10-Q 1 d96052d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

Or

 

¨

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: 001-33033

 

 

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Kentucky   61-1142247

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky   40223
(Address of principal executive offices)   (Zip Code)

(502) 499-4800

(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 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 a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange 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 class of common stock, as of the latest practicable date.

19,301,217 shares of Common Stock and 6,458,000 shares of Non-Voting Common Stock, no par value, were outstanding at July 31, 2015.

 

 

 


Table of Contents

INDEX

 

          Page  

PART I –

  

FINANCIAL INFORMATION

  

ITEM 1.

  

FINANCIAL STATEMENTS

     3   

ITEM 2.

  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     36   

ITEM 3.

  

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     56   

ITEM 4.

  

CONTROLS AND PROCEDURES

     56   

PART II –

  

OTHER INFORMATION

  

ITEM 1.

  

LEGAL PROCEEDINGS

     57   

ITEM 1A.

  

RISK FACTORS

     57   

ITEM 2.

  

UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS

     57   

ITEM 3.

  

DEFAULTS UPON SENIOR SECURITIES

     57   

ITEM 4.

  

MINE SAFETY DISCLOSURES

     57   

ITEM 5.

  

OTHER INFORMATION

     57   

ITEM 6.

  

EXHIBITS

     58   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

 

The following consolidated financial statements of Porter Bancorp, Inc. and subsidiary, PBI Bank, Inc. are submitted:

  
Unaudited Consolidated Balance Sheets for June 30, 2015 and December 31, 2014      4   
Unaudited Consolidated Statements of Operations for the three and six months ended June 30, 2015 and 2014      5   
Unaudited Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2015 and 2014      6   
Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2015      7   
Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014      8   
Notes to Unaudited Consolidated Financial Statements      9   

 

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PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

     June 30,
2015
    December 31,
2014
 

Assets

    

Cash and due from banks

   $ 7,403      $ 14,169   

Interest bearing deposits in banks

     63,987        66,011   
  

 

 

   

 

 

 

Cash and cash equivalents

     71,390        80,180   

Securities available for sale

     151,758        190,791   

Securities held to maturity (fair value of $43,677 and $44,498, respectively)

     42,202        42,325   

Loans held for sale

     125        8,926   

Loans, net of allowance of $16,809 and $19,364, respectively

     631,512        605,635   

Premises and equipment, net

     19,167        19,507   

Other real estate owned

     39,545        46,197   

Federal Home Loan Bank stock

     7,323        7,323   

Bank owned life insurance

     9,320        9,167   

Accrued interest receivable and other assets

     6,998        7,938   
  

 

 

   

 

 

 

Total assets

   $ 979,340      $ 1,017,989   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Non-interest bearing

   $ 108,800      $ 114,910   

Interest bearing

     795,351        811,931   
  

 

 

   

 

 

 

Total deposits

     904,151        926,841   

Repurchase agreements

     1,265        1,341   

Federal Home Loan Bank advances

     3,430        15,752   

Accrued interest payable and other liabilities

     10,949        10,640   

Subordinated capital note

     4,500        4,950   

Junior subordinated debentures

     25,000        25,000   
  

 

 

   

 

 

 

Total liabilities

     949,295        984,524   

Stockholders’ equity

    

Preferred stock, no par

    

Series B—0 and 40,536 issued and outstanding, respectively

     —          2,229   

Series D—0 and 64,580 issued and outstanding, respectively

     —          3,552   

Series E—6,198 issued and outstanding; Liquidation preference of $6.2 million

     1,644        1,644   

Series F—4,304 issued and outstanding; Liquidation preference of $4.3 million

     1,127        1,127   
  

 

 

   

 

 

 

Total preferred stockholders’ equity

     2,771        8,552   
  

 

 

   

 

 

 

Common stock, no par, 86,000,000 shares authorized, 19,301,223 and 14,890,514 voting, and 6,458,000 and 0 non-voting shares issued and outstanding, respectively

     119,019        113,238   

Additional paid-in capital

     21,623        21,442   

Retained deficit

     (109,131     (107,595

Accumulated other comprehensive income (loss)

     (4,237     (2,172
  

 

 

   

 

 

 

Total common stockholders’ equity

     27,274        24,913   
  

 

 

   

 

 

 

Total stockholders’ equity

     30,045        33,465   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 979,340      $ 1,017,989   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  

Interest income

        

Loans, including fees

   $ 7,846      $ 8,572      $ 15,601      $ 16,893   

Taxable securities

     1,010        1,215        2,136        2,388   

Tax exempt securities

     190        235        393        476   

Fed funds sold and other

     121        144        240        306   
  

 

 

   

 

 

   

 

 

   

 

 

 
     9,167        10,166        18,370        20,063   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

      

Deposits

     1,607        2,319        3,299        4,680   

Federal Home Loan Bank advances

     24        32        51        65   

Subordinated capital note

     41        47        83        97   

Junior subordinated debentures

     155        153        307        305   

Federal funds purchased and other

     1        1        1        2   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,828        2,552        3,741        5,149   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     7,339        7,614        14,629        14,914   

Provision for loan losses

     —          6,300        —          6,300   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     7,339        1,314        14,629        8,614   

Non-interest income

      

Service charges on deposit accounts

     475        487        884        955   

Bank card interchange fees

     229        205        432        366   

Other real estate owned rental income

     372        18        729        25   

Net gain on sales of securities

     199        2        1,696        46   

Other

     290        237        520        472   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,565        949        4,261        1,864   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expense

      

Salaries and employee benefits

     4,028        3,949        7,875        7,690   

Occupancy and equipment

     828        896        1,698        1,788   

Professional fees

     714        484        1,693        773   

FDIC Insurance

     564        571        1,134        1,111   

Data processing expense

     278        280        582        549   

State franchise and deposit tax

     285        405        570        830   

Other real estate owned expense

     2,932        774        3,665        1,436   

Loan collection expense

     291        1,249        574        1,788   

Other

     1,114        1,196        2,635        2,341   
  

 

 

   

 

 

   

 

 

   

 

 

 
     11,034        9,804        20,426        18,306   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (2,130     (7,541     (1,536     (7,828

Income tax benefit

     —          (1,307     —          (1,307
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (2,130     (6,234     (1,536     (6,521

Less:

      

Dividends on preferred stock

     —          789        —          1,574   

Earnings allocated to participating securities

     (91     (693     (269     (772
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common shareholders

   $ (2,039   $ (6,330   $ (1,267   $ (7,323
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per common share

   $ (0.08   $ (0.53   $ (0.06   $ (0.61
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Loss

(in thousands)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2015     2014     2015     2014  

Net loss

   $ (2,130   $ (6,234   $ (1,536   $ (6,521

Other comprehensive income (loss):

        

Unrealized gain (loss) on securities:

        

Unrealized gain (loss) arising during the period

     (1,762     2,139        (433     3,781   

Amortization during the period of net unrealized loss transferred to held to maturity

     32        33        64        67   

Reclassification adjustment for gains included in net income

     (199     (2     (1,696     (46
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gain/(loss) recognized in comprehensive income

     (1,929     2,170        (2,065     3,802   

Tax effect

     —          (1,307     —          (1,307
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     (1,929     863        (2,065     2,495   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (4,059   $ (5,371   $ (3,601   $ (4,026
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Six Months Ended June 30,

(Dollar amounts in thousands except share and per share data)

 

    Shares     Amount        
    Common     Preferred           Preferred     Common        
    Common     Non-
Voting
Common
    Total
Common
    Series B     Series D     Series E     Series F     Common
and

Non-
Voting
Common
    Series B     Series D     Series E     Series F     Additional
Paid-In
Capital
    Retained
Deficit
    Accumulated
Other
Compre-
hensive
Loss
    Total  

Balances, January 1, 2015

    14,890,514        —          14,890,514        40,536        64,580        6,198        4,304      $ 113,238      $ 2,229      $ 3,552      $ 1,644      $ 1,127      $ 21,442      $ (107,595   $ (2,172 )   $ 33,465   

Issuance of unvested stock

    915,740        —          915,740        —          —          —          —          —          —          —          —          —          —          —          —          —     

Terminated stock

    (538,479     —          (538,479     —          —          —          —          —          —          —          —          —          —          —          —          —     

Forfeited unvested stock

    (20,152     —          (20,152     —          —          —          —          —          —          —          —          —          —          —          —          —     

Stock-based compensation expense

    —          —          —          —          —          —          —          —          —          —          —          —          181        —          —          181   

Net loss

    —          —          —          —          —          —          —          —          —          —          —          —          —          (1,536     —          (1,536

Net change in accumulated other comprehensive loss, net of taxes

    —          —          —          —          —          —          —          —          —          —          —          —          —          —          (2,065     (2,065

Conversion of preferred stock to common and non-voting common stock

    4,053,600        6,458,000        10,511,600        (40,536     (64,580     —          —          5,781        (2,229     (3,552     —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances, June 30, 2015

    19,301,223        6,458,000        25,759,223        —          —          6,198        4,304      $ 119,019      $ —        $ —        $ 1,644      $ 1,127      $ 21,623      $ (109,131   $ (4,237 )   $ 30,045   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Six Months Ended June 30, 2015 and 2014

(dollars in thousands)

 

     2015     2014  

Cash flows from operating activities

    

Net loss

   $ (1,536   $ (6,521

Adjustments to reconcile net loss to net cash from operating activities

    

Depreciation and amortization

     814        852   

Provision for loan losses

     —          6,300   

Net amortization on securities

     721        773   

Stock-based compensation expense

     181        283   

Tax benefit from OCI components

     —          (1,307

Net loss (gain) on sales of loans held for sale

     232        (34

Loans originated for sale

     (4,146     (1,574

Proceeds from sales of loans held for sale

     4,075        1,477   

Net (gain) loss on sales of other real estate owned

     (43     (54

Net write-down of other real estate owned

     2,630        650   

Net realized gain on sales of investment securities

     (1,696     (46

Earnings on bank owned life insurance, net of premium expense

     (153     (128

Net change in accrued interest receivable and other assets

     742        (588

Net change in accrued interest payable and other liabilities

     309        205   
  

 

 

   

 

 

 

Net cash from operating activities

     2,130        288   

Cash flows from investing activities

    

Purchases of available for sale securities

     (16,800     (21,990

Sales and calls of available for sale securities

     44,110        1,004   

Maturities and prepayments of available for sale securities

     10,756        6,804   

Proceeds from mandatory redemption of Federal Home Loan Bank stock

     —          2,749   

Proceeds from sale of other real estate owned

     5,020        4,281   

Proceeds from sales of loans not originated for sale

     8,640        —     

Loan originations and payments, net

     (26,974     25,997   

Purchases of premises and equipment, net

     (134     (284
  

 

 

   

 

 

 

Net cash from investing activities

     24,618        18,561   
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net change in deposits

     (22,690     (36,890

Net change in repurchase agreements

     (76     (19

Repayment of Federal Home Loan Bank advances

     (17,322     (358

Advances from Federal Home Loan Bank

     5,000        10,000   

Repayment of subordinated capital note

     (450     (450
  

 

 

   

 

 

 

Net cash from financing activities

     (35,538     (27,717
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     (8,790     (8,868

Beginning cash and cash equivalents

     80,180        111,134   
  

 

 

   

 

 

 

Ending cash and cash equivalents

   $ 71,390      $ 102,266   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Interest paid

   $ 3,622      $ 4,872   

Income taxes paid (refunded)

     —          —     

Supplemental non-cash disclosure:

    

Transfer from loans to other real estate

   $ 955      $ 30,866   

Financed sales of other real estate owned

     —          —     

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company) and its subsidiary, PBI Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2014 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income (loss) or stockholders’ equity.

