be reversed. Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date. If future events differ significantly from COB’s current forecasts, COB may need to increase this valuation allowance, which could have a material adverse effect on the results of operations and financial condition. See also Note 11 for discussion of the impact on deferred taxes associated with the Merger.
Earnings per Share (“EPS”)
As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the statements of operations, and a reconciliation is provided in a footnote of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. See also Note 17 for discussion of the one-for-one hundred reverse stock split and its impact on share and per share amounts.
Comprehensive Income
Comprehensive income is defined as the change in equity of an enterprise during a period from transactions and other events and circumstances from non-owner sources and, accordingly, includes both net income and amounts referred to as other comprehensive income. The items of other comprehensive income are included in the consolidated statement of comprehensive loss. The accumulated balance of other comprehensive loss is included in the shareholders’ equity section of the consolidated balance sheet. COB’s components of accumulated other comprehensive loss for each period presented include unrealized gains (losses) on investment securities classified as available-for-sale, and the effect of the defined benefit pension and other postretirement plans for employees.
For the twelve months ended December 31, 2013, 2012 and 2011, total other comprehensive loss was $(18.8) million, $(36.4) million and $(137.6) million, respectively. The deferred income tax benefit/(liability) related to the components of other comprehensive loss amounted to $11.0 million, $0.2 million and $2.6 million respectively, for the same periods as previously mentioned.
The accumulated balances related to each component of other comprehensive loss are as follows:
Employee Benefit Plans
COB has a matching retirement/savings plan, a postretirement benefit plan, a defined benefit pension plan, and noncontributory, nonqualified supplemental executive retirement plans (“SERPs”) covering certain employees.
COB’s matching defined contribution retirement/savings plan permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. A portion of the employee contributions are matched by COB based on the plan formula, which is $.50 for each dollar on the first 6% of eligible pay deferred by the employee under the plan. Additionally, commencing in 2007, COB on a discretionary basis may make an annual contribution up to a specified percentage of compensation as defined by the plan to the account of each eligible employee. COB did not make a discretionary contribution in 2013, 2012 or 2011. The matching and discretionary contributions amounted to $0.5 million in 2013, $0.6 million in 2012, and $0.4 million in 2011.
The postretirement benefit plan, provides medical and life insurance benefits to retirees who obtained certain age and service requirements. Postretirement benefit costs, which are actuarially determined using the attribution method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet. Effective December 31, 2006, no new employees are eligible to enter the postretirement medical and life insurance plan. Employees who had obtained certain age and service qualifications continued to accrue benefits through December 31, 2010. Benefits are based on the employee's years of service at retirement. Only employees who qualified for continued benefit accrual are eligible for benefits under this plan.
The defined benefit pension plan was frozen in 2006 and no additional employees are eligible to enter the plan. Employees who had obtained certain age and service qualifications continued to accrue benefits through December 31, 2010. Benefits are based on the employee’s compensation, years of service and age at retirement. Defined benefit pension costs, which are actuarially determined using the projected unit credit method, are charged to current operations. Pension costs of $0.3 million, $0.4 million and $0.4 million were recognized during 2013, 2012 and 2011, respectively. Annual funding contributions are made up to the maximum amounts allowable for Federal income tax purposes.
The noncontributory, nonqualified supplemental executive retirement plans (“SERPs”), cover certain executives and pay benefits based on factors similar to those for the defined benefit pension plan, with offsets related to amounts payable under the pension plan and social security benefits. SERP costs, which are actuarially determined using the projected unit credit method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet.
In 2010, the Board of Directors approved an amendment to one of the plans which stopped additional benefit accrual under the Plan after December 31, 2010. This action did not impact a participant's vested or accrued benefit in the plan. In September 2012, the Board of Directors approved an amendment to terminate this Plan. The amendment provides for lump sum cash distributions of participant benefits in accordance with Internal Revenue Code Section 409A. Based on the decision to terminate the SERP by providing a lump sum settlement, a deferred gain of $0.4 million was recorded in other comprehensive income in 2012, and was recognized into earnings when payments were made in 2013.
See Note 14 “Employee Benefit Plans” for additional information on all benefit plans described below.
COB also offers medical, dental, life, long term disability, and vision care to its employees and shares in the costs of these programs.
Derivatives and Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. COB uses derivatives primarily to manage interest rate risk related to mortgage servicing rights, and long-term debt. The fair value of derivatives in a gain or loss position is included in other assets or liabilities, respectively, on the Consolidated Statements of Operations.
COB classifies its derivative financial instruments as either a hedge of an exposure to changes in the fair value of a recorded asset or liability, or a fair value hedge, or a hedge of an exposure to changes in the cash flows of a recognized asset, liability or forecasted transaction, or a cash flow hedge. COB has master netting agreements with the derivatives dealers with which it does business, but reflects gross gains and losses on the Consolidated Income Statements and Balance Sheets.
COB uses the long-haul method to assess hedge effectiveness. COB documents, both at inception and over the life of the hedge, at least quarterly, its analysis of actual and expected hedge effectiveness. This analysis includes techniques such as regression analysis and hypothetical derivatives to demonstrate that the hedge has been, and is expected to be, highly effective in off-setting corresponding changes in the fair value or cash flows of the hedged item. For a qualifying fair value hedge, changes in the value of the derivatives that have been highly effective as hedges are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged. For a qualifying cash flow hedge, the portion of changes in the fair value of the derivatives that have been highly effective are recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings.
For either fair value hedges or cash flow hedges, ineffectiveness may be recognized in noninterest income to the extent that changes in the value of the derivative instruments do not perfectly offset changes in the value of the hedged items attributable to the risk being hedged. If the hedge ceases to be highly effective, COB discontinues hedge accounting and recognizes the changes in fair value in current period earnings. 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 into income over the original hedge period (fair value hedge) or 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).
See Note 19 for additional information related to derivatives and financial instruments.
Recent Accounting Pronouncements
Troubled Debt Restructurings - In January 2014, the FASB issued ASU No. 2014-04 Troubled Debt Restructurings by Creditors (Subtopic 310-40): "Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure" (“ASU No. 2014-04”). This pronouncement clarifies the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
Comprehensive Income - In February 2013, the FASB issued ASU No. 2013-02 Comprehensive Income (Topic 220): "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" (“ASU No. 2013-02”). This pronouncement requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income for each applicable component of net income, as well as a roll forward of the components of accumulated other comprehensive income on a prospective basis. This pronouncement is effective beginning January 1, 2013. The provisions of ASU No. 2013-02 relate only to financial statement presentation of other comprehensive income and, accordingly, its adoption did not have a material effect on COB's financial statements. These new disclosures appear in Note 19.
FASB - From time to time, the Financial Accountings Standards Board (“FASB”) issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards.
Management considers the effect of the proposed statements on the consolidated financial statements of COB and monitors the status of changes to and proposed effective dates of exposure drafts. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on COB’s financial position, results of operations or cash flows.
2. Acquisition of Bank of Granite Corporation
On October 21, 2011, as part of the recapitalization of COB, COB acquired Granite Corp., through the Merger of a wholly owned subsidiary of COB merging into Granite Corp. The Merger was part of the Company’s recapitalization strategy, a condition to the closing of the Investment Agreements, and was a 100% stock exchange transaction. The Merger allows us to improve efficiencies and opens new markets for us. Upon consummation of the Merger, each outstanding share of Granite Corp.’s common stock, par value $1.00 per share, other than shares held by COB, Granite Corp.’s and shares owned in a fiduciary capacity or as a result of debts previously contracted, was converted into the right to receive 3.375 shares of COB common stock, resulting in COB issuing approximately 521,595 shares (adjusted for the Reverse Stock Split) of COB common stock to Granite Corp.’s stockholders.
Granite Corp. was a Delaware corporation organized on June 1, 1987, which was registered as a bank holding company due to its ownership of Granite, a North Carolina state chartered bank which has been in existence and continuously operating since August 2, 1906. Granite conducted banking business operations from 17 full-service branches located in Burke, Caldwell, Catawba, Forsyth, Iredell, Mecklenburg, Watauga, and Wilkes counties in North Carolina. We completed the merger of the Bank and Granite effective June 8, 2013.
Granite Corp. also owned Granite Mortgage, Inc. (“Granite Mortgage”), a North Carolina corporation which ceased mortgage operations in July 2009 and filed for Chapter 11 bankruptcy on February 15, 2012.
