Item 1. Business
First Community
First Community Financial Partners, Inc. (“First Community” or the “Company”) was formed as a bank holding company in 2006 to focus on organizing de novo banks. First Community is headquartered in Joliet, Illinois. First Community has one banking subsidiary, First Community Financial Bank (the “Bank”). The Bank is the result of the consolidation of our four legacy banking subsidiaries and affiliates (the “Consolidation”), which is discussed in more detail below.
As of December 31, 2014 on a consolidated basis, First Community had total assets of $924.1 million, total deposits of $769.4 million and total stockholders’ equity of $92.1 million. For the Company’s complete financial information as of December 31, 2014 and 2013 and for each of the years then ended, see Item 8. Financial Statements and Supplementary Data.
The Bank
The Bank is a full-service community bank principally engaged in the business of commercial, family and personal banking, and offers customers a broad range of loan, deposit, and other financial products and services through six full-service banking offices and one loan production office located in Cook, DuPage, and Will Counties, Illinois.
The Bank’s primary business is making loans and accepting deposits. The Bank also offers customers a variety of financial products and services that are related or ancillary to loans and deposits, including cash management, funds transfers, bill payment and other online banking transactions, automated teller machines, and safe deposit boxes.
The Bank’s primary lending area consists of the counties where its banking offices are located, and contiguous counties in the State of Illinois. The Bank derives the most significant portion of its revenues from these geographic areas.
The Bank originates deposits predominantly from the areas where its banking offices are located. The Bank relies on its favorable locations, customer service, competitive pricing, Internet access and related deposit services, such as cash management, to attract and retain deposits. While the Bank accepts certificates of deposit in excess of FDIC deposit insurance limits, the Bank generally does not solicit such deposits because they are more difficult to retain than core deposits and at times are more costly than wholesale deposits.
Lending Activities
The Bank’s loan portfolio consists primarily of non-residential real estate loans (owner occupied commercial real estate and investor commercial real estate, multi-family, construction and land development loans), which represented 59.38% of the total loan portfolio of $689.4 million at December 31, 2014. At December 31, 2014, $24.4 million, or 3.54% of the total loan portfolio, consisted of multi-family mortgage loans; $354.0 million, or 51.35% of the total loan portfolio, consisted of other commercial real estate loans; $171.5 million, or 24.87% of the total loan portfolio, consisted of commercial loans; $18.7 million, or 2.71%, of the total loan portfolio, consisted of construction and land loans; and $100.8 million, or 14.62% of the total loan portfolio, consisted of one-to-four family residential mortgage loans, including home equity loans and lines of credit. In addition, the Bank had farm and agricultural loans totaling $9.4 million, or 1.36%, and consumer and other loans totaling $10.7 million, or 1.55%, of the total portfolio as of December 31, 2014.
Deposit Activities
The Bank’s deposit accounts consist principally of savings accounts, NOW accounts, checking accounts, money market accounts, certificates of deposit, and IRAs and other qualified plan accounts. The Bank also provides commercial checking accounts and related services such as cash management, as well as provide low-cost checking account services.
At December 31, 2014, the Bank’s deposits totaled $769.4 million; interest bearing deposits totaled $611.1 million; non-interest bearing demand deposits totaled $158.3 million; savings, money market and NOW account deposits totaled $300.2 million; and certificates of deposit totaled $165.4 million.
Competition
First Community and the Bank face significant competition in both originating loans and attracting deposits. The Chicago metropolitan area has a high concentration of financial institutions, many of which are significantly larger institutions that have greater financial resources than us, and many of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, the U.S. government, credit unions, leasing companies, insurance companies, real estate conduits and other companies that provide financial services to businesses and individuals. Our most direct competition for deposits has historically come from commercial banks, savings
banks and credit unions. We face additional competition for deposits from Internet-based financial institutions and non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies.
We seek to meet this competition by emphasizing personalized service and efficient decision-making tailored to individual needs. In addition, we reward long-standing relationships with preferred rates and terms on deposit products based on existing and prospective lending business. We do not rely on any individual, group or entity for a material portion of our loans or our deposits.
The Consolidation
Prior to the closing of the Consolidation on March 12, 2013, First Community had an ownership interest in four banking subsidiaries and affiliates: First Community Bank of Joliet (“FCB Joliet”), First Community Bank of Plainfield (“FCB Plainfield”), First Community Bank of of Homer Glen & Lockport (“FCB Homer Glen”), and Burr Ridge Bank and Trust (“Burr Ridge”), as follows:
On August 27, 2012, First Community entered into definitive merger agreements that resulted in the merger of our four legacy banking subsidiaries and affiliates into the Bank, an Illinois chartered banking institution that is wholly owned by First Community. Specifically, the Consolidation consisted of the following mergers: (1) the merger of Interim First Community Bank of Plainfield, an interim Illinois state banking organized for the purpose of carrying out the Consolidation, with and into FCB Plainfield, which resulted in FCB Plainfield becoming a wholly owned subsidiary of First Community, (2) the merger of FCB Homer Glen with and into FCB Joliet, which resulted in the independent banking business of FCB Homer Glen ceasing and its business becoming part of FCB Joliet’s banking business, (3) the merger of Burr Ridge with and into FCB Joliet, which resulted in the independent banking business of Burr Ridge ceasing and its business becoming part of FCB Joliet’s banking business and (4) immediately following the consummation of the three mergers described above, the merger of FCB Joliet with and into FCB Plainfield, both of which were wholly owned by First Community at such time, which resulted in FCB Plainfield becoming the sole surviving bank following the Consolidation and wholly owned by First Community. Upon the closing of the Consolidation, FCB Plainfield was named “First Community Financial Bank”.
In each of the mergers included in the Consolidation, excluding the last step merger of the two then wholly owned banks, FCB Joliet and FCB Plainfield, the consideration paid by First Community to the stockholders of FCB Plainfield, FCB Homer Glen and Burr Ridge (other than shares held in any such bank's treasury or owned by any such bank's subsidiary, First Community or any First Community subsidiary) consisted of common stock of First Community registered with the Securities and Exchange Commission (the “SEC”) pursuant to Registration Statements on Form S-4. Specifically, each such share of FCB Plainfield common stock was converted into the right to receive 2.30 shares of First Community common stock, each such share of FCB Plainfield preferred stock was converted into the right to receive 305.9 shares of First Community common stock, each such share of FCB Homer common stock was converted into the right to receive 1.20 shares of First Community common stock, and each such share of Burr Ridge common stock was converted into the right to receive 2.81 shares of First Community stock. This resulted in the issuance of approximately 4,000,525 shares of First Community common stock. Pursuant to the terms of the Consolidation, all existing FCB Plainfield, FCB Homer Glen and Burr Ridge stock options outstanding as of the time immediately prior to the effective time of the Consolidation terminated in their entirety and were replaced with restricted stock unit awards issued under First Community’s 2008 Equity Incentive Plan.
Employees
At December 31, 2014, First Community and the Bank had 101 full-time employees and seven part-time employees. The employees are not represented by a collective bargaining unit and we consider our working relationship with our employees to be good.
Internet Website
We maintain a website with the address www.fcbankgroup.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own Internet access charges, we make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the SEC.
SUPERVISION AND REGULATION
General
Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of First Community may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Illinois Department of Financial and Professional Regulation (the “DFPR”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and the Bureau of Consumer Financial Protection (the “CFPB”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board, securities laws administered by the Securities and Exchange Commission (the “SEC”) and state securities authorities, and anti-money laundering laws enforced by the U.S. Department of the Treasury (the “Treasury”) have an impact on the business of First Community. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to the operations and results of First Community and the Bank, and the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of financial institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than shareholders. These federal and state laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with insiders and affiliates and the payment of dividends.
This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to First Community and the Bank. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
Financial Regulatory Reform
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represented a sweeping reform of the U.S. supervisory and regulatory framework applicable to financial institutions and capital markets in the wake of the global financial crisis, certain aspects of which are described below in more detail. In particular, and among other things, the Dodd-Frank Act: created a Financial Stability Oversight Council as part of a regulatory structure for identifying emerging systemic risks and improving interagency cooperation; created the CFPB, which is authorized to regulate providers of consumer credit, savings, payment and other consumer financial products and services; narrowed the scope of federal preemption of state consumer laws enjoyed by national banks and federal savings associations and expanded the authority of state attorneys general to bring actions to enforce federal consumer protection legislation; imposed more stringent capital requirements on bank holding companies and subjected certain activities, including interstate mergers and acquisitions, to heightened capital conditions; with respect to mortgage lending, (i) significantly expanded requirements applicable to loans secured by 1-4 family residential real property, (ii) imposed strict rules on mortgage servicing, and (iii) required the originator of a securitized loan, or the sponsor of a securitization, to retain at least 5% of the credit risk of securitized exposures unless the underlying exposures are qualified residential mortgages or meet certain underwriting standards;
repealed the prohibition on the payment of interest on business checking accounts; restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater; in the so-called “Volcker Rule,” subject to numerous exceptions, prohibited depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity funds and from engaging in proprietary trading; provided for enhanced regulation of advisers to private funds and of the derivatives markets; enhanced oversight of credit rating agencies; and prohibited banking agency requirements tied to credit ratings. These statutory changes shifted the regulatory framework for financial institutions, impacted the way in which they do business and have the potential to constrain revenues.
Numerous provisions of the Dodd-Frank Act were required to be implemented through rulemaking by the appropriate federal regulatory agencies. Many of the required regulations have been issued and others have been released for public comment, but are not yet final. Although the reforms primarily targeted systemically important financial service providers, their influence is expected to filter down in varying degrees to smaller institutions over time. Our management will continue to evaluate the effect of the Dodd-Frank Act; however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on our results of operations and financial condition.
The Increasing Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a financial institution available to absorb losses. Because of the risks attendant to their business, depository institutions are generally required to hold more capital than other businesses, which directly affects earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role became fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from being included in capital determinations. Once fully implemented, these standards will represent regulatory capital requirements that are meaningfully more stringent than those in place previously.
First Community and Bank Required Capital Levels. Historically, bank holding companies have had to comply with less stringent capital standards than their bank subsidiaries and have been able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank Act mandated the Federal Reserve to establish minimum capital levels for bank holding companies on a consolidated basis as stringent as those required for insured depository institutions. As a consequence, the components of holding company permanent capital known as “Tier 1 Capital” were restricted to those capital instruments that are considered to be Tier 1 Capital for insured depository institutions.
The minimum capital standards effective for the year ended December 31, 2014 were:
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A leverage requirement, consisting of a minimum ratio of Tier 1 Capital to total adjusted book assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others, and
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A risk-based capital requirement, consisting of a minimum ratio of Total Capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 Capital to total risk-weighted assets of 4%.
For these purposes, “Tier 1 Capital” consisted primarily of common stock, noncumulative perpetual preferred stock and related surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships). “Total Capital” consisted primarily of Tier 1 Capital plus “Tier 2 Capital,” which included other non-permanent capital items, such as certain other debt and equity instruments that do not qualify as Tier 1 Capital, and a portion of the Bank’s allowance for loan and lease losses. Further, risk-weighted assets for the purpose of the risk-weighted ratio calculations were balance sheet assets and off-balance sheet exposures to which required risk weightings of 0% to 100% were applied.
The capital standards described above are minimum requirements and were increased beginning January 1, 2015 under Basel III, as discussed below. Bank regulatory agencies uniformly encourage banks and bank holding companies to be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is “well-capitalized” may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept, roll-over or renew brokered deposits. Under the capital regulations of the FDIC and Federal Reserve, in order to be “well-capitalized,” a banking organization, for the year ended December 31, 2014, must have maintained:
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A leverage ratio of Tier 1 Capital to total assets of 5% or greater,
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A ratio of Tier 1 Capital to total risk-weighted assets of 6% or greater, and
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A ratio of Total Capital to total risk-weighted assets of 10% or greater.
The FDIC and Federal Reserve guidelines also provide that banks and bank holding companies experiencing internal growth or making acquisitions would be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the agencies will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activities.
Higher capital levels could also be required if warranted by the particular circumstances or risk profile of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.
Prompt Corrective Action. A banking organization’s capital plays an important role in connection with regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
As of December 31, 2014: (i) the Bank was not subject to a directive from its regulatory agencies to increase its capital and (ii) the Bank was “well-capitalized,” as defined by FDIC regulations. As of December 31, 2014, First Community had regulatory capital in excess of the Federal Reserve’s requirements and met the Dodd-Frank Act requirements.
The Basel International Capital Accords. The risk-based capital guidelines described above are based upon the 1988 capital accord known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors, as implemented by the U.S. federal banking regulators on an interagency basis. In 2008, the banking agencies collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally defined for U.S. purposes as having total assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more). Basel II emphasized internal assessment of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital requirements.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis. Basel III was intended to be effective globally on January 1, 2013, with phase-in of certain elements continuing until January 1, 2019, and it is currently effective in many countries.
U.S. Implementation of Basel III. In July of 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital requirements previously, which were in the form of guidelines, Basel III was released in the form of regulations by each of the federal regulatory agencies. The Basel III Rule is applicable to all financial institutions that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to most bank and savings and loan holding companies.
The Basel III Rule not only increased most of the required minimum capital ratios as of January 1, 2015, but it introduced the concept of “Common Equity Tier 1 Capital,” which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests, subject to certain regulatory adjustments. The Basel III Rule also established more stringent criteria for instruments to be considered “Additional Tier 1 Capital” (Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that qualified as Tier 1 Capital will not qualify, or their qualifications will change. For example, cumulative preferred stock and certain hybrid capital instruments, including trust preferred securities, will no longer qualify as Tier 1 Capital of any kind, with the exception, subject to certain restrictions, of such instruments issued before May 10, 2010, by bank holding companies with total consolidated assets of less than $15 billion as of December 31, 2009. For those institutions, trust preferred securities and other nonqualifying capital instruments currently included in consolidated Tier 1 Capital were permanently grandfathered under the Basel III Rule, subject to certain restrictions. Noncumulative perpetual preferred stock, which formerly qualified as simple Tier 1 Capital, will not qualify as Common Equity Tier 1 Capital, but will
instead qualify as Additional Tier 1 Capital. The Basel III Rule also constrained the inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in the event that such assets exceed a certain percentage of a banking institution’s Common Equity Tier 1 Capital.
As of January 1, 2015, the Basel III Rule requires:
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A new minimum ratio of Common Equity Tier 1 Capital to risk-weighted assets of 4.5%;
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An increase in the minimum required amount of Tier 1 Capital to 6% of risk-weighted assets;
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A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets; and
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A minimum leverage ratio of Tier 1Capital to total assets equal to 4% in all circumstances.
The Basel III Rule maintained the general structure of the prompt corrective action framework, while incorporating the increased requirements and adding the Common Equity Tier 1 Capital ratio. In order to be “well-capitalized” under the new regime, a depository institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a leverage ratio of 5% or more
In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% of risk-weighted assets in Common Equity Tier 1 attributable to a capital conservation buffer to be phased in over three years beginning in 2016. The purpose of the conservation buffer is to ensure that banking institutions maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1, 8.5% for Tier 1 Capital and 10.5% for Total Capital. The leverage ratio is not impacted by the conservation buffer, and a banking institution may be considered well-capitalized while remaining out of compliance with the capital conservation buffer.
As discussed above, most of the capital requirements are based on a ratio of specific types of capital to “risk-weighted assets.” Not only did Basel III change the components and requirements of capital, but, for nearly every class of financial assets, the Basel III Rule requires a more complex, detailed and calibrated assessment of credit risk and calculation of risk weightings. While Basel III would have changed the risk weighting for residential mortgage loans based on loan-to-value ratios and certain product and underwriting characteristics, there was concern in the United States that the proposed methodology for risk weighting residential mortgage exposures and the higher risk weightings for certain types of mortgage products would increase costs to consumers and reduce their access to mortgage credit. As a result, the Basel III Rule did not effect this change, and banking institutions will continue to apply a risk weight of 50% or 100% to their exposure from residential mortgages.
Furthermore, there was significant concern noted by the financial industry in connection with the Basel III rulemaking as to the proposed treatment of accumulated other comprehensive income (“AOCI”). Basel III requires unrealized gains and losses on available-for-sale securities to flow through to regulatory capital as opposed to the previous treatment, which neutralized such effects. Recognizing the problem for community banks, the U.S. bank regulatory agencies adopted the Basel III Rule with a one-time election for smaller institutions like First Community and the Bank to opt out of including most elements of AOCI in regulatory capital. This opt-out, which must be made in the first quarter of 2015, would exclude from regulatory capital both unrealized gains and losses on available-for-sale debt securities and accumulated net gains and losses on cash-flow hedges and amounts attributable to defined benefit post-retirement plans. We expect to make this election to avoid variations in the level of our capital depending on fluctuations in the fair value of our securities portfolio.
Banking institutions (except for large, internationally active financial institutions) became subject to the Basel III Rule on January 1, 2015, and both First Community and the Bank are currently in compliance with the new required ratios. There are separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules. The phase-in periods commence on January 1, 2016 and extend until 2019.
First Community
General. As the sole shareholder of the Bank, we are a bank holding company. As a bank holding company, we are registered with, and are subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”). In accordance with Federal Reserve policy, and as now codified by the Dodd-Frank Act, we are legally obligated to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the Federal Reserve. We are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding First Community and the Bank as the Federal Reserve may require.
Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding
company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA and the Dodd-Frank Act), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “The Increasing Regulatory Emphasis on Capital” above.
The BHCA generally prohibits us from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit us to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of nonbank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. We do not currently operate as a financial holding company.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.
Capital Requirements. Bank holding companies are required to maintain capital in accordance with Federal Reserve capital adequacy requirements, as affected by the Dodd-Frank Act and Basel III. For a discussion of capital requirements, see “The Increasing Regulatory Emphasis on Capital” above.
Dividend Payments. Our ability to pay dividends to our shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Illinois corporation, we are subject to the Illinois Business Corporation Act, as amended, which prohibits us from paying a dividend if, after giving effect to the dividend: (i) First Community would be insolvent; (ii) the net assets of First Community would be less than zero; or (iii) the net assets of First Community would be less than the maximum amount then payable to shareholders of First Community who would have preferential distribution rights if we were liquidated. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “The Increasing Regulatory Emphasis on Capital” above.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly reduce dividends to shareholders if: (i) the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. We are required to file certain reports and otherwise comply with the rules and regulations of the SEC under federal securities laws.
Corporate Governance. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit
voters for their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
The Bank
