Item 1: Business
Throughout this Annual Report on Form 10-K, the registrant, Republic First Bancorp, Inc., is referred to as the “Company” or as “we,” “our” or “us”. The Company’s website address is www.myrepublicbank.com. The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed by the Company with the United States Securities and Exchange Commission (“SEC”) are available free of charge on the Company’s website under the Investor Relations menu. Such documents are available on the Company’s website as soon as reasonably practicable after they have been filed electronically with the SEC.
Forward Looking Statements
This document contains “forward-looking statements,” as that term is defined in the U.S. Private Securities Litigation Reform Act of 1995. These statements can be identified by reference to a future period or periods or by the use of words such as “would be,” “could be,” “should be,” “probability,” “risk,” “target,” “objective,” “may,” “will,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions or variations on such expressions. These forward-looking statements include, among others: statements of goals, intentions and expectations, statements regarding the impact of accounting pronouncements, statements regarding prospects and business strategy, statements regarding allowance for loan losses, asset quality and market risk and estimates of future costs, benefits and results.
Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For example, and in addition to the “Risk Factors” discussed elsewhere in this Form 10-K, risks and uncertainties can arise with changes in or related to:
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general economic conditions, including turmoil in the financial markets and related efforts of government agencies to stabilize the financial system;
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the adequacy of our allowance for loan losses and our methodology for determining such allowance;
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adverse changes in our loan portfolio and credit risk-related losses and expenses;
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concentrations within our loan portfolio, including our exposure to commercial real estate loans, and to our primary service area;
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changes in interest rates;
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business conditions in the financial services industry, including competitive pressure among financial services companies, new service and product offerings by competitors, price pressures and similar items;
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deposit flows;
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loan demand;
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the regulatory environment, including evolving banking industry standards, changes in legislation or regulation;
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the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act;
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our securities portfolio and the valuation of our securities;
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accounting principles, policies and guidelines as well as estimates and assumptions used in the preparation of our financial statements;
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rapidly changing technology;
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litigation liabilities, including costs, expenses, settlements and judgments; and
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other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.
Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s beliefs only as of the date hereof. Except as required by applicable law or regulation, we do not undertake, and specifically disclaim any obligation, to update or revise any forward-looking statements to reflect any changed assumptions, any unanticipated events or any changes in the future. Significant factors which could have an adverse effect on the operations and future prospects of the Company are detailed in the “Risk Factors” section included under Item 1A
Item 1A: Risk Factors
In addition to the other information included elsewhere in this report and in “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” the following factors could significantly affect our business, financial condition, results of operations, or future prospects. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial condition, results of operations, or future prospects. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may be materially adversely affected. There may be additional risks that we do not presently know or that we currently believe are immaterial which could also materially adversely affect our business, financial condition, results of operations, or future prospects.
We are subject to credit risk in connection with our lending activities, and our financial condition and results of operations may be negatively impacted by economic conditions and other factors that adversely affect our borrowers.
Our financial condition and results of operations are affected by the ability of our borrowers to repay their loans, and in a timely manner. Lending money is a significant part of the banking business. Borrowers, however, do not always repay their loans. The risk of non-payment is assessed through our underwriting and loan review procedures based on several factors including credit risks of a particular borrower, changes in economic conditions, the duration of the loan, and in the case of a collateralized loan, uncertainties as to the future value of the collateral and other factors. Despite our efforts, we do and will experience loan losses, and our financial condition and results of operations will be adversely affected. Our non-performing assets were approximately $25.2 million at December 31, 2014. Our allowance for loan losses was approximately $11.5 million at December 31, 2014. Our loans between thirty and eighty-nine days delinquent totaled $15.7 million at December 31, 2014.
Our concentration of commercial real estate loans could result in increased loan losses and costs of compliance.
A substantial portion of our loan portfolio is comprised of commercial real estate loans. The commercial real estate market is cyclical and poses risks of loss to us because of the concentration of commercial real estate loans in our loan portfolio, and the lack of diversity in risk associated with such a concentration. Banking regulators have been giving and continue to give commercial real estate lending greater scrutiny, and banks with larger commercial real estate loan portfolios are expected by their regulators to implement improved underwriting, internal controls, risk management policies and portfolio stress-testing practices to manage risks associated with commercial real estate lending. In addition, commercial real estate lenders are making greater provisions for loan losses and accumulating higher capital levels as a result of commercial real estate lending exposures. Additional losses or regulatory requirements related to our commercial real estate loan concentration could materially adversely affect our business, financial condition and results of operations.
Our allowance for loan losses may not be adequate to absorb actual loan losses, and we may be required to make further provisions for loan losses and charge off additional loans in the future, which could materially and adversely affect our business.
We attempt to maintain an allowance for loan losses, established through a provision for loan losses accounted for as an expense, which is adequate to absorb losses inherent in our loan portfolio. If our allowance for loan losses is inadequate, it may have a material adverse effect on our financial condition and results of operations.
The determination of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. Increases in nonperforming loans have a significant impact on our allowance for loan losses. Our allowance for loan losses may not be adequate to absorb actual loan losses. If trends in the real estate markets were to deteriorate, we could experience increased delinquencies and credit losses, particularly with respect to real estate construction and land acquisition and development loans and one-to-four family residential mortgage loans. As a result, we may have to make provisions for loan losses and charge off loans in the future, which could materially adversely affect our financial condition and results of operations.
In addition to our internal processes for determining loss allowances, bank regulatory agencies periodically review our allowance for loan losses and may require us to increase the provision for loan losses or recognize further loan charge-offs, based on judgments that differ from those of our management. If loan charge-offs in future periods exceed the allowance for loan losses, we will need to increase our allowance for loan losses. Furthermore, growth in our loan portfolio would generally lead to an increase in the provision for loan losses. Any increases in our allowance for loan losses will result in a decrease in net income and capital, and may have a material adverse effect on our financial condition, results of operations and cash flows.
We are required to make significant estimates and assumptions in the preparation of our financial statements, including our allowance for loan losses, and our estimates and assumptions may not be accurate.
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, require our management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income and expense during the reporting periods. Critical estimates are made by management in determining, among other things, the allowance for loan losses, carrying values of other real estate owned, assessment of other than temporary impairment (“OTTI”) of investment securities, fair value of financial instruments, and the realization of deferred income taxes. If our underlying estimates and assumptions prove to be incorrect, our financial condition and results of operations may be materially adversely effected.
Our results of operations may be materially and adversely affected by other-than-temporary impairment charges relating to our investment portfolio.
In prior years we recorded other-than-temporary impairment charges for certain bank pooled trust preferred securities, and we may be required to record future impairment charges on our investment securities if they suffer declines in value that we determine are other-than-temporary. Numerous factors, including the lack of liquidity for re-sales of certain investment securities, the absence of reliable pricing information for investment securities, adverse changes in the business climate, adverse regulatory actions or unanticipated changes in the competitive environment, could have a negative effect on our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the Bank’s ability to pay dividends, which could materially adversely affect us. Significant impairment charges could also negatively impact our regulatory capital ratios and result in us not being classified as “well-capitalized” for regulatory purposes.
Our net interest income, net income and results of operations are sensitive to fluctuations in interest rates.
Our net income depends on the net income of Republic, and Republic is dependent primarily upon its net interest income, which is the difference between the interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings.
Our results of operations will be affected by changes in market interest rates and other economic factors beyond our control. If our interest-earning assets have longer effective maturities than our interest-bearing liabilities, the yield on our interest-earning assets generally will adjust more slowly than the cost of our interest-bearing liabilities, and, as a result, our net interest income generally will be adversely affected by material and prolonged increases in interest rates, and positively affected by comparable declines in interest rates. Conversely, if liabilities re-price more slowly than assets, net interest income would be adversely affected by declining interest rates, and positively affected by increasing interest rates. At any time, our assets and liabilities will reflect interest rate risk of some degree.
In addition to affecting interest income and expense, changes in interest rates also can affect the value of our interest-earning assets, comprising fixed and adjustable-rate instruments, as well as the ability to realize gains from the sale of such assets. Generally, the value of fixed-rate instruments fluctuates inversely with changes in interest rates, and changes in interest rates may therefore have a material adverse affect on our results of operations.
We are a holding company dependent for liquidity on payments from our banking subsidiary, which payments are subject to restrictions.
We are a holding company and depend on dividends, distributions and other payments from Republic to fund dividend payments, if any, and to fund all payments on obligations. Republic and its subsidiaries are subject to laws that restrict dividend payments or authorize regulatory bodies to block or reduce the flow of funds from those subsidiaries to us. Restrictions or regulatory actions of that kind could impede our access to funds that we may need to make payments on our obligations or dividend payments, if any. In addition, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.
We may be required to pay higher FDIC premiums or special assessments in the future that could adversely affect our earnings.
The FDIC’s insurance fund has been depleted over recent years as a result of bank failures across the country. The Dodd-Frank Act requires the FDIC to increase reserves against future losses, which requires increased assessments that are to be borne primarily by institutions with assets of greater than $10 billion. In addition, the FDIC may issue a special assessment across all FDIC insured institutions. Any future increases in FDIC assessments or higher periodic fees could adversely affect us.
Our business is concentrated in and dependent upon the continued growth and welfare of our primary market area.
Our primary service area consists of Greater Philadelphia and Southern New Jersey. Our success depends upon the business activity, population, income levels, deposits and real estate activity in this area. Although our customers’ businesses and financial interests may extend well beyond this area, adverse economic conditions that affect our primary service area could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally adversely affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.
Unfavorable economic and financial market conditions may adversely affect our financial position and results of operations.
Although the U.S. economy has continued to gradually improve from the depressed levels of 2008 and early 2009, economic growth has been slow and uneven. We are operating in a challenging and uncertain economic environment, including generally uncertain conditions nationally and globally. While economic conditions in the United States are showing signs of recovery, there can be no assurance that these difficult conditions will continue to improve. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity.
The existing economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of current economic conditions would likely exacerbate the adverse effects of existing market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:
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increased regulation of our industry and increased compliance costs;
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hampering our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure, as such assessments are made more complex by these difficult market and economic conditions;
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increasing our credit risk, by increasing the likelihood that our major customers become insolvent and unable to satisfy their obligations to us;
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impairing our ability to originate loans, by making our customers and prospective customers less willing to borrow, and making loans that meet our underwriting criteria difficult to find; and
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limiting our interest income, by depressing the yields we are able to earn on our investment portfolio.
These potential effects are difficult to forecast and mitigate. Distress in the credit markets and issues relating to liquidity among financial institutions have resulted in the failure of some financial institutions and others have been forced to seek acquisition partners. The United States and other governments have taken unprecedented steps in an effort to stabilize the financial system, including investing in financial institutions. These efforts, however, may not succeed. Our business as well as our financial condition and results of operations could be adversely affected by disruption and volatility in financial markets, continued capital and liquidity concerns regarding financial institutions, limitations resulting from further governmental action in an effort to stabilize or provide additional regulation of the financial system.
Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.
As of December 31, 2014, we had approximately $29.5 million of U.S. Federal net operating loss carryforwards, referred to as “NOLs,” available to reduce taxable income in future years.
Utilization of the NOLs may be subject to a substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended, referred to as the “Code.” These ownership changes may limit the amount of NOLs that can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50 percentage points of the outstanding stock of a company by certain stockholders or public groups. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a corporation may offset with pre-ownership change NOLs. The limitation imposed by Section 382 for any post-change year would be determined by multiplying the value of our stock immediately before the ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Any unused annual limitation may be carried over to later years, and the limitation may under certain circumstances be increased by built-in gains which may be present with respect to assets held by us at the time of the ownership change that are recognized in the five-year period after the ownership change.
In addition, the ability to use NOLs will be dependent on our ability to generate taxable income. The NOLs may expire before we generate sufficient taxable income. There were no NOLs that expired in the fiscal years ended December 31, 2014 and December 31, 2013. There are no NOLs that could expire if not utilized for the year ending December 31, 2015.
Our assets as of December 31, 2014 included a deferred tax asset and we may not be able to realize the full amount of such asset.
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. At December 31, 2014, the net deferred tax asset was approximately $5.0 million, compared to a balance of approximately $6.1 million at December 31, 2013. The decrease in the net deferred tax asset resulted mainly from decreases in the net operating loss carryforward and the unrealized losses on securities available for sale in 2014.
We regularly review our deferred tax assets for recoverability to determine whether it is more likely than not (i.e. likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.
Based on the analysis of the available positive and negative evidence, we determined that a valuation allowance should be recorded as of December 31, 2014. As a result of cumulative losses in recent years and the slow and uneven growth in the current economic environment, we did not use projections of future taxable income, exclusive of reversing temporary timing differences and carryforwards, as a factor to project recoverability of the deferred tax asset balance. We will exclude future taxable income as a factor until we can show consistent and sustained profitability. The release of this valuation allowance would have a positive impact on future earnings. There can be no assurance as to when we could be in a position to recapture the benefits of our deferred tax asset. Further discussion on the analysis of our deferred tax asset can be found in the “Provision (Benefit) for Income Taxes” section of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
We may not be able to manage our growth, which may adversely impact our financial results.
As part of our retail growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets by opening new stores and acquiring existing stores of other financial institutions. To the extent that we undertake additional stores openings and acquisitions, we are likely to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.
As part of our retail strategy, we plan to open new stores in our primary service area, including Southern New Jersey. We may not, however, be able to identify attractive locations on terms favorable to us, obtain regulatory approvals, or hire qualified management to operate new stores. In addition, the organizational and overhead costs may be greater than we anticipate. New stores may take longer than expected to reach profitability, or may not become profitable. The additional costs of starting new stores may adversely impact our financial results.
Our ability to manage growth successfully will depend on whether we can continue to fund our growth while maintaining cost controls, as well as on factors beyond our control, such as national and regional economic conditions and interest rate trends. If we are not able to control costs, such growth could adversely impact our earnings and financial condition.
Our retail strategy relies heavily on our management team, and the unexpected loss of key managers may adversely affect our operations.
Since June 2008, we have been successful in attracting new, talented management to Republic, to add to our management team. We believe that our ability to successfully implement our retail strategy will require us to retain and attract additional management experienced in banking and financial services, and familiar with the communities in our market. Our ability to retain executive officers, the current management teams, branch managers and loan officers of Republic will continue to be important to the successful implementation of our strategy. It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market areas to implement the community-based operating strategy. The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial condition and results of operations.
We are subject to numerous governmental regulations and to comprehensive examination and supervision by regulators, which could have an adverse impact on our operations and could restrict the scope of our operations.
Both the Company and Republic operate in a highly regulated environment and are subject to supervision and regulation by several governmental regulatory agencies, including the Board of Governors of the Federal Reserve System, the FDIC and the Pennsylvania Department of Banking and Securities (“PDB”). We are subject to federal and state regulations governing virtually all aspects of our activities, including lines of business, capital, liquidity, investments, payment of dividends, and others. Regulations that apply to us are generally intended to provide protection for depositors and customers rather than investors.
We are subject to extensive regulation and supervision under federal and state laws and regulations. See Item 1. Business - Supervision and Regulation. The requirements and limitations imposed by such laws and regulations limit the manner in which we conduct our business, undertake new investments and activities and obtain financing. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is within our control. For example, Basel III regulations adopted by the federal bank regulatory agencies will require bank holding companies and banks to undertake significant activities to demonstrate compliance with the new and higher capital standards. Compliance with these rules, which are still being analyzed, could impose additional costs on banking entities and their holding companies. Management is reviewing the new standards and evaluating all options and strategies to ensure compliance with the new standards, notwithstanding Republic’s current status as well-capitalized.
New programs and proposals may subject us and other financial institutions to additional restrictions, oversight and costs that may have an adverse impact on our business, financial condition, results of operations or the price of our common stock. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied or enforced. We cannot predict the substance or impact of future legislation, regulation or the application thereof. Compliance with such current and potential regulation and scrutiny may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital and limit our ability to pursue business opportunities in an efficient manner.
We face significant competition in our market from other banks and financial institutions.
The banking and financial services industry in our market area is highly competitive. We may not be able to compete effectively in our markets, which could adversely affect our results of operations. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and consolidation among financial service providers. Larger institutions have greater access to capital markets, with higher lending limits and a broader array of services. Competition may require increases in deposit rates and decreases in loan rates, and adversely impact our net interest margin.
We may not have the resources to effectively implement new technologies, which could adversely affect our competitive position and results of operations.
The financial services industry is constantly undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations as we continue to grow and expand in our market. Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products to those that we will be able to offer, which would put us at a competitive disadvantage. Accordingly, we may not be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to our customers. If we are unable to do so, our competitive position and results of operations could be adversely affected.
Our disclosure controls and procedures and our internal control over financial reporting may not achieve their intended objectives.
We maintain disclosure controls and procedures designed to ensure that we timely report information as specified in the rules and forms of the Securities and Exchange Commission, although we have not always so reported. We also maintain a system of internal control over financial reporting. These controls may not achieve their intended objectives. Control processes that involve human diligence and compliance, such as our disclosure controls and procedures and internal control over financial reporting, are subject to lapses in judgment and breakdowns resulting from human failures. Controls can also be circumvented by collusion or improper management override. Because of such limitations, there are risks that material misstatements due to error or fraud may not be prevented or detected and that information may not be reported on a timely basis. If our controls are not effective, it could have a material adverse effect on our financial condition, results of operations, and market for our common stock, and could subject us to regulatory scrutiny.
We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.
Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. 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. 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 financial claims for negligence.
We maintain a system of internal controls and insurance coverage to mitigate operational risks, including data processing system failures and errors, and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.
The computer systems and network infrastructure we use 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. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. 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, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, these security measures may not be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results of operations.
If we want to, or are compelled to, raise additional capital in the future, that capital may not be available to us when it is needed or on terms that are favorable to us or current shareholders.
Federal banking regulators require us, and Republic, to maintain capital to support our operations. Regulatory capital ratios are defined and required ratios are established by laws and regulations promulgated by banking regulatory agencies. At December 31, 2014, our regulatory capital ratios were above “well capitalized” levels under current bank regulatory guidelines. To be “well capitalized,” banking companies generally must maintain a Tier 1 leverage ratio of at least 5%, a Tier 1 risk-based capital ratio of at least 6%, and a total risk-based capital ratio of at least 10%. Regulators, however, may require us, or Republic, to maintain higher regulatory capital ratios. For example, regulators recently have required some banks to attain a Tier 1 leverage ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 10%, and a total risk-based capital ratio of at least 12%. In addition, as discussed in Item 1. Business - Supervision and Regulation - Capital Adequacy, in July 2013 the FDIC and other federal banking agencies adopted new standards revising regulatory capital requirements, which establish new higher capital ratio requirements and narrow the definitions of capital.
Our ability to raise additional capital in the future will depend on conditions in the capital markets at that time, which are outside of our control, on our financial performance and on other factors. Accordingly, we may not be able to raise additional capital on terms and time frames acceptable to us, or at all. If we cannot raise additional capital in sufficient amounts when needed, our ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect our operations, financial condition and results of operations. Our ability to borrow could also be impaired by factors that are nonspecific to us, such as disruption of the financial markets or negative news and expectations about the prospects for the financial services industry. If we raise capital through the issuance of additional shares of our common stock or other securities, we would likely dilute the ownership interests of investors, and could dilute the per share book value and earnings per share of our common stock. Furthermore, a capital raise through issuance of additional shares may have an adverse impact on our stock price.
We are exposed to environmental liabilities with respect to real estate that we have or had title to in the past.
A significant portion of our loan portfolio is secured by real property. In the course of our business, we may foreclose, accept deeds in lieu of foreclosure, or otherwise acquire real estate, and in doing so could become subject to environmental liabilities with respect to these properties. We may become responsible to a governmental agency or third parties for property damage, personal injury, investigation and clean-up costs incurred by those parties in connection with environmental contamination, or may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at a property. The costs associated with environmental investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Although we have policies and procedures to perform an environmental review before acquiring title to any real property, these may not be sufficient to detect all potential environmental hazards. If we were to become subject to significant environmental liabilities, it could materially and adversely affect us.
Our common stock is not insured by any governmental entity and, therefore, an investment in our common stock involves risk.
Our common stock is not a deposit account or other obligation of any bank, and is not insured by the FDIC or any other governmental entity, and is subject to investment risk, including possible loss.
There may be future sales of our common stock, which may materially and adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of our common stock, including securities that are convertible into or exchangeable or exercisable for shares of our common stock. Our issuance of shares of common stock in the future will dilute the ownership interests of our existing shareholders.
Additionally, the sale of substantial amounts of our common stock or securities convertible into or exchangeable or exercisable for our common stock, whether directly by us or by existing common shareholders in the secondary market, the perception that such sales could occur or the availability for future sale of shares of our common stock or securities convertible into or exchangeable or exercisable for our common stock could, in turn, materially and adversely affect the market price of our common stock and our ability to raise capital through future offerings of equity or equity-related securities. We are party to a registration rights agreement with the holders of the convertible trust preferred securities of Republic First Bancorp Capital Trust IV, which requires us, under certain circumstances, to register up to 1.7 million shares of our common stock into which the trust preferred securities may be converted for resale under the Securities Act of 1933.