The acquisition of Granite Corp. by COB was accounted for under the acquisition method of accounting in accordance with relevant accounting guidance. The purchased assets and assumed liabilities were recorded at their respective acquisition date fair values, and identifiable intangible assets were recorded at fair value. Fair value adjustments were preliminary and were subject to refinement for up to one year after the closing date of the acquisition as additional information relative to closing date fair values became available. During the first quarter of 2012, we recognized $0.3 million in additional goodwill from the Merger. This additional goodwill was due to new valuations received on OREO acquired in the Merger, which had been written down to our best estimate of fair value at October 21, 2011.
None of the goodwill recognized is expected to be deductible for income tax purposes.
The following table summarizes the fair values of assets and liabilities of Granite Corp. assumed by COB.
The following table presents our unaudited pro forma results of operations for the periods presented as if the Merger had been completed on January 1, 2011. The unaudited pro forma results of operations include the historical accounts of COB and Granite Corp. and pro forma adjustments as may be required, including the amortization of intangibles with definite lives and the amortization or accretion of any premiums or discounts arising from fair value adjustments for assets acquired and liabilities assumed. The unaudited pro forma information is intended for informational purposes only and is not necessarily indicative of our future operating results or operating results that would have occurred had the Merger been completed on January 1, 2011. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions.
The proforma results are not necessarily indicative of actual results had the acquisition been completed as of the beginning of each fiscal period presented, nor are they necessarily indicative of future consolidated results.
3. Discontinued Operations
All operations of Dover, a subsidiary of the Bank, were discontinued as of March 17, 2011. Dover, acquired by us in 2003, originated, underwrote and closed mortgage loans for sale into the secondary market. It maintained a retail origination network based in Charlotte, North Carolina, which originated loans for properties located in North Carolina. Dover also engaged in the wholesale mortgage origination business and conducted retail mortgage origination business outside of North Carolina. Operations outside of the State of North Carolina and the wholesale mortgage origination business were discontinued in February 2011, and all remaining operations were discontinued on March 17, 2011. Dover filed for Chapter 11 bankruptcy on February 15, 2012 in the United States Bankruptcy Court for the Western District of North Carolina. All of the assets and liabilities of Dover were written off at that time.
The results of operations of a component of an entity that has been disposed of shall be reported in discontinued operations if both the operations and cash flows of the component have been, or will be, eliminated from ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. As a result, the Consolidated Balance Sheets, Statements of Operations and Statement of Cash Flows for all periods reflect retrospective application of Dover's classification as a discontinued operation.
There were no assets and liabilities of discontinued operations as of December 31, 2013 and December 31, 2012.
There was no financial activity related to discontinued operations during 2013. Net loss from discontinued operations, net of tax, for the years ended December 31, 2012 and 2011 were as follows:
All financial information in the consolidated financial statements and notes to the consolidated financial statements reflects continuing operations, unless otherwise noted.
4. Intangible Assets
Business Combinations
Unamortized Intangible Assets (Goodwill)
COB conducted an annual goodwill impairment test as of September 30, 2013, and determined there was no impairment to goodwill. The goodwill relates to the Granite acquisition. Bank of Granite was merged with the Bank on June 8, 2013.
For intangible assets related to business combinations, the following is a summary of the changes in the balance of unamortized intangible assets (goodwill) during the years ended December 31, 2013, 2012 and 2011:
Amortized Intangible Assets
Core Deposit Premium
For intangible assets related to business combinations, the following is a summary of the changes in the original gross carrying amount of amortized intangible assets during the years ended December 31, 2013, 2012 and 2011:
For intangible assets related to business combinations, the following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets and the carrying amount of unamortized intangible assets:
Amortization of core deposit premium intangibles totaled approximately $1.4 million in 2013, $1.4 million in 2012 and $0.9 million in 2011.
The following table presents the estimated amortization expense for intangible assets related to business combinations for each of the five calendar years ending December 31, 2018 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets.
Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others amounted to $190.2 million and $65.1 million at December 31, 2013 and 2012, respectively, and the fair value of mortgage servicing rights was $1.6 million and $0.7 million as of the same dates.
5. Investment Securities
Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of loan production, current interest rate risk strategies and an assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risks.
The following table summarizes the amortized cost and estimated fair value of investment securities and presents the related gross unrealized gains and losses:
As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB based generally upon the balances of total assets and FHLB advances. FHLB capital stock is pledged to secure FHLB advances. This investment is carried at cost since no ready market exists for FHLB stock and there is no quoted market value. However, redemption of this stock has historically been at par value. The Bank owned a total of $5.9 million of FHLB stock at December 31, 2013 and $6.3 million at December 31, 2012. Due to the redemption provisions of FHLB stock, we estimate that fair value approximates cost and that this investment is not impaired at December 31, 2013. FHLB stock is included in other assets at its original cost basis.
As a member bank of the Federal Reserve Bank of Richmond (“FRBR”), the Bank also is required to own capital stock of the FRBR based upon a percentage of the bank's common stock and surplus. This investment is carried at cost since no ready market exists for FRBR stock and there is no quoted market value. At December 31, 2013 and December 31, 2012, the Bank owned a total of $4.3 million and $3.1 million of FRBR stock, respectively. Due to the nature of this investment in an entity of the U.S. government, we have estimated that fair value approximated the cost and that this investment was not impaired at December 31, 2013. FRBR stock is included in other assets at its original cost basis.
Other investments are recorded at cost are included in Other Assets on the Consolidated Balance Sheets, and are composed of the following:
Gross gains and losses recognized (by specific identification) on the sale of securities are summarized as follows:
At December 31, 2013, $91.2 million of the investment securities portfolio was pledged to secure public deposits, $18.8 million was pledged to retail repurchase agreements and $77.4 million was pledged to others, principally the FHLB and FRBR, leaving $376.3 million available as unpledged securities collateral. At December 31, 2012, $111.4 million of the investment securities portfolio was pledged to secure public deposits and $6.1 million was pledged to others, leaving $447.3 million available as lendable collateral.
The following tables show our investments' estimated fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2013 and December 31, 2012. The change in unrealized losses during the years ending December 31, 2013 and 2012 was attributed to changes in interest rates and not to changes in the credit quality of these securities. All unrealized losses on investment securities are considered by management to be temporary given the credit quality of these investment securities or the short duration of the unrealized loss, or both.
At December 31, 2013, there were 10 investment securities that had continuous unrealized losses for more than twelve months. At December 31, 2012, there were 4 investment securities that had continuous unrealized losses for more than twelve months. The unrealized losses relate to fixed-rate debt securities that have incurred fair value reductions due to higher market interest rates and, for certain securities, increased credit spreads since the respective purchase date. The unrealized losses are not likely to reverse unless and until market interest rates and credit spreads decline to the levels that existed when the securities were purchased.
Unrealized losses for all investment securities are reviewed to determine whether the losses are other than temporary. Investment securities are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other than temporary. In conducting this assessment, COB evaluates a number of factors including, but not limited to:
•
How much fair value has declined below amortized cost;
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How long the decline in fair value has existed;
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The financial condition of the issuer;
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Contractual or estimated cash flows of the security;
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Underlying supporting collateral;
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Past events, current conditions, forecasts;
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Significant rating agency changes on the issuer; and
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COB’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.
COB analyzed its securities portfolio at December 31, 2013, and considered ratings, fair value, cash flows and other factors to determine if any of the securities were other than temporarily impaired. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and COB has determined that it is not more likely than not that COB will be required to sell the security before recovery of its amortized cost basis, none of the securities are deemed to be other than temporarily impaired.
The aggregate amortized cost and fair value of securities at December 31, 2013, by remaining contractual maturity, are shown in the following table. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.
6. Loans and Allowance for Loan Losses
The following table presents an aging analysis of accruing and nonaccruing loans as of December 31, 2013:
The following table presents an aging analysis of accruing and nonaccruing loans as of December 31, 2012:
All PI loans are considered to be accruing for all periods presented, in accordance with ASC 310-30.
During the twelve months ended December 31, 2013, we purchased $157.6 million of performing residential mortgage loans, including premiums of $1.3 million. During the twelve months ended December 31, 2012, we purchased $173.2 million of performing residential mortgage loans, including premiums of $4.0 million. These loan purchases are accounted for as PC loans.
Risk Grades
The risk-grade categories presented in the following table, which are standard categories used by the bank regulators, are:
Pass - Loans categorized as Pass are higher quality loans that have adequate sources of repayment and little risk of collection.
Special Mention - A Special Mention loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual assets classified Substandard.
