10-Q 1 hbi10q05142015.htm FORM 10-Q hbi10q05142015.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2015

[   ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number:  0-27622

HIGHLANDS BANKSHARES, INC.
(Exact name of registrant as specified in its charter)


Virginia
(State or other jurisdiction of
incorporation or organization)
54-1796693
(I.R.S. Employer
Identification No.)
 
P.O. Box 1128
Abingdon, Virginia
(Address of principal executive offices)
 
 
24212-1128
(Zip Code)

276-628-9181
(Registrant’s telephone number, including area code)

 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes [ X ]        No [    ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company (See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Act). Large Accelerated Filer  [  ]   Accelerated Filer  [  ]    Non-Accelerated Filer [  ]  Smaller Reporting Company  [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
7,851,780 shares of common stock, par value $0.625 per share,
outstanding as of May 14, 2015

 
 
 

 
Highlands Bankshares, Inc.

FORM 10-Q
For the Quarter Ended March 31, 2015

INDEX
   
PART I. FINANCIAL INFORMATION  
PAGE
   
Item 1.  Financial Statements
 
   
Consolidated Balance Sheets
  at March 31, 2015 (Unaudited) and December 31, 2014
 
3
 
 
Consolidated Statements of Income (Unaudited)
  for the Three Months Ended March 31, 2015 and 2014
4
   
 
Consolidated Statements of Comprehensive Income (Unaudited)
for the Three Months Ended March 31, 2015 and 2014
5
Consolidated Statements of Cash Flows (Unaudited)
  for the Three Months Ended March 31, 2015 and 2014
6
   
Consolidated Statements of Changes in
  Stockholders’ Equity (Unaudited) for the Three Months
  Ended March 31, 2015 and 2014
7
   
Notes to Consolidated Financial Statements (Unaudited)
8-39
   
Item 2. Management’s Discussion and Analysis of
              Financial Condition and Results of Operations
39-44
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
45
   
Item 4.  Controls and Procedures
45
 
 
PART II.  OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
45
   
Item 1A. Risk Factors
45
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
45
   
Item 3.  Defaults Upon Senior Securities
45
   
Item 4.  Mine Safety Disclosures
45
   
Item 5.  Other Information
45
   
Item 6.  Exhibits
45
   
SIGNATURES AND CERTIFICATIONS
46


 
2

 
PART I.
FINANCIAL INFORMATION
          ITEM 1.  Financial Statements

Consolidated Balance Sheets
(Amounts in thousands)
   
       (Unaudited)
  March 31, 2015
 
(Note 1)
December 31, 2014
                                              ASSETS
       
Cash and due from banks
 
$     19,120
 
     $      15,018
Federal funds sold
 
      36,833
 
  40,792
         
   Total Cash and Cash Equivalents
 
      55,953
 
55,810
         
Investment securities available for sale (amortized cost $85,161 at  March 31, 2015, $84,191 at December 31, 2014)
 
85,538
 
84,335
Other investments, at cost
 
6,599
 
6,767
Loans, net of allowance for loan losses of  $5,289 at March 31, 2015, $5,477 at December 31, 2013
 
403,827
 
401,520
Premises and equipment, net
 
20,088
 
20,236
Deferred tax assets
 
10,487
 
10,744
Interest receivable
 
2,234
 
2,235
Bank owned life Insurance
 
14,280
 
14,183
Other real estate owned
 
9,081
 
6,685
Other assets
 
       2,313
 
        2,599
         
    Total Assets
 
$   610,400
 
$    605,114
         
LIABILITIES AND STOCKHOLDERS’ EQUITY
       
         
LIABILITIES
       
         
Deposits:
       
  Non-interest bearing
 
$    117,005
 
$      118,557
  Interest bearing
 
    370,987
 
     364,940
         
    Total Deposits
 
    487,992
 
     483,497
         
Interest, taxes and other liabilities
 
1,317
 
1,014
Other short-term borrowings
 
20,050
 
20,051
Long-term debt
 
47,738
 
47,750
         
    Total Other Liabilities
 
      69,105
 
       68,815
         
    Total Liabilities
 
    557,097
 
     552,312
         
STOCKHOLDERS’ EQUITY
       
         
Common stock (7,851 shares issued and outstanding)
 
4,907
 
4,907
Preferred Stock (2,092 shares issued and outstanding)
 
4,184
 
4,184
Additional paid-in capital
 
 17,947
 
18,180
Retained earnings
 
26,016
 
25,436
Accumulated other comprehensive income
 
      249
 
      95
         
  Total Stockholders’ Equity
 
      53,303
 
      52,802
         
    Total Liabilities and Stockholders’ Equity
 
$  610,400
 
$   605,114
         
See accompanying Notes to Consolidated Financial Statements
 
 
3

 
Consolidated Statements of Income
(Amounts in thousands, except per share data)
(Unaudited)
 
Three Months Ended                  March 31, 2015
 
Three Months Ended March 31, 2014
INTEREST INCOME
     
Loans receivable and fees on loans
$    5,298
 
$    5,392
Securities available for sale:
     
  Taxable
313
 
222
  Exempt from taxable income
108
 
123
Other investment income
52
 
45
Federal funds sold
          21
 
          38
       
    Total Interest Income
     5,792
 
     5,820
       
INTEREST EXPENSE
     
Deposits
570
 
663
Other borrowed funds
         585
 
         741
       
    Total Interest Expense
      1,155
 
      1,404
       
    Net Interest Income
      4,637
 
      4,416
       
Provision for Loan Losses
      100
 
      265
       
    Net Interest Income after Provision for                   Loan Losses
         4,537
 
         4,151
       
NON-INTEREST INCOME
     
Securities gains (losses), net
16
 
-
Service charges on deposit accounts
391
 
452
Other service charges, commissions and fees
335
 
399
Other  operating income
124
 
149
 
     
    Total Non-Interest Income
         866
 
         1,000
       
NON-INTEREST EXPENSE
     
Salaries and employee benefits
2,446
 
2,467
Occupancy expense of bank premises
309
 
280
Furniture and equipment expense
340
 
302
Other operating expense
1,317
 
1,189
Foreclosed Assets – Write-down and Operating Expenses
      234
 
      273
       
    Total Non-Interest Expense
      4,646
 
      4,511
       
    Income Before Income Taxes
757
 
640
       
Income Tax Expense (Note 3)
    177
 
    139
       
    Net Income
$     580
 
$     501
       
Basic Earnings  Per Common Share (Note 6)
$     0.07
 
$     0.10
       
Earnings Per Common Share – Assuming Dilution
$      0.06
 
$      0.10
       
Dividends Per Share
$            -
 
$            -

See accompanying Notes to Consolidated Financial Statements



 
4

 

