10-Q 1 hbiform10q081415.htm FORM 10Q hbiform10q081415.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 June 30, 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 August 14, 2015
 
 
 
 

 

 
Highlands Bankshares, Inc.

FORM 10-Q
For the Quarter Ended June 30, 2015

INDEX
   
PART I. FINANCIAL INFORMATION  
PAGE
   
Item 1.  Financial Statements
 
   
Consolidated Balance Sheets
  at June 30, 2015 (Unaudited) and December 31, 2014
 
2
 
 
Consolidated Statements of Income (Unaudited)
  for the Three Months and Six Months Ended June 30, 2015 and 2014
3
   
    Consolidated Statements of   Comprehensive Income (Unaudited)
for the Three Months and Six Months Ended June 30, 2015 and 2014
4
 
Consolidated Statements of Cash Flows (Unaudited)
 for the Six Months Ended June 30, 2015 and 2014
5
   
Consolidated Statements of Changes in
 Stockholders’ Equity (Unaudited) for the Three Months and Six Months
 Ended June 30, 2015 and 2014
6-7
   
Notes to Consolidated Financial Statements (Unaudited)
8-37
   
Item 2. Management’s Discussion and Analysis of
              Financial Condition and Results of Operations
387-432
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
44
   
Item 4.  Controls and Procedures
44
 
 
PART II.  OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
44
   
Item 1A. Risk Factors
44
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
44
   
Item 3.  Defaults Upon Senior Securities
44
   
Item 4.  Mine Safety Disclosures
44
   
Item 5.  Other Information
45
   
Item 6.  Exhibits
45
   
SIGNATURES AND CERTIFICATIONS
45
 
 
 
1

 
PART I.
FINANCIAL INFORMATION
          ITEM 1.  Financial Statements

Consolidated Balance Sheets
(Amounts in thousands)
   
       (Unaudited)
  June 30, 2015
 
(Note 1)
December 31, 2014
                                              ASSETS
       
Cash and due from banks
 
$     20,384
 
     $      15,018
Federal funds sold
 
      31,364
 
  40,792
         
   Total Cash and Cash Equivalents
 
 51,748
 
55,810
         
Investment securities available for sale  (amortized cost $84,028  at  June 30, 2015, $84,191 at December 31, 2014)
 
83,896
 
84,335
Other investments, at cost
 
6,599
 
6,767
Loans, net of allowance for loan losses of  $5,446 at June 30, 2015, $5,477 at December 31, 2014
 
408,496
 
401,520
Premises and equipment, net
 
20,112
 
20,236
Deferred tax assets
 
11,695
 
10,744
Interest receivable
 
2,233
 
2,235
Bank owned life Insurance
 
14,379
 
14,183
Other real estate owned
 
7,955
 
6,685
Other assets
 
       2,974
 
        2,599
         
    Total Assets
 
$   610,087
 
$    605,114
         
LIABILITIES AND STOCKHOLDERS’ EQUITY
       
         
LIABILITIES
       
         
Deposits:
       
  Non-interest bearing
 
$    118,592
 
$      118,557
  Interest bearing
 
    368,608
 
     364,940
         
    Total Deposits
 
    487,200
 
     483,497
         
Interest, taxes and other liabilities
 
1,010
 
1,014
Other short-term borrowings
 
20,051
 
20,051
Long-term debt
 
47,724
 
47,750
         
    Total Other Liabilities
 
      68,785
 
       68,815
         
    Total Liabilities
 
    555,985
 
     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
 
27,150
 
25,436
Accumulated other comprehensive income (loss)
 
   (86)
 
                           95
  Total Stockholders’ Equity
 
      54,102
 
      52,802
         
    Total Liabilities and Stockholders’ Equity
 
$  610,087
 
$   605,114
 
See accompanying Notes to Consolidated Financial Statements


 
2

 
Consolidated Statements of Income
(Amounts in thousands, except per share data)
(Unaudited)
 
Six Months Ended June 30, 2015
Six Months Ended June 30, 2014
Three Months
Ended June 30, 2015
Three Months
Ended June 30, 2014
 
INTEREST INCOME
       
Loans receivable and fees on loans
$    10,574
$    10,587
$  5,276
$  5,195
Securities available for sale:
       
  Taxable
592
414
279
192
  Exempt from taxable income
197
247
89
124
Other investment income
113
101
61
56
Federal funds sold
           46
           78
           25
           40
         