Doubtful - A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors, which may work to the advantage of strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
Loans categorized as Special Mention or worse are considered Criticized. Loans categorized as Substandard or Doubtful are considered Classified. Purchased loans acquired in the Merger are recorded at estimated fair value on the date of acquisition
without the carryover of related ALL. The table below includes $40.5 million and $60.6 million in Granite Purchased Loans categorized as Substandard or Doubtful at December 31, 2013 and December 31, 2012, respectively.
The following table presents loans held for investment balances by risk grade as of December 31, 2013:
The following table presents loans held for investment balances by risk grade as of December 31, 2012:
Loans included in the preceding loan composition table are net of participations sold. Loans are increased by net loan premiums and deferred loan costs of $3.6 million at December 31, 2013. Loans are increased by net deferred loan costs of $3.6 million at December 31, 2012.
At December 31, 2013 and 2012, loans held for sale consisted of originated residential mortgage loans held for sale at the lower of cost or fair market value.
Loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of loans serviced for others amounted to $190.2 million at December 31, 2013 and $65.1 million at December 31, 2012.
Loans Pledged
To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. Investment securities of $24.1 million and $0 million and gross loans of $169.5 million and $270.2 million were pledged to collateralize FHLB advances and letters of credit at December 31, 2013 and December 31, 2012, respectively, of which there was $31.8 million and $19.1 million of credit availability for borrowing, respectively. At December 31, 2013, $9.6 million of loans and $51.2 million of securities were pledged to collateralize potential borrowings from the Federal Reserve Discount Window, of which $54.7 million was available as borrowing capacity. We could also access $301.8 million of additional borrowings from the FHLB under credit lines by pledging additional collateral.
Nonaccruing and Impaired Loans
Interest income on loans is calculated by using the interest method based on the daily outstanding balance. The recognition of interest income is discontinued when, in management's opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. The past due status of loans is based on the contractual payment terms. Had nonaccruing loans been on accruing status, interest income would have been higher by $4.7 million and $5.4 million for the twelve months ended December 31, 2013 and December 31, 2012, respectively. At December 31, 2013 and December 31,
2012, COB had certain impaired loans of $35.2 million and $79.2 million, respectively, which were on nonaccruing interest status.
The following table summarizes information relative to impaired loans for the dates indicated:
The following table presents loans held for investment on nonaccrual status by loan class for the dates indicated:
There were no loans held for sale on nonaccrual status as of December 31, 2013 or December 31, 2012.
The following table presents individually reviewed impaired loans and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of December 31, 2013:
The following table presents individually reviewed impaired loans, and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of December 31, 2012:
The following summary includes impaired loans individually reviewed as well as impaired loans held for sale. Average recorded investment and interest income recognized on impaired loans, segregated by portfolio segment, is shown in the following tables as of December 31, 2013 and December 31, 2012:
Impaired loans also include loans for which we may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower. Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that we otherwise may have to incur. If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans. Nonaccruing restructured loans will remain as nonaccruing until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months and when it is otherwise determined that continued adherence is reasonably assured. Some restructured loans continue as accruing loans after restructuring if the borrower is not past due at the time of restructuring, adequate collateral valuations support the restructured loans, and the cash flows of the underlying business appear adequate to support the restructured debt service. Not included in nonaccruing loans are loans that have been restructured that were performing as of the restructure date. At December 31, 2013, there was $18.1 million in restructured loans, of which $12.1 million were accruing and in a performing status. At December 31, 2012, there was $20.8 million in restructured loans, of which $4.5 million were accruing and in a performing status.
Sale of Problem Loans
During 2012, we sold loans to third party buyers in order to reduce our problem loan exposure. These loans were transferred to loans held for sale at the time we received a signed contract for the purchase of the loans. Prior to transferring these loans to
loans held for sale, the loans were marked down to the contract price less associated selling costs. All transactions were conducted at arm's length and loans were sold without recourse.
The following table presents sold loans by portfolio segment for the periods indicated below:
Granite Purchased Loans
Granite Purchased Loans include PI loans and PC loans. PC loans include performing revolving consumer and commercial loans on October 21, 2011, the acquisition date.
PI loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL. PI loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade. PI loans generally meet our definition for nonaccrual status; however, even if the borrower is not currently making payments, we will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows. All Granite Purchased PI loans are presented on an accruing basis. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.
Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates. 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 the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income. Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
We have elected to account for the Granite Purchased PI loans under ASC 310-30 and the Granite Purchased PC loans under ASC 310-20.
At December 31, 2013, and December 31, 2012, our financial statements reflected a PI loan ALL of $5.6 million and $5.4 million, respectively, and an ALL for PC loans of $0.3 million and $0.7 million, respectively.
The following table presents the balance of all Granite Purchased Loans:
The table below includes only those Granite Purchased Loans accounted for under the expected cash flow method (PI loans) for the periods indicated. These tables do not include PC loans, including Granite Purchased PC loans or purchased performing residential mortgage loans.
Allowance for Loan Losses
An analysis of the changes in the ALL is as follows:
During the year ended December 31, 2013, we charged off $13.3 million in loans and realized $10.3 million in recoveries, for $3.1 million of net charge-offs. The majority of the loans charged off were loans that were previously impaired and had specific reserves assigned in prior periods.
The ALL, as a percentage of loans held for investment, was 2.21% at December 31, 2013, compared to 2.49% at December 31, 2012.
The following table presents ALL activity by portfolio segment for the year ended December 31, 2013:
The following table presents ALL activity by portfolio segment for the year ended December 31, 2012:
The following table presents ALL activity by portfolio segment for the year ended December 31, 2011:
The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at December 31, 2013:
The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at December 31, 2012:
Troubled Debt Restructuring
The following tables presents a breakdown of troubled debt restructurings that were restructured during the periods presented, segregated by portfolio segment:
During the twelve months ended December 31, 2013, we modified 19 loans that were considered to be troubled debt restructurings. We extended the terms for 3 of these loans, modified the interest rate for 2 of these loans, and modified the remaining 14 loans in both ways. During the twelve months ended December 31, 2012, we modified 17 loans that were considered to be troubled debt restructurings. We extended the terms and lowered the interest rate for seven of these loans, and only extended the terms for the remaining ten loans.
There were no loans restructured in the twelve months prior to December 31, 2013 that went into default during the year ended December 31, 2013. There were also no loans restructured in the twelve months prior to December 31, 2012 that went into default during the year ended December 31, 2012.
In the determination of the ALL, management considers troubled debt restructurings and any subsequent defaults in these restructurings as impaired loans. The amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's initial effective interest rate, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent.
Unfunded Commitments
The reserve for unfunded commitments, which is included in other liabilities, is calculated by estimating the amount of additional funding on the commitment and multiplying that amount by the historical loss rate (including Q&E factors). The following describes our method for determining the estimated additional funding by commitment type:
•
Straight Lines of Credit - Unfunded balance of line of credit (100% utilization)
•
Revolving Lines of Credit - Average Utilization (for the last 12 months) less Current Utilization
•
Letters of Credit - 10% utilization
The reserve for unfunded commitments was $0.5 million as of December 31, 2013 and $0.6 million at December 31, 2012.
7. Premises and Equipment
Premises and equipment at December 31 is summarized as follows:
Depreciation and amortization expense totaled $3.7 million, $3.8 million, and $3.3 million for the years ended December 31, 2013, 2012 and 2011, respectively.
8. Other Real Estate Owned and Personal Property Acquired in Settlement of Loans
OREO consists of real estate acquired through foreclosure or deed in lieu thereof. The property is classified as held for sale. The property is initially carried at fair value based on recent appraisals, less estimated costs to sell. Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income.
Total OREO and personal property acquired in settlement of loans decreased $34.7 million from $63.1 million at December 31, 2012, to $28.4 million at December 31, 2013.
The following table summarizes real estate acquired in settlement of loans and personal property acquired in settlement of loans at the periods indicated:
The following table summarize the changes in real estate acquired in settlement of loans at the periods indicated:
At December 31, 2013, 13 assets with a net carrying amount of $5.0 million were under contract for sale and are primarily expected to close during the first quarter of 2014. Estimated losses on these sales have been recognized in the Consolidated Statements of Operations for 2013. At December 31, 2012, 35 assets with a net carrying amount of $22.0 million were under contract for sale. The sale of these assets closed during the first and second quarter of 2013. Estimated losses on these sales were recognized in the Consolidated Statements of Operations for 2012.