In addition, our Board of Directors is authorized to designate and issue preferred stock without further shareholder approval, and we may issue other equity securities that are senior to our common stock in the future for a number of reasons, including, without limitation, to support operations and growth, to maintain our capital ratios and to comply with any future changes in regulatory standards.
Our common stock is currently traded on the Nasdaq Global Market. During 2014, the average daily trading volume for our common stock was approximately 91,300 shares. Sales of our common stock may place significant downward pressure on the market price of our common stock. Furthermore, it may be difficult for holders to resell their shares at prices they find attractive, or at all.
Our common stock is subordinate to our existing and future indebtedness and any preferred stock and effectively subordinated to all indebtedness and preferred equity claims against our subsidiaries.
Shares of our common stock are common equity interests in us and, as such, will rank junior to all of our existing and future indebtedness and other liabilities. Additionally, holders of our common stock may become subject to the prior dividend and liquidation rights of holders of any classes or series of preferred stock that our Board of Directors may designate and issue without any action on the part of the holders of our common stock. Furthermore, our right to participate in a distribution of assets upon any of our subsidiaries’ liquidation or reorganization is subject to the prior claims of that subsidiary’s creditors and preferred shareholders. As of December 31, 2014, we had $22.5 million of outstanding debt.
Our ability to pay dividends depends upon the results of operations of our subsidiaries.
We have never declared or paid cash dividends on our common stock. Our Board of Directors intends to follow a policy of retaining earnings for the purpose of increasing our capital for the foreseeable future.
Holders of our common stock are entitled to receive dividends if, as and when declared from time to time by our Board of Directors in its sole discretion out of funds legally available for that purpose, after debt service payments and payments of dividends required to be paid on our outstanding preferred stock, if any.
While we, as a bank holding company, are not subject to certain restrictions on dividends applicable to Republic, our ability to pay dividends to the holders of our common stock will depend to a large extent upon the amount of dividends paid by Republic to us. Regulatory authorities restrict the amount of cash dividends Republic can declare and pay without prior regulatory approval. Presently, Republic cannot declare or pay dividends in any one-year in excess of retained earnings for that year subject to risk based capital requirements.
If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, current and potential shareholders may lose confidence in our financial reporting and disclosures and could subject us to regulatory scrutiny.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, referred to as Section 404, we are required to include in our Annual Reports on Form 10-K, our management’s report on internal control over financial reporting. While we have reported no material weaknesses in the Form 10-K for the fiscal year ended December 31, 2014, we cannot guarantee that we will not have any material weaknesses in the future.
Compliance with the requirements of Section 404 is expensive and time-consuming. If, in the future, we fail to complete this evaluation in a timely manner we could be subject to regulatory scrutiny and a loss of public confidence in our internal control over financial reporting. In addition, any failure to maintain an effective system of disclosure controls and procedures could cause our current and potential shareholders and customers to lose confidence in our financial reporting and disclosure required under the Exchange Act, which could adversely affect our business.
Our governing documents, Pennsylvania law, and current policies of our Board of Directors contain provisions, which may reduce the likelihood of a change in control transaction, which may otherwise be available and attractive to shareholders.
Our articles of incorporation and bylaws contain certain anti-takeover provisions that may make it more difficult or expensive or may discourage a tender offer, change in control or takeover attempt that is opposed by our Board of Directors. In particular, the articles of incorporation and bylaws classify our Board of Directors into three groups, so that shareholders elect only approximately one-third of the Board each year; permit shareholders to remove directors only for cause and only upon the vote of the holders of at least 75% of the voting shares; require our shareholders to give us advance notice to nominate candidates for election to the Board of Directors or to make shareholder proposals at a shareholders’ meeting; require the vote of the holders of at least 60% of our voting shares for shareholder amendments to our bylaws; require the vote of the holders of at least 75% of our voting shares to approve certain business combinations; and restrict the holdings and voting rights of shareholders who would acquire more than 10% of our outstanding common stock without the approval of two-thirds of our Board of Directors. These provisions of our articles of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change in control, even though a majority of our shareholders may consider such proposals desirable. Such provisions could also make it more difficult for third parties to remove and replace the members of our Board of Directors. Moreover, these provisions could diminish the opportunities for shareholders to participate in certain tender offers, including tender offers at prices above the then-current market value of our common stock, and may also inhibit increases in the trading price of our common stock that could result from takeover attempts or speculation.
In addition, anti-takeover provisions in Pennsylvania law could make it more difficult for a third party to acquire control of us. These provisions could adversely affect the market price of our common stock and could reduce the amount that shareholders might receive if we are sold. For example, Pennsylvania law may restrict a third party’s ability to obtain control of us and may prevent shareholders from receiving a premium for their shares of our common stock. Pennsylvania law also provides that our shareholders are not entitled by statute to propose amendments to our articles of incorporation.
Item 1B:
Item 1B: Unresolved Staff Comments
None.
Item 2:
Item 2: Description of Properties
The Company currently leases its headquarters, executive offices, and twelve store locations under lease agreements that expire at various dates in the future. The spaces covered by these leases range in square footage from approximately 800 square feet to 40,000 square feet. Please see Note 11 “Commitments and Contingencies” to the Consolidated Financial Statements for further information regarding the leases. In addition, the Company owns five properties utilized for store locations. Three of the stores are open and operating today and two are currently under construction. Management believes these facilities are adequate to meet the Company’s present and immediately foreseeable needs.
Item 3:
Item 3: Legal Proceedings
The Company and Republic are from time to time parties (plaintiff or defendant) to lawsuits in the normal course of business. While any litigation involves an element of uncertainty, management is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.
Item 4:
Item 4: Mine Safety Disclosures
Not applicable.
PART II
Item 5:
Item 5: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Shares of the Company’s class of common stock are listed on the Nasdaq Global Market under the symbol “FRBK.” The table below sets forth the high and low sales prices reported for the common stock on the Nasdaq Global Market for the periods indicated. As of March 12, 2015, there were approximately 2,100 record holders of the Company’s common stock. On March 12, 2015, the closing price of a share of common stock on The Nasdaq Stock Market LLC was $3.55.
Quarter
High
Low
2014:
4th
$ 4.32
$ 3.61
3rd
$ 5.18
$ 3.86
2nd
$ 6.00
$ 3.48
1st
$ 4.59
$ 2.86
2013:
4th
$ 3.30
$ 2.90
3rd
$ 3.83
$ 2.75
2nd
$ 3.19
$ 2.62
1st
$ 2.78
$ 1.97
Dividend Policy
The Company has not paid any cash dividends on its common stock and has no plans to pay cash dividends during 2015. The Company’s ability to pay dividends depends primarily on receipt of dividends from the Company’s subsidiary, Republic. Dividend payments from Republic are subject to legal and regulatory limitations. The ability of Republic to pay dividends is also subject to profitability, financial condition, capital expenditures and other cash flow requirements.
Item 6:
Item 6: Selected Financial Data
Item 7:
Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the results of operations and financial condition should be read in conjunction with Item 6 “Selected Financial Data” and the consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth in Item 1A, entitled, “Risk Factors” and elsewhere in this report may cause actual results to differ materially from those projected in the forward-looking statements.
Executive Summary
The highlights for the year ended December 31, 2014 are as follows:
·
Total assets increased by $253 million, or 26%, to $1.2 billion as of December 31, 2014 compared to $962 million as of December 31, 2013.
·
Non-interest bearing demand deposits increased by 42% to $224 million as of December 31, 2014 compared to $158 million as of December 31, 2013.
·
Total deposits increased by $203 million, or 23%, to $1.1 billion as of December 31, 2014 compared to $870 million as of December 31, 2013. The cost of funds on interest bearing deposits decreased to 0.47% for the year ended December 31, 2014 compared to 0.50% for the year ended December 31, 2013.
·
Total loans grew $103 million, or 15%, to $782 million as of December 31, 2014 compared to $679 million at December 31, 2013.
·
SBA lending continued to be a focal point of the Company’s lending strategy. More than $56 million in new SBA loans were originated during the year ended December 31, 2014. Our team is currently ranked as the #1 SBA lender in the tri-state market of New Jersey, Pennsylvania, and Delaware based on the dollar volume of loan originations.
·
Shareholders’ equity increased by 79% to $113 million as of December 31, 2014 compared to $63 million as of December 31, 2013 as a result of the $45 million common stock offering closed during the second quarter of 2014.
·
The Company’s Total Risk-Based Capital ratio was 15.10% and Tier I Leverage ratio was 11.23% at December 31, 2014.
·
Tangible book value per share was $2.98 as of December 31, 2014.
·
In 2014, we opened two new locations in Cherry Hill and Glassboro, NJ which feature our new and distinctive prototype building. We also relocated our store in Voorhees, NJ to a prime location on the other side of town and expanded and renovated our 1601 Market store in Center City Philadelphia in 2014.
·
Our Haddonfield, NJ store, which opened four years ago, has grown to more than $100 million in core deposits during 2014.
Critical Accounting Policies, Judgments and Estimates
In reviewing and understanding our financial information, you are encouraged to read and understand the significant accounting policies used in preparing the consolidated financial statements. These policies are described in Note 2 - Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements. The accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Management evaluates these estimates and assumptions on an ongoing basis including those related to the allowance for loan losses, other than temporary impairment of securities and deferred income taxes. Management bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances. These form the basis for making judgments on the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We have identified the policies related to the allowance for loan losses, other-than-temporary impairment of securities and deferred income taxes as being critical.
Allowance for Loan Losses - Management’s ongoing evaluation of the adequacy of the allowance for loan losses is based on our past loan loss experience, the volume and composition of our lending, adverse situations that may affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors affecting the known and inherent risk in the portfolio. The allowance for loan losses is increased by charges to income through the provision for loan losses and decreased by charge-offs (net of recoveries). The allowance is maintained at a level that management, based upon its evaluation, considers adequate to absorb losses inherent in the loan portfolio. This evaluation is inherently subjective as it requires material estimates including, among others, the amount and timing of expected future cash flows on impacted loans, exposure at default, value of collateral, and estimated losses on our commercial and residential loan portfolios. All of these estimates may be susceptible to significant change.
The allowance consists of specific allowances for both impaired and classified loans and a general allowance on the remainder of the portfolio. Although management determines the amount of each element of the allowance separately, the allowance for loan losses is available for the entire loan portfolio.
Management establishes an allowance on certain impaired loans for the amount by which the discounted cash flows, observable market price, or fair value of collateral if the loan is collateral dependent, is lower than the carrying value of the loan. A loan is considered to be impaired when, based upon current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. A delay or shortfall in amount of payments does not necessarily result in the loan being identified as impaired.
Management also establishes a general allowance on non-classified loans to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular loans. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends, and management’s evaluation of the collectability of the loan portfolio.
Management also evaluates classified loans, which are not impaired. We segregate these loans by category and assign qualitative factors to each loan based on inherent losses associated with each type of lending and consideration that these loans, in the aggregate, represent an above-average credit risk and that more of these loans will prove to be uncollectible compared to loans in the general portfolio. Classification of a loan within this category is based on identified weaknesses that increase the credit risk of the loan.
The allowance is adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting its primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, loss experience in particular segments of the portfolio, duration of the current business cycle, and bank regulatory examination results. The applied loss factors are re-evaluated each reporting period to ensure their relevance in the current economic environment.
While management uses the best information known to it in order to make loan loss allowance valuations, adjustments to the allowance may be necessary based on changes in economic and other conditions, changes in the composition of the loan portfolio, or changes in accounting guidance. In times of economic slowdown, either regional or national, the risk inherent in the loan portfolio could increase resulting in the need for additional provisions to the allowance for loan losses in future periods. An increase could also be necessitated by an increase in the size of the loan portfolio or in any of its components even though the credit quality of the overall portfolio may be improving. Historically, the estimates of the allowance for loan loss have provided adequate coverage against actual losses incurred. In addition, the Pennsylvania Department of Banking and Securities and the FDIC, as an integral part of their examination processes, periodically review the allowance for loan losses. The Pennsylvania Department of Banking and Securities or the FDIC may require the recognition of adjustment to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.
Other-Than-Temporary Impairment of Securities - Securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and our intent and ability to retain its investment in the security for a period of time sufficient to allow for an anticipated recovery in the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.
Income Taxes - Management makes estimates and judgments to calculate various tax liabilities and determine the recoverability of various deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. Management also estimates a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, management’s estimates and judgments to calculate the deferred tax accounts have not required significant revision.
In evaluating our ability to recover deferred tax assets, management considers all available positive and negative evidence, including the past operating results and forecasts of future taxable income. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require management to make judgments about the future taxable income and are consistent with the plans and estimates used to manage the business. Any reduction in estimated future taxable income may require management to record a valuation allowance against the deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.
Results of Operations
For the year ended December 31, 2014 as compared to the year ended December 31, 2013
We reported net income of $2.4 million, or $0.07 per share, for the twelve months ended December 31, 2014 compared to a net loss of $3.5 million, or $(0.13) per share, for the twelve months ended December 31, 2013. Prior year net income was impacted by a loan loss provision in the amount of $3.6 million on a single loan and a one-time charge of $1.9 million related to a legal settlement.
Net interest income for the twelve months ended December 31, 2014 increased $3.2 million to $35.8 million as compared to $32.6 million for the twelve months ended December 31, 2013. Interest income increased $3.3 million, or 8.8%, due primarily to an increase in average loan balances. Interest expense increased $54,000 or 1.2%, primarily due to an increase in average deposit balances.
We recorded a loan loss provision in the amount of $900,000 for the twelve months ended December 31, 2014 compared to a provision of $4.9 million during the twelve months ended December 31, 2013. The lower provision recorded for the twelve months ended December 31, 2014 was driven by a loan loss provision in the amount of $3.6 million on one loan recorded in 2013 which did not recur in 2014.
Non-interest income decreased $1.2 million to $8.0 million during the twelve months ended December 31, 2014 as compared to $9.2 million during the twelve months ended December 31, 2013 primarily due to a decrease of $621,000 in gains recognized on the sale of SBA loans during the twelve months ended December 31, 2014 as a result of fewer SBA loan originations during the current period. In addition, there was a decrease of $245,000 in gains on the sale of investment securities and a decrease of $238,000 in legal settlements compared to December 31, 2013.
Non-interest expenses increased $139,000 to $40.6 million during the twelve months ended December 31, 2014 as compared to $40.4 million during the twelve months ended December 31, 2013. The increase during the twelve months ended December 31, 2014 was primarily due to an increase in salaries and benefits of $3.0 million driven primarily by annual merit increases along with increased staffing levels related to the Company’s growth strategy of adding and relocating stores. Occupancy related expenses also increased by $889,000 as a result of the growth and relocation strategy. These increases were offset by a legal settlement of $1.9 million recorded in 2013, a decrease in other real estate owned expenses of $1.4 million, and a decrease of $588,000 in legal expenses.
Return on average assets and average equity from continuing operations were 0.23% and 2.51%, respectively, during the twelve months ended December 31, 2014 compared to (0.37)% and (5.07)%, respectively, for the twelve months ended December 31, 2013.
Average Balances and Net Interest Income
Historically, our earnings have depended primarily upon Republic’s net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is affected by changes in the mix of the volume and rates of interest-earning assets and interest-bearing liabilities. The following table provides an analysis of net interest income on an annualized basis, setting forth for the periods average assets, liabilities, and shareholders’ equity, interest income earned on interest-earning assets and interest expense on interest-bearing liabilities, average yields earned on interest-earning assets and average rates on interest-bearing liabilities, and Republic’s net interest margin (net interest income as a percentage of average total interest-earning assets). Averages are computed based on daily balances. Non-accrual loans are included in average loans receivable. Yields are adjusted for tax equivalency, using a rate of 35% in 2014, 2013 and 2012.
Average Balances and Net Interest Income
(1) Yields on investments are calculated based on amortized cost.
(2) Net interest income and net interest margin are presented on a tax equivalent basis. Net interest income has been increased over the financial statement amount by $379, $323, and $396 in 2014, 2013, and 2012, respectively, to adjust for tax equivalency.
The tax equivalent net interest margin is calculated by dividing tax equivalent net interest income by average total interest earning assets.
Rate/Volume Analysis of Changes in Net Interest Income
Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table sets forth an analysis of volume and rate changes in net interest income for the periods indicated. For purposes of this table, changes in interest income and expense are allocated to volume and rate categories based upon the respective changes in average balances and average rates.
Net Interest Income and Net Interest Margin
Net interest income, on a fully tax-equivalent basis, for the twelve months of 2014 increased by $3.3 million, or 9.9%, over the same period in 2013. Interest income on interest-earning assets totaled $40.9 million for the twelve months of 2014, an increase of $3.3 million, compared to the same period in 2013. The increase in interest income earned was the result of an increase in the average balance of loans receivable and investment securities that helped to offset a 24 bp decrease in the yield on loans receivable. Total interest expense for the twelve months of 2014 increased $54,000, or 1.2%, from $4.6 million in 2013 to $4.6 million in 2014. Interest expense on deposits increased by $58,000, or 1.7%, for the twelve months of 2014 versus the same period of 2013. Interest expense on short-term borrowings decreased by $4,000 for the twelve months of 2014 compared to the same period in 2013.
Changes in net interest income are frequently measured by two statistics: net interest rate spread and net interest margin. Net interest rate spread is the difference between the average rate earned on interest-earning assets and the average rate incurred on interest-bearing liabilities. Our net interest rate spread on a fully tax-equivalent basis was 3.41% during the twelve months of 2014 versus 3.54% during the twelve months of 2013. Net interest margin represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average interest-earning assets. For the twelve months of 2014 and 2013, the fully tax-equivalent net interest margin was 3.56% and 3.66%, respectively. The net interest margin for the year ending December 31, 2014 decreased primarily as a result of a decrease in the yield on loans receivable.
Provision for Loan Losses
We recorded a provision for loan losses in the amount of $900,000 for the twelve months ended December 31, 2014 compared to a $4.9 million provision for the twelve months ended December 31, 2013. The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that management believes is adequate to absorb inherent losses in the loan portfolio.
The higher provision recorded during 2013 was primarily driven by a single loan relationship which was originated in 2006 and determined to be impaired during the fourth quarter of 2013 due to delinquency in payments. The need for a provision in the amount of $3.6 million was the result of a significant reduction in the collateral value supporting the loan based upon a current appraisal. Management is working closely with this borrower to resolve the delinquency issue and address the collateral deficiency.
In addition, the provision recorded for the twelve months ended December 31, 2014 as compared to the twelve months ended December 31, 2013 decreased due to a reduction in the allowance for loan losses related to non-impaired loans evaluated collectively for impairment. The decrease associated with loans collectively evaluated for impairment was driven by a reduction in the factor used in the calculation related to historical charge-offs which has declined as a result of lower charge-offs in recent years.
Non-Interest Income
Total noninterest income for the first twelve months of 2014 decreased by $1.2 million, or 13.0%, from the same period in 2013. Gains recognized on the sale of SBA loans were $4.7 million during the twelve months of 2014 compared to $5.3 million in the same period of 2013. In addition, we also recognized gains of $458,000 on the sale of investment securities during 2014 compared to gains of $703,000 on the sale of investment securities in 2013. We recorded no legal settlements during the twelve month period ended December 31, 2014 compared to $238,000 in the twelve month period ended December 31, 2013.
Non-Interest Expenses
In 2014, noninterest expenses increased by $139,000, or 0.3%, compared to 2013. A explanation of changes in noninterest expenses for certain categories is presented in the following paragraphs.
Salary expenses and employee benefits in 2014 were $20.1 million, an increase of $3.0 million, or 17.7%, compared to 2013 primarily driven by annual merit increases along with increased staffing levels related to our growth strategy of adding and relocating stores.
Occupancy related expenses increased by $889,000, or 15.5%, in 2014 compared to 2013, also as a result of the growth and relocation strategy.
Other real estate owned expenses totaled $1.8 million during 2014, a decrease of $1.4 million, or 43.6%, when compared to 2013 primarily due to lower writedowns in 2014 on assets held in the other real estate owned category.
As previously mentioned, we settled a legal matter totaling $1.9 million in 2013. This one-time charge of $1.9 million in 2013 was related to an agreement in connection with litigation in which the Company was a defendant. In addition, we had a decrease of $588,000 in legal expenses. Other minor decreases in regulatory assessments, insurance, and other operating expenses were offset by increases in data processing, advertising, professional fees, and other taxes for the twelve months of 2014 versus the same period last year.