    Total Interest Income
    11,522
    11,427
    5,730
    5,607
         
INTEREST EXPENSE
       
Deposits
1,117
1,303
547
640
Other borrowed funds
       1,176
       1,456
      591
      715
         
    Total Interest Expense
      2,293
      2,759
      1,138
      1,355
         
    Net Interest Income
      9,229
      8,668
      4,592
      4,252
         
Provision for Loan Losses
       482
       896
         382
         631
         
    Net Interest Income after Provision for Loan Losses
      8,747
      7,772
      4,210
      3,621
         
NON-INTEREST INCOME
       
Securities gains, losses, net
16
-
-
-
Service charges on deposit accounts
821
946
430
494
Other service charges, commissions and fees
829
852
494
453
Other operating income
281
361
          157
          212
    Total Non-Interest Income
       1,947
2,159
      1,081
1,159
         
NON-INTEREST EXPENSE
       
Salaries and employee benefits
5,013
4,973
2,567
2,506
Occupancy expense of bank premises
594
576
285
296
Furniture and equipment expense
               676
               572
336
270
Other operating expense
        2,732
        2,661
1,415
1,472
Foreclosed Assets – Write-down and operating expenses
823
772
589
499
    Total Non-Interest Expense
      9,838
      9,554
       5,192
       5,043
         
    Income Before Income Taxes
856
377
99
(263)
         
 
Income Tax Benefit
(858)    
      (1,030)
      (1,035)
      (1,169)
         
    Net Income
$       1,714
$       1,407
$          1,134
$          906
         
Basic Earnings Per Common Share – Weighted Average
$         0.22
$         0.23
$        0.14
$        0.13
         
Earnings Per Common Share – Assuming Dilution
$         0.17
$         0.17
$         0.11
$         0.10
 
See accompanying Notes to Consolidated Financial Statements



 
3

 



Consolidated Statements of Comprehensive Income
(Amounts in thousands)
(Unaudited)
 
Six Months Ended  June 30, 2015
 
Six Months Ended  June 30, 2014
       
       
Net Income
$     1,714
 
$     1,407
       
     Other Comprehensive Income
     
  Unrealized gains (losses) on securities during  the period
(258)
 
1,016
  Less: reclassification adjustment for gains included in net income
(16)
 
-
          Other Comprehensive Income (Loss), before tax
(274)
 
1,016
           Income tax (expense) benefit related to other
           comprehensive income
93
 
(345)
    Other Comprehensive Income (Loss)
(181)
 
671
Comprehensive Income
$     1,533
 
$     2,078
       


 
Three Months Ended  June 30, 2015
 
Three Months Ended June 30, 2014
       
       
Net Income
$     1,134
 
$     906
       
     Other Comprehensive Income
     
  Unrealized gains  (losses) on securities during  the period
(508)
 
495
  Less: reclassification adjustment for losses  included in net income
-
 
-
          Other Comprehensive Income (Loss), before tax
(508)
 
495
           Income tax (expense) benefit related to other
           comprehensive income
173
 
(168)
    Other Comprehensive Income (Loss)
(335)
 
327
Comprehensive Income
$     799
 
$     1,233
       


See accompanying Notes to Consolidated Financial Statements




 
4

 

 


Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
 
Six Months Ended
Six Months Ended
 
June 30, 2015
 
June 30, 2014
CASH FLOWS FROM OPERATING  ACTIVITIES:
   
Net income
$        1,714
$        1,407
Adjustments to reconcile net income to net cash provided by                 operating activities
   
Provision for loan losses
482
896
Depreciation and amortization
490
435
Net realized (gains) losses on available for sale securities
(16)
-
Net amortization on securities
526
269
Amortization of capital issue costs
-
7
            (Increase) decrease in interest receivable
2
(104)
Valuation adjustment of other real estate owned
20
160
Valuation adjustment of deferred tax assets
(1,000)
(1,000)
Increase in other assets
                     (245)
                  (1,274)
Increase (decrease) in interest, taxes and other liabilities
    (4)
    154
     
Net cash provided by operating activities
              1,969
              950
     
CASH FLOWS FROM INVESTING ACTIVITIES:
   
Securities available for sale:
   
       Proceeds from sale of securities
 1,025
 -
Proceeds from maturities of debt and equity securities
 8,945
 3,870
Purchase of securities
(10,317)
(3,445)
(Purchases) sales of other investments
168
                   (1,820)
Net increase in loans
(10,979)
(6,391)
Proceeds from sales of other real estate owned
1,709
1,236
Premises and equipment expenditures
           (259)
           (242)
     