9. Accumulated Other Comprehensive Income
The following table presents the changes in our accumulated other comprehensive income (loss), net of tax, by component for the period indicated:
The following table presents the reclassifications out of our accumulated other comprehensive income (loss) for the year ended December 31, 2013:
10. Commitments and Contingencies
From time to time, we are subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against us incident to the operation of our business. In management's opinion, there are no proceedings pending to which we are a party or to which our property is subject, which, if determined adversely to us, would be material in relation to our shareholder's equity or financial condition. In addition, no material proceedings are pending or are known to be threatened or contemplated against us by governmental authorities or other parties.
COB leases certain facilities and equipment for use in its business. The lease for facilities generally runs for periods of 5 to 10 years with various renewal options, while leases for equipment generally have terms not in excess of 5 years. The majority of the leases for facilities contain rental escalation clauses tied to changes in price indices. Certain real property leases contain purchase options. Management expects that most leases will be renewed or replaced with new leases in the normal course of business.
Future obligations at December 31, 2013 for minimum rentals under non-cancelable operating lease commitments, primarily relating to premises, are as follows:
Net rental expense for all operating leases amounted to $2.2 million, $2.2 million, and $1.7 million for the years ended December 31, 2013, 2012 and 2011, respectively.
11. Income Taxes
The components of income tax expense for the years ended December 31 are as follows:
A reconciliation of income tax expense computed at the statutory federal income tax rate to actual income tax expense is presented in the following table as of December 31:
Deferred taxes are provided using the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. Excluding unrealized losses on available-for-sale securities, COB has recorded a 100% deferred tax valuation allowance related to various temporary differences, principally consisting of the provision for loan losses and its net operating loss carryforwards.
As of December 31, 2013 and December 31, 2012, net deferred income tax assets totaling $10.2 million and $0.8 million, respectively, are recorded on COB’s balance sheet. No valuation allowance is recorded for unrealized losses on investment securities because it is not more likely than not that COB will have to sell these securities at a loss.
The components of deferred tax assets and liabilities and the tax effect of each are as follows:
Under GAAP, COB is not required to provide a deferred tax liability for the tax effect of additions to the tax bad debt reserve through 1987, the base year. Retained earnings at December 31, 2013 include approximately $5.0 million for which no provision for federal income tax has been made. These amounts represent allocations of income to bad debt deductions for tax purposes only. Reductions of such amounts for purposes other than bad debt losses could create income for tax purposes in certain remote instances, which would then be subject to the then current corporate income tax rate.
The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder. Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral. Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016. Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires. Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period. During 2013, COB reduced its deferred tax asset by $28.3 million based on its inability to use the Granite Corp. net operating losses and built in losses that are limited due to the change in ownership that occurred at acquisition. The net reduction in DTA is offset by a corresponding reduction in the valuation allowance. The Company believes the remaining DTA of $2.9 million related to NOL carryforwards from Granite Corp. will be realized on a go forward basis.
The State of North Carolina passed legislation to reduce the income tax rates from 6.90% to 6.0% in 2014 and to 5.0% in 2015. The DTA has been reduced by $5.3 million to account for the reduction in income tax rates to 5%. The net reduction in DTA is offset by a corresponding reduction in the valuation allowance. Beginning in the third quarter, the Company will use an effective tax rate of 38.25%, from 39.485%, based on the reduction in the North Carolina income tax rate.
12. Deposits
The following table summarizes deposit composition at the dates indicated.
The aggregate amount of jumbo certificates of deposit, which includes no brokered deposits and have minimum denominations of $100,000, was approximately $229.4 million and $290.2 million in 2013 and 2012, respectively.
At December 31, 2013 and December 31, 2012, $0.4 million of overdrawn transaction deposit accounts were reclassified to loans.
The accompanying table presents the scheduled maturities of time and brokered deposits at December 31, 2013.
Interest expense on time deposits of $100,000 or more amounted to $2.6 million in 2013, $5.0 million in 2012 and $6.1 million in 2011.
13. Short-Term Borrowings and Long-Term Debt
The following table stratifies COB’s borrowings as short-term and long-term at the periods indicated.
Retail Repurchase Agreements and Federal Funds Purchased
Funds are borrowed on an overnight basis through retail repurchase agreements with bank customers and federal funds purchased from other financial institutions. Retail repurchase agreement borrowings are collateralized by securities of the U.S. Treasury and U.S. Government agencies and corporations.
At December 31, 2013, the Bank had no borrowings at the Federal Reserve Bank.
Information concerning retail repurchase agreements and federal funds purchased is as follows:
Federal Home Loan Bank (“FHLB”) Advances
At December 31, 2013, the Bank had an available borrowing capacity of $31.8 million and access to additional borrowings of $301.8 million by pledging additional collateral with the FHLB. At December 31, 2013, outstanding FHLB advances under the current line amounted to $73.3 million and were at interest rates ranging from 0.93% to 6.15%. These borrowings are secured by collateral on qualifying mortgage loans and, as required, by other qualifying collateral. At December 31, 2012, FHLB advances amounted to $58.3 million and were at interest rates ranging from 2.33% to 6.15%.
At December 31, 2013, the scheduled maturities of FHLB advances payable over the next five years and thereafter, certain of which are convertible to a variable rate at the option of the FHLB before scheduled maturity, are as follows:
Long-term debt included of the following advances from the FHLB at the periods indicated.
During the second quarter of 2013 we restructured $50 million of Federal Home Loan Bank advances from fixed rate to floating rate, which we expect to further reduce interest costs. The restructured advances, per ASC 470-50 "Debt - Modifications and Extinguishments," are not substantially different than the prior advances so there was no debt extinguishment.
Subordinated Debt
On October 21, 2011, as part of the Recapitalization, the Bank settled $2.5 million aggregate principal amount of subordinated debt outstanding and held by SunTrust Bank for cash in an amount equal to the sum of 35% of the principal amount thereof plus 100% of the unpaid and accrued interest thereon as of the closing date. The Bank recognized a gain of approximately $1.6 million as part of the settlement. During 2010, we converted $7.5 million of subordinated debt into $7.5 million of nonvoting, nonconvertible, nonredeemable cumulative preferred stock, and converted an additional $5.0 million during the first quarter of 2011. On October 21, 2011, the Bank repurchased from SunTrust the shares of nonvoting, nonconvertible, nonredeemable cumulative preferred stock of the Bank held by SunTrust and having an aggregate liquidation preference of $12.5 million for cash in an amount equal to the sum of 25% of the aggregate liquidation preference plus 100% of the unpaid and accrued dividends thereon as of the closing date. The Bank recorded an increase in retained earnings of approximately $9.4 million in connection with this settlement. Thus, as of October 21, 2011, the Bank no longer had any outstanding subordinated debt.
Long-term Notes Payable
The amount reported as long-term notes payable consists of a note, secured by Bank stock, payable to Howe Barnes Hoefer & Arnett, Inc. ("Howe Barnes") in connection with the settlement of legal proceedings between Howe Barnes and the Bank. The note bears an imputed interest rate of 1.41% and matures in 2016.
Junior Subordinated Deferrable Interest Debentures
COB has Junior Subordinated Deferrable Interest Debentures or Junior Subordinated Debentures outstanding. Two issues of Junior Subordinated Debentures resulted from funds invested from the sale of trust preferred securities by FNB United Statutory Trust I (“FNB Trust I”) and by FNB United Statutory Trust II (“FNB Trust II”), which are owned by COB. Two additional issues of Junior Subordinated Debentures were acquired on April 28, 2006 as a result of COB’s merger with Integrity Financial Corporation. These acquired issues resulted from funds invested from the sale of trust preferred securities by Catawba Valley Capital Trust I (“Catawba Trust I”) and by Catawba Valley Capital Trust II (“Catawba Trust II”), which were owned by Integrity and acquired by COB in the merger. COB initiated the redemption of the securities issued by Catawba Valley Trust I as of December 30, 2007 and that trust was subsequently dissolved.
COB fully and unconditionally guarantees the preferred securities issued by each trust through the combined operation of the debentures and other related documents. Obligations under these guarantees are unsecured and subordinate to senior and subordinated indebtedness of COB. The preferred securities qualify as Tier 1 and Tier 2 capital for regulatory capital purposes.
During the second quarter of 2010, COB suspended payment of interest on junior subordinated debt for liquidity purposes. The associated interest expense on junior subordinated debt has been fully accrued and is included in the Consolidated Statements of Operations. Payment of this interest was made in connection with the Recapitalization in order to be able to redeem the
CommunityOne preferred stock issued to SunTrust Bank, described above. COB again suspended payment of interest on the Junior Subordinated Debentures as of the first quarter 2012.