One key measure that management utilizes to monitor progress in controlling overhead expenses is the ratio of annualized net noninterest expenses to average assets. For purposes of this calculation, net noninterest expenses equal noninterest expenses less noninterest income and nonrecurring expense. For the twelve month period ended December 31, 2014, the ratio equaled 3.05% compared to 3.09% for the twelve month period ended December 31, 2013, respectively, reflecting higher average assets related to the Company’s growth strategy of adding and relocating stores.
Another productivity measure utilized by management is the operating efficiency ratio. This ratio expresses the relationship of noninterest expenses to net interest income plus noninterest income. The efficiency ratio equaled 92.5% for the twelve months of 2014, compared to 96.6% for the twelve months of 2013. The decrease for the twelve months ended December 31, 2014 versus December 31, 2013 was due to a 4.8% increase in total revenues.
Provision (Benefit) for Income Taxes
We recorded a benefit for income taxes of $46,000 for the twelve months ended December 31, 2014, compared to a $35,000 benefit for the twelve months ended December 31, 2013. The $46,000 benefit recorded during the twelve months of 2014 was the net result of an estimated tax provision in the amount of $633,000 calculated on the net profit generated during the period using our normal estimated tax rate, offset by an adjustment to the deferred tax asset valuation allowance in the amount of $679,000. The effective tax rates for the twelve month periods ended December 31, 2014 and 2013 were 26% and (42%), respectively, excluding an adjustment to the deferred tax asset valuation allowance.
We evaluate the carrying amount of its deferred tax assets on a quarterly basis or more frequently, if necessary, in accordance with the guidance provided in Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 740 (ASC 740), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e. a likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods, a valuation allowance is calculated and recorded. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.
In conducting the deferred tax asset analysis, we believe it is important to consider the unique characteristics of an industry or business. In particular, characteristics such as business model, level of capital and reserves held by financial institutions and their ability to absorb potential losses are important distinctions to be considered for bank holding companies like the Company. In addition, it is also important to consider that net operating loss carryforwards (“NOLs”) for federal income tax purposes can generally be carried back two years and carried forward for a period of twenty years. In order to realize our deferred tax assets, we must generate sufficient taxable income in such future years.
In assessing the need for a valuation allowance, we carefully weighed both positive and negative evidence currently available. Judgment is required when considering the relative impact of such evidence. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent to which it can be objectively verified. A cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome. Based on the analysis of available positive and negative evidence, we determined that a valuation allowance should be recorded as of December 31, 2014 and December 31, 2013.
When calculating an estimate for a valuation allowance, we assessed the possible sources of taxable income available under tax law to realize a tax benefit for deductible temporary differences and carry forwards as defined in ASC 740. As a result of cumulative losses in recent years and the slow, ongoing recovery in the current economic environment, we did not use projections of future taxable income, exclusive of reversing temporary timing differences and carryforwards, as a factor. We will exclude future taxable income as a factor until we can show consistent and sustainable profitability.
We did assess tax planning strategies as defined under ASC 740 to determine the amount of a valuation allowance. Strategies reviewed included the sale of investment securities and loans with fair values greater than book values, redeployment of cash and cash equivalents into higher yielding investment options, a switch from tax-exempt to taxable investments and loans, and the election of a decelerated depreciation method for tax purposes on future fixed asset purchases. We believe that these tax planning strategies are (a) prudent and feasible, (b) steps that we would not ordinarily take, but would take to prevent an operating loss or tax credit carryforward from expiring unused, and (c) would result in the realization of existing deferred tax assets. These tax planning strategies, if implemented, would result in taxable income in the first full reporting period after deployment and accelerate the recovery of deferred tax asset balances if faced with the inability to recover those assets or the risk of potential expiration. We believe that these are viable tax planning strategies and appropriately considered in the analysis at this time, but may not align with the strategic direction of the organization today and therefore, has no present intention to implement such strategies.
The net deferred tax asset balance before consideration of a valuation allowance was $19.6 million as of December 31, 2014 and $21.4 million as of December 31, 2013. After assessment of all available tax planning strategies, we determined that a partial valuation allowance in the amount of $14.7 million as of December 31, 2014 and $15.3 million as of December 31, 2013 should be recorded.
The deferred tax asset will continue to be analyzed on a quarterly basis for changes affecting realizability. When the determination is made to include projections of future taxable income as a factor in recovering the deferred tax asset, the valuation allowance will be reduced accordingly resulting in a corresponding increase in net income.
Net Income and Net Income per Common Share
Net income for the twelve month period ended December 31, 2014 was $2.4 million, an increase of $5.9 million, compared to a $3.5 million net loss recorded for the twelve month period ended December 31, 2013. The higher net income in 2014 was due to a $4.0 million decrease in the provision for loan losses, a $3.2 million increase in net interest income, partially offset by a $1.2 million decrease in noninterest income and a $139,000 increase in noninterest expenses.
For the twelve month period ended December 31, 2014, basic and fully-diluted net income per common share was $0.07 compared to basic and fully-diluted net loss per common share of $(0.13) for the twelve month period ended December 31, 2013.
Return on Average Assets and Average Equity
Return on average assets (ROA) measures our net income in relation to our total average assets. The ROA for the twelve month periods ended December 31, 2014 and 2013 was 0.23% and (0.37)%, respectively. Return on average equity (ROE) indicates how effectively we can generate net income on the capital invested by our stockholders. ROE is calculated by dividing annualized net income by average stockholders' equity. The ROE for the twelve month period ended December 31, 2014 was 2.51%, compared to (5.07)% for the twelve month period ended December 31, 2013.
Results of Operations
For the year ended December 31, 2013 as compared to the year ended December 31, 2012
We recorded a net loss of $3.5 million, or $(0.13) per diluted share for 2013 compared to net income of $3.6 million, or $0.14 per diluted share, for 2012. The net loss in 2013 was primarily driven by two isolated events.
We recorded a one-time charge in the amount of $1.9 million during the third quarter of 2013 related to a settlement agreement in connection with a lawsuit in which we were a defendant. The lawsuit arose from an issue that occurred prior to 2007. We had vigorously contested the claims in the suit. However, as a result of reversals of certain procedural rulings in the case, we concluded that it would be in our best interest to avoid further litigation by executing a settlement agreement. The settlement released us from all claims and actions related to the matter.
We also recorded a loan loss provision in the amount of $3.6 million during the fourth quarter of 2013 related to a single loan in our portfolio. This loan was determined to be impaired during the fourth quarter and the provision was a result of a significant reduction in the collateral value supporting the loan based upon a current appraisal.
Return on average assets and average equity was (0.37)% and (5.07)%, respectively, for 2013 as compared to 0.37% and 5.36%, respectively, for 2012. Average equity to average assets was 7.22% for 2013 as compared to 6.95% for 2012.
Net Interest Income
The tax equivalent net interest margin increased 13 basis points to 3.66% during 2013, compared to 3.53% during 2012 and the Company’s tax equivalent net interest income increased $648,000, or 2.0%, to $32.9 million for 2013, as compared to $32.3 million for 2012. Yields on interest-bearing assets decreased 6 basis points to 4.17% in 2013 from 4.23% in 2012 and the rates on total deposits and other borrowings decreased 18 basis points to 0.53% in 2013 from 0.71% in 2012.
The Company’s total tax equivalent interest income decreased $1.1 million, or 2.9%, to $37.5 million for 2013 as compared to $38.7 million for 2012. A 29 basis point decrease in loan yields and a 49 basis point decrease in securities yields were partially offset by a $30.3 million increase in average loans outstanding.
The Company’s total interest expense decreased $1.8 million, or 27.9%, to $4.6 million for 2013, from $6.4 million for 2012 as the Company continues to lower the rates paid on interest bearing deposit accounts. Interest-bearing liabilities averaged $724.8 million for 2013, versus $757.8 million for 2012, a decrease of $33.0 million. Average deposit balances decreased $20.8 million, as a result of the Company’s retail focused, customer service strategy, which emphasizes the gathering of low-cost core deposits, while reducing its dependence on wholesale funding sources such as brokered and internet-based certificates of deposit. Internet based certificate of deposit balances decreased by $36.9 million during 2013. The average rate paid on interest-bearing deposits decreased 21 basis points to 0.50% for 2013, as compared to 0.71% for 2012. Average time deposit balances declined $63.1 million for 2013 as compared to 2012. Interest expense paid on time deposit balances decreased $851,000 to $867,000 in 2013 from $1.7 million in 2012. The maturity and roll-off of higher cost time deposits resulted in the decrease in the average rate paid on time deposits of 16 basis points to 0.94% for 2013 as compared to 1.10% for 2012. Average interest-bearing demand balances increased $45.9 million for 2013 as compared to 2012. Money market and savings interest expense decreased $932,000 to $1.8 million in 2013 from $2.7 million in 2012, primarily due to a reduction in rates paid on money market and savings deposits. Accordingly, rates on total interest-bearing liabilities decreased 21 basis points in 2013 when compared to 2012.
Interest expense on other borrowings decreased $22,000 to $1.1 million in 2013. Average other borrowings, consisting mainly of $22.5 million of trust preferred securities outstanding, decreased $55,000, or 0.2%, between the respective periods.
Provision for Loan Losses
The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that management believes is adequate to absorb inherent losses in the loan portfolio. The Company recorded a $4.9 million provision for loan losses during 2013 compared to $1.4 million for the comparable prior year period.
The increase in the provision recorded during 2013 was primarily driven by a single loan relationship which was originated in 2006 and determined to be impaired during the fourth quarter of 2013 due to delinquency in payments. The need for a provision in the amount of $3.6 million was the result of a significant reduction in the collateral value supporting the loan based upon a current appraisal. Management is working closely with this borrower to resolve the delinquency issue and address the collateral deficiency.
The lower provision recorded during 2012 was mainly attributable to the significant improvement in credit quality in the loan portfolio, along with a reduction in the component of the allowance for loan losses related to loans collectively evaluated for impairment caused by an adjustment to the analysis of historical losses during the period. See disclosure under “Credit Quality” and “Allowance for Loan Losses” for further discussion.
Non-Interest Income
Total non-interest income increased to $9.2 million for 2013 compared to $8.8 million for 2012, primarily due to the growth in fees earned on the servicing of SBA loans.
Non-Interest Expenses
Total non-interest expenses increased $4.5 million, or 12.6%, to $40.4 million for 2013 compared to $35.9 million for 2012 primarily as a result of higher expenses related to foreclosed real estate during 2013 and a one-time charge related to a settlement agreement in connection with litigation in which the Company was a defendant. Carrying costs and write downs of other real estate owned amounted to $3.2 million in 2013 compared to $763,000 in 2012. The increase was primarily driven by the writedown in value of one property as a result of a current appraisal. The legal settlement of $1.9 million was executed to avoid further litigation on a matter stemming from an issue associated with a lending relationship that arose several years ago. The settlement released the Company from all claims and actions related to this matter.
Provision (Benefit) for Income Taxes
The Company recorded a benefit for income taxes in the amount of $35,000 for the twelve month period ended December 31, 2013, compared to a benefit for income taxes of $144,000 for the twelve month period ended December 31, 2012. The $35,000 benefit recorded in 2013 was the result of a tax benefit in the amount of $1.5 million calculated on the net loss generated during the period using the Company’s normal estimated tax rates offset by an adjustment to the deferred tax asset valuation allowance in the amount of $1.4 million. The effective tax rate was (42%) for 2013 and 27% for 2012, excluding the adjustment to the deferred tax asset valuation allowance.
For information regarding the evaluation, calculation, and assessment undertaken by the Company in connection with its deferred tax asset, see the discussion under the heading “- Results of Operations - For the year ended December 31, 2014 as compared to the year ended December 31, 2013 - Provision (Benefit) for Income Taxes” above.
The net deferred tax asset balance before consideration of a valuation allowance was $21.4 million as of December 31, 2013 and $17.5 million as of December 31, 2012. The tax planning strategies assessed resulted in the projected realization of approximately $6.1 million in tax assets which can be considered more likely than not to be realized as of December 31, 2013 and $3.6 million as of December 31, 2012. Accordingly, the Company recorded a partial valuation allowance related to the deferred tax asset balance in the amount of $15.3 million as of December 31, 2013 and $13.9 million as of December 31, 2012.
Financial Condition
December 31, 2014 compared to December 31, 2013
Total assets increased by $252.9 million to $1.2 billion at December 31, 2014, compared to $961.7 million at December 31, 2013.
Cash and Cash Equivalents
Cash and due from banks and interest bearing deposits comprise this category, which consists of our most liquid assets. The aggregate amount in these two categories increased by $92.9 million to $128.8 million at December 31, 2014, from $35.9 million at December 31, 2013. The increase was primarily caused by a growth in deposit balances during 2014 along with the sale of common stock in a private placement offering during the second quarter of 2014.
Loans Held for Sale
Loans held for sale are comprised of loans guaranteed by the U.S. Small Business Administration (“SBA”) which we usually originate with the intention of selling in the future. Total SBA loans held for sale were $1.7 million at December 31, 2014. The decrease of $3.2 million was primarily driven by the timing of settlement on the sale of two loans which closed shortly after year end in 2013. Loans held for sale, as a percentage of our total assets, were less than 1% at December 31, 2014.
Loans Receivable
The loan portfolio represents our largest asset category and is our most significant source of interest income. Our lending strategy is focused on small and medium sized businesses and professionals that seek highly personalized banking services. The loan portfolio consists of secured and unsecured commercial loans including commercial real estate, construction loans, residential mortgages, automobile loans, home improvement loans, home equity loans and lines of credit, overdraft lines of credit, and others. Commercial loans typically range between $250,000 and $5,000,000 but customers may borrow significantly larger amounts up to our legal lending limit to a customer, which was approximately $19.9 million at December 31, 2014. Loans made to one individual customer, even if secured by different collateral, are aggregated for purposes of the lending limit. The aggregate amount of those relationships that exceeded $13.3 million at December 31, 2014, was $14.4 million. A $13.3 million threshold, which amounts to approximately 10% of total regulatory capital, reflects an additional internal monitoring guideline.
Loans increased $102.6 million, or 15%, to $781.9 million at December 31, 2014, versus $679.3 million at December 31, 2013. This growth was the result of an increase in loan demand in the commercial real estate, owner occupied real estate, commercial and industrial, consumer, and construction and land development categories driven by the successful execution of our relationship banking strategy which focuses on customer service.
Investment Securities
Investment securities considered available-for-sale are investments that may be sold in response to changing market and interest rate conditions, and for liquidity and other purposes. Our investment securities classified as available-for-sale consist primarily of U.S. Government agency collateralized mortgage obligations (CMO), agency mortgage-backed securities (MBS), municipal securities, corporate bonds, asset-backed securities (ABS), and pooled trust preferred securities (CDO). Available-for-sale securities totaled $185.4 million at December 31, 2014, compared to $204.9 million at December 31, 2013. The decrease was primarily due to the transfer of $70.1 million of available-for-sale securities to held-to-maturity in addition to sales and pay downs of securities totaling $31.5 million, partially offset by the purchase of available-for-sale securities totaling $78.8 million during 2014. At December 31, 2014, the portfolio had a net unrealized gain of $129,000 compared to a net unrealized loss of $4.4 million at December 31, 2013. The change in value of the investment portfolio was driven by a decrease in market interest rates which drove an increase in value of the bonds held in our portfolio during 2014.
Investment securities held-to-maturity are investments for which there is the intent and ability to hold the investment to maturity. These investments are carried at amortized cost. The held-to-maturity portfolio consists primarily of U.S. Government agency collateralized mortgage obligations. The fair value of securities held-to-maturity totaled $68.3 million and $21,000 at December 31, 2014 and December 31, 2013, respectively. The increase was due to the transfer of $70.1 million of available for sale securities to held-to-maturity, partially offset by pay downs of securities totaling $2.3 million.
ASC 320 “Investments - Debt and Equity Securities” requires an entity to determine how to classify a security at the time of acquisition. The appropriateness of the original classification should be reassessed at each reporting period. The transfer of investment securities from available-for-sale to held-to maturity category during the quarter ended September 30, 2014 was completed after an extensive analysis of the characteristics of all securities held in the portfolio, in addition to a review of our liquidity position under multiple scenarios including varying interest rate environments. Twelve of the thirteen securities transferred were GNMA collateralized mortgage obligations which are backed by the full faith and credit of the U.S. government. The other bond was a collateralized mortgage obligation issued by FNMA. Bonds issued by GNMA receive favorable risk rating when calculating regulatory risk-based capital ratios. In addition, both GNMA and FNMA securities are often pledged as collateral as required to hold certain government deposits and are accepted as collateral as a result of the high quality and low-risk nature of these bonds.
After completion of these analyses and consideration of the factors mentioned above, management determined that it had the intent and ability to hold specific securities until maturity and it was appropriate to transfer them to the held-to-maturity category during the third quarter of 2014.
The fair value of the securities transferred to the held-to-maturity category was $70.1 million. The book value of the securities on the date of transfer was $71.3 million. The unrealized holding gain or loss on each individual security calculated at the time of transfer was reported as a component of shareholders’ equity in the accumulated other comprehensive income account and will be amortized as an adjustment to yield over the remaining life of each security.
Restricted Stock
Restricted stock, which represents a required investment in the capital stock of correspondent banks related to available credit facilities, is carried at cost as of December 31, 2014 and December 31, 2013. As of those dates, restricted stock consisted of investments in the capital stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”) and Atlantic Central Bankers Bank (“ACBB”). In 2012, the FHLB repurchased 29% of Republic’s total restricted stock outstanding and issued its first dividend payments since 2008. During 2013, FHLB repurchased all remaining excess restricted stock outstanding and continued with the quarterly payment of dividends.
At December 31, 2014 and December 31, 2013, the investment in FHLB of Pittsburgh stock totaled $1.0 million and $1.4 million, respectively. At both December 31, 2014 and December 31, 2013, ACBB stock totaled $143,000.
Other Real Estate Owned
The balance of other real estate owned decreased to $3.7 million at December 31, 2014 from $4.1 million at December 31, 2013, primarily due to writedowns in the amount of $1.1 million on existing foreclosed properties during 2014 and sales during 2014 totaling $197,000, partially offset by transfers from loans receivable totaling $1.0 million.
Deposits
Deposits, which include non-interest and interest-bearing demand deposits, money market, savings and time deposits, are Republic’s major source of funding. Deposits are generally solicited from the Company’s market area through the offering of a variety of products to attract and retain customers, with a primary focus on multi-product relationships.
Total deposits increased by $202.7 million to $1.1 billion at December 31, 2014, from $869.5 million at December 31, 2013. The increase was primarily the result of a $120.0 million increase in demand deposits and an $86.2 million increase in money market and savings deposits, which reflects the success of our retail-focused strategy of gathering low-cost core deposits. Republic has continued to focus on its efforts to gather low-cost, core deposits by successfully executing its relationship banking model which is based upon high levels of customer service. In addition, the Company has begun to implement its relocation and expansion strategy through the opening of additional stores. This strategy has also allowed Republic to nearly eliminate its dependence on the more volatile sources of funding in brokered and public fund certificates of deposit.
Shareholders’ Equity
Total shareholders’ equity increased $49.9 million to $112.8 million at December 31, 2014, compared to $62.9 million at December 31, 2013, primarily due to $44.9 million in net proceeds received from the sale of common stock in a private placement offering. To support our growth and expansion strategy, we sold 11.8 million shares of common stock at a price of $3.80 per share during the second quarter of 2014. In addition, there was also a reduction in accumulated other comprehensive losses associated with unrealized losses in the investment securities portfolio resulting in an increase in shareholder’s equity of $2.2 million. The shift in market value of the securities portfolio resulted in accumulated other comprehensive losses of $632,000 at December 31, 2014 compared to accumulated other comprehensive losses of $2.8 million at December 31, 2013 which was primarily driven by a decrease in market interest rates which drove an increase in value of the bonds held in our portfolio and the transfer of available-for-sale securities to held-to-maturity. We also recognized net income of $2.4 million during 2014.
Investment Securities Portfolio
Republic’s investment securities portfolio is intended to provide liquidity and contribute to earnings while diversifying credit risk. We attempt to maximize earnings while minimizing our exposure to interest rate risk. The securities portfolio consists primarily of U.S. Government agency collateralized mortgage obligations (CMO), agency mortgage-backed securities (MBS), corporate bonds, municipal securities, asset-backed securities (ABS), and pooled trust preferred securities (CDO). Our ALCO committee monitors and reviews all security purchases.
A summary of investment securities available-for-sale and investment securities held-to-maturity at December 31, 2014, 2013 and 2012 is as follows:
No single issuer of securities (excluding government agencies) in the portfolio exceeded more than 10% of shareholders’ equity at December 31, 2014 with the exception of corporate bonds issued by Morgan Stanley. The Morgan Stanley bonds had a book value of $12.0 million and a market value of $12.2 million at December 31, 2014. No single issuer of securities (excluding government agencies) in the portfolio exceeded more than 10% of shareholders’ equity at December 31, 2013 with the exception of corporate bonds issued by Goldman Sachs and Morgan Stanley. The Goldman Sachs bonds had a book value of $10.3 million and a market value of $10.8 million at December 31, 2013. The Morgan Stanley bonds had a book value of $10.0 million and a market value of $10.3 million at December 31, 2013.