Net cash used in investing activities
       (9,708)
       (6,792)
     
CASH FLOWS FROM FINANCING ACTIVITIES:
   
      Issuance of Common Stock
-
9,356
      Issuance of Preferred Stock
-
7,168
Net decrease in time deposits
                      (7,249)
                    (7,111)
Net increase (decrease) in demand, savings and other deposits
                   10,952
                   (718)
Decrease in short-term borrowings
-
(3,450)
Decrease in long-term debt
(26)
(26)
     
Net cash  provided by  financing activities
  3,677
   5,219
     
Net  decrease in cash and cash equivalents
                    (4,062)
                    (623)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
     55,810
     83,995
     
CASH AND CASH EQUIVALENTS AT END OF PERIOD
$    51,748
$    83,372
     
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
   
Cash paid during the period for:
   
Interest
$      2,302
$      2,381
     
     SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
   
Transfer of loans to other real estate owned
$      3,520
$      2,358
Loans originated from sales of other real estate owned
$         130
$         342
 
See accompanying Notes to Consolidated Financial Statements


 
5

 

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

Three Months Ended June 30
           
Accumulated
 
         
Additional
 
Other
Total
 
    Common Stock
 
    Preferred Stock
Paid In
Retained
Comprehensive
Stockholders’
 
Shares
 Par Value
Shares
 Par Value
Capital
Earnings
Income (Loss)
Equity
                 
 
Balance, March 31, 2014
5,011
$    3,132
   
$    7,783
$    23,411
$       (490)
$    33,836
                 
 
Net income
-
-
   
-
906
-
906
                 
 
Common Stock Issuance
2,673
1,671
   
7,685
   
9,356
                 
 
Preferred Stock Issuance
   
 
2,048
 
4,096
3,073
   
7,169
                 
Other comprehensive income
-
-
   
-
-
327
327
                 
 
Balance June 30, 2014
7,684
$    4,803
 
2,048
 
$4,096
$    18,541
$    24,317
$        (163)
$    51,594
                 
 
Balance, March 31, 2015
7,851
$    4,907
 
2,092
 
$  4,184
$    17,947
$    26,016
$       249
$    53,303
                 
Net income
-
-
   
-
1,134
-
1,134
                 
Other comprehensive income (loss)
-
-
   
-
-
(335)
(335)
                 
 
Balance, June 30, 2015
7,851
$    4,907
 
2,092
 
$4,184
$    17,947
$    27,150
$        (86)
$    54,102
                 
                 



 
6

 



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





Six Months Ended June 30
           
Accumulated
 
         
Additional
 
Other
Total
 
    Common Stock
 
    Preferred Stock
Paid-in
Retained
Comprehensive
Stockholders’
 
Shares
 Par Value
Shares
 Par Value
Capital
Earnings
Income (Loss)
Equity
                 
 
Balance, December 31, 2013
5,011
$    3,132
   
$    7,783
$    22,910
$       (834)
$    32,991
                 
                 
Net income
-
-
   
-
1,407
-
1,407
                 
Common Stock Issuance
2,673
1,671
   
7,685
   
9,356
                 
 
Preferred Stock Issuance
   
 
2,048
 
4,096
3,073
   
7,169
                 
                 
                 
Other comprehensive income
-
-
   
-
-
671
671
                 
Balance, June 30, 2014
7,684
$    4,803
2,048
$4,096
$    18,541
$    24,317
$        (163)
$    51,594
                 
                 
 
Balance, December 31, 2014
7,851
$    4,907
 
2,092
 
$  4,184
$    18,180
$    25,436
$       95
$    52,802
                 
                 
Net income
-
-
   
-
1,714
-
1,714
                 
Additional Paid In Capital
       
(233)
   
(233)
                 
Other comprehensive income (loss)
-
-
   
-
-
(181)
(181)
                 
 
Balance, June 30, 2015
7,851
$    4,907
 
2,092
 
$4,184
$    17,947
$    27,150
$        (86)
$    54,102

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 and six month periods ended June 30, 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:
 
June 30, 2015
 
December 31, 2014
Real Estate Secured:
     
Residential 1-4 family
$ 190,840
 
$   186,829
Multifamily
23,599
 
21,131
Construction and Land Loans
17,007
 
18,518
Commercial, Owner Occupied
69,382
 
70,748
Commercial, Non-owner occupied
32,118
 
32,173
Second mortgages
7,870
 
8,075
Equity lines of credit
            5,902
 
6,499
Farmland
9,113
 
8,246
 
355,831
 
352,219
       
Secured (other) and unsecured
     
Personal
21,056
 
20,901
Commercial
34,376
 
31,586
Agricultural
3,143
 
2,683
 
58,575
 
55,170
       
Overdrafts
246
 
285
       
 
414,652
 
407,674
Less:
     