General. The Bank is an Illinois-chartered bank. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations. As an Illinois-chartered FDIC-insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the DFPR, the chartering authority for Illinois banks, and the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like the Bank, are not members of the Federal Reserve System (“nonmember banks”).
Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see “The Increasing Regulatory Emphasis on Capital” above.
Liquidity Requirements. Liquidity is a measure of the ability and ease with which bank assets may be converted to cash. Liquid assets are those that can be converted to cash quickly if needed to meet financial obligations. To remain viable, financial institutions must have enough liquid assets to meet their near-term obligations, such as withdrawals by depositors. Because the global financial crisis was in part a liquidity crisis, Basel III also included a liquidity framework that requires financial institutions to measure their liquidity against specific liquidity tests. One test, referred to as the Liquidity Coverage Ratio (“LCR”), is designed to ensure that the banking entity has an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet liquidity needs for a 30-calendar day liquidity stress scenario. The other test, known as the Net Stable Funding Ratio (“NSFR”), is designed to promote more medium- and long-term funding of the assets and activities of financial institutions over a one-year horizon. These tests provide an incentive for banks and holding companies to increase their holdings in Treasury securities and other sovereign debt as a component of assets, increase the use of long-term debt as a funding source and rely on stable funding like core deposits (in lieu of brokered deposits).
In addition to liquidity guidelines already in place, the U.S. bank regulatory agencies implemented the LCR in September 2014, which requires large financial firms to hold levels of liquid assets sufficient to protect against constraints on their funding during times of financial turmoil. While the LCR only applies to the largest banking organizations in the country, certain elements are expected to filter down to all insured depository institutions. We are reviewing our liquidity risk management policies in light of the LCR and NSFR.
Continuing De Novo Bank Requirements. Each of FCB Plainfield, FCB Homer Glen and Burr Ridge were chartered as follows:
As a result, the Bank, which was known as FCB Plainfield prior to the Consolidation, remains subject to certain of the FDIC’s de novo bank requirements until the Bank has been chartered for a period longer than seven years. Until the Bank has been chartered for a period longer than seven years, it is required, among other items, to obtain FDIC approval for any material change to its business plan and to maintain a Tier 1 Leverage Capital Ratio of at least 8%.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. For deposit insurance assessment purposes, an insured depository institution is placed in one of four risk categories each quarter. An institution’s assessment is determined by multiplying its assessment rate by its assessment base. The total base assessment rates range from 2.5 basis points to 45 basis points. While in the past an insured depository institution’s assessment base was determined by its deposit base, amendments to the Federal Deposit Insurance Act revised the assessment base so that it is calculated using average consolidated total assets minus average tangible equity. This change shifted the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.
The FDIC has authority to raise or lower assessment rates on insured deposits in order to achieve statutorily required reserve ratios in the DIF and to impose special additional assessments. In light of the significant increase in depository institution failures in 2008-2010 and the increase of deposit insurance limits, the DIF incurred substantial losses during recent years. To bolster reserves in the DIF, the Dodd-Frank Act increased the minimum reserve ratio of the DIF to 1.35% of insured deposits and deleted the statutory cap for the reserve ratio. In December 2010, the FDIC set the designated reserve ratio at 2%, 65 basis points above the statutory minimum. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if
needed, will increase or decrease the assessment rates, following notice and comment on proposed rulemaking. As a result, the Bank’s FDIC deposit insurance premiums could increase.
FICO Assessments. In addition to paying basic deposit insurance assessments, insured depository institutions must pay Financing Corporation (“FICO”) assessments. FICO is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately $8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations. The FICO assessment rate is adjusted quarterly and for the fourth quarter of 2014 was approximately 0.620 basis points (62 cents per $100 of assessable deposits).
Supervisory Assessments. Illinois-chartered banks are required to pay supervisory assessments to the DFPR to fund its operations. The amount of the assessment paid by an Illinois bank to the DFPR is calculated on the basis of the institution’s total assets, including consolidated subsidiaries, as reported to the DFPR. During the year ended December 31, 2014, the Bank paid supervisory assessments to the DFPR totaling $136,470.
Dividend Payments. The primary source of funds for First Community is dividends from the Bank. Under the Illinois Banking Act, the Bank generally may not pay dividends in excess of its net profits.
The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As of December 31, 2014, the Bank was unable to pay dividends due to having negative retained earnings. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2014. Notwithstanding the availability of funds for dividends, however, the FDIC and DFPR may prohibit the payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice. In addition, under the Basel III Rule, institutions that seek the freedom to pay dividends will have to maintain 2.5% in Common Equity Tier 1 attributable to the capital conservation buffer to be phased in over three years beginning in 2016. See “The Increasing Regulatory Emphasis on Capital” above.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.” We are an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to us, investments in our stock or other securities and the acceptance of our stock or other securities as collateral for loans made by the Bank. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates as of July 21, 2011, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of First Community and its subsidiaries, to principal shareholders of First Community and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of First Community or the Bank, or a principal shareholder of First Community, may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each financial institution is responsible for establishing its own procedures to achieve those goals. If a financial institution fails to comply with any of the standards set forth in the guidelines, the financial institution’s primary federal regulator may require the financial institution to submit a plan for achieving and maintaining compliance. If a financial institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the financial institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the financial institution’s rate of growth, require the financial institution to increase its capital, restrict the rates the financial institution pays on deposits or require the financial institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the financial institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has
become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk management and cybersecurity are critical sources of operational risk that financial institutions are expected to address in the current environment. The Bank is expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal controls.
Branching Authority. Illinois banks, such as the Bank, have the authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been permitted only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized and well-managed banks to establish new branches across state lines without these impediments.
State Bank Investments and Activities. The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Illinois law. However, under federal law, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
Transaction Account Reserves. Federal Reserve regulations require insured depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2015: the first $14.5 million of otherwise reservable balances are exempt from the reserve requirements; for transaction accounts aggregating more than $14.5 million to $103.6 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $103.6 million, the reserve requirement is $2,673,000 plus 10% of the aggregate amount of total transaction accounts in excess of $103.6 million. These reserve requirements are subject to annual adjustment by the Federal Reserve.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Chicago (the “FHLB”), which serves as a central credit facility for its members. The FHLB is funded primarily from proceeds from the sale of obligations of the FHLB system. It makes loans to member banks in the form of FHLB advances. All advances from the FHLB are required to be fully collateralized as determined by the FHLB.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law enforcement authorities.
Concentrations in Commercial Real Estate. Concentration risk exists when financial institutions deploy too many assets to any one industry or segment. Concentration stemming from commercial real estate is one area of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with
the level and nature of their commercial real estate concentrations. Based on the Bank’s loan portfolio, the Bank does not exceed these guidelines.
Consumer Financial Services
The historical structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, like the Bank, will continue to be examined by their applicable bank regulators.
Because abuses in connection with residential mortgages were a significant factor contributing to the financial crisis, many new rules issued by the CFPB and required by the Dodd-Frank Act address mortgage and mortgage-related products, their underwriting, origination, servicing and sales. The Dodd-Frank Act significantly expanded underwriting requirements applicable to loans secured by 1-4 family residential real property and augmented federal law combating predatory lending practices. In addition to numerous disclosure requirements, the Dodd-Frank Act imposed new standards for mortgage loan originations on all lenders, including banks and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay, while also establishing a presumption of compliance for certain “qualified mortgages.” In addition, the Dodd-Frank Act generally required lenders or securitizers to retain an economic interest in the credit risk relating to loans that the lender sells, and other asset-backed securities that the securitizer issues, if the loans do not comply with the ability-to-repay standards described below. The risk retention requirement generally is 5%, but could be increased or decreased by regulation. We do not currently expect the CFPB’s rules to have a significant impact on our operations, except for higher compliance costs.
Ability-to-Repay Requirement and Qualified Mortgage Rule. On January 10, 2013, the CFPB issued a final rule implementing the Dodd-Frank Act’s ability-to-repay requirements. Under the final rule, lenders, in assessing a borrower’s ability to repay a mortgage-related obligation, must consider eight underwriting factors: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) monthly payment on the subject transaction; (iv) monthly payment on any simultaneous loan; (v) monthly payment for all mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) monthly debt-to-income ratio or residual income; and (viii) credit history. The final rule also includes guidance regarding the application of, and methodology for evaluating, these factors.
Further, the final rule clarified that qualified mortgages do not include “no-doc” loans and loans with negative amortization, interest-only payments, balloon payments, terms in excess of 30 years, or points and fees paid by the borrower that exceed 3% of the loan amount, subject to certain exceptions. In addition, for qualified mortgages, the rule mandated that the monthly payment be calculated on the highest payment that will occur in the first five years of the loan, and required that the borrower’s total debt-to-income ratio generally may not be more than 43%. The final rule also provided that certain mortgages that satisfy the general product feature requirements for qualified mortgages and that also satisfy the underwriting requirements of Fannie Mae and Freddie Mac (while they operate under federal conservatorship or receivership), or the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service, are also considered to be qualified mortgages. This second category of qualified mortgages will phase out as the aforementioned federal agencies issue their own rules regarding qualified mortgages, the conservatorship of Fannie Mae and Freddie Mac ends, and, in any event, after seven years.
As set forth in the Dodd-Frank Act, subprime (or higher-priced) mortgage loans are subject to the ability-to-repay requirement, and the final rule provided for a rebuttable presumption of lender compliance for those loans. The final rule also applied the ability-to-repay requirement to prime loans, while also providing a conclusive presumption of compliance (i.e., a safe harbor) for prime loans that are also qualified mortgages. Additionally, the final rule generally prohibited prepayment penalties (subject to certain exceptions) and set forth a 3-year record retention period with respect to documenting and demonstrating the ability-to-repay requirement and other provisions.
Mortgage Loan Originator Compensation. As a part of the overhaul of mortgage origination practices, mortgage loan originators’ compensation was limited such that they may no longer receive compensation based on a mortgage transaction’s terms or conditions other than the amount of credit extended under the mortgage loan. Further, the total points and fees that a bank and/or a broker may charge on conforming and jumbo loans was limited to 3.0% of the total loan amount. Mortgage loan originators may receive compensation from a consumer or from a lender, but not both. These rules contain requirements designed to prohibit mortgage loan originators from “steering” consumers to loans that provide mortgage loan originators with greater compensation. In addition, the rules contain other requirements concerning recordkeeping.
Servicing. The CFPB was also required to implement certain provisions of the Dodd-Frank Act relating to mortgage servicing through rulemaking. The servicing rules require servicers to meet certain benchmarks for loan servicing and customer service in general. Servicers must provide periodic billing statements and certain required notices and acknowledgments, promptly credit borrowers’ accounts for payments received and promptly investigate complaints by borrowers and are required to take
additional steps before purchasing insurance to protect the lender’s interest in the property. The servicing rules also called for additional notice, review and timing requirements with respect to delinquent borrowers, including early intervention, ongoing access to servicer personnel and specific loss mitigation and foreclosure procedures. The rules provided for an exemption from most of these requirements for “small servicers.” A small servicer is defined as a loan servicer that services 5,000 or fewer mortgage loans and services only mortgage loans that they or an affiliate originated or own.
Additional Constraints on First Community and Bank
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
The Volcker Rule. In addition to other implications of the Dodd-Frank Act discussed above, the Act amended the BHCA to require the federal regulatory agencies to adopt rules that prohibit banking entities and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This statutory provision is commonly called the “Volcker Rule.” On December 10, 2013, the federal regulatory agencies issued final rules to implement the prohibitions required by the Volcker Rule.
Although the Volcker Rule has significant implications for many large financial institutions, we do not currently anticipate that it will have a material effect on our operations. We may incur costs if we are required to adopt additional policies and systems to ensure compliance with certain provisions of the Volcker Rule, but any such costs are not expected to be material.
Item 1A.
Item 1A. Risk Factors
RISK FACTORS
Various risks and uncertainties, some of which are difficult to predict and beyond First Community’s control, could negatively impact First Community or the Bank. As financial institutions, First Community and the Bank are exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others. Adverse experience with these or other risks could have a material impact on the financial condition and results of operations of First Community or the Bank, as well as the value of First Community common stock.
Our business may be adversely affected by the highly regulated environment in which we operate.
The Company and the Bank are subject to extensive federal and state regulation, supervision and examination. Banking regulations are primarily intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things.
As a bank holding company, we are subject to regulation and supervision primarily by the Federal Reserve. The Bank, as an Illinois-chartered bank, is subject to regulation and supervision by both the IDFPR and the FDIC. We and the Bank undergo periodic examinations by these regulators, which have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies.
The primary federal and state banking laws and regulations that affect us are described in Item 1. Business under the section captioned “Supervision and Regulation.” These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time. For example, on July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks will be regulated in the future. In addition, the Federal Reserve has adopted numerous new regulations addressing banks’ overdraft and mortgage lending practices. Further, the CFPB was recently established, with broad powers to supervise and enforce consumer protection laws, and additional consumer protection legislation and regulatory activity is anticipated in the near future.
In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III Rule. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1 billion). The Basel III Rule not only increases most of the required minimum regulatory capital ratios, it introduces a new Common Equity Tier 1 Capital ratio and the concept of a capital conservation buffer. The Basel III Rule also expands the current definition of capital by establishing additional criteria that capital instruments must meet to be considered Additional Tier 1 Capital (i.e., Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1 Capital will not qualify, or their qualifications will change when the Basel III Rule is fully implemented. However, the Basel III Rule permits banking organizations with less than $15 billion in assets to retain, through a one-time election, the existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Basel III Rule has maintained the general structure of the current prompt corrective action thresholds while incorporating the increased requirements, including the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under the new regime, an institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10.0% or more; and a leverage ratio of 5.0% or more. Institutions must also maintain a capital conservation buffer consisting of Common Equity Tier 1 Capital to avoid certain restrictions on dividends and compensation. Generally, financial institutions became subject to the Basel III Rule on January 1, 2015 with a phase-in period through 2019 for many of the changes.
Such changes, including changes regarding interpretations and implementation, could affect the Company in substantial and unpredictable ways and could have a material adverse effect on the Company’s business, financial condition and results of operations. Further, such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties, and/or damage to the Company’s reputation, which could have a material adverse effect on the Company’s business, financial condition and results of operations.
The policies of the Federal Reserve also have a significant impact on us. Among other things, the Federal Reserve’s monetary policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits, and can also affect the value of financial instruments we hold and the ability of borrowers to repay their loans, which could have a material adverse effect on our business, financial condition and results of operations.
Competition from financial institutions and other financial services providers may adversely affect our growth and profitability and have a material adverse effect on us.
We operate in a highly competitive industry and experience intense competition from other financial institutions in our market. We compete with these institutions in making loans, attracting deposits and recruiting and retaining talented people. We also compete with non-bank financial service providers, including mortgage companies, finance companies, mutual funds and credit unions. Many of these competitors are not subject to the same regulatory restrictions that we are and may be able to compete more effectively as a result. We have observed that the competition in our market for making commercial loans has resulted in more competitive pricing and credit structure, as well as intense competition for qualified commercial lending officers. We also may face a competitive disadvantage as a result of our smaller size, limited branch network, narrower product offerings and lack of geographic diversification as compared to some of our larger competitors. Although our competitive strategy is to provide a distinctly superior customer and employee experience, this strategy could be unsuccessful. Our growth and profitability depend on our continued ability to compete effectively within our market area and our inability to do so could have a material adverse effect on us.
Our business is subject to the conditions of the local economy in which we operate and weakness in the local economy and the real estate markets may materially and adversely affect us.
Our success is dependent to a large extent upon the general economic conditions in the Illinois and Chicago area where the Bank provides banking and financial services. Accordingly, the local economic conditions in Chicago have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources.
While economic conditions have generally improved since the recession, weakness in the Illinois and Chicago area economy has had and may continue to have a material adverse affect on us, including higher provisions for loan losses and net loan charge-offs, lower net interest income caused by an increase in nonaccrual loans, and higher legal and collection costs. In addition, we may be required to continue to devote substantial additional attention and resources to nonperforming asset management rather than focusing on business growth activities. Adverse conditions in the local economy could also reduce demand for new loans and other financial services and impair our ability to attract and retain deposits.
Our business is subject to economic conditions and other factors, many of which are beyond our control and could materially and adversely affect us.
From December 2007 through June 2009, the United States economy was in recession. Business activity across a wide range of industries and regions in the United States was greatly reduced. Although general economic conditions have improved, certain sectors remain weak, including within the Chicago area, where most of our customers are located. In addition, local governments and many businesses continue to experience difficulty due to lower consumer spending and decreased liquidity in the credit markets.
Market conditions also led to the failure or merger of several prominent financial institutions and numerous regional and community-based financial institutions. These failures, as well as projected future failures, have had a significant negative impact on the capitalization level of the deposit insurance fund of the FDIC, which, in turn, has led to a significant increase in deposit insurance premiums paid by financial institutions.
The Company’s financial performance generally, and in particular the ability of customers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent upon the business environment in the markets where the Company operates, in the state of Illinois generally and in the United States as a whole. A favorable business environment is generally characterized by, among other factors: economic growth; efficient capital markets; low inflation; low unemployment; high business and investor confidence; and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.
While economic conditions in the Chicago area, the state of Illinois and the United States have generally improved since the recession, improvement may not continue or occur at a meaningful rate. Such conditions could materially and adversely affect us.
The preparation of our consolidated financial statements requires us to make estimates and judgments, which are subject to an inherent degree of uncertainty and which may differ from actual results.
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and general reporting practices within the financial services industry, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Some accounting policies, such as those pertaining to our allowance for loan losses and deferred tax assets and the necessity of any related valuation allowance, require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results may differ from these estimates and judgments under different assumptions or conditions, which may have a material adverse effect on our financial condition or results of operations in subsequent periods.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio, which could have a material adverse effect on us.
Making loans is a substantial part of our business, and every loan we make is subject to the risk that it will not be repaid or that any underlying collateral in the case of secured loans will not be sufficient to assure full repayment. Among other things, the risk of non-payment is affected by:

changes in economic, market and industry conditions,

the credit risks associated with the particular borrower and type of loan,

cash flow of the borrower and/or the project being financed,

the duration of the loan, and

opportunities to identify potential loan repayment issues when remedial action may be most effective.
We maintain an allowance for loan losses, which is an accounting reserve established through a provision for loan losses charged to expense, which we believe is adequate to provide for probable losses inherent in our loan portfolio as of the corresponding balance sheet date. The determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which are subject to material changes. Deterioration in or stagnation of economic conditions affecting borrowers, new information regarding existing loans and any underlying collateral, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance for loan losses.
In addition, our federal and state regulators periodically review our allowance for loan losses and, based on judgments that differ from those of our management, may require an increase in our provision for loan losses or the recognition of further loan charge-offs. Further, if loan charge-offs in future periods exceed our allowance for loan losses, we will need additional provisions to increase the allowance. Any increases in our allowance for loan losses will result in a decrease in net income, and possibly capital, and may have a material adverse effect on us.
We are subject to interest rate risk, including interest rate fluctuations, that could have a material adverse effect on us.
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Open Market Committee of the Federal Reserve.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect:

the Company’s ability to originate loans and obtain deposits,

the fair value of the Company’s financial assets and liabilities, and

the average duration of the Company’s securities portfolio.
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore, earnings and cash flows, could be adversely affected.
Earnings and cash flows could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies, to reduce the potential effects of changes in interest rates on the Company’s results of operations, if these strategies prove ineffective, or if any substantial, unexpected and prolonged change in market interest rates occurs, such events could have a material adverse effect on us.
We have counterparty risk and therefore we may be materially and adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding and other transactions could be materially and negatively affected by the actions and the soundness of other financial institutions. Financial services institutions are generally interrelated as a result of trading, clearing, counterparty, credit or other relationships. We have exposure to many different industries and counterparties and regularly engage in transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions may expose us to credit or other risks if another financial institution experiences adverse circumstances. In certain circumstances, the collateral that we hold may be insufficient to fully cover the risk that a counterparty defaults on its obligations, which may cause us to experience losses that could have a material adverse affect on us.
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors and customer or employee fraud. First Community’s controls and procedures may fail or be circumvented.
There have been a number of highly publicized cases involving fraud or other misconduct by employees of financial services firms in recent years. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. Employee fraud, errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to civil claims for negligence.
We maintain a system of internal controls and procedures designed to reduce the risk of loss from employee or customer fraud or misconduct, employee errors and operational risks, including data processing system failures and errors and customer or employee fraud. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on us.
We are dependent upon outside third parties for the processing and handling of our records and data.
We rely on software developed by third party vendors to process various Company transactions. In some cases, we have contracted with third parties to run their proprietary software on behalf of the Company. These systems include, but are not limited to, general ledger, payroll, employee benefits, loan and deposit processing, and securities portfolio management. While the Company performs a review of controls instituted by the applicable vendor over these programs in accordance with industry standards and performs its own testing of user controls, we must rely on the continued maintenance of controls by these third party vendors, including safeguards over the security of customer data. In addition, the Company maintains, or contracts with third parties to maintain, backups of key processing output daily in the event of a failure on the part of any of these systems. Nonetheless, we may incur a temporary disruption in our ability to conduct our business or process our transactions, or incur damage to our reputation if the third party vendor fails to adequately maintain internal controls or institute necessary changes to systems. Such disruption or a breach of security may have a material adverse effect on us.
System failure or breaches of our network security, including with respect to our Internet banking activities, could subject us to increased operating costs as well as litigation and other liabilities.
The computer systems and network infrastructure we use in our operations and Internet banking activities could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Computer break-ins, “phishing” and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, as well as that of our customers engaging in Internet banking activities. In addition, advances in computer capabilities or other developments could result in a compromise or breach of our systems designed to protect customer data.
These risks have increased for all financial institutions as new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against large financial institutions, particularly denial of service attacks, that are designed to disrupt key business services, such as customer-facing web sites.
The Company also faces risks related to cyber-attacks and other security breaches in connection with credit card and debit card transactions that typically involve the transmission of sensitive information regarding the Company’s customers through various third parties, including merchant acquiring banks, payment processors, payment card networks and its processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that the Company does not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact the Company through no fault of its own, and in some cases it may have exposure and suffer losses for breaches or attacks relating to them. Further cyber-attacks or other breaches in the future, whether affecting the Company or others, could intensify consumer concern and regulatory focus and result in reduced use of payment cards and increased costs, all of which could have a material adverse effect on the Company’s business. To the extent we are involved in any future cyber-attacks or other breaches, the Company’s reputation could be affected, would could also have a material adverse effect on the Company’s business, financial condition or results of operations.
Although we have procedures in place to prevent or limit the effects of any of these potential problems and intend to continue to implement security technology and establish operational procedures to mitigate the risk of such occurrences, these measures could be unsuccessful. Any interruption in, or breach in security of, our computer systems and network infrastructure, or that of our Internet banking customers, could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on us.
We are subject to lending concentration risks.
As of December 31, 2014, 78.95% of the Bank’s loan portfolio consisted of commercial loans, of which approximately 51.35% were commercial real estate loans. Our commercial loans are typically larger in amount than loans to individual consumers and, therefore, have the potential for higher losses on an individual loan basis. Credit quality issues on larger commercial loans, if they were to occur, could cause greater volatility in reported credit quality performance measures, such as total impaired or non-performing loans, and the amount of charge-offs and recoveries between periods. The deterioration of any one or a few of these loans may cause a significant increase in uncollectible loans, which would have a material adverse impact on us. In such case, we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and materially and adversely affect our operating results, financial condition or capital levels.
We may not be able to access sufficient and cost-effective sources of liquidity.
Liquidity is essential to our business and drives our ability to make new loans or invest in securities. In addition, the Company requires liquidity to meet its deposit and debt obligations as they come due. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or the economy generally. Factors that could reduce our access to liquidity sources include a downturn in the Chicago area market, difficult credit markets or adverse regulatory actions against us.
As part of our liquidity management, we use a number of funding sources in addition to what is provided by in-market deposit and repayments and maturities of loans and investments. Although we have recently increased our funding from our core customers to reduce our reliance on wholesale funding, we continue to use brokered money market accounts and certificates of deposits, out-of-local-market certificates of deposit, broker/dealer repurchase agreements, federal funds purchased and FHLB and Federal Reserve Bank advances as a source of liquidity.
Our liquidity position is affected by the amount of cash and other liquid assets on hand, payment of interest and dividends on our outstanding debt and equity instruments, capital we inject into the Bank, redemption of our previously issued debt, proceeds we raise through the issuance of debt and equity instruments, and dividends received from the Bank. Our future liquidity position may be materially adversely affected if, in the future, one or a combination of the following events occur:

the Bank reports net losses or its earnings are weak relative to our cash flow needs as a holding company,

we deem it advisable or are required by our regulators to use cash at the holding company level to support loan growth of the Bank or address other capital needs of the Bank through downstream capital injections, or

we have difficulty raising cash at the holding company level through the issuance of debt or equity securities or accessing additional sources of credit.
Our usual liquidity management challenges include responding to potential volatility in our customers’ deposit balances. We primarily use advances from the FHLB, broker/dealer repurchase agreements and federal funds purchased to meet our immediate liquidity needs. We maintain stable client deposits, which allows us to not heavily rely on wholesale funding sources. However, our client deposits may not remain at current levels and we may not be able to maintain the recent reduced reliance on wholesale deposits. Increased customer confidence in general economic conditions, higher expected rates of return on other investments (including a rise in interest rates) or additional restrictions on the availability of FDIC coverage could each cause our customers to move all or a portion of their deposits to other investment options, thus causing a reduction in our deposits and increasing our reliance on wholesale or other funding sources.
Given the losses recorded by our legacy bank subsidiaries and affiliates from 2008 through 2011, the negative retained earnings at the Bank as of December 31, 2014, and the resulting limitations on the ability of the Bank to pay dividends to First Community, we have been dependent upon our current cash position and cash proceeds generated by capital raises to meet liquidity needs at the holding company level. If we foresee that we face diminished liquidity, we may, to the extent possible, seek to issue additional debt or securities which could cause ownership or economic dilution to our current shareholders.
The repeal of federal prohibitions on payment of interest on business demand deposits could increase the Company’s interest expense and have a material adverse effect on us.
All federal prohibitions on the ability of financial institutions to pay interest on business demand deposit accounts were repealed as part of the Dodd-Frank Act. As a result, some financial institutions have commenced offering interest on these demand deposits to compete for customers. If competitive pressures require the Company to pay interest on these demand deposits to attract and retain business customers, its interest expense would increase and its net interest margin would decrease. This could have a material adverse effect on us. Further, the effect of the repeal of the prohibition could be more significant in a higher interest rate environment as business customers would have a greater incentive to seek interest on demand deposits.
Changes in our credit ratings could increase our financing costs or make it more difficult for us to obtain funding or capital on commercially acceptable terms.
We are rated by several different rating agencies, including International Data Corporation and Bankrate.com. Many factors, both within and out of our control, may cause these agencies to downgrade their ratings related to the Company, which could subject us to negative publicity, adversely impact our ability to acquire or retain deposits and increase our cost of borrowing or limit our asset growth. Also, our credit ratings are an important factor to the institutions that provide our sources of liquidity, and reductions in our credit ratings could adversely affect our liquidity, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.
The Company is a bank holding company and its sources of funds are limited.
The Company is a bank holding company, and its operations are primarily conducted by the Bank, which is subject to significant federal and state regulation. The Company’s ability to receive dividends or loans from the Bank is restricted and therefore the ability to pay dividends to shareholders is restricted. Currently the Bank is unable to pay dividends due to negative retained earnings. Dividend payments by the Bank to the Company in the future will require generation of future earnings by the Bank and could require regulatory approval if any proposed dividends are in excess of prescribed guidelines. Further, as a structural matter, the Company’s right to participate in the assets of the Bank in the event of a liquidation or reorganization of the Bank would be subject to the claims of the Bank’s creditors, including depositors, which would take priority except to the extent the Company may be a creditor with a recognized claim. As of December 31, 2014, the Bank had deposits and other liabilities of approximately $832.0 million.
Our business strategy is dependent on our continued ability to attract, develop and retain highly qualified and experienced personnel in senior management and customer relationship positions.
We believe our future success is dependent, in part, on our ability to attract and retain highly qualified and experienced personnel in key senior management and other positions. Our competitive strategy is to provide each of our commercial customers with a highly qualified relationship manager that will serve as the customer’s key point of contact with us. Achieving the status of a “trusted advisor” for our customers also requires that we minimize relationship manager turnover and provide stability to our customer relationships. Competition for experienced personnel in our industry is intense, and we may not be able to successfully attract and retain such personnel.
Our reputation could be damaged by negative publicity.
Reputational risk, or the risk to us from negative publicity, is inherent in our business. Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate
governance, litigation, inadequate protection of customer data, ethical behavior of our employees, and from actions taken by regulators, ratings agencies and others as a result of that conduct. Damage to our reputation could impact our ability to attract new or maintain existing loan and deposit customers, employees and business relationships.
New lines of business or new products and services may subject us to certain additional risks.
From time to time, we will consider and may enter into new lines of business or offer new products or services. These activities can involve a number of uncertainties, risks and expenses, including the investment of significant time and resources, and our projected price and profitability targets may not be attainable or our efforts may not be successful. These initiatives have required and will continue to require us to enter geographical markets that are new to us. In addition, new lines of business and new products and services could significantly impact the effectiveness of our system of internal controls, and present requirements for legal compliance with which we were previously unfamiliar. Failure to successfully manage these risks could have a material adverse affect on us.
We may experience difficulties in managing our future growth.
Our future success, in part, depends on our achieving growth in commercial banking relationships that results in increased commercial loans at yields that are profitable to us. Achieving our growth targets requires us to attract customers who currently bank at other financial institutions in our market, thereby increasing our share of the market. Although we believe that we have the necessary resources in place to successfully manage our future growth, our growth strategy exposes us to certain risks and expenses, including adversely affecting our results of operations and placing a significant strain on our management, personnel, systems and resources. In addition, maintaining credit quality while growing our loan portfolio is critical to achieving and sustaining profitable growth. We may not be able to manage our growth effectively. If we fail to do so, we would be materially harmed.
In furtherance of our growth strategy, we may also seek to further reorganize our corporate structure or acquire other financial institutions or parts of those institutions in the future, and we may engage in banking center expansion. In connection with future reorganizations or acquisitions, we may issue equity securities which could cause ownership and economic dilution to our current shareholders. Moreover, our regulators will need to formally approve our implementation of a reorganization or acquisition strategy. Furthermore, following any future reorganization merger or acquisition, our integration efforts may not be successful or, after giving effect to the acquisition, we may not achieve a level of profitability that will justify the investment that we made in any such acquisition.
The Company and the Bank are subject to changes in federal and state tax laws and changes in interpretation of existing laws.
The Company’s financial performance is impacted by federal and state tax laws. Given the current economic and political environment, and ongoing federal and state budgetary pressures, the enactment of new federal or state tax legislation may occur. For example, in January 2011, the State of Illinois passed an income tax increase for both individuals and corporations, which increased our state income tax rate. The further enactment of such legislation, or changes in the interpretation of existing law, including provisions impacting tax rates, apportionment, consolidation or combination, income, expenses, and credits, may have a material adverse effect on us.
Regulatory requirements, growth plans or operating results may require us to raise additional capital, which may not be available on favorable terms or at all.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. At December 31, 2014, the Bank was categorized as “well-capitalized” under the applicable regulatory capital framework. To the extent regulatory requirements change, our future operating results erode capital or we seek to expand through loan growth or acquisitions, we may be required to raise additional capital. Our ability to raise capital in any such event would depend on conditions in the capital markets, which are outside of our control, and on our financial condition and performance. Accordingly, our ability to raise capital when needed or on favorable terms is uncertain. The inability to attract new capital investment, or to attract capital on terms acceptable to us, could have a material adverse impact on us.
We have not paid a dividend on our common stock since the Company’s formation in 2006. In addition, regulatory restrictions and liquidity constraints at the holding company level could impair our ability to make distributions on our outstanding securities.
Historically, our primary source of funds at the holding company level has been debt and equity issuances. The Bank and its predecessor banks have not paid dividends to the Company, and the Company has not paid dividends to our common shareholders, since the Company’s formation in 2006. Current and future liquidity constraints at the holding company level could continue to impair our ability to declare and pay dividends on our common stock or pay interest on our outstanding debt securities in the future. If we are unable to pay dividends or interest on our outstanding securities in the future, the market value of such securities may be materially adversely affected.
We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors. In addition, our election not to opt out of JOBS Act extended accounting transition period may make our financial statements less easily comparable to the financial statements of other companies.
We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We will remain an emerging growth company for up to five years, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million). We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. We have elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. This may make comparison of our financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accountant standards used.
The utilization of our tax losses could be substantially limited if we experienced an ownership change, as defined in the Internal Revenue Code.
Our net deferred tax asset totaled $14.2 million as of December 31, 2014. The ultimate realization of a deferred tax asset is dependent upon the generation of future taxable income during the periods prior to the expiration of the related net operating losses and the limitations of Section 382 of the Internal Revenue Code. Section 382 contains rules that limit the ability of a company that undergoes an ownership change to utilize its net operating loss carryforwards and certain built-in losses recognized in years after the ownership change. Under the rules, such an ownership change is generally any change in ownership of more than 50% of its stock within a rolling three-year period, as calculated in accordance with the rules. The rules generally operate by focusing on changes in ownership among stockholders considered by the rules as owning directly or indirectly 5% or more of the stock of the company and any change in ownership arising from new issuances of stock by the company. If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, our ability to use any of our net operating loss carryforwards, tax credit carryforwards or net unrealized built-in losses at the time of ownership change would be subject to the limitations of Section 382 on their use against future taxable income. The limitation may affect the amount of our deferred income tax asset and, depending on the limitation, a portion of our built-in losses, any net operating loss carryforwards or tax credit carryforwards could expire before we would be able to use them. This could adversely affect our financial position, results of operations and cash flow.
We have a substantial amount of debt outstanding and may incur additional indebtedness in the future, which could restrict our operations.
As of December 31, 2014, we had $29.1 million of subordinated debt outstanding. We currently expect our interest expense to be approximately $2.4 million in fiscal year 2015. We may not generate sufficient revenues to service or repay our
debt, and have sufficient funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs, and to pay dividends to our common shareholders.
The degree to which we are leveraged could have important consequences for our shareholders, including:
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limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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making it more difficult for us to satisfy its debt and other obligations;
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limiting our ability to borrow additional funds, or to sell assets to raise funds, if needed, for working capital, capital expenditures, acquisitions or other purposes;
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increasing our vulnerability to general adverse economic and industry conditions, including changes in interest rates; and
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placing us at a competitive disadvantage compared to our competitors that have less debt.
The market price of our common stock may be volatile, which could cause the value of an investment in our common stock to decline.
The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:

general market conditions;

domestic and international economic factors unrelated to our performance;

actual or anticipated fluctuations in our quarterly operating results;

changes in or failure to meet publicly disclosed expectations as to our future financial performance;

downgrades in any securities analysts’ estimates of our financial performance or lack of research and reports by industry analysts;

changes in market valuations or earnings of similar companies;