Information concerning the Junior Subordinated Debentures is as follows at the periods indicated.
14. Employee Benefit Plans
Pension Plan
COB maintains a defined benefit pension plan. In September 2006, the Board of Directors of COB approved a modified freeze to the pension plan. Effective December 31, 2006, no new employees were eligible to enter the plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of COB and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. In November 2010, COB’s Board of Directors approved an additional amendment to the plan which ceased participant benefit accruals as of December 31, 2010. The retirement benefits of all other participants in the pension plan were frozen as of December 31, 2006.
Benefits are based on the employee's compensation, years of service and age at retirement. COB's funding policy is to contribute annually to the plan an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes.
The following table sets forth the plan’s change in benefit obligation, plan assets and the funded status of the pension plan, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
The expected long-term rate of return on plan assets considers the portfolio as a whole and not on the sum of the returns on individual asset categories.
Components of net periodic pension cost (income) and other amounts recognized in other comprehensive income are as follows:
The estimated net loss and prior service cost that will be amortized from accumulated other comprehensive income/(loss) into net periodic pension cost over the next year are approximately $0.4 million and $0, respectively.
COB’s investment policies and strategies for the pension plan use a target allocation for equity and for debt securities based on the funding status of the plan. The investment goals attempt to maximize returns while remaining within specific risk management policies. While the risk management policies permit investment in specific debt and equity securities, a significant percentage of total plan assets are maintained in mutual funds, approximately 99.7% at December 31, 2013, to assist in investment diversification. Generally the investments are readily marketable and can be sold to fund benefit payment obligations as they become payable.
The following table provides the fair values of investments held in the pension plan by major asset category:
December 31, 2013
December 31, 2012
The equity securities measured at fair value consist primarily of stock mutual funds (Level 1 inputs). Debt securities include corporate bonds, bond mutual funds, U.S. government and agency securities and obligations of state and political subdivisions (Level 1 inputs). Other investments consist of money market deposits (Level 1 inputs). For further information regarding levels of input used to measure fair value, refer to Note 20.
In 2013, COB contributed $0 to its pension plan. COB expects to contribute $150 thousand to its pension plan in 2014. However, the assets of the COB Employees Pension Plan are less in value than the present value of the accrued benefits (vested and unvested) of the participants in the Pension Plan on a termination and projected benefit obligation basis.
The estimated benefit payments for each year ending December 31 from 2014 through 2018 are as follows: $0.8 million in 2014, $0.8 million in 2015, $0.9 million in 2016, $0.9 million in 2017 and $0.9 million in 2018. The estimated benefit payments to be paid in the aggregate for the five year period from 2019 through 2023 are $4.5 million. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2013 and include estimated future employee service.
Supplemental Executive Retirement Plans
COB has maintained three noncontributory, nonqualified supplemental executive retirement plans (“SERPs”), covering certain executive employees.
Annual benefits payable under the first of these SERPs are based on factors similar to those for the pension plan, with offsets related to amounts payable under the pension plan and social security benefits. SERP costs, which are actuarially determined using the projected unit credit method and recorded on an unfunded basis, are charged to current operations and credited to a liability account on the consolidated balance sheet. In 2010, the Board of Directors approved an amendment to the plan which stopped additional benefit accrual under the SERP after December 31, 2010. This action did not impact a participant's vested or accrued benefit in the plan. In September, 2012 the Board of Directors approved an amendment to terminate the Plan. The amendment provides for lump sum cash distributions of participant benefits in accordance with Internal Revenue Code Section 409A. These payments were made in 2013 and there are no further obligations under this SERP.
In connection with the acquisition by COB of Carolina Fincorp, Inc. in 2000, CommunityOne assumed the obligations of Richmond Savings Bank, Inc., SSB under its Nonqualified Supplemental Retirement Plan. There was one retired executive covered under this plan, who was entitled to a retirement benefit of $30,000 per year payable for 10 years. Benefit payments began in 2012. In September, 2012 the Board of Directors approved an amendment to terminate the Plan. The amendment provided for a lump sum cash distribution of the participant benefit in accordance with Internal Revenue Code Section 409A. These payments were made during 2013 and there are no future obligations under this SERP.
As a result of the acquisition of Integrity Financial Corporation in 2006, CommunityOne assumed the obligations of a nonqualifying deferred compensation plan for the former president of Integrity. Under the plan provisions, benefit payments began in 2006 and are payable for 10 years. During 2013, 2012 and 2011, provisions of $17,000, $39,000, and $49,000 respectively, were expensed for future benefits to be provided under this plan. The total liability under this plan was $0.3 million at December 31, 2013 and $0.4 million at December 31, 2012, respectively, and is included in other liabilities in the accompanying consolidated balance sheets. Payments amounting to $78,000 in 2013, $80,000 in 2012 and $76,000 in 2011 were made under the provisions of this SERP.
The following table sets forth the change in benefit obligation, plan assets and the funded status of the three SERPs, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
The increase in the assumed discount rate is the result of COB's decision to terminate the SERP plan and pay out the remaining balance in 2013.
Components of net periodic SERP cost and other amounts recognized in other comprehensive loss are as follows:
The estimated net (gain) loss and prior service cost that will be amortized from accumulated other comprehensive income (loss) into net periodic SERP cost over the next year are approximately $0 and $0 respectively.
The remaining SERP is an unfunded plan. Consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.
Other Postretirement Defined Benefit Plans
COB has maintained a postretirement benefit plan, which provides medical and life insurance benefits to retirees who obtained certain age and service requirements. The medical plan is contributory, with retiree contributions adjusted whenever medical insurance rates change. The life insurance plan is noncontributory.
In conjunction with the modified freeze of the pension plan, the postretirement medical and life insurance plan was also amended. Effective December 31, 2006, no new employees are eligible to enter the postretirement medical and life insurance plan. Participants who were at least age 40, had earned 10 years of vesting service as an employee of COB and remained an active employee as of December 31, 2006 qualified for a grandfathering provision. In November 2010, COB’s Board of Directors approved an additional amendment to the plan which ceased participant benefit accruals as of December 31, 2010.
The following table sets forth the plans change in benefit obligation, plan assets and the funded status of the postretirement plans, using a December 31 measurement date, and amounts recognized in the consolidated statements as of December 31:
Increasing or decreasing the assumed medical cost trend rate by one percentage point would not have a significant effect on either the postretirement benefit obligation at December 31, 2013 or the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2013.
Components of net postretirement benefit cost and other amounts recognized in other comprehensive income are as follows:
The estimated net (gain) loss and prior service credit that will be amortized from accumulated other comprehensive income/(loss) into net periodic postretirement benefit cost over the next year are $(4,000) and $(4,200).
The postretirement medical and life insurance plans are unfunded plans. Consequently, there are no plan assets or cash contribution requirements other than for the direct payment of benefits.
The estimated benefit payments for each year ending December 31 from 2014 through 2018 are as follows: $65,000 in 2014, $68,000 in 2015, $68,000 in 2016, $69,000 in 2017 and $70,000 in 2018. The estimated benefit payments to be paid in the aggregate for the five year period from 2019 through 2023 are $0.4 million. The estimated benefit payments are based on the same assumptions used to measure the benefit obligation at December 31, 2013 and include estimated future employee service.
Matching Retirement/Savings Plan
COB has a matching retirement/savings plan which permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. A portion of the employee contributions are matched by COB based on the plan formula, which is $0.50 for each dollar on the first 6% of eligible pay deferred by the employee under the plan. Additionally, commencing in 2007, COB on a discretionary basis may make an annual contribution up to a specified percentage of compensation as defined by the plan to the account of each eligible employee. COB did not make a discretionary contribution in 2013, 2012 or 2011. The matching and discretionary contributions amounted to $0.5 million in 2013, $0.6 million in 2012, and $0.4 million in 2011.
Granite sponsored a tax-qualified profit-sharing and savings retirement plan covering substantially all Granite employees. Contributions to the plan were made at the discretion of the Board of Directors but were not permitted to exceed the maximum amount allowable for federal income tax purposes. There were no Company contributions made for the years ended December 31, 2013 and 2012. The plan permits eligible employees to make contributions to the plan up to a specified percentage of compensation as defined by the plan. Effective January 1, 2012, the plan was amended to provide a match on a portion of the employee contributions. The match is based on the plan formula, which is $0.50 for each dollar on the first 6% of eligible pay deferred by the employee under the plan. During July 2012, Granite's plan and COB's plan were merged together into an amended and restated CommunityOne 401(k) plan.