Consolidated Statements of Comprehensive Income
(Amounts in thousands)
(Unaudited)
 
Three Months Ended                  March 31, 2015
 
Three Months Ended March 31, 2014
       
       
Net Income
$     580
 
$     501
       
     Other Comprehensive Income
     
  Unrealized gains on securities during  the period
250
 
521
  Less: reclassification adjustment for (gains)  included in net income
(16)
 
-
          Other Comprehensive Income, before tax
234
 
521
           Income tax expense related to other
           comprehensive income
80
 
177
    Other Comprehensive Income
154
 
344
Comprehensive Income
$     734
 
$     845
       

See accompanying Notes to Consolidated Financial Statements



 
5

 

Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
   
Three Months Ended
   
Three Months Ended
 
   
March 31, 2015
   
March 31, 2014
 
CASH FLOWS FROM OPERATING  ACTIVITIES:
           
Net income
  $ 580     $ 501  
Adjustments to reconcile net income  to net cash provided by                 operating activities
               
Provision for loan losses
    100       265  
Depreciation and amortization
    233       221  
 
Net realized gains on available for sale securities
    (16 )     -  
Net amortization on securities
    249       118  
            (Increase) decrease in interest receivable
    1       (136 )
Valuation adjustment of other real estate owned
    20       111  
Decrease in other assets
    174       43  
Increase in interest, taxes and other liabilities
    303       297  
                 
Net cash provided by operating activities
     1,644        1,420  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Securities available for sale:
               
       Proceeds from sale of securities
    1025       -  
Proceeds from maturities of debt and equity securities
    3,826       1,469  
Purchase of debt and equity securities
    (6,045 )     -  
Redemption of other investments
    168       172  
Net increase in loans
    (5,199 )     (3,020 )
Proceeds from sales of other real estate owned
    328       219  
Premises and equipment expenditures
    (86 )     (221 )
                 
Net cash used in investing activities
    (5,983 )     (1,381 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
 
Net decrease in time deposits
    (2,865 )     (3,049 )
Net increase in demand, savings and other deposits
    7,360       8,963  
Decrease in short-term borrowings
    (1 )     (27 )
Decrease in long-term debt
    (12 )     (13 )
                 
Net cash provided by financing activities
    4,482       5,874  
                 
Net increase in cash and cash equivalents
    143       5,913  
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    55,810       83,995  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 55,953     $ 89,908  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid during the period for:
               
Interest
  $ 1,165     $ 1,139  
Income taxes
  $ -     $ -  
                 
     SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
               
Transfer of loans to other real estate owned
  $ 2,794     $ 330  
Loans originated from sales of other real estate owned
  $ -     $ 56  

See accompanying Notes to Consolidated Financial Statements


 
6

 


Consolidated Statements of Changes in Stockholders’ Equity
(Amounts in thousands)
(Unaudited)



 
Common Stock Shares
Par Value
Preferred Stock
Shares
Preferred Stock
Par Value
Additional Paid
In Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Stockholders’
Equity
Balance
December 31, 2013
 
5,011
 
$ 3,132
 
-
 
-
 
$   7,783
 
 
$  22,910
 
$    (834)
 
$  32,991
 
Net Income
         
 
         501
 
 
     501
Other
Comprehensive
Income
           
 
      344
 
      344
Balance,
March 31, 2014
 
5,011
 
$ 3,132
 
-
 
-
 
$   7,783
 
 
$23,411
 
$  (490)
 
$   33,836
                 
Balance
December 31, 2014
 
7,851
 
$ 4,907
 
2,092
 
$ 4,184
 
$  18,180
 
$25,436
 
$      95
 
$    52,802
 
Net Income
         
 
580
 
 
$    580
Additional
Paid In Capital
       
 
(233)
   
 
    (233)
Other
Comprehensive
Income
           
 
$  154
 
$      154
Balance
March 31, 2015
 
7,851
 
$4,907
 
2,092
 
$ 4,184
 
$ 17,947
 
$ 26,016
 
$    249
 
$ 53,303
                 

See accompanying Notes to Consolidated Financial Statements




 
7

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
 
Note 1  -  General

The consolidated financial statements of Highlands Bankshares, Inc. (the “Company”) conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2014 has been extracted from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Form 10-K”). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2014 Form 10-K. The results of operations for the three-month period ended March 31, 2015 are not necessarily indicative of the results to be expected for the full year.

The preparation of 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 2  -  Loans and Allowance for Loan Losses  (amounts in thousands)
 The composition of net loans is as follows:

 
March 31, 2015
 
December 31, 2014
Real Estate Secured:
     
Residential 1-4 family
$ 189,243
 
$   186,829
Multifamily
20,273
 
21,131
Construction and Land Loans
17,425
 
18,518
Commercial, Owner Occupied
70,340
 
70,748
Commercial, Non-owner occupied
32,278
 
32,173
Second mortgages
7,874
 
8,075
Equity lines of credit
            6,239
 
6,499
Farmland
9,261
 
8,246
 
352,933
 
352,219
       
Secured (other) and unsecured
     
Personal
20,456
 
20,901
Commercial
33,065
 
31,586
Agricultural
3,034
 
2,683
 
56,555
 
55,170
       
Overdrafts
320
 
285
       
 
409,808
 
407,674
Less:
     
  Allowance for loan losses
            5,289
 
            5,477
  Net deferred fees
692
 
               677
 
5,981
 
6,154
       
Loans, net
$ 403,827
 
$    401,520




 
8

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following table is an analysis of past due loans as of March 31, 2015:

   
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater Than 90 Days
 
Total Past Due
 
Current
 
Total Financing Receivables
 
Recorded Investment > 90 Days and Accruing
                             
Real Estate Secured
                           
Residential 1-4 family
 
 $ 4,265
 
 $    1,298
 
 $  3,039
 
 $  8,602
 
 $  180,641
 
 $  189,243
 
 $         -
Equity lines of credit
 
 22
 
 13
 
-
 
 35
 
 6,204
 
 6,239
 
-
Multifamily
 
 -
 
 -
 
 -
 
 -
 
 20,273
 
 20,273
 
-
Farmland
 
11
 
 394
 
 -
 
405
 
 8,856
 
 9,261
 
-
Construction, Land Development, Other Land Loans
 
141
 
 42
 
148
 
331
 
 17,094
 
 17,425
 
 -
Commercial Real Estate- Owner Occupied
 
 690
 
 -
 
2,048
 
 2,738
 
 67,602
 
 70,340
 
 -
Commercial Real Estate- Non Owner Occupied
 
 2
 
-
 
 85
 
 87
 
 32,191
 
 32,278
 
 -
Second Mortgages
 
 45
 
 62
 
 53
 
 160
 
 7,714
 
 7,874
 
 -
Non Real Estate Secured
                           
Personal
 
 388
 
 120
 
 168
 
 676
 
 20,100
 
 20,776
 
 -
Commercial
 
 210
 
 84
 
 449
 
 743
 
 32,322
 
 33,065
 
 -
Agricultural
 
 15
 
 75
 
 -
 
 90
 
 2,944
 
 3,034
 
 -
                             
          Total
 
 $  5,789
 
 $    2,088
 
 $   5,990
 
 $  13,867
 
 $  395,941
 
 $  409,808
 
 $          -
                             




 
9

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following table is an analysis of past due loans as of December 31, 2014:


   
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater Than 90 Days
 
Total Past Due
 
Current
 
Total Financing Receivables
 
Recorded Investment > 90 Days and Accruing
                             
Real Estate Secured
                           
Residential 1-4 family
 
 $    4,521
 
 $    3,001
 
 $    2,884
 
 $    10,406
 
 $  176,423
 
 $  186,829
 
 $          -
Equity lines of credit
 
 45
 
 -
 
 -
 
 45
 
 6,454
 
 6,499
 
-
Multifamily
 
 1,252
 
-
 
 -
 
 1,252
 
 19,879
 
 21,131
 
-
Farmland
 
 208
 
 -
 
 477
 
 685
 
 7,561
 
 8,246
 
-
Construction,  Land Development, Other Land Loans
 
 417
 
 31
 
 168
 
 616
 
 17,902
 
 18,518
 
 -
Commercial Real Estate- Owner Occupied
 
 2,193
 
 790
 
 2,344
 
 5,327
 
 65,421
 
 70,748
 
 -
Commercial Real Estate- Non Owner Occupied
 
 225
 
 85
 
 1,547
 
 1,857
 
 30,316
 
 32,173
 
 -
Second Mortgages
 
 107
 
 51
 
 134
 
 292
 
 7,783
 
 8,075
 
 -
Non Real Estate Secured
                           
Personal
 
 404
 
 105
 
233
 
 742
 
 20,444
 
 21,186
 
22
Commercial
 
 720
 
 49
 
 447
 
 1,216
 
 30,370
 
 31,586
 
 -
Agricultural
 
 3
 
 -
 
 -
 
 3
 
 2,680
 
 2,683
 
 -
                             
          Total
 
 $    10,095
 
 $    4,112
 
 $   8,234
 
 $   22,441
 
 $  385,233
 
 $  407,674
 
 $          22
                             





 
10

 


 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Loans are considered delinquent when payments have not been made according to the terms of the contract. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Additionally, in certain instances, loans that have been restructured or modified may also be classified as non-accrual per regulatory guidance until a satisfactory payment history has been established. Credit card loans and other personal loans are typically charged off no later than 180 days past due.   In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following is a summary of non-accrual loans at March 31, 2015 and December 31, 2014:
 
 
March 31, 2015
 
December 31, 2014
Real Estate Secured
     
Residential 1-4 Family
                                                       $           3,039
 
 $       3,401
Multifamily
-
 
-
Construction and Land Loans
148
 
168
Commercial-Owner Occupied
3,568
 
5,259
Commercial- Non Owner Occupied
1,632
 
1,547
Second Mortgages
53
 
134
Equity Lines of Credit
-
 
-
Farmland
-
 
477
Secured (other) and Unsecured
     
Personal
168
 
211
Commercial
449
 
447
Agricultural
            -
 
             -
       
Total
$             9,057
 
$     11,644


 
The following is a summary of residential real estate currently in the process of foreclosure as well as foreclosed residential real estate as of March 31, 2015.
 
          Number      03/31/15 Balance
Residential real estate in the process of foreclosure
 
                           6
 
                     $     748
Foreclosed residential real estate
                         15
                     $  2,718





 
11

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables represent a summary of credit quality indicators of the Company’s loan portfolio at March 31, 2015 and December 31, 2014.  The grades are assigned and/or modified by the Company’s credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

Credit Risk Profile by Internally Assigned Grade as of March 31, 2015
Grade (1)
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
                         
Quality
 
 29,276
 
6
 
 33
 
 2,632
 
 2,805
 
 658
Satisfactory
 
 103,015
 
 15,494
 
 4,214
 
 6,807
 
 36,272
 
 15,891
Acceptable
 
 43,377
 
 2,694
 
 3,991
 
 5,610
 
 19,077
 
 11,632
Special Mention
 
 2,991
 
 819
 
 197
 
 2,160
 
 4,222
 
 2,098
Substandard
 
 10,584
 
 1,260
 
 826
 
 216
 
 7,964
 
 1,999
Doubtful
 
 -
 
 -
 
 -
 
 -
 
 -
 
 -
                         
     Total
 
$   189,243
 
$     20,273
 
$     9,261
 
$        17,425
 
$     70,340
 
$     32,278
 

 
Credit Risk Profile by Internally Assigned Grade as of December 31, 2014
Grade (1)
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
                         
Quality
 
 29,494
 
6
 
 37
 
 3,278
 
 4,159
 
 874
Satisfactory
 
 100,767
 
 16,326
 
 3,090
 
 8,091
 
 31,018
 
 15,052
Acceptable
 
 44,021
 
 2,719
 
 4,080
 
 4,745
 
 20,987
 
 12,223
Special Mention
 
 2,640
 
828
 
 198
 
 2,231
 
 3,994
 
 2,108
Substandard
 
 9,907
 
 1,252
 
 841
 
 173
 
 10,590
 
 1,916
Doubtful
 
 -
 
 -
 
 -
 
 -
 
 -
 
 -
                         
     Total
 
$   186,829
 
$     21,131
 
$     8,246
 
$        18,518
 
$     70,748
 
$      32,173


 
12

 
 
(1)  Quality--This grade is reserved for the Bank’s top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection.  Generally, loans assigned this rating will demonstrate the following characteristics:
 
 
·  
Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
 
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.
 