any future sales of our common stock or other securities; and

additions or departures of key personnel.
The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These types of broad market fluctuations may adversely affect the trading price of our common stock. In the past, shareholders have sometimes instituted securities class action litigation against companies following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention and resources and harm our business or results of operations.
Our stock is relatively thinly traded.
Although our common stock is quoted on the OTCQB marketplace, the average daily trading volume of our common stock is relatively small compared to many public companies. The desired market characteristics of depth, liquidity, and orderliness require the substantial presence of willing buyers and sellers in the marketplace at any given time. In our case, this presence depends on the individual decisions of a relatively small number of investors and general economic and market conditions over which we have no control. Due to the relatively small trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause the stock price to fall more than would be justified by the inherent worth of the Company. Conversely, attempts to purchase a significant amount of our stock could cause the market price to rise above the reasonable inherent worth of the Company.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
As of December 31, 2014, the net book value of our properties was $19.4 million. The following is a list of our offices:
Item 3.
Item 3. Legal Proceedings
The Company is involved from time to time in various legal actions arising in the normal course of business. While the outcome of the pending proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operation.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
First Community’s common stock is quoted on the OTCQB marketplace under the symbol “FCMP.” There were approximately 981 holders of record of our common stock as of March 2, 2015.
The following table presents quarterly high and low bid prices per share information for our common stock for 2014 and 2013. These quotations represent inter-dealer prices without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.
The timing and amount of cash dividends paid on our common stock depends on our earnings, capital requirements, financial condition and other relevant factors including the ability of the Bank to pay dividends to the Company. Currently, regulatory policies prohibit the Bank to pay dividends due to its negative retained earnings. See Item 1. Business above and Note 13 to our Consolidated Financial Statements contained in Item 8. Financial Statements and Supplementary Data.
First Community has not paid cash dividends on its common stock since its formation in 2006.
Item 6.
Item 6. Selected Financial Data
Not applicable.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our financial statements and related notes thereto included elsewhere in this report. This report may contain certain forward-looking statements, such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties, including those described in Item 1A. Risk Factors and other sections of this Annual Report on Form 10-K and the Company’s other filings with the SEC, and other risks and uncertainties, including changes in interest rates, general economic conditions and those in the Company’s market area, legislative/regulatory changes, including the rules recently adopted by the U.S. federal banking authorities to implement the Basel III capital accords, monetary and fiscal policies of the U.S. government, including policies of the Treasury and the Federal Reserve, the Company’s success in raising capital, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.
Overview
2014 Highlights
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Loans increased $37.1 million, or 5.69%, from $652.1 million at December 31, 2013 to $689.2 million at December 31, 2014.
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Noninterest bearing deposit accounts increased $46.4 million, or 41.42%, from $112.0 million at December 31, 2013 to $158.3 million at December 31, 2014.
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Pre-tax pre-provision income was $11.6 million for the year ended December 31, 2014, compared to $10.1 million for the year ended December 31, 2013.
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Book value per common share increased 5.34% from $5.24 at December 31, 2013 to $5.52 at December 31, 2014.
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Nonperforming assets were 1.03% of total assets at December 31, 2014, compared to 3.18% at December 31, 2013.
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The Company repurchased all of its remaining outstanding shares of its Series B Preferred Stock and Series C Preferred Stock.
2014 Financial Performance
Balance sheet
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In 2014, commercial loans increased $12.0 million and residential 1-4 family loans increased $14.0 million. Additionally, commercial real estate loans increased $9.2 million while construction and land development loan balances decreased $2.0 million.
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Noninterest bearing deposit accounts increased $46.4 million, or 41.42%, year over year. The Company’s increased focus on commercial business depositors with a mix of new businesses and increases in the balances of existing depositors has led to the improvement in noninterest bearing deposits. NOW and money market accounts increased $29.4 million year over year. This growth has reduced First Community’s overall reliance on time deposits for funding its asset growth, which decreased $37.6 million year over year.
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First Community’s ratio of tangible common shareholder’s equity to tangible assets was 9.96% at December 31, 2014, compared to 9.78% at September 30, 2014, and 9.86% at December 31, 2013.
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First Community Financial repurchased all of its remaining outstanding shares of Series B Preferred Stock and Series C Preferred Stock that were originally issued to the U.S. Department of the Treasury under the Troubled Asset Relief Program Capital Purchase Program. On December 9, 2014, First Community repurchased 5,176 shares of Series B Preferred Stock and 1,100 shares of Series C Preferred Stock, with a liquidation preference of $1,000 per share, from certain third-party investors at an aggregate purchase price of $6.3 million. The proceeds from First Community’s 7.0% subordinated debt raise that closed on October 31, 2014, were used to fund the repurchase of the preferred stock. With the Series B Preferred Stock dividend rate increasing from 5.0% to 9.0% in 2015, the repurchase of the preferred stock will result in an estimated annual savings of $301,000, due to the elimination of payment of dividends on the repurchased shares.
Income and Expenses
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Net interest income was $28.9 million for the year ended December 31, 2014, compared to $28.7 million for the year ended December 31, 2013.
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Interest income on loans was $32.1 million for the year ended December 31, 2014, compared to $32.7 million for the year ended December 31, 2013. The year over year interest income on the increased loan balances was offset by newer loans being booked at lower yields due to current competitive market conditions. As the year progressed, we saw an improvement in income related to loans as a result of growth, despite the lower yields.
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Interest income on securities was $3.1 million for the year ended December 31, 2014, compared to $2.1 million for the year ended December 31, 2013. The increase in interest income on securities was the result of $27.4 million of growth in the portfolio, along with improvement in the overall yield of the portfolio based on new investment strategies implemented during 2014.
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Interest expense on deposits was $4.4 million for the year ended December 31, 2014, compared to $4.9 million for the year ended December 31, 2013. The overall improvement was the result of time deposit run off of $37.6 million, which was replaced with $46.4 million in noninterest bearing deposits along with $35.3 million in lower cost NOW, money market and savings accounts.
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Noninterest income was $3.3 million for the year ended December 31, 2014, compared to $1.6 million for the year ended December 31, 2013.
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Service charges on deposit accounts increased $241,000 year over year as a result of increases in noninterest bearing deposit and money market accounts which provide greater fee income. In addition, the Bank experienced higher levels of overdrafts during 2014 which resulted in significantly higher overdraft fee collection during the year.
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Gains on sales of securities were up $908,000. This was the result of investment sales during 2014 as a part of changes in the overall investment strategy and repositioning the investment portfolio.
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Mortgage fee income was $34,000 higher in 2014 compared to 2013, in the first full year of mortgage operations.
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Other noninterest income was up $766,000 over the prior year. This was primarily the result of $483,000 of income related to proceeds received from a bank owned life insurance policy. In addition, $288,000 of income was recognized from an earnest money deposit for a loan sale that did not occur.
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Noninterest expense was $20.6 million for the year ended December 31, 2014, compared to $20.2 million for the year ended December 31, 2013.
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Salaries and benefits increased $525,000 year over year. This increase was the result of additions to the mortgage lending staff and the addition of two market presidents in late 2013.
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Professional fees decreased $141,000 in 2014, which was the result of improvement in asset quality and loan related legal fees along with the continued cost savings experienced subsequent to the 2013 charter consolidation.
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Losses and write downs on foreclosed assets were up $266,000 for 2014. The write downs were related to updated appraisals on properties being held in addition to losses incurred on the sale of properties during the year. The focus on reducing nonperforming assets included the disposition $1.6 million of foreclosed assets during 2014.
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Other expense for the year ended December 31, 2014, was down $625,000 from $4.2 million, for the year ended December 31, 2013. This decrease was the result of continued cost savings as a result of the Consolidation.
Continued Aggressive Cleanup of Loan Portfolio
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Nonperforming assets declined by $18.1 million, or 65.49% from December 31, 2013.
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Nonperforming loans decreased $16.2 million or 69.83% since December 31, 2013. This was the result of management’s efforts to improve asset quality and the reduction was the result of loan payoffs, charge-offs and transfers to foreclosed assets.
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Provisions for loan losses decreased from $8.0 million for the year ended December 31, 2013 to $3.0 million for the year ended December 31, 2014. This decrease reflected the substantial improvement in asset quality since December 31, 2013, and overall improvement in the three year loss history, which is the starting point in the allowance for loan loss calculation and in turn loan loss provisions.
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Total net charge-offs for 2014 were $4.9 million, an improvement over the $15.1 million in net charge-offs taken in 2013. The reduction in net charge-offs was also the result of improved asset quality and strides made to improve the loan portfolio over the past two years.
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The allowance for loan losses represented 2.02% of total loans and 198.73% of nonperforming loans at December 31, 2014. These ratios have changed year over year from 2.43% and 68.21%, respectively, at December 31, 2013, as a result of the continued improvement in asset quality.
Footnotes:
(1) Includes available for sale securities recorded at fair value and FHLB stock at cost.
(2) All periods other than December 31, 2014 include shareholders’ equity attributable to then outstanding shares of Series B Preferred Stock and Series C Preferred Stock
(3) Nonperforming loans include loans on nonaccrual status and those past due more than 90 days and still accruing interest.
(4) Nonperforming assets consist of non-performing loans and other real estate owned.
(5) Tangible common equity to tangible assets is total shareholders' equity less preferred stock divided by total assets.
A summary of the Company’s balances of loans follows:
A summary of the Company’s commercial real estate portfolio follows:
A summary of the Company’s balances of deposits follows:
Reconciliation of Non-GAAP Selected Quarterly Financial Data
Results of Operations
Net Interest Income
Net interest income is the largest component of our income, and is affected by the interest rate environment and the volume and the composition of interest earning assets and interest-bearing liabilities. Our interest earning assets include loans, interest bearing deposits in other banks, investment securities, and federal funds sold. Our interest bearing liabilities include deposits, advances from the FHLB, subordinated debentures, repurchase agreements and other short-term borrowings.
The following table reflects the components of net interest income for the years ended December 31, 2014, 2013 and 2012:
Footnotes:
(1) Average loans include nonperforming loans.
(2) No tax-equivalent adjustments were made, as the effect thereof was not material.
Net interest income was $28.9 million for the year ended December 31, 2014, a increase of $208,000 or 0.72%, from $28.7 million for the same period in the prior year. The net interest margin was 3.39% for this period in 2014 and 3.37% for 2013. While overall loan yields were down over the prior year primarily as a result of new loans being booked at lower rates due to the competitive market, interest income on securities is up significantly as a result of changes in strategy in the securities portfolio. In addition, the change in the mix of deposits from interest bearing to noninterest bearing has helped to improve our cost of funds and lower interest income on deposits.
Rate/Volume Analysis
The following table sets forth certain information regarding changes in our interest income and interest expense for the years noted (dollars in thousands):
Footnotes:
(1) Average loans includes nonperforming loans.
(2) No tax-equivalent adjustments were made, as the effect thereof was not material.
Provision for Loan Losses
The provision for loan losses was $3.0 million for the year ended December 31, 2014, compared to $8.0 million for the same period in 2013. Net charge-offs decreased to $4.9 million for the year ended December 31, 2014 compared to $15.1 million for the year ended December 31, 2013. Nonperforming loans decreased from December 31, 2013 to December 31, 2014 by 69.8%, to $7.0 million from $23.2 million. During the year ended December 31, 2014, the Company sold approximately $2.7 million in nonperforming loans and had charge-offs of $4.9 million, in addition to $96,000 in loans transferred to foreclosed assets and paydowns and payoffs of nonpeforming loans during the year. This decrease was the result of management’s continued focus on improving asset quality and allowed for lower loan loss provisions in 2014.
Noninterest Income
Noninterest income for the year ended December 31, 2014 increased significantly from the year ended December 31, 2013. This increase related primarily to the increase in income related to gains on sales of securities. In 2014, $912,000 in income was earned on the sales of securities as a result of changes in the investment strategy that were implemented during 2014. Other income also increased as result of $483,000 of income related to proceeds received from a bank owned life insurance policy. In addition, $288,000 of income was recognized from an earnest money deposit for a loan sale that did not occur. In addition, service charges on deposit accounts were up over the prior year primarily the result of significant increases in overdrafts during 2014. Mortgage fee income was also up as this was the first full year of mortgage operations. The following table sets forth the components of non-interest income for the periods indicated:
Noninterest Expense
Noninterest expense increased slightly for the year ended December 31, 2014 compared to the year ended December 31, 2013. Salaries and employee benefits increased for the year ended December 31, 2014 compared to the year ended December 31, 2013, which was the result of additions to the mortgage lending staff due to the Bank’s new mortgage operations, and the addition of two market presidents in late 2013. Professional fees decreased during 2014, which was the result of improvement in asset quality and loan-related legal fees along with the continued cost savings experienced subsequent to the Consolidation. Losses on foreclosed assets were also up during 2014. The write downs were related to updated appraisals on properties held by the Bank, in addition to losses incurred on the sale of properties during the year. Other expense was also down which again is the result of continued cost savings as a result of the Consolidation, along with new cost savings measures.
Income Taxes
Prior to the Consolidation, the Company filed four tax returns, one consolidated return for First Community and FCB Joliet and one for each legacy banking subsidiary. Because of multiple returns, we separately calculated income tax expense, established deferred tax assets and determined valuation allowances. Subsequent to the Consolidation, the Company now calculates income tax expense on a consolidated basis.
Under generally accepted accounting principles in the United States (“U.S. GAAP”) a valuation allowance against a net deferred tax asset is required to be recognized if it is more-likely-than-not that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, forecasts of future income, applicable tax planning strategies and assessments of current and future economic and business conditions.
Prior to the Consolidation, the Company determined a valuation allowance was necessary for two of those bank charters as of December 31, 2012, largely based on negative evidence including cumulative losses caused by credit losses in its loan portfolio and general uncertainty surrounding future economic and business conditions.
The Company evaluates the need for a deferred tax asset valuation allowance on an ongoing basis, considering both positive and negative evidence. As of September 30, 2013, positive evidence included seven consecutive quarters of income, continued improvement in asset quality ratios, termination of our Memoranda of Understanding with our banking regulators, completion of our Consolidation in March 2013 and the prospect that other key drivers of profitability will continue in the future. Negative evidence included no available taxes paid in open carryback years, no significant tax planning opportunities to accelerate taxable income and that 2013 was the first year of taxable income since 2007. Based on the Company’s assessment of all available evidence, management determined that it was more-likely-than-not that the deferred tax asset would be realized. Therefore, at September 30, 2013, the Company released its $15.6 million valuation allowance against the net deferred tax assets resulting in a credit to income tax (benefit) expense.
The Company realized income tax expense of $2.7 million and income tax benefit of $14.6 million for the year ended December 31, 2014 and 2013, respectively. The increase in income taxes for the year ended December 31, 2014 compared to the year ended December 31, 2013, was the result of the new tax structure and the release of the deferred tax valuation allowance during the third quarter of 2013. Management now expects normalized income tax expense for future reporting periods.
Financial Condition
The Company’s assets totaled $924.1 million and $867.6 million at December 31, 2014 and December 31, 2013, respectively. Total loans at December 31, 2014 and December 31, 2013 were $689.4 million and $652.5 million, respectively. Total deposits were $769.4 million and $725.4 million at December 31, 2014 and December 31, 2013, respectively. We continued to see decreases in time deposit accounts in 2014 as we continued to lower our rates in an effort to lower our overall cost of funding. Increases in total assets was the result of growth in the loan and securities portfolios over 2014. Borrowed funds, consisting of securities sold under agreements to repurchase and a mortgage note payable, totaled $29.5 million and $25.6 million at December 31, 2014 and December 31, 2013, respectively. In addition, $9.8 million in subordinated debt was issued during 2014.
Total shareholders’ equity was $92.1 million and $91.6 million at December 31, 2014 and December 31, 2013, respectively. The increase was as a result of the net income available to common shareholders for the year ended December 31, 2014, partially offset by the repurchase of preferred shares.
Loans
The loan portfolio consists principally of loans to individuals and small- and medium-sized businesses within our primary market area. The table below shows our loan portfolio composition (dollars in thousands):
Total loans increased by $37.1 million during the year ended December 31, 2014 as a result of new loan originations. New loans originated during 2014 were primarily in the residential real estate, commercial real estate and commercial loan categories which is in line with our current strategy for loan growth.
The contractual maturity distributions of our loan portfolio as of December 31, 2014 are indicated in the tables below:
Allowance for Loan Losses
Management reviews the level of the allowance for loan losses on a quarterly basis. The methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The specific component relates to loans that are impaired. For such loans that are classified as impaired, an allowance is established when the collateral value, discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan. The general component is established for non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include local economic trends, concentrations, management experience, and other elements of the Company’s lending operations.
At December 31, 2014 and December 31, 2013, the allowance for loan losses was $13.9 million and $15.8 million, respectively, with a resulting allowance to total loans ratio of 2.02% and 2.42%, respectively. Net charge-offs amounted to $4.9
million for the year ended December 31, 2014, compared to $15.1 million for the same period in 2013. Charge-offs, recoveries and selected loan quality ratios for each major loan category are shown in the table below:
The following table provides additional detail of the balance of the allowance for loan losses by portfolio segment (dollars in thousands):
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining the impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis using the fair value of collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate, or the loan’s obtainable market price due to financial difficulties of the borrower.
Residential 1-4 family and consumer loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
There were approximately $7.0 million in nonperforming loans at December 31, 2014, down from $23.2 million at December 31, 2013. The decrease was the result of current year charge-offs, paydowns, and loans moved to foreclosed assets. One nonperforming loan was moved to held for sale while the sale was pending during 2013 and the sale closed in the first quarter of 2014.
Impaired loans were $15.6 million and $28.6 million at December 31, 2014 and December 31, 2013, respectively. Included in impaired loans at December 31, 2014 were $1.4 million in loans with valuation allowances totaling $590,000, and $14.2 million in loans without a valuation allowance. Included in impaired loans at December 31, 2013 were $9.9 million in loans with valuation allowances totaling $2.4 million, and $18.7 million in loans without a valuation allowance.
The following presents the recorded investment in nonaccrual loans and loans past due over 90 days and still accruing as of:
We define potential problem loans as loans rated substandard which are still accruing interest. We do not necessarily expect to realize losses on all potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management. The aggregate principal amounts of potential problem loans as of December 31,
2014 and December 31, 2013 were approximately $4.4 million and $3.8 million, respectively. Management believes it has established an appropriate allowance for loan losses under U.S. GAAP.
The gross interest income that would have been recorded if nonaccrual loans and performing troubled debt restructurings had been current in accordance with their original terms was $850,000 and $1.4 million, respectively, for the years ended December 31, 2014 and 2013, respectively. The amount of interest collected on nonaccrual loans and performing troubled debt restructurings that was included in interest income was $446,000 and $101,000 for the years ended December 31, 2014 and 2013, respectively.
Investment Securities
Investment securities serve to enhance the overall yield on interest earning assets while supporting interest rate sensitivity and liquidity positions, and as collateral on public funds and securities sold under agreements to repurchase. All securities are classified as available for sale as the Company intends to hold the securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale are reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of the related deferred tax effect. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
The amortized cost and fair value of securities available for sale (in thousands) are as follows:
Available for sale securities increased $27.4 million to $168.7 million at December 31, 2014 from $141.3 million December 31, 2013, as excess cash was invested during the year ended December 31, 2014. In 2014, the investment strategy was reviewed, and as a result the securities portfolio grew significantly leading to increased income and less uninvested cash.
Securities with a fair value of $40.5 million and $41.0 million were pledged as collateral on public funds, securities sold under agreements and for other purposes as required or permitted by law as of December 31, 2014 and December 31, 2013, respectively.
The amortized cost of debt securities available for sale as of December 31, 2014, by contractual maturity are shown below (in thousands). Maturities may differ from contractual maturities in residential collateralized mortgage obligations and residential mortgage backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore these securities are segregated in the following maturity summary.
No tax-equivalent yield adjustments were made as the effect thereof was not material.
The Company holds securities issued by the State of Illinois, in the amount of $326,000, all of which are sales tax revenue bonds. In addition, approximately 62% of the state and political subdivisions portfolio consisted of securities issued by municipalities in Illinois. Approximately 6% of state and political subdivisions securities were insured and approximately 79% of our state and political subdivisions securities consisted of general obligation issues.
Deposits
Deposits, which include noninterest-bearing demand deposits, interest bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds. The Company offers a variety of products designed to attract and retain customers, with a primary focus on building and expanding relationships. The Company continues to focus on establishing comprehensive relationships with business borrowers, seeking deposits as well as lending relationships.