  Allowance for loan losses
            5,446
 
                         5,477
  Net deferred fees
710
 
                             677
 
6,156
 
6,154
       
Loans, net
$    408,496
 
$    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 June 30, 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
 
 $ 3,966
 
 $    2,179
 
 $  1,909
 
 $  8,054
 
 $  182,786
 
 $  190,840
 
 $         -
Equity lines of credit
 
 33
 
 12
 
6
 
 51
 
 5,851
 
 5,902
 
-
Multifamily
 
 -
 
 -
 
 -
 
 -
 
 23,599
 
 23,599
 
-
Farmland
 
1,206
 
 -
 
 68
 
1,274
 
 7,839
 
 9,113
 
-
Construction, Land Development, Other Land Loans
 
435
 
 61
 
81
 
577
 
 16,430
 
 17,007
 
 -
Commercial Real Estate- Owner Occupied
 
 2,236
 
 -
 
3,592
 
 5,828
 
 63,554
 
 69,382
 
 -
Commercial Real Estate- Non Owner Occupied
 
 -
 
368
 
 85
 
 453
 
 31,665
 
 32,118
 
 -
Second Mortgages
 
 59
 
 61
 
 52
 
 172
 
 7,698
 
 7,870
 
 -
Non Real Estate Secured
                           
Personal
 
 362
 
 55
 
 193
 
 610
 
 20,692
 
 21,302
 
 -
Commercial
 
 484
 
 348
 
 484
 
 1,316
 
 33,060
 
 34,376
 
 -
Agricultural
 
 24
 
 -
 
 -
 
 24
 
 3,119
 
 3,143
 
 -
                             
          Total
 
 $  8,805
 
 $    3,084
 
 $   6,470
 
 $  18,359
 
 $  396,293
 
 $  414,652
 
 $          -
                             

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
                             


 
9

 
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.  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 June 30, 2015 and December 31, 2014:


 
June 30, 2015
 
December 31, 2014
 
Real Estate Secured
       
Residential 1-4 Family
                                                       $           1,909
 
 $       3,401
 
Multifamily
-
 
-
 
Construction and Land Loans
81
 
168
 
Commercial-Owner Occupied
3,592
 
5,259
 
Commercial- Non Owner Occupied
1,627
 
1,547
 
Second Mortgages
52
 
134
 
Equity Lines of Credit
6
 
-
 
Farmland
146
 
477
 
Secured (other) and Unsecured
       
Personal
193
 
211
 
Commercial
484
 
447
 
Agricultural
            -
 
             -
 
         
Total
$             8,090
 
$     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 June 30, 2015.

 
Number
Balance
 
Residential real estate in the process of foreclosure
 
-
 
                     $         -
 
Foreclosed residential real estate
                     13
                     $ 1,631
 





 
10

 

 
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 June 30, 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 June 30, 2015
Grade (1)
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
                         
Quality
 
 28,340
 
1,253
 
 29
 
 2,272
 
 3,181
 
 527
Satisfactory
 
 103,372
 
 17,545
 
 4,527
 
 6,909
 
 35,174
 
 15,371
Acceptable
 
 45,678
 
 2,783
 
 3,542
 
 5,552
 
 19,977
 
 11,832
Special Mention
 
 3,671
 
810
 
 196
 
 2,159
 
 3,277
 
 2,394
Substandard
 
 9,779
 
 1,208
 
 819
 
 115
 
 7,773
 
 1,994
Doubtful
 
 -
 
 -
 
 -
 
 -
 
 -
 
 -
                         
     Total
 
$   190,840
 
$     23,599
 
$     9,113
 
$        17,007
 
$     69,382
 
$     32,118


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


 
(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.  
 
11

 

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.
 
 
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.
 
 
12

 
 
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; and/or,
 
 
·  
Liquidation of assets or the pledging of additional collateral.
 