Granite sponsored a non-tax qualified profit-sharing supplemental executive retirement plan for certain executive officers, which allowed Granite to supplement the level of the executive officers' retirement incomes over that which is obtainable through the tax-qualified profit-sharing retirement plan sponsored by Granite. There was no expense for the years ended December 31, 2013 and 2012. The plan was terminated in October, 2011 and two remaining balances were paid out in 2012. There are no future obligations under this plan.
15. CommunityOne Bancorp (Parent Company)
The parent company’s principal asset is its investments in its bank subsidiary, the Bank.
The condensed financial position as of December 31, 2013 and 2012, and the condensed results of operations and cash flows for each of the years in the three-year period ended December 31, 2013 of COB, parent company only, are presented below.
16. Capital Matters
COB and the Bank are required to comply with capital adequacy requirements established by the federal banking agencies. Failure to meet these minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on COB’s and the Bank's financial statements. Under the capital adequacy guidelines, COB and the bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. COB and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. In addition, the prompt corrective action provisions of federal law require the federal banking agencies to take action to resolve problems of insured depository institutions such as the Bank as their capital levels decrease.
The Bank had been subject to a Consent Order with the OCC, dated July 22, 2010, which was terminated by the OCC effective June 10, 2013. However, the Bank has continuing obligations to, among other things, adhere to its 2013 Business Plan for which the Bank has obtained supervisory non-objection from the OCC, including maintaining the capital ratios contained in the Plan, and continues to have restrictions on its ability to pay dividends. Likewise, the Written Agreement between COB and the FRBR dated October 21, 2010 was terminated effective November 7, 2013; however, COB remains obligated to make sure the Bank adheres to its Business Plan. COB also remains obligated to not declare or pay any dividends or make any payments on its trust preferred securities or incur, increase or guarantee additional debt without prior written approval of the FRBR. The Bank is in compliance with its Business Plan and COB is in compliance with the obligations described above.
Quantitative measures established by regulation to ensure capital adequacy require each bank to maintain minimum amounts and ratios (set forth in the accompanying table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). The minimum capital requirements to be characterized as “well-capitalized” and “adequately capitalized,” as defined by the prompt corrective action provision of federal law and CommunityOne’s capital ratios as of December 31, 2013 are noted in the following table. At December 31, 2013 CommunityOne Bank was designated as “well capitalized.”
17. Shareholders’ Equity
Earnings per Share
COB filed articles of amendment to its articles of incorporation on October 31, 2011 to effect a one-for-one hundred reverse stock split (the “Reverse Stock Split”) of its common stock. The amendment became effective following the close of trading on October 31, 2011. A purpose of the Reverse Stock Split is to increase the per share trading price of COB's common stock to satisfy the $1.00 minimum bid price requirement for continued listing on The Nasdaq Capital Market. As a result of the Reverse Stock Split, every 100 shares of COB's common stock issued and outstanding prior to the opening of trading on November 1, 2011 were consolidated into one issued and outstanding share. No fractional shares were issued as a result of the Reverse Stock Split. Instead, any fractional share resulting from the Reverse Stock Split was rounded up to the next largest whole share. All share and per share amounts have been retroactively adjusted in the financial statements and footnotes to account for the impact of the Reverse Stock Split.
Basic net loss per share, or basic earnings (loss) per share (“EPS”), is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period.
During the years ended December 31, 2013 and December 31, 2012, COB had no preferred stock outstanding. During the year ended December 31, 2011, and in order the complete the Recapitalization, COB paid dividends and deferred interest of approximately $4.5 million on Series A preferred stock, in addition to the $0.6 million accretion of the discount on the preferred stock. At December 31, 2013 and December 31, 2012, COB had no unpaid cumulative dividends.
The following table represents the impact of preferred stock activity on the Consolidated Statement of Operations for the years ended December 31, 2013, 2012, and 2011:
Diluted EPS reflects the potential dilution that could occur if COB’s potential common stock, which consists of dilutive stock options and a common stock warrant held by the U.S. Treasury, were issued. As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement.
Due to a net loss for the twelve month periods ended December 31, 2013, 2012 and 2011; all stock options and the common stock warrant were considered antidilutive and thus are not included in this calculation. Additionally, for the periods ended December 31, 2013, December 31, 2012 and December 31, 2011, there were 22,713, 23,197 and 24,818 antidilutive shares, respectively. Of the antidilutive shares, the number of shares relating to stock options were 641 at December 31, 2013, 1,125 at December 31, 2012, and 2,746 at December 31, 2011. Average antidilutive shares relating to the common stock warrant were 22,072 for each of the three years. Because the exercise price exceeded the average market price for the periods discussed and because of the net loss, the stock options and common stock warrant were omitted from the calculation of diluted earnings per share for their respective periods.
Stock Based Compensation
For the years ended December 31, 2013, 2012 and 2011, COB had five share-based compensation plans in effect. The compensation expense charged against income for those plans was $653,000, $3,000, and $23,000, respectively, and the related income tax benefit was $250,000, $1,000 and $9,000, respectively.
On June 21, 2012, COB shareholders approved the FNB 2012 Incentive Plan. The 2012 Incentive Plan, which was intended to replace the 2003 plan, provides for the grant of stock options, restricted stock and other stock-based awards, as well as cash-based performance awards. An amended and restated Incentive Plan was approved by the shareholders on June 20, 2013. As amended, a total of 1,800,000 shares have been authorized for issuance under the 2012 Incentive Plan, and the maximum number of shares of COB common stock with respect to which an employee may be granted awards under the 2012 Incentive Plan during any calendar year period is 100,000 shares. On December 28, 2012, a total of 110,059 shares of long-term restricted stock were granted pursuant to the 2012 Incentive Plan to the top six officers of COB and during 2013, a total of 158,302 shares of restricted stock were issued to the
same six officers, eight of the nine non-executive directors, and a larger group of employees pursuant to the same plan. In each case such shares were valued at the closing price of COB common stock on the grant date.
COB adopted stock compensation plans in 1993 and 2003 that allow for the granting of incentive and nonqualified stock options to key employees and directors. The 2003 stock compensation plan also allows for the granting of restricted stock. Under terms of both the 1993 and 2003 plans, options are granted at prices equal to the fair market value of the common stock on the date of grant. Options become exercisable after one year in equal, cumulative installments over a five-year period. No option shall expire later than ten years from the date of grant. No further grants can be made under the 1993 stock compensation plan after March 10, 2003. Based on the stock options outstanding at December 31, 2013, no shares of common stock have been reserved for issuance under the 1993 stock compensation plan. No shares of common stock has been reserved for issuance under the 2003 stock compensation plan. At December 31, 2013, there were no shares available under the 2003 plan for the granting of additional options or stock awards.
With the completion of the Merger, each outstanding option to purchase shares of Granite Corp. common stock, whether or not exercisable, was converted into options to purchase COB common stock. After adjusting for the Reverse Stock Split and rounding up to the nearest whole share, there were 78 stock options assumed from Granite Corp. All of those options expired during 2012, and none remain exercisable at December 31, 2013.
COB assumed three stock compensation plans in its acquisition of Integrity Financial Corporation in 2006. Qualified and nonqualified stock options are outstanding under these plans for grants issued from 1997 to 2004 to key employees and directors at a price equal to fair market value on the date of grant. No additional grants will be made under these plans. Based on the stock options outstanding at December 31, 2013, no shares of common stock have been reserved for issuance under these stock compensation plans.
The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based on the historical volatility of the COB’s common stock over approximately the previous 6 years, except for the options granted in 2013, which are based on the historical volatility of COB's common stock since July 1, 2012. The expected life of the options has historically been considered to be approximately 6 years. The expected dividend yield is based upon the current yield in effect at the date of grant. There were 54,060 options granted to employees during 2013 with a risk-free rate of 2.60%, a historical volatility of 29.60% and an expected dividend yield of 0%. The fair value of options granted during 2013 was $3.27. There were no stock options granted in 2012 or 2011, respectively.
The following is a summary of stock option activity:
At December 31, 2013, information concerning stock options outstanding and exercisable is as follows:
In 2013, 2012 and 2011, there was no intrinsic value of options exercised, and the grant-date fair value of options vested was $0 in each of the three years. There were no options exercised in 2013.