The following table sets forth the composition of our deposits at the dates indicated (dollars in thousands):
Total deposits increased $44.0 million to $769.4 million at December 31, 2014, from $725.4 million at December 31, 2013. The increase in deposits was the result of efforts by management to place increased focus on commercial business depositors, including new business and increases in the balances held by current depositors. Noninterest bearing deposits accounted for $46.4 million in deposit growth, in addition to increases in NOW and money market accounts of $29.4 million, and increases of $5.8 million in savings accounts, all of which was offset by decreases in time deposits of $37.6 million year over year.
The following table sets forth our time deposits segmented by months to maturity and deposit amount (dollars in thousands):
Impact of Inflation and Changing Prices
The consolidated financial statements of the Company and the accompanying notes have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike industrial companies, nearly all of the assets and liabilities of the Company are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Liquidity and Capital Resources
Our goal in liquidity management is to satisfy the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. Our Board of Directors has established an Asset/Liability Policy in order to achieve and maintain earnings performance consistent with long-term goals while maintaining acceptable levels of interest rate risk, a “well-capitalized” balance sheet, and adequate levels of liquidity. This policy designates the Bank’s Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO, which includes members of management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions.
Overall deposit levels are monitored on a constant basis as are liquidity policy levels. Primary sources of liquidity include cash and due from banks, short-term investments such as federal funds sold, securities sold under agreements to repurchase, and our investment portfolio, which can also be used as collateral on public funds. Alternative sources of funds include unsecured federal funds lines of credit through correspondent banks, brokered deposits, and FHLB advances. The Bank has established contingency plans in the event of extraordinary fluctuations in cash resources.
The following table reflects the average daily outstanding, year-end outstanding, maximum month-end outstanding and weighted average rates paid for each of the categories of short-term borrowings:
Provisions of the Illinois banking laws place restrictions upon the amount of dividends that can be paid to the Company by the Bank. The availability of dividends may be further limited because of the need to maintain capital ratios satisfactory to applicable regulatory agencies.
The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial results and condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company 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. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. In addition, the Bank remains subject to certain of the FDIC’s de novo bank requirements until the Bank has been chartered for a period longer than seven years. Until October 28, 2015, the Bank is required, among other items, to obtain FDIC approval for any material change to its business plan.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets and of Tier I
capital to average assets, each as defined in the applicable regulations. Management believes, as of December 31, 2014 and December 31, 2013, the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2014, the Bank was well capitalized under the regulatory framework for prompt corrective action. As of such date, to be categorized as well capitalized, the Bank must have maintained minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in Note 13 to our Consolidated Financial Statements. Bank regulators can modify capital requirements as part of their examination process. Moreover, the Basel III Rules, which became effective as of January 1, 2015, will affect the Company’s and the Bank’s capital requirements. See Note 13 to our Consolidated Financial Statements for more information.
Critical Accounting Policies and Estimates
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. When establishing the allowance for loan losses, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to recognize adjustments to its allowance based on their judgments of information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to impaired loans. For loans classified as impaired, an allowance is established when the collateral value, discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors consider local economic trends, concentrations, management experience, and other elements of the Company’s lending operations.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining the impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the fair value of collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate, or the loan’s obtainable market price due to financial difficulties of the borrower.
Foreclosed Assets
Assets acquired through loan foreclosure or other proceedings are initially recorded at fair value less estimated selling costs at the date of foreclosure establishing a new cost basis. After foreclosure, foreclosed assets are held for sale and are carried at the lower of cost or fair value less estimated costs of disposal. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sales are included in other noninterest income. Operating results from foreclosed assets are recorded in other noninterest expense.
Income taxes
Deferred taxes are provided using the liability method. 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.
The Company had adopted the accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. There are no uncertain tax positions as of December 31, 2014 and 2013.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized or sustained upon examination. The term more-likely-than-not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more-likely-than-not that some portion or all of a deferred tax asset will not be realized.
Off-Balance Sheet Arrangements
Refer to Note 12 of our Consolidated Financial Statements for a description of off-balance sheet arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
FIRST COMMUNITY FINANCIAL PARTNERS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
INDEX
Page
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
FINANCIAL STATEMENTS
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
First Community Financial Partners, Inc.
Joliet, Illinois
We have audited the accompanying consolidated balance sheet of First Community Financial Partners, Inc. and subsidiaries (the Company) as of December 31, 2014, and the related consolidated statements of operations, comprehensive income, changes of shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion of these consolidated financial statements based on our audit. The consolidated balance sheet of First Community Financial Partners, Inc. and subsidiaries as of December 31, 2013, and the related consolidated statements of operations, comprehensive income, changes of shareholders’ equity, and cash flows for the years ended December 31, 2013 and 2012 were audited by other auditors whose report dated March 20, 2014, was unqualified.
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 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 audit provides 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 First Community Financial Partners, Inc. and subsidiaries as of December 31, 2014, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ CliftonLarsonAllen LLP
Oak Brook, Illinois
March 13, 2015
Report of Independent Registered Public Accounting Firm
To the Board of Directors
First Community Financial Partners, Inc.
We have audited the accompanying consolidated balance sheet of First Community Financial Partners, Inc. and Subsidiaries (“the Company”) as of December 31, 2013, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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 the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides 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 First Community Financial Partners, Inc. and Subsidiaries as of December 31, 2013, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
/s/McGladrey LLP
Chicago, Illinois
March 20, 2014
Notes to Consolidated Financial Statements
Note 1.
Summary of Significant Accounting Policies
Principles of consolidation: The consolidated financial statements include the accounts of First Community Financial Partners, Inc. (the “Company” or “First Community”) and its subsidiaries, including its wholly-owned bank subsidiary, First Community Financial Bank (the “Bank”), based in Plainfield, Illinois, and other wholly-owned real estate holding entities.
All significant intercompany balances and transactions have been eliminated in consolidation.
Nature of operations: First Community is a bank holding company providing a full range of financial services to individuals and corporate clients through the Bank.
Use of estimates: In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of foreclosed assets, and the valuation of deferred tax assets.
Presentation of cash flows: For purposes of the statements of cash flows, cash and cash equivalents include cash on hand, cash items and balances due from banks. Cash flows from federal funds sold, interest bearing deposits in banks, loans originated by the Company, deposits and other borrowings are reported as net increases or decreases.
Interest bearing deposits in banks: Interest bearing deposits in banks mature within one year and are carried at cost.
Securities: All securities are classified as available for sale as the Company intends to hold the securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale are reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of the related deferred tax effect. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Declines in the fair value of individual securities available for sale below their cost that are related to credit losses are deemed to be other-than-temporary and reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent or requirement of the Company to sell its investment in the issuer prior to any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Non-marketable equity securities: The Company owns common stock issued by the FHLB. No ready market exists for these stocks, and they have no quoted market values. The Bank, as a member of the FHLB, is required to maintain an investment in the capital stock of the FHLB. The stock is redeemable at par value by the FHLB, and is therefore, carried at cost and periodically evaluated for impairment. The Company records dividends in income on the date received.
Loans held for sale: Loans held for sale consists of loans the Company has identified for sale. The loans are transferred from the portfolio to held for sale once the determination is made and they are carried at fair value less any costs to sell with charges being taken through the allowance for loan losses.
Loans: The Company grants commercial, commercial and residential mortgage and consumer loans to clients. A substantial portion of the loan portfolio is represented by commercial and commercial mortgage loans throughout communities in Will, Grundy, DuPage, Cook, and Kane counties in Illinois. The ability of the Company’s loan clients to honor their contracts is dependent upon general economic conditions and real estate values in this area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield.
The accrual of interest is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Troubled debt restructurings: Loans are accounted for as troubled debt restructurings (“TDRs”) when a borrower is experiencing financial difficulties that leads to a restructuring of the loan, and the Company grants a “concession” to the borrower that they would not otherwise consider. These concessions include a modification of terms such as a reduction of the stated interest rate or loan balance, a reduction of accrued interest, an extension of the maturity date at an interest rate lower than a current market rate for a new loan with similar risk, or some combination thereof to facilitate repayment.
TDRs are classified as impaired loans. TDRs are reviewed at the time of modification and on a quarterly basis to determine if a specific reserve is needed. The carrying amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for collateral dependent loans, to the fair value of the collateral. Any shortfall is recorded as a specific reserve. Payment performance prior and subsequent to the restructuring is taken into account in assessing whether it is likely that the borrower can meet the new terms. A period of sustained repayment for at least six months generally is required for return to accrual status. This may result in the loan being returned to accrual at the time of restructuring. A loan that is modified at a market rate of interest will not be classified as a TDR in the calendar year subsequent to the restructuring if it is in compliance with the modified terms.
Allowance for loan losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
When establishing the allowance for loan losses, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment. These risk categories and the relevant risk characteristics are as follows:
Construction and land development loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates, and financial analyses of the developers and property owners. Construction and land development loans are generally based upon estimates of costs and value associated with the completed project. Construction and land development loans often involve the disbursement of substantial funds with repayment primarily dependent upon the success of the completed project. Sources of repayment for these types of loans may be permanent loans from long-term lenders, sales of developed property, or an interim loan commitment until permanent financing is obtained. Generally, these loans have a higher risk profile than other real estate loans due to their repayment being sensitive to real estate values, interest rate changes, governmental regulation of real property, demand and supply of alternative real estate, the availability of long-term financing, and changes in general economic conditions.
Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to ensure repayment of loans and mitigate loss exposure. As part of the underwriting process, the Company examines current and projected cash flows to determine the ability of the borrower to repay its obligation as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of the borrower, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and usually incorporate a personal guarantee. However, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent upon the ability of the borrower to collect amounts due from its customers. Agricultural production loans are subject to underwriting standards and processes similar to commercial loans.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those standards and processes specific to real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is largely dependent upon the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate market or in the general economy. The properties securing the Company’s commercial real estate portfolio are
diverse in terms of type and geographic location within Will, Grundy, Dupage, Cook and Kane counties and their surrounding communities. Management monitors and evaluates commercial real estate loans based on cash flow, collateral, geography, and risk grade criteria. Farmland loans are subject to underwriting standards and processes similar to commercial real estate loans.
Residential 1-4 family and consumer loans are underwritten by evaluating the credit history of the borrower, the ability of the borrower to meet the debt service requirements of the loan and total debt obligations, as well as the underlying collateral and the loan to collateral value. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, loan-to-value and affordability ratios, risk-based pricing strategies, and documentation requirements. Included in the Company’s residential 1-4 family loans are loans made to investors. These loans are underwritten using the same criteria as other residential 1-4 family loans.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to recognize adjustments to its allowance based on their judgments of information available to them at the time of their examinations.
The allowance consists of specific and general components. The specific component relates to impaired loans. For loans classified as impaired, an allowance is established when the collateral value, discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors consider local economic trends, concentrations, management experience, and other elements of the Company’s lending operations.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining the impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the fair value of collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate, or the loan’s obtainable market price.
Residential 1-4 family and consumer loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
Premises and equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed over the lesser of the remaining lease term, including renewal options controlled by the Company or the assets’ useful lives using the straight-line method.
Foreclosed assets: Assets acquired through loan foreclosure or other proceedings are initially recorded at fair value less estimated selling costs at the date of foreclosure establishing a new cost basis. After foreclosure, foreclosed assets are held for sale and are carried at the lower of cost or fair value less estimated costs of disposal. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sales are included in noninterest expense. Operating results from foreclosed assets are recorded in noninterest expense.
Cash surrender value of life insurance: The Bank has purchased bank-owned life insurance policies on certain executives. Bank-owned life insurance is recorded at its cash surrender value. Changes in the cash surrender values and death proceeds after recovery of cash surrender values are included in non-interest income.
Transfers of financial assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange
the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
The transfer of a participating interest in an entire financial asset must also meet the definition of a participating interest. A participating interest in a financial asset has all of the following characteristics: (1) from the date of transfer, it must represent a proportionate (pro rata) ownership interest in the financial asset, (2) from the date of transfer, all cash flows received, except any cash flows allocated as any compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, (3) the rights of each participating interest holder must have the same priority, (4) no party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to do so.
Income taxes: Deferred taxes are provided using the liability method. 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.
The Company adopted the accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. The adoption of this standard did not have a significant impact on the Company and there are no uncertain tax positions as of December 31, 2014 and 2013.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized or sustained upon examination. The term more-likely-than-not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment.
The Company would recognize interest and penalties on income taxes as a component of income tax expense.
The Company is no longer subject to U.S. federal or state and local income tax examinations by tax authorities for years before 2011.
Stock compensation plans: The Company recognizes compensation cost relating to share-based payment transactions (stock options, and restricted share plans) in the consolidated financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued.
The Company calculates and recognizes compensation cost for all stock awards over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company uses a Black-Sholes model to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards.
Comprehensive income: Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale net of deferred taxes, are reported as a separate component of the equity section of the balance sheets, such items, along with net income, are components of comprehensive income. The amounts reclassified from accumulated other comprehensive income are included in “gain on sale of securities” in the consolidated statements of operations.
Basic and diluted earnings per common share: Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding during the applicable period. Diluted earnings per share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation and warrants using the treasury stock method.
The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share (amounts in thousands, except common share data).
Segment: The Company’s operations consist of one segment called community banking.
Reclassifications: Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income or shareholders’ equity.
Emerging Growth Company Critical Accounting Policy Disclosure
The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act (the “JOBS Act”). Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.
Note 2.
Securities Available for Sale
The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follows (in thousands):
Securities with a fair value of $40.5 million and $41.0 million were pledged as collateral on public funds, securities sold under agreements to repurchase and for other purposes as required or permitted by law as of December 31, 2014 and 2013, respectively.
The amortized cost and fair value of debt securities available for sale as of December 31, 2014, by contractual maturity are shown below (in thousands). Maturities may differ from contractual maturities in residential collateralized mortgage obligations and residential mortgage backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are segregated in the following maturity summary:
There were gross realized gains of $912,000 and $4,000 on the sales of securities during years ended December 31, 2014 and 2013, respectively.
There were no gross realized losses during the years ended December 31, 2014 and 2013.
There were no securities with material unrealized losses existing longer than 12 months, and no securities with unrealized losses which management believes were other-than-temporarily impaired, at December 31, 2014 and 2013.
The unrealized losses in the portfolio at December 31, 2014, resulted from fluctuations in market interest rates and not from deterioration in the creditworthiness of the issuers. Because the Company does not intend to sell and does not believe it will be required to sell these securities until market price recovery or maturity, these investment securities are not considered to be other-than-temporarily impaired.
Note 3.
Loans
A summary of the balances of loans follows (in thousands):
The following table presents the contractual aging of the recorded investment in past due and non-accrual loans by class of loans as of December 31, 2014 and December 31, 2013 (in thousands):
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt and comply with various terms of their loan agreements. The Company considers current financial information, historical payment experience, credit documentation, public information and current economic trends. Generally, all sizable credits receive a financial review no less than annually to monitor and adjust, if necessary, the credit’s risk profile. Credits classified as watch generally receive a review more frequently than annually. For special mention, substandard, and doubtful credit classifications, the frequency of review is increased to no less than quarterly in order to determine potential impact on credit loss estimates.
The Company categorizes loans into the following risk categories based on relevant information about the ability of borrowers to service their debt:
Pass - A pass asset is well protected by the current worth and paying capacity of the borrower (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner. Pass assets also include certain assets considered watch, which are still protected by the worth and paying capacity of the borrower but deserve closer attention and a higher level of credit monitoring.
Special Mention - A special mention asset, or risk rating of 5, 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 Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard - A substandard asset, or risk rating of 6 or 7, is an asset with a well-defined weakness that jeopardizes repayment, in whole or in part, of the debt. These credits are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged. These assets are characterized by the distinct possibility
that the Company will or has sustained some loss of principal and/or interest if the deficiencies are not corrected.
Doubtful - An asset that has all the weaknesses, or risk rating of 8, inherent in the substandard classification, 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. These credits have a high probability for loss, yet because certain important and reasonably specific pending factors may work toward the strengthening of the asset, its classification of loss is deferred until its more exact status can be determined.
Loss - An asset, or portion thereof, classified as loss, or risk rated 9, is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not necessarily mean that an asset has no recovery or salvage value but that it is not practical or desirable to defer writing off this basically worthless asset even though a partial recovery may occur in the future. Therefore, there was no balance to report at December 31, 2014 and 2013.
Residential 1-4 family, consumer and other loans are assessed for credit quality based on the contractual aging status of the loan and payment activity. In certain cases, based upon payment performance, the loan being related with another commercial type loan or for other reasons, a loan may be categorized into one of the risk categories noted above. Such assessment is completed at the end of each reporting period.
The following tables present the risk category of loans evaluated by internal asset classification based on the most recent analysis performed and the contractual aging as of December 31, 2014 and December 31, 2013 (in thousands):
Non-performing loans include those on non-accrual status and those past due 90 days or more and still on accrual.
The following table provides additional detail of the activity in the allowance for loan losses, by portfolio segment, for the years ended December 31, 2014 and 2013 (in thousands):
The following table presents the balance in the allowance for loan losses and the unpaid principal balance of loans by portfolio segment and based on impairment method as of December 31, 2014 and December 31, 2013 (in thousands):
The following tables present additional detail of impaired loans, segregated by class, as of and for the year ended December 31, 2014 and year ended December 31, 2013 (in thousands). The unpaid principal balance represents the recorded balance prior to any partial charge-offs. The recorded investment represents customer balances net of any partial charge-offs recognized on the loans. The interest income recognized column represents all interest income reported after the loan became impaired.
The following table presents TDRs and the financial effects of the TDRs during the years ended December 31, 2014 and 2013 (in thousands, except number of contracts):
During the year ended December 31, 2014, there were $3.7 million in TDRs added, of which $3.67 million were the result of the payment of real estate taxes and $41,000 was the result of a payment concession. During the year ended December 31, 2013 there were $2.9 million in TDRs added, of which $2.6 million were the result of interest rate reductions to interest only and $349,000 were the result of interest rate reductions to below a market rate of interest. Of the TDRs entered into during the past twelve months, none subsequently defaulted during the year ended December 31, 2014. Performing TDRs are considered to have defaulted when they become 90 days or more past due post restructuring or are placed on non-accrual status.
TDRs that were accruing were $2.8 million and $3.2 million, respectively, as of December 31, 2014 and December 31, 2013. TDRs that were non-accruing were $2.8 million and $5.1 million, respectively, as of December 31, 2014 and December 31, 2013.
The following presents a rollfoward activity of TDRs (in thousands except number of loans):