Satisfactory - This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:
 
 
·  
General conformity to the Bank's policy requirements, product guidelines and underwriting standards.  Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
 

 
13

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor
 
 
For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.
 
Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this rating may demonstrate some or all of the following characteristics:
 
 
·  
Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
 
 
·  
Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.
 
 
·  
Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.
 
 
 
14

 
Special Mention -This grade is given to Watch List loans that include the following characteristics:
 
 
·  
Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.
 
 
·  
Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
 
 
·  
Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.
 
 
Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
 
 The weaknesses may include, but are not limited to:
 
 
·  
High debt to worth ratios and or declining or negative earnings trends
 
 
·  
Declining or inadequate liquidity
 
 
·  
Improper loan structure  or questionable repayment sources
 
 
·  
Lack of well-defined secondary repayment source, and
 
 
·  
Unfavorable competitive comparisons.
 
 
Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
 
 

 
15

 
 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 

 
Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.
 
However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:
 
 
·  
Injection of capital
 
 
·  
Alternative financing
 
 
·  
Liquidation of assets or the pledging of additional collateral.
 
Credit Risk Profile based on payment activity as of March 31, 2015
   
Consumer - Non Real Estate
 
Equity Line of Credit / Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
                 
Performing
 
$       20,608
 
$          14,060
 
$              32,616
 
$            3,034
Nonperforming (>90 days past due)
 
168
 
 53
 
449
 
-
                 
     Total
 
$       20,776
 
$        14,113
 
$              33,065
 
$           3,034
                 


Credit Risk Profile based on payment activity as of December 31, 2014
   
Consumer - Non Real Estate
 
Equity Line of Credit /Jr. liens
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
                 
Performing
 
$       20,953
 
$          14,440
 
$               31,139
 
$            2,683
Nonperforming (>90 days past due)
 
 233
 
 134
 
 447
 
 -
                 
     Total
 
$       21,186
 
$         14,574
 
$              31,586
 
$           2,683
                 





 
16

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at March 31, 2015:
 
 
March 31, 2015
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With No Related Allowance
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     8,815
 
$     8,815
 
$          -
 
$     8,402
 
$       81
Equity lines of credit
 
74
 
74
 
-
 
49
 
1
Multifamily
 
1,260
 
1,260
 
-
 
1,256
 
16
Farmland
 
826
 
826
 
-
 
834
 
21
Construction, Land Development, Other Land Loans
 
1,757
 
1,757
 
-
 
1,748
 
25
Commercial Real Estate- Owner Occupied
 
7,964
 
7,964
 
-
 
8,576
 
48
Commercial Real Estate- Non Owner Occupied
 
85
 
85
 
-
 
43
 
-
Second Mortgages
 
242
 
242
 
-
 
430
 
4
Non Real Estate Secured
                   
Personal /Consumer
 
24
 
24
 
-
 
39
 
-
Commercial
 
222
 
222
 
-
 
292
 
2
Agricultural
 
-
 
-
 
-
 
-
 
-
                     
          Total
 
$    21,269
 
$    21,269
 
$          -
 
$   21,669
 
$       198



 
 
March 31, 2015
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an Allowance Recorded
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     2,916
 
$     2,916
 
$       567
 
$     3,032
 
$       29
Equity lines of credit
 
-
 
-
 
-
 
-
 
-
Multifamily
 
-
 
-
 
-
 
-
 
-
Farmland
 
-
 
-
 
-
 
-
 
-
Construction, Land Development, Other Land Loans
 
366
 
366
 
20
 
366
 
5
Commercial Real Estate- Owner Occupied
 
-
 
-
 
-
 
702
 
-
Commercial Real Estate- Non Owner Occupied
 
1,914
 
1,914
 
320
 
1,915
 
4
Second Mortgages
 
-
 
-
 
-
 
-
 
-
Non Real Estate Secured
                   
Personal /Consumer
 
202
 
202
 
144
 
228
 
2
Commercial
 
932
 
932
 
604
 
867
 
6
Agricultural
 
-
 
-
 
-
 
3
 
-
                     
          Total
 
$    6,330
 
$     6,330
 
$     1,655
 
$    7,113
 
$       46


 
17

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at December 31, 2014:


 
 
December 31, 2014
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With no Related Allowance
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     7,988
 
$     7,988
 
$          -
 
$     7,015
 
$       256
Equity lines of credit
 
24
 
24
 
-
 
194
 
1
Multifamily
 
1,252
 
1,252
 
-
 
626
 
21
Farmland
 
842
 
842
 
-
 
663
 
32
Construction, Land Development, Other Land Loans
 
1,738
 
1,738
 
-
 
1,716
 
64
Commercial Real Estate- Owner Occupied
 
9,188
 
9,392
 
-
 
7,291
 
262
Commercial Real Estate- Non Owner Occupied
 
-
 
-
 
-
 
3,227
 
-
Second Mortgages
 
618
 
618
 
-
 
340
 
20
Non Real Estate Secured
                   
Personal
 
54
 
54
 
-
 
53
 
3
Commercial
 
361
 
361
 
-
 
229
 
20
Agricultural
 
-
 
-
 
-
 
-
 
-
                     
          Total
 
$    22,065
 
$    22,269
 
$          -
 
$   21,354
 
$       679


 
 
December 31, 2014
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an Allowance Recorded
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     3,148
 
$     3,148
 
$       586
 
$     3,087
 
$       125
Equity lines of credit
 
-
 
-
 
-
 
19
 
-
Multifamily
 
-
 
-
 
-
 
-
 
-
Farmland
 
-
 
-
 
-
 
100
 
-
Construction, Land Development, Other Land Loans
 
366
 
366
 
20
 
183
 
13
Commercial Real Estate- Owner Occupied
 
1,403
 
1,403
 
143
 
2,466
 
56
Commercial Real Estate- Non Owner Occupied
 
1,916
 
1,916
 
322
 
3,249
 
31
Second Mortgages
 
-
 
-
 
-
 
28
 
-
Non Real Estate Secured
                   
Personal
 
253
 
253
 
188
 
193
 
7
Commercial
 
802
 
802
 
540
 
863
 
28
Agricultural
 
7
 
7
 
7
 
94
 
1
                     
          Total
 
$    7,895
 
$    7,895
 
$     1,806
 
$    10,282
 
$       261




 
18

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)


The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan category and is segregated by impairment
evaluation method as of March 31, 2015 and March 31, 2014.