At December 31, 2014, the investment portfolio included twenty-eight municipal securities with a total market value of $16.1 million. The securities are reviewed quarterly for impairment. Research on each issuer is completed to assess the financial stability of the municipal entity. The largest geographic concentration was in Pennsylvania and New Jersey where twenty-one municipal securities had a market value of $11.6 million. As of December 31, 2014, management found no evidence of other than temporary impairment (“OTTI”) on any of the municipal securities held in the investment securities portfolio.
At December 31, 2014, the portfolio included two asset-backed securities with a total market value of $18.5 million, the majority of which (97%) is guaranteed by the U.S. Dept. of Education. At December 31, 2014, the portfolio also included pooled trust preferred securities (CDOs) with a market value of $3.2 million. The unrealized loss for the CDOs was due to the secondary market for such securities becoming inactive and is considered temporary.
The following table presents the maturity distribution and weighted average yield by holding type and year of maturity of our investment securities portfolio at December 31, 2014.
Fair Value of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.
The Company follows the guidance issued under ASC 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under GAAP, and identifies required disclosures on fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities, which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.
The types of instruments valued on matrix pricing in active markets include all of the U.S. government and agency securities, municipal obligations and corporate bonds. Such instruments are generally classified within Level 2 of the fair value hierarchy. As required by ASC 820, we do not adjust the matrix pricing for such instruments.
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. The Level 3 investment securities currently held in the company’s portfolio are classified as available for sale and consist of various issues of trust preferred securities and a single corporate bond.
The trust preferred securities are pools of similar securities that are grouped into an asset structure commonly referred to as collateralized debt obligations (“CDOs”) which consist of the debt instruments of various banks, diversified by the number of participants in the security as well as geographically. These securities are performing according to terms, however the secondary market for such securities has become inactive, and such securities are therefore classified as Level 3 securities. The fair value analysis does not reflect or represent the actual terms or prices at which any party could purchase the securities. There is currently no secondary market for the securities and there can be no assurance that any secondary market for the securities will develop.
The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2014, 2013, and 2012:
An independent, third party pricing service is used to estimate the current fair market value of each CDO held in the investment securities portfolio. The calculations used to determine fair value are based on the attributes of the trust preferred securities, the financial condition of the issuers of the trust preferred securities, and market based assumptions. The INTEX CDO Deal Model Library was utilized to obtain information regarding the attributes of each security and its specific collateral as of December 31, 2014 and December 31, 2013. Financial information on the issuers was also obtained from Bloomberg, the FDIC and SNL Financial. Both published and unpublished industry sources were utilized in estimating fair value. Such information includes loan prepayment speed assumptions, discount rates, default rates, and loss severity percentages. A detailed explanation of the assumptions used to estimate the fair market value of the CDOs can be found in Note 14 “Fair Value Measurements and Fair Values of Financial Investments” to the Consolidated Financial Statements.
The fair market valuation for each CDO was determined based on discounted cash flow analyses. The cash flows are primarily dependent on the estimated speeds at which the trust preferred securities are expected to prepay, the estimated rates at which the trust preferred securities are expected to defer payments, the estimated rates at which the trust preferred securities are expected to default, and the severity of the losses on securities that do default.
Increases (decreases) in actual or expected issuer defaults tend to decrease (increase) the fair value of the Company’s senior and mezzanine tranches of CDOs. The values of the Company’s mezzanine tranches of CDOs are also affected by expected future interest rates. However, due to the structure of each security, timing of cash flows, and secondary effects on the financial performance of the underlying issuers, the effects of changes in future interest rates on the fair value of the Company’s holdings are not quantifiably estimable.
Also included in Level 3 investment securities classified as available for sale is a single-issuer corporate bond transferred from Level 2 in 2010 since the bond is not actively traded. Impairment would depend on the repayment ability of the underlying issuer, which is assessed through a detailed quarterly review of the issuer’s financial statements. The issuer is a “well capitalized” financial institution as defined by federal banking regulations and has demonstrated the ability to raise additional capital, when necessary, through the public capital markets. The fair value of this corporate bond is estimated by obtaining a price of a comparable floating rate debt instrument through Bloomberg.
Loan Portfolio
Our loan portfolio consists of secured and unsecured commercial loans including commercial real estate loans, construction and land development loans, commercial and industrial loans, owner occupied real estate loans, consumer and other loans, and residential mortgages. Commercial loans are primarily secured term loans made to small to medium-sized businesses and professionals for working capital, asset acquisition and other purposes. Commercial loans are originated as either fixed or variable rate loans with typical terms of 1 to 5 years. Republic’s commercial loans typically range between $250,000 and $5.0 million, but customers may borrow significantly larger amounts up to Republic’s legal lending limit of approximately $19.9 million at December 31, 2014. Individual customers may have several loans often secured by different collateral. Such relationships in excess of $13.3 million (an internal monitoring guideline which approximates 10% of capital and reserves) at December 31, 2014, amounted to $14.4 million. There were no loans in excess of the legal lending limit at December 31, 2014.
The majority of loans outstanding are with borrowers in our marketplace, Philadelphia and surrounding suburbs, including southern New Jersey. In addition, we have loans to customers whose assets and businesses are concentrated in real estate. Repayment of our loans is in part dependent upon general economic conditions affecting our market place and specific industries. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral varies but primarily includes residential, commercial and income-producing properties.
At December 31, 2014, we had loan concentrations exceeding 10% of total loans for credits extended to lessors of nonresidential real estate in the aggregate amount of $204.6 million, which represented 26.2% of gross loans receivable and lessors of residential real estate in the aggregate amount of $128.8 million, which represented 16.5% of gross loans receivable. Loan concentrations are considered to exist when amounts are loaned to multiple numbers of borrowers engaged in similar activities that management believes would cause them to be similarly impacted by economic or other conditions. At December 31, 2014, we had no foreign loans outstanding.
Total loans, net of deferred loan fees, increased by $102.6 million, or 15.1%, to $781.9 million at December 31, 2014, from $679.3 million at December 31, 2013, as we saw a positive trend in quality loan demand during 2014 and continued success in our relationship banking model.
The following table sets forth gross loans by major categories for the periods indicated:
Loan Maturity and Interest Rate Sensitivity
The amount of loans outstanding by category as of the dates indicated, which are due in: (i) one year or less, (ii) more than one year through five years, and (iii) over five years, is shown in the following table. Loan balances are also categorized according to their sensitivity to changes in interest rates.
In the ordinary course of business, loans maturing within one year may be renewed, in whole or in part, as to principal amount, and at interest rates prevailing at the date of renewal. At December 31, 2014, 68.0% of total loans were fixed rate compared to 65.9% at December 31, 2013.
Credit Quality
Republic’s written lending policies require specific underwriting, loan documentation and credit analysis standards to be met prior to funding, with independent credit department approval for the majority of new loan balances. A committee consisting of senior management and certain members of the Board of Directors oversees the loan approval process to monitor that proper standards are maintained, while approving the majority of commercial loans.
Loans, including impaired loans, are generally classified as non-accrual if they are past due as to maturity or payment of interest or principal for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual if repayment of principal and/or interest in full is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms.
While a loan is classified as non-accrual, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. For non-accrual loans, which have been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
The following summary shows information concerning loan delinquency and non-performing assets at the dates indicated:
(1) Non-performing loans are comprised of (i) loans that are on non-accrual basis and (ii) accruing loans that are 90 days or more past due. Non-performing assets are composed of non-performing loans and other real estate owned.
Problem loans can consist of loans that are performing, but for which potential credit problems of the borrowers have caused management to have serious doubts as to the ability of such borrowers to continue to comply with present repayment terms. At December 31, 2014, all identified problem loans included in the preceding table are internally classified and have been evaluated for a specific reserve allocation in the allowance for loan losses (see “Allowance for Loan Losses”).
Non-performing assets increased by $10.7 million, or 74%, to $25.2 million at December 31, 2014, compared to $14.5 million at December 31, 2013. This increase was primarily driven by one loan in the amount of $13.0 million that was transferred to non-accrual status during the second quarter of 2014. A reserve for this loan was recorded in the fourth quarter of 2013 when it was initially downgraded to impaired status.
The following summary shows the impact on interest income of non-accrual loans, subsequent to being placed on non-accrual for the periods indicated:
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. The Company evaluates the need to establish an allowance against loan losses on a quarterly basis. When an increase in this allowance is necessary, a provision for loan losses is charged to earnings. The allowance for loan losses consists of three components. The first component is allocated to individually evaluated loans found to be impaired and is calculated in accordance with ASC 310 Receivables. The second component is allocated to all other loans that are not individually identified as impaired pursuant to ASC 310-10 (“non-impaired loans”). This component is calculated for all non-impaired loans on a collective basis in accordance with ASC 450 Contingencies. The third component is an unallocated allowance to account for a level of imprecision in management’s estimation process.
The Company evaluates loans for impairment and potential charge-off on a quarterly basis. Management regularly monitors the condition of borrowers and assesses both internal and external factors in determining whether any loan relationships have deteriorated. Any loan rated as substandard or lower will have an individual collateral evaluation analysis prepared to determine if a deficiency exists. We first evaluate the primary repayment source. If the primary repayment source is seriously inadequate and unlikely to repay the debt, we then look to the secondary and/or tertiary repayment sources. Secondary sources are conservatively reviewed for liquidation values. Updated appraisals and financial data are obtained to substantiate current values. If the reviewed sources are deemed to be inadequate to cover the outstanding principal and any costs associated with the resolution of the troubled loan, an estimate of the deficient amount will be calculated and a specific allocation of loan loss reserve is recorded.
Factors considered in the calculation of the allowance for non-impaired loans include several qualitative and quantitative factors such as historical loss experience, trends in delinquency and nonperforming loan balances, changes in risk composition and underwriting standards, experience and ability of management, and general economic conditions along with other external factors. Historical loss experience is analyzed by reviewing charge-offs over a three year period to determine loss rates consistent with the loan categories depicted in the allowance for loan loss table below.
Prior to the first quarter of 2012, historical losses for all commercial loans secured by real estate were aggregated into one group for purposes of calculating a loss rate for loans collectively evaluated for impairment in the allowance for loan loss calculation. During the first quarter of 2012, management elected to disaggregate this grouping into five separate categories based on distinct risk factors to provide a more detailed estimate for the allowance calculation. This change resulted in a reduction of approximately $2.6 million in the estimated allowance required for non-impaired loans in the first quarter of 2012 due to the application of lower loss rates to a larger segment of the commercial real estate portfolio with a lower risk profile.
The factors supporting the allowance for loan losses do not diminish the fact that the entire allowance for loan losses is available to absorb losses in the loan portfolio and related commitment portfolio, respectively. The Company’s principal focus, therefore, is on the adequacy of the total allowance for loan losses. The allowance for loan losses is subject to review by banking regulators. The Company’s primary bank regulators regularly conduct examinations of the allowance for loan losses and make assessments regarding the adequacy and the methodology employed in their determination.
A detailed analysis of our allowance for loan losses for the years ended December 31, 2014, 2013, 2012, 2011 and 2010 is as follows:
(1) Includes non-accruing loans.
The provision for loan losses is charged to operations in an amount necessary to bring the total allowance for loan losses to a level that management believes is adequate to absorb inherent losses in the loan portfolio. The Company recorded a loan loss provision in the amount of $900,000 in 2014 compared to a $4.9 million provision in 2013.
The decrease in the provision recorded during 2014 when compared to 2013 was primarily driven by a single loan relationship which was determined to be impaired during the fourth quarter of 2013 due to delinquency in payments. The need for a provision in the amount of $3.6 million, recorded in 2013, was the result of a significant reduction in the collateral value supporting the loan based upon a current appraisal. Management is working closely with this borrower to resolve the delinquency issue and address the collateral deficiency.
The allowance for loan losses as a percentage of non-performing loans (coverage ratio) was 53.8% at December 31, 2014 as compared to 117.7% at December 31, 2013 and 59.5% at December 31, 2012. The decrease in the coverage ratio at December 31, 2014 when compared to December 31, 2013 was primarily the result of an increase in non-performing loans during 2014. This increase was driven by one loan relationship that transferred to non-accrual status in the second quarter 2014. A reserve for this loan was recorded during the fourth quarter of 2013 when it was initially downgraded to impaired status. Coverage is considered adequate by management as of December 31, 2014.
Management makes at least a quarterly determination as to an appropriate provision from earnings to maintain an allowance for loan losses that it determines is adequate to absorb inherent losses in the loan portfolio. The Board of Directors periodically reviews the status of all non-accrual and impaired loans and loans classified by the management team. The Board of Directors also considers specific loans, pools of similar loans, historical charge-off activity, economic conditions and other relevant factors in reviewing the adequacy of the allowance for loan losses. Any additions deemed necessary to the allowance for loan losses are charged to operating expenses.
The Company evaluates loans for impairment and potential charge-offs on a quarterly basis. Any loan rated as substandard or lower will have a collateral evaluation analysis completed in accordance with the guidance under generally accepted accounting principles (GAAP) on impaired loans to determine if a deficiency exists. Our credit monitoring process assesses the ultimate collectability of an outstanding loan balance from all potential sources. When a loan is determined to be uncollectible it is charged-off against the allowance for loan losses. Unsecured commercial loans and all consumer loans are charged-off immediately upon reaching the 90-day delinquency mark unless they are well secured and in the process of collection. The timing on charge-offs of all other loan types is subjective and will be recognized when management determines that full repayment, either from the cash flow of the borrower, collateral sources, and/or guarantors, will not be sufficient and that repayment is unlikely. A full or partial charge-off is recognized equal to the amount of the estimated deficiency calculation.
Serious delinquency is often the first indicator of a potential charge-off. Reductions in appraised collateral values and deteriorating financial condition of borrowers and guarantors are factors considered when evaluating potential charge-offs. The likelihood of possible recoveries or improvements in a borrower’s financial condition is also assessed when considering a charge-off.
Partial charge-offs of non-performing and impaired loans can significantly reduce the coverage ratio and other credit loss statistics due to the fact that the balance of the allowance for loan losses will be reduced while still carrying the remainder of a non-performing loan balance in the impaired loan category. The amount of non-performing loans for which there were partial charge-offs during the year amounted to $17.8 million at December 31, 2014 compared to $6.2 million at December 31, 2013.
The Company’s charge-off policy is reviewed on an annual basis and updated as necessary. During the twelve months ended December 31, 2014, there have been no changes made to this policy.
We have an existing loan review program, which monitors the loan portfolio on an ongoing basis. A loan review officer who reviews both the loan portfolio and overall adequacy of the allowance for loan losses conducts this loan review on a quarterly basis and reports directly to the Board of Directors.
Estimating the appropriate level of the allowance for loan losses at any given date is difficult, particularly in a continually changing economy. In management’s opinion, the allowance for loan losses was appropriate at December 31, 2014. However, there can be no assurance that, if asset quality deteriorates in future periods, additions to the allowance for loan losses will not be required.
Management is unable to determine in which loan category future charge-offs and recoveries may occur. The following schedule sets forth the allocation of the allowance for loan losses among various categories. The allocation is based on management’s evaluation of historical charge-off experience and adjusted for qualitative factors. The entire allowance for loan losses is available to absorb loan losses in any loan category.
The allocation of the allowance for loan losses for the past five years is as follows:
The allowance for loan losses is an amount that represents management’s estimate of known and inherent losses related to the loan portfolio and unfunded loan commitments. Because the allowance for loan losses is dependent, to a great extent, on the general economy and other conditions that may be beyond our control, the estimate of the allowance for loan losses could differ materially in the near term.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are categorized as “internally classified”. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value 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. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. All identified losses are immediately charged off and therefore no portion of the allowance for loan losses is restricted to any individual loan or group of loans, and the entire allowance is available to absorb any and all loan losses.
In estimating the allowance for loan losses, management considers current economic conditions, past loss experience, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews and regulatory examinations, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant and qualitative risk factors. These qualitative risk factors include:
1.
Lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices.
2.
National, regional and local economic and business conditions as well as the condition of various segments.
3.
Nature and volume of the portfolio and terms of loans.
4.
Experience, ability and depth of lending management and staff.
5.
Volume and severity of past due, classified and nonaccrual loans as well as other loan modifications.
6.
Quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.
7.
Existence and effect of any concentration of credit and changes in the level of such concentrations.
8.
Effect of external factors, such as competition and legal and regulatory requirements.
Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.
We also provide specific reserves for impaired loans to the extent the estimated realizable value of the underlying collateral is less than the loan balance, when the collateral is the only source of repayment. Also, we estimate and recognize reserve allocations on loans classified as “internally classified accruing loans” based upon any factor that might impact loss estimates. Those factors include but are not limited to the impact of economic conditions on the borrower and management’s potential alternative strategies for loan or collateral disposition. An unallocated allowance is established for losses that have not been identified through the formulaic and other specific components of the allowance as described above. Management has identified several factors that impact credit losses that are not considered in either the formula or the specific allowance segments. These factors consist of macro and micro economic conditions, industry and geographic loan concentrations, changes in the composition of the loan portfolio, changes in underwriting processes and trends in problem loan and loss recovery rates. The impact of the above is considered in light of management’s conclusions as to the overall adequacy of underlying collateral and other factors.
The majority of our loan portfolio represents loans made for commercial purposes, while significant amounts of residential property may serve as collateral for such loans. We attempt to evaluate larger loans individually, on the basis of our loan review process, which scrutinizes loans on a selective basis and other available information. Even if all commercial purpose loans could be reviewed, information on potential problems might not be available. Our portfolio of loans made for purposes of financing residential mortgages and consumer loans are evaluated in groups. At December 31, 2014, loans made for commercial real estate, construction and land development, commercial and industrial, owner occupied real estate, consumer and other, and residential mortgage purposes, respectively, amounted to $379.3 million, $29.9 million, $145.1 million, $188.0 million, $39.7 million, and $408,000.
A loan is considered impaired, in accordance with ASC 310, when based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans, but also include internally classified accruing loans. As of December 31, 2014, management identified a total of three troubled debt restructurings in the loan portfolio in the amount of $9.6 million. Three troubled debt restructurings in the amount of $4.2 million were identified as of December 31, 2013.
The following table presents the Company’s impaired loans at December 31, 2014, 2013, and 2012:
The recorded investment in loans that are impaired in accordance with ASC 310 totaled $35.6 million, $32.5 million, and $41.0 million at December 31, 2014, 2013, and 2012, respectively. The amounts of related valuation allowances were $5.1 million, $5.6 million, and $2.9 million, respectively at those dates. For the years ended December 31, 2014, 2013, and 2012 the average recorded investment in impaired loans was approximately $33.0 million, $33.7 million, and $40.8 million, respectively. Republic earned $614,000, $1.2 million, and $1.6 million of interest income on impaired loans (internally classified accruing loans) in 2014, 2013, and 2012, respectively. There were no commitments to extend credit to any borrowers with impaired loans as of the end of the periods presented herein.
Total impaired loans increased by $3.1 million, or 10%, during the year ended December 31, 2014. This increase was due to a credit downgrade on one loan relationship in the amount of $6.1 million identified as a troubled debt restructuring in the fourth quarter of 2014. The loan has been and continues to be an accruing loan and the borrower has remained current since the modification. The downgrade was partially offset by balance payoffs, writedowns, and credit upgrades processed in 2014. The valuation allowance related to impaired loans decreased to $5.1 million at December 31, 2014 compared to $5.6 million at December 31, 2013. At December 31, 2014 and 2013, internally classified accruing loans totaled approximately $14.2 million and $22.1 million, respectively.
The following table presents the Company’s 30 to 89 days past due loans at December 31, 2014, 2013, and 2012:
The decrease in loan balances 30 to 59 days past due was the result of delinquency in two lending relationships at December 31, 2013, one of which in the amount of $12.7 million moved from 30 to 59 days past due at December 31, 2013 to greater than 90 days past due as of December 31, 2014, the other in the amount of $6.0 million moved from 30 to 59 days past due at December 31, 2013 to current status at December 31, 2014. The increase in loan balances 60 to 89 days past due was the result of delinquency in one lending relationship at December 31, 2014 in the amount of $5.0 million. Management has engaged in active discussions with all delinquent relationships to address delinquencies and is confident that acceptable resolutions will be achieved in the near term.