Note 2 – Going Concern Considerations and Future Plans

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

During the first six months of 2015, we reported net loss attributable to common shareholders of $1.3 million, compared with net loss attributable to common shareholders of $7.3 million for the first six months of 2014. The improvement for 2015 is primarily attributable to no loan loss provision expense incurred in 2015, compared to $6.3 million provision expense recorded in 2014.

At June 30, 2015, we continued to be involved in various legal proceedings in which we dispute the material factual allegations against us. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

For the year ended December 31, 2014, we reported a net loss of $11.2 million. This loss was attributable primarily to loan loss provision of $7.1 million, OREO expense of $5.8 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices, and ongoing operating expense, along with $3.0 million in loan collection expenses. We also had lower net interest margin due to lower average loans outstanding, loans re-pricing at lower rates, and the level of non-performing loans in our portfolio. After deductions for dividends and accretion on preferred stock of $2.4 million, allocating losses to participating securities of $3.2 million, and the effect of the exchange of preferred stock for common stock of $36.1 million, net income attributable to common shareholders was $19.4 million for the year ended December 31, 2014, compared with a net loss attributable to common shareholders of $3.4 million for the year ended December 31, 2013.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. In October 2012, the Bank entered into a revised Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.

We expect to continue to work with our regulators toward capital ratio compliance. The revised Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The revised Consent Order was included in our Current Report on 8-K filed on September 19, 2012. As of June 30, 2015, the capital ratios required by the Consent Order had not been met.

 

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In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate and implement strategies to achieve the following objectives:

 

   

Increasing capital through the issuance of common stock to new and existing shareholders.

 

   

Continuing to operate the Company and Bank in a safe and sound manner. We have reduced our lending concentrations, and the size of our balance sheet while continuing to remediate non-performing loans, and reduce other noninterest expense through the disposition of OREO.

 

   

Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

   

Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

 

   

We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $648.3 million at June 30, 2015.

 

   

We have reduced our construction and development loans to less than 75% of total risk-based capital at June 30, 2015.

 

   

We have reduced our non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans. These loans represented 248% of total risk-based capital at June 30, 2015, down from 262% at December 31, 2014.

 

   

Executing on our commitment to sell OREO and reinvest in quality income producing assets.

 

   

Our acquisition of real estate assets through the loan remediation process increased during 2014, as we acquired $32.3 million of OREO in 2014 compared with $20.6 million during 2013. We acquired $955,000 in the first six months of 2015. However, nonaccrual loans totaled $30.2 million at June 30, 2015, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio.

 

   

We incurred OREO losses totaling $2.6 million during the first six months of 2015, comprised of $2.6 million in fair value write-downs to reflect reductions in listing prices for certain properties as well as updated appraisals, offset by $43,000 in net gain on sales of OREO. OREO expense may be elevated in future periods given the current size of the OREO portfolio and as we work to sell these properties. Currently, $12.7 million of OREO property is subject to a contract for sale or letter of intent.

 

   

To ensure we maximize the value we receive upon the sale of OREO, we continually evaluate sales opportunities. Proceeds from the sale of OREO totaled $5.0 million for the six months ended June 30, 2015, and $4.3 million for the six months ended June 30, 2014.

 

   

Real estate construction represents 41% of the OREO portfolio at June 30, 2015 compared with 40% at December 31, 2014. Commercial real estate represents 37% of the OREO portfolio at June 30, 2015 compared with 31% at December 31, 2014, and 1-4 family residential properties represent 12% of the portfolio at June 30, 2015 compared with 17% at December 31, 2014.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions such as directing a bank to seek a buyer or taking a bank into receivership.

The Company’s liquid assets were $1.3 million at June 30, 2015. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, interest on deposits with the Bank, the issuance of new debt, or the issuance of capital securities. Ongoing operating expenses of the parent company are forecast at approximately $1.0 million for 2015.

Effective with the fourth quarter of 2011, we began deferring interest payments on the junior subordinated debentures relating to our trust preferred securities. Deferring interest payments on the junior subordinated debentures resulted in a deferral of distributions on our trust preferred securities. If we defer distributions on our trust preferred securities for 20 consecutive quarters, we must pay all deferred distributions in full or we will be in default. Our deferral period expires in the third quarter of 2016. Deferred distributions on our trust preferred securities, which totaled $2.5 million as of June 30, 2015, are cumulative, and unpaid distributions accrue and compound on each subsequent payment date. If as a result of a default we become subject to any liquidation, dissolution or winding up, holders of the trust preferred securities will be entitled to receive the liquidation amounts to which they are entitled, including all accrued and unpaid distributions, before any distribution can be made to our shareholders. In addition, the holders of our Series E and Series F Preferred Shares will be entitled to receive liquidation distributions totaling $10.5 million before any distribution can be made to the holders of our common shares.

 

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Note 3 – Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

     Amortized
Cost
     Gross
Unrealized

Gains
     Gross
Unrealized
Losses
     Fair Value  
     (in thousands)  

June 30, 2015

           

Available for sale

           

U.S. Government and federal agency

   $ 31,749       $ 91       $ (507    $ 31,333   

Agency mortgage-backed: residential

     109,688         1,174         (559      110,303   

State and municipal

     6,834         318         (10      7,142   

Corporate bonds

     2,312         30         (13      2,329   

Other debt securities

     572         79         —           651   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

   $ 151,155       $ 1,692       $ (1,089    $ 151,758   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Amortized
Cost
     Gross
Unrecognized
Gains
     Gross
Unrecognized

Losses
     Fair Value  

Held to maturity

           

State and municipal

   $ 42,202       $ 1,505       $ (30    $ 43,677   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity

   $ 42,202       $ 1,505       $ (30    $ 43,677   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2014

           

Available for sale

           

U.S. Government and federal agency

   $ 35,725       $ 308       $ (590    $ 35,443   

Agency mortgage-backed: residential

     121,985         1,970         (357      123,598   

State and municipal

     11,690         722         (8      12,404   

Corporate bonds

     18,087         853         (252      18,688   

Other debt securities

     572         86         —           658   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

   $ 188,059       $ 3,939       $ (1,207    $ 190,791   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Amortized
Cost
     Gross
Unrecognized
Gains
     Gross
Unrecognized

Losses
     Fair Value  

Held to maturity

           

State and municipal

   $ 42,325       $ 2,173       $ —         $ 44,498   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held to maturity

   $ 42,325       $ 2,173       $ —         $ 44,498   
  

 

 

    

 

 

    

 

 

    

 

 

 

Sales and calls of available for sale securities were as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2015      2014      2015      2014  
     (in thousands)      (in thousands)  

Proceeds

   $ 9,972       $ 675       $ 44,110       $ 1,004   

Gross gains

     281         2         1,832         46   

Gross losses

     82         —           136         —     

 

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The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity. Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately.

 

     June 30, 2015  
     Amortized
Cost
     Fair
Value
 
     (in thousands)  

Maturity

     

Available for sale

     

Within one year

   $ 5,915       $ 5,973   

One to five years

     8,742         9,029   

Five to ten years

     26,238         25,802   

Beyond ten years

     572         651   

Agency mortgage-backed: residential

     109,688         110,303   
  

 

 

    

 

 

 

Total

   $ 151,155       $ 151,758   
  

 

 

    

 

 

 

Held to maturity

     

One to five years

   $ 13,952       $ 14,412   

Five to ten years

     24,693         25,561   

Beyond ten years

     3,557         3,704   
  

 

 

    

 

 

 

Total

   $ 42,202       $ 43,677   
  

 

 

    

 

 

 

Securities pledged at June 30, 2015 and December 31, 2014 had carrying values of approximately $52.9 million and $80.8 million, respectively, and were pledged to secure public deposits and repurchase agreements.

At June 30, 2015 and December 31, 2014, we held securities issued by the Commonwealth of Kentucky or municipalities in the Commonwealth of Kentucky having a book value of $17.9 million and $19.1 million, respectively. Additionally, at June 30, 2015 and December 31, 2014, we held securities issued by the State of Texas or municipalities in the State of Texas having a book value of $4.3 million and $4.4 million, respectively. At June 30, 2015 and December 31, 2014, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

Securities with unrealized losses at June 30, 2015 and December 31, 2014, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

 

     Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 
     (in thousands)  

June 30, 2015

               

Available for sale

               

U.S. Government and federal agency

   $ 8,242       $ (55   $ 15,228       $ (452   $ 23,470       $ (507

Agency mortgage-backed: residential

     36,994         (314     3,958         (245     40,952         (559

State and municipal

     470         (10     —           —          470         (10

Corporate bonds

     1,536         (13     —           —          1,536         (13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available for sale temporarily impaired

   $ 47,242       $ (392   $ 19,186       $ (697   $ 66,428       $ (1,089
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     Fair
Value
     Unrecognized
Loss
    Fair
Value
     Unrecognized
Loss
    Fair
Value
     Unrecognized
Loss
 

Held to maturity

               

State and municipal

   $ —         $ —        $ 966       $ (30   $ 966       $ (30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held to maturity temporarily impaired

   $ —         $ —        $ 966       $ (30   $ 966       $ (30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2014

               

Available for sale

               

U.S. Government and federal agency

   $ 7,778       $ (60   $ 18,681       $ (530   $ 26,459       $ (590

Agency mortgage-backed: residential

     6,960         (12     17,938         (345     24,898         (357

State and municipal

     569         (8     —           —          569         (8

Corporate bonds

     4,884         (119     1,660         (133     6,544         (252
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 20,191       $ (199   $ 38,279       $ (1,008   $ 58,470       $ (1,207
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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There were no held to maturity securities in an unrecognized loss position at December 31, 2014.

The Company evaluates securities for other than temporary impairment (OTTI) on a quarterly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity. As of June 30, 2015, management does not believe securities within our portfolio with unrealized losses should be classified as other than temporarily impaired.