Three  months ended March 31, 2015
Residential
1-4 Family
Multifamily
Construction and Land Loans
Commercial Owner Occupied
Commercial Non-Owner Occupied
Second Mortgages
Equity Line of Credit
Farmland
Personal and  Overdrafts
Commercial and Agricultural
Unallocated
Total
Allowance for Credit Losses:
                       
Beginning Balance December 31,  2014
$  995
$   20
$   87
$  409
$   1,063
$   67
$   74
$   12
$   665
$   982
$   1,103
$   5,477
Provision for Credit Losses
42
(20)
(19)
42
(29)
3
(6)
1
31
177
(122)
100
Charge-offs
47
-
-
392
-
3
-
-
77
64
-
583
Recoveries
-
-
7
275
-
-
-
-
12
1
-
295
Net Charge-offs
47
            -
(7)
117
-
3
-
-
65
63
-
288
Ending Balance
 March 31, 2015
990
-
75
334
1,034
67
68
13
631
1,096
981
5,289
Ending Balance: Individually evaluated for impairment
567
-
20
-
320
-
-
-
144
604
-
1,655
Ending Balance:  Collectively Evaluated for Impairment
423
-
55
334
714
67
68
13
487
492
981
3,634
Loans:
                       
Ending Balance: Individually Evaluated for Impairment
11,731
1,260
2,123
7,964
1,999
242
74
826
226
1,154
-
27,599
Ending Balance: Collectively Evaluated for Impairment
177,512
19,013
15,302
62,376
30,279
7,632
6,165
8,435
20,550
34,945
-
382,209
Ending Balance: March 31, 2015
$189,243
$20,273
$17,425
$70,340
$32,278
$7,874
$6,239
$9,261
$20,776
$36,099
-
$409,808

 
 
19

 
Three  months ended March 31, 2014
Residential
1-4 Family
Multifamily
Construction and Land Loans
Commercial Owner Occupied
Commercial Non-Owner Occupied
Second Mortgages
Equity Line of Credit
Farmland
Personal and  Overdrafts
Commercial and Agricultural
Unallocated
Total
Allowance for Credit Losses:
                       
Beginning Balance December 31,  2013
$  975
$   143
$   230
$  1,029
$   1,415
$   153
$   50
$   65
$   483
$   1,264
$   1,018
$   6,825
Provision for Credit Losses
148
5
(14)
(23)
73
(7)
(39)
(5)
243
(163)
47
265
Charge-offs
68
-
-
-
159
25
-
-
78
114
-
444
Recoveries
-
-
2
-
-
1
-
-
23
7
-
33
Net Charge-offs
68
            -
(2)
-
159
24
-
-
55
107
-
411
Ending Balance
 March 31, 2014
1,055
148
218
1,006
1,329
122
11
60
671
994
1,065
6,679
Ending Balance: Individually evaluated for impairment
379
-
-
588
1,074
-
-
25
42
386
-
2,494
Ending Balance:  Collectively Evaluated for Impairment
676
148
218
418
255
122
11
35
629
608
1,065
4,185
Loans:
                       
Ending Balance: Individually Evaluated for Impairment
8,312
-
1,551
9,940
11,002
61
349
666
92
985
-
32,958
Ending Balance: Collectively Evaluated for Impairment
173,084
20,178
16,697
61,817
24,329
  7,746
7,187
8,256
20,093
34,343
-
373,730
Ending Balance: March 31, 2014
$181,396
$20,178
$18,248
$71,757
$35,331
$7,807
$7,536
$8,922
$20,185
$35,328
-
$406,688





 
20

 



Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

A loan is considered impaired and an allowance for loan losses is established on loans for which it is probable that the full collection of principal and interest is in doubt. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value based on recent appraisal and /or tax assessment value, liquidation value and/or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March  31, 2015 and December 31, 2014, all of the total impaired loans were evaluated based on the fair value of the collateral. On a quarterly basis, the ALLL methodology begins with the determination of individually impaired loans. All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans with the following characteristics warrant further analysis before completing an assessment of impairment:

•  
A loan is 60 days or more delinquent on scheduled principal or interest;
•  
A loan is presently in an unapproved over advanced position;
•  
A loan is newly modified; or,
•  
A loan is expected to be modified.


The Company’s credit administration personnel and senior financial officers are responsible for tracking, coding, and monitoring loans that become Troubled Debt Restructurings (“TDRs”). Concessions are made to existing borrowers in the form of modified interest rates and / or payment terms. The loans are segregated for regulatory and external reporting. Each specific TDR is reviewed to determine if the accrual of interest should be discontinued and also reviewed for impairment. The Company’s senior credit administration officer performs this analysis on a quarterly basis in addition to determining any other loans that are impaired within the loan portfolio. The Company had a total of $9,305 and $12,060 of loans categorized as troubled debt restructurings as of March 31, 2015 and December 31, 2014, respectively. Interest is accrued on TDRs if the loan is otherwise not impaired and the full collection of principal and interest under the modified terms is still deemed probable.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.

The following tables summarize the troubled debt restructurings during the three months ended March 31, 2015 and 2014.