The following is a summary of non-vested restricted stock activity:
The fair value of restricted stock vested in 2013, 2012 and 2011 was $0, $1,040, and $1,040 respectively.
On December 19, 2013, a total of 158,302 shares of restricted stock were granted by the COB Board of Directors to the same six officers, eight of the nine non-executive directors, and a larger group of employees. The awards to the six officers constituted long-term restricted stock, some of which were time vesting only, with 2/3rds of the stock vesting on the second anniversary of the date of grant and the final 1/3 vesting on the third anniversary of the date of grant, and a portion of which also require COB common stock to reach a certain stock price target. The awards to the directors constituted restricted stock, some of which were time vesting only, with 1/3 of the stock vesting on the first anniversary of the date of grant, the second 1/3 vesting on the second anniversary of the date of grant, and the final 1/3 vesting on the third anniversary of the date of grant, and a portion of which also require COB common stock to reach a certain stock price target. The awards to the larger group of employees vest over time, with 1/4 of the stock vesting on each of the first, second, third and fourth anniversary of the date of the grant. On December 28, 2012, a total of 110,059 shares of long-term restricted stock were granted by the COB Board of Directors to the top six officers of COB at the closing price of COB common stock on the grant date. Under the terms of the awards, 2/3rds of the restricted stock vests on the later of the lifting of the Consent Orders or the second anniversary of the date of grant and the final 1/3rd of the stock vesting on the later of the lifting of the Consent Order or the third anniversary of the date of grant. As indicated previously, all of the Consent Orders have been lifted.
As of December 31, 2013, unrecognized compensation cost related to non-vested share-based compensation arrangements granted under COB’s stock benefit plans totaled $2.5 million, which will be fully recognized by December 2016.
COB funds the option shares and restricted stock from authorized but unissued shares. COB does not typically purchase shares to fulfill the obligations of the stock benefit plans. COB’s policy does allow option holders under certain plans to exercise options with seasoned shares.
18. Off-Balance Sheet Arrangements
In the normal course of business, various commitments are outstanding that are not reflected in the consolidated financial statements. Significant commitments at December 31, 2013 are discussed below.
Commitments by the Bank to extend credit and undisbursed advances on customer lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. At December 31, 2013, total commitments to extend credit and undisbursed advances on customer lines of credit amounted to $225.6 million. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments expire without being fully drawn, the total
commitment amounts do not necessarily represent future cash requirements. COB evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on the credit evaluation of the borrower.
The Bank issues, and Granite previously issued, standby letters of credit whereby each guarantees the performance of a customer to a third party if a specified triggering event or condition occurs. The guarantees generally expire within one year and may be automatically renewed depending on the terms of the guarantee. All standby letters of credit provide for recourse against the customer on whose behalf the letter of credit was issued, and this recourse may be further secured by a pledge of assets. The maximum potential amount of undiscounted future payments related to standby letters of credit was $0.7 million at December 31, 2013 and $0.9 million at December 31, 2012.
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. The fair value of these commitments was not considered material.
COB does not have any special purpose entities or other similar forms of off-balance sheet financing.
19. Derivatives and Financial Instruments
A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. These instruments include interest rate swaps, caps, floors, collars, options or other financial instruments designed to hedge exposures to interest rate risk or for speculative purposes.
Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.
During the fourth quarter 2009 and first quarter 2010, the Bank entered into four interest rate swaps totaling $45.0 million, using a receive-fixed swap to mitigate the exposure to changes in the fair value attributable to the benchmark interest rate (3-month LIBOR) of the hedged items (FHLB advances) from the effective date to the maturity date of the hedged instruments. As structured, the pay-variable, receive-fixed swaps are evaluated as fair value hedges and are considered highly effective. As highly effective hedges, all fair value designated hedges and the underlying hedged instrument are recorded on the balance sheet at fair value with the periodic changes of the fair value reported in the income statement.
During the third quarter of 2011, the Bank terminated a $15.0 million interest swap at a gain of $0.9 million. This swap was used to hedge a FHLB advance that was terminated concurrently at a loss of $2.0 million. The gain on the swap and loss on the hedged item were netted in noninterest expense in the Consolidated Statements of Operations. The Bank is now under no additional obligations related to either this swap or the terminated FHLB advance. During the fourth quarter of 2011, the Bank terminated the remaining $30.0 million interest swaps at a gain of $0.8 million. This swap was used to hedge a FHLB advance that was terminated concurrently at a loss of $1.3 million. These swaps were used to convert fixed-rate FHLB advances to a floating interest rate. The gain on the swap and loss on the hedged item were netted in noninterest expense in the Consolidated Statements of Operations. The Bank is now under no additional obligations related to either the terminated swaps or the terminated FHLB advance. The net loss on the early termination of these advances was $1.6 million and is recorded as prepayment penalty on borrowings in the Consolidated Statements of Operations. There are no swaps hedging FHLB advances at December 31, 2013 or 2012.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts or forward contracts and rate lock loan commitments. The fair value of our derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.
The table below provides data about the amount of gains and losses related to derivative instruments designated as hedges included in the “Accumulated other comprehensive loss” section of “Shareholders’ Equity” on the COB’s Consolidated Balance Sheets, and in “Other income” in the COB’s Consolidated Statements of Operations:
During 2012, we began originating residential mortgage loans for sale in the secondary market. We have established guidelines in originating, selling loans to Fannie Mae, and retaining or selling the loan servicing rights. The commitments to borrowers to originate residential mortgage loans and the forward sales commitments to investors are freestanding derivative instruments. As such, they do not qualify for hedge accounting treatment, and the fair value adjustments for these instruments is recorded through the Consolidated Statements of Operations in mortgage loan income. The fair market value of mortgage banking derivatives at December 31, 2013 was recorded in the consolidated balance sheet in Other Assets.
Discontinued Operations
On April 7, 2009, Dover irrevocably opted to elect the fair value option for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. This election allowed Dover to enter into a hedging arrangement for the purpose of limiting risk inherent in the closed but unlocked mortgage loan pipeline and loans held for sale portfolio.
The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:
(1)
Recognized in “Net loss from discontinued operations” in the Company’s Consolidated Statements of Operations.
Dover originated certain residential mortgage loans with the intention of selling these loans. Between the time that Dover entered into an interest rate lock or a commitment to originate a residential mortgage loan with a potential borrower and the time the closed loan is sold, COB was subject to variability in market prices related to these commitments. COB believed that it was prudent to limit the variability of expected proceeds from the future sales of these loans by entering into forward sales commitments and commitments to deliver loans into a mortgage-backed security. The commitments to originate residential mortgage loans and the forward sales commitments were freestanding derivative instruments. They did not qualify for hedge accounting treatment so their fair value adjustments were recorded through the income statement in income from mortgage loan sales.
20. Fair Values of Assets and Liabilities
We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale, derivative assets and liabilities, certain FHLB advances hedged by interest rate swaps designated as fair value hedges, performing mortgage loans held for sale, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as nonperforming loans held for sale, loans held for investment, impaired loans and certain other assets and
liabilities. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets or liabilities.
Fair Value Hierarchy
We group assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3: Valuation is generated from model-based 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 use of option pricing models, discounted cash flow models and similar techniques.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
Investments Securities
Investment securities classified as available-for-sale are recorded at fair value on a recurring basis. Investment securities classified as held-to-maturity are recorded at amortized cost. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security's credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 may include asset-backed securities in less liquid markets.
Liquidity is a significant factor in the determination of the fair values of available-for-sale debt securities. Market price quotes may not be readily available for some positions, or positions within a market sector where trading activity has slowed significantly or ceased. Some of these instruments are valued using a discounted cash flow model, which estimates the fair value of the securities using internal credit risk, interest rate and prepayment risk models that incorporate management's best estimate of current key assumptions such as default rates, loss severity and prepayment rates. Principal and interest cash flows are discounted using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value for the specific security. Underlying assets are valued using external pricing services, where available, or matrix pricing based on the vintages and ratings. Situations of illiquidity generally are triggered by the market's perception of credit uncertainty regarding a single company or a specific market sector. In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer's financial statements and changes in credit ratings made by one or more ratings agencies.
Loans Held for Sale
Loans held for sale are carried at the lower of cost or fair value less estimated costs to sell. Once sold, the loans are beyond the reach of COB in all respects and the purchasing investor has all rights of ownership, including the ability to pledge or exchange the loans. Most of the loans sold are without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in Consolidated Statements of Operations. Since loans held for sale are carried at the lower of cost or fair value, the fair value of loans held for sale is based on contractual agreements with independent third-party buyers. As such, we classify loans held for sale subjected to nonrecurring fair value adjustments as Level 2.