Note 4 – Loans

Loans were as follows:

 

     June 30,
2015
     December 31,
2014
 
     (in thousands)  
     

Commercial

   $ 78,742       $ 60,936   

Commercial Real Estate:

     

Construction

     39,014         33,173   

Farmland

     77,935         77,419   

Nonfarm nonresidential

     160,518         175,452   

Residential Real Estate:

     

Multi-family

     44,702         41,891   

1-4 Family

     206,564         197,278   

Consumer

     9,958         11,347   

Agriculture

     30,391         26,966   

Other

     497         537   
  

 

 

    

 

 

 

Subtotal

     648,321         624,999   

Less: Allowance for loan losses

     (16,809      (19,364
  

 

 

    

 

 

 

Loans, net

   $ 631,512       $ 605,635   
  

 

 

    

 

 

 

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2015 and 2014:

 

     Commercial     Commercial
Real Estate
    Residential
Real Estate
    Consumer     Agriculture     Other     Total  
     (in thousands)  

June 30, 2015:

            

Beginning balance

   $ 2,046      $ 10,680      $ 5,221      $ 244      $ 391      $ 15      $ 18,597   

Provision for loan losses

     (296     (330     604        10        3        9          

Loans charged off

     (99     (1,224     (809     (62     (37     (33 )     (2,264

Recoveries

     295        87        44        34        2        14        476   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 1,946      $ 9,213      $ 5,060      $ 226      $ 359      $ 5      $ 16,809   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

June 30, 2014:

            

Beginning balance

   $ 3,608      $ 13,929      $ 7,071      $ 383      $ 415      $ 9      $ 25,415   

Provision for loan losses

     (329     6,074        560        (28     38        (15     6,300   

Loans charged off

     (308     (6,894     (1,048     (51     (21     (1 )     (8,323

Recoveries

     144        1,250        290        35        3        19        1,741   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 3,115      $ 14,359      $ 6,873      $ 339      $ 435      $ 12      $ 25,133   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table presents the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2015 and 2014:

 

     Commercial     Commercial
Real Estate
    Residential
Real Estate
    Consumer     Agriculture     Other     Total  
     (in thousands)  

June 30, 2015:

            

Beginning balance

   $ 2,046      $ 10,931      $ 5,787      $ 274      $ 319      $ 7      $ 19,364   

Provision for loan losses

     (27     (323     220        22        107        1        —     

Loans charged off

     (474     (1,593     (1,291     (130 )     (70 )     (33 )     (3,591

Recoveries

     401        198        344        60        3        30        1,036   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 1,946      $ 9,213      $ 5,060      $ 226      $ 359      $ 5      $ 16,809   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

June 30, 2014:

            

Beginning balance

   $ 3,221      $ 16,414      $ 7,762      $ 416      $ 305      $ 6      $ 28,124   

Provision for loan losses

     116        4,947        1,094        (9 )     151        1        6,300   

Loans charged off

     (454     (8,368     (2,356     (179 )     (30 )     (18 )     (11,405

Recoveries

     232        1,366        373        111        9        23        2,114   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 3,115      $ 14,359      $ 6,873      $ 339      $ 435      $ 12      $ 25,133   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of June 30, 2015:

 

     Commercial      Commercial
Real Estate
     Residential
Real Estate
     Consumer      Agriculture      Other      Total  
     (in thousands)  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 1       $ 671       $ 170       $ —         $ —         $ —         $ 842   

Collectively evaluated for impairment

     1,945         8,542         4,890         226         359         5         15,967   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 1,946       $ 9,213       $ 5,060       $ 226       $ 359       $ 5       $ 16,809   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 1,555       $ 27,478       $ 19,728       $ 20       $ 230       $ —         $ 49,011   

Loans collectively evaluated for impairment

     77,187         249,989         231,538         9,938         30,161         497         599,310   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 78,742       $ 277,467       $ 251,266       $ 9,958       $ 30,391       $ 497       $ 648,321   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2014:

 

     Commercial      Commercial
Real Estate
     Residential
Real Estate
     Consumer      Agriculture      Other      Total  
     (in thousands)  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 33       $ 491       $ 227       $ 1       $ —         $ —         $ 752   

Collectively evaluated for impairment

     2,013         10,440         5,560         273         319         7         18,612   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 2,046       $ 10,931       $ 5,787       $ 274       $ 319       $ 7       $ 19,364   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 2,022       $ 48,141       $ 21,384       $ 61       $ 263       $ 122       $ 71,993   

Loans collectively evaluated for impairment

     58,914         237,903         217,785         11,286         26,703         415         553,006   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 60,936       $ 286,044       $ 239,169       $ 11,347       $ 26,966       $ 537       $ 624,999   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loans

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

The following tables present information related to loans individually evaluated for impairment by class of loans as of June 30, 2015 and December 31, 2014 and for the three and six months ended June 30, 2015 and 2014:

 

                          Three Months Ended
June 30, 2015
     Six Months Ended
June 30, 2015
 
     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
For Loan
Losses
Allocated
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (in thousands)  

With No Related Allowance Recorded:

                    

Commercial

   $ 1,792       $ 1,548       $ —         $ 1,605       $ 5       $ 1,730       $ 5   

Commercial real estate:

                    

Construction

     1,599         1,012         —           2,475         4         3,016         8   

Farmland

     6,893         4,447         —           4,659         3         4,685         26   

Nonfarm nonresidential

     25,674         17,291         —           20,356         72         21,043         137   

Residential real estate:

                    

Multi-family

     34         34         —           17         —           38         —     

1-4 Family

     16,616         13,900         —           14,235         110         14,579         244   

Consumer

     85         20         —           22         —           25         —     

Agriculture

     297         230         —           231         —           241         —     

Other

     —           —           —           62         2         82         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     52,990         38,482         —           43,662         196         45,439         424   

With An Allowance Recorded:

                    

Commercial

     7         7         1         10         —           22         —     

Commercial real estate:

                    

Construction

     —           —           —           —           —           —           —     

Farmland

     —           —           —           —           —           105         —     

Nonfarm nonresidential

     8,150         4,728         671         2,615         6         7,266         12   

Residential real estate:

                    

Multi-family

     4,221         4,221         64         4,235         55         4,246         102   

1-4 Family

     1,573         1,573         106         1,628         14         1,676         39   

Consumer

     —           —           —           4         —           13         —     

Agriculture

     —           —           —           —           —           —           —     

Other

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     13,951         10,529         842         8,492         75         13,328         153   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 66,941       $ 49,011       $ 842       $ 52,154       $ 271       $ 58,767       $ 577   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     As of December 31, 2014      Three Months Ended
June 30, 2014
     Six Months Ended
June 30, 2014
 
     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
For Loan
Losses
Allocated
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (in thousands)  

With No Related Allowance Recorded:

                    

Commercial

   $ 2,546       $ 1,978       $ —         $ 2,359       $ 54       $ 2,447       $ 55   

Commercial real estate:

                    

Construction

     4,714         4,100         —           5,488         3         6,340         6   

Farmland

     6,636         4,739         —           6,403         31         6,899         48   

Nonfarm nonresidential

     34,437         22,418         —           42,897         275         47,731         458   

Residential real estate:

                    

Multi-family

     81         81         —           323         —           2,719         —     

1-4 Family

     18,496         15,266         —           21,844         131         26,156         417   

Consumer

     93         29         —           10         —           9         —     

Agriculture

     276         263         —           264         —           283         3   

Other

     367         122         —           180         2         330         9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     67,646         48,996         —           79,768         496         92,914         996   

With An Allowance Recorded:

                    

Commercial

     145         44         33         1,115         2         1,534         20   

Commercial real estate:

                    

Construction

     —           —           —           665         5         863         11   

Farmland

     658         315         38         —           —           82         —     

Nonfarm nonresidential

     19,454         16,569         453         13,308         63         15,370         171   

Residential real estate:

                    

Multi-family

     4,266         4,266         91         4,301         39         4,533         76   

1-4 Family

     1,791         1,771         136         1,749         19         1,907         38   

Consumer

     32         32         1         44         —           58         1   

Agriculture

     —           —           —           —           —           —           —     

Other

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     26,346         22,997         752         21,182         128         24,347         317   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 93,992       $ 71,993       $ 752       $ 100,950       $ 624       $ 117,261       $ 1,313   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Cash basis income recognized for the three and six months ended June 30, 2015 was $29,000 and $102,000, respectively, compared to $225,000 and $422,000 for the three and six months ended June 30, 2014.

Troubled Debt Restructuring

A troubled debt restructuring (TDR) occurs when the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

 

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Table of Contents

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of June 30, 2015 and December 31, 2014:

 

     TDRs
Performing to
Modified
Terms
     TDRs Not
Performing to
Modified
Terms
     Total
TDRs
 
     (in thousands)  

June 30, 2015

        

Commercial

        

Rate reduction

   $ 8       $ 69       $ 77   

Principal deferral

     —           869         869   

Commercial Real Estate:

        

Construction

        

Rate reduction

     265         337         602   

Farmland

        

Principal deferral

     —           2,365         2,365   

Nonfarm nonresidential

        

Rate reduction

     5,504         11,366         16,870   

Principal deferral

     655         —           655   

Residential Real Estate:

        

Multi-family

        

Rate reduction

     4,221         —           4,221   

1-4 Family

        

Rate reduction

     7,895         —           7,895   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 18,548       $ 15,006       $ 33,554   
  

 

 

    

 

 

    

 

 

 

 

     TDRs
Performing to
Modified Terms
     TDRs Not
Performing to
Modified Terms
     Total
TDRs
 
     (in thousands)  

December 31, 2014

        

Commercial

        

Rate reduction

   $ 14       $ —         $ 14   

Principal deferral

     —           869         869   

Commercial Real Estate:

        

Construction

        

Rate reduction

     268         3,379         3,647   

Farmland

        

Principal deferral

     —           2,365         2,365   

Other

        

Rate reduction

     8,622         13,894         22,516   

Principal deferral

     671         —           671   

Residential Real Estate:

        

Multi-family

        

Rate reduction

     4,266         —           4,266   

1-4 Family

        

Rate reduction

     8,112         —           8,112   

Consumer

        

Rate reduction

     32         —           32   
  

 

 

    

 

 

    

 

 

 

Total TDRs

   $ 21,985       $ 20,507       $ 42,492   
  

 

 

    

 

 

    

 

 

 

At June 30, 2015 and December 31, 2014, 55% and 52%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $824,000 and $579,000 in reserves to borrowers whose loan terms have been modified in TDRs as of June 30, 2015, and December 31, 2014, respectively. The Company has committed to lend no additional amounts to customers as of June 30, 2015 and December 31, 2014 to borrowers with outstanding loans classified as TDRs.