 
21

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

 
 
Troubled Debt Restructurings –Three months ended March 31, 2015
Interest only
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
         Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
2
2,203
2,203
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
2
2,203
2,203

Troubled Debt Restructurings
Below Market Rate
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
        Real Estate Secured
     
Residential 1-4 family
1
863
863
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
1
1,547
1,547
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
2
2,410
2,410


 
22

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings
Loan term extension
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
                Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
     
Troubled Debt Restructurings
All
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
Total Restructurings
4
4,613
4,613

Troubled Debt Restructurings
That Subsequently Defaulted
Number of Contracts
 
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
                 Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development, Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
-
-
-


 
23

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

 
 
Troubled Debt Restructurings –Three months ended March 31, 2014
Interest only
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
         Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
1
1,395
1,395
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
1
1,395
1,395

Troubled Debt Restructurings
Below Market Rate
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
        Real Estate Secured
     
Residential 1-4 family
1
879
879
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
1
707
707
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
2
1,586
1,586


 
24

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Troubled Debt Restructurings
Loan term extension
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
                Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
1
129
129
       
Total
1
129
129
Troubled Debt Restructurings
All
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
Total Restructurings
4
3,110
3,110

Troubled Debt Restructurings
That Subsequently Defaulted
Number of Contracts
 
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
                 Real Estate Secured
     
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development, Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
-
-
-



 
25

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The loan review function performs various tasks that are utilized to discover weaknesses within the loan portfolio.  These include annual reviews on loan relationships that are greater than $500.  The relationship review includes a discussion on the collateral, repayment history, guarantor(s) financial position, and debt service coverage on an individual and global level.  These reviews are based primarily upon federal tax returns for cash flow determination, internally prepared interim statements and personal financial statements.  Debt service coverage (DSC) is calculated on each individual customer, or guarantor, as well as the aggregate or global DSC.  The DSC is discounted to determine a “stressed” DSC.  Collateral evaluation includes an inspection of the collateral file to determine if the Bank is indeed properly securitized.  Collateral is discounted, when appropriate, to determine a “stressed” loan to value (LTV) ratio.   In addition to annual loan relationship reviews, quarterly reviews on all loan relationships over $100 that are graded Substandard, Doubtful and Loss are also completed.  This quarterly review process is comprised of a shortened version of the full relationship review.  These quarterly reviews include a discussion on personal credit management, DSC and LTV.  In addition to these quarterly reviews of  non-pass watch list relationships, a semi-annual review is conducted on all Special Mention loan relationships that are on the watch list.  These reviews are prepared in the same manner as the quarterly non-pass relationship reviews.  The appropriateness of the risk rating of each relationship is assessed, with changes to the risk rating being made by the Senior Credit Review Officer, when deemed appropriate. Other measures taken to determine potential problem relationships include the monthly preparation of the watch list.  During that process, past due loan reports are reviewed, as well as any other information that might be presented by loan officers, regarding a particular loan relationship that is exhibiting stress.  To be considered as a watch list relationship, distinct characteristics must be exhibited.  These include, but are not limited to late payments greater than 60 days, a low DSC calculation, bankruptcy filings, casualty losses, or other issues that would cause a perceived increase in the risk of loss to the Bank. The final segment of the loan review process involves special reviews.  These reviews target specific segments of the loan portfolio, i.e. credit cards, equity lines, consumer loans, construction loans, and other specific segments of the loan portfolio that management wishes to have reviewed.  However, currently, the primary emphasis of the loan review function is loan relationship review work, and watch list management.

The segments of the Company’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. In reviewing risk, management has determined there to be several different risk categories within the loan portfolio. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate loan portfolio; (iii) the construction loan portfolio; (iv) the consumer loan portfolio; and, (v) the residential loan portfolio. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing.

The following describes the Company’s basic methodology for computing its ALLL.

On a quarterly basis, the ALLL methodology begins with the identification of loans subject to ASC 310.  All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired under ASC 310. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans, together with any Troubled Debt Restructured (TDR) loan, may warrant further analysis before completing an assessment of impairment.

For ASC 310 loans that are individually evaluated and found to be impaired (primarily those designated as Substandard and Doubtful), the associated ALLL will be based upon one of the three impairment measurement methods specified within ASC 310:

(1)  
Present value of expected future cash flows discounted at the loan’s effective interest rate;
(2)  
Loan’s observable market price; or
(3)  
Fair value of the collateral.


 
26

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

To determine the amount of loan loss exposure for the impaired ASC 310 loans, the value of collateral for secured loans is evaluated to determine the current value and potential exposure.  The collateral value is adjusted for its age and condition, and, for real estate, adjusted for condition, location, and age of the most current appraisal.  If the adjusted value of the collateral is less than the current principal balance, the difference is designated as direct exposure for loan loss calculations.  The total balance of unsecured loans is considered as direct exposure.
 
 
ASC 450 Loan Loss:

For all other loans, including individual loans determined not to be impaired under ASC 310, the associated ALLL is calculated in accordance with ASC 450 that provides for estimated credit losses likely to be realized on groups of loans with similar risk characteristics. The Company uses standard call report categories to segregate loans into groups with similar risk characteristics. Estimated credit losses reflect significant factors that affect the collectability of the portfolio as of the evaluation date. Key factors that influence risk within the Company’s loan portfolio are divided into three major categories:

(1) Historical Loss Factor: To calculate the anticipated loan loss in each call report category for ASC 450 loans, the Company begins with the net loss in each category for each of the last twelve quarters. The Company uses a rolling twelve quarter weighted historical loss average where the most recent quarters are weighted heavier than the earlier quarters so that the calculation reflects current risk trends within the portfolio.  The weighting used by the Company is similar to the Rule of 78’s with the net losses of the most recent quarter weighted at 12/78ths and those in the first quarter in the twelve quarter period weighted at 1/78th.   Therefore, the net losses of the most recent year represent approximately 54% of the calculation compared with 33% if a simple average of losses over the three-year period was used.  The total of weighted factors for each call report category is applied to the current outstanding loan balance in each category to calculate expected loss based on historical data for a group of loans with similar risk characteristics.  The same weighting is applied to all loan types.

(2)External economic factors:  Economic conditions have a significant impact on Company’s loan portfolio because deteriorating conditions can adversely impact both collateral values and the customer’s ability to service debt.  Management has selected the following external factors as indicators of economic conditions:

a.  
National GDP Growth Rate
b.  
Local Unemployment Rates
c.  
The Prime Rate

The values for external factors are updated on a quarterly basis based on current economic data.

(3)Internal process factors:  Internal factors that influence loss rates as a result of risk management and control practices include the following:

d.  
Past-Due Loans
e.  
Non-Accrual Loans
f.  
CRE Concentrations
g.  
Loan Volume Level
h.  
Level and Trend of Classified Loans

  The values for internal factors are updated on a quarterly basis based on current portfolio metrics.

Once the quarterly ALLL is computed, the calculations are reviewed by the Company’s credit administration committee which is comprised of the CEO, CFO, and Senior Lending Officers, including Credit Review personnel.  The Company’s controller also performs a detailed review of the computations, estimates, etc. included in the ALLL calculation. The ALLL is then reviewed and approved by the Board of Directors.