Credit Risk Profile based on payment activity as of  June 30, 2015
   
Consumer - Non Real Estate
 
Equity Line of Credit / Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
                 
Performing
 
$       21,109
 
$          13,714
 
$              33,892
 
$            3,143
Nonperforming (>90 days past due)
 
193
 
 58
 
484
 
-
                 
     Total
 
$       21,302
 
$        13,772
 
$              34,376
 
$           3,143
                 


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
                 




 
13

 
 
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 June 30, 2015:
 
 
June 30, 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
 
$     8,067
 
$     8,067
 
$          -
 
$     8,028
 
$       180
Equity lines of credit
 
76
 
76
 
-
 
50
 
2
Multifamily
 
1,208
 
1,208
 
-
 
1,230
 
32
Farmland
 
830
 
830
 
-
 
836
 
30
Construction, Land Development, Other Land Loans
 
1,591
 
1,591
 
-
 
1,665
 
46
Commercial Real Estate- Owner Occupied
 
7,022
 
7,022
 
-
 
8,105
 
75
Commercial Real Estate- Non Owner Occupied
 
85
 
85
 
-
 
43
 
-
Second Mortgages
 
239
 
239
 
-
 
429
 
6
Non Real Estate Secured
                   
Personal /Consumer
 
57
 
57
 
-
 
56
 
2
Commercial
 
438
 
438
 
-
 
400
 
4
Agricultural
 
-
 
-
 
-
 
-
 
-
                     
          Total
 
$    19,613
 
$    19,613
 
$          -
 
$   20,842
 
$       377



 
 
June 30, 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
 
$     2,952
 
$     2,952
 
$       567
 
$     3,050
 
$       70
Equity lines of credit
 
6
 
6
 
6
 
3
 
-
Multifamily
 
-
 
-
 
-
 
-
 
-
Farmland
 
-
 
-
 
-
 
-
 
-
Construction, Land Development, Other Land Loans
 
366
 
366
 
20
 
366
 
11
Commercial Real Estate- Owner Occupied
 
750
 
750
 
1
 
1,077
 
18
Commercial Real Estate- Non Owner Occupied
 
1,909
 
1,909
 
314
 
1,913
 
17
Second Mortgages
 
-
 
-
 
-
 
-
 
-
Non Real Estate Secured
                   
Personal /Consumer
 
184
 
184
 
124
 
219
 
3
Commercial
 
834
 
834
 
666
 
818
 
16
Agricultural
 
-
 
-
 
               -
 
-
 
-
                     
          Total
 
$    7,001
 
$    7,001
 
$     1,698
 
$    7,446
 
$       135




 
14

 
 
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






 
15

 
 
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 June 30, 2015 and June 30, 2014.



Six  months ended June 30, 2015
Residential
1-4 Family
Multifamily
Construction and Land Loans
Commercial  R./E Owner Occupied
Commercial R/E 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
64
(20)
(52)
(123)
(18)
(8)
(80)
(1)
134
362
224
482
Charge-offs
98
-
-
-
392
3
-
-
230
177
-
900
Recoveries
(1)
-
(18)
(1)
(275)
-
(41)
-
(44)
(7)
-
(387)
Net Charge-offs
97
            -
(18)
(1)
117
3
(41)
-
186
170
-
513
Ending Balance
 June 30, 2015
962
-
53
287
928
56
35
11
613
1,174
1,327
5,446
Ending Balance: Individually evaluated for impairment
567
-
20
1
314
-
6
-
124
666
-
1,698
Ending Balance:  Collectively Evaluated for Impairment
395
-
33
286
614
56
29
11
489
508
1,327
3,748
Loans:
                       
Ending Balance: Individually Evaluated for Impairment
11,019
1,208
1,957
7,772
1,994
239
82
830
241
1,272
-
26,614
Ending Balance: Collectively Evaluated for Impairment
179,821
22,391
15,050
61,610
30,124
7,631
5,820
8,283
21,061
36,247
-
388,038
Ending Balance: June 30, 2015
$190,840
$23,599
$17,007
$69,382
$32,118
$7,870
$5,902
$9,113
$21,302
$37,519
-
$414,652
 

 
 
 
 
 
16

 
 
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 June 30, 2015 and June 30, 2014.