 

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Table of Contents

Management periodically reviews renewals/modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

No TDR loan modifications occurred during the three or six months ended June 30, 2015 or June 30, 2014. During the first six months of 2015 and 2014, no TDRs defaulted on their restructured loan within the 12 month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

Nonperforming Loans

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of June 30, 2015, and December 31, 2014:

 

     Nonaccrual      Loans Past Due 90 Days
And Over Still Accruing
 
     June 30,
2015
     December 31,
2014
     June 30,
2015
     December 31,
2014
 
     (in thousands)  

Commercial

   $ 1,548       $ 1,978       $ —         $ —     

Commercial Real Estate:

           

Construction

     747         3,831         —           —     

Farmland

     4,447         5,054         —           —     

Nonfarm nonresidential

     15,859         26,892         —           —     

Residential Real Estate:

           

Multi-family

     34         80         —           —     

1-4 Family

     7,330         8,925         92         151   

Consumer

     20         30         —           —     

Agriculture

     230         263         —           —     

Other

     —           122         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 30,215       $ 47,175       $ 92       $ 151   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the aging of the recorded investment in past due loans as of June 30, 2015 and December 31, 2014:

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     90 Days
And Over
Past Due
     Nonaccrual      Total
Past Due
And
Nonaccrual
 
     (in thousands)  

June 30, 2015

              

Commercial

   $ 28       $ —         $ —         $ 1,548       $ 1,576   

Commercial Real Estate:

              

Construction

     —           —           —           747         747   

Farmland

     267         61         —           4,447         4,775   

Nonfarm nonresidential

     152         238         —           15,859         16,249   

Residential Real Estate:

              

Multi-family

     —           —           —           34         34   

1-4 Family

     1,442         335         92         7,330         9,199   

Consumer

     52         4         —           20         76   

Agriculture

     —           12         —           230         242   

Other

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,941       $ 650       $ 92       $ 30,215       $ 32,898   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     90 Days
And Over
Past Due
     Nonaccrual      Total
Past Due
And
Nonaccrual
 
     (in thousands)  

December 31, 2014

              

Commercial

   $ 86       $ —         $ —         $ 1,978       $ 2,064   

Commercial Real Estate:

              

Construction

     —           —           —           3,831         3,831   

Farmland

     400         14         —           5,054         5,468   

Nonfarm nonresidential

     241         318         —           26,892         27,451   

Residential Real Estate:

              

Multi-family

     —           —           —           80         80   

1-4 Family

     3,124         601         151         8,925         12,801   

Consumer

     109         47         —           30         186   

Agriculture

     —           —           —           263         263   

Other

     —           —           —           122         122   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,960       $ 980       $ 151       $ 47,175       $ 52,266   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Credit Quality Indicators

We categorize all loans into risk categories at origination based upon original underwriting. Thereafter, we categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed continuously through our internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through our credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility we will sustain some losses if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

 

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Table of Contents

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of June 30, 2015, and December 31, 2014, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful      Total  
     (in thousands)  

June 30, 2015

              

Commercial

   $ 68,226       $ 4,266       $ —         $ 6,250       $ —         $ 78,742   

Commercial Real Estate:

                 

Construction

     31,715         5,582         —           1,717         —           39,014   

Farmland

     65,245         5,768         —           6,922         —           77,935   

Nonfarm nonresidential

     114,410         20,813         1,351         23,944         —           160,518   

Residential Real Estate:

                 

Multi-family

     35,769         4,958         —           3,975         —           44,702   

1-4 Family

     162,179         18,719         69         25,597         —           206,564   

Consumer

     9,095         307         298         258         —           9,958   

Agriculture

     22,707         7,299         —           385         —           30,391   

Other

     497         —           —           —           —           497   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 509,843       $ 67,712       $ 1,718       $ 69,048       $ —         $ 648,321   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful      Total  
     (in thousands)  

December 31, 2014

              

Commercial

   $ 49,440       $ 5,063       $ —         $ 6,433       $ —         $ 60,936   

Commercial Real Estate:

                 

Construction

     25,266         2,990         —           4,917         —           33,173   

Farmland

     61,672         7,922         —           7,825         —           77,419   

Nonfarm nonresidential

     111,426         21,017         3,747         39,262         —           175,452   

Residential Real Estate:

                 

Multi-family

     31,526         6,039         —           4,326         —           41,891   

1-4 Family

     145,450         23,928         131         27,769         —           197,278   

Consumer

     10,115         537         311         384         —           11,347   

Agriculture

     25,816         704         —           446         —           26,966   

Other

     415         —           —           122         —           537   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 461,126       $ 68,200       $ 4,189       $ 91,484       $ —         $ 624,999   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to contractors and subcontractors to clear mechanics’ liens.

Fair value of OREO is determined on an individual property basis. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property or have staff from our special assets group or in our centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. We typically obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraised amount.

 

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Table of Contents

The following table presents the major categories of OREO at the period-ends indicated:

 

     June 30,
2015
     December 31,
2014
 
     (in thousands)  

Commercial Real Estate:

     

Construction, land development, and other land

   $ 16,303       $ 18,748   

Farmland

     231         669   

Nonfarm nonresidential

     14,664         14,860   

Residential Real Estate:

     

Multi-family

     3,864         4,988   

1-4 Family

     4,790         7,998   
  

 

 

    

 

 

 
     39,852         47,263   

Valuation allowance

     (307      (1,066
  

 

 

    

 

 

 
   $ 39,545       $ 46,197   
  

 

 

    

 

 

 

 

     For the Three
Months Ended
June 30,
     For the Six
Months Ended
June 30,
 
     2015      2014      2015      2014  
     (in thousands)      (in thousands)  

OREO Valuation Allowance Activity:

           

Beginning balance

   $ 492       $ 208       $ 1,066       $ 230   

Provision to allowance

     2,330         400         2,630         650   

Write-downs

     (2,515      (409      (3,389      (681
  

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance

   $ 307       $ 199       $ 307       $ 199   
  

 

 

    

 

 

    

 

 

    

 

 

 

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $2.1 million and $3.6 million at June 30, 2015 and December 31, 2014, respectively. Currently, $12.7 million of OREO property is subject to a contract for sale or letter of intent.

Net activity relating to other real estate owned during the three months ended June 30, 2015 and 2014 is as follows:

 

     For the Six
Months Ended
June 30,
 
     2015      2014  
     (in thousands)  

OREO Activity

     

OREO as of January 1

   $ 46,197       $ 30,892   

Real estate acquired

     955         30,867   

Valuation adjustment writedowns

     (2,630      (650

Gain/(loss) on sale

     43         54   

Proceeds from sale of properties

     (5,020      (4,281
  

 

 

    

 

 

 

OREO as of June 30

   $ 39,545       $ 56,882   
  

 

 

    

 

 

 

Expenses related to other real estate owned include:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2015      2014      2015      2014  
     (in thousands)      (in thousands)  

Net (gain) loss on sales

   $ (40    $ (54    $ (43    $ (54

Provision to allowance

     2,330         400         2,630         650   

Operating expense

     642         428         1,078         840   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,932       $ 774       $ 3,665       $ 1,436   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Note 6 – Deposits

The following table shows ending deposit balances by category as of:

 

     June 30,
2015
     December 31,
2014
 
     (in thousands)  

Non-interest bearing

   $ 108,800       $ 114,910   

Interest checking

     84,627         91,086   

Money market

     110,529         109,734   

Savings

     35,942         36,430   

Certificates of deposit

     564,253         574,681   
  

 

 

    

 

 

 

Total

   $ 904,151       $ 926,841   
  

 

 

    

 

 

 

Time deposits of $250,000 or more were $34.2 million and $34.4 million at June 30, 2015 and December 31, 2014, respectively.

Scheduled maturities of all time deposits at June 30, 2015 were as follows (in thousands):

 

Year 1

   $ 327,242   

Year 2

     159,912   

Year 3

     10,715   

Year 4

     13,874   

Year 5

     52,510   

Thereafter

     —     
  

 

 

 
   $ 564,253   
  

 

 

 

Note 7 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

 

     June 30,      December 31,  
     2015      2014  
     (in thousands)  

Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2017 through 2033, averaging 2.79% at June 30, 2015 and 1.02% at December 31, 2014

   $ 3,430       $ 15,752   
  

 

 

    

 

 

 

Each advance is payable based upon the terms on agreement, with a prepayment penalty. New advances are limited to a one year maturity or less. No prepayment penalties were incurred during 2015 or 2014. The advances are collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At June 30, 2015, our additional borrowing capacity with the FHLB was $23.8 million. The availability of our borrowing capacity could be affected by our financial condition and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion.

 

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Table of Contents

Note 8 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.

 

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Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value or asking price is below our recorded investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property or have staff in our special assets group or centralized appraisal department evaluate the latest in-file appraisal in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We generally obtain updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

Financial assets measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014 are summarized below:

 

            Fair Value Measurements at June 30, 2015 Using  
            (in thousands)  
            Quoted Prices In             Significant  
            Active Markets for      Significant Other      Unobservable  
     Carrying      Identical Assets      Observable Inputs      Inputs  

Description

   Value      (Level 1)      (Level 2)      (Level 3)  

Available for sale securities

     

U.S. Government and federal agency

   $ 31,333       $ —         $ 31,333       $ —     

Agency mortgage-backed: residential

     110,303         —           110,303         —     

State and municipal

     7,142         —           7,142         —     

Corporate bonds

     2,329         —           2,329         —     

Other debt securities

     651         —           —           651   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 151,758       $ —         $ 151,107       $ 651   
  

 

 

    

 

 

    

 

 

    

 

 

 
            Fair Value Measurements at December 31, 2014 Using  
            (in thousands)  

Description

   Carrying
Value
     Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Available for sale securities

     

U.S. Government and federal agency

   $ 35,443       $ —         $ 35,443       $ —     

Agency mortgage-backed: residential

     123,598         —           123,598         —     

State and municipal

     12,404         —           12,404         —     

Corporate bonds

     18,688         —           18,688         —     

Other debt securities

     658         —           —           658   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 190,791       $ —         $ 190,133       $ 658   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between Level 1 and Level 2 during 2015 or 2014.

 

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The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended June 30, 2015 and 2014:

 

     Other Debt
Securities
 
     2015      2014  
     (in thousands)  

Balances of recurring Level 3 assets at January 1

   $ 658       $ 632   

Total gain (loss) for the period:

     

Included in other comprehensive income (loss)

     (7      19   
  

 

 

    

 

 

 

Balance of recurring Level 3 assets at June 30

   $ 651       $ 651   
  

 

 

    

 

 

 

Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 8.25% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality. We also consider the issuer’s publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults.

Financial assets measured at fair value on a non-recurring basis are summarized below:

 

            Fair Value Measurements at June 30, 2015 Using  
            (in thousands)  

Description

   Carrying
Value
     Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired loans:

        

Commercial

   $ 7       $ —         $ —         $ 7   

Commercial real estate:

           

Construction

     —           —           —           —     

Farmland

     —           —           —           —     

Nonfarm nonresidential

     3,770         —           —           3,770   

Residential real estate:

           

Multi-family

     —           —           —           —     

1-4 Family

     1,467         —           —           1,467   

Consumer

     —           —           —           —     

Other

     —           —           —           —     

Other real estate owned, net:

           

Commercial real estate:

           

Construction

     16,178         —           —           16,178   

Farmland

     230         —           —           230   

Nonfarm nonresidential

     14,551         —           —           14,551   

Residential real estate:

           

Multi-family

     3,834         —           —           3,834   

1-4 Family

     4,752         —           —           4,752   

 

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Table of Contents
            Fair Value Measurements at December 31, 2014 Using  
            (in thousands)  

Description

   Carrying
Value
     Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired loans:

        

Commercial

   $ 12       $ —         $ —         $ 12   

Commercial real estate:

           

Construction

     —           —           —           —     

Farmland

     278         —           —           278   

Other

     15,825         —           —           15,825   

Residential real estate:

           

Multi-family

     —           —           —           —     

1-4 Family

     1,635         —           —           1,635   

Consumer

     31         —           —           31   

Other

     —           —           —           —     

Other real estate owned, net:

           

Commercial real estate:

           

Construction

     18,325         —           —           18,325   

Farmland

     654         —           —           654   

Other

     14,525         —           —           14,525   

Residential real estate:

           

Multi-family

     4,875         —           —           4,875   

1-4 Family

     7,818         —           —           7,818   

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $5.2 million at June 30, 2015 with a valuation allowance of $742,000, resulting in no additional provision for loan losses for the three and six months ended June 30, 2015. Impaired loans had a carrying amount of $13.3 million with a valuation allowance of $1.6 million, with an additional provision of $5.2 million for the three and six months ended June 30, 2014. At December 31, 2014, impaired loans had a carrying amount of $18.4 million, with a valuation allowance of $622,000.