Deposits
Total deposits at December 31, 2014 were $1.1 billion, a increase of $202.7 million or 23.3% from total deposits of $869.5 million at December 31, 2013. Total deposits by account type at December 31, 2014, 2013 and 2012 are as follows:
In general, Republic pays higher interest rates on time deposits compared to other deposit categories. Republic’s various deposit liabilities may fluctuate from period-to-period, reflecting customer behavior and strategies to optimize net interest income. The increase in total deposits to $1.1 billion at December 31, 2014 from $869.5 million at December 31, 2013 was primarily the result of a $120.0 million increase in demand deposits, an $86.2 million increase in money market and savings deposits, which reflects the success of our retail-focused strategy of gathering low-cost core deposits. This strategy has also allowed us to nearly eliminate our dependence on the more volatile sources of funding in brokered and internet based certificates of deposit.
The average balances and weighted average rates of Republic’s deposits for the last three years are as follows:
The remaining maturity of certificates of deposit for $100,000 or more as of December 31, 2014 is as follows:
The following is a summary of the remaining maturity of time deposits, which includes certificates of deposits of $100,000 or more, as of December 31, 2014:
Off-Balance Sheet Arrangements
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
Credit risk is defined as the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform in accordance with the terms of the contract. The maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. We use the same underwriting standards and policies in making credit commitments as we do for on-balance-sheet instruments.
Financial instruments whose contract amounts represent potential credit risk are commitments to extend credit of approximately $138.4 million and $109.3 million and standby letters of credit of approximately $3.8 million and $2.7 million at December 31, 2014 and 2013, respectively. Commitments often expire without being drawn upon. The $138.4 million of commitments to extend credit at December 31, 2014, substantially all were variable rate commitments.
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 many require the payment of a fee. Since 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 upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.
Standby letters of credit are conditional commitments issued that guarantee the performance of a customer to a third party. The credit risk and collateral policy involved in issuing letters of credit is essentially the same as that involved in extending loan commitments. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.
Contractual Obligations and Other Commitments
The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2014:
As of December 31, 2014, we had entered into non-cancelable lease agreements for our main office and operations center, twelve current Republic retail branch facilities, two loan offices, and one training center expiring through November 30, 2054, including renewal options. The leases are accounted for as operating leases. The minimum rental payments required under these leases are $55.8 million through the year 2055, including renewal options. We have retirement plan agreements with certain directors and officers. At December 31, 2014, the accrued benefits under the plan were approximately $1.4 million, with a minimum age of 65 established to qualify for the payments.
Interest Rate Risk Management
We attempt to manage our assets and liabilities in a manner that optimizes net interest income in a range of interest rate environments. Management uses an “interest sensitivity gap” (“GAP”) analysis and simulation models to monitor behavior of its interest sensitive assets and liabilities. A GAP analysis is the difference between interest-sensitive assets and interest-sensitive liabilities. Adjustments to the mix of assets and liabilities are made periodically in an effort to provide steady growth in net interest income.
Management presently believes that the effect on Republic of any future reduction in interest rates, reflected in lower yielding assets, could be detrimental since Republic may not have the immediate ability to commensurately decrease rates on its interest bearing liabilities, primarily time deposits, other borrowings and certain transaction accounts. An increase in interest rates could have a negative effect on Republic, due to a possible lag in the re-pricing of core deposits not taken into account in the static GAP analysis. Interest rate risk management involves managing the extent to which interest-sensitive assets and interest-sensitive liabilities are matched. We attempt to optimize net interest income while managing period-to-period fluctuations therein. We typically define interest-sensitive assets and interest-sensitive liabilities as those that re-price within one year or less. Generally, we limit long-term fixed rate assets and liabilities in our efforts to manage interest rate risk.
A positive GAP occurs when interest-sensitive assets exceed interest-sensitive liabilities re-pricing in the same time periods, and a negative GAP occurs when interest-sensitive liabilities exceed interest-sensitive assets re-pricing in the same time periods. A negative GAP ratio suggests that a financial institution may be better positioned to take advantage of declining interest rates rather than increasing interest rates, and a positive GAP ratio suggests the converse. Static GAP analysis describes interest rate sensitivity at a point in time; however, it alone does not accurately measure the magnitude of changes in net interest income as changes in interest rates do not impact all categories of assets and liabilities equally or simultaneously. Interest rate sensitivity analysis also requires assumptions about re-pricing certain categories of assets and liabilities. For purposes of interest rate sensitivity analysis, assets and liabilities are stated at their contractual maturity, estimated likely call date, or earliest re-pricing opportunity. Mortgage-backed securities and amortizing loans are scheduled based on their anticipated cash flow, including prepayments based on historical data and current market trends. Savings, money market and interest-bearing demand accounts do not have a stated maturity or re-pricing term and can be withdrawn or re-priced at any time. Management estimates the re-pricing characteristics of these accounts based upon decay rates and run off projections obtained in a deposit study performed by an independent third party, along with management’s estimates of when rates would have to be increased to retain balances in response to competition. Such estimates are necessarily arbitrary and wholly judgmental. As a result of the run off projections, these deposits are not considered to re-price simultaneously and, accordingly, a portion of the deposits are moved into time brackets exceeding one year. However, management may choose not to re-price liabilities proportionally to changes in market interest rates, for competitive or other reasons.
Shortcomings, inherent in a simplified and static GAP analysis, may result in an institution with a negative GAP having interest rate behavior associated with an asset-sensitive balance sheet. For example, although certain assets and liabilities may have similar maturities or periods to re-pricing, they may react in different degrees to changes in market interest rates. Furthermore, re-pricing characteristics of certain assets and liabilities may vary substantially within a given time period. In the event of a change in interest rates, prepayments and other cash flows could also deviate significantly from those assumed in calculating GAP in the manner presented in the table on the following page.
The following tables present a summary of our GAP analysis at December 31, 2014. Amounts shown in the table include both estimated maturities and instruments scheduled to re-price, including prime based loans. For purposes of these tables, we have used assumptions based on industry data and historical experience to calculate the expected maturity of loans because, statistically, certain categories of loans are prepaid before their maturity date, even without regard to interest rate fluctuations. Additionally, certain prepayment assumptions were made with regard to investment securities based upon the expected prepayment of the underlying collateral of the mortgage-backed securities. The interest rate on a portion of the CDOs is variable and adjusts quarterly.
(1) Demand, savings and money market accounts are scheduled to reprice based upon decay rate and run off percentage estimates obtained through a deposit study performed by an independent third party, along with management’s estimates of when rates would have to be increased to retain balances in response to competition. Such estimates are necessarily arbitrary and wholly judgmental.
In addition to the GAP analysis, we utilize income simulation modeling in measuring our interest rate risk and managing our interest rate sensitivity. Income simulation considers not only the impact of changing market interest rates on forecasted net interest income, but also other factors such as yield curve relationships, the volume and mix of assets and liabilities and general market conditions.
Net Portfolio Value and Net Interest Income Analysis
The income simulation models management used to measure interest rate risk and manage interest rate sensitivity generates estimates of the change in net portfolio value (NPV) and net interest income (NII) over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The following table sets forth our NPV as of December 31, 2014 and reflects the changes to NPV as a result of immediate and sustained changes in interest rates as indicated (dollars in thousands):
In addition to modeling changes in NPV, we also analyze potential changes to NII for a forecasted twelve-month period under rising and falling interest rate scenarios. The following table shows the NII model as of December 31, 2014 (dollars in thousands):
Change in Interest Rates in Basis Points(1)
Net Interest Income
$
Change
%
Change
+400
$41,239
1.78%
+300
41,055
1.34%
+200
40,899
0.92%
+100
40,731
0.53%
Static
40,517
-
0.00%
40,422
(95)
(0.23)%
(1)The net interest income results were calculated assuming a rate ramp, achieving the rate change over a 12-month period, not an immediate and sustained rate shock.
As is the case with the GAP table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and NII require the making of certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the models presented assume that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or re-pricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.
Management believes that the assumptions utilized in evaluating our estimated net interest income are reasonable; however, the interest rate sensitivity of our assets, liabilities and off-balance sheet financial instruments as well as the estimated effect of changes in interest rates on estimated net interest income could vary substantially if different assumptions are used or actual experience differs from the experience on which the assumptions were based. Periodically, we may and do make significant changes to underlying assumptions, which are wholly judgmental. Prepayments on residential mortgage loans and mortgage-backed securities have increased over historical levels in recent years due to the lower interest rate environment, and may result in reductions in margins.
Capital Resources
We have sponsored three outstanding issues of corporation-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely junior subordinated debentures of the Corporation more commonly known as trust preferred securities. The subsidiary trusts are not consolidated for financial reporting purposes. The purpose of the issuances of these securities was to increase capital. The trust preferred securities qualify as Tier 1 capital for regulatory purposes in amounts up to 25% of total Tier 1 capital.
On December 27, 2006, Republic Capital Trust II (Trust II) issued $6.0 million of trust preferred securities to investors and $0.2 million of common securities to us. Trust II purchased $6.2 million of our floating rate junior subordinated debentures due 2037, and we used the proceeds to call the securities of Republic Capital Trust I (Trust I). The debentures purchased by Trust II have a variable interest rate, adjustable quarterly, at 1.73% over the 3-month LIBOR. We may redeem the debentures on any interest payment date without a prepayment penalty.
On June 28, 2007, Republic Capital Trust III (Trust III), issued $5.0 million of trust preferred securities to one investor and $0.2 million common securities to us. Trust III purchased $5.2 million of our floating rate junior subordinated debentures due 2037, which have a variable interest rate, adjustable quarterly, at 1.55% over the 3 month LIBOR. We have the ability to redeem the debentures on any interest payment date without a prepayment penalty.
On June 10, 2008, Republic First Bancorp Capital Trust IV (Trust IV) issued $10.8 million of convertible trust preferred securities as part of our strategic capital plan. The securities were purchased by investors, including Vernon W. Hill, II, founder and chairman (retired) of Commerce Bancorp, and, since the investment, a consultant to the Company. The investor group also included a family trust of Harry D. Madonna, our chairman, president and chief executive officer, and Theodore J. Flocco, Jr., who has been elected by the shareholders to our Board of Directors and serves as the Chairman of our Audit Committee. Trust IV also issued $0.3 million of common securities to us. Trust IV purchased $11.1 million of our fixed rate junior subordinated convertible debentures due 2038, which pay interest at an annual rate of 8.0% and are redeemable on any interest payment date (a) at any time on or after June 13, 2013 if the closing price of our common stock for 20 trading days in the period of 30 consecutive trading days ending on the trading day prior to the mailing of the notice of redemption exceeds 120% of the then-applicable conversion price, or (b) on or after June 30, 2018, without a prepayment penalty. The trust preferred securities of Trust IV are currently convertible into approximately 1.7 million shares of our common stock, which is subject to customary adjustments.
Additionally, on April 22, 2014, the Company issued 11,842,106 shares of its common stock in a private placement for gross proceeds of $45.0 million.
Shareholders’ equity as of December 31, 2014 totaled approximately $112.8 million compared to approximately $62.9 million as of December 31, 2013. The book value per share of our common stock increased from $2.42 as of December 31, 2013, based upon 25,972,897 shares outstanding, as adjusted for treasury stock and deferred compensation plan shares, to $2.98 as of December 31, 2014, based upon 37,815,503 shares outstanding at December 31, 2014, as adjusted for treasury stock and deferred compensation plan shares.
Regulatory Capital Requirements
The Company is required to comply with certain “risk-based” capital adequacy guidelines issued by the FRB and the FDIC. The risk-based capital guidelines assign varying risk weights to the individual assets held by a bank. The guidelines also assign weights to the “credit-equivalent” amounts of certain off-balance sheet items, such as letters of credit and interest rate and currency swap contracts. Under these guidelines, banks are expected to meet a minimum target ratio for “qualifying total capital” to weighted risk assets of 8%, at least one-half of which is to be in the form of “Tier 1 capital”. Qualifying total capital is divided into two separate categories or “tiers”. “Tier 1 capital” includes common stockholders’ equity, certain qualifying perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. “Tier 2 capital” components (limited in the aggregate to one-half of total qualifying capital) includes allowances for credit losses (within limits), certain excess levels of perpetual preferred stock and certain types of “hybrid” capital instruments, subordinated debt and other preferred stock. Applying the federal guidelines, the ratio of qualifying total capital to weighted-risk assets was 15.10% and 11.53% at December 31, 2014 and 2013, respectively, and as required by the guidelines, at least one-half of the qualifying total capital consisted of Tier l capital elements. Tier l risk-based capital ratios on December 31, 2014 and 2013 were 13.88% and 10.28%, respectively. At December 31, 2014 and 2013, we exceeded the requirements for risk-based capital adequacy under federal guidelines. At December 31, 2014 and 2013, our leverage ratio was 11.23% and 8.59%, respectively.
The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level or earnings; concentrations of credit, quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.
Under FDIC regulations, a bank is deemed to be “well capitalized” when it has a “leverage ratio” (“Tier l capital to total assets”) of at least 5%, a Tier l capital to weighted-risk assets ratio of at least 6%, and a total capital to weighted-risk assets ratio of at least 10%. At December 31, 2014 and 2013, Republic was considered “well capitalized” under FDIC regulations.
The following table presents our regulatory capital ratios at December 31, 2014 and 2013:
Management believes that the Company and Republic met, as of December 31, 2014 and 2013, all capital adequacy requirements to which we are subject. In the current year, the FDIC categorized Republic as well capitalized under the regulatory framework for prompt corrective action provisions of the Federal Deposit Insurance Act. There are no calculations or events since that notification which management believes would have changed Republic’s category.
The Company and Republic’s ability to maintain the required levels of capital is substantially dependent upon the success of their capital and business plans, the impact of future economic events on Republic’s loan customers and Republic’s ability to manage its interest rate risk, growth and other operating expenses.
In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016. Management has reviewed the new standards and evaluated all options and strategies to ensure compliance with the new standards. Management believes that Republic will maintain its status as a “well-capitalized” financial institution under the new standards.
Liquidity
A financial institution must maintain and manage liquidity to ensure it has the ability to meet its financial obligations. These obligations include the payment of deposits on demand or at their contractual maturity; the repayment of borrowings as they mature; the payment of lease obligations as they become due; the ability to fund new and existing loans and other funding commitments; and the ability to take advantage of new business opportunities. Liquidity needs can be met by either reducing assets or increasing liabilities. Our most liquid assets consist of cash, amounts due from banks and federal funds sold.
Regulatory authorities require us to maintain certain liquidity ratios in order for funds to be available to satisfy commitments to borrowers and the demands of depositors. In response to these requirements, we have formed an asset/liability committee (ALCO), comprised of certain members of Republic’s Board of Directors and senior management to monitor such ratios. The ALCO committee is responsible for managing the liquidity position and interest sensitivity. That committee’s primary objective is to maximize net interest income while configuring Republic’s interest-sensitive assets and liabilities to manage interest rate risk and provide adequate liquidity for projected needs. The ALCO committee meets on a quarterly basis or more frequently if deemed necessary.
Our target and actual liquidity levels are determined by comparisons of the estimated repayment and marketability of interest-earning assets with projected future outflows of deposits and other liabilities. Our most liquid assets, comprised of cash and cash equivalents on the balance sheet, totaled $128.8 million at December 31, 2014, compared to $35.9 million at December 31, 2013. Loan maturities and repayments are another source of asset liquidity. At December 31, 2014, Republic estimated that more than $40.0 million of loans would mature or repay in the six-month period ending June 30, 2015. Additionally, a significant portion of our investment securities are available to satisfy liquidity requirements through sales on the open market or by pledging as collateral to access credit facilities. At December 31, 2014, we had outstanding commitments (including unused lines of credit and letters of credit) of $142.2 million. Certificates of deposit scheduled to mature in one year totaled $54.4 million at December 31, 2014. We anticipate that we will have sufficient funds available to meet all current commitments.
Daily funding requirements have historically been satisfied by generating core deposits and certificates of deposit with competitive rates, buying federal funds or utilizing the credit facilities of the FHLB. We have established a line of credit with the FHLB of Pittsburgh. Our maximum borrowing capacity with the FHLB was $397.8 million at December 31, 2014. As of December 31, 2014 and 2013, we had no outstanding borrowings with the FHLB. As of December 31, 2014 FHLB had issued letters of credit, on Republic’s behalf, totaling $75.1 million against our available credit line. We also established a contingency line of credit of $10.0 million with Atlantic Central Bankers Bank (“ACBB”) to assist in managing our liquidity position. We had no amounts outstanding against the ACBB line of credit at December 31, 2014 and 2013.
Variable Interest Entities
The Company follows the guidance under ASC 810, Consolidation, with regard to variable interest entities. ASC 810 clarifies the application of consolidation principles for certain legal entities in which voting rights are not effective in identifying the investor with the controlling financial interest. An entity is subject to consolidation under ASC 810 if the investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities, or are not exposed to the entity’s losses or entitled to its residual returns ("variable interest entities"). Variable interest entities within the scope of ASC 810 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both.
The Company does not consolidate its subsidiary trusts. ASC 810 precludes consideration of the call option embedded in the preferred securities when determining if the Company has the right to a majority of the trusts’ expected residual returns. The non-consolidation results in the investment in the common securities of the trusts to be included in other assets with a corresponding increase in outstanding debt of $676,000. In addition, the income received on the Company’s investment in the common securities of the trusts is included in other income.
Effects of Inflation
The majority of assets and liabilities of a financial institution are monetary in nature. Therefore, a financial institution differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Management believes that the most significant impact of inflation on financial results is our need and ability to react to changes in interest rates. As discussed previously, management attempts to maintain an essentially balanced position between rate sensitive assets and liabilities over a one-year time horizon in order to protect net interest income from being affected by wide interest rate fluctuations.
Item 7A:
Item 7A: Quantitative and Qualitative Disclosure about Market Risk
See “Management Discussion and Analysis of Results of Operations and Financial Condition - Interest Rate Risk Management”.
Item 8:
Item 8: Financial Statements and Supplementary Data
The Consolidated Financial Statements of the Company begin on page 66.
Tel: 717-233-8800
Fax: 717-233-8801
www.bdo.com
945 E. Park Drive, Suite 103
Harrisburg, PA 17111
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Republic First Bancorp, Inc.
Philadelphia, Pennsylvania
We have audited the accompanying consolidated balance sheets of Republic First Bancorp, Inc. and Subsidiaries (the "Bancorp"), Inc. as of December 31, 2014 and December 31, 2013 and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Bancorp's management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Republic First Bancorp, Inc. and Subsidiaries at December 31, 2014 and 2013 and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Bancorp's internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 13, 2015 expressed an unqualified opinion.
Harrisburg, Pennsylvania
March 13, 2015
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Republic First Bancorp, Inc.
We have audited the accompanying consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows of Republic First Bancorp, Inc. and Subsidiaries (the “Bancorp”) for the year ended December 31, 2012. These consolidated financial statements are the responsibility of the Bancorp’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Republic First Bancorp, Inc. and Subsidiaries for the year ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
/s/ Baker Tilly Virchow Krause, LLP
Pittsburgh, Pennsylvania
March 15, 2013
Republic First Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2014 and 2013
(Dollars in thousands, except per share data)
(See notes to consolidated financial statements)
Republic First Bancorp, Inc. and Subsidiaries
Consolidated Statements of Operations
For the Years Ended December 31, 2014, 2013 and 2012
(Dollars in thousands, except per share data)
(See notes to consolidated financial statements)
Republic First Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
For the Years Ended December 31, 2014, 2013 and 2012
(Dollars in thousands)
(See notes to consolidated financial statements)
Republic First Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2014, 2013 and 2012
(Dollars in thousands)
(See notes to consolidated financial statements)
Republic First Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the Years Ended December 31, 2014, 2013 and 2012
(Dollars in thousands)
(See notes to consolidated financial statements)
Republic First Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1.
Nature of Operations
Republic First Bancorp, Inc. (“The Company”) is a one-bank holding company organized and incorporated under the laws of the Commonwealth of Pennsylvania. It is comprised of one wholly-owned subsidiary, Republic First Bank, which does business under the name of Republic Bank (“Republic”). Republic is a Pennsylvania state chartered bank that offers a variety of banking services to individuals and businesses throughout the Greater Philadelphia and South Jersey area through its offices and store locations in Philadelphia, Montgomery, Delaware and Camden Counties. The Company also has three unconsolidated subsidiaries, which are statutory trusts established by the Company in connection with its sponsorship of three separate issuances of trust preferred securities.
The Company and Republic encounter vigorous competition for market share in the geographic areas they serve from bank holding companies, national, regional and other community banks, thrift institutions, credit unions and other non-bank financial organizations, such as mutual fund companies, insurance companies and brokerage companies.
The Company and Republic are subject to federal and state regulations governing virtually all aspects of their activities, including but not limited to, lines of business, liquidity, investments, the payment of dividends and others. Such regulations and the cost of adherence to such regulations can have a significant impact on earnings and financial condition.
2.
Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Republic. The Company follows accounting standards set by the Financial Accounting Standards Board (“FASB”). The FASB sets accounting principles generally accepted in the United States of America (“US GAAP”) that are followed to ensure consistent reporting of financial condition, results of operations, and cash flows.