Six  months ended June 30, 2014
 
Residential
1-4 Family
   
Multifamily
   
Construction and Land Loans
   
Commercial R./E Owner Occupied
   
Commercial R/E 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
    259       (62 )     (65 )     (45 )     1,071       (39 )     134       (43 )     234       (74 )     (474 )     896  
Charge-offs
    141       -       18       240       1,163       25       9       -       187       329       -       2,112  
Recoveries
    -       -       (2 )     -       -       (1 )     -       -       (41 )     (20 )     -       64  
Net Charge-offs
    141       -       16       240       1,163       24       9       -       146       309       -       2,048  
Ending Balance
 June 30, 2014
    1,069       81       149       744       1,323       90       175       22       571       881       568       5,673  
Ending Balance: Individually evaluated for impairment
    530       -       -       308       397       -       162       -       164       427       -       1,988  
Ending Balance:  Collectively Evaluated for Impairment
    539       81       149       436       926       90       13       22       407       454       568       3,685  
Loans:
                                                                                               
Ending Balance: Individually Evaluated for Impairment
    8,261       -       1,678       10,585       2,257       148       431       479       305       1,391       -       25,535  
Ending Balance: Collectively Evaluated for Impairment
    174,163       21,168       16,705       60,764       31,180       7,401       6,940       8,540       20,903       32,926       -       380,690  
Ending Balance: June 30, 2014
  $ 182,424     $ 21,168     $ 18,383     $ 71,349     $ 33,437     $ 7,549     $ 7,371     $ 9,019     $ 21,208     $ 34,317       -     $ 406,225  

 
17

 
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 June 30, 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 $9,494 and $12,060 of loans categorized as troubled debt restructurings as of June 30, 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 six months ended June 30, 2015 and 2014.




 
18

 


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

 
 
Troubled Debt Restructurings –Six months ended June 30, 2015
Interest only
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
         Real Estate Secured
     
Residential 1-4 family
1
188
188
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
1
68
68
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
4
2,459
2,459
 
 
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
1
1,547
1,547
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Commercial
     
Agricultural
     
       
Total
2
2,410
2,410



 
19

 



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
6
4,869
4,869
 

 
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
-
-
-




 
20

 
 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
Troubled Debt Restructurings –Six months ended June 30, 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




 
21

 


 
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
6
1,217
1,217
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
 
7
1,346
1,346
Troubled Debt Restructurings
All
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post - Modification Recorded Investment
Total Restructurings
10
4,327
4,327
 

 
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
-
-
-




 
22

 

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.


 
23

 


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.




 
24

 



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

Note 3  -  Income Taxes

Income tax expense (benefit) for the six months ended June 30 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
$     291
$     128
Reduction in taxes from:
   
Tax-exempt interest
(67)
(84)
Valuation adjustment for deferred tax assets
(1,000)
(1,000)
Other, net
      (82)
      (74)
     
Income tax benefit
$     (858)
$     (1,030)

In the second quarter of 2015, the Company reversed the remaining balance of the valuation allowance that was established against the deferred tax assets (“DTA”) during the fourth quarter of 2011. The valuation allowance was established during 2011 due to uncertainty at the time regarding the ability to generate sufficient future taxable income to fully realize the benefit of the net DTA. Subsequent to 2011, earnings performance and asset quality have improved resulting in greater expected realization of the DTA. In addition, the Company raised $16,123 in net proceeds of new capital in 2014 which allowed the Company to pay off two high rate debt instruments (the Company’s Community Bankers Bank note and Trust Preferred Securities) improving future earnings potential.  As a result of these factors, the Company reversed $1,000 of the DTA in the second quarter of 2014, and due to the continued improvements in asset quality and earnings performance the remaining $1,000 of the DTA valuation allowance was reversed in the second quarter of 2015. In assessing the realizability of DTA, management considers whether it is more likely than not that some portion or all of the DTA will not be realized. The Company evaluates the carrying amount of its DTA on a quarterly basis in accordance with the guidance provided in FASB ASC 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 DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict.  If the Company’s forecast of taxable income within the carry forward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Management considers the reversal of deferred tax liabilities (including the impact of available carry-back and carry-forward periods), projected future taxable income and tax-planning strategies in making this assessment.

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 began phase in during 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
 
 

 
 
25

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

(Board) to propose revisions to the Small Bank Holding Company Policy Statement (Policy Statement) to raise the total consolidated asset threshold 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.


                                                                      June 30, 2015
 
Entity
Tier 1
Total Risk Based
Leverage
 CET 1
       
Effective in 2015
Highlands Union Bank
 
11.63%
 
12.89%
 
7.41%
 
11.63%
 
 
                                                                   December 31, 2014
 
Entity
Tier 1
Total Risk Based
Leverage
CET 1
         
         
Highlands Union Bank
 
12.93%
 
14.19%
 
7.71%
 
N/A

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.




 
26

 


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

Note 6 – Per Share Amounts

Earnings per common share is computed using the weighted average outstanding shares for the three and six months ended June 30, 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 June 30
         2015
 
          2014
 
         
Income available to common stockholders
$       1,134