OREO, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $39.5 million as of June 30, 2015, compared with $56.9 million at June 30, 2014 and $46.2 million at December 31, 2014. Fair value write-downs of $2.6 million and $650,000 were recorded on OREO for the six months ended June 30, 2015 and 2014, respectively.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2015:

 

     Fair Value     

Valuation

Technique(s)

  

Unobservable Input(s)

  

Range (Weighted

Average)

     (in thousands)                 

Impaired loans – Commercial

   $ 7      

Market value approach

  

Adjustment for receivables and inventory discounts

   11% - 14% (13%)

Impaired loans – Commercial real estate

   $ 3,770      

Sales comparison approach

  

Adjustment for differences between the comparable sales

   2% - 17% (10%)
     

Income approach

  

Discount or capitalization rate

   8% - 10% (9%)

Impaired loans – Residential real estate

   $ 1,467      

Sales comparison approach

  

Adjustment for differences between the comparable sales

   1% - 16% (7%)

Other real estate owned – Commercial real estate

   $ 30,959      

Sales comparison approach

  

Adjustment for differences between the comparable sales

  

0% - 69% (22%)

 

8% - 20% (13%)

     

Income approach

  

Discount or capitalization rate

  

Other real estate owned – Residential real estate

   $ 8,586      

Sales comparison approach

  

Adjustment for differences between the comparable sales

   0% - 15% (5%)

 

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The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2014:

 

    Fair Value     

Valuation

Technique(s)

 

Unobservable Input(s)

  Range (Weighted
Average)
    (in thousands)               

Impaired loans – Commercial

  $ 12       Market value approach   Adjustment for receivables and inventory discounts   16% - 32% (24%)

Impaired loans – Commercial real estate

  $ 16,103      

Sales comparison approach

Income approach

 

Adjustment for differences between the comparable sales

Discount or capitalization

rate

  0% - 62% (14%)

 

 

8% - 9% (8%)

Impaired loans – Residential real estate

  $ 1,635       Sales comparison approach   Adjustment for differences between the comparable sales   0% - 39% (11%)

Other real estate owned – Commercial real estate

  $ 33,504      

Sales comparison approach

 

Income approach

 

Adjustment for differences between the comparable sales

Discount or capitalization rate

  0% - 45% (18%)

 

9% - 20% (13%)

Other real estate owned – Residential real estate

  $ 12,693       Sales comparison approach   Adjustment for differences between the comparable sales   0% - 15% (6%)

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

            Fair Value Measurements at June 30, 2015 Using  
     Carrying
Amount
     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Financial assets

           

Cash and cash equivalents

   $ 71,390       $ 58,734       $ 12,656       $ —         $ 71,390   

Securities available for sale

     151,758         —           151,107         651         151,758   

Securities held to maturity

     42,202         —           43,677         —           43,677   

Federal Home Loan Bank stock

     7,323         N/A         N/A         N/A         N/A   

Loans held for sale

     125         —           125         —           125   

Loans, net

     631,512         —           —           642,894         642,894   

Accrued interest receivable

     3,256         —           1,111         2,145         3,256   

Financial liabilities

              

Deposits

   $ 904,151       $ 108,800       $ 790,086       $ —         $ 898,886   

Securities sold under agreements to repurchase

     1,265         —           1,265         —           1,265   

Federal Home Loan Bank advances

     3,430         —           3,438         —           3,438   

Subordinated capital notes

     4,500         —           —           4,351         4,351   

Junior subordinated debentures

     25,000         —           —           14,644         14,644   

Accrued interest payable

     2,977         —           564         2,413         2,977   

 

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Table of Contents
            Fair Value Measurements at December 31, 2014 Using  
     Carrying
Amount
     Level 1      Level 2      Level 3      Total  
     (in thousands)  

Financial assets

           

Cash and cash equivalents

   $ 80,180       $ 49,007       $ 31,173       $ —         $ 80,180   

Securities available for sale

     190,791         —           190,133         658         190,791   

Securities held to maturity

     42,325         —           44,498         —           44,498   

Federal Home Loan Bank stock

     7,323         N/A         N/A         N/A         N/A   

Loans held for sale

     8,926         —           8,926         —           8,926   

Loans, net

     605,635         —           —           615,914         615,914   

Accrued interest receivable

     3,503         —           1,389         2,114         3,503   

Financial liabilities

              

Deposits

   $ 926,841       $ 114,910       $ 804,508       $ —         $ 919,418   

Securities sold under agreements to repurchase

     1,341         —           1,341         —           1,341   

Federal Home Loan Bank advances

     15,752         —           15,758         —           15,758   

Subordinated capital notes

     4,950         —           —           4,765         4,765   

Junior subordinated debentures

     25,000         —           —           14,214         14,214   

Accrued interest payable

     2,858         —           751         2,107         2,858   

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Non-interest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Loans, Net

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and and/or quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

 

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Note 9 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

 

     June 30,      December 31,  
     2015      2014  
     (in thousands)  

Deferred tax assets:

     

Net operating loss carry-forward

   $ 34,095       $ 32,111   

Allowance for loan losses

     5,883         6,777   

Other real estate owned write-down

     9,379         10,000   

Alternative minimum tax credit carry-forward

     692         692   

Net assets from acquisitions

     670         668   

Other than temporary impairment on securities

     46         46   

Net unrealized loss on securities

     144         —     

New market tax credit carry-forward

     208         208   

Nonaccrual loan interest

     846         958   

Amortization of non-compete agreements

     13         14   

Other

     1,810         1,701   
  

 

 

    

 

 

 
     53,786         53,175   
  

 

 

    

 

 

 

Deferred tax liabilities:

     

FHLB stock dividends

     928         928   

Fixed assets

     236         264   

Originated mortgage servicing rights

     42         53   

Net unrealized gain on securities

     —           579   

Other

     669         703   
  

 

 

    

 

 

 
     1,875         2,527   
  

 

 

    

 

 

 

Net deferred tax assets before valuation allowance

     51,911         50,648   
  

 

 

    

 

 

 

Valuation allowance

     (51,911      (50,648
  

 

 

    

 

 

 

Net deferred tax asset

   $ —         $ —     
  

 

 

    

 

 

 

Our estimate of the realizability of the deferred tax asset is dependent on our estimate of projected future levels of taxable income. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. The valuation allowance remains in effect as of June 30, 2015.

The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. No tax benefit or expense was recognized for the six months ended June 30, 2015, and a tax benefit of $1.3 million was allocated to continuing operations for the six months ended June 30, 2014. The June 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the six months ended June 30, 2015 or June 30, 2014 related to unrecognized tax benefits. On June 24, 2015, the Board of Directors approved the adoption of a tax benefits preservation plan designed to preserve the value of certain of the Company’s deferred tax assets primarily associated with net operating loss carryforwards (NOLs) under Section 382 of the Internal Revenue Code. NOLs can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company’s ability to use its NOLs would be limited if there was an “ownership change” under Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company’s increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time. The plan is intended to reduce the likelihood of an “ownership change” occurring as a result of the buying and selling of the Company’s common stock.

In connection with the tax benefits preservation plan, the Company declared a dividend of one preferred stock purchase right for each share of common stock outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company’s board of directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, in its discretion, the Board of Directors may exempt certain transactions and certain persons whose acquisition of securities is determined by the board not to jeopardize the Company’s deferred tax assets.

 

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The rights will expire upon the earlier of (i) June 29, 2018, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2011.

Note 10 – Stock Plans and Stock Based Compensation

The Company has two stock incentive plans. The Porter Bancorp, Inc. 2006 Stock Incentive Plan permits the issuance of up to 1,563,050 shares of the Company’s common stock upon the grant of stock awards. As of June 30, 2015, the Company had issued and outstanding 1,019,109 unvested shares net of forfeitures and vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over three to ten years. The Company has 291,902 shares remaining available for issuance under the plan.

The Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan permits the issuance of up to 700,000 shares of the Company’s voting common stock upon the grant of stock awards. The Plan awards restricted shares having a fair market value of $25,000 annually to each non-employee director. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest on December 31 in the year of grant. The Company has issued and outstanding 115,740 unvested shares, net of forfeitures and vesting, to non-employee directors. At June 30, 2015, 185,774 shares remain available for issuance under this plan.

Upon the sale of our Series A preferred shares by the U.S. Treasury at a discount to face amount on December 4, 2014, restricted shares previously granted to senior executives became subject to permanent transfer restrictions. On March 25, 2015, the Compensation Committee modified the equity compensation arrangements with our four named executive officers to restore the incentive that was intended by including equity grants in their employment agreements. The Compensation Committee and the named executive officers mutually agreed to terminate 538,479 restricted shares that were subject to permanent restrictions on transfer. We then awarded 800,000 new service-based restricted shares to our named executive officers. The new awards were accounted for as a modification and vest over four years, with one-third of the shares vesting on each of the second, third and fourth anniversaries of the date of grant. The modification results in incremental compensation expense of approximately $233,000 and will be amortized in accordance with the vesting schedule.

The fair value of the 2015 unvested shares issued to employees was $712,000, or $0.89 per weighted-average share. The fair value of the 2015 unvested shares issued to directors was $125,000, or $1.08 per weighted-average share. The Company recorded $181,000 and $283,000 of stock-based compensation during the first six months of 2015 and 2014, respectively, to salaries and employee benefits. We expect substantially all of the unvested shares outstanding at the end of the period will vest according to the vesting schedule. No deferred tax benefit was recognized related to this expense for either period.

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

 

     Six Months Ended
June 30, 2015
     Twelve Months Ended
December 31, 2014
 
            Weighted             Weighted  
            Average             Average  
            Grant             Grant  
     Shares      Price      Shares      Price  

Outstanding, beginning

     770,440       $ 1.33         787,426       $ 1.56   

Granted

     800,000         0.89         122,220         0.93   

Vested

     (80,185      1.81         (133,227      2.20   

Terminated

     (450,994      1.25         —           —     

Forfeited

     (20,152      1.06         (5,979      4.21   
  

 

 

       

 

 

    

Outstanding, ending

     1,019,109       $ 0.99         770,440       $ 1.33   
  

 

 

       

 

 

    

 

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The following table summarizes unvested share activity as of and for the periods indicated for the Non-Employee Directors Stock Ownership Incentive Plan:

 

     Six Months Ended      Twelve Months Ended  
     June 30, 2015      December 31, 2014  
            Weighted             Weighted  
            Average             Average  
            Grant             Grant  
     Shares      Price      Shares      Price  

Outstanding, beginning

     5,052       $ 1.65         47,428       $ 1.69   

Granted

     115,740         1.08         166,668         0.90   

Vested

     (5,052      1.65         (154,222      0.98   

Forfeited

     —           —           (54,822      1.29   
  

 

 

       

 

 

    

Outstanding, ending

     115,740       $ 1.08         5,052       $ 1.65   
  

 

 

       

 

 

    

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2015 and beyond is estimated as follows (in thousands):

 

July 2015 – December 2015

   $ 269   

2016

     257   

2017

     156   

2018

     149   

2019 & thereafter

     —     

Note 11 – Earnings (Loss) per Share

The factors used in the basic and diluted loss per share computations follow:

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2015      2014      2015      2014  
     (in thousands, except share and per share data)  

Net loss

   $ (2,130 )    $ (6,234 )    $ (1,536 )    $ (6,521 )

Less:

           

Preferred stock dividends

     —           789         —           1,574   

Earnings allocated to unvested shares

     (91      (517      (60      (569

Earnings allocated to Series C preferred

     —           (176      (209      (203
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss attributable to common shareholders, basic and diluted

   $ (2,039    $ (6,330    $ (1,267    $ (7,323
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic

           

Weighted average common shares including unvested common shares outstanding

     25,687,579         13,293,226         25,554,292         13,256,911   

Less:

           

Weighted average unvested common shares

     1,098,072         979,211         990,545         931,092   

Weighted average Series B preferred

     —           —           1,343,735         —     

Weighted average Series C preferred

     —           332,894         —           332,894   

Weighted average Series D preferred

     —           —           2,140,774         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares outstanding

     24,589,507         11,981,121         21,079,238         11,992,925   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic loss per common share

   $ (0.08    $ (0.53    $ (0.06    $ (0.61
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

           

Add: Dilutive effects of assumed exercises of common and Preferred Series C stock warrants

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average common shares and potential common shares

     24,589,507         11,981,121         21,079,238         11,992,925   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted loss per common share

   $ (0.08    $ (0.53    $ (0.06    $ (0.61
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company had no outstanding stock options at June 30, 2015 or 2014. A warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at June 30, 2015 and 2014 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Additionally, warrants for the purchase of 650,544 and 1,449,459 shares of non-voting common stock at an exercise price of $10.95 per share were outstanding at June 30, 2015 and 2014, respectively, but were not included in the diluted EPS computation as inclusion would have been anti-dilutive.