Restructured loans are evaluated for impairment at each reporting date as part of the Company’s determination of the allowance for loan losses.
Executive officers, directors and principal shareholders of the Company, including their families and companies of which they are principal owners, are considered to be related parties. These related parties were loan clients of the Company in the ordinary course of business. In management's opinion, these loans and transactions are on the same terms as those for comparable loans and transactions with unrelated parties. Transfers from related party status are loans to directors who have resigned. Loans to related parties totaled as follows (in thousands):
No loans to executive officers, directors, and their affiliates were past due greater than 90 days at December 31, 2014 or 2013.
Note 4.
Premises and Equipment
Premises and equipment are summarized as follows (in thousands):
Depreciation and amortization expense was $1.3 million and $1.2 million for the years ended December 31, 2014 and 2013, respectively.
Rent expense for banking facilities was $301,000 and $382,000 for the years ended December 31, 2014 and 2013, respectively.
The Company leases office space for certain branches and loan production offices. The future minimum annual rental commitments for the noncancelable leases of these spaces are as follows (in thousands):
Under the terms of these leases, the Company is required to pay its pro rata share of the cost of maintenance and real estate taxes. Certain leases also provide for increased rental payments up to 3%.
During 2013 and 2014, pursuant to its lease agreement with MCM Building LLC, the lessor, dated December 1, 2010, FCB Joliet, and the Bank as successor to FCB Joliet, made lease payments to MCM Building LLC in an aggregate amount of approximately $236,000 in 2013 and $59,000 in 2014 with respect to FCB Joliet’s branch located at 25407 South Bell Road, Channahon, Illinois 60410. Following the Consolidation, this branch and lease are maintained by the Bank. In 2013, MCM Building LLC was owned (i) 70% by Roger A. D’Orazio, a First Community director until his resignation in July 2014, (ii) 10% by Rex Easton, a First Community director, (iii) 10% by Terry D’Orazio, the brother of Roger A. D’Orazio, and (iv) 10% by Keith Rezin, a director of the Bank. In March 2014, the Company purchased this building from MCM Building LLC for $3.3 million.
Note 5.
Foreclosed Assets
Foreclosed assets are presented net of an allowance for losses. An analysis of the foreclosed assets and the related provision for losses is as follows (in thousands):
Expenses applicable to foreclosed assets include the following:
Note 6.
Deposits
The composition of interest bearing deposits is as follows (in thousands):
At December 31, 2014 and December 31, 2013, brokered deposits amounted to $9.1 million and $4.8 million, respectively, which are included in other time deposit certificates.
At December 31, 2014, maturities of certificates of deposit are summarized as follows (in thousands):
Deposits from related parties held by the Bank at December 31, 2014 and 2013 amounted to approximately $38.5 million and $34.9 million, respectively.
Note 7.
Subordinated Debt
The following table summarizes subordinated debt outstanding at December 31, 2014 and 2013 (dollars in thousands):
In May 2009, the Company completed a private placement offering to individual accredited investors of $4.1 million of 8% Series A non-cumulative convertible preferred stock (the “Series A Preferred Stock”) with a purchase price and liquidation preference of $1,000 per share. The Series A Preferred Stock was convertible to common stock at $10.00 per share on or after five years. On July 9, 2009, each share of Series A Preferred Stock was, automatically and without any action on the part of the holder thereof, exchanged for Company subordinated notes in the same face amount as the shares for which they were exchanged. The holders of the notes are entitled to interest at 8.0% payable annually, and the notes will mature on the tenth anniversary from the date of issuance. The notes are redeemable by the Company on or after five years of the date of issuance, in whole or in part. The notes are convertible to common stock at $10.00 per share on or after five years. The outstanding balance at December 31, 2014 and December 31, 2013 was $4.1 million.
On March 12, 2013, the Company completed a private placement offering of $10.0 million of subordinated indebtedness coupled with warrants to purchase in the aggregate 250,000 shares of Company common stock at a price of $4.00 per share. These securities were offered in denominations of $10,000 per note evidencing the subordinated indebtedness along with a warrant to purchase 250 shares of Company common stock at $4.00 per share. The subordinated indebtedness bears interest at an annual rate of 9.0% and will mature on the tenth anniversary from the date of issuance. Interest on the subordinated indebtedness has been accruing from the date of issuance and is payable semi-annually, in arrears. The warrants will remain outstanding following any such redemption of the subordinated indebtedness, and will have a term of ten years from the date of issuance, whereafter they will expire. The notes are redeemable by the Company on or after two years from the date of issuance, in whole or in part, at a price equal to 100% of the outstanding principal amount of such note redeemed. Proceeds from the private placement were allocated to the two instruments based on the relative fair values of the subordinated indebtedness without the warrants and of the warrants themselves at time of issuance. The portion of the proceeds allocated to the warrants was approximately $277,000 and was accounted for as paid-in capital at estimated fair value. The remainder of the discount was allocated to the subordinated indebtedness as part of the transaction. The discount will be accreted over the term of the warrants using the interest method. The outstanding balance net of the associated discount was $9.8 million and $9.7 million at December 31, 2014 and 2013, respectively.
On September 30, 2013, the Company completed a private placement offering of $5.5 million of subordinated indebtedness. These securities were offered in denominations of $1,000 per note. The subordinated notes will mature on the eighth anniversary of the issuance of the notes. The Company will have the option to redeem the notes in whole or part, upon the occurrence of certain events affecting the regulatory capital or tax treatment of the notes prior to the fifth anniversary of the issuance. The holders of the notes are entitled to interest at 8.625% payable quarterly, in arrears. On or after the fifth anniversary of the effective date of the subordinated notes, the Company may redeem the notes, in whole or in part. The outstanding balance was $5.5 million at December 31, 2014 and 2013.
On October 31, 2014, the Company completed a private placement offering of $9.8 million of subordinated indebtedness. These securities were offered in denominations of $10,000 per note. The subordinated notes will mature on the eighth anniversary of the issuance of the notes. The Company will have the option to redeem the notes in whole or part, upon the occurrence of certain events affecting the regulatory capital or tax treatment of the notes prior to the fifth anniversary of the issuance. The holders of the notes are entitled to interest at 7.0% payable semi-annually, in arrears. On or after the fifth anniversary of the effective date of the subordinated notes, the Company may redeem the notes, in whole or in part. The outstanding balance was $9.8 million at December 31, 2014.
A portion of the Company’s subordinated debt is held by related parties.
Note 8.
Other Borrowed Funds
The composition of other borrowed funds is as follows (in thousands):
Securities sold under agreements to repurchase are agreements in which the Bank acquires funds by selling securities to another party under a simultaneous agreement to repurchase the same securities at a specified price and date. These agreements represent a demand deposit account product to clients that sweep their balances in excess of an agreed upon target amount into overnight repurchase agreements.
Information pertaining to securities sold under agreements to repurchase as of December 31, 2014 and 2013 is as follows:
The securities underlying the agreements as of December 31, 2014 and 2013 were under the Company’s control in safekeeping at third-party financial institutions. The sweep agreements generally mature within one day from the transaction date.
In conjunction with the purchase of a building in Burr Ridge, Illinois, a $1.0 million mortgage note was signed on February 28, 2012. The terms of the note require monthly payments at a fixed rate of 6.0% amortized over a period of five years.
At December 31, 2014, future principal payments on the note are as follows (in thousands):
To secure advances from the FHLB, the Bank is party to a collateral pledge agreement whereby at all times, the Bank must keep on hand, free of all other pledges, liens, and encumbrances, first mortgage loans, home equity loans and commercial real estate loans with unpaid principal balances aggregating no less than 133% for first mortgage loans and 200% for home equity loans, of the outstanding secured advances from the FHLB. The Bank had $267.2 million and $74.2 million of loans pledged as collateral for FHLB advances as of December 31, 2014 and 2013, respectively. There were no advances outstanding at December 31, 2014 and 2013, respectively.
The Bank has also entered into collateral pledge agreements, with the Federal Reserve whereby the Bank pledges commercial and agricultural loans to the Federal Reserve, which allows the Bank to borrow on a short term basis, typically overnight from the Federal Reserve Discount Window. The Bank had $99.8 million and $87.1 million of loans pledged as collateral under these agreements as of December 31, 2014 and 2013, respectively. There were no borrowings outstanding at December 31, 2014 and 2013.
Note 9.
Income Taxes
Income tax (benefit) expense recognized is as follows (in thousands):
The table below presents a reconciliation of the amount of income taxes determined by applying the U.S. federal income tax rate to pretax income (in thousands):
Deferred tax assets and liabilities consist of (in thousands):
Under U.S. GAAP, a valuation allowance against a net deferred tax asset is required to be recognized if it is more-likely-than-not that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence,
forecasts of future income, applicable tax planning strategies and assessments of current and future economic and business conditions.
Prior to the Consolidation in 2013, the Company determined a valuation allowance was necessary for two of those bank charters as of December 31, 2012, largely based on negative evidence including cumulative losses caused by credit losses in its loan portfolio and general uncertainty surrounding future economic and business conditions.
The Company evaluates the need for a deferred tax asset valuation allowance on an ongoing basis, considering both positive and negative evidence. As of September 30, 2013, positive evidence included seven consecutive quarters of income, continued improvement in asset quality ratios, termination of our Memoranda of Understanding with our banking regulators, completion of our Consolidation in March 2013 and the prospect that other key drivers of profitability will continue into the future. Negative evidence included no available taxes paid in open carryback years, no significant tax planning opportunties to accelerate taxable income and that 2013 will be the first year of taxable income since 2007. Based on the Company’s assessment of all available evidence, management determined that it was more-likely-than-not that the deferred tax asset would be realized. Therefore, at September 30, 2013, the Company released its $15.6 million valuation allowance against the net deferred tax assets resulting in a credit to income tax (benefit) expense.
The Company had a federal net operating loss carryforward of $20.3 million and $25.2 million that can be used to offset future regular corporate federal income tax as of December 31, 2014 and 2013, respectively. This net operating loss carryforward expires between the years ended December 31, 2030 and December 31, 2033. The Company had an Illinois net operating loss carryforward of $22.6 million and $27.7 million that can be used to offset future regular corporate state income tax as of December 31, 2014 and 2013, respectively. These Illinois net operating loss carryforwards will expire between the years ended December 31, 2025 and December 31, 2028.
Note 10.
Benefit Plan
The Company has a 401(k) plan that covers substantially all employees. Participants make tax-deferred contributions. The Company matches contributions equal to 100% of each participant’s contribution up to 6%. Expense of the plan is based on the annual contributions and was $437,000 and $426,000 for the years ended December 31, 2014 and 2013, respectively.
Note 11.
Stock Compensation Plans
The Company maintains the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan (the “2008 Equity Incentive Plan”), which assumed and incorporated all outstanding awards under previously adopted Company equity incentive plans. The 2008 Equity Incentive Plan allows for the granting of awards including stock options, restricted stock, restricted stock units, stock appreciation rights, stock awards and cash incentive awards. This plan was amended in December 2011 to increase the number of shares authorized for delivery by 1,000,000 shares. As a result, under the 2008 Equity Incentive Plan, 2,430,000 shares of Company common stock have been reserved for the granting of awards.
Under the 2008 Equity Incentive Plan, options are to be granted at the fair value of the stock at the date of the grant and generally vest at 33-1/3% as of the first anniversary of the grant date and an additional 33-1/3% as of each successive anniversary of the grant date. Options must be exercised within 10 years after the date of grant.
On August 15, 2013, the Company adopted the First Community Financial Partners 2013 Equity Incentive Plan (“the 2013 Equity Incentive Plan”). The 2013 Equity Incentive Plan allows for the granting of awards including stock options, restricted stock, restricted stock units, stock appreciation rights, stock awards and cash incentive awards. Under this plan, 100,000 shares of Company common stock have been reserved for the granting of awards.
On December 18, 2014, the Company amended the 2013 Equity Incentive Plan to increase the shares of the Company’s common stock that has been reserved for the granting of awards by 900,000 shares to 1,000,000 shares.
There were no options granted for the years ended December 31, 2014 and 2013.
The following table summarizes data concerning stock options (aggregate intrinsic value in thousands):
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax amount by which the current market value of the underlying stock exceeds the price of the option that would have been received by the option holders had all option holders exercised their options on December 31, 2014. The intrinsic value will change when the market value of the Company’s stock changes. The fair value (present value of the estimated future benefit to the option holder) of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.
The Company recognized $0 and $5,000 in compensation expense related to the options for the year ended December 31, 2014 and 2013, respectively. At December 31, 2014, there was no further compensation expense to be recognized related to outstanding stock options.
In June 2014, the Board of Directors approved the extension in the expiration period of 370,376 of the options granted for an additional 5 year period. This adjustment is reflected in the contractual terms of the options outstanding below. Information pertaining to options outstanding at December 31, 2014, is as follows:
There were no options vested during the year ended December 31, 2014.
The Company also grants restricted stock units to select officers and directors within the organization under the 2008 and 2013 Equity Incentive Plans, which entitle the holder to receive shares of Company common stock in the future, subject to certain terms, conditions and restrictions. Holders of restricted stock units are also entitled to receive additional units equal in value to any dividends paid with respect to the restricted stock units during the vesting period. Compensation expense for the restricted stock units equals the market price of the related stock at the date of grant and is amortized on a straight-line basis over the vesting period.
In 2013, as a part of the Consolidation, 408,262 restricted stock units were granted under the 2008 Equity Incentive Plan with a weighted-average grant-date per share fair value of $3.97, and with vesting over a two-year period, as replacement awards for the stock options which were canceled at the Consolidation date. In addition, all restricted stock units granted as a part of the
canceled FCB Plainfield 2012 Equity Incentive Plan were fully vested and canceled at the date of Consolidation and all holders were paid out in an equivalent amount of cash.
The Company recognized compensation expense of $828,000 and $814,000, respectively, for the years ended December 31, 2014 and 2013, related to the 2008 and 2013 Equity Incentive Plans, the year ended December 31, 2013 included $385,000 in expense related to the canceled FCB Plainfield awards. Total unrecognized compensation expense related to restricted stock grants was $34,000 as of December 31, 2014.
The following is a summary of non-vested restricted stock units:
Note 12.
Concentrations, Commitments and Contingencies
Concentrations of credit risk: In addition to financial instruments with off-balance-sheet risk, the Company, to a certain extent, is exposed to varying risks associated with concentrations of credit. Concentrations of credit risk generally exist if a number of borrowers are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by economic or other conditions.
The Company conducts substantially all of its lending activities in Will, Grundy, DuPage, Cook and Kane counties in Illinois and their surrounding communities. Loans granted to businesses are primarily secured by business assets, investment real estate, owner-occupied real estate or personal assets of commercial borrowers. Loans to individuals are primarily secured by personal residences or other personal assets. Since the Company’s borrowers and its loan collateral have geographic concentration in its primary market area, the Company could have exposure to declines in the local economy and real estate market. However, management believes that the diversity of its customer base and local economy, its knowledge of the local market, and its proximity to customers limits the risk of exposure to adverse economic conditions.
Credit related financial instruments: The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
A summary of the Company’s commitments is as follows (in thousands):
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-
case basis. The amount of collateral obtained, if deemed necessary by the Company, is based on management’s credit evaluation of the party.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral, which may include accounts receivable, inventory, property and equipment, income producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the summary above. If the commitment were funded, the Company would be entitled to seek recovery from the customer. At December 31, 2014 and 2013, there was $0 and $220,000, respectively, recorded as liabilities for the Company’s potential obligations under these guarantees.
Contingencies: In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such pending proceedings would not be expected to have a material adverse effect on the Company’s consolidated financial statements.
Cash concentrations: The nature of the Company’s business requires that it maintain amounts due from banks, federal funds sold and interest-bearing deposits in banks which, at times, may exceed federally insured limits. Management monitors these correspondent relationships and the Company has not experienced any losses in such accounts.
Note 13.
Capital and Regulatory Matters
The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial results and condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company 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. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. In addition, the Bank remains subject to certain of the de novo bank requirements of the Federal Deposit Insurance Corporation (“FDIC”) until the Bank has been chartered for a period longer than seven years. Until October 28, 2015, the Bank is required, among other items, to obtain FDIC approval for any material change to its business plan.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets, each as defined in the applicable regulations. Management believes, as of December 31, 2014 and December 31, 2013, the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2014, the Bank was well capitalized under the regulatory framework for prompt corrective action. As of such date, to be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. Bank regulators can modify capital requirements as part of their examination process.
The Company’s and the Bank’s capital amounts and ratios are presented in the following table (dollar amounts in thousands):
In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III regulatory capital reforms and issued rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rules”). The Basel III Rules are applicable to all U.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1 billion). The Basel III Rules not only increase most of the required minimum regulatory capital ratios, but they introduce a new Common Equity Tier 1 Capital ratio and the concept of a capital conservation buffer. The Basel III Rules also expand the definition of capital as in effect currently by establishing criteria that instruments must meet to be considered Additional Tier 1 Capital (Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1 Capital do not qualify or their qualifications have changed when the Basel III rules are fully implemented. The Basel III Rules also permit banking organizations with less than $15.0 billion in assets to retain, through a one-time election, the existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Basel III Rules have maintained the general structure of the current prompt corrective action framework, while incorporating the increased requirements. The prompt corrective action guidelines were also revised to add the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under the new regime, a bank and holding company must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a leverage ratio of 5% or more. Generally, financial institutions become subject to the new Basel III Rules on January 1, 2015, with phase-in periods for many of the changes.
Under the Illinois Banking Act, Illinois-chartered banks generally may not pay dividends in excess of their net profits, after first deducting their losses (including any accumulated deficit) and provision for loan losses. The payment of dividends by any bank is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. Moreover, the FDIC prohibits the payment of any dividends by a bank if the FDIC determines such payment would constitute an unsafe or unsound practice. In addition, the FDIC places restrictions on dividend payments during the first seven years of a new bank’s operations, after which time allowing cash dividends to be paid only from net operating income and does not permit dividends to be paid until an appropriate allowance for loan and lease losses has been established and overall capital is adequate. There were no common share dividends paid during the years ended December 31, 2014 and 2013 by the Company or the Bank.
Note 14.
Fair Value Measurements
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert expected future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and/or quarterly valuation process.
Financial Instruments Recorded at Fair Value on a Recurring Basis
Securities Available for Sale: The fair value of the Company’s securities available for sale is determined using Level 2 inputs from independent pricing services. Level 2 inputs consider observable data that may include dealer quotes, market spread, cash flows, treasury yield curve, trading levels, credit information and terms, among other factors. Certain state and political subdivision securities are not valued based on observable transactions and are, therefore, classified as Level 3.
Derivatives: The Bank provides clients with interest rate swap transactions and offset the transactions with interest rate swap transactions with another financial institution as a means of providing loan terms agreeable to both parties. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative and classified as Level 2. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including LIBOR rate curves.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):
The significant unobservable inputs used in the Level 3 fair value measurements of the Company’s state and political subdivisions in the table above primarily relate to the discounted cash flows including the bond’s coupon, yield and expected maturity date.
The Company did not have any transfers between Level 1 and Level 2 of the fair value hierarchy during the year ended December 31, 2014. The Company’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.
The following tables present additional information about assets and liabilities measured at fair value on a recurring basis for which the Company has utilized Level 3 inputs to determine fair value (in thousands):
Financial Instruments Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with 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. Assets measured at fair value on a nonrecurring basis are set forth below:
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis for which the Company has utilized Level 3 inputs to determine fair value:
Impaired loans: Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair value hierarchy. The fair value for an impaired loan is generally determined utilizing appraisals for real estate loans and value guides or consultants for commercial and industrial loans and other loans secured by items such as equipment, inventory, accounts receivable or vehicles. In substantially all instances, a 10% discount is utilized for selling costs which includes broker fees and closing costs. It is our general practice to obtain updated values on impaired loans every twelve to eighteen months. In instances where the appraisal is greater than one year old, an additional discount is considered ranging from 5% to 20%. Any adjustment is based on either comparisons from other recent appraisals obtained by the Company on like properties or using third party resources such as real estate brokers or Reis, Inc., a nationally recognized provider of commercial real estate information including real estate values.
As of December 31, 2014 and December 31, 2013, approximately $10.8 million or 69% and $13.2 million, or 46%, of impaired loans were evaluated for impairment using appraisals performed within the last twelve month period, respectively. In addition to appraisals, management performs evaluations and other analysis to update valuations when no appraisal is performed within the prior twelve months.
Loans Held for Sale: The fair value of loans held for sale is determined using quoted secondary market prices and classified as Level 3.
Foreclosed assets: Foreclosed assets upon initial recognition are measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset. Fair values are generally based on third party appraisals of the property resulting in Level 3 classification. The appraised value is discounted by 10% for estimated selling costs which includes broker fees and closing costs and appraisals are obtained annually.
Fair Value of Financial Instruments
Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. Fair value is determined under the framework established by Fair Value Measurements, based upon criteria noted above. Certain financial instruments and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value at the Company. The methodologies for measuring fair value of financial assets and financial liabilities that are measured at fair value on a recurring or nonrecurring basis are discussed above. The methodologies for other financial assets and financial liabilities are discussed below.