 
27

 



Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note 3  -  Income Taxes

Income tax expense for the three months ended March 31 is different than the amount computed by applying the statutory corporate federal income tax rate of 34% to income before taxes.  The reasons for these differences are as follows:

   
2015
   
2014
 
             
Tax expense at statutory rate
  $ 257     $ 218  
Reduction in taxes from:
               
Tax-exempt interest
    (37)       (42)  
Other, net
    (43)       (37)  
                 
Income tax expense
  $ 177     $ 139  

Note 4  - Capital Requirements

Regulators of the Company and its subsidiary, Highlands Union Bank (the “Bank”), have implemented risk-based capital guidelines which require compliance with certain minimum capital ratios as a percent of assets and other certain off-balance sheet items that are adjusted for predefined credit risk factors.  On July 7, 2013 the Federal Reserve Board approved Basel III Final Rules to begin implementation January 1, 2015. The desired overall objective of Basel III is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress.  The Final Rule includes a new Common Equity Tier 1 (CET1) minimum ratio and raises the Tier 1 Risk Weighted Assets ratio to 6% from 4%.  In addition, the new rules require a bank to maintain a capital conservation buffer of between 2 and 2 ½ % beginning in 2016.  Additionally, the new rules increase the risk weighting of various assets. The new rules will be phased in beginning in 2015 with complete compliance required by 2019.  Generally, the Basel III Final Rule will require banks to maintain higher levels of common equity and regulatory capital. On December 18, 2014, the President of the United States signed into law Public Law 113-250 (the “Act”), which directs the Board of Governors of the Federal Reserve System (Board) to propose revisions to the Small Bank Holding Company Policy Statement (Policy Statement) to raise the total consolidated asset limit in the Policy Statement from $500 million to $1 billion. On February 5, 2015 the Company received notification from the Federal Reserve Bank that it would no longer be required to report holding company consolidated capital ratios. The following tables present the capital ratios for the Bank only.


                                                                      March 31, 2015
 
Entity
Tier 1
Total Risk Based
Leverage
 CET 1
       
Effective 3/31/15
Highlands Union Bank
11.65%
12.92%
7.42%
11.65%

                                                                   December 31, 2014
 
Entity
Tier 1
Total Risk Based
Leverage
CET 1
         
         
Highlands Union Bank
12.93%
14.19%
7.71%
N/A



 
28

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note 5. Private Placement Capital Raise / Rights Offering

On April 16, 2014, management and board of directors of Highlands Bankshares, Inc. announced the completion of a $16,525 private placement capital raise. Purchasers in the private placement included outside investors, as well as certain directors and executive officers of the Company. The Company sold 2,673,249 newly issued shares of the Company’s common stock at $3.50 per share, and 2,048,179 shares of Series-A convertible perpetual preferred stock at $3.50 per share. The private placement was disclosed on Form 8-K on April 16, 2014. The Company immediately paid off a Holding Company Loan in the amount of $3,440 to Community Bankers Bank on April 16, 2014 with the funds received from the capital raise. The Company also paid off the remaining $3,150 of its trust preferred securities including accrued interest. The payoff totaling $4,802 was completed on July 15, 2014. The Company down-streamed to the subsidiary Bank in June 2014 $7,500 of funds received from the capital raise. During the third quarter of 2014, the Company also conducted a rights offering to its existing shareholders other than directors and executive officers. The Company raised a total of $556 as a result of the offering. The Company immediately down-streamed $400 of the $556 to the Bank in September of 2014. In October 2014, one of the private placement purchasers, TNH Financial Fund, LP, purchased another $183 of common and preferred stock which allowed them to maintain the same ownership percentage that was held immediately prior to the rights offering. Net proceeds received from the private placement issues and rights offering totaled $16,123.

Note 6 – Stock and Earnings Per Share

Earnings per common share is computed using the weighted average outstanding shares for the three months  ended March 31, 2014 and 2015.  Outstanding stock options impact on earnings per share is determined using the treasury stock method. For 2015 and 2014, the impact of conversions of outstanding stock options was anti-dilutive. During 2014, the Company issued a total of 2,092,287 shares of Series A preferred stock (See Note 5). These preferred shares are non-voting mandatorily convertible non-cumulative preferred shares which are entitled to receive dividends equal to dividends paid on the Company’s common shares. The Series A preferred shares will rank pari passu with the common stock with respect to all terms (other than voting), including, the payment of dividends or distributions, and payments and rights upon liquidation and dissolution. The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per common share computation:

For the three months ended March 31
         2015
 
          2014
       
Income available to common stockholders
$          580
 
$           501
Weighted average shares outstanding
         7,851
 
          5,011
Shares outstanding including assumed conversion
         9,943
 
          5,011
Basic earnings per common share
 $        0.07
 
 $         0.10
Fully diluted earnings per share (including convertible preferred shares oustanding)
 $        0.06
 
 $         0.10

Note 7 – Commitments and Contingencies

The Bank is a party to various financial instruments with off-balance sheet risk arising in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. At March 31, 2015, these commitments included: standby letters of credit of $356; equity lines of credit of $8,101; credit card lines of credit of $6,205; commercial real estate, construction and land development commitments of $2,544; and other unused commitments to fund interest earning assets of $26,288.


 
29

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note  8 – Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy
        
Under ASC Topic 820 on Fair Value Measurements and Disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 
Level 1 
 
Valuation is based upon quoted prices for identical instruments traded in active markets.
       
 
Level 2 
 
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
       
 
Level 3 
 
Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
        
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.




 
30

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Recurring - Investment Securities Available for Sale

Securities classified as available for sale are reported at fair value utilizing Level 2. For Level 2 securities, the Company obtains fair value measurements from multiple independent third party sources. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things.

The following tables summarize the Company’s available for sale securities portfolio measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014, segregated by the level of the valuation inputs within the fair value hierarchy.