Note 12 – Capital Requirements and Restrictions on Retained Earnings

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement.

On June 24, 2011, the Bank entered into a Consent Order with the FDIC and the Kentucky Department of Financial Institutions. The consent order required the Bank to complete a management study, to maintain Tier 1 capital as a percentage of total assets of at least 9% and a total risk based capital ratio of at least 12%, to develop a plan to reduce our risk position in each substandard asset in excess of $1 million, to complete board review of the adequacy of the allowance for loan losses prior to quarterly Call Report submissions, to adopt procedures which strengthen the loan review function and ensure timely and accurate grading of credit relationships, to charge-off all assets classified as loss, to develop a plan to reduce concentrations of construction and development loans to not more than 75% of total risk based capital and non-owner occupied commercial real estate loans to not more than 250% of total risk based capital, to limit asset growth to no more than 5% in any quarter or 10% annually, not to extend additional credit to any borrower classified substandard unless the board of directors first adopts a detailed statement why the extension is in the best interest of the bank, and not to declare or pay any dividend without the prior consent of our regulators. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis in which we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

In October 2012, the Bank entered into a revised Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank cannot be considered well-capitalized while under the Consent Order. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a capital investment into the Bank sufficient to fully meet the capital requirements. We have not been directed by the FDIC to implement such a plan.

The revised Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. As of June 30, 2015, the capital ratios required by the Consent Order had not been met.

 

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The following table shows the ratios and amounts of Common Equity Tier 1, Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and the Bank at the dates indicated (dollars in thousands):

 

     Actual     For Capital Adequacy Purposes  
     Amount      Ratio     Amount      Ratio  

As of June 30, 2015:

          

Total risk-based capital (to risk-weighted assets)

          

Consolidated

   $ 72,471         10.25   $ 56,542         8.00

Bank

     72,858         10.34        56,388         8.00   

Total common equity Tier I risk-based capital (to risk-weighted assets)

          

Consolidated

     31,267         4.42        31,805         4.50   

Bank

     59,449         8.43        31,718         4.50   

Tier I capital (to risk-weighted assets)

          

Consolidated

     42,548         6.02        42,407         6.00   

Bank

     59,449         8.43        42,291         6.00   

Tier I capital (to average assets)

          

Consolidated

     42,548         4.25        40,039         4.00   

Bank

     59,449         5.95        39,988         4.00   

 

     Actual     For Capital Adequacy Purposes  
     Amount      Ratio     Amount      Ratio  

As of December 31, 2014:

          

Total risk-based capital (to risk-weighted assets)

          

Consolidated

   $ 73,595         10.61   $ 55,483         8.00

Bank

     73,174         10.57        55,383         8.00   

Tier I capital (to risk-weighted assets)

          

Consolidated

     46,459         6.70        27,741         4.00   

Bank

     59,438         8.59        27,691         4.00   

Tier I capital (to average assets)

          

Consolidated

     46,459         4.51        41,193         4.00   

Bank

     59,438         5.78        41,143         4.00   

The Consent Order requires the Bank to achieve the minimum capital ratios presented below:

 

     Actual as of June 30, 2015     Ratio Required by Consent Order  
     Amount      Ratio     Amount      Ratio  

Total capital to risk-weighted assets

   $ 72,858         10.34   $ 84,582         12.00

Tier I capital to average assets

     59,449         5.95        89,973         9.00   

At June 30, 2015, the Bank’s Tier 1 leverage ratio was 5.95%, and its total risk-based capital ratio was 10.34%, which are below the 9% and 12% minimum capital ratios required by the Consent Order. Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a Consent Order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. The Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, the Bank cannot pay dividends to the Company for the foreseeable future.

 

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Note 13 – Contingencies

We are defendants in various legal proceedings. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Currently, we have accrued approximately $2.2 million related to ongoing litigation matters for which we believe liability is probable and reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. Aside from the amounts currently accrued, there is nothing that is reasonably probable. We disclose legal matters when we believe liability is reasonably possible and may be material to our consolidated financial statements.

Signature Point Litigation. On June 18, 2010, three real estate development companies filed suit in Kentucky state court against the Bank and Managed Assets of Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al., Jefferson Circuit Court, Case No 10-CI-04295. On July 16, 2013, a jury in Louisville, Kentucky returned a verdict against the Bank, awarding the plaintiffs compensatory damages of $1,515,000 and punitive damages of $5,500,000. The case arose from a settlement in which the Bank agreed to release the plaintiffs and guarantors from obligations of more than $26 million related to a real estate project in Louisville. The plaintiffs were granted a right of first refusal to repurchase a tract of land within the project. In exchange, the plaintiffs conveyed the real estate securing the loans to the Bank. After plaintiffs declined to exercise their right of first refusal, the Bank sold the tract to the third party. Plaintiffs alleged the Bank had knowledge of the third party offer before the conveyance of the land by the Plaintiffs to the Bank. Plaintiffs asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair dealing, tortious interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against the Bank.

After conferring with its legal advisors, the Bank believes the findings and damages are excessive and contrary to law, and that it has meritorious grounds on which it has moved to appeal. The Bank’s Notice of Appeal was filed on October 25, 2013. After a number of procedural issues were resolved, the Bank filed its appellate brief on September 30, 2014. Appellee’s brief was filed on December 1, 2014. We will continue to defend this matter vigorously. Although we have made provisions in our consolidated financial statements for this self-insured matter, the amount of our legal accrual is less than the original amount of the damages awarded, plus accrued interest. The ultimate outcome of this matter could have a material adverse effect on our financial condition, results of operations or cash flows.

SBAV LP Litigation. On December 17, 2012, SBAV LP filed a lawsuit against the Company, the Bank, J. Chester Porter and Maria L. Bouvette in New York state court. The proceeding was removed to New York federal district court on January 16, 2013, and on February 27, 2013, SBAV LP filed an Amended Complaint. On July 10, 2013, the New York federal district court granted the defendants’ motion to transfer the case to federal district court in Kentucky. SBAV LP v. Porter Bancorp, et. al., Civ. Action 3:13-CV-710 (W.D.KY). The Amended Complaint alleges a violation of the Kentucky Securities Act and negligent misrepresentation against all named defendants, and breach of contract against Porter Bancorp alone. The plaintiff seeks damages in an amount in excess of $4,500,000, or the difference between the $5,000,016 purchase price and the value of the securities when tendered by the plaintiff, plus interest at the applicable statutory rate, costs and reasonable attorneys’ fees. On September 13, 2013, defendants filed a motion to dismiss all claims in the complaint for pleading failures and for failure to state a claim upon which relief may be granted. On March 25, 2014, the judge ruled that SBAV had failed to state a claim against the Bank and dismissed the Bank from the case. The claims against the Company, the Estate of J. Chester Porter and Ms. Bouvette remain and have proceeded to discovery. On April 21, 2014, the Company filed a third-party complaint for contribution against SBAV’s investment adviser, the Clinton Group, Inc. On September 16, 2014, the Court dismissed the Third-Party Complaint, but held that, if proven, Clinton’s errors in conducting due diligence may lessen any recovery available to SBAV. Discovery is continuing. At the joint request of the parties, the Court vacated the previous schedule and trial date of October 20, 2015 in order to provide additional time for discovery and motion practice in the case. We dispute the material factual allegations made in SBAV’s complaint and intend to defend against SBAV’s claims vigorously.

Miller’s Health System Inc. Employee Stock Ownership Plan. On December 26, 2013, the United States Department of Labor (“DOL”) filed a lawsuit against the Bank in U.S. District Court for the Northern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. (Civ. Action 3:13-CV-1400-PPS). The complaint alleges that in 2007 the Bank, in the capacity of trustee for the Miller’s Health System’s Inc. Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of Miller’s Health Systems, Inc. (“Miller’s Health”) in 2007 for $40 million, a price allegedly far in excess of the stock’s fair market value. The suit also alleges, among other things, that the Bank approved 100% seller financing for the transaction at an excessive rate of interest. On March 31, 2014, the Bank filed its answer, disputing the material factual allegations of the complaint. On April 10, 2014, the Bank filed a third-party complaint against Miller’s Health seeking to enforce its indemnity rights, as well as third party claims for contribution against named directors and officers of Miller’s Health. On March 12, 2015, the parties agreed to settle the litigation and executed a written settlement agreement on July 10, 2015. The Bank agreed to a settlement payment, which, to the extent not paid from insurance proceeds, had been previously reserved for. The court entered an agreed order ending the litigation on July 20, 2015.

 

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AIT Laboratories Employee Stock Ownership Plan. On August 29, 2014, the United States Department of Labor (“DOL”) filed a lawsuit against the Bank and Michael A. Evans in the U.S. District Court for the Southern District of Indiana. Thomas E. Perez, Secretary of the United States Department of Labor v. PBI Bank, Inc. and Michael A. Evans (Case No. 1:14-CV-01429-SEB-MJD). The complaint alleges that in 2009, the Bank, in the capacity of trustee for the AIT Laboratories Employee Stock Ownership Plan, authorized the alleged imprudent and disloyal purchase of the stock of AIT Holdings, Inc. in 2009 for $90 million, a price allegedly far in excess of the stock’s fair market value. The Bank’s responsive pleading was filed on November 4, 2014, disputing the material factual allegations that have been made by the DOL. Discovery is in the early stages. A settlement conference has been set for December 15, 2015, and a trial date has been set for November 7, 2016. We intend to defend against DOL’s claims vigorously.

United States Department of Justice Investigation. On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that the Bank was the subject of an investigation into possible violations of federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred stock from the Company in November 2008. The Bank will respond to and cooperate with any requests for information from DOJ. At this time the investigation is ongoing, and DOJ has made no determination whether to pursue any action in the matter.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the following:

 

   

Our inability to increase our capital to the levels required by our agreements with bank regulators could have a material adverse effect on our business.