The following methods and assumptions were used by the Company in estimating the fair value disclosures of its other financial instruments:
Cash, due from banks: The carrying amounts reported in the consolidated balance sheets for cash and due from banks and approximate their fair values.
Interest bearing deposits in banks: The carrying amounts of interest bearing deposits maturing within one year approximate their fair values.
Non-marketable equity securities: These securities are either redeemable at par or current redemption values; therefore, market value equals cost.
Loans: For those variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for fixed rate and all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Deposits: The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amount payable on demand. The carrying amounts for variable-rate certificates of deposit approximate their fair value at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Subordinated debt: The fair values of the Company’s subordinated debt are estimated using discounted cash flows based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Other borrowed funds: The carrying amounts of securities sold under repurchase agreements and mortgage notes payable approximate their fair values.
Accrued interest receivable and payable: The carrying amounts of accrued interest approximate their fair values.
Off-balance-sheet instruments: Fair values for the Company’s off-balance-sheet lending commitments (standby letters of credit and commitments to extend credit) are based on fees currently charged to enter into similar agreements taking into account the remaining term of the agreements and the counterparties’ credit standing. The fair value of these commitments is not material.
The estimated fair values of the Company’s financial instruments are as follows as of December 31, 2014 (in thousands):
The estimated fair values of the Company’s financial instruments are as follows as of December 31, 2013 (in thousands):
Note 15.
Derivatives and Hedging Activities
Derivative contracts entered into by the Bank are limited to those that do not qualify for hedge accounting treatment. The Bank provides clients with interest rate swap transactions and offsets the transactions with interest rate swap transactions with FTN Financial Capital Markets as a means of providing loan terms agreeable to both parties. As of December 31, 2014 and 2013, respectively, there were $3.4 million and $3.5 million outstanding notional values of swaps where the Bank received a variable rate of interest and the client received a fixed rate of interest. This was offset with counterparty contracts where the Bank paid a floating rate of interest and receives a fixed rate of interest. The estimated fair value of interest rate swaps was $314,000 and $324,000 as of December 31, 2014 and 2013, respectively, and was recorded gross as an asset and a liability. Swaps with clients and third-party financial institutions are carried at fair value with adjustments recorded in other income, the net effect of which was immaterial during the years ended December 31, 2014 and 2013. The gross amount of the adjustments to the income statement were $10,000 and $302,000 during the years ended December 31, 2014 and 2013, respectively.
Note 16.
Preferred Stock
In December 2009, as part of the Troubled Asset Relief Program (“TARP”) Capital Purchase Program of the United States Treasury (“Treasury”), the Company entered into a Letter Agreement and Securities Purchase Agreement with Treasury, pursuant to which the Company (i) sold to Treasury 22,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), or $22 million in the aggregate, and (ii) issued to Treasury a warrant to purchase 1,100 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series C (“Series C Preferred Stock”), or $1.1 million in the aggregate. The warrant was immediately exercised for all 1,100 shares of Series C Preferred Stock. The preferred stock had a liquidation value of $1,000 per share.
On July 26, 2012, Treasury announced that all of First Community’s 1,100 shares of Series C Preferred Stock were sold to one or more third parties at $661.50 per share, for an aggregate total of $727,650. On September 13, 2012, Treasury announced that all 22,000 shares of Series B Preferred Stock were sold to one or more third parties at $652.50 per share, for an aggregate total of $14.4 million.
On November 8, 2012, First Community entered into a TARP Securities Purchase Option Agreement with certain of the holders of the Series B Preferred Stock and Series C Preferred Stock. Pursuant to the TARP Securities Purchase Option Agreement, First Community had the option, but was not required, to repurchase from such certain holders their shares of Series B Preferred Stock at a discount. $16,824,000 face amount, or 16,824 shares, of Series B preferred stock were subject to the discount option. The TARP Securities Purchase Option Agreement provided that First Community could achieve a discount
upon repurchase between 18.5% and 31% from the $1,000 per share face value of the Series B Preferred Stock if such shares are repurchased, in whole or in part, before September 13, 2014.
On March 12, 2013, pursuant to the terms of the TARP Securities Purchase Option Agreement the Company repurchased 9,500 shares, or $9.5 million, of its Series B Preferred Stock at $690.00 per share. The total cost of repurchasing these shares was approximately $6.6 million which included accrued and unpaid dividends earned on the shares through the date of repurchase. A gain on retirement of preferred stock of $2.9 million was recorded through accumulated deficit.
On September 30, 2013, pursuant to the terms of the TARP Securities Purchase Option Agreement the Company repurchased 7,324 shares, or $7.3 million, of its Series B Preferred Stock at $728.61 per share. The total cost of repurchasing these shares was $5.3 million which included accrued and unpaid dividends earned on the shares through the date of repurchase. A gain on retirement of preferred stock of $2.0 million was recorded through accumulated deficit.
On December 4, 2014, the Company repurchased all of its remaining outstanding shares of Series B Preferred Stock and Series C Preferred Stock. 5,176 shares of Series B Preferred stock and 1,100 shares of Series C Preferred Stock were repurchased from certain third-party investors at an aggregate purchase price of $6.3 million, which included accrued and unpaid dividends earned on the shares through the date of repurchase. A gain on the retirement of preferred stock of $4,800 was recorded through accumulated deficit.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company’s management carried out an evaluation, under the supervision and with the participation of the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rule 15d-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2014. Based upon that evaluation, the chief executive officer along with the chief financial officer concluded that the Company’s disclosure controls and procedures as of December 31, 2014, were effective.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined by Rule 13a-15(f) and 15d-15(f) promulgated under the Exchange Act). The Company’s internal control over financial reporting is a process designed under the supervision of the chief executive officer and the chief financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. GAAP.
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.
Management has made a comprehensive review, evaluation, and assessment of the Company’s internal control over financial reporting as of December 31, 2014. In making its assessment of the effectiveness of the Company’s internal control over financial reporting, management used the framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework in 2013. Based on that assessment, management concluded that, as of December 31, 2014, the Company’s internal control over financial reporting was effective.
This Annual Report on Form 10-K does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the rules of the SEC permitting the Company to provide only a management’s report in this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.
Item 9B. Other Information
Not applicable.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Board of Directors
The following table sets forth information regarding our directors as of March 2, 2015:
George Barr. Mr. Barr has been a director and the chairman of the board of directors of First Community since 2006. He has also served as a director of First Community Financial Bank since 2013. From 2004 to 2013, he served as a director and the chairman of the board of directors of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. Mr. Barr also was a director of Burr Ridge, of which First Community was a stockholder prior to the Consolidation, from 2009 to 2013. Since 1987, Mr. Barr has been an attorney at the law firm of George Barr & Associates, located in Joliet, Illinois. Since 1990, Mr. Barr has been the president and owner of The Barr Group, P.C., also located in Joliet, Illinois, a real estate management and development company. We believe that Mr. Barr’s significant legal and business experience provides much insight to the board of directors. Mr. Barr’s involvement with numerous local commercial, industrial, apartment, residential and entertainment real estate development projects provide him and the board of directors with a detailed knowledge of the real estate markets in the areas in which First Community and the First Community Financial Bank operate and provide loans. His in depth knowledge of First Community and First Community Financial Bank also provides the board of directors of First Community with source of historical knowledge of our business.
Peter Coules, Jr. Mr. Coules has been a director of First Community since 2013. From 2008 to 2013, Mr. Coules served as a director and the vice-chairman of the board of directors of FCB Homer Glen, of which First Community was a stockholder prior to the Consolidation. Since December 1994, Mr. Coules has been an attorney, officer and shareholder of Donatelli & Coules, Ltd., a law firm located in Hinsdale, Illinois. We believe that Mr. Coules’ experience with FCB Homer Glen while serving on its board of directors provides the board of directors of First Community with additional insight into our business’ banking market and operations. Additionally, we believe that the board of directors benefits from Mr. Coules’ legal experience in the areas of borrowing and bonding. Mr. Coules also has extensive ties to the local community, including serving as a trustee for the Village of Lemont, Illinois from 2002 through 2010.
Terrence O. D’Arcy. Mr. D’Arcy has been on the board of directors of First Community since 2006. From 2004 to 2013, he was on the board of directors of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation, and from 2008 to 2013, he was on the board of directors of FCB Plainfield, which is now known as First Community Financial Bank. Since 1991, Mr. D’Arcy has been the owner and operator of automobile dealerships located in Joliet, Illinois. He currently operates three dealerships which sell Buick and GMC Truck, Hyundai and Volkswagen vehicles and provide parts and services for customers. From 2000 through 2009, Mr. D’Arcy was a director of the Chicago Automobile Trade Association. We believe that Mr. D’Arcy’s involvement in the local community provides the board of directors with insights into the business markets in which First Community and First Community Financial Bank operate, and that his business and leadership experience provides the board with keen judgment on issues relating to our local business community. The board also benefits from Mr. D’Arcy’s extensive historical knowledge of First Community and our banking market.
John J. Dollinger. Mr. Dollinger has been on the board of directors of First Community since 2006. From 2004 to 2013, he was on the board of directors of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. Since 1977, Mr. Dollinger has been a self-employed farmer in Joliet, Illinois. Mr. Dollinger also manages his family businesses. We believe that Mr. Dollinger’s knowledge of the local farming community and farm real estate matters, and his performance as a local businessman, provide the board of directors with insights into the local community and a knowledge base on local farming related matters.
Rex D. Easton. Mr. Easton has been on the board of directors of First Community since 2006. From 2004 to 2013, he served as a director of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. Mr. Easton also was a director of Burr Ridge, of which First Community was a stockholder prior to the Consolidation, from 2009 to 2013. Since 1994 Mr. Easton has been the majority owner Packard Transport, Inc. and Packard Transport Management, Inc., located in Channahon, Illinois, which provide equipment to transport machinery, building materials and other products nationwide. Mr. Easton also has experience serving on the board of directors of a community bank located in Channahon, Illinois during the 1980s to early 1990s, and working as a teller, auditor and installment loan officer in a community bank located in Joliet, Illinois during the late 1960s and 1970s. We believe that Mr. Easton’s experience as a businessman in our local communities and his extensive background in local community banking provide the board of directors with an important source of banking expertise.
Vincent E. Jackson. Mr. Jackson has been a director of First Community since 2013. Mr. Jackson also served as a director of Burr Ridge, of which First Community was a stockholder prior to the Consolidation, from 2009 to 2013. Since 1991, Mr. Jackson has been the president of Bo Jackson Enterprises, a celebrity endorsement and promotion company. Additionally, since 2007, Mr. Jackson has served as chief executive officer of Bo Jackson Elite Sports, which provides sports training facilities in the Chicago area. From 2001 to 2008, he was an officer of N’Genuity Enterprise, a food broker and supplier of protein products to commissaries worldwide. We believe that Mr. Jackson’s experience with Burr Ridge, gained while serving on its board of directors, provides the board of directors of First Community with additional insight into Burr Ridge’s banking market and operations. Additionally, we believe that the board of directors benefits from Mr. Jackson’s extensive business experience as an entrepreneur invested in the local community.
Patricia L. Lambrecht. Ms. Lambrecht has served on the board of directors of First Community since 2006. From 2004 to 2013, she served as a director of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. From 2008 to 2013, she also served as a director of FCB Homer Glen, of which First Community was a stockholder prior to the Consolidation. Since 2003, Ms. Lambrecht has been on the board of directors of T. J. Lambrecht Construction, Inc., a heavy civil contractor headquartered in Joliet, Illinois with a special expertise in earthmoving, underground and project management. We believe Ms. Lambrecht position as a local business leader and her long time involvement with First Community provide First Community with insights into our local economy and businesses coupled with a deep understanding of our business.
Stephen G. Morrissette. Mr. Morrissette has served on the board of directors of First Community since 2006. From 2004 to 2013, he served as a director of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. He also served on the boards of directors of three banks of which First Community was a majority stockholder prior to the Consolidation: FCB Homer Glen (serving from 2008 to 2013), FCB Plainfield, now known as First Community Financial Bank (serving from 2008 to 2013) and Burr Ridge (serving from 2009 to 2013). From 2004 to 2009, Mr. Morrissette was the chief executive officer of each of First Community and FCB Joliet. Prior to that, he was a professor of finance at the University of St. Francis, located in Joliet, Illinois, from 1994 to 2004. In 2010, he returned to his professor of finance position at the University of St. Francis and became an adjunct professor of strategy at the University of Chicago’s Booth School of Business. He continues to serve in those capacities today. Additionally, in 2011, Mr. Morrissette became a managing director of Providence Advisors, a strategic planning and bank consulting business. We believe that Mr. Morrissette’s years of banking experience, which includes executive leadership positions and extensive consulting experience with local community banks, is a
tremendous asset to the board. Moreover, Mr. Morrissette’s educational background, including a Ph.D. and MBA in finance and strategy, and his teaching experience, contribute to the board a deep knowledge of corporate finance.
Daniel Para. Mr. Para has been a director of First Community since 2013. From 2009 to 2013, he also served as a director of Burr Ridge, of which First Community was a stockholder prior to the Consolidation. Until 2009, Mr. Para served as the chief executive officer of Concert Group Logistics, a company he founded in 2001 and sold to XPO Logistics, Inc. (NYSE: XPO, formerly Express-1 Expedited Solutions) in 2008. He served on the board of directors of this public company until 2012 where he also headed the mergers and acquisitions committee of the board. We believe that Mr. Para’s experience with public company acquisitions and his past board service contribute valuable skills to the First Community board. The board also benefits from his experience with growing existing companies and overseeing matters related to that growth.
Michael F. Pauritsch. Mr. Pauritsch has been on the board of directors of First Community since 2008. The board of directors has determined he is an “audit committee financial expert” within the meaning of SEC regulations. From 2009 to 2013, he also served as the chairman of the board of directors of Burr Ridge, of which First Community was a stockholder prior to the Consolidation. Since 1976, Mr. Pauritsch has been a partner at Mulcahy, Pauritsch, Salvador & Co., Ltd, an accounting firm. Since 1999, Mr. Pauritsch has served on the business development committees of each of MPS Loria Financial Partners LLC, an investment firm, and Loria Financial Group, LLC, a broker/dealer. We believe that Mr. Pauritsch’s extensive accounting background, including many years of experience as a Certified Public Accountant for small and medium-sized businesses, provides the board of directors with valuable accounting and financial expertise. Moreover, Mr. Paurtisch provides the board with years of experience in the securities industry. Finally, Mr. Pauritsch’s prior service on the boards of First Community and Burr Ridge provides the board with significant historical knowledge.
William L. Pommerening. Mr. Pommerening has served on the board of directors of First Community since 2008. From 2008 to 2013, he was also on the board of directors of FCB Plainfield, which is now known as First Community Financial Bank, including serving as its chairman. For 26 years, Mr. Pommerening served as President of Valley Concrete, Inc., a concrete production company. We believe that Mr. Pommerening’s experience as a business owner in our local communities offers the board valuable insight and his service on the boards of directors of First Community and FCB Plainfield provides the board with significant historical knowledge.
Patrick J. Roe. Mr. Roe has served as a director of First Community since 2011. From 2011 to 2013, Mr. Roe served as First Community’s president and chief executive officer and, since 2013, has served as First Community’s president and chief operating officer. He has also served as the president and a director of First Community Financial bank since 2013. From 2010 to 2013, he has served as served as the president and chief executive officer, and as a director, of FCB Homer Glen, of which First Community was a stockholder prior to the Consolidation, and from 2011 to 2013, served as a director of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. From February 2008 through March 2009, Mr. Roe served as senior vice president of Old Second National Bank, a community banking institution. From 1984 through 2008, he was employed by Heritage Bank, also a community banking institution. He served as president, chief operating officer and director of Heritage Bank from 1996 through 2008. Mr. Roe also served as the president, chief operating officer and a director of HeritageBanc, Inc., a bank holding company and parent of Heritage Bank. We believe that Mr. Roe’s extensive community banking experience, including prior to his work with First Community, where his responsibilities are substantially similar to the work performed for his prior employers, provides First Community and its board of directors with a wide array of expertise and vast experience in community banking. Mr. Roe’s significant qualifications in many facets of commercial banking, including with respect to lending, deposits, lending operations and accounting, also benefit First Community and the board of directors.
Robert L. Sohol. Mr. Sohol has served on the board of directors of First Community since 2006. From 2004 to 2013, he served as a director of FCB Joliet, a wholly owned subsidiary of First Community prior to the Consolidation. From 2008 to 2013, Mr. Sohol also served on the board of director of FCB Plainfield, now known as First Community Financial Bank. Since 1983, Mr. Sohol has served as chief executive officer of two construction companies, RL Sohol Carpenter Contractor Inc. and RL Sohol General Contractor Inc. Since 1987, he has been a partner in Phase III, a real estate and development company, and since 1997, he has been the chief executive officer of American Built Systems Inc., a manufacturing company. We believe that Mr. Sohol’s extensive executive experience, including experience with being primarily responsible for the creation of financial statements and responding to tax audits, benefits the board. Additionally, Mr. Sohol’s longstanding service on the boards of directors of First Community and its banking affiliates provide the board with valuable institutional knowledge.
Roy C. Thygesen. Mr. Thygesen has been a director of First Community since 2013. Since 2013, he has also served as the chief executive officer of First Community, and the chief executive officer and a director of First Community Financial Bank. From 2009 to 2013, Mr. Thygesen was the president and chief executive officer, and a director, of Burr Ridge, of which First Community was a stockholder prior to the Consolidation. From 1993 to 2007, Mr. Thygesen served as regional president
of a predecessor to BMO Harris Bank, a banking institution, as well as chief executive officer, president, and a director of several of that organization’s wholly owned community bank subsidiaries. Mr. Thygesen possesses a material amount of experience and knowledge in the community banking market in which First Community operates, and his responsibilities at his job prior to commencing work at Burr Ridge, and prior to his appointment to officer positions at First Community and First Community Financial Bank, provide Mr. Thygesen with a substantial level expertise in the banking markets of First Community in the areas of banking business development, commercial lending, cash management and relationship management. We believe that Mr. Thygesen’s continuing expertise in community banking within our local markets, including his knowledge of and experience with Burr Ridge, benefits the board of directors of First Community.
Dennis G. Tonelli. Mr. Tonelli has served on the board of directors of First Community since 2008. From 2008 to 2013, he was a director and chairman of the board of FCB Homer Glen, of which First Community was a stockholder prior to the Consolidation. From 1981 to 2011, Mr. Tonelli was a director and vice president of Ruettiger Tonelli & Assoc., a land survey and civil engineering firm that he co-founded. His experience also includes being a director of Three Rivers Manufacturers Association from 1985 to 1988, and a director of the Joliet Chamber of Commerce from 1995 to 2000. From 1997 to 2009, and from 2010 to the present, Mr. Tonelli served as a trustee of Lewis University, located in Romeoville, Illinois. We believe that Mr. Tonelli’s experience being a local business owner, his deep knowledge of the local community and his service as a director of several diverse organizations, including First Community and FCB Homer Glen, provides the board with a unique viewpoint and skillset.
Scott A. Wehrli. Mr. Wehrli has been on the board of directors of First Community since 2008. From 2008 to 2013, he was a director of FCB Plainfield, now known as First Community Financial Bank. Since 1997, Mr. Wehrli has served as secretary and treasurer of DuKane Precast, Inc., a Naperville, Illinois producer of pre-stressed, pre-cast concrete wall panels, columns, beams and parking deck components. Mr. Wehrli became a partner of DuKane Precast in 2005, and he also serves as vice president of Naperville Excavating, an excavating company, overseeing its administrative and legal matters. Mr. Wehrli is also active in the communities of Naperville, Illinois and its surrounding areas, including serving presently, and in the past, on numerous city commissions and community groups. We believe that Mr. Wehrli’s service on the board of directors of First Community, and his prior service on the board of directors of FCB Plainfield, has provided him with valuable knowledge of the banking industry. Additionally, Mr. Wehrli’s service with local companies and community focused groups has given him an understanding of corporate governance matters and local issues that are relevant to the board.
Executive Officers
In addition to Mr. Thygesen, our chief executive officer, and Mr. Roe, our president and chief operating officer, the following individual is an executive officer of First Community:
Glen L. Stiteley. Mr. Stiteley, age 44, is the executive vice president and chief financial officer of First Community and First Community Financial Bank. From 2005 to 2013, he served as the senior vice president and chief financial officer of First Community and FCB Joliet. Mr. Stiteley’s skills have assisted First Community as it has grown in size and operations since 2005. Prior to 2005, Mr. Stiteley was a practice leader for the Chicago-based community bank practice of McGladrey & Pullen, LLP and was with the firm from 1995 to 2005. His community bank clients ranged in size from de novo institutions to institutions with $5 billion in assets, including a number of SEC registrants.
Corporate Governance
Code of Ethics
We have adopted a code of ethics that applies to all of our employees, officers, and directors, including those officers responsible for financial reporting. The code of ethics is available on our website at www.fcbankgroup.com. The inclusion of our website address in this annual report does not include or incorporate by reference the information on or accessible through our website into this annual report. We also will furnish copies of the Code of Ethics to any person without charge, upon written request. Requests for copies should be made in writing to First Community Financial Partners, Inc., 2801 Black Road, Joliet, Illinois 60435, Attention: Glen Stiteley.
Identification of Audit Committee and Audit Committee Financial Expert
The Company’s audit committee consists of Messrs. Pauritsch, Dollinger and Sohol, each of whom satisfies the independence requirements under the NASDAQ listing standards and Rule 10A-3(b)(1) of the Exchange Act. The chairperson of our audit committee is Mr. Pauritsch, whom our board of directors has determined is an “audit committee financial expert” within the meaning of SEC regulations. Each member of our audit committee can read and understand fundamental financial
statements in accordance with audit committee requirements. In arriving at this determination, the board has examined each audit committee member’s scope of experience and the nature of their employment.
Item 11.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth information regarding compensation in 2014 and 2013 for each of our named executive officers.
Terms of Mr. Thygesen’s Employment Agreement
Simultaneous with the closing of the Consolidation, Mr. Thygesen entered into a new employment agreement with First Community and First Community Financial Bank, which became effective upon the closing of the Consolidation. Mr. Thygesen serves as the chief executive officer of First Community and First Community Financial Bank under the employment agreement, as well as a member of the boards of directors of both entities. The agreement has an initial term of one year, with automatic one-year renewal terms unless either party gives notice of non-renewal. Mr. Thygesen is entitled to a minimum annual salary of $272,950 pursuant to the agreement, as well as annual performance bonuses, a monthly automobile allowance of $500, a monthly general expense allowance of $1,700, a monthly life insurance allowance of $900, and participation in First Community Financial Bank’s benefit plans.
Under the agreement, upon a termination of Mr. Thygesen’s employment by the employer without cause or by Mr. Thygesen for good reason, Mr. Thygesen will be entitled to severance payments equal to 100% of his base salary plus annual bonus, payable in 24 equal semi-monthly installments following the date of termination (or in a lump sum if the termination occurs within six months before or two years following a change in control), as well as one year of continued medical coverage. Further under the agreement, in the event of a termination of his employment due to his disability, Mr. Thygesen will be entitled to a lump sum payment equal to 100% of his annual base salary, as well as one year of continued medical coverage and disability and life insurance coverage. In the event of his death, Mr. Thygesen’s beneficiaries will be entitled to a lump sum payment equal to 50% of his annual base salary, as well as one year of employer-paid medical coverage. All of the aforementioned severance benefits are contingent upon Mr. Thygesen’s (or his beneficiaries’, if applicable) execution of a general release of claims. Mr. Thygesen’s agreement also provides that if any payments or benefits would be subject to an excise tax under Section 280G of the Internal Revenue Code, the payments or benefits may be reduced to the largest portion payable that would result in no such excise tax if that amount would result in a better net after-tax result to Mr. Thygesen than if there were no such reduction of payments or benefits. Under the agreement, Mr. Thygesen will be subject to one-year non-solicit restrictive covenants following the termination of his employment.
Terms of Mr. Roe’s Employment Agreement
Simultaneous with the closing of the Consolidation, Mr. Roe entered into a new employment agreement with First Community and First Community Financial Bank, which became effective upon the closing of the Consolidation. Mr. Roe serves as the president and chief operating officer of First Community and First Community Financial Bank under the employment agreement, as well as a member of the boards of directors of both entities. The agreement has an initial term of one year, with automatic one-year renewal terms unless either party gives notice of non-renewal. Mr. Roe is entitled to a minimum annual salary of $280,000 pursuant to the agreement, as well as annual performance bonuses, a monthly automobile allowance of $750, and participation in First Community Financial Bank’s benefit plans.
Under the agreement, upon a termination of Mr. Roe’s employment by the employer without cause or by Mr. Roe for good reason, Mr. Roe will be entitled to severance payments equal to 100% of his base salary plus annual bonus, payable in 24 equal semi-monthly installments following the date of termination (or in a lump sum if the termination occurs within six months before or two years following a change in control), as well as one year of continued medical coverage. Further under the agreement, in the event of a termination of his employment due to his disability, Mr. Roe will be entitled to a lump sum
payment equal to 100% of his annual base salary, as well as one year of continued medical coverage and disability and life insurance coverage. In the event of his death, Mr. Roe’s beneficiaries will be entitled to a lump sum payment equal to 50% of his annual base salary, as well as one year of employer-paid medical coverage. All of the aforementioned severance benefits are contingent upon Mr. Roe’s (or his beneficiaries’, if applicable) execution of a general release of claims. Mr. Roe’s agreement also provides that if any payments or benefits would be subject to an excise tax under Section 280G of the Internal Revenue Code, the payments or benefits may be reduced to the largest portion payable that would result in no such excise tax if that amount would result in a better net after-tax result to Mr. Roe than if there were no such reduction of payments or benefits. Under the agreement, Mr. Roe will be subject to one-year non-solicit restrictive covenants following the termination of his employment.
Terms of Mr. Stiteley’s Employment Agreement
Simultaneous with the closing of the Consolidation, Mr. Stiteley entered into a new employment agreement with First Community and First Community Financial Bank, which became effective upon the closing of the Consolidation. Mr. Stiteley serves as chief financial officer of First Community and First Community Financial Bank under the employment agreement. The agreement has an initial term of one year, with automatic one-year renewal terms unless either party gives notice of non-renewal. Mr. Stiteley is entitled to a minimum annual salary of $162,750 pursuant to the agreement, as well as annual performance bonuses, and participation in First Community Financial Bank’s benefit plans.
Under the agreement, upon a termination of Mr. Stiteley’s employment by the employer without cause or by Mr. Stiteley for good reason, Mr. Stiteley will be entitled to severance payments equal to 100% of his base salary plus annual bonus, payable in 24 equal semi-monthly installments following the date of termination (or in a lump sum if the termination occurs within six months before or two years following a change in control), as well as one year of continued medical coverage. Further under the agreement, in the event of a termination of his employment due to his disability, Mr. Stiteley will be entitled to a lump sum payment equal to 100% of his annual base salary, as well as one year of continued medical coverage and disability and life insurance coverage. In the event of his death, Mr. Stiteley’s beneficiaries will be entitled to a lump sum payment equal to 50% of his annual base salary, as well as one year of employer-paid medical coverage. All of the aforementioned severance benefits are contingent upon Mr. Stiteley’s (or his beneficiaries’, if applicable) execution of a general release of claims. Mr. Stiteley’s agreement also provides that if any payments or benefits would be subject to an excise tax under Section 280G of the Internal Revenue Code, the payments or benefits may be reduced to the largest portion payable that would result in no such excise tax if that amount would result in a better net after-tax result to Mr. Stiteley than if there were no such reduction of payments or benefits. Under the agreement, Mr. Stiteley will be subject to one-year non-solicit restrictive covenants following the termination of his employment.
Retirement Plans
All eligible employees, including our named executive officers, may participate in the First Community 401(k) Plan and are permitted to contribute up to the maximum percentage allowable not to exceed the limits of the Internal Revenue Code. First Community makes a matching contribution to the plan equal to 100% of each participant’s first 6% of compensation deferred.
Outstanding Equity Awards at 2014 Fiscal Year-End
The following table provides information for each of our named executive officers regarding outstanding stock options and unvested stock awards held by the officers as of December 31, 2014. Market values for outstanding stock awards are based on the closing price of First Community stock on December 31, 2014.
(1) Represents a grant of restricted stock units in 2013 in exchange for stock options outstanding at the time of the Consolidation, which remaining units are vested on March 1, 2015.
Potential Payments upon Termination or Change in Control
Employment Agreements
The terms of our employment agreements with Messrs. Thygesen, Roe and Stiteley are described above. As covered in these descriptions, these agreements provide for potential payments to the officers upon termination of employment and change in control.
Mr. Thygesen - Equity Awards
Upon the closing of the Consolidation, Mr. Thygesen received 64,218 restricted stock units under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan in exchange for his outstanding options under the Burr Ridge Bank and Trust 2009 Stock Incentive Plan. Under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan, any unvested restricted stock units will become fully earned and vested upon a change in control of First Community that occurs prior to the respective participant’s termination of employment. Similarly, any unvested options under such plan will become fully vested and exercisable upon a change in control of First Community that occurs prior to the respective participant’s termination of employment.
Mr. Roe - Equity Awards
Upon the closing of the Consolidation, Mr. Roe received 13,141 restricted stock units under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan in exchange for his outstanding options under the First Community Bank of Homer Glen & Lockport 2008 Stock Incentive Plan. Under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan, any unvested restricted stock units will become fully earned and vested upon a change in control of First Community that occurs prior to the respective participant’s termination of employment. Similarly, any unvested options under such plan will become fully vested and exercisable upon a change in control of First Community that occurs prior to the respective participant’s termination of employment.
Mr. Stiteley - Equity Awards
Under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan, any unvested restricted stock units or stock options will become fully earned and vested upon a change in control of First Community that occurs prior to the respective participant’s termination of employment.
Director Compensation
The following table sets forth information regarding compensation in 2014 for each of those individuals who are our nonemployee directors.
Director Compensation Program
There are no formal director compensation programs at First Community or First Community Financial Bank. Directors at those entities periodically receive equity compensation awards, including restricted stock units and stock options, at the discretion of the respective compensation committee.
Regulatory Impact on Compensation
Under its long-standing Interagency Guidelines Establishing Standards for Safety and Soundness, the FDIC has long held that excessive compensation is prohibited as an unsafe and unsound practice. In describing a framework within which to make a determination as to whether compensation is to be considered excessive, the FDIC has indicated that financial institutions should consider whether aggregate cash amounts paid, or noncash benefits provided, to employees are unreasonable or disproportionate to the services performed by an employee. The FDIC encourages financial institutions to review an employee’s compensation history and to consider internal pay equity, and, as appropriate, to consider benchmarking compensation to peer groups. Finally, the FDIC provides that, in order to give proper context, such an assessment must be made in light of the institution’s overall financial condition.
In addition to the Safety and Soundness standards, the Compensation Committee must also take into account the joint agency Guidance on Sound Incentive Compensation Policies. Various financial institution regulatory agencies worked together to issue the Guidance, which is intended to serve as a compliment to the Safety and Soundness standards. The Guidance sets forth a framework for assessing and mitigating risk associated with incentive compensation plans, programs and arrangements maintained by financial institutions. The Guidance is more narrow in scope than the Safety and Soundness standards because it applies only to senior executive officers and those other individuals who, either alone or as a group, could pose a material risk to an institution. With respect to such individuals, the Guidance is intended to focus an institution’s attention on balanced risk-taking incentives, compatibility of incentives with effective controls and risk management, and a focus on general principles of strong corporate governance in establishing, reviewing and maintaining incentive compensation programs.
The Compensation Committee, with the assistance of its advisors and management, continues to monitor the status of compensation-related rules and regulations expected to be finalized or issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). While the committee believes its own risk assessment procedures are effective, the committee is prepared to implement any additional steps that may be deemed necessary to fully comply with such rules and regulations when finally finalized or issued. The Compensation Committee does note, however, that the proposed risk assessment rules issued under the Dodd-Frank Act nearly mirror the Safety and Soundness standards and the framework of the Guidance. As such, the committee already adheres, in many respects, with the proposed rules and regulations under the Dodd-Frank Act.
Finally, in addition to the foregoing, First Community also follows the Securities and Exchange Commission rules regarding risk assessment. Those rules require a publicly-traded company to determine whether any of its existing incentive compensation plans, programs or arrangements create risks that are reasonably likely to have a material adverse effect on the company.
The Compensation Committee continues to believe in and practice a sensible approach to balancing risk-taking and rewarding reasonable, but not necessarily easily attainable, goals, and this has always been a component of its overall assessment of the compensation plans, programs and arrangements it has put in place for First Community’s named executive officers. In this regard, the committee has regularly revisited the components of the frameworks set forth in the Safety and Soundness standards and the Guidance as an effective tool for conducting its own assessment of the balance between risk and reward built into First Community’s compensation programs for its named executive officers. The committee believes there are adequate policies and procedures in place to balance and control any risk-taking that may be incentivized by the employee compensation plans. The Compensation Committee further believes that such policies and procedures will work to limit the risk that any employee would manipulate reporting earnings in an effort to enhance his or her compensation.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding beneficial ownership of our common stock as of March 2, 2015, by: (i) each of our named executive officers; (ii) each of our directors; and (ii) all of our directors and executive officers as a group. The information presented in the table is based upon information provided by such persons to the Company.
Beneficial ownership is determined according to the rules of the SEC and generally includes any shares over which a person possesses sole or shared voting or investment power as of December 31, 2014 as well as any shares that such person has the right to acquire on or before May 1, 2015 (60 days after March 2, 2015), through the exercise of options or other rights. Except as otherwise indicated, we believe that the beneficial owners of stock listed below have sole investment or voting power with respect to the shares described.
The applicable percentage ownership for each person listed below is based upon 16,970,721 shares of our common stock outstanding as of March 2, 2015. Shares of our common stock subject to options or other securities currently exercisable or exercisable on or before March 2, 2015, are deemed outstanding for the purpose of calculating the percentage ownership of the person holding those options or other securities, but are not treated as outstanding for the purpose of calculating the percentage ownership of any other person.
No shareholder known by us is the beneficial owner of more than five percent of the outstanding shares of our common stock.
Equity Compensation Plan Information
All shares authorized for issuance under our compensation plans as of December 31, 2014 were authorized under the First Community Financial Partners, Inc. Amended and Restated 2008 Equity Incentive Plan (our “2008 Plan”) or the First Community Financial Partners, Inc. 2013 Equity Incentive Plan (our “2013 Plan,” and together with our 2008 Plan, our “Equity Plans”).
Our 2008 Plan was amended and restated effective May 20, 2009, which amendment and restatement was approved by our shareholders. Our 2008 Plan was subsequently amended, effective December 21, 2011, to increase the number of shares of our common stock available by 1,000,000 (from 1,430,000 to 2,430,000). Our shareholders did not approve this amendment. Our 2008 Plan was further amended, effective June 19, 2014, to allow certain awards to expire more than 10 years after the date of grant where provided by the Board of Director. Our shareholders did not approve this amendment. Our 2008 Plan has not been amended further.
Our 2013 Plan was adopted by the Board of Directors on August 15, 2013 and was not approved by our shareholders. Under our 2013 Plan, the maximum number of shares of our common stock that may be issued to participants is 100,000. On December 18, 2014, the Board of Directors approved an amendment to the Plan to increase the maximum number of shares from 100,000 shares to 1,000,000 shares.
Our Equity Plans permit awards of stock options, stock appreciation rights, other stock awards (including without limitation restricted stock units and restricted stock awards) and cash incentive awards to our employees, directors and other service providers. Each Equity Plan will remain in effect as long as any awards under the respective plan are outstanding. However, no awards may be granted after the 10-year anniversary of the respective plan’s effective date. The Company generally reserves the right to amend or terminate our Equity Plans at any time. Awards under our Equity Plans may also be amended by the Company, but the participant generally must consent to the change if it impairs the participant’s rights under the award. Our Compensation Committee currently administers our Equity Plans.
The following table provides certain summary information as of December 31, 2014 concerning our compensation plans under which shares of our common stock may be issued.
(1) Our shareholders approved an amendment and restatement of our 2008 Plan, effective May 20, 2009, at which time 1,430,000 shares of our common stock were available for issuance. Our 2008 Plan was subsequently amended, effective December 21, 2011, to increase the number of shares of our common stock available for issuance by 1,000,000 (from 1,430,000 to 2,430,000). Our shareholders did not approve this amendment.
(2) Our shareholders did not approve our 2013 Plan.
(3) Reflects outstanding stock options under our 2008 Plan, which are granted at the fair market value of our common stock at the grant date, generally vest in three equal annual increments beginning on the first anniversary of the grant date and must be exercised within 10 years after the grant date.
(4) Reflects no outstanding restricted stock units granted under our 2008 Plan and 538,261 outstanding restricted stock units granted under our 2013 Plan. Restricted stock units entitle the holder to a specified number of shares of our common stock at a specified future date, subject to the continued service of the holder.
(5) All shares to be issued pursuant to outstanding awards under the portion of our 2008 Plan that was not approved by our shareholders, and our 2013 Plan, are issuable pursuant to restricted stock units. The weighted average exercise price in this column (b) does not take into account these awards.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Director Independence
As of December 31, 2014, the board of directors concluded that except for Messrs. Roe and Thygesen, the members of the board of directors satisfy the NASDAQ independence requirements. Although First Community’s common stock is not listed on NASDAQ, First Community has elected to use its independence standards when determining the independence of the members of its board of directors.
Our board of directors has undertaken a review of its composition, the composition of its committees, and the independence of each director. Based upon information requested from and provided by each director concerning his or her background, employment, and affiliations, including family relationships, our board of directors has determined that Messrs. Barr, Coules, D’Arcy, D’Orazio, Dollinger, Easton, Jackson, Morrissette, Para, Pauritsch, Pommerening, Sohol, Tonelli and Wehrli and Ms. Lambrecht, do not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each of these directors is “independent” as that term is defined under the applicable rules and regulations of the SEC and the listing requirements and rules of the NASDAQ. Mr. Morrissette was employed by the Company prior to March 31, 2011, and as a result, he was considered independent starting on April 1, 2014.
Certain Relationships and Related Party Transactions
Various First Community policies and procedures, which are generally in writing, questionnaires completed by all First Community directors and executive officers and regulatory compliance requirements (including Regulation O, which restricts loans by a bank to directors, executive officers, principal stockholders and their affiliates and requires approval by the board of directors of a bank for certain such loans), identify to First Community transactions or relationships that may constitute conflicts of interest or otherwise require disclosure under applicable SEC rules. Although First Community’s processes vary with the particular transaction or relationship, when such a transaction or relationship is identified, the board of directors of First Community or the Bank, or the appropriate committee of the board of directors, evaluates the transaction or relationship and approves or ratifies it (without the vote of any interested person) only if it is judged to be fair and in the best interests of First Community. In addition, it is the practice of the board of directors of First Community, although not part of a written policy, to review each of the transactions specifically disclosed as a related person transaction to the extent any such transaction has not previously been reviewed, applying the same standard. All of the transactions described below were considered and approved or ratified by the board of directors of First Community, or the appropriate committee of the board of directors.
Directors, executive officers, principal shareholders, members of their immediate families, and entities in which one or more of them have a material interest had extensions of credit from the Bank during 2014. All such extensions of credit were on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with unrelated persons, and did not involve more than the normal risk of collectability or present other unfavorable features. In addition, directors, executive officers, principal shareholders, members of their immediate families and entities in which one or more of them have a material interest obtained during 2014, and may in the future be expected to obtain, depositary or other banking services, trust, custody or investment management services, individual retirement account services or insurance brokerage services from First Community and its subsidiaries, on terms no less favorable to First Community and its subsidiaries than those prevailing at the time for comparable transactions involving persons unrelated to First Community.
During 2013 and 2014, pursuant to its lease agreement with MCM Building LLC, the lessor, dated December 1, 2010, FCB Joliet, and the Bank as successor to FCB Joliet, made lease payments to MCM Building LLC in an aggregate amount of approximately $236,000 in 2013 and $59,000 in 2014 with respect to FCB Joliet’s branch located at 25407 South Bell Road, Channahon, Illinois 60410. Following the Consolidation, this branch and lease are maintained by the Bank. In 2013, MCM Building LLC was owned (i) 70% by Roger A. D’Orazio, a First Community director until his resignation in July 2014, (ii) 10% by Rex Easton, a First Community director, (iii) 10% by Terry D’Orazio, the brother of Roger A. D’Orazio, and (iv) 10% by Keith Rezin, a director of the Bank. In March 2014, the Company purchased this building from MCM Building LLC for $3.3 million.
During 2013 and 2014, First Community made payments to Brown & Brown of Northern Illinois, Inc., an insurance agency, in an aggregate amount of approximately $232,181 in connection with First Community obtaining insurance for itself and its subsidiaries. John Manner, who was a director of First Community during 2013 and who ceased being a director upon the closing of the Consolidation, is an insurance broker for Brown & Brown of Northern Illinois.
On October 31, 2014, First Community issued subordinated indebtedness in a private placement offering. Purchasers of the subordinated indebtedness include directors, executive officers, members of their immediate families, and entities in which one or more of such persons have a material interest. The below table sets forth certain related parties to whom First Community sold the subordinated indebtedness:
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees. The aggregate fees billed for professional services rendered by CliftonLarsonAllen LLP for the audit of First Community’s annual financial statements and for other services that are normally provided by the accountants in connection with statutory regulatory filings were $159,500 for the fiscal years ended December 31, 2014. The aggregate fees billed for professional services rendered by McGladrey LLP for the audit of First Community’s annual financial statements and for other services that are normally provided by the accountants in connection with statutory regulatory filings were $202,780 for the fiscal year ended December 31, 2013.
Audit-Related Fees. There were no fees billed for professional services rendered by CliftonLarsonAllen LLP or McGladrey LLP for audit-related services for the fiscal years ended December 31, 2014 and 2013.
Tax Fees. The aggregate fees billed for professional services rendered by CliftonLarsonAllen LLP for preparation of federal and state tax returns, tax planning and tax advice for the fiscal years ended December 31, 2014 and 2013 were $33,092 and $36,354, respectively. There were no fees paid to McGladrey LLP for preparation of federal and state tax returns, tax planning or tax advice for the fiscal years ended December 31, 2014 and 2013.
All Other Fees. The other fees billed by CliftonLarsonAllen LLP for the fiscal years ended December 31, 2014 and 2013 were $8,414 and $0, respectively. There were no other fees billed by McGladrey LLP for the fiscal years ended December 31, 2014 and 2013.
The audit committee pre-approves all auditing services and permitted non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. The audit committee pre-approved all services performed by the independent auditors for the fiscal years ended December 31, 2014 and 2013.
Part IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements: See Item 8. Financial Statements and Supplementary Data.
(a)(2) Financial Statement Schedules: All financial statement schedules have been omitted as the information is not required under the related instructions or is not applicable.
(a)(3) Exhibits: See Exhibit Index.
(b) Exhibits: See Exhibit Index.
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.
First Community Financial Partners, Inc.
(registrant)
By: /s/ Glen L. Stiteley
Glen L. Stiteley
Executive Vice President and Chief Financial Officer
Date: March 13, 2015
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 13, 2015 by the following persons on behalf of the Registrant and in the capacities indicated:
Supplemental Information Rider
Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Exchange Act by Registrants Which Have Not Registered Securities Pursuant to Section 12 of the Exchange Act
No annual report to security holders or proxy materials covering the Company’s last fiscal year have been sent as of the date of this report. If sent, copies of these materials will be furnished to the SEC when they are mailed to security holders. The annual report and proxy materials shall not be deemed to be “filed” with the SEC or otherwise subject to the liabilities of Section 18 of the act.
Exhibit Index