March 31, 2015
 
Level 1
Level 2
Level 3
Total Fair Value
Available for Sale Securities
       
State and Political Subdivisions
$          -
$    8,300
$          -
$    8,300
Mortgage Backed Securities
$          -
$  64,665
$          -
$  64,665
Single Issue Trust Preferred
$          -
$       484
$          -
$       484
SBA Pools
$          -
$  12,089
$          -
$  12,089
Total AFS Securities
$          -
$  85,538
        $          -
$  85,538



December 31, 2014
 
Level 1
Level 2
Level 3
Total Fair Value
Available for Sale Securities
       
State and Political Subdivisions
$          -
$    9,701
$          -
$    9,701
Mortgage Backed Securities
$          -
$  61,723
$          -
$  61,723
Single Issue Trust Preferred
$          -
$       488
$          -
$       488
SBA Pools
$          -
$  12,423
$          -
$  12,423
Total AFS Securities
$          -
$  84,335
        $          -
$  84,335



 
31

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Non Recurring - Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including recently appraised collateral value and /or tax assessed value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2015 and December 31, 2014, all of the total impaired loans were evaluated based on the fair value of the collateral.  The Company frequently obtains appraisals prepared by external professional appraisers and applies discounts ranging from 8% to 40% depending on type of property, condition, location, etc. which the Company considers to be nonrecurring Level 3. The Company also, in certain instances, prepares internally generated valuations from on-site inspections, third-party valuation models or other information.

Non Recurring -Foreclosed Assets / Repossessions

Foreclosed assets and repossessions are adjusted to fair value upon transfer of the loans to foreclosed assets and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or recent appraised values of the collateral, which the Company considers to be nonrecurring Level 2.  When the current appraised value is not available and /or further discounted below the most recent appraised value less selling costs due to such things as absorption rates and market conditions, the Company classifies the foreclosed assets within Level 3 of the fair value hierarchy.

The following table summarizes the Company’s assets at fair value on a non - recurring basis as of March 31, 2015 and December 31, 2014 segregated by the level of the valuation inputs within the fair value hierarchy. The tables disclose the recorded investment of impaired loans requiring a specific allowance.

March 31, 2015
 
Level 1
   
Level 2
   
Level 3
   
Total Fair Value
 
Impaired Loans
  $ -     $ -     $ 6,330     $ 6,330  
Repossessions/OREO, net
  $ -     $ -     $ 9,109     $ 9,109  

December 31, 2014
 
Level 1
   
Level 2
   
Level 3
   
Total Fair Value
 
Impaired Loans
  $ -     $ -     $ 7,895     $ 7,895  
Repossessions/OREO, net
  $ -     $ -     $ 6,704     $ 6,704  



 
32

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Company uses Level 3 inputs to determine fair value (dollars in thousands):
 
       
Quantitative Information about Level 3 Fair Value Measurements
 
 
   
 March 31,
 
December 31, 
 
Valuation
 
Unobservable
 
Range
 
   
2015
 
2014
 
Techniques
 
Input (2)
 
(Weighted Average)
 
OREO,Repossessions
 
$
9,109
 
$
6,704
 
Appraisal of collateral (1)
 
Appraisal adjustments
 
0% to 45% (13%)
 
               
Liquidation expenses
 
0% to 10% (9%)
 
                       
Impaired loans
 
$
6,330
 
$
7,895
 
Fair value of collateral –real estate  (1), (3)
 
Appraisal adjustments
 
0% to 10% (9%)
 
           
 Fair value of collateral –equipment, inventory, other  (1), (3)
 
Appraisal adjustments
 
25% to 50% (33%)
 
               
Liquidation expenses
 
0% to 10% (9%)
 

Valuation adjustments and liquidation cost adjustments represent unobservable inputs for OREO and impaired loans.  The ranges of discounts applied are based on age of independent appraisals, type and condition of collateral, current market conditions, and experience with the local market.
 
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.
 
(2)
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses.  The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
 
(3)
Includes qualitative adjustments by management.
   
 
 
 
 
 
33

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

General

The Company has no liabilities carried at fair value or measured at fair value on a recurring or non-recurring basis.

Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and Cash Equivalents

The carrying amount reported in the balance sheets for cash, short-term investments and federal funds sold approximates fair value.

Securities Available for Sale

Fair values are determined in the manner as described above.

Other Investments

Other investments include Federal Home Loan Bank stock, Federal Reserve Bank stock, Community Bankers Bank stock, and Pacific Coast Bankers Bank.  The carrying value of those securities approximates fair value based on the redemption provisions of those Banks. Also included in other investments are certificates of deposit purchased from other FDIC insured banks in which the carrying amount approximates fair value.

Loans

The fair value of loans represent the amount at which the loans of the Bank could be exchanged on the open market, based upon the current lending rate for similar types of lending arrangements discounted over the remaining life of the loans. For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the cash flow analysis.

Deposits

The fair value of time deposits is based on discounted cash flows using current market rates applied to the cash flow analysis for each time deposit. Other non-maturity deposits are reported at their carrying values.
 
Other Short-Term Borrowings
 

Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Estimated maturity dates are also included in the calculation of fair value for these borrowings.


 
34

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)


Long-term Debt and Capital Securities

Rates currently available to the Company for debt with similar terms and remaining maturities or established call prices are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments

The amount of off-balance sheet commitments to extend credit, standby letters of credit, and financial guarantees, is considered equal to fair value.  Because of the uncertainty involved in attempting to assess the likelihood and timing of commitments being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the given value of the commitment.

The carrying amounts and fair values of the Company's financial instruments at March 31, 2015 and December 31, 2014 were as follows:
 



 
March 31, 2015
 
December 31, 2014
 
 
Carrying Amount
Fair Value
 
Carrying Amount
Fair Value
 
     
             
Cash and cash equivalents
$    55,953
$    55,953
 
$    55,810
$    55,810
 
Securities available for
 sale
85,538
85,538
 
84,335
84,335
 
Other investments
6,599
6,599
 
6,767
6,767
 
Loans, net
403,827
400,547
 
401,520
398,019
 
Deposits
(487,992)
(472,282)
 
(483,497)
(464,335)
 
Other short-term
  borrowings
(20,050)
(21,453)
 
(20,051)
(21,495)
 
Long-term debt
(47,738)
(51,117)
 
(47,750)
(50,799)
 
 

 
 
35

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note  9 -Investment Securities Available For Sale

The amortized cost and market value of securities available for sale are as follows:
 
 
March 31, 2015
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
               
State and political subdivisions
$   8,128
 
$      172
 
$         -
 
$      8,300
Mortgage backed securities
64,299
 
510
 
144
 
64,665
Single Issue Trust Preferred
500
 
-
 
16
 
484
SBA Pools
12,234
 
13
 
158
 
12,089
 
$    85,161
 
$       695
 
$    318