 

   

A significant percentage of our loan portfolio is comprised of non-owner occupied commercial real estate loans, real estate construction and development loans, and multi-family residential real estate loans, all of which carry a higher degree of risk.

 

   

We continue to hold and acquire a significant amount of OREO properties, which could increase operating expenses and result in future losses.

 

   

Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses.

 

   

Our ability to pay cash dividends on our common and preferred stock and pay interest on the junior subordinated debentures that relate to our trust preferred securities is currently restricted. Our inability to resume paying interest on our trust preferred securities could adversely affect our common and preferred shareholders.

 

   

While we believe our provision for legal contingencies is adequate, the outcome of legal proceedings is difficult to predict and we may settle legal claims or be subject to judgments for amounts that exceed our estimates.

We also refer you to Part II, Item 1A – Risk Factors in this report and to the risks identified and the cautionary statements discussed in greater detail in our December 31, 2014 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and they are reasonable. We caution you however, forward looking statements relying upon such assumptions or bases almost always vary from actual results, and the differences between those statements and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. (the “Company”) is a bank holding company headquartered in Louisville, Kentucky. Our wholly owned subsidiary PBI Bank (“the Bank”) is the ninth largest bank domiciled in the Commonwealth of Kentucky based on total assets. We operate banking offices in twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of June 30, 2015, we had total assets of $979.3 million, total loans of $648.3 million, total deposits of $904.2 million and stockholders’ equity of $30.0 million.

The Company reported a net loss of $2.1 million and $1.5 million for the three and six months ended June 30, 2015, respectively, compared with a net loss of $6.2 million and $6.5 million for the same periods of 2014, respectively. After deductions for earnings allocated to participating securities, net loss attributable to common shareholders was $2.0 million and $1.3 million for the three and six months ended June 30, 2015, respectively, compared with net loss attributable to common shareholders of $6.3 million and $7.3 million for the three and six months ended June 30, 2014, respectively.

 

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Basic and diluted loss per common share were ($0.08) and ($0.06) for the three and six months ended June 30, 2015, respectively, compared with basic and diluted loss per common share of ($0.53) and ($0.61) for the three and six months ended June 30, 2014, respectively.

The following significant items are of note for the six months ended June 30, 2015:

 

   

Net interest margin increased 17 basis points to 3.21% in the first six months of 2015 compared with 3.04% in the first six months of 2014. The increase in margin between periods was primarily due to a decrease in the cost of interest bearing liabilities from 1.15% in the first six months of 2014 to 0.89% in the first six months of 2015. The decrease in cost of interest bearing liabilities was primarily driven by the continued repricing of certificates of deposit at lower rates. Average loans decreased 6.6% to $642.3 million in the first six months of 2015 compared with $687.9 million in the first six months of 2014. Net loans increased 2.2% to $631.5 million at June 30, 2015, compared with $617.9 million at June 30, 2014.

 

   

No provision for loan losses was recorded in the first six months of 2015, compared to $6.3 million for the first six months of 2014 because of improvements in asset quality and management’s assessment of risk in the loan portfolio. Net charge-offs of $2.6 million were recognized for the first six months of 2015, compared to $9.3 million for the six months ended June 30, 2014.

 

   

Non-performing loans decreased $17.0 million to $30.3 million at June 30, 2015, compared with $47.3 million at December 31, 2014. The decrease in non-performing loans was primarily due to $16.1 million in paydowns, as well as a decrease in loans moved to nonaccrual during the six months ended June 30, 2015 compared to the same period in 2014. Net charge-offs were $2.6 million for the six months ended June 30, 2015.

 

   

Loans past due 30-59 days decreased from $4.0 million at December 31, 2014 to $1.9 million at June 30, 2015 and loans past due 60-89 days decreased from $980,000 at December 31, 2014 to $650,000 at June 30, 2015. Total loans past due and nonaccrual loans decreased to $32.9 million at June 30, 2015 from $52.3 million at December 31, 2014.

 

   

Non-interest income increased $2.4 million to $4.3 million compared with $1.9 million for the first six months of 2014 driven primarily by gains on the sales of securities totaling $1.7 million in the first six months of 2015, compared to $44,000 in the first six months of 2014, as well as an increase in OREO rental income of $704,000 between the two periods. The increase in OREO income is the result of several larger properties with tenants being transferred to OREO in the second quarter of 2014.

 

   

Non-interest expense increased $2.1 million to $20.4 million compared with $18.3 million for the first six months of 2014, primarily due to increased OREO expenses related to fair value write-downs of $2.6 million for the first six months of 2015, and an increase in professional fees of $920,000 related to legal fees and litigation expenses, offset by a decrease in loan collection expenses of $1.2 million.

 

   

Foreclosed properties were $39.5 million at June 30, 2015, compared with $46.2 million at December 31, 2014, and $56.9 million at June 30, 2014. During the first six months of 2015, the Company acquired $955,000 and sold $5.0 million of OREO. We incurred OREO losses totaling $2.6 million during the first six months of 2015, comprised of $2.6 million in fair value write-downs to reflect reductions in listing prices for certain properties as well as updated appraisals, offset by $43,000 in net gain on sales of OREO. OREO expense may be elevated in future periods given the current size of the OREO portfolio and as we work to sell these properties. Currently, $12.7 million of OREO property is subject to a contract for sale or letter of intent.

 

   

Our ratio of non-performing assets to total assets decreased to 7.13% at June 30, 2015, compared with 9.19% at December 31, 2014, and 9.69% at June 30, 2014.

 

   

Deposits decreased 2.4% to $904.2 million at June 30, 2015 compared with $926.8 million at December 31, 2014. Certificate of deposit balances decreased $10.4 million during the first six months of 2015 to $564.3 million at June 30, 2015, from $574.7 million at December 31, 2014. Demand deposits decreased 5.3% during the first six months of 2015 compared with December 31, 2014.

 

   

On February 25, 2015, shareholders approved the conversion of all mandatorily convertible Series B Preferred Shares into 4,053,600 common shares and the conversion of all mandatorily convertible Series D Preferred Shares into 6,458,000 non-voting common shares. The conversion reduced preferred stockholders’ equity by $5.8 million and increased common stockholders’ equity by the same amount. Total issued and outstanding common shares and non-voting common shares were 25,759,223 at June 30, 2015.

 

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The Board of Directors approved the adoption of a tax benefits preservation plan designed to preserve the value of certain of the Company’s deferred tax assets primarily associated with net operating loss carryforwards (NOLs) under Section 382 of the Internal Revenue Code. At June 30, 2015 the Company’s net deferred tax asset totaled $51.9 million and was subject to a full valuation allowance. The plan is intended to reduce the likelihood of an “ownership change” occurring as a result of the buying and selling of the Company’s common stock. The tax benefits preservation plan is more fully described in Note 9 – “Income Taxes”.

Going Concern Considerations and Future Plans

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. In October 2012, the Bank entered into a revised Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.

We continue to work toward capital ratio compliance. As of June 30, 2015, the capital ratios required by the Consent order had not been met. The revised Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The revised Consent Order was included in our Current Report on 8-K filed on September 19, 2012.

At June 30, 2015, we continued to be involved in various legal proceedings in which we dispute the material factual allegations against us. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

The Board of Directors and management continue to evaluate and implement strategies to meet the obligations of the Consent Order. These include:

 

   

Increasing capital through the issuance of common stock to new and existing shareholders.

 

   

Continuing to operate the Company and Bank in a safe and sound manner. We have reduced our lending concentrations and the size of our balance sheet, while continuing to remediate non-performing loans and reduce other noninterest expense through the disposition of OREO.

 

   

Continuing to improve our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

 

   

Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

 

   

We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $648.3 million at June 30, 2015.

 

   

We have reduced our construction and development loans to less than 75% of total risk-based capital at June 30, 2015.

 

   

We have reduced our non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans. These loans represented 248% of total risk-based capital at June 30, 2015, down from 262% at December 31, 2014.

 

   

Executing on our commitment to sell OREO and reinvest in quality income producing assets.

 

   

Our acquisition of real estate assets through the loan remediation process increased during 2014, as we acquired $32.3 million of OREO in 2014 compared with $20.6 million during 2013. We acquired $955,000 in the first six months of 2015. However, nonaccrual loans totaled $30.2 million at June 30, 2015, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio.

 

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We incurred OREO losses totaling $2.6 million during the first six months of 2015, comprised of $2.6 million in fair value write-downs to reflect reductions in listing prices for certain properties as well as updated appraisals, offset by $43,000 in net gain on sales of OREO. OREO expense may be elevated in future periods given the current size of the OREO portfolio and as we work to sell these properties.

 

   

To ensure we maximize the value we receive upon the sale of OREO, we continually evaluate sales opportunities. Proceeds from the sale of OREO totaled $5.0 million for the six months ended June 30, 2015, and $4.3 million for the six months ended June 30, 2014.

 

   

Real estate construction represents 41% of the OREO portfolio at June 30, 2015 compared with 40% at December 31, 2014. Commercial real estate represents 37% of the OREO portfolio at June 30, 2015 compared with 31% at December 31, 2014, and 1-4 family residential properties represent 12% of the portfolio at June 30, 2015 compared with 17% at December 31, 2014.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions such as directing a bank to seek a buyer or taking a bank into receivership.

The Company’s liquid assets were $1.3 million at June 30, 2015. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to earnings on investment securities, sales of investment securities, interest on deposits with the Bank, the issuance of new debt, or the issuance of capital securities. Ongoing operating expenses of the parent company are forecasted at approximately $1.0 million for 2015.

Effective with the fourth quarter of 2011, we began deferring interest payments on the junior subordinated debentures relating to our trust preferred securities. Deferring interest payments on the junior subordinated debentures resulted in a deferral of distributions on our trust preferred securities. If we defer distributions on our trust preferred securities for 20 consecutive quarters, we must pay all deferred distributions in full or we will be in default. Our deferral period expires in the third quarter of 2016. Deferred distributions on our trust preferred securities, which totaled $2.5 million as of June 30, 2015, are cumulative, and unpaid distributions accrue and compound on each subsequent payment date. If as a result of a default we become subject to any liquidation, dissolution or winding up, holders of the trust preferred securities will be entitled to receive the liquidation amounts to which they are entitled, including all accrued and unpaid distributions, before any distribution can be made to our shareholders. In addition, the holders of our Series E and Series F Preferred Shares will be entitled to receive liquidation distributions totaling $10.5 million before any distribution can be made to the holders of our common shares.

Application of Critical Accounting Policies

We continually review our accounting policies and financial information disclosures. Our more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2014. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first six months of 2015, there were no material changes in the critical accounting policies and assumptions.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended June 30, 2015, compared with the same period of 2014:

 

     For the Three Months
Ended June 30,
     Change from
Prior Period
 
     2015      2014      Amount      Percent  
     (dollars in thousands)  

Gross interest income

   $ 9,167       $ 10,166       $ (999      (9.8 )%

Gross interest expense

     1,828         2,552         (724      (28.4 )

Net interest income

     7,339         7,614         (275      (3.6

Provision for loan losses

     —           6,300         (6,300      (100.0

Non-interest income

     1,565         949         616         64.9   

Non-interest expense

     11,034         9,804         1,230         12.5   

Net income (loss) before taxes

     (2,130      (7,541      5,411         (71.8

Income tax benefit

     —           (1,307      1,307         (100.0

Net income (loss)

     (2,130      (6,234      4,104         (65.8

 

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Net loss before taxes for the three months ended June 30, 2015 totaled $2.1 million, compared with a net loss before taxes of $7.5 million for the comparable period of 2014.