Loans Held for Investment
We do not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management determines the fair value of the loan to quantify impairment, should such exist. The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans. At December 31, 2013 and December 31, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. We record impaired loans as nonrecurring Level 3.
Other Real Estate Owned
OREO is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. Given the lack of observable market prices for identical properties, we record OREO as nonrecurring Level 3.
Interest Rate Locks and Forward Loan Sale Commitments
We enter into interest rate lock commitments and commitments to sell mortgages. The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and the balance sheet date. We record interest rate lock commitments as recurring level 3, and based on their immaterial value, has excluded them from the fair value table.
Mortgage Servicing Rights
The fair value of mortgage serving rights (MSR) is dependent upon a number of assumptions including the fee per loan, the cost to service, the expected loan prepayment rate, and the discount rate. In determining the fair value of the existing MSR management reviews the key assumptions, analyzes pricing in the market for comparable MSR, and uses a third party provider to independently calculate the fair value of its MSR. We record mortgage servicing rights as recurring Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Assets and liabilities carried at fair value on a recurring basis at December 31, 2013 for continuing operations are summarized in the following table:
Assets and liabilities carried at fair value on a recurring basis at December 31, 2012 for continuing operations are summarized in the following table:
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) during the periods indicated:
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. This is due to further deterioration in the value of the assets.
Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2013 for continuing operations:
Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2012 for continuing operations:
There are no assets or liabilities measured at fair value on a nonrecurring basis at December 31, 2013 or December 31, 2012 for discontinued operations.
Quantitative Information about Level 3 Fair Value Measurements
Level 3 Valuation Methodologies. Following is a description of the unobservable inputs used for Level 3 fair value measurements.
Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.
Because no market exists for a portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value for each class of COB's financial instruments.
Cash and cash equivalents. Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.
Investment securities. The fair value of investment securities is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The fair value of equity investments in the restricted stock of the FRBR and FHLB approximates the carrying value. The fair value of investment securities is classified as Level 1 if a quoted market price is available, or Level 2 if a quoted market price is not available.
Loans held for sale. Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value. We classified the fair value of loans held for sale as Level 2.
Loans held for investment. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of variable rate loans with frequent repricing and negligible credit risk approximates book value. The fair value of loans is further discounted by credit and liquidity factors. We classified the fair value of loans as Level 3.
Accrued interest receivable and payable. The carrying amounts of accrued interest payable and receivable approximate fair value and are classified as Level 2 if the related asset or liability is classified as Level 2, or Level 3 if the related asset or liability is classified as Level 3.
Deposits. The fair value of noninterest-bearing and interest-bearing demand deposits and savings are the amounts payable on demand because these products have no stated maturity. The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities and are classified as Level 2.
Borrowed funds. The carrying value of retail repurchase agreements is considered to be a reasonable estimate of fair value. The fair value of FHLB advances and other borrowed funds is estimated using the rates currently offered for advances of similar remaining maturities and is classified as Level 2. For the long-term note payable, the current market rate for similar debt is substantially equal to the rate on this note, so its fair value approximates its carrying value.
Junior subordinated debentures. Included in junior subordinated debentures are variable rate trust preferred securities issued by COB. Fair values for the trust preferred securities were estimated by developing cash flow estimates for each of these debt instruments based on scheduled principal and interest payments and current interest rates. Once the cash flows were determined, a rate for comparable subordinated debt was used to discount the cash flows to the present value. The estimated fair value for our junior subordinated debentures have declined due to wider credit spreads (i.e., spread to LIBOR) on similar trust preferred issues. This is due, in part, to proposed bank regulatory changes in bank capital structure. We classified the fair value of junior subordinated debentures as Level 3.
Financial instruments with off-balance sheet risk. The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity. For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value.
The estimated fair values of financial instruments for continuing operations are as follows at the periods indicated:
There were no transfers between valuation levels for any assets during the years ended December 31, 2013 or December 31, 2012. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.
21. Common Dividends
COB is a legal entity separate and distinct from its banking and other subsidiaries and has in the past relied on dividends from the Bank as its primary source of liquidity. The Bank currently is restricted from paying dividends if it is not in compliance with its OCC-approved business plan, and COB would need to obtain prior FRBR approval to pay a dividend. There also are limitations and requirements imposed by applicable law and regulation on the payment of dividends by the Bank to COB, as well as by COB to its shareholders. COB did not declare any dividends with respect to its common stock in 2013.
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
COB’s management, with the participation of its Chief Executive Officer and its Chief Financial Officer, has evaluated the effectiveness of COB’s disclosure controls and procedures as of December 31, 2013. Based on that evaluation, COB’s Chief Executive Officer and Chief Financial Officer concluded that COB’s disclosure controls and procedures were effective as of December 31, 2013.
Management’s Report on Internal Control over Financial Reporting
Management of COB is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as defined in Rule 13a-15(f) of the Exchange Act. COB’s internal control over financial reporting is a process designed to provide reasonable assurance to management and the board of directors regarding the reliability of the financial reporting and the preparation of COB’s financial statements for external reporting purposes in accordance with GAAP. COB’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of COB’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of COB are being made only in accordance with the authorizations of COB’s management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of COB’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 misstatement. 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.
Management has evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 Framework), commonly referred to as the COSO framework. Based on this evaluation, management has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2013.
COB’s internal control over financial reporting has been audited by Dixon Hughes Goodman LLP, an independent registered public accounting firm. Their report expresses an unqualified opinion on the effectiveness of COB’s internal control over financial reporting as of December 31, 2013.
Management is also responsible for compliance with laws and regulations relating to safety and soundness which are designated by the FDIC and the appropriate federal banking agency. Management assessed its compliance with these designated laws and regulations relating to safety and soundness and has concluded that the Company complied, in all significant respects, with such laws and regulations during the year ended December 31, 2013.
Changes in Internal Control over Financial Reporting
The Company assesses the adequacy of its internal control over financial reporting quarterly and enhances its control in response to internal control assessments and internal and external audit and regulatory recommendations. No control enhancements during the year ended December 31, 2013 have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B.
OTHER INFORMATION
None
PART III
Item 10.
Item 10.
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information set forth in COB’s proxy statement for the Annual Meeting of Shareholders to be held on May 28, 2014 (the “Proxy Statement”) under the headings “Election of Directors,” “Executive Officers,” “Report of the Audit Committee,” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.
The information set forth in the Proxy Statement under the headings “Compensation Discussion and Analysis,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Report of the Compensation Committee on the Compensation Discussion and Analysis” is incorporated herein by reference.
Item 12.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information set forth in the Proxy Statement under the headings “Voting Securities Outstanding and Principal Shareholders,” “Security Ownership of Management,” and “Equity Compensation Plan Information” is incorporated herein by reference.
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information set forth in the Proxy Statement under the headings “Business Relationships and Related Person Transactions” and “Election of Directions” is incorporated herein by reference.
Item 14.
Item 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information set forth in the Proxy Statement under the heading “Independent Registered Public Accounting Firm” is incorporated herein by reference.
PART IV
Item 15.
Item 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of this report.
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to the Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below.
INDEX TO EXHIBITS
*
Management contract, or compensatory plan or arrangement.
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, as of March 7, 2014.
CommunityOne Bancorp
(Registrant)
By:
/s/ BRIAN E. SIMPSON
Brian E. Simpson
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated, as of March 7, 2014.
Signature
Title
/s/ BRIAN E. SIMPSON
Chief Executive Officer and Director
Brian E. Simpson
(Principal Executive Officer)
/s/ DAVID L. NIELSEN
Executive Vice President
David L. Nielsen
(Principal Financial and Accounting Officer)
/s/ AUSTIN A. ADAMS
Director
Austin A. Adams
/s/ JOHN J. BRESNAN
Director
John J. Bresnan
/s/ SCOTT B. KAUFFMAN
Director
Scott B. Kauffman
/s/ JERRY R. LICARI
Director
Jerry R. Licari
/s/ J. CHANDLER MARTIN
Director
J. Chandler Martin
/s/ T. GRAY MCCASKILL
Director
T. Gray McCaskill
/s/ H. RAY MCKENNEY, JR.
Director
H. Ray McKenney, Jr.
/s/ ROBERT L. REID
Director
Robert L. Reid
/s/ BOYD C. WILSON, JR.
Director
Boyd C. Wilson, Jr.