The Company has evaluated subsequent events through the date of issuance of the financial data included herein.
Risks and Uncertainties and Certain Significant Estimates
The earnings of the Company depend primarily on the earnings of Republic. The earnings of Republic are dependent primarily upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, our results of operations are subject to risks and uncertainties surrounding our exposure to changes in the interest rate environment.
Prepayments on residential real estate mortgage and other fixed rate loans and mortgage-backed securities vary significantly and may cause significant fluctuations in interest margins.
The preparation of financial statements in conformity with US GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Significant estimates are made by management in determining the allowance for loan losses, carrying values of other real estate owned, assessment of other than temporary impairment (“OTTI”) of investment securities, fair value of financial instruments and the realization of deferred income tax assets. Consideration is given to a variety of factors in establishing these estimates.
In estimating the allowance for loan losses, management considers current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant factors. An estimate for the carrying value of other real estate owned is normally derived through appraisals which are updated on a regular basis or through agreements of sale that have been negotiated. Because the allowance for loan losses and carrying value of other real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond the Company’s control, the estimate of the allowance for loan losses and the carrying values of other real estate owned could differ materially in the near term.
In estimating OTTI of investment securities, securities are evaluated on at least a quarterly basis and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other than temporary. To determine whether a loss in value is other than temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline, the intent to hold the security and the likelihood of the Company not being required to sell the security prior to an anticipated recovery in the fair value. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of investment. Once a decline in value is determined to be other than temporary, the value of the security is reduced by the portion of the decline related to credit impairment.
In evaluating the Company’s ability to recover deferred tax assets, management considers all available positive and negative evidence. Management also makes assumptions on the amount of future taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require management to make judgments that are consistent with the plans and estimates used to manage the Company’s business. As a result of cumulative losses in recent years and the slow and uneven growth in the current economic environment, the Company has decided to currently exclude future taxable income from its analysis of the ability to recover deferred tax assets and has recorded a valuation allowance against its deferred tax assets. An increase or decrease in the valuation allowance would result in an adjustment to income tax expense in the period and could have a significant impact on the Company’s future earnings.
Significant Group Concentrations of Credit Risk
Most of the Company’s activities are with customers located within the Greater Philadelphia region. Note 3 - Investment Securities discusses the types of investment securities that the Company invests in. Note 4 - Loans Receivable discusses the types of lending that the Company engages in as well as loan concentrations. The Company does not have a significant concentration of credit risk with any one customer.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all cash and due from banks, interest-bearing deposits with an original maturity of ninety days or less and federal funds sold, maturing in ninety days or less, to be cash and cash equivalents.
Restrictions on Cash and Due from Banks
Republic is required to maintain certain average reserve balances as established by the Federal Reserve Board. The amounts of those balances for the reserve computation periods that include December 31, 2014 and 2013 were approximately $4.0 million and $3.1 million, respectively. These requirements were satisfied through the restriction of vault cash and a balance at the Federal Reserve Bank of Philadelphia.
Investment Securities
Held to Maturity - Certain debt securities that management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at their remaining unpaid principal balances, net of unamortized premiums or unaccreted discounts. Premiums are amortized and discounts are accreted using the interest method over the estimated remaining term of the underlying security.
Available for Sale - Debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest or prepayment rates, needs for liquidity, and changes in the availability of and in the yield of alternative investments, are classified as available for sale. These assets are carried at fair value. Unrealized gains and losses are excluded from operations and are reported net of tax as a separate component of other comprehensive income until realized. Realized gains and losses on the sale of investment securities are reported in the consolidated statements of operations and determined using the adjusted cost of the specific security sold on the trade date.
Investment securities are evaluated on at least a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline, the intent to hold the security and the likelihood of the Company not being required to sell the security prior to an anticipated recovery in the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the portion of the decline related to credit impairment is charged to earnings. Impairment charges on bank pooled trust preferred securities of $7,000, $0, and $34,000 were recognized during the years ended December 31, 2014, 2013 and 2012, respectively, as a result of estimated other-than-temporary impairment.
Restricted Stock
Restricted stock, which represents a required investment in the capital stock of correspondent banks related to available credit facilities, was carried at cost as of December 31, 2014 and 2013. As of those dates, restricted stock consisted of investments in the capital stock of the FHLB of Pittsburgh and Atlantic Central Bankers Bank (“ACBB”). The required investment in the capital stock of the FHLB is calculated based on outstanding loan balances and open credit facilities with the FHLB. Excess investments are returned to Republic on a quarterly basis.
Loans Receivable
The loans receivable portfolio is segmented into commercial real estate loans, construction and land development loans, commercial and industrial loans, owner occupied real estate loans, consumer and other loans, and residential mortgages. Consumer loans consist of home equity loans and other consumer loans.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated based upon the principal amounts outstanding. The Company defers and amortizes certain origination and commitment fees, and certain direct loan origination costs over the contractual life of the related loan. This results in an adjustment of the related loans yield.
The Company accounts for amortization of premiums and accretion of discounts related to loans purchased based upon the effective interest method. If a loan prepays in full before the contractual maturity date, any unamortized premiums, discounts or fees are recognized immediately as an adjustment to interest income.
Loans are generally classified as non-accrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower, in accordance with the contractual terms. Generally, in the case of non-accrual loans, cash received is applied to reduce the principal outstanding.
Allowance for Credit Losses
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments would represent management’s estimate of losses inherent in its unfunded loan commitments and would be recorded in other liabilities on the consolidated balance sheet, if necessary. The allowance for credit losses is established through a provision for loan losses charged to operations. Loans are charged against the allowance when management believes that the collectability of the loan principal is unlikely. Recoveries on loans previously charged off are credited to the allowance.
The allowance for credit losses is an amount that represents management’s estimate of known and inherent losses related to the loan portfolio and unfunded loan commitments. Because the allowance for credit losses is dependent, to a great extent, on the general economy and other conditions that may be beyond Republic’s control, the estimate of the allowance for credit losses could differ materially in the near term.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are categorized as “internally classified”. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value 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. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. All identified losses are immediately charged off and therefore no portion of the allowance for loan losses is restricted to any individual loan or group of loans, and the entire allowance is available to absorb any and all loan losses.
In estimating the allowance for credit losses, management considers current economic conditions, past loss experience, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews and regulatory examinations, borrowers’ perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant and qualitative risk factors. These qualitative risk factors include:
1)
Lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices.
2)
National, regional and local economic and business conditions as well as the condition of various segments.
3)
Nature and volume of the portfolio and terms of loans.
4)
Experience, ability and depth of lending management and staff.
5)
Volume and severity of past due, classified and nonaccrual loans as well as other loan modifications.
6)
Quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.
7)
Existence and effect of any concentration of credit and changes in the level of such concentrations.
8)
Effect of external factors, such as competition and legal and regulatory requirements.
Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.
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 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 the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
For commercial and industrial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual residential mortgage loans, home equity loans and other consumer loans for impairment disclosures, unless such loans are the subject of a troubled debt restructuring agreement.
Loans whose terms are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary reduction in interest rate or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.
In addition, federal and state 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 additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
Transfers of Financial Assets
The Company accounts for the transfers and servicing financial assets in accordance with ASC 860, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. ASC 860, revises the standards for accounting for the securitizations and other transfers of financial assets and collateral.
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, (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.
Loans Held for Sale
Loans held for sale consist of the guaranteed portion of SBA loans that the Company intends to sell after origination and are reflected at the lower of aggregate cost or fair value. When the sale of the loan occurs, the premium received is combined with the estimated present value of future cash flows on the related servicing asset and recorded as a Gain on the Sale of SBA loans which is categorized as non-interest income. Subsequent fees collected for servicing of the sold portion of a loan are combined with fair value adjustments to the SBA servicing asset and recorded as a net amount in Loan Advisory and Servicing Fees, which is also categorized as non-interest income.
Guarantees
The Company accounts for guarantees in accordance with ASC 815 Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others. ASC 815 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has financial and performance letters of credit. Financial letters of credit require the Company to make payment if the customer’s financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Company to make payments if the customer fails to perform certain non-financial contractual obligations. The maximum potential undiscounted amount of future payments of these letters of credit as of December 31, 2014 is $3.8 million and they expire as follows: $2.7 million in 2015, $1.0 million in 2019, and $135,000 in 2020. Amounts due under these letters of credit would be reduced by any proceeds that the Company would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer.
Premises and Equipment
Premises and equipment (including land) are stated at cost less accumulated depreciation and amortization. Depreciation of furniture and equipment is calculated over the estimated useful life of the asset using the straight-line method for financial reporting purposes, and accelerated methods for income tax purposes. The estimated useful lives are 40 years for buildings and 3 to 13 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of their estimated useful lives or terms of their respective leases, which range from 1 to 30 years. Repairs and maintenance are charged to current operations as incurred, and renewals and major improvements are capitalized.
Other Real Estate Owned
Other real estate owned consists of assets acquired through, or in lieu of, loan foreclosure. They are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value, less the cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from other real estate owned.
Advertising Costs
It is the Company’s policy to expense advertising costs in the period in which they are incurred.
Income Taxes
Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of the evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company accounts for uncertain tax positions if it is more likely than not, based on the technical merits, that the tax position will be realized 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 tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a 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 recognizes interest and penalties on income taxes, if any, as a component of the provision for income taxes.
Stock Based Compensation
The Company has a Stock Option and Restricted Stock Plan (“Plan”), under which stock options, restricted stock or stock appreciation rights may be granted to the Company’s employees, directors, and certain consultants. Under the terms of the Plan, 1.5 million shares of common stock, plus an annual increase equal to the number of shares needed to restore the maximum number of shares that may be available for grant under the Plan to 1.5 million shares, are available for such grants. As of December 31, 2014, the only grants under the Plan have been option grants. The Plan provides that the exercise price of each option granted equals the market price of the Company’s stock on the date of grant. Options granted pursuant to the Plan vest within one to four years from the date of grant and have a maximum term of 10 years. The Plan terminates pursuant to its terms on November 14, 2015.
On April 29, 2014, the Company’s shareholders approved the 2014 Republic First Bancorp, Inc. Equity Incentive Plan (the “2014 Plan”), under which the Company may grant options, restricted stock, stock units, or stock appreciation rights to the Company’s employees, directors, independent contractors, and consultants. Under the terms of the 2014 Plan, 2.6 million shares of common stock, plus an annual adjustment to be no less than 10% of the outstanding shares or such lower number as the Board of Directors may determine, are available for such grants.
Earnings Per Share
Earnings per share (“EPS”) consists of two separate components, basic EPS and diluted EPS. Basic EPS is computed by dividing net income (loss) by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of common shares outstanding plus dilutive common stock equivalents (“CSE”). CSEs consist of dilutive stock options granted through the Company’s Plan and convertible securities related to trust preferred securities issued in 2008. In the diluted EPS computation, the after tax interest expense on the trust preferred securities issuance is added back to the net income. In 2014, 2013, and 2012, the effect of CSEs (convertible securities related to the trust preferred securities only) and the related add back of after tax interest expense was considered anti-dilutive and therefore was not included in the EPS calculations.
The calculation of EPS for the years ended December 31, 2014, 2013 and 2012 is as follows:
Comprehensive Income / (Loss)
The Company presents as a component of comprehensive income (loss) the amounts from transactions and other events, which currently are excluded from the consolidated statements of operations and are recorded directly to shareholders’ equity. These amounts consist of unrealized holding gains (losses) on available for sale securities.
Trust Preferred Securities
The Company has sponsored three outstanding issues of corporation-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely junior subordinated debentures of the corporation, more commonly known as trust preferred securities. The subsidiary trusts are not consolidated with the Company for financial reporting purposes. The purpose of the issuances of these securities was to increase capital. The trust preferred securities qualify as Tier 1 capital for regulatory purposes in amounts up to 25% of total Tier 1 capital. See Note 7 “Borrowings” for further information regarding the issuances.
Variable Interest Entities
The Company follows the guidance under ASC 810, Consolidation, with regard to variable interest entities. ASC 810 clarifies the application of consolidation principles for certain legal entities in which voting rights are not effective in identifying the investor with the controlling financial interest. An entity is subject to consolidation under ASC 810 if the investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities, or are not exposed to the entity’s losses or entitled to its residual returns ("variable interest entities"). Variable interest entities within the scope of ASC 810 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both.
The Company does not consolidate its subsidiary trusts. ASC 810 precludes consideration of the call option embedded in the preferred securities when determining if the Company has the right to a majority of the trusts’ expected residual returns. The non-consolidation results in the investment in the common securities of the trusts to be included in other assets with a corresponding increase in outstanding debt of $676,000. In addition, the income received on the Company’s investment in the common securities of the trusts is included in other income.
Recent Accounting Pronouncements
ASU 2014-04
In January 2014, the FASB issued ASU 2014-04, “Receivables - Troubled Debt Restructuring by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure - a consensus of the FASB Emerging Issues Task Force. The guidance clarifies when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized. For public business entities, the ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For entities other than public business entities, the ASU is effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. The Company does not believe the adoption of the amendment to this guidance will have a material impact on the financial statements.
ASU 2014-09
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 660): Summary and Amendments that Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40).” The purpose of this guidance is to clarify the principles for recognizing revenue. The guidance in this update supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the industry topics of the codification. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2016. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements, but does not expect a material impact.
ASU 2014-14
In August 2014, the FASB issued ASU 2014-14, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure - a consensus of the FASB Emerging Issues Task Force.” The amendments in this Update address a practice issue related to the classification of certain foreclosed residential and nonresidential mortgage loans that are either fully or partially guaranteed under government programs. Specifically, creditors should reclassify loans that meet certain conditions to "other receivables" upon foreclosure, rather than reclassifying them to other real estate owned (OREO). The separate other receivable recorded upon foreclosure is to be measured based on the amount of the loan balance (principal and interest) the creditor expects to recover from the guarantor. The ASU is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For all other entities, the amendments are effective for annual periods ending after December 15, 2015, and interim periods beginning after December 15, 2015. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements, but does not expect a material impact.
Reclassifications
Certain reclassifications have been made to 2013 and 2012 information to conform to the 2014 presentation. The reclassifications had no effect on results of operations.
3.
Investment Securities
A summary of the amortized cost and market value of securities available for sale and securities held to maturity at December 31, 2014 and 2013 is as follows:
The maturity distribution of the amortized cost and estimated market value of investment securities by contractual maturity at December 31, 2014 is as follows:
Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without prepayment penalties.
As of December 31, 2014 and December 31, 2013, the collateralized mortgage obligations and mortgage backed securities included in the investment securities portfolio consist solely of securities issued by U.S. government sponsored agencies. There were no private label mortgage securities held in the investment securities portfolio as of those dates. The Company did not hold any mortgage-backed securities that were rated “Alt-A” or “Subprime” as of December 31, 2014 and December 31, 2013. In addition, the Company did not hold any private label CMO’s as of December 31, 2014 and December 31, 2013. As of December 31, 2014 and December 31, 2013, the asset-backed securities held in the investment securities portfolio consist solely of Sallie Mae bonds collateralized by student loans which are guaranteed by the U.S. Department of Education.
In instances when a determination is made that an other-than-temporary impairment exists with respect to a debt security but the investor does not intend to sell the debt security and it is more likely than not that the investor will not be required to sell the debt security prior to its anticipated recovery, accounting standards require the other-than-temporary impairment to be separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income. Impairment charges (credit losses) on trust preferred securities for the years ended December 31, 2014, 2013, and 2012 amounted to $7,000, $0 and $34,000, respectively.
The Company realized gross gains on the sale of securities of $458,000 in 2014. The related sale proceeds amounted to $5.7 million. The tax provision applicable to these gross gains in 2014 amounted to approximately $165,000. The Company realized gross gains on the sale of securities of $703,000 in 2013. The related sale proceeds amounted to $7.9 million. The tax provision applicable to these gross gains in 2013 amounted to approximately $253,000. The Company realized gross gains on the sale of securities of $737,000 in 2012. The related sale proceeds amounted to $25.8 million. The tax provision applicable to these gross gains in 2012 amounted to approximately $265,000.
At December 31, 2014 and 2013, investment securities in the amount of approximately $149.0 million and $113.1 million, respectively, were pledged as collateral for public deposits and certain other deposits as required by law.
The following table presents a roll-forward of the balance of credit-related impairment losses on securities held at December 31, 2014 and 2013 for which a portion of OTTI was recognized in other comprehensive income:
The following tables show the fair value and gross unrealized losses associated with the investment portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2014 and 2013:
The impairment of the investment portfolio totaled $2.4 million with a total fair value of $62.2 million at December 31, 2014. The most significant components of this impairment are related to the trust preferred securities and collateralized mortgage obligations held in the portfolio. The unrealized losses on the CMO’s are primarily related to the recent movement in market interest rates rather than the underlying credit quality of the issuers. The Company does not currently intend to sell these securities prior to maturity or recovering the cost bases and does not believe it will be forced to sell these securities prior to maturity or recovering the cost bases.
At December 31, 2014, the investment portfolio included thirty-four collateralized mortgage obligations with a total market value of $167.5 million. Nine of these securities carried an unrealized loss at December 31, 2014. At December 31, 2014, the investment portfolio included forty-three mortgage-backed securities with a total market value of $13.8 million. Two of these securities carried an unrealized loss at December 31, 2014. Management found no evidence of OTTI on any of these securities and the unrealized losses are due to changes in market value resulting from changes in market interest rates and are considered temporary as of December 31, 2014.
The unrealized losses on the trust preferred securities are primarily the result of the secondary market for such securities becoming inactive and are also considered temporary at this time.
The following table provides additional detail about trust preferred securities as of December 31, 2014.
At December 31, 2014, the investment portfolio included twenty-eight municipal securities with a total market value of $16.1 million. Three of these securities carried an unrealized loss at December 31, 2014. Each of the municipal securities are reviewed quarterly for impairment. Research on each issuer is completed to ensure the financial stability of the municipal entity. The largest geographic concentration was in Pennsylvania and New Jersey where twenty-one municipal securities had a market value of $11.6 million. As of December 31, 2014, management found no evidence of OTTI on any of the municipal securities held in the investment securities portfolio.
In July 2014, thirteen CMOs with a fair value of $70.1 million that were previously classified as available-for-sale were transferred to the held-to-maturity category. These securities were transferred at fair value. Unrealized losses of $1.2 million associated with the transferred securities will remain in other comprehensive income and be amortized as an adjustment to yield over the remaining life of those securities. At December 31, 2014, the fair market value of the securities transferred to held-for-maturity is $68.2 million and the unrealized losses are $728,000.
4.
Loans Receivable
The following table sets forth the Company’s gross loans by major categories as of December 31, 2014 and 2013:
A loan is considered impaired, in accordance with ASC 310 Receivables, when based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans, but also include internally classified accruing loans.
The following table summarizes information with regard to impaired loans by loan portfolio class as of December 31, 2014 and 2013:
The following table presents additional information regarding the Company’s impaired loans for the years ended December 31, 2014 and 2013:
The total average recorded investment on the Company’s impaired loans for the years ended December 31, 2014, 2013, and 2012 were $33.0 million, $33.7 million, and $40.8 million, respectively, and the related interest income recognized for those dates was $614,000, $1.2 million, and $1.6 million, respectively. If these loans were performing under their original contractual rate, interest income on such loans would have increased approximately $980,000, $488,000, and $699,000 for the years ended December 31, 2014, 2013, and 2012, respectively.
Included in loans are loans due from directors and other related parties of $8.8 million, $8.8 million, and $9.1 million at December 31, 2014, 2013, and 2012, respectively. All loans made to directors have substantially the same terms and interest rates as other bank borrowers. The Board of Directors approves loans to individual directors to confirm that collateral requirements, terms and rates are comparable to other borrowers and are in compliance with underwriting policies. The following presents the activity in amount due from directors and other related parties for the years ended December 31, 2014, 2013 and 2012.
5. Allowances for Loan Losses
The following tables provide the activity in and ending balances of the allowance for loan losses by loan portfolio class at and for the years ended December 31, 2014, 2013, and 2012:
The following tables provide a summary of the allowance for loan losses and balance of loans receivable by loan class and by impairment method as of December 31, 2014 and 2013:
The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of December 31, 2014 and 2013:
The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within our internal risk rating system as of December 31, 2014 and 2013:
The following table shows non-accrual loans by class as of December 31, 2014 and 2013:
If these loans were performing under their original contractual rate, interest income on such loans would have increased approximately $980,000, $488,000, and $699,000, for 2014, 2013, and 2012, respectively.
Troubled Debt Restructurings
A modification to the contractual terms of a loan which results in a concession to a borrower that is experiencing financial difficulty is classified as a troubled debt restructuring (“TDR”). The concessions made in a TDR are those that would not otherwise be considered for a borrower or collateral with similar risk characteristics. A TDR is typically the result of efforts to minimize potential losses that may be incurred during loan workouts, foreclosure, or repossession of collateral at a time when collateral values are declining. Concessions include a reduction in interest rate below current market rates, a material extension of time to the loan term or amortization period, partial forgiveness of the outstanding principal balance, acceptance of interest only payments for a period of time, or a combination of any of these conditions.
The following table summarizes information with regard to outstanding troubled debt restructurings at December 31, 2014 and 2013:
All TDRs are considered impaired and are therefore individually evaluated for impairment in the calculation of the allowance for loan losses. Some TDRs may not ultimately result in the full collection of principal and interest as restructured and could lead to potential incremental losses. These potential incremental losses would be factored into our estimate of the allowance for loan losses. The level of any subsequent defaults will likely be affected by future economic conditions. There was one loan modification made during the year ended December 31, 2014 that met the criteria of a TDR. There were no modifications made during the year ended December 31, 2013 that met the criteria of a TDR.
The Company modified one commercial real estate loan during the year ended December 31, 2014. In accordance with the modified terms of the commercial real estate loan, the Company modified the amortization time frame and reduced the effective interest rate when compared to the interest rate of the original loan. The Company also extended the maturity date of the loan. Escrow has been established regarding property taxes and accrued interest has been capitalized. The commercial real estate loan has been and continues to be an accruing loan. The borrower has remained current since the modification. The pre-modification balance was $6.0 million and the post-modification balance was $6.1 million.
After a loan is determined to be a TDR, we continue to track its performance under the most recent restructured terms. There were no TDRs that subsequently defaulted during the year ended December 31, 2014. One loan classified as a TDR subsequently defaulted during the year ended December 31, 2013 and a partial writedown was recorded during the year ended December 31, 2014.
6. Premises and Equipment
A summary of premises and equipment is as follows:
Depreciation expense on premises, equipment and leasehold improvements amounted to approximately $2.4 million, $2.1 million, and $2.0 million in 2014, 2013 and 2012, respectively. The construction in progress balance of $4.4 million mainly represents costs incurred for the selection and development of future store locations. Of this balance, $4.0 million represents land purchased for two specific store locations. Costs to complete the projects in process are estimated to be $11.9 million as of December 31, 2014.
7.
Borrowings
Republic has a line of credit with the Federal Home Loan Bank (“FHLB”) of Pittsburgh with a maximum borrowing capacity of $397.8 million as of December 31, 2014. As of December 31, 2014 and 2013, there were no fixed term or overnight advances against this line of credit. As of December 31, 2014, FHLB had issued letters of credit, on Republic’s behalf, totaling $75.1 million against its available credit line, primarily to be used as collateral for public deposits. There were no fixed term advances outstanding at any month-end during 2014 and 2013. The maximum amount of overnight borrowings outstanding at any month-end was $0 in 2014 and 2013.
Republic also has a line of credit in the amount of $10.0 million available for the purchase of federal funds through another correspondent bank. At December 31, 2014 and 2013, Republic had no amount outstanding against this line. The maximum amount of overnight advances on this line at any month end was $0 in 2014 and $0 in 2013.
Subordinated debt and corporation-obligated-mandatorily redeemable capital securities of subsidiary trust holding solely junior obligations of the corporation:
The Company has sponsored three outstanding issues of corporation-obligated mandatorily redeemable capital securities of a subsidiary trust holding solely junior subordinated debentures of the corporation, more commonly known as trust preferred securities. The subsidiary trusts are not consolidated with the Company for financial reporting purposes. The purpose of the issuances of these securities was to increase capital. The trust preferred securities qualify as Tier 1 capital for regulatory purposes in amounts up to 25% of total Tier 1 capital.
In December 2006, Republic Capital Trust II (“Trust II”) issued $6.0 million of trust preferred securities to investors and $0.2 million of common securities to the Company. Trust II purchased $6.2 million of junior subordinated debentures of the Company due 2037, and the Company used the proceeds to call the securities of Republic Capital Trust I (“Trust I”). The debentures supporting Trust II have a variable interest rate, adjustable quarterly, at 1.73% over the 3-month Libor. The Company may call the securities on any interest payment date after five years without a prepayment penalty.
On June 28, 2007, the Company caused Republic Capital Trust III (“Trust III”), through a pooled offering, to issue $5.0 million of trust preferred securities to investors and $0.2 million common securities to the Company. Trust III purchased $5.2 million of junior subordinated debentures of the Company due 2037, which have a variable interest rate, adjustable quarterly, at 1.55% over the 3 month Libor. The Company has the ability to call the securities on any interest payment date without a prepayment penalty.
On June 10, 2008, the Company caused Republic First Bancorp Capital Trust IV (“Trust IV”) to issue $10.8 million of convertible trust preferred securities as part of the Company’s strategic capital plan. The securities were purchased by various investors, including Vernon W. Hill, II, founder and chairman (retired) of Commerce Bancorp and, since the investment, a consultant to the Company. This investor group also included a family trust of Harry D. Madonna, chairman, president and chief executive officer of the Company, and Theodore J. Flocco, Jr., who, since the investment, has been elected to the Company’s Board of Directors and serves as the Chairman of the Audit Committee. Trust IV also issued $0.3 million of common securities to the Company. Trust IV purchased $11.1 million of junior subordinated debentures due 2038, which pay interest at an annual rate of 8.0% and are callable after the fifth year. The trust preferred securities of Trust IV are convertible into approximately 1.7 million shares of common stock of the Company, based on a conversion price of $6.50 per share of Company common stock, and at December 31, 2014 were fully convertible.
8.
Deposits
The following is a breakdown, by contractual maturities of the Company’s certificates of deposit for the years 2015 through 2019.
(dollars in thousands)
Thereafter
Total
Certificates of Deposit
$54,442
$17,886
$1,627
$ 907
$ 507
$ -
$75,369
Certificates of deposit of $100,000 or more totaled $39.8 million and $39.4 million at December 31, 2014 and 2013, respectively.
Deposits of related parties totaled $84.0 million and $57.5 million at December 31, 2014 and 2013, respectively.
9.
Income Taxes
The benefit for income taxes for the years ended December 31, 2014, 2013, and 2012 consists of the following:
The following table reconciles the difference between the actual tax provision and the amount per the statutory federal income tax rate of 35.0% for the years ended December 31, 2014, 2013, and 2012.
The significant components of the Company’s net deferred tax asset as of December 31, 2014 and 2013 are as follows:
The Company’s net deferred tax asset before the consideration of a valuation allowance decreased to $19.6 million at December 31, 2014 compared to $21.4 million at December 31, 2013. This decrease was primarily driven by decreases in the net operating loss carryforward and the unrealized loss on securities available for sale during the twelve month period ended December 31, 2014. The $19.6 million net deferred tax asset as of December 31, 2014 is comprised of $10.6 million currently recognizable through NOL carryforwards and $9.0 million attributable to several items associated with temporary timing differences which will reverse at some point in the future to provide a net reduction in tax liabilities. The Company’s largest future reversal relates to its allowance for loan losses, which totaled $4.1 million as of December 31, 2014.
The Company evaluates the carrying amount of its deferred tax assets on a quarterly basis or more frequently, if necessary, in accordance with the guidance provided in Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 740 (ASC 740), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e. a likelihood of more than 50%) that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods a valuation allowance is calculated and recorded. These determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.
In conducting the deferred tax asset analysis, the Company believes it is important to consider the unique characteristics of an industry or business. In particular, characteristics such as business model, level of capital and reserves held by financial institutions and their ability to absorb potential losses are important distinctions to be considered for bank holding companies like the Company. In addition, it is also important to consider that NOLs for federal income tax purposes can generally be carried back two years and carried forward for a period of twenty years. The Company has an NOL which will begin to expire after December 31, 2030 if not utilized prior to that date. In order to realize our deferred tax assets, we must generate sufficient taxable income in such future years.
In assessing the need for a valuation allowance, the Company carefully weighed both positive and negative evidence currently available. Judgment is required when considering the relative impact of such evidence. The weight given to the potential effect of positive and negative evidence must be commensurate with the extent to which it can be objectively verified. A cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome. Based on the analysis of available positive and negative evidence, the Company determined that a valuation allowance should be recorded as of December 31, 2014 and 2013.
When determining an estimate for a valuation allowance, the Company assessed the possible sources of taxable income available under tax law to realize a tax benefit for deductible temporary differences and carryforwards as defined in ASC 740-10-30. As a result of cumulative losses in recent years and the uncertain nature of the current economic environment, the Company did not use projections of future taxable income, exclusive of reversing temporary timing differences and carryforwards, as a factor. The Company will continue to exclude future taxable income as a factor until it can show consistent and sustained profitability.
The Company did assess tax planning strategies as defined under ASC 740-10-30 to determine the amount of a valuation allowance. Strategies reviewed included the sale of investment securities and loans with fair values greater than book values, redeployment of cash and cash equivalents into higher yielding investment options, a switch from tax-exempt to taxable investments and loans, and the election of a decelerated depreciation method for tax purposes for future fixed asset purchases. The Company believes that these tax planning strategies are (i.) prudent and feasible, (ii.) steps that the Company would not ordinarily take, but would take to prevent an operating loss or tax credit carryforward from expiring unused, and (iii.) would result in the realization of existing deferred tax assets. These tax planning strategies, if implemented, would result in taxable income in the first full reporting period after deployment and accelerate the recovery of deferred tax asset balances if faced with the inability to recover those assets or the risk of potential expiration. The Company believes that these are viable tax planning strategies and appropriately considered in the analysis at this time, but may not align with the strategic direction of the organization today and therefore, has no present intention to implement such strategies.
The net deferred tax asset balance before consideration of a valuation allowance was $19.6 million as of December 31, 2014 and $21.4 million as of December 31, 2013. The tax planning strategies assessed resulted in the projected realization of approximately $5.0 million in tax assets as of December 31, 2014 and $6.1 million as of December 31, 2013 which can be considered more likely than not to be realized. Accordingly, the Company recorded a partial valuation allowance related to the deferred tax asset balance in the amount of $14.7 million as of December 31, 2014 and $15.3 million as of December 31, 2013.
The deferred tax asset will continue to be analyzed on a quarterly basis for changes affecting realizability. As the Company continues to record consecutive quarters of profitable results, projections of future taxable income become more reliable and can again be used as a factor in assessing the ability to fully realize the deferred tax asset. When the determination is made to include projections of future taxable income as a factor, the valuation allowance will be reduced accordingly resulting in a corresponding increase in net income.
The Company accounts for uncertain tax positions if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The Internal Revenue Service has completed its audits of the Company’s federal tax returns for all tax years through December 31, 2008. There are currently no income tax audits being conducted by the Internal Revenue Service or the Pennsylvania Department of Revenue. The Company’s federal income tax returns filed subsequent to 2008 remain subject to examination by the Internal Revenue Service.
10.
Financial Instruments with Off-Balance Sheet Risk
The Company is a party to 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. These instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements.
Credit risk is defined as the possibility of sustaining a loss due to the failure of the other parties to a financial instrument to perform in accordance with the terms of the contract. The maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same underwriting standards and policies in making credit commitments as it does for on-balance-sheet instruments.
Financial instruments whose contract amounts represent potential credit risk are commitments to extend credit of approximately $138.4 million and $109.3 million and standby letters of credit of approximately $3.8 million and $2.7 million at December 31, 2014 and 2013, respectively. Commitments often expire without being drawn upon. Of the $138.4 million of commitments to extend credit at December 31, 2014, substantially all were variable rate commitments.
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 many require the payment of a fee. Since 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 upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable.
Standby letters of credit are conditional commitments issued that guarantee the performance of a customer to a third party. The credit risk and collateral policy involved in issuing letters of credit is essentially the same as that involved in extending loan commitments. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include real estate, marketable securities, pledged deposits, equipment and accounts receivable. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of liability as of December 31, 2014 and 2013 for guarantees under standby letters of credit issued is not material.
11.
Commitments and Contingencies
Lease Arrangements
As of December 31, 2014, the Company had entered into non-cancelable leases expiring through November 30, 2054, including renewal options. The leases are accounted for as operating leases. The minimum annual rental payments required under these leases are as follows (dollars in thousands):
The Company incurred rent expense of $2.7 million, $2.3 million, and $2.2 million for the years ended December 31, 2014, 2013 and 2012, respectively.
Other
The Company and Republic are from time to time a party (plaintiff or defendant) to lawsuits that are in the normal course of business. While any litigation involves an element of uncertainty, management is of the opinion that the liability of the Company and Republic, if any, resulting from such actions will not have a material effect on the financial condition or results of operations of the Company and Republic.
12.
Regulatory Capital
Dividend payments by Republic to the Company are subject to the Pennsylvania Banking Code of 1965 (the “Banking Code”) and the Federal Deposit Insurance Act (the “FDIA”). Under the Banking Code, no dividends may be paid except from “accumulated net earnings” (generally, undivided profits). Under the FDIA, an insured bank may pay no dividends if the bank is in arrears in the payment of any insurance assessment due to the FDIC. Under current banking laws, Republic would be limited to $14.3 million of dividends plus an additional amount equal to its net profit for 2015, up to the date of any such dividend declaration. However, dividends would be further limited in order to maintain capital ratios.
State and Federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by Republic. Federal banking agencies impose three minimum capital requirements on the Company’s risk-based capital ratios based on total capital, Tier 1 capital, and a leverage capital ratio. The risk-based capital ratios measure the adequacy of a bank’s capital against the riskiness of its assets and off-balance sheet activities. Failure to maintain adequate capital is a basis for “prompt corrective action” or other regulatory enforcement action. In assessing a bank’s capital adequacy, regulators also consider other factors such as interest rate risk exposure; liquidity, funding and market risks; quality and level or earnings; concentrations of credit; quality of loans and investments; risks of any nontraditional activities; effectiveness of bank policies; and management’s overall ability to monitor and control risks.
The following table presents the Company’s and Republic’s capital regulatory ratios at December 31, 2014 and 2013:
Management believes that Republic met, as of December 31, 2014, all capital adequacy requirements to which it is subject. As of December 31, 2014 and 2013, the FDIC categorized Republic as well capitalized under the regulatory framework for prompt corrective action provisions of the Federal Deposit Insurance Act. There are no calculations or events since that notification that management believes have changed Republic’s category.
In July 2013, the federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered “well capitalized”). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016. Management has reviewed the new standards and evaluated all options and strategies to ensure compliance with the new standards. Management believes that Republic will maintain its status as a “well-capitalized” financial institution under the new standards.
13.
Benefit Plans
Defined Contribution Plan
The Company has a defined contribution plan pursuant to the provision of 401(k) of the Internal Revenue Code. The Plan covers all full-time employees who meet age and service requirements. The plan provides for elective employee contributions with a matching contribution from the Company limited to 4% of total salary. The total expense charged to Republic, and included in salaries and employee benefits relating to the plan, was $480,000 in 2014, $425,000 in 2013, and $366,000 in 2012.
Directors’ and Officers’ Plans
The Company has agreements that provide for an annuity payment upon the retirement or death of certain directors and officers, ranging from $15,000 to $25,000 per year for ten years. The agreements were modified for most participants in 2001, to establish a minimum age of 65 to qualify for the payments. All participants are fully vested. The accrued benefits under the plan at both December 31, 2014 and 2013 totaled $1.4 million. The expense for the years ended December 31, 2014, 2013 and 2012, totaled $36,000, $39,000, and $27,000, respectively. The Company funded the plan through the purchase of certain life insurance contracts. The cash surrender value of these contracts (owned by the Company) aggregated $2.2 million and $2.2 million at December 31, 2014 and 2013, respectively, which is included in other assets.
The Company maintains a deferred compensation plan for the benefit of certain officers and directors. As of December 31, 2014, no additional individuals may participate in the plan. The plan permits certain participants to make elective contributions to their accounts, subject to applicable provisions of the Internal Revenue Code. In addition, the Company may make discretionary contributions to participant accounts. Company contributions are subject to vesting, and generally vest three years after the end of the plan year to which the contribution applies, subject to acceleration of vesting upon certain changes in control (as defined in the plan) and to forfeiture upon termination for cause (as defined in the plan). Participant accounts are adjusted to reflect contributions and distributions, and income, gains, losses, and expenses as if the accounts had been invested in permitted investments selected by the participants, including Company common stock. The plan provides for distributions upon retirement and, subject to applicable limitations under the Internal Revenue Code, limited hardship withdrawals. As of December 31, 2014 and 2013, $833,000 and $638,000, respectively, in benefits had vested.
Expense recognized for the deferred compensation plan for 2014, 2013, and 2012 was $147,000, $0 and $109,000, respectively. Although the plan is an unfunded plan, and does not require the Company to segregate any assets, the Company has purchased shares of Company common stock in anticipation of its obligation to pay benefits under the plan. Such shares are classified in the financial statements as stock held by deferred compensation plan. No purchases were made in 2014, 2013 and 2012. As of December 31, 2014, approximately 25,437 shares of Company common stock were classified as stock held by deferred compensation plan.
14.
Fair Value Measurements and Fair Values of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end.
The Company follows the guidance issued under ASC 820, Fair Value Measurement, which defines fair value, establishes a framework for measuring fair value under GAAP, and identifies required disclosures on fair value measurements.
ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).
An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
For financial assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2014 and 2013 were as follows:
The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2014, 2013, and 2012:
For assets measured at fair value on a nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at December 31, 2014 and 2013, respectively, were as follows:
The table below presents additional quantitative information about Level 3 assets measured at fair value on a nonrecurring basis (dollars in thousands):
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which include Level 3 inputs that are not identifiable.
(2)
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.
(3)
There is a lack of transactional data in this market place for the non-guaranteed portion of SBA loans.
(4)
The range and weighted average of qualitative factors such as economic conditions and estimated liquidation expenses are presented as a percent of the appraised value.
The significant unobservable inputs for impaired loans and other real estate owned are the appraised value or an agreed upon sales price. These values are adjusted for estimated costs to sell which are incremental direct costs to transact a sale such as broker commissions, legal fees, closing costs and title transfer fees. The costs must be considered essential to the sale and would not have been incurred if the decision to sell had not been made. The costs to sell are based on costs associated with the Company’s actual sales of other real estate owned which are assessed annually.
The following table presents an analysis of the activity in the SBA servicing assets for the years ended December 31, 2014 and 2013:
Fair Value Assumptions
The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair values of the Company’s financial instruments at December 31, 2014 and December 31, 2013:
Cash and Cash Equivalents (Carried at Cost)
The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.
Investment Securities
The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities, which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments, are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.
The types of instruments valued based on matrix pricing in active markets include all of the Company’s U.S. government and agency securities, corporate bonds, asset backed securities, and municipal obligations. Such instruments are generally classified within Level 2 of the fair value hierarchy. As required by ASC 820-10, the Company does not adjust the matrix pricing for such instruments.
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, and may be adjusted to reflect illiquidity and/or non-transferability, with such adjustment generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Subsequent to inception, management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. The Level 3 investment securities classified as available for sale are comprised of various issues of trust preferred securities and a single corporate bond.
The trust preferred securities are pools of similar securities that are grouped into an asset structure commonly referred to as collateralized debt obligations (“CDOs”) which consist of the debt instruments of various banks, diversified by the number of participants in the security as well as geographically. The secondary market for these securities has become inactive, and therefore these securities are classified as Level 3 securities. The fair value analysis does not reflect or represent the actual terms or prices at which any party could purchase the securities. There is currently a limited secondary market for the securities and there can be no assurance that any secondary market for the securities will expand.
An independent, third party pricing service is used to estimate the current fair market value of each CDO held in the investment securities portfolio. The calculations used to determine fair value are based on the attributes of the trust preferred securities, the financial condition of the issuers of the trust preferred securities, and market based assumptions. The INTEX CDO Deal Model Library was utilized to obtain information regarding the attributes of each security and its specific collateral as of December 31, 2014 and December 31, 2013. Financial information on the issuers was also obtained from Bloomberg, the FDIC, the Office of Thrift Supervision and SNL Financial. Both published and unpublished industry sources were utilized in estimating fair value. Such information includes loan prepayment speed assumptions, discount rates, default rates, and loss severity percentages. Due to the current state of the global capital and financial markets, the fair market valuation is subject to greater uncertainty that would otherwise exist.
The fair market valuation for each CDO was determined based on discounted cash flow analyses. The cash flows are primarily dependent on the estimated speeds at which the trust preferred securities are expected to prepay, the estimated rates at which the trust preferred securities are expected to defer payments, the estimated rates at which the trust preferred securities are expected to default, and the severity of the losses on securities that do default.
Increases (decreases) in actual or expected issuer defaults tend to decrease (increase) the fair value of the Company’s senior and mezzanine tranches of CDOs. The values of the Company’s mezzanine tranches of CDOs are also affected by expected future interest rates. However, due to the structure of each security, timing of cash flows, and secondary effects on the financial performance of the underlying issuers, the effects of changes in future interest rates on the fair value of the Company’s holdings are not quantifiably estimable.
Also included in Level 3 investment securities classified as available for sale is a single-issuer corporate bond transferred from Level 2 in 2010 that is not actively traded. Impairment would depend on the repayment ability of the underlying issuer, which is assessed through a detailed quarterly review of the issuer’s financial statements. The issuer is a “well capitalized” financial institution as defined by federal banking regulations and has demonstrated the ability to raise additional capital, when necessary, through the public capital markets. The fair value of this corporate bond is estimated by obtaining a price of a comparable floating rate debt instrument through Bloomberg.
Loans Held For Sale (Carried at Lower of Cost or Fair Value)
The fair values of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted prices exist, the fair value of a loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of that loan. The Company did not write down any loans held for sale during the years ended December 31, 2014 and 2013.
Loans Receivable (Carried at Cost)
The fair values of loans receivable, excluding all nonaccrual loans and accruing loans deemed impaired with specific loan allowances, are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Due to the significant judgment involved in evaluating credit quality, loans are classified within Level 3 of the fair value hierarchy.
Impaired Loans (Carried at Lower of Cost or Fair Value)
Impaired loans are those that the Company has measured impairment based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. The fair value consists of the loan balances less any valuation allowance. The valuation allowance amount is calculated as the difference between the recorded investment in a loan and the present value of expected future cash flows or it is calculated based on discounted collateral values if the loans are collateral dependent.
Other Real Estate Owned (Carried at Lower of Cost or Fair Value)
These assets are carried at the lower of cost or fair value. At December 31, 2014 and 2013 these assets are carried at current fair value.
SBA Servicing Asset (Carried at Fair Value)
The SBA servicing asset is initially recorded when loans are sold and the servicing rights are retained and recorded on the balance sheet. Updated fair values are obtained on a quarterly basis and adjustments are presented as loan advisory and servicing fees on the statement of operations. The valuation begins with the projection of future cash flows for each asset based on their unique characteristics, our market-based assumptions for prepayment speeds and estimated losses and recoveries. The present value of the future cash flows are then calculated utilizing our market-based discount ratio assumptions. In all cases, we model expected payments for every loan for each quarterly period in order to create the most detailed cash flow stream possible.
The Company uses assumptions and estimates in determining the impairment of the SBA servicing asset. These assumptions include prepayment speeds and discount rates commensurate with the risks involved and comparable to assumptions used by participants to value and bid serving rights available for sale in the market. At December 31, 2014, the sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% adverse changes in key assumptions are included in the accompanying table.
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in value may not be linear. Also in this table, the effect of an adverse variation in a particular assumption on the value of the SBA servicing rights is calculated without changing any other assumption. While in reality, changes in one factor may magnify or counteract the effect of the change.
Restricted Stock (Carried at Cost)
The carrying amount of restricted stock approximates fair value, and considers the limited marketability of such securities.
Accrued Interest Receivable and Payable (Carried at Cost)
The carrying amounts of accrued interest receivable and accrued interest payable approximates fair value.
Deposit Liabilities (Carried at Cost)
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Subordinated Debt (Carried at Cost)
Fair values of subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity. Due to the significant judgment involved in developing the spreads used to value the subordinated debt, it is classified within Level 3 of the fair value hierarchy.
Off-Balance Sheet Financial Instruments (Disclosed at Notional amounts)
Fair values for the Company’s off-balance sheet financial instruments (lending commitments and letters of credit) are based on fees currently charged in the market to enter into similar agreements, taking into account, the remaining terms of the agreements and the counterparties’ credit standing.
The estimated fair values of the Company’s financial instruments were as follows at December 31, 2014 and 2013:
15. Stock Based Compensation
The Company has a Stock Option and Restricted Stock Plan (“Plan”) which originally became effective in 1995 and was subsequently amended and restated in 2005. The Plan allows stock options, restricted stock or stock appreciation rights to be granted to the Company’s employees, directors, and certain consultants. Under the terms of the Plan, 1.5 million shares of common stock, plus an annual increase equal to the number of shares needed to restore the maximum number of shares that may be available for grant under the Plan to 1.5 million shares, are available for such grants. As of December 31, 2014, the only grants under the Plan have been option grants. The Plan provides that the exercise price of each option granted equals the market price of the Company’s stock on the date of grant. Any option granted vests within one to four years and has a maximum term of ten years. The Plan terminates pursuant to its terms on November 14, 2015.
On April 29, 2014, the Company’s shareholders approved the 2014 Republic First Bancorp, Inc. Equity Incentive Plan (the “2014 Plan”), under which the Company may grant options, restricted stock, stock units, or stock appreciation rights to the Company’s employees, directors, independent contractors, and consultants. Under the terms of the 2014 Plan, 2.6 million shares of common stock, plus an annual adjustment to be no less than 10% of the outstanding shares or such lower number as the Board of Directors may determine, are available for such grants.
During the twelve months ended December 31, 2014, 360,900 options were granted under the Plan. There were no options granted under the 2014 Plan.
The Company utilized the Black-Scholes option pricing model to calculate the estimated fair value of each stock option granted on the date of the grant. A summary of the assumptions used in the Black-Scholes option pricing model for 2014, 2013, and 2012 is as follows:
Dividend yield(1)
0.0%
0.0%
0.0%
Expected volatility(2)
55.79% to 57.99%
54.88% to 55.61%
53.12% to 54.49%
Risk-free interest rate(3)
1.51% to 2.26%
1.28% to 2.03%
1.01% to 1.61%
Expected life(4)
5.5 to 7.0 years
7.0 years
7.0 years
(1)
A dividend yield of 0.0% is utilized because cash dividends have never been paid.
(2)
Expected volatility is based on Bloomberg’s five and one-half to seven year volatility calculation for “FRBK” stock.
(3)
The risk-free interest rate is based on the five to seven year Treasury bond.
(4)
The expected life reflects a 1 to 4 year vesting period, the maximum ten year term and review of historical behavior.
During 2014, 209,825 options vested as compared to 127,287 options in 2013 and 146,000 options in 2012. Expense is recognized ratably over the period required to vest. At December 31, 2014 the intrinsic value of the 1,494,399 options outstanding was $1,027,276, while the intrinsic value of the 454,761 exercisable (vested) options was $190,601. During 2014, 81,531 options were forfeited with a weighted average grant date fair value of $40,369.
Information regarding stock based compensation for the years ended December 31, 2014, 2013, and 2012 is set forth below:
The remaining amount of $702,220 will be recognized ratably as expense through September 2018.
A summary of stock option activity under the Plan as of December 31, 2014, 2013 and 2012 is as follows:
A summary of stock option exercises and related proceeds during the years end December 31, 2014, 2013, and 2012 is as follows:
The following table summarizes information about options outstanding at December 31, 2014:
A roll-forward of non-vested options during the year ended December 31, 2014 is as follows:
16. Segment Reporting
The Company has one reportable segment: community banking. The community banking segment primarily encompasses the commercial loan and deposit activities of Republic, as well as consumer loan products in the area surrounding its stores.
17. Transactions with Affiliates and Related Parties
At December 31, 2014 and 2013, Republic had outstanding balances of $0 and $2.7 million, respectively, of commercial loans, which had been participated to First Bank of Delaware (“FBD”), a wholly-owned subsidiary of the Company prior to January 1, 2005. As of December 31, 2014 and 2013 Republic had no outstanding commercial loan balances it had purchased from FBD. The above loan participations and sales were made at arms length. They are made as a result of lending limit and other regulatory requirements.
The Board of Directors of FBD approved a Plan of Liquidation and Dissolution on April 27, 2012. As a result of stockholder approval of the Plan of Dissolution, FBD executed the FBD Liquidating Trust Agreement. On November 6, 2012, FBD gave notice to the Financial Industry Regulatory Authority of its intent to dissolve on or about November 16, 2012.
The Company made payments to related parties in the amount of $754,000 during 2014 as compared to $412,000 during 2013 and $346,000 during 2012. The disbursements made during 2014, 2013 and 2012 include $343,000, $127,000, and $95,000, respectively, in fees for marketing, graphic design, architectural and project management services paid to InterArch, a company owned by the spouse of Vernon W. Hill, II. Mr. Hill is a significant shareholder of the Company, beneficially owning 9.9% of the common shares currently outstanding. The Company paid $28,000 during 2014 to Glassboro Properties, LLC related to a land lease agreement for its Glassboro store. Mr. Hill has an ownership interest in Glassboro Properties LLC, a commercial real estate firm. He also acts as a consultant for the Company and is paid $250,000 annually.
The Company paid $133,000 during 2014 and $35,000 during 2013 to Brian Communications for public relations services. Brian Tierney, a member of the Board of Directors, is the CEO of Brian Communications, a strategic communications agency.
18. Parent Company Financial Information
The following financial statements for Republic First Bancorp, Inc. (Parent Company) should be read in conjunction with the consolidated financial statements and the other notes related to the consolidated financial statements.
19. Quarterly Financial Data (unaudited)
The following represents summarized unaudited quarterly financial data of the Company for each of the quarters ended during 2014 and 2013.
Summary of Selected Quarterly Consolidated Financial Data
(dollars in thousands, except per share data)
(1)
Quarterly net income (loss) per share does not add to full year net income (loss) per share due to rounding.
Item 9:
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A:
Item 9A: Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
The Company’s management, with the participation of the principal executive officer and the principal financial officer, conducted an evaluation, as of the end of the period covered by this report, of the effectiveness of the Company’s disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e). Based on this evaluation, the principal executive officer and the principal financial officer have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e), were effective at the reasonable assurance level.
Changes in Internal Controls
The principal executive officer and principal financial officer also conducted an evaluation of the Company’s internal control over financial reporting (“Internal Control”) to determine whether any changes in Internal Control occurred during the quarter ended December 31, 2014 that have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no such change during the quarter ended December 31, 2014.
Management’s Report on Internal Controls
Management of Republic First Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
The Company’s management, under the supervision and with the participation of the principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of internal control over financial reporting, as of December 31, 2014, based on the framework in Internal Control - Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control - Integrated Framework 2013, management of the Company has concluded the Company maintained effective internal control over financial reporting, as such term is defined in Securities Exchange Act of 1934 Rules 13a-15(f), as of December 31, 2014.
Limitations on the Effectiveness of Controls
Control systems, no matter how well designed and operated, can provide only reasonable, not an absolute, level of assurance that the objectives of the control system are met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
BDO, an independent registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the years ended December 31, 2014 and 2013, and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 and 2013, as stated in their reports, which are included herein.
Tel: 717-233-8800
Fax: 717-233-8801
www.bdo.com
945 E. Park Drive, Suite 103
Harrisburg, PA 17111
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Republic First Bancorp, Inc.
Philadelphia, Pennsylvania
We have audited Republic First Bancorp, Inc. and Subsidiaries (the "Company") internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Bancorp's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Republic First Bancorp, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Republic First Bancorp, Inc. and Subsidiaries as of December 31, 2014 and December 31, 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for the years then ended and our report dated March 13, 2015 expressed an unqualified opinion.
Harrisburg, Pennsylvania
March 13, 2015
Item 9B:
Item 9B: Other Information
None.
PART III
Item 10:
Item 10: Directors, Executive Officers and Corporate Governance
Except as set forth below, the information required by this Item is incorporated by reference from the definitive proxy materials of the Company to be filed with the Securities and Exchange Commission in connection with the Company’s 2015 annual meeting of shareholders, including, but not necessarily limited to, the sections entitled “Board of Directors and Committees” and “Executive Officers and Compensation.”
The Company has adopted a code of ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The text of the Company’s code of ethics is available on the Company’s website at www.myrepublicbank.com. We intend to disclose any changes in or revision to our code of ethics on our website , if applicable.
Item 11:
Item 11: Executive Compensation
The information required by this Item is incorporated by reference from the definitive proxy materials of the Company to be filed with the Securities and Exchange Commission in connection with the Company’s 2015 annual meeting of shareholders, including, but not necessarily limited to, the section entitled “Executive Officers and Compensation.”
Item 12:
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Except as set forth below, the information required by this Item is incorporated by reference from the definitive proxy materials of the Company to be filed with the Securities and Exchange Commission in connection with the Company’s 2015 annual meeting of shareholders, including, but not necessarily limited to, the section entitled “Security Ownership of Certain Beneficial Owners and Management.”
The following table sets forth information as of December 31, 2014, with respect to the shares of common stock that may be issued under the Company’s existing equity compensation plans.
Plan Category
Number of Shares to be Issued Upon Exercise of Outstanding Options, Warrants and Rights
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights
Number of Shares Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in First Column)
Equity compensation plans approved by security holders
1,494,399
$3.59
(1)(2)
Equity compensation plans not approved by security holders
-
-
-
Total
1,494,399
$3.59
(1)(2)
(1)The Stock Option and Restricted Stock Plan originally adopted in 1995 and subsequently amended and restated in 2005, includes an “evergreen formula” which provides that the maximum number of shares which may be issued is 1,540,000 shares plus an annual increase equal to the number of shares required to restore the maximum number of shares available for grant to 1,540,000 shares.
(2)The 2014 Republic First Bancorp, Inc. Equity Incentive Plan provides for 2,600,000 shares of common stock plus an annual adjustment to be no less than 10% of the outstanding shares or such lower number as the Board of Directors may determine, to be available for such grants.
Item 13:
Item 13: Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated by reference from the definitive proxy materials of the Company to be filed with the Securities and Exchange Commission in connection with the Company’s 2015 annual meeting of shareholders, including, but not necessarily limited to, the sections entitled “Certain Relationships and Related Transactions” and “Board of Directors and Committees.”
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference from the definitive proxy materials of the Company to be filed with the Securities and Exchange Commission in connection with the Company’s 2015 annual meeting of shareholders, including, but not necessarily limited to, the section entitled “Information Regarding Independent Registered Public Accounting Firm”.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)
(1) The following financial statements and related documents of Republic First Bancorp, Inc. are filed as part of this Annual Report on Form 10-K in Part II - Item 8 “Financial Statements and Supplementary Data”:
a.
Consolidated Balance Sheets as of December 31, 2014 and 2013;
b.
Consolidated Statements of Operations for the years ended December 31, 2014, 2013, and 2012;
c.
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2014, 2013, and 2012;
d.
Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012;
e.
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2014, 2013 and 2012; and
f.
Notes to Consolidated Financial Statements.
(a)
(2) None
(a)
(3) The exhibits filed or furnished, as applicable, as part of this report are listed under Exhibits at subsection (b) of this Item 15.
(b)
Exhibits
The following Exhibits are filed as part of this report.
Exhibit Number
Description
Location
3.1
Amended and Restated Articles of Incorporation of Republic First Bancorp, Inc.
Incorporated by reference to Form 8-K filed May 13, 2010
3.2
Amended and Restated By-Laws of Republic First Bancorp, Inc.
Incorporated by reference to Form S-1 filed April 23, 2010 (333-166286)
4.1
The Company will furnish to the SEC upon request copies of the following documents relating to the Company’s Floating Rate Junior Subordinated Debt Securities due 2037: (i) Indenture dated as of December 27, 2006, between the Company and Wilmington Trust Company, as trustee; (ii) Amended and Restated Declaration of Trust of Republic Capital Trust II, dated as of December 27, 2006; and (iii) Guarantee Agreement dated as of December 27, 2006, between the Company and Wilmington Trust Company, as trustee, for the benefit of the holders of the capital securities of Republic Capital Trust II
Exhibit Number
Description
Location
4.2
The Company will furnish to the SEC upon request copies of the following documents relating to the Company’s Floating Rate Junior Subordinated Debt Securities due 2037: (i) Indenture dated as of June 28, 2007, between the Company and Wilmington Trust Company, as trustee; (ii) Amended and Restated Declaration of Trust of Republic Capital Trust III, dated as of June 28, 2007; and (iii) Guarantee Agreement dated as of June 28, 2007, between the Company and Wilmington Trust Company, as trustee, for the benefit of the holders of the capital securities of Republic Capital Trust III
4.3
The Company will furnish to the SEC upon request copies of the following documents relating to the Company’s Fixed Rate Junior Subordinated Convertible Debt Securities due 2038: (i) Indenture dated as of June 10, 2008, between the Company and Wilmington Trust Company, as trustee; (ii) Amended and Restated Declaration of Trust of Republic First Bancorp Capital Trust IV, dated as of June 10, 2008; and (iii) Guarantee Agreement dated as of June 10, 2008, between the Company and Wilmington Trust Company, as trustee, for the benefit of the holders of the capital securities of Republic First Bancorp Capital Trust IV
10.1
Employment Agreement between the Company and Harry D. Madonna, dated May 10, 2013*
Incorporated by reference to Form 10-Q filed May 10, 2013
10.2
Amended and Restated Stock Option Plan and Restricted Stock Plan*
Incorporated by reference to Form 10-K filed March 10, 2008
10.3
Deferred Compensation Plan*
Incorporated by reference to Form 10-K filed March 16, 2010
10.4
Amended and Restated Supplemental Retirement Plan Agreements between Republic First Bank and Certain Directors*
Incorporated by reference to Form 10-Q filed November 7, 2008
10.5
Purchase Agreement among Republic First Bancorp, Inc., Republic First Bancorp Capital Trust IV, and Purchasers of the Trust IV Capital Securities
Incorporated by reference to Form 10-Q filed November 7, 2008
Exhibit Number
Description
Location
10.6
Registration Rights Agreement among Republic First Bancorp, Inc. and the Holders of the Trust IV Capital Securities
Incorporated by reference to Form10-Q filed November 7, 2008
10.7
Consulting Agreement between Republic First Bancorp, Inc. and Vernon W. Hill, II
Incorporated by reference to Form 10-Q filed November 7, 2008
10.8
Employment Agreement between Republic First Bank and Andrew J. Logue, dated August 20, 2008*
Incorporated by reference to Form S-1 filed April 23, 2010 (333-166286)
10.9
Employment Agreement between Republic First Bank and Rhonda S. Costello, dated August 25, 2008*
Incorporated by reference to Form S-1 filed April 23, 2010 (333-166286)
10.10
Form of Option Award*
Incorporated by reference to Form S-1 filed April 23, 2010 (333-166286)
10.11
Amendment to Employment Agreement, by and between Andrew J. Logue and Republic First Bank, dated April 26, 2010*
Incorporated by reference to Form 8-K filed May 4, 2010
10.12
Amendment to Employment Agreement, by and between Andrew J. Logue and Republic First Bank, dated March 13, 2013.*
Incorporated by reference to Form 10-Q filed May 10, 2013
10.13
Amendment to Employment Agreement, by and between Rhonda Costello and Republic First Bank, dated March 13, 2013.*
Incorporated by reference to Form 10-Q filed May 10, 2013
10.14
Letter Agreement, by and between Jay Neilon and the Company, dated March 13, 2013.*
Incorporated by reference to Form 10-Q filed May 10, 2013
10.15
Letter Agreement, by and between Frank A. Cavallaro and the Company, dated March 13, 2013.*
Incorporated by reference to Form 10-Q filed May 10, 2013
10.16
Republic First Bancorp, Inc. 2014
Equity Incentive Plan*
Incorporated by reference to the definitive proxy statement on Schedule 14A filed on March 26, 2014
10.17
Form of Incentive Stock Option Award - 2014
Equity Incentive Plan*
Filed Herewith
Exhibit Number
Description
Location
10.18
Form of Nonqualified Stock Option Award - 2014
Equity Incentive Plan*
Filed Herewith
10.19
Form of Investment Agreement
Incorporated by reference to Form 8-K filed on April 22, 2014
21.1 Subsidiaries of the Company
Filed Herewith
23.1
Consent of BDO USA, LLP
Filed Herewith
23.2
Consent of Baker Tilly Virchow Krause, LLP
Filed Herewith
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chairman and Chief Executive Officer of Republic First Bancorp, Inc.
Filed Herewith
(c)
All financial statement schedules are omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule or because the information required is included in the respective financial statements or notes thereto contained herein.
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.
REPUBLIC FIRST BANCORP, INC.
Date: March 13, 2015
By:
/s/ Harry D. Madonna
Harry D. Madonna
Chairman, President and Chief Executive Officer
(principal executive officer)
Date: March 13, 2015
By:
/s/ Frank A. Cavallaro
Frank A. Cavallaro
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: March 13, 2015
By:
/s/ Robert Coleman
Robert Coleman, Director
Date: March 13, 2015
By:
/s/ Theodore J. Flocco, Jr.
Theodore J. Flocco, Jr., Director
Date: March 13, 2015
By:
/s/ Harry D. Madonna
Harry D. Madonna, Director and Chairman of the Board
Date: March 13, 2015
By:
/s/ Barry L. Spevak
Barry L. Spevak, Director
Date: March 13, 2015
By:
/s/ Brian P. Tierney
Brian P. Tierney, Director
Date: March 13, 2015
By:
/s/ Harris Wildstein, Esq.
Harris Wildstein, Esq., Director