Net interest income decreased $275,000 from the second quarter of 2014 and was adversely affected by the reduction in net interest earning assets as well as interest lost on nonaccrual loans in the second quarters of 2015 and 2014 of $464,000 and $948,000, respectively. No provision for loan losses was recorded in the first six months of 2015, compared to $6.3 million for the first six months of 2014 because of improvements in asset quality and management’s assessment of risk in the loan portfolio. The provision for loan losses of $6.3 million recorded in the second quarter of 2014 was primarily attributable to $5.2 million in commercial real estate loan charge-offs in the second quarter of 2014 associated with loans to a borrower with which the company reached a settlement agreement and transferred the commercial real estate securing the loans to OREO at estimated fair value less cost to sell. The charge-offs were in addition to reserves established through that time.

Non-interest income increased by $616,000 to $1.6 million from $949,000 in the second quarter of 2014, primarily due to increases in net gains on sales of securities and OREO rental income. Non-interest expense also increased during the period from $9.8 million to $11.0 million for the three months ended June 30, 2014 and 2015, respectively. This increase was primarily due to increases in OREO expenses of $2.2 million, offset by a reduction in loan collection expenses of $958,000. OREO expense was elevated during the second quarter of 2015 due to write-downs of $2.3 million resulting from declines in fair value of the real estate based upon reductions in listing prices for certain properties as well as updated appraisals. OREO expense may be elevated in future periods given the current size of the OREO portfolio and as we work to sell these properties. Additionally, nonaccrual loans totaled $30.2 million at June 30, 2015, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio. Loan collection expenses for the second quarter of 2014 included $860,000 of expense related to the settlement agreement with a borrower and acquisition of OREO, as noted above.

A tax benefit was recognized in the second quarter of 2014 due to gains in other comprehensive income that are presented in current operations. The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income, or OCI, which is a component of stockholders’ equity on the balance sheet. However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against net deferred tax assets, there is a loss from continuing operations and there is income in other components of the financial statements. In such a case, pre-tax income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations. For the quarter ended June 30, 2014, this resulted in $1.3 million of income tax benefit allocated to continuing operations. The June 30, 2014 tax benefit is entirely due to gains in other comprehensive income that are presented in current operations in accordance with applicable accounting standards. There was no tax benefit recorded during the quarter ended June 30, 2015. Net loss after recognition of the tax benefit was $6.2 million for the second quarter of 2014.

The following table summarizes components of income and expense and the change in those components for the six months ended June 30, 2015, compared with the same period of 2014:

 

     For the Six Months Ended
June 30,
     Change from
Prior Period
 
     2015      2014      Amount      Percent  
     (dollars in thousands)  

Gross interest income

   $ 18,370       $ 20,063       $ (1,693      (8.4 )%

Gross interest expense

     3,741         5,149         (1,408      (27.3 )

Net interest income

     14,629         14,914         (285      (1.9

Provision for loan losses

             6,300         (6,300      (100.0

Non-interest income

     4,261         1,864         2,397         128.6   

Non-interest expense

     20,426         18,306         2,120         11.6   

Net loss before taxes

     (1,536      (7,828      6,292         (80.4

Income tax benefit

             (1,307      1,307         (100.0

Net loss

     (1,536      (6,521      4,985         (76.4

Net loss before taxes for the six months ended June 30, 2015 totaled $1.5 million, compared with a net loss before taxes of $7.8 million for the comparable period of 2014. After the tax benefit recorded in the second quarter as noted above, net loss for the first six months 2014 was $6.5 million. Provision for loan losses expense decreased $6.3 million for the first six months of 2015 compared with the same period in 2014. Net charge-offs were $2.6 million for the six months ended June 30, 2015, compared to $9.3 million for the same period in 2014.

 

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Net interest income decreased $285,000 from the first six months of 2014 and was adversely affected by a reduction in net interest earning assets as well as interest lost on nonaccrual loans in the first six months of 2015 and 2014 of $1.1 million and $2.1 million, respectively. Non-interest income increased by $2.4 million to $4.3 million from $1.9 million for the first six months of 2014, primarily due to increases in net gains on sales of securities and OREO rental income. Non-interest expense also increased during the period from $18.3 million to $20.4 million for the six months ended June 30, 2014 and 2015, respectively. This increase was primarily due to increases in OREO expenses of $2.2 million and professional fees of $920,000, offset by a decrease in loan collection expenses of $1.2 million. OREO expense was elevated during the first six months of 2015 due to writedowns of $2.6 million resulting from declines in fair value of the real estate based upon reductions in listing prices as well as updated appraisals. OREO expenses may be elevated in future periods given the current size of the OREO portfolio as we work to sell these properties. Additionally, nonaccrual loans totaled $30.2 million at June 30, 2015, and we expect to resolve many of these loans by foreclosure which could result in further additions to our OREO portfolio. Professional fees are elevated for 2015 as a result of current litigation as described in Note 13 – “Contingencies”. Loan collection expenses for the first six months of 2014 included $860,000 of expense related to the settlement agreement with a borrower and acquisition of OREO, as noted above.

Net Interest Income – Our net interest income was $7.3 million for the three months ended June 30, 2015, a decrease of $275,000, or 3.6%, compared with $7.6 million for the same period in 2014. Net interest spread and margin were 3.13% and 3.21%, respectively, for the second quarter of 2015, compared with 3.01% and 3.13%, respectively, for the second quarter of 2014. Net average non-accrual loans were $33.4 million and $66.7 million for the second quarters of 2015 and 2014, respectively. Cost of funds decreased 28 basis points from 1.15% in the second quarter of 2014 to 0.87% for the second quarter of 2015.

Average loans receivable declined approximately $36.1 million for the quarter ended June 30, 2015 compared with the second quarter of 2014. This resulted in a decline in interest revenue of approximately $447,000 for the quarter ended June 30, 2015 compared with the prior year period.

Net interest margin increased eight basis points from our margin of 3.13% in the prior year second quarter. The yield on earning assets decreased 16 basis points from the second quarter of 2014, compared with a 28 basis point decline in rates paid on interest-bearing liabilities. The increase in net interest margin was offset by a decrease in earning assets which resulted in a $275,000 reduction in net interest income.

Net interest income was $14.6 million for the six months ended June 30, 2015, a decrease of $285,000, or 1.9%, compared with $14.9 million for the same period in 2014. Net interest spread and margin were 3.13% and 3.21%, respectively, for the first six months of 2015, compared with 2.93% and 3.04%, respectively, for the first six months of 2014. Net average non-accrual loans were $38.8 million and $79.0 million for the first six months of 2015 and 2014, respectively. Cost of funds decreased 26 basis points from 1.15% for the first six months of 2014 to 0.89% for the first six months of 2015.

Average loans receivable declined approximately $45.6 million for the six months ended June 30, 2015 compared with the first six months of 2014. This resulted in a decline in interest revenue of approximately $1.1 million for the six months ended June 30, 2015 compared with the prior year period.

Net interest margin increased 17 basis points from our margin of 3.04% in the first six months of 2014. The yield on earning assets decreased six basis points from the first six months of 2014, compared with a 26 basis point decline in rates paid on interest-bearing liabilities. The increase in net interest margin was offset by a decrease in earning assets which resulted in a $285,000 reduction in net interest income.

 

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended June 30, 2015 and 2014, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Three Months Ended June 30,  
     2015     2014  
     Average
Balance
    Interest
Earned/Paid
     Average
Yield/Cost
    Average
Balance
    Interest
Earned/Paid
     Average
Yield/Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 641,857      $ 7,846         4.91   $ 677,643      $ 8,572         5.07

Securities

              

Taxable

     171,608        1,010         2.36        181,706        1,215         2.68   

Tax-exempt (3)

     25,187        190         4.65        30,549        235         4.75   

FHLB stock

     7,323        72         3.94        7,323        89         4.87   

Federal funds sold and other

     84,710        49         0.23        94,195        55         0.23   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     930,415        9,167         4.00     991,416        10,166         4.16
    

 

 

        

 

 

    

Less: Allowance for loan losses

     (18,035          (25,326     

Non-interest earning assets

     91,127             90,719        
  

 

 

        

 

 

      

Total assets

   $ 1,003,507           $ 1,056,809        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 581,786      $ 1,410         0.97   $ 642,881      $ 2,133         1.33

NOW and money market deposits

     194,730        176         0.36        176,192        163         0.37   

Savings accounts

     36,217        21         0.23        37,277        23         0.25   

Repurchase agreements

     951        1         0.42        2,199        1         0.18   

FHLB advances

     3,487        24         2.76        4,751        32         2.70   

Junior subordinated debentures

     29,721        196         2.65        30,621        200         2.62   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     846,892        1,828         0.87     893,921        2,552         1.15
    

 

 

        

 

 

    

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     112,107             109,814        

Other liabilities

     10,738             15,463        
  

 

 

        

 

 

      

Total liabilities

     969,737             1,019,198        

Stockholders’ equity

     33,770             37,611        
  

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 1,003,507           $ 1,056,809        
  

 

 

        

 

 

      

Net interest income

     $ 7,339           $ 7,614      
    

 

 

        

 

 

    

Net interest spread

          3.13          3.01
       

 

 

        

 

 

 

Net interest margin

          3.21          3.13
       

 

 

        

 

 

 

 

(1)

Includes loan fees in both interest income and the calculation of yield on loans.

(2)

Calculations include non-accruing loans averaging $33.4 million and $66.7 million, respectively, in average loan amounts outstanding.

(3)

Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

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The following table presents the average balance sheets for the six month periods ended June 30, 2015 and 2014, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Six Months Ended June 30,  
     2015     2014  
     Average
Balance
    Interest
Earned/Paid
     Average
Yield/Cost
    Average
Balance
    Interest
Earned/Paid
     Average
Yield/Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 642,269      $ 15,601         4.90   $ 687,857      $ 16,893         4.95

Securities

              

Taxable

     175,146        2,136         2.46        179,654        2,388         2.68   

Tax-exempt (3)

     25,967        393         4.70        30,816        476         4.79   

FHLB stock

     7,323        146         4.02        8,204        191         4.69   

Other equity securities

     —          —           —          43        —           —     

Federal funds sold and other

     82,505        94         0.23        98,644        115         0.24   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-earning assets

     933,210        18,370         4.02     1,005,218        20,063         4.08
    

 

 

        

 

 

    

Less: Allowance for loan losses

     (18,646          (26,573     

Non-interest earning assets

     92,948             86,506        
  

 

 

        

 

 

      

Total assets

   $ 1,007,512           $ 1,065,151        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 585,327      $ 2,906         1.00   $ 656,500      $ 4,324         1.33

NOW and money market deposits

     194,431        352         0.37        171,335        310         0.36   

Savings accounts

     36,336        41         0.23        37,091        46         0.25   

Repurchase agreements

     990        1         0.20        2,277        2         0.18   

FHLB advances

     3,719        51         2.77        4,569        65         2.87   

Junior subordinated debentures

     29,834        390         2.64        30,734        402         2.64   
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities