10-K 1 pstb20161231_10k.htm FORM 10-K pstb20161231_10k.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

 

FORM 10-K

 

[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

 

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 001-35032

 

 

 

PARK STERLING CORPORATION

(Exact name of registrant as specified in its charter)

 

NORTH CAROLINA

27-4107242

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

   

 1043 E. Morehead Street, Suite 201

 

Charlotte, North Carolina

28204

(Address of principal executive offices)

(Zip Code)

 

(704) 716-2134

(Registrant’s telephone number, including area code)

___________________________

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

 

Name of each exchange

Title of each class

 

on which registered

Common Stock, $1.00 par value

 

 NASDAQ Global Select Market

       

Securities Registered Pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes   No 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No

 

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

 

 
 

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

 

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 

 (Do not check if a smaller reporting company)

Smaller reporting company 

 ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

 

As of June 30, 2016, the aggregate market value of the common stock of the registrant held by non-affiliates was approximately $354,629,208 (based on the closing price of $7.09 per share on June 30, 2016). For purposes of the foregoing calculation only, all directors and executive officers of the registrant have been deemed affiliates.

 

The number of shares of common stock of the registrant outstanding as of February 28, 2017 was 53,061,926.

 

Documents Incorporated by Reference

 

Portions of the registrant’s Definitive Proxy Statement for its 2017 Annual Meeting of Shareholders scheduled to be held on May 25, 2017 are incorporated by reference into Part III, Items 10-14. 

 

 
 

 

  

PARK STERLING CORPORATION

 

 

 

Table of Contents  

 

 

 

Page No.

Part I  

 

 

 

 

Item 1.

Business

2

Item 1A. 

Risk Factors  

12

Item 1B.

Unresolved Staff Comments  

24

Item 2.

Properties  

24

Item 3.

Legal Proceedings 

24

Item 4. 

Mine Safety Disclosures

24

 

 

 

Part II

 

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

25

Item 6. 

Selected Financial Data

28

Item 7. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations  

30

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

58

Item 8.  

Financial Statements and Supplementary Data  

59

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

124

Item 9A. 

Controls and Procedures

124

Item 9B.

Other Information

126

 

 

 

Part III

 

 

     
Item 10. Directors, Executive Officers and Corporate Governance  126
Item 11. Executive Compensation 128
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  128
Item 13.  Certain Relationships and Related Transactions, and Director Independence 129
Item 14.  Principal Accounting Fees and Services 129
     
Part IV    
     
Item 15. Exhibits and Financial Statement Schedules  129
  Signatures 130
  Exhibit Index 132

 

 
 

 

  

PART I

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

I Information set forth in this Annual Report on Form 10-K, including information incorporated by reference in this document, may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” “goal,” “target” and similar expressions. Forward-looking statements express management’s current expectations, plans or forecasts of future events, results and conditions, including the general business strategy of engaging in bank mergers and organic growth, expansion in new markets, hiring of additional personnel, expansion or addition of product capabilities; anticipated loan growth; changes in loan mix and deposit mix; capital and liquidity levels; net interest income; provision expense; noninterest income and noninterest expenses; realization of deferred tax asset; credit trends and conditions, including loan losses, allowance for loan loss, charge-offs, delinquency trends and nonperforming asset levels; the amount, timing and prices of any share repurchases; the payment of common stock dividends; and other similar matters. These forward-looking statements reflect management’s beliefs and assumptions based on the information available to management at the time these disclosures are prepared. The matters discussed in these forward-looking statements are not guarantees of future results or performance and by their nature involve certain known and unknown risks, uncertainties and assumptions that are difficult to predict and are often beyond the Company’s control. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.

 

You should not place undue reliance on any forward-looking statement and should consider all of the following uncertainties and risks, as well as those more fully discussed elsewhere in this report, including Item 1A. “Risk Factors,” and in any of the Company’s subsequent filings with the SEC, which could cause actual results and trends to differ materially from those made, projected or implied in or by the forward-looking statements: inability to identify and successfully negotiate and complete combinations with potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to adequately estimate or to realize the benefits and cost savings from and limit any unexpected liabilities acquired as a result of any such business combination; inability to generate future organic growth in loan balances, retail banking, wealth management, mortgage banking or capital markets results through the hiring of new personnel, development of new products, opening of de novo branches or otherwise in a timely, cost-effective manner; inability to capitalize on identified revenue enhancements or expense management opportunities; failure of assumptions underlying noninterest expense levels; failure of assumptions underlying the establishment of allowances for loan losses; deterioration in the value of securities held in the investment securities portfolio; our ability to fully realize the value of our net deferred tax asset, including the impact of lower federal income tax rates on the carrying amount or the risk that we may be required to establish a valuation allowance; uncertainties about the financial stability and growth rates of non-U.S. jurisdictions, the risk that those jurisdictions may face difficulties servicing their sovereign debt, and related stresses on the financial, credit and real estate markets generally, which could negatively impact our revenues and the value of our assets and liabilities; changes in general economic or business conditions, customer behavior and other uncertainties that could lead to reduced revenues and deterioration in the credit quality of the loan portfolio or the value of the collateral securing those loans and result in higher credit losses than currently expected; sensitivity to the interest rate environment, including continued low interest rates, a rapid increase in interest rates or a change in the shape of the yield curve, and the impact on net interest margin; cyber-security concerns; failure to anticipate or inability to adapt to rapid technological developments and changes; fluctuations in the market price of the common stock, regulatory, legal and contractual requirements, other uses of capital, the Company’s financial performance, market conditions generally, and future actions by the board of directors, in each case impacting repurchases of common stock or declaration of dividends; the impact of implementation and compliance with legal and regulatory developments including changes in the federal risk-based capital rules; increased competition from both banks and nonbanks; changes in accounting standards, rules and interpretations, inaccurate estimates or assumptions in accounting, including acquisition accounting fair market value assumptions and accounting for purchased credit-impaired loans, and the impact on the Company’s financial statements; and management’s ability to effectively manage credit risk, market risk, operational risk, legal risk, and regulatory and compliance risk.

 

Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made. 

 

 
 

 

  

Item 1. Business

General

 

Park Sterling Corporation (the “Company”) was formed in 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) pursuant to a bank holding company reorganization effective January 1, 2011, and is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Bank is a North Carolina-chartered commercial nonmember bank that was incorporated in September 2006 and opened for business at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina on October 25, 2006. At December 31, 2016, the Company’s primary operations and business were that of owning the Bank. The main office of both the Company and the Bank is located at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina, 28204, and its phone number is (704) 716-2134.

 

In August 2010, the Bank raised gross proceeds of $150 million in an equity offering (the “Public Offering”), to facilitate a change in the Bank’s business plan from primarily organic growth at a moderate pace to creating a regional community bank through a combination of mergers and acquisitions and accelerated organic growth. Consistent with this growth strategy, over the past several years the Bank has opened additional branches in North Carolina and South Carolina and in 2014 and 2015 expanded into the Virginia market through the opening of two branches in Richmond, Virginia. Also consistent with this strategy, on January 1, 2016 the Company acquired First Capital Bancorp, Inc. (“First Capital”), the parent company of First Capital Bank. As a result of the merger of First Capital into the Company, First Capital Bank, which operated eight branches in the Richmond, Virginia area, became a wholly-owned subsidiary of the Company and thereafter was merged into the Bank. The aggregate merger consideration consisted of approximately 8.4 million shares of Common Stock and approximately $25.8 million in cash. Based on the $7.32 per share closing price of the Company’s common stock on December 31, 2015, the transaction value was approximately $87.1 million.

 

In addition, since the Public Offering, the Company has completed the following acquisitions of community banks in its existing or targeted markets:

 

 

In May 2014, the Company acquired Provident Community Bancshares, Inc. (“Provident Community”), the parent company of Provident Community Bank, N.A., which operated nine branches in South Carolina.

 

 

In October 2012, the Company acquired Citizens South Banking Corporation (“Citizens South”), the parent company of Citizens South Bank, which operated 21 branches in North Carolina, South Carolina and North Georgia.

 

 

In November 2011, the Company acquired Community Capital Corporation (“Community Capital”), the parent company of CapitalBank, which operated 18 branches in the Upstate and Midlands area of South Carolina.

 

Each of these banks has merged into the Bank.

 

The Company remains focused on its intention to create a regional community bank with locations in North Carolina, South Carolina, Virginia and North Georgia, through selective acquisitions of banks or branches and organic growth through the opening of additional branches and selective investment in additional bankers and enhanced products and services. 

 

 
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Banking Services

 

Our objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank. We strive to develop a personal relationship with our customers so that we are positioned to anticipate and address their financial needs.

 

Through our branches and offices, we provide banking services to small and mid-sized businesses, owner-occupied and income-producing real estate owners, residential builders, institutions, professionals and consumers doing business or residing within our target markets. We provide a wide range of banking products, including personal, business and non-profit checking accounts, IOLTA accounts, individual retirement accounts, business and personal money market accounts, time deposits, overdraft protection, safe deposit boxes and online and mobile banking. Our lending activities include a range of short- to medium-term commercial (including asset-based lending), real estate, construction, residential mortgage, home equity and consumer loans, as well as long-term residential mortgages. Our wealth management activities include investment management, private banking, personal trust and investment brokerage services. Our cash management activities include remote deposit capture, lockbox services, sweep accounts, purchasing cards, ACH and wire payments. Our capital markets activities include interest rate and currency risk management products, loan syndications and debt placements. We are committed to providing “Answers You Can Bank OnSM to our customers. We pride ourselves on being large enough to help customers achieve their financial aspirations, yet small enough to care that they do. We are focused on building a banking franchise that is noted for sound risk management, broad product capabilities, strong community focus and exceptional customer service.

 

 

Market Area

 

The Bank serves its customers through eighteen full-service branches in North Carolina, twenty three full-service branches in South Carolina, nine full-service branches in Virginia and five full-service branches in North Georgia.

 

The Bank maintains nineteen branches in the Charlotte-Concord-Gastonia Metropolitan Statistical Area (“MSA”) in North Carolina, ten branches in the Greenville-Anderson-Mauldin MSA in South Carolina, and ten branches in the Richmond MSA in Virginia. Additionally, we serve our communities through five branches in the Greenwood, South Carolina MSA, two each in the Spartanburg, South Carolina MSA and the Columbia, South Carolina MSA, and one each in the Newberry, South Carolina MSA, the Raleigh, North Carolina MSA, the Wilmington, North Carolina MSA, and the Charleston-North Charleston, South Carolina MSA. Our five North Georgia branches are not located in an identified MSA.

 

With the Bank’s operations stretching from Virginia, throughout the Carolinas and down into North Georgia, we have a diverse economic and customer base. We do not believe we are dependent on any one or any several customers or types of business whose loss would have a material adverse effect on us.

 

 

Competition

 

Commercial banking and other financial activities in all of our market areas are highly competitive, and there are numerous branches of national, regional and local institutions in each of these markets. We compete for deposits in our banking markets with other commercial banks, savings banks and other thrift institutions, credit unions, agencies issuing United States government securities, and all other organizations and institutions engaged in money market transactions. In our lending activities, we compete with all other financial institutions as well as consumer finance companies, mortgage companies and other lenders. In our wealth management activities, we compete with commercial and investment banking firms, investment advisory firms and brokerage firms.

 

Interest rates, both on loans and deposits, and prices of fee-based services are significant competitive factors among financial institutions generally. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and, in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of our larger competitors have greater resources, broader geographic markets and higher lending limits than we do, and they can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than we can. To counter these competitive disadvantages, we depend on our reputation as a community bank in our local markets, our direct customer contact, our ability to make credit and other business decisions locally, our wide range of banking products and our personalized service.

 

 
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In recent years, federal and state legislation has heightened the competitive environment in which all financial institutions conduct their business, and the potential for competition among financial institutions of all types has increased significantly. Additionally, with the elimination of restrictions on interstate banking, commercial banks operating in our market areas may be required to compete not only with other financial institutions based in the states in which we operate, but also with out-of-state financial institutions which may acquire institutions, or establish or acquire branch offices in these states, or otherwise offer financial services across state lines, thereby adding to the competitive atmosphere of the industry in general.

 

Employees

 

As of February 28, 2017, we employed 544 people and had 532 full time equivalent employees. Each of these individuals is an employee of the Bank. There are no employees at the bank holding company level. We are not a party to a collective bargaining agreement, and we consider our relations with employees to be good.

 

Subsidiaries

 

The Company’s primary subsidiary is the Bank. As of February 28, 2017, the Company has five wholly-owned non-consolidated subsidiaries; Community Capital Corporation Statutory Trust I, CSBC Statutory Trust I, Provident Community Bancshares Capital Trust I, Provident Community Bancshares Capital Trust II and FCRV Statutory Trust 1, which were used to issue $10.3 million, $15.5 million, $4.1 million, $8.2 million and $5.0 million (in each case before related acquisition accounting fair market value adjustments), respectively, of trust preferred securities (“TruPS”) by predecessor companies. The Company has fully and unconditionally guaranteed each trust’s obligations under the TruPS. Proceeds from these TruPS were used by the predecessor companies to purchase junior subordinated notes in Community Capital, Citizens South, Provident Community and First Capital, respectively, which constitute Tier I capital of the Company.

 

The Bank has two subsidiaries, Park Sterling Financial Services, Inc., and Citizens Properties, LLC. Park Sterling Financial Services, Inc., originally Citizens South Financial Services, Inc., primarily owns stock in a title insurance company which was used by Citizens South Bank for certain real estate transactions and continues to operate as such. Citizens Properties, LLC was formed in January 2012 for the purpose of holding, managing and resolving certain real estate that was acquired through foreclosure, or other nonperforming and substandard assets, and continues to operate as such.

 

Supervision and Regulation

 

Bank holding companies and state commercial banks are subject to extensive supervision and regulation by federal and state agencies. Regulation of bank holding companies and banks is intended primarily for the protection of consumers, depositors, borrowers, the Federal Deposit Insurance Fund (the “DIF”) and the banking system as a whole and not for the protection of shareholders or creditors. The following is a brief summary of certain material statutory and regulatory provisions applicable to the Company and the Bank but is not intended to be an exhaustive description of all statutes and regulations applicable to our business. To the extent such provisions are described, this description is qualified in its entirety by reference to the applicable laws and regulations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in July 2010, has had and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes including, among other things: (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the Federal Deposit Insurance Corporation (“FDIC”) for federal deposit insurance; (v) enhanced corporate governance and executive compensation requirements and disclosures; and (vi) numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness for, the financial services sector. Additionally, the Dodd-Frank Act established a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve Board, the Office of the Comptroller of the Currency, and the FDIC. Many of the requirements called for in the Dodd-Frank Act continue to be implemented, and/or are subject to implementing regulations over the course of several years. In addition, recent government policy has advocated for significant reduction of financial services regulation, including amendments to the Dodd-Frank Act. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, or amended as a result of government policy, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

 

 
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In addition, from time to time, various other legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as regulatory agencies, that may impact the Company or the Bank. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change bank statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any such legislation or regulatory policies will be enacted or, if enacted, the effect that such would have on our financial condition or results of operations, which could be material.

 

General. As a registered bank holding company, the Company is subject to regulation under the BHC Act and to inspection, examination and supervision by the Federal Reserve Board and the Federal Reserve Bank of Richmond (“Federal Reserve”). In general, the Federal Reserve may initiate enforcement actions for violations of laws and regulations and unsafe or unsound practices. The Federal Reserve may assess civil money penalties, issue cease and desist or removal orders and require that a bank holding company divest subsidiaries, including subsidiary banks. The Company is also required to file reports and other information with the Federal Reserve regarding its business operations and those of the Bank.

 

The Bank is a North Carolina-chartered commercial nonmember bank subject to regulation, supervision and examination by its chartering regulator, the North Carolina Commissioner of Banks (the “NC Commissioner”), and by the FDIC, as deposit insurer and primary federal regulator. As an insured depository institution, numerous federal and state laws, as well as regulations promulgated by the FDIC and the NC Commissioner, govern many aspects of the Bank’s operations. The NC Commissioner and the FDIC regulate and monitor compliance with these state and federal laws and regulations, as well as the Bank’s operations and activities, including, but not limited to, loan and lease loss reserves, lending and mortgage operations, interest rates paid on deposits and received on loans, the payment of dividends to the Company, loans to officers and directors, record-keeping, mergers of state-chartered banks, capital requirements, and the establishment of branches. The Bank is a member of the Federal Home Loan Bank of Atlanta, which is one of the 12 regional banks comprising the Federal Home Loan Bank (“FHLB”) system.

 

In addition to state and federal banking laws, regulations and regulatory agencies, the Company and the Bank are subject to various other laws and regulations of, and supervision and examination by, other regulatory agencies, including, with respect to the Company, the SEC and the NASDAQ Global Select Market (“NASDAQ”).

 

Bank Holding Companies. The Federal Reserve is authorized to adopt regulations affecting various aspects of bank holding companies. In general, the BHC Act limits the business of a bank holding company and its subsidiaries to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The Federal Reserve has the power to order a bank holding company or its subsidiaries to terminate any activity or control of any nonbank subsidiary when the continuation of the activity or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.

 

The BHC Act requires prior Federal Reserve Board approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. The BHC Act also prohibits a bank holding company from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless such business is determined by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.

 

The Company also is subject to the North Carolina Bank Holding Company Act of 1984. This state legislation requires the Company, by virtue of its ownership of the Bank, to register as a bank holding company with the NC Commissioner.

 

Under the BHC Act, a bank holding company may elect to become a “financial holding company,” provided certain conditions are met. A financial holding company, and the companies it controls, are permitted to engage in activities considered “financial in nature” (including, without limitation, insurance and securities activities), and therefore may engage in a broader range of activities than permitted by bank holding companies and their subsidiaries. The Company remains a bank holding company, but may at some time in the future elect to become a financial holding company. If the Company were to do so, the Bank would have to be well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act (“CRA”), which is discussed below.

 

 

 
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Acquisitions. As an acquirer, we must comply with numerous laws related to our acquisition activity. As noted above, under the BHC Act, a bank holding company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. In addition, the Bank Merger Act requires prior approval from the applicable federal regulatory agency (the FDIC, in the case of the Bank) before any bank may merge or consolidate with, acquire the assets of or assume the deposit liabilities of another bank. Current federal law authorizes interstate acquisitions of banks by well-capitalized and well-managed bank holding companies, and allows a bank headquartered in one state to merge with or acquire a bank headquartered in another state (where the resulting institution is well-capitalized and well-managed) as long as neither of the states has opted out of such interstate bank merger authority, in each case subject to any state requirement that the target bank shall have been in existence and operating for a minimum period of time, not to exceed five years, and to certain deposit market-share limitations.

 

Branching. With appropriate regulatory approvals, North Carolina commercial banks are authorized to establish branches both in North Carolina as well as in other states, where the laws of the state where the de novo branch is to be opened would permit a bank chartered by that state to open a de novo branch. A bank that establishes a branch in another state may conduct any activity at that branch office that is permitted by the law of that state to the extent that the activity is permitted either for a state bank chartered by that state or for a branch in the state of an out-of-state national bank. 

 

Minimum Capital Requirements. The various federal bank regulators, including the Federal Reserve Board and the FDIC, have adopted substantially similar minimum risk-based and leverage capital guidelines applicable to United States banking organizations, including bank holding companies and banks. As a prudential matter, however, banking organizations generally are expected to operate well above the minimum regulatory capital ratios, with capital commensurate to the level and nature of risks that they hold. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum prescribed levels, whether because of its financial condition or actual or anticipated growth.

 

The risk-based capital standards establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures explicitly into account in assessing capital adequacy and minimizes disincentives to holding liquid, low-risk assets. For purposes of the risk-based ratios, assets and specified off-balance sheet instruments are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The leverage ratio represents core capital as a percentage of total average assets adjusted as specified in the guidelines.

 

In July 2013, the regulatory agencies approved final regulatory capital rules that replaced the then existing general risk-based capital and related rules, broadly revising the basic definitions and elements of regulatory capital and making substantial changes to the credit risk weightings for assets. The new regulatory capital rules establish the benchmark capital rules and capital floors that are generally applicable to United States banks under the Dodd-Frank Act and make the capital rules consistent with heightened international capital standards known as Basel III. These new capital standards apply to all banks, regardless of size, and to all bank holding companies with consolidated assets greater than $500 million, and became effective January 1, 2015 subject to a transition period providing for full implementation as of January 1, 2019. More stringent requirements are imposed on “advanced approaches” banking organizations (organizations with either total assets of $250 billion or more, or with foreign exposure of $10 billion or more).

 

The required regulatory capital minimum ratios are as follows:

 

 

common equity Tier 1 capital ratio (common equity Tier 1 capital to standardized total risk-weighted assets) of 4.5%;

 

Tier 1 capital ratio (Tier 1 capital to standardized total risk-weighted assets) of 6%;

 

total capital ratio (total capital to standardized total risk-weighted assets) of 8%; and

 

leverage ratio (Tier 1 capital to average total consolidated assets less amounts deducted from Tier 1 capital) of 4%.

  

 
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Generally, under the applicable guidelines, common equity Tier 1 capital includes common stock (plus related surplus), retained earnings and qualifying minority interests, less applicable regulatory adjustments and deductions including goodwill, intangible assets subject to limitation and certain deferred tax assets subject to limitation. In addition, under the final capital rule, accumulated other comprehensive income (AOCI) is presumptively included in common equity Tier 1 capital, subject to a one-time opportunity for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI. Total Tier 1 capital is comprised of common equity Tier 1 capital plus generally non-cumulative perpetual preferred stock, tier 1 minority interests and, for bank holding companies with less than $15 billion in consolidated assets at December 31, 2009, certain restricted capital instruments including qualifying cumulative perpetual preferred stock and grandfathered trust preferred securities, up to a limit of 25% of Tier 1 capital, less applicable regulatory adjustments and deductions. Tier 2, or supplementary, capital generally includes portions of trust preferred securities and cumulative perpetual preferred stock not otherwise counted in Tier 1 capital, as well as preferred stock subordinated debt, total capital minority intersts not included in Tier 1, and the allowance for loan losses in an amount not exceeding 1.25% of standardized risk-weighted assets, less applicable regulatory adjustments and dedections. Total capital is the sum of Tier 1 and Tier 2 capital.

 

The new regulatory capital requirements also include changes in the risk-weighting of assets to better reflect credit risk and other risk exposure. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential loans that are 90 days past due or otherwise in nonaccrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital.

  

The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The required amount of capital conservation buffer is being phased in annually beginning January 1, 2016 at the 0.625% level, and increasing by that same amount on each subsequent January 1 until it reaches 2.5% on January 1, 2019. When fully phased in, the capital conservation buffer effectively will result in a required minimum common equity Tier 1 capital ratio of at least 7.0%, Tier 1 capital ratio of at least 8.5% and total capital ratio of at least 10.5%. Advanced approaches banking organizations also are subject to a supplementary leverage ratio that incorporates a broader set of exposures in the denominator, as well as a countercyclical capital buffer. Failure to satisfy the capital buffer requirements will result in increasingly stringent limitations on various types of capital distributions, including dividends, share buybacks and discretionary payments on Tier 1 instruments, and discretionary bonus payments.

  

To assess a bank’s capital adequacy, federal banking agencies, including the FDIC, have also adopted regulations to require an assessment of exposure to declines in the economic value of a bank’s capital due to changes in interest rates. Under such a risk assessment, examiners will evaluate a bank’s capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors. Applicable considerations include the quality of the bank’s interest rate risk management process, the overall financial condition of the bank and the level of other risks at the bank for which capital is needed. Institutions with significant interest rate risk may be required to hold additional capital. The agencies also issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies’ evaluation of interest rate risk in connection with capital adequacy.

 

Prompt Corrective Action. The Federal Deposit Insurance Act (the “FDI Act”), as amended by the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. An institution is subject to progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which it is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An FDIC-supervised insured depositary institution that is undercapitalized is required to submit a capital restoration plan to the FDIC, which plan must include a performance guarantee by its bank holding company. In addition, pursuant to the FDICIA, the various federal regulatory agencies have prescribed certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and such agencies may take action against a financial institution that does not meet the applicable standards.

 

 
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The various federal regulatory agencies have adopted substantially similar regulations that define the five capital categories identified under the FDICIA, using the capital ratios as the relevant capital measures. The new risk-based and leverage capital guidelines incorporate the revised changes in regulatory capital described above into the prompt corrective action framework, using the total risk-based capital ratio, the Tier 1 risk-based capital ratio, the common equity Tier 1 ratio, the leverage ratio (including, for certain large institutions, beginning January 1, 2018, the supplementary leverage ratio), as well as a tangible equity to total assets ratio, under which an institution’s capital adequacy will be measured for purposes of the “prompt corrective action” framework. Effective January 1, 2015, generally an insured depository institution will be treated as:

 

 

“well capitalized” if its total risk-based capital ratio is at least 10%, its Tier 1 risk-based capital ratio is at least 8%, its common equity Tier 1 capital ratio is at least 6.5%, its leverage ratio is at least 5% and, if applicable, its supplementary leverage ratio is at least 6%, and if it is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by its primary Federal regulator;

 

“adequately capitalized” if its total risk-based capital ratio is at least 8%, its Tier 1 risk-based capital ratio is at least 6%, its common equity Tier 1 capital ratio is at least 4.5%, its leverage ratio is at least 4% and, if applicable, its supplementary leverage ratio is at least 3%, and it is not considered a well-capitalized institution;

 

“undercapitalized” if its total risk-based capital ratio is less than 8%, its Tier 1 risk-based capital ratio is less than 6%, its common equity Tier 1 capital ratio is less than 4.5%, its leverage ratio is less than 4% or, if applicable, its supplementary leverage ratio is less than 3%;

 

“significantly undercapitalized” if its total risk-based capital ratio is less than 6%, its Tier 1 risk-based capital ratio is less than 4%, its common equity Tier 1 capital ratio is less than 3%, or its leverage ratio is less than 3%; and

 

“critically undercapitalized” if it has a ratio of tangible equity (Tier 1 capital plus non-Tier 1 perpetual preferred stock) to total assets equal to or less than 2%.

 

Under these guidelines, the Bank was considered “well capitalized” as of December 31, 2016.

 

Other Safety and Soundness Regulations. The Federal Reserve Board has enforcement powers over bank holding companies and has authority to prohibit activities that represent unsafe or unsound practices or constitute violations of law, rule, regulation, administrative order or written agreement with a federal regulator. These powers may be exercised through the issuance of cease and desist orders, civil monetary penalties or other actions.

 

There also are a number of obligations and restrictions imposed on bank holding companies and their depositary institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the DIF in the event the depository institution is insolvent or is in danger of becoming insolvent. For example, a bank holding company is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each such subsidiary bank. Under this policy, the Federal Reserve may require a holding company to contribute additional capital to an undercapitalized subsidiary bank and may disapprove of the payment of dividends to the holding company’s shareholders if the Federal Reserve believes the payment of such dividends would be an unsafe or unsound practice.

 

In addition, the “cross guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the DIF as a result of the insolvency of commonly controlled insured depository institutions or for any assistance provided by the FDIC to commonly controlled insured depository institutions in danger of failure. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interests of the DIF. The FDIC’s claim for reimbursement under the cross-guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled depository institution.

 

Federal and state banking regulators also have broad enforcement powers over the Bank, including the power to impose fines and other civil and criminal penalties, and to appoint a conservator (with the approval of the Governor in the case of a North Carolina state bank) in order to conserve the assets of any such institution for the benefit of depositors and other creditors. The NC Commissioner also has the authority to take possession of a North Carolina state bank in certain circumstances, including, among other things, when it appears that such bank has violated its charter or any applicable laws, is conducting its business in an unauthorized or unsafe manner, is in an unsafe or unsound condition to transact its business or has an impairment of its capital stock.

 

 
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In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk taking. The guidance, which covers senior executives and other employees who have the ability to expose an institution to material amounts of risk (either individually or as part of a group), is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks, (ii) be compatible with effective internal controls and risk management and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. The applicable federal regulator will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations,” based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. These supervisory findings will be included in reports of examination and will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. The applicable federal regulator can take enforcement action against an institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

Deposit Insurance and Assessments. The Bank’s deposits are insured by the DIF as administered by the FDIC, up to the applicable limits set by law (currently $250,000 for accounts under the same name and title), and are subject to the deposit insurance premium assessments of the DIF. The DIF imposes a risk-based deposit insurance premium system under which the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. Assessment rates for small banking institutions (an institution with assets of less than $10 billion) are determined based on a combination of financial ratios. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed quarterly. Assessments are calculated as a percentage of average consolidated total assets less average tangible equity during the assessment period. The Dodd-Frank Act also increased the minimum designated reserve ratio of the DIF from 1.15% to 1.35% (subsequently set at 2% by the FDIC) of the estimated amount of total insured deposits.

 

In addition to deposit insurance assessments, insured depository institutions have been required to pay a pro rata portion of the interest due on the obligations issued by the Financing Corporation to fund the closing and disposal of failed thrift institutions by the Resolution Trust Corporation.

 

The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the Federal Reserve. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. We are not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

 

Dividends and Repurchase Limitations. The payment of dividends and repurchase of stock by the Company are subject to certain requirements and limitations of North Carolina corporate law. In addition, the Federal Reserve Board has issued a policy statement regarding payment of cash dividends by a bank holding company, indicating that a bank holding company generally should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover the cash dividends, the holding company’s prospective rate of earnings retention is consistent with the holding company’s capital needs and overall financial condition, and the holding company is not in danger of not meeting its minimum regulatory capital adequacy ratios. As a bank holding company, the Company also must obtain Federal Reserve approval prior to repurchasing its Common Stock in excess of 10% of its consolidated net worth during any twelve-month period unless the Company (i) both before and after the repurchase satisfies capital requirements for "well capitalized" bank holding companies; (ii) is “well managed”; and (iii) is not the subject of any unresolved supervisory issues. For this purpose, a bank holding company will be considered to be "well-capitalized" if it maintains a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6%, and is not subject to a written agreement, order, capital directive or prompt corrective action directive issued by the Federal Reserve Board to meet and maintain a specific capital level for any capital measure; and a bank holding company will be considered to be "well-managed" if it has received at least a satisfactory composite rating and at least a satisfactory rating for management, if applicable.

 

The Company is a legal entity separate and apart from the Bank. The primary source of funds for distributions paid by the Company, as well as funds used to pay principal and interest on the Company’s indebtedness, is dividends from the Bank, and the Bank is subject to laws and regulations that limit the amount of dividends it can pay. North Carolina law provides that, subject to certain capital requirements, the Bank generally may declare a dividend out of undivided profits as the board of directors deems expedient.

 

 
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In addition to the foregoing, the ability of either the Company or the Bank to pay dividends may be affected by the various minimum capital requirements and the capital and non-capital standards established under the FDICIA, as described above. For instance, as an insured depository institution, the Bank is prohibited from making capital distributions, including the payment of dividends, if after such distribution the institution would be “undercapitalized” (as defined). Furthermore, if in the opinion of a federal regulatory agency, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such agency may require, after notice and hearing, that such bank cease and desist from such practice. The right of the Company, its shareholders and its creditors to participate in any distribution of assets or earnings of the Bank is further subject to the prior claims of creditors against the Bank.

 

Volcker Rule. The Dodd-Frank Act amended the BHC Act to require the federal banking regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund and or private equity fund), commonly referred to as the “Volcker Rule.” In December 2013, the federal banking regulatory agencies adopted a final rule construing the Volcker Rule, which was effective April 1, 2014. Banking entities will have until July 21, 2017 (unless such banking entity had filed an application for a five-year extension by the January 20, 2017 filing deadline, which, if granted would extend the compliance deadline July 21, 2022) to conform their activities to the requirements of the rule.

 

Interchange Fees. The Dodd-Frank Act also amended the Electronic Fund Transfer Act to require that the amount of any interchange fee charged for electronic debit transactions by debit card issuers having assets over $10 billion must be reasonable and proportional to the actual cost of a transaction to the issuer, commonly referred to as the “Durbin Amendment”. The Federal Reserve Board has adopted final rules which limit the maximum permissible interchange fees that such issuers can receive for an electronic debit transaction. Although the restrictions on interchange fees do not apply to institutions with less than $10 billion in assets, the price controls could negatively impact bankcard services income for smaller banks if the reductions that are required of larger banks cause industry-wide reduction of swipe fees.

 

Transactions with Affiliates of the Bank. Transactions between an insured bank and any of its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls or is under common control with the bank. Sections 23A and 23B, as implemented by the Federal Reserve Board’s Regulation W, (i) limit the extent to which a bank or its subsidiaries may engage in covered transactions (including extensions of credit) with any one affiliate to an amount equal to 10% of such bank’s capital stock and retained earnings, and limit such transactions with all affiliates to an amount equal to 20% of capital stock and retained earnings; (ii) require collateralization of between 100% and 130% for extensions of credit to an affiliate; and (iii) require that all affiliated transactions be on terms that are consistent with safe and sound banking practices. The term “covered transaction” includes the making of loans, purchasing of assets, issuing of guarantees and other similar types of transactions and, pursuant to the Dodd-Frank Act, includes securities lending, repurchase agreements and derivative activities. In addition, any covered transaction by a bank with an affiliate and any purchase of assets or services by a bank from an affiliate must be on terms that are substantially the same, or at least as favorable to the bank, as those that prevailing at the time for similar transactions with non-affiliates.

 

Community Reinvestment Act. Under the CRA, any insured depository institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA neither establishes specific lending requirements or programs for institutions nor limits an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the FDIC, in connection with its examination of a bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain bank applications, including applications for additional branches and acquisitions. In addition, in connection with an application by a bank holding company to acquire a bank or other bank holding company, the Federal Reserve Board is required to assess the record of each subsidiary bank of the bank holding company. Failure to adequately meet the credit needs of the community it serves could impose additional requirements or limitations on a bank or delay action on an application. The Bank received a “satisfactory” rating in its most recent CRA examination, dated April 11, 2014.

 

Loans to Insiders. Federal law also constrains the types and amounts of loans that the Bank may make to its executive officers, directors and principal shareholders. Among other things, these loans are limited in amount, must be approved by the Bank’s board of directors in advance, and must be on terms and conditions as favorable to the Bank as those available to an unrelated person. The Dodd-Frank Act strengthened restrictions on loans to insiders and expanded the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. The Dodd-Frank Act also places restrictions on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

 

 
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Bank Secrecy Act; Anti-Money Laundering. We are subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act (the “BSA”). The BSA gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. The BSA takes measures intended to encourage information sharing among institutions, bank regulatory agencies and law enforcement bodies and imposes affirmative obligations on a broad range of financial institutions, including the Company. The following obligations are among those imposed by the BSA:

 

• Financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program.

 

• Financial institutions must satisfy minimum standards with respect to customer identification and verification, including adoption of a written customer identification program appropriate for the institution’s size, location and business.

 

• Financial institutions that establish, maintain, administer or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) must establish appropriate, specific and where necessary, enhanced due diligence policies, procedures and controls designed to detect and report money laundering through these accounts.

 

• Financial institutions may not establish, maintain, administer or manage correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country).

 

• Bank regulators are directed to consider a bank’s effectiveness in combating money laundering when ruling on certain applications.

 

Commercial Real Estate (“CRE”) and Construction and Development (“C&D”) Concentration Guidance. The federal banking agencies, including the FDIC, have issued guidance designed to emphasize risk management for institutions with significant CRE and C&D loan concentrations. The guidance reinforces and enhances the FDIC’s existing regulations and guidelines for real estate lending and loan portfolio management and emphasizes the importance of strong capital and loan loss allowance levels and robust credit risk-management practices for institutions with significant CRE and C&D exposure. While the defined thresholds past which a bank is deemed to have a concentration in CRE loans prompt enhanced risk management protocols, the guidance does not establish specific lending limits. Rather, the guidance seeks to promote sound risk management practices that will enable banks to continue to pursue CRE and C&D lending in a safe and sound manner. In addition, a bank should perform periodic market analyses for the various property types and geographic markets represented in its portfolio and perform portfolio level stress tests or sensitivity analyses to quantify the impact of changing economic conditions on asset quality, earnings and capital.

 

Consumer Laws and Regulations. Banks are also subject to certain laws and regulations that are designed to protect consumers. Among the more prominent of such laws and regulations are the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act and consumer privacy protection provisions of the Gramm-Leach-Bliley Act and comparable state laws. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions deal with consumers. With respect to consumer privacy, the Gramm-Leach-Bliley Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually.

 

The Dodd-Frank Act created the Bureau of Consumer Financial Protection (the “Bureau”) within the Federal Reserve System. The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions. The Bureau has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Depository institutions with less than $10 billion in assets are subject to rules promulgated by the Bureau, but continue to be examined and supervised by federal banking regulatory agencies for consumer compliance purposes.

 

 
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During 2013, the Bureau issued a series of proposed and final rules related to mortgage loan origination and mortgage loan servicing. In particular, in January 2013, the Bureau issued its final rule, which was effective January 10, 2014, on ability to repay and qualified mortgage standards to implement various requirements of the Dodd-Frank Act amending the Truth in Lending Act. The final rule requires mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a borrower will have the ability to repay a mortgage loan according to its terms before making the loan. The final rule also includes a definition of a “qualified mortgage,” which provides the lender with a presumption that the ability to repay requirements has been met. This presumption is conclusive (i.e. a safe harbor) if the loan is a “prime” loan and rebuttable if the loan is a higher-priced, or subprime, loan. The ability-to-repay rule has the potential to significantly affect our business, as a borrower can challenge a loan’s status as a qualified mortgage or that the lender otherwise established the borrower’s ability to repay in a direct cause of action for three years from the origination date, or as a defense to foreclosure at any time. In addition, the value and marketability of non-qualified mortgages may be adversely affected.

 

Anti-Tying Restrictions. Under the BHC Act and Federal Reserve Board regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease or sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property or services from or to the bank, its bank holding company or any subsidiary of the bank holding company or (ii) the customer may not obtain some other credit, property or services from a competitor of the bank, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

 

Annual Disclosure Statement

 

This Annual Report on Form 10-K also serves as the annual disclosure statement of the Bank pursuant to Part 350 of the FDIC’s rules and regulations. This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.

 

Website Access to the Company’s SEC Filings

 

The Company maintains an Internet website at www.parksterlingbank.com (this uniform resource locator, or URL, is an inactive textual reference only and is not intended to incorporate the Company’s website into this Annual Report on Form 10-K). The Company makes available, free of charge on or through this website, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after the Company electronically files each such report or amendment with, or furnishes it to, the SEC.

 

 

Item 1A. Risk Factors

  

In addition to the other information included and incorporated by reference in this Annual Report on Form 10-K, you should carefully consider the risk factors and uncertainties described below in evaluating an investment in the Company’s Common Stock. If any of the events described in these risk factors actually occurs, then our business, results of operations and financial condition could be materially adversely affected. Additional risks and uncertainties not currently known to the Company, or which the Company currently deems not material, also may adversely impact the Company’s business operations. The value or market price of the Company’s Common Stock could decline due to any of these identified or other risks, and you could lose all or part of your investment.

 

Risks Associated With Our Growth Strategy

 

We may not be able to implement aspects of our growth strategy.

 

Our growth strategy contemplates the continued expansion of our business and operations both organically and by selective acquisitions such as through the establishment or acquisition of banks and banking offices in our market areas and other markets. Implementing these aspects of our growth strategy depends, in part, on our ability to successfully identify acquisition opportunities and strategic partners that will complement our operating philosophy and to successfully integrate their operations with ours, as well as generate loans and deposits of acceptable risk and expense. To successfully acquire or establish banks or banking offices, we must be able to correctly identify profitable or growing markets, as well as attract the necessary relationships and high caliber banking personnel to make these new banking offices profitable. In addition, we may not be able to identify suitable opportunities for further growth and expansion or, if we do, we may not be able to successfully integrate these new operations into our business. As consolidation of the financial services industry continues, the competition for suitable acquisition candidates may increase. We will compete with other financial services companies for acquisition opportunities, and many of these competitors have greater financial resources than we do and may be able to pay more for an acquisition than we are able or willing to pay. We can offer no assurance that we will have opportunities to acquire other financial institutions or acquire or establish any new branches or loan production offices, or that we will be able to negotiate, finance and complete any opportunities available to us. If we are unable to effectively implement our growth strategies, our business and results of operations may be materially and adversely affected.

 

 
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Future expansion involves risks.

 

The acquisition by us of other financial institutions or parts of those institutions, or the establishment of de novo branch offices and loan production offices, involves a number of risks, including the risk that:

 

 

we may incur substantial costs in identifying and evaluating potential acquisitions and merger partners, or in evaluating new markets, hiring experienced local managers, and opening new offices;

 

 

our estimates and judgments used to evaluate credit, operations, management and market risks relating to target institutions may not be accurate;

 

 

the institutions we acquire may have distressed assets and there can be no assurance that we will be able to realize the value we predict from those assets or that we will make sufficient provisions or have sufficient capital for future losses;

 

 

we may be required to take write-downs or write-offs, restructuring and impairment, or other charges related to the institutions we acquire that could have a significant negative effect on our financial condition and results of operations;

 

 

there may be substantial lag-time between completing an acquisition or opening a new office and generating sufficient assets and deposits to support costs of the expansion;

 

 

we may not be able to finance an acquisition, or the financing we obtain may have an adverse effect on our results of operations or result in dilution to our existing shareholders;

 

 

our management’s attention in negotiating a transaction and integrating the operations and personnel of the combining businesses may be diverted from our existing business and we may not be able to successfully integrate such operations and personnel;

 

 

our announcement of another transaction prior to completion of a merger could result in a delay in obtaining regulatory or shareholder approval for a merger, which could have the effect of limiting our ability to fully realize the expected financial benefits from the transaction;

 

 

we may not be able to obtain regulatory approval for an acquisition;

 

 

we may enter new markets where we lack local experience or that introduce new risks to our operations, or that otherwise result in adverse effects on our results of operations;

 

 

we may introduce new products and services we are not equipped to manage or that introduce new risks to our operations, or that otherwise result in adverse effects on our results of operations;

 

 

we may incur intangible assets in connection with an acquisition, or the intangible assets we incur may become impaired, which results in adverse short-term effects on our results of operations;

 

 

we may assume liabilities in connection with an acquisition, including unrecorded liabilities that are not discovered at the time of the transaction, and the repayment of those liabilities may have an adverse effect on our results of operations, financial condition and stock price; or

 

 

we may lose key employees and customers.

  

 
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We cannot assure you that we will be able to successfully integrate any banking offices that we acquire into our operations or retain the customers of those offices. If any of these risks occur in connection with our expansion efforts, it may have a material and adverse effect on our results of operations and financial condition.

 

We may not be able to maintain our rate of growth, which may adversely affect our results of operations and financial condition.

 

We have grown rapidly since we commenced operations in October 2006, and our business strategy contemplates continued growth, both organically and through selective acquisitions. We can provide no assurance that we will continue to be successful in increasing the volume of loans and deposits or in introducing new products and services at acceptable risk levels and upon acceptable terms while managing the costs and implementation risks associated with our historical or modified organic growth strategy. We may be unable to continue to increase our volume of loans and deposits or to introduce new products and services at acceptable risk levels for a variety of reasons, including an inability to maintain capital and liquidity sufficient to support continued growth. If we are successful in continuing our growth, we cannot assure you that further growth would offer the same levels of potential profitability or that we would be successful in controlling costs and maintaining asset quality. Accordingly, an inability to maintain growth, or an inability to effectively manage growth, could adversely affect our results of operations and financial condition.

 

New bank office facilities and other facilities may not be profitable.

 

We may not be able to organically expand into new markets that are profitable for our franchise. The costs to start up new bank branches and loan production offices in new markets, other than through acquisitions, and the additional costs to operate these facilities would increase our noninterest expense and may decrease our earnings. It may be difficult to adequately and profitably manage our growth through the establishment of bank branches or loan production offices in new markets. In addition, we can provide no assurance that our expansion into any such new markets will successfully attract enough new business to offset the expenses of the operation of new bank branches or loan production offices. If we are not able to do so, our earnings may be negatively impacted.

 

Acquisition of assets and assumption of liabilities may expose us to intangible asset risk, which could impact our results of operations and financial condition.

 

In connection with any acquisitions, as required by United States generally accepted accounting principles (“GAAP”), we will record assets acquired and liabilities assumed at their fair value, and, as such, acquisitions may result in us recording intangible assets, including deposit intangibles and goodwill. We will perform a goodwill valuation at least annually to test for goodwill impairment. Impairment testing is a two-step process that first compares the fair value of goodwill with its carrying amount, and second measures impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. Adverse conditions in our business climate, including a significant decline in future operating cash flows, a significant change in our stock price or market capitalization, or a deviation from our expected growth rate and performance, may significantly affect the fair value of any goodwill and may trigger impairment losses, which could adversely affect our results of operations and financial condition.

 

The continued success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand.

 

Our growth strategy contemplates that we will continue to expand our business and operations in the Carolinas and Virginia. We intend to primarily target market areas that we believe possess attractive demographic, economic or competitive characteristics. To the extent we expand into new markets, we must identify and retain experienced key management members with local expertise and relationships in these markets. Competition for qualified personnel in the markets in which we may expand may be intense, and there may be a limited number of qualified persons with knowledge of and experience in the commercial banking industry in these markets. Even if we identify individuals that we believe could assist us in establishing a presence in a new market, we may be unable to recruit these individuals away from other banks or be unable to do so at a reasonable cost. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition and results of operations.

 

 
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We may need additional access to capital, which we may be unable to obtain on attractive terms or at all.

 

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.

 

Risks Associated With Our Business

 

Our business may be adversely affected by conditions in the financial markets and economic conditions generally. 

 

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services that we offer, is highly dependent upon the business and economic environment in the primary markets in which we operate and in the United States as a whole. Although there has been improvement in general economic conditions in the United States since the recession experienced in 2007-2009, with evidence of stabilizing home prices and a reduction in unemployment levels, economic growth and business activity across a wide range of industries and regions in the United States has been slow and uneven, underemployment and household debt levels remain elevated and interest rates remain historically low. There can be no assurance that that economic conditions will continue to improve, and they may worsen.

 

Our business also is impacted by the domestic and international financial markets. Uncertainties about the financial stability and growth rates of non-U.S. jurisdictions, and the risk that those jurisdictions may face difficulties servicing their sovereign debt, can lead to stresses on financial markets and global economic conditions generally, including economic conditions in the United States.

 

Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and savings habits. A return of recessionary conditions or negative developments in global financial markets or economies may significantly affect the markets in which we do business, the value of our loans and investments and our ongoing operations, costs and profitability. In particular, negative developments in our current and target markets could drive losses beyond those that are or will be provided for in our allowance for loan losses and result in the following consequences:

 

 

increases in loan delinquencies;

 

increases in nonperforming loans and foreclosures;

 

decreases in demand for our products and services, which could adversely affect our liquidity position;

 

decreases in the value of the collateral securing loans, especially real estate, which could reduce customers’ borrowing power;

decreases in the values of our investment securities, which could lead to write-downs negatively impacting our earnings; and

 

decreases in the ability to raise additional capital on acceptable terms, or at all.

 

Changes in the policies of monetary authorities and other governmental action could adversely affect our profitability.

 

Our business and results of operations also are affected by fiscal and monetary policy. The actions of the Federal Reserve Board in the United States, and central banks internationally, regulate the supply of money and credit and the global financial system, impacting the cost of funds for lending, investing and capital-raising activities and the return earned on those loans and investments, both of which affect net interest margin. The actions of monetary authorities also can affect the value of financial instruments and other assets. Changes in domestic and international fiscal and monetary policies are beyond our control and difficult to predict but could have an adverse impact on our financial condition and results of operations.

 

 
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Our estimated allowance for loan losses may not be sufficient to cover actual loan losses, which could adversely affect our earnings.

 

We maintain an allowance for loan losses in an attempt to cover loan losses inherent in our loan portfolio. The determination of the allowance for loan losses, which represents management’s estimate of probable losses inherent in our credit portfolio, involves a high degree of judgment and complexity. Our policy is to establish reserves for estimated losses on delinquent and other problem loans when it is determined that losses are expected to be incurred on such loans. At December 31, 2016, our allowance for loan losses totaled approximately $12.1 million, which represented 0.50% of total loans and 93.69% of total nonperforming loans. Management’s determination of the adequacy of the allowance is based on various factors, including an evaluation of the portfolio, current economic conditions, the volume and type of lending conducted by us, composition of the portfolio, the amount of our classified assets, seasoning of the loan portfolio, the status of past due principal and interest payments and other relevant factors. Changes in such estimates may have a significant impact on our financial statements. If our assumptions and judgments prove to be incorrect, our current allowance may not be sufficient and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. In addition, we may be required to increase the allowance due to the conditions of loans acquired as result of our acquisitions of financial institutions should the remaining acquisition accounting fair market value adjustments for such loans be judged inadequate relative to their estimated future performance. Federal and state regulators also periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different from those of management. However, no assurance can be given that the allowance will be adequate to cover loan losses inherent in our loan portfolio, and we may experience losses in our loan portfolio or perceive adverse conditions and trends that may require us to significantly increase our allowance for loan losses in the future. Any increase in our allowance for loan losses would have an adverse effect on our results of operations and financial condition, which could be material.

 

If our nonperforming assets increase, our earnings will suffer.

 

At December 31, 2016, our nonperforming assets totaled approximately $12.9 million, or 0.47% of total assets. Our nonperforming assets adversely affect our earnings in various ways. We do not record interest income on nonaccrual loans or other real estate owned (“OREO”). We must reserve for probable losses, which is established through a current period charge to the provision for loan losses as well write-downs from time to time, as appropriate, of the value of properties in our OREO portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our OREO. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity. Finally, if our estimate for the recorded allowance for loan losses proves to be incorrect and our allowance is inadequate, we will have to increase the allowance accordingly and as a result our earnings may be adversely affected.

 

Our concentration in loans secured by real estate, particularly commercial real estate and construction and development, may increase our loan losses.

 

We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market areas. Consequently, declines in economic conditions in these market areas may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse.

 

At December 31, 2016, approximately 81% of our loans had real estate as a primary or secondary component of collateral, with 18% of those loans secured by construction and development collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Real estate values declined significantly during the recession experienced in 2007-2009. Although real estate prices in most of our markets have since stabilized or are improved, a renewed decline in real estate values could adversely affect the value of the collateral for all loans secured by real estate which in turn could adversely affect our results of operations and financial condition.

 

Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans, particularly when there is a downturn in the business cycle. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions and a downturn in the local economy or in occupancy rates in the local economy where the property is located, each of which could increase the likelihood of default on the loan. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in the percentage of nonperforming loans. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our results of operations and financial condition.

  

 
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Banking regulators are examining commercial real estate lending activity with heightened scrutiny and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures. Beginning with the First Capital acquisition and at December 31, 2016, the Bank’s concentration in commercial real estate (CRE) and construction and development (C&D) loans exceeded the thresholds specified in the federal banking agencies’ guidance emphasizing the need for enhanced risk management activities over the CRE and C&D concentrations. As a result, the Bank has instituted enhanced risk management activities which are reviewed periodically with the Company’s Board of Directors. While we believe that such actions address the general concern expressed in this regulatory guidance, if the banking regulators determine that additional actions are necessary, such as restricting our ability to originate certain types of loans until concentrations are reduced or requiring an increase to the allowance for loan losses, it could have a material adverse effect on our results of operations.

  

Since we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs associated with the ownership of real property, which could adversely impact our results of operations and stock price.

 

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to: general or local economic conditions; environmental cleanup liability; neighborhood values; interest rates; real estate tax rates; operating expenses of the mortgaged properties; supply of and demand for rental units or properties; ability to obtain and maintain adequate occupancy of the properties; zoning laws; governmental rules, regulations and fiscal policies; and acts of God. Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating income-producing real property may exceed the rental income earned from such property, and we may have to advance funds in order to protect our investment or we may be required to dispose of the real property at a loss.

 

We maintain a number of large lending relationships, any of which could have a material adverse effect on our results of operations if our borrowers were not to perform according to the terms of these loans.

 

Our ten largest lending relationships (including aggregate exposure to guarantors) at December 31, 2016, range from $15.0 million to $33.7 million and averaged $18.9 million. None of these lending relationships was included in nonperforming loans at December 31, 2016. The deterioration of one or more large relationship loans could result in a significant increase in our nonperforming loans and our provision for loan losses, which would negatively impact our results of operations.

 

The FDIC deposit insurance assessments that we are required to pay may increase in the future, which would have an adverse effect on our earnings.

 

As an insured depository institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC to maintain the level of the FDIC deposit insurance reserve ratio. The failures of many financial institutions during and following the recession experienced in 2007-2009 significantly increased the loss provisions of the DIF, resulting in a decline in the reserve ratio. As a result, the FDIC revised its assessment rates which raised deposit premiums for certain insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, further special assessments or increases in deposit insurance premiums may be required. The Company is generally unable to control the amount of premiums that it is required to pay for FDIC insurance. If there are additional bank or financial institution failures, the FDIC may increase the deposit insurance assessment rates. Any future assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect our earnings.

 

Our net interest income could be negatively affected by interest rate changes.

 

As a financial institution, our earnings are dependent upon our net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve Board’s policies, affects us more than non-financial institutions and can have a significant effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of our assets and liabilities that could cause the net interest rate spread to compress, depending on the level and type of changes in the interest rate environment. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and actions by monetary and fiscal authorities, including the Federal Reserve Board. A significant reduction in our net interest income will adversely affect our business and results of operations. Thus, if we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.

 

 
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The Federal Reserve Board raised interest rates by 25 basis points in December 2015 and again by 25 basis points in December 2016 after having held interest rates at almost zero over recent years. However, the consistently low rate environment has negatively impacted our net interest margin, notwithstanding decreases in nonperforming loans and improvements in deposit mix. Any reduction in net interest income will negatively affect our business, financial condition, liquidity, results of operations, and/or cash flows.

 

The primary tool that management uses to measure short-term interest rate risk is a net interest income simulation model prepared by an independent correspondent bank. As of December 31, 2016, the Company is considered to be in an asset-sensitive position, meaning income and capital are generally expected to increase with an increase in short-term interest rates and, conversely, to decrease with a decrease in short-term interest rates. Based on the results of this simulation model, which assumed a static environment with no contemplated asset growth or changes in our balance sheet management strategies, if short-term interest rates immediately decreased by 200 basis points, we could expect net interest income to decrease by approximately $6.9 million over a 12-month period. This result is primarily due to the current low interest rate environment, under which interest rates on the Company’s average interest-bearing liabilities cannot benefit fully from a 200 basis point rate reduction, without turning negative, while yields on our average interest-earning assets could decline by 200 basis points. Furthermore, if short-term interest rates increase by 200 basis points, simulation modeling predicts net interest income would increase by approximately $2.1 million over a 12-month period as a result of our asset-sensitive position. The simulation model uses several critical assumptions, such as the pace at which deposits may reprice in a rising or falling interest rate environment. The actual amount of any increase or decrease may be higher or lower than predicted by our simulation model.

  

Declines in the value of investment securities held by us could require write-downs, which would reduce our earnings.

 

In order to diversify earnings and enhance liquidity, we own both debt and equity instruments of government agencies, municipalities and other companies. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Additionally, the value of these investments may fluctuate depending on the interest rate environment, general economic conditions and circumstances specific to the issuer of the securities. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit or liquidity risks. Changes in the value of these instruments may result in a reduction to earnings and/or capital, which could adversely affect our results of operations and financial condition.

 

We have recorded significant deferred tax assets, and we might never realize their full value, which could adversely affect our results of operations and financial condition.

 

At December 31, 2016, the Company had recorded $25.7 million in net deferred tax assets which management believed was more-likely-than-not realizable and, therefore, a valuation allowance was not considered necessary. Deferred tax assets are designed to reduce current income taxes in subsequent periods and arise, in part, as a result of the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. Management periodically evaluates the carrying amount of our deferred tax asset to determine if it is realizable. If, based on available information, it is more-likely-than-not that the deferred tax asset will not be realized, we would have to establish a valuation allowance against the net deferred tax assets, with a corresponding charge to net income. In evaluating the need for a valuation allowance, we estimate future taxable income based on management forecasts as well as tax planning and other strategies that may be available to us, which requires significant judgment by management about matters that are by nature uncertain. If future events differ significantly from our current forecasts, we may need to establish a valuation allowance, which would result in a charge to earnings in the period the determination is made and could have a material adverse effect on our results of operations and financial condition.

 

A reduction in future enacted tax rates could have a material impact to the value of our deferred tax assets.

 

Our net deferred tax assets are measured using the tax rates under the current enacted tax law expected to apply to taxable income in future years. The effects of future changes in tax laws or rates are not anticipated in the determination of the value of our deferred tax assets and liabilities. The U.S. Congress and the current administration have indicated an interest in, among other changes to federal tax laws, lowering the federal corporate tax rate from the current 35% to as low as 15%. It is difficult to predict whether any change to the federal corporate tax rate will occur, or if any change to the federal corporate tax rate did occur, the magnitude or timing of any change. Although any reduction in the corporate tax rate would reduce the amount of taxes we would pay in the future, the reduction also would result in a decrease in the value of our deferred tax asset, and thus a reduction in our net income and total equity, during the period in which any such tax rate change is enacted. This reduction in our net income and total equity could materially and adversely affect our results of operations and financial condition.

 

We are subject to extensive regulation that could limit or restrict our activities.

 

We operate in a highly regulated industry and currently are subject to examination, supervision and comprehensive regulation by the NC Commissioner, the FDIC and the Federal Reserve Board. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, locations of offices, and the ability to accept brokered deposits. We must also meet regulatory capital requirements. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity, deposit funding strategy and results of operations would be materially and adversely affected. Our failure to remain well capitalized and well managed for regulatory purposes could affect customer confidence, the ability to execute our business strategies, the ability to grow our assets or establish new branches, the ability to obtain or renew brokered deposits, our cost of funds and FDIC insurance, the ability to pay dividends on or repurchase shares of our Common Stock and the ability to make acquisitions.

 

 
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The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. For example, new legislation or regulation could limit the manner in which we may conduct our business, including our ability to obtain financing, attract deposits and make loans. Many of these regulations are intended to protect depositors, the public and the FDIC, not shareholders. In addition, the burden imposed by these regulations may place us at a competitive disadvantage compared to competitors who are less regulated. The laws, regulations, interpretations and enforcement policies that apply to us have been subject to significant change in recent years, sometimes retroactively applied, and may change significantly in the future.

 

The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial-services industry, including new or revised regulation of such things as systemic risk, capital adequacy, deposit insurance assessments and consumer financial protection. The federal banking regulators have adopted new regulatory capital rules applicable to United States banking organizations. Complying with these and other new legislative or regulatory requirements, and any programs established thereunder, could have a material adverse impact on our business, financial condition and results of operations. In addition, recent government policy has advocated for significant reduction of financial services regulation, including amendments to the Dodd-Frank Act, which could create additional uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, or amended as a result of government policy. As a result, the full extent of the impact such requirements will have on financial institutions’ operations is unclear.

   

Our success depends significantly on economic conditions in our market areas.

 

Unlike larger organizations that are more geographically diversified, our banking offices are currently concentrated in North Carolina, South Carolina, North Georgia, and Richmond, Virginia, and we expect that our banking offices will remain primarily concentrated in North Carolina, South Carolina, North Georgia and Virginia. As a result of this geographic concentration, our financial results will depend largely upon economic conditions in these market areas. If the communities in which we operate do not grow or if prevailing economic conditions, locally or nationally, deteriorate, this may have a significant impact on the amount of loans that we originate, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. A return to economic downturn conditions caused by inflation, recession, unemployment, government action or other factors beyond our control would likely contribute to the deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would have an adverse effect on our business.

 

In addition, some portions of our target market are in coastal areas, which are susceptible to hurricanes and tropical storms. Such weather events can disrupt our operations, result in damage to our properties, decrease the value of real estate collateral for our loans and negatively affect the local economies in which we operate. We cannot predict whether or to what extent damage that may be caused by future hurricanes or other weather events will affect our operations or the economies in our market areas, but such weather events could result in a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in delinquencies, foreclosures and loan losses. Our business or results of operations may be adversely affected by these and other negative effects of hurricanes or other significant weather events.

 

If we lose key employees, our business may suffer.

 

Our operating results and ability to adequately manage our growth and minimize loan losses is highly dependent on the services, managerial abilities and performance of our current executive officers and other key personnel, many of whom have significant local experience and contacts within our market areas. If we lose key employees temporarily or permanently, this could disrupt our business and adversely affect our financial condition, results of operations and liquidity. 

 

To be profitable, we must compete successfully with other financial institutions that have greater resources and capabilities than we do.

 

The banking business in our target markets is highly competitive. Many of our existing and potential competitors are larger and have greater resources than we do and have been in existence a longer period of time. We compete with these institutions in both attracting deposits and originating loans. We may not be able to attract customers away from our competition. We compete for loans and deposits with other commercial banks; savings banks; thrifts; trust companies; credit unions; securities brokerage firms; mortgage brokers; insurance companies; mutual funds; and industrial loan companies.

 

Competitors that are not depository institutions are generally not regulated as extensively as we are and, therefore, may have greater flexibility in competing for business. Other competitors are subject to similar regulation but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, greater advertising and marketing budgets or other factors.

 

Our legal lending limit is determined by law and is calculated as a percentage of our capital and unimpaired surplus. The size of the loans that we are able to offer to our customers is less than the size of the loans that larger competitors are able to offer. This limit may affect our success in establishing relationships with the larger businesses in our market. We may not be able to successfully compete with the larger banks in our target markets.

 

Our liquidity needs could adversely affect our results of operations and financial condition.

 

Our primary sources of funds are deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including, but not limited to, changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, availability of, and/or access to, sources of refinancing, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including, but not limited to, rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include FHLB advances, sales of securities and loans, federal funds lines of credit from correspondent banks and borrowings from the Federal Reserve Discount Window, as well as additional out-of-market time deposits and brokered deposits. While we currently believe that these sources are adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if we continue to grow and experience increasing loan demand. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.

 

 
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We depend on the accuracy and completeness of information about customers and counterparties, which, if incorrect or incomplete, could harm our earnings.

 

In deciding whether to extend credit or enter into other transactions with customers and counterparties, we rely on information furnished to us by or on behalf of customers and counterparties, including financial statements and other financial information. We also may rely on representations of customers, counterparties or other third parties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform to GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. Our financial condition and results of operations could be negatively impacted to the extent we incorrectly assess the creditworthiness of our borrowers, fail to detect or respond to deterioration in asset quality in a timely manner, or rely on information provided to us, such as financial statements that do not comply with GAAP and may be materially misleading.

 

The soundness of other financial institutions could adversely affect us.

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led in the past, and could lead in the future, to market-wide liquidity problems and could lead to losses or defaults by us or other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or customer. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. There can be no assurance that any such losses would not materially and adversely affect our results of operations.

 

Negative public opinion could damage our reputation and adversely impact our earnings.

 

Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our operations. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract customers and employees and can expose us to litigation and regulatory action and adversely impact our results of operations. Although we take steps to minimize reputation risk in dealing with our customers and communities, this risk will always be present given the nature of our business.

 

Failure to keep pace with technological changes could have a material adverse effect on our business, financial condition and results of operations.

 

The financial services industry is constantly undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better service customers and reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy client demands, as well as create additional efficiencies within our operations. Many of our large competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement now technology-driven products and services quickly or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition and results of operations.

 

 
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A failure in or breach of our operational or security systems or infrastructure, or those of third parties, could disrupt our businesses, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.

 

Our operational and security systems, infrastructure, including our computer systems, data management, and internal processes, as well as those of third parties, are integral to our business. In addition, we rely on our employees and third parties in our day-to-day and ongoing operations, who may, as a result of human error, misconduct or malfeasance or failure or breach of third-party systems or infrastructure, expose us to risk. We have taken measures to implement backup systems and other safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact. In addition, our ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with respect to our own systems.

 

Our financial, accounting, data processing, check processing, electronic funds transfer, loan processing, online and mobile banking, automated teller machines (“ATMs”), backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control, which could adversely affect our ability to process these transactions or provide these services. There could be sudden increases in customer transaction volume, electrical, telecommunications outages or other major physical infrastructure outages, natural disasters, events arising from local or larger scale political or social matters, including terrorist acts, and cyber attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.

 

A cyber attack, information or security breach, or a technology failure of ours or of a third party, could adversely affect our ability to conduct our business or manage our exposure to risk, result in the disclosure or misuse of confidential or proprietary information, increase our costs to maintain and update our operational and security systems and infrastructure, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.

 

Our business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software, and networks to conduct our operations. In addition, to access our network, products and services, our customers and third parties may use personal mobile devices or computing devices that are outside of our network environment. Financial services institutions have been subject to, and are likely to continue to be the target of, cyber attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or information or other security breaches, that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its employees or customers or of third parties, or otherwise materially disrupt network access or business operations. For example, denial of service attacks have been launched against a number of large financial services institutions. Additionally, several large retailers have disclosed substantial cyber security breaches affecting debit and credit card accounts of their customers[, some of whom were our cardholders]. Although we have not experienced any cyber security incidents in the past, we anticipate that, as a growing regional bank, we could experience such incidents, and there can be no assurance that we will not suffer material losses or other material consequences relating to technology failure, cyber attacks or other information or other security breaches or other consequences in the future. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents.

 

We also face indirect technology, cyber security and operational risks relating to the third parties with whom we do business or upon whom we rely to facilitate or enable our business activities. Each of these third parties faces the risk of cyber attack, information breach or loss, or technology failure. Any such cyber attack, information breach or loss, or technology failure of a third party could, among other things, adversely affect our ability to effect transactions, service our clients, manage our exposure to risk or expand our businesses.

 

 
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Any of the matters discussed above could result in our loss of customers and business opportunities, significant business disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, or damage to our customers’ and/or third parties’ computers or systems, and could result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, and additional compliance costs. In addition, any of the matters described above could adversely impact our results of operations, liquidity and financial condition.

 

Risks Related to our Common Stock

 

We may issue additional shares of stock or equity derivative securities, including awards to current and future executive officers, directors and employees, which could result in the dilution of shareholders’ investment.

 

Our authorized capital includes 200,000,000 shares of Common Stock and 5,000,000 shares of preferred stock. As of December 31, 2016, we had 53,116,519 shares of Common Stock outstanding, including approximately 405,732 shares that have voting rights but no economic interest related to unvested shares of restricted stock, and had reserved or otherwise set aside for issuance 1,405,515 shares underlying outstanding options and 635,239 shares that are available for future grants of stock options, restricted stock or other equity-based awards pursuant to our equity incentive plans. Subject to NASDAQ rules, our board of directors generally has the authority to issue all or part of any authorized but unissued shares of Common Stock or preferred stock for any corporate purpose. We anticipate that we would issue additional equity in connection with the selective acquisition of other strategic partners and that in the future we could seek additional equity capital as we develop our business and expand our operations, depending on the timing and magnitude of any particular future acquisition. These issuances would dilute the ownership interests of existing shareholders and may dilute the per share book value of the Common Stock. New investors also may have rights, preferences and privileges that are senior to, and that adversely affect, our then existing shareholders.

  

In addition, the issuance of shares under our equity compensation plans will result in dilution of our shareholders’ ownership of our Common Stock. The exercise price of stock options could also adversely affect the terms on which we can obtain additional capital. Option holders are most likely to exercise their options when the exercise price is less than the market price for our Common Stock. They may profit from any increase in the stock price without assuming the risks of ownership of the underlying shares of Common Stock by exercising their options and selling the stock immediately.

 

Our stock price may be volatile, which could result in losses to our investors and litigation against us.

 

Our stock price has been volatile in the past and several factors could cause the price to fluctuate in the future. These factors include, but are not limited to actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and nontraditional competitors, news reports of trends and concerns and other issues related to the financial services industry. Fluctuations in our stock price may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our Common Stock, and the current market price may not be indicative of future market prices.

 

Stock price volatility may make it more difficult for you to resell our Common Stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of fluctuation in the market price of their securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business, which could result in losses to investors.

 

Future sales of our Common Stock by shareholders or the perception that those sales could occur may cause our Common Stock price to decline.

 

Although our Common Stock is listed for trading on NASDAQ, the trading volume in the Common Stock may be lower than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the Common Stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the potential for lower relative trading volume in the Common Stock, significant sales of the Common Stock in the public market, or the perception that those sales may occur, could cause the trading price of our Common Stock to decline or to be lower than it otherwise might be in the absence of those sales or perceptions.

 

 
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State laws and provisions in our articles of incorporation or bylaws could make it more difficult for another company to purchase us, even though such a purchase may increase shareholder value.

 

In many cases, shareholders may receive a premium for their shares if we were purchased by another company. State law and our articles of incorporation and bylaws could make it difficult for anyone to purchase us without approval of our board of directors. For example, our articles of incorporation divide our board of directors into three classes of directors serving staggered three-year terms with approximately one-third of the board of directors elected at each annual meeting of shareholders. This classification of directors makes it difficult for shareholders to change the composition of our board of directors. As a result, at least two annual meetings of shareholders would be required for the shareholders to change a majority of directors, whether or not a change in the board of directors would be beneficial and whether or not a majority of shareholders believe that such a change would be desirable.

 

Our ability to pay dividends is limited and we may be unable to pay future dividends.

 

Our board of directors initiated payment of cash dividends in 2013. However, any future declaration of dividends will be made at the discretion of our board of directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our board of directors may deem relevant. We make no assurances that we will pay any dividends in the future. The holders of our Common Stock are entitled to receive dividends only when and if declared by our board of directors out of funds legally available for that purpose. As part of our consideration to pay cash dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business.

 

Moreover, we are a bank holding company that is a separate and distinct legal entity from the Bank. As a result, our ability to make dividend payments, if any, on our Common Stock depends primarily upon receipt of dividends and other distributions received from the Bank. Various federal and state regulations limit the amount of dividends that the Bank may pay to us and that we may pay to our shareholders. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition.

 

Your right to receive liquidation and dividend payments on our Common Stock is junior to our existing and future indebtedness and to any other senior securities we may issue in the future.

 

Shares of our Common Stock are equity interests in the Company and do not constitute indebtedness. This means that shares of our Common Stock will rank junior to all of our indebtedness and to other nonequity claims against us and our assets available to satisfy claims against us, including in our liquidation. As of December 31, 2016, we had outstanding approximately $29.7 million under a senior loan facility and approximately $48.0 million (excluding acquisition accounting fair market value adjustments) aggregate principal amount of a subordinated loan and junior subordinated debt which, in addition to our other liabilities, would be senior in right of payment to our Common Stock. We also may incur additional indebtedness from time to time without the approval of the holders of our Common Stock.

 

Our common shareholders also are subject to the prior dividend and liquidation rights of any preferred stock outstanding from time to time. Our board of directors is authorized to issue classes or series of preferred stock in the future without any action on the part of our common shareholders.

 

In addition, our right to participate in, and thus the ability of our shareholders to benefit indirectly from, any distribution of assets of the Bank or any other subsidiary we may have from time to time upon the subsidiary’s liquidation or otherwise, will be subject to the prior claims of creditors of the subsidiary, except to the extent any of our claims as a creditor of the subsidiary may be recognized. As a result, our Common Stock effectively will be subordinated to all existing and future liabilities and obligations of the Bank and any other subsidiaries we may have.

 

Our Common Stock is not insured by the FDIC.

 

Our Common Stock is not a savings or deposit account, and is not insured by the FDIC or any other governmental agency and is subject to risk, including the possible loss of all or some principal. 

 

 
23

 

 

 Item 1B.   Unresolved Staff Comments

  

None.

 

 

 Item 2.   Properties

 

The Company leases space in a building located at 1043 E. Morehead Street, Charlotte, North Carolina that serves as its corporate headquarters and the Bank’s main branch office location. The Company also leases space in a building adjacent to the Morehead Street location to accommodate the Company’s expanded operations. Both of the buildings are owned by an entity with respect to which a former director is president.

 

At February 28, 2017, the Bank operated 55 full service branches and one drive through facility located in North Carolina, South Carolina, North Georgia and Virginia. The Bank leases seventeen of these branches and the remaining properties are owned. Management believes the terms of the various leases are consistent with market standards and were arrived at through arm’s length bargaining. Additional information relating to premise, equipment and lease commitments is set forth in Note 8 – Premises and Equipment or Note 14 – Leases to the Company’s audited financial statements as of December 31, 2016 and 2015 and for the fiscal years ended December 31, 2016, 2015 and 2014 and the notes thereto, included in Part II, Item 8 of this report (the “Consolidated Financial Statements”).

 

 

Item 3.   Legal Proceedings 

  

In the ordinary course of business, the Company may be a party to various legal proceedings from time to time. There are no material pending legal proceedings to which the Company is a party or of which any of its property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on its business, operating results or financial condition.

  

 

Item 4.   Mine Safety Disclosures

Not applicable.

 

 
24

 

  

PART II

 

Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Common Stock Market Prices; Dividends

 

The Company’s Common Stock is traded publicly on NASDAQ under the symbol “PSTB”. The following table summarizes and sets forth the high and low closing sales prices of the Common Stock on NASDAQ and dividends declared per share for the periods indicated:

 

Year

Quarter

 

High

   

Low

   

Dividend

 

2016

Fourth

  $ 11.01     $ 8.01     $ 0.04  
 

Third

    8.54       7.05       0.04  
 

Second

    7.51       6.55       0.03  
 

First

    7.63       6.05       0.03  
                           

2015

Fourth

  $ 7.97     $ 6.72     $ 0.03  
 

Third

    7.39       6.80       0.03  
 

Second

    7.32       6.56       0.03  
 

First

    7.35       6.60       0.03  

 

As of February 28, 2017, there were 53,109,406 shares of our Common Stock outstanding held by approximately 2,000 shareholders of record.

 

Under North Carolina law, we are authorized to pay dividends as declared by our board of directors, provided that no such distribution results in our insolvency on a going concern or balance sheet basis. On July 26, 2013, our board of directors approved the initiation of a quarterly cash dividend to our common shareholders. Future dividends will be subject to board approval. As we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders is dividends we receive from the Bank. For that reason, our ability to pay dividends is subject to the limitations that apply to the Bank. For more information on applicable restrictions on the payment of dividends, see Note 13 – Regulatory Matters to the Consolidated Financial Statements and the section captioned “Supervision and Regulation- Dividend and Repurchase Limitations” under Part I, Item 1, “Business” of this report.

 

Unregistered Sales of Equity Securities

 

We did not sell any of our equity securities during the fiscal year ended December 31, 2016 that were not registered under the Securities Act of 1933, as amended (the “Securities Act”). 

 

 
25

 

  

Repurchase of Equity Securities

 

The following table provides information regarding the purchase of equity securities by the Company during the three months ended December 31, 2016:

 

Period

 

(a) Total

Number of

Shares

Purchased (1)

   

(b) Average

Price Paid

per Share

   

(c) Total Number

of Shares

Purchased as Part

of Publicly

Announced Plans

or Programs

   

(d) Maximum

Number of Shares

that May Yet Be

Purchased Under

the Plans or

Programs

 
                                 

Repurchases from October 1, 2016 through October 31, 2016

    934     $ 8.17       -       1,750,000  (2)
                                 

Repurchases from November 1, 2016 through November 30, 2016

    230,000       9.78       230,000       2,420,000  (3)
                                 

Repurchases from December 1, 2016 through December 31, 2016

    358,271       10.10       246,900       2,173,100  (3)
                                 

Total

    589,205     $ 6.79       476,900       2,173,100  
     
 

(1)

Included in the total number of shares purchased are 934 and 111,371 shares of the Company’s Common Stock acquired by the Company in connection with satisfaction of tax withholding obligations on vested restricted stock in October and December, respectively.

 

(2)

Represents the number of shares remaining available to be repurchased as of period end under the Company’s share repurchase program approved on October 29, 2014, which expired on November 1, 2016.

 

(3)

On October 27, 2016, the board of directors approved a new share repurchase program, effective November 1, 2016, to replace the expiring program. Under the new share repurchase program, which expires November 1, 2018, the Company may repurchase up to 2,650,000 shares from time to time, depending on market conditions and other factors.

  

 
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Performance Graph

 

The following graph compares the cumulative total shareholder return (“CTSR”) of our Common Stock during the previous five years with the CTSR over the same measurement period of the S&P 500 Index, the Keefe Bruyette & Woods (“KBW”) Bank Index and the KBW Regional Bank Index. Each trend line assumes that $100 was invested on December 31, 2011 and that all dividends were reinvested.

 

  

The foregoing performance graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C or to the liabilities of Section 18 under the Exchange Act, nor shall it be incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into any such filing.

 

 
27

 

  

Item 6.   Selected Financial Data

 

The following selected consolidated financial data for the five years ended December 31, 2016 are derived from our consolidated financial statements and other data. The selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements. Year-to-year financial information comparability is affected by the transaction expenses and the accounting treatment of our acquisitions as described in Part I, Item 1. “Business” and in Note 3 - Business Combinations to the Consolidated Financial Statements.

 

   

At or for the Year Ended December 31,

 
   

2016

   

2015

   

2014

    2013 (1)     2012 (1)  
   

(dollars in thousands, except per share data)

 

Income Statement Data

                                       

Total interest income

  $ 119,516     $ 89,312     $ 85,297     $ 78,805     $ 57,946  

Total interest expense

    14,475       7,931       7,655       6,382       6,570  

Net interest income

    105,041       81,381       77,642       72,423       51,376  

Provision for (recovery of) loan losses

    2,630       723       (1,286 )     746       2,023  

Net interest income after provision

    102,411       80,658       78,928       71,677       49,353  

Noninterest income

    21,394       18,243       13,953       15,086       11,372  

Noninterest expense

    94,236       74,153       73,934       64,099       54,076  

Income before taxes

    29,569       24,748       18,947       22,664       6,649  

Income tax expense

    9,621       8,142       6,058       7,359       2,306  

Net income

    19,948       16,606       12,889       15,305       4,343  

Preferred dividends

    -       -       -       353       51  

Net income to common shareholders

  $ 19,948     $ 16,606     $ 12,889     $ 14,952     $ 4,292  
                                         

Per Share Data

                                       

Basic earnings per common share

  $ 0.38     $ 0.38     $ 0.29     $ 0.34     $ 0.12  

Diluted earnings per common share

  $ 0.38     $ 0.37     $ 0.29     $ 0.34     $ 0.12  

Cash dividends per common share (2)

  $ 0.14     $ 0.12     $ 0.08     $ 0.04       n/a  

Weighted-average common shares outstanding:

                                       
Basic     52,450,780       43,939,039       43,924,457       43,965,408       35,101,407  

Diluted

    52,850,617       44,304,888       44,247,000       44,053,253       35,108,229  
                                         

Balance Sheet Data

                                       

Cash and cash equivalents

  $ 83,614     $ 70,526     $ 51,390     $ 55,067     $ 184,142  

Investment securities

    494,253       491,392       491,424       401,463       245,571  

Loans

    2,400,061       1,732,751       1,572,431       1,286,977       1,346,116  

Allowance for loan losses

    (12,125 )     (9,064 )     (8,262 )     (8,831 )     (10,591 )

Total assets

    3,255,395       2,514,264       2,359,230       1,960,827       2,032,831  

Deposits

    2,513,752       1,952,662       1,851,354       1,599,885       1,632,004  

Borrowings

    314,736       215,000       180,000       55,996       80,143  

Subordinated loan and junior subordinated debt

    33,501       24,262       23,583       22,052       21,573  

Shareholders’ equity

  $ 355,844     $ 284,704     $ 275,105     $ 262,120     $ 275,739  
                                         

Profitability Ratios

                                       

Return on average total assets

    0.63 %     0.68 %     0.59 %     0.76 %     0.32 %

Return on average stockholders’ equity

    5.62 %     5.90 %     4.78 %     5.42 %     1.99 %

Net interest margin (3)

    3.66 %     3.70 %     3.96 %     4.20 %     4.29 %

Efficiency ratio (4)

    74.48 %     74.47 %     80.88 %     73.33 %     88.29 %
                                         

Asset Quality Ratios

                                       

Net charge-offs to total loans

    -0.02 %     0.00 %     -0.06 %     0.23 %     0.12 %

Allowance for loan losses to total loans

    0.51 %     0.52 %     0.52 %     0.68 %     0.78 %

Nonperforming loans to total loans and OREO

    0.54 %     0.47 %     0.56 %     0.94 %     1.29 %

Nonperforming assets to total assets

    0.47 %     0.54 %     0.89 %     1.37 %     2.11 %
                                         

Liquidity Ratios

                                       

Net loans to total deposits

    95.48 %     88.74 %     84.93 %     80.44 %     82.49 %

Liquidity ratio (5)

    16.25 %     20.10 %     19.55 %     20.92 %     21.96 %

Equity to total assets

    10.93 %     11.32 %     11.66 %     13.37 %     13.56 %
                                         

Capital Ratios

                                       

Tangible common equity to tangible assets (6)

    10.93 %     11.32 %     11.66 %     13.37 %     12.14 %

Tier 1 leverage

    9.92 %     11.00 %     10.17 %     11.63 %     11.25 %

Tier 1 risk-based capital

    12.02 %     13.83 %     13.46 %     15.34 %     15.09 %

Total risk-based capital

    12.48 %     14.30 %     13.95 %     16.46 %     16.30 %

 

 

 
28

 

 

(1)

Revised to reflect measurement period adjustments to goodwill.

(2)

On July 26, 2013, our board of directors approved the initiation of a quarterly cash dividend to our common shareholders. Future dividends are subject to board approval.

(3)

Net interest margin is presented on a tax equivalent basis.

(4)

Calculated by dividing noninterest expense by the sum of net interest income and noninterest income. Gains and losses on sales of securities and OREO are excluded from the calculation.

(5)

Calculated by dividing total liquid assets by net deposits and short-term liabilities.

(6)

Non-GAAP Financial Measure. See "Non-GAAP Financial Measures" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this report for a reconciliation of this non-GAAP measure to the most directly comparable GAAP measure.

 

 
29

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth in Part I, Item 1A. “Risk Factors” and the Consolidated Financial Statements. 

 

Executive Overview

 

The Company experienced strong financial performance in 2016 and continued growth. We reported net income of $19.9 million, or $0.38 per diluted common share, for the year ended December 31, 2016 compared to net income of $16.6 million, or $0.37 per diluted common share, for the year ended December 31, 2015. Excluding merger-related expenses and (loss)/gain on sale of securities, we reported adjusted net income (non-GAAP) of $27.2 million, or $0.52 per diluted common share, for the year ended December 31, 2016 compared to adjusted net income (non-GAAP) of $17.8 million, or $0.40 per diluted common share, for the year ended December 31, 2015. Merger-related expenses totaled $10.9 million in 2016 compared to $1.7 million in 2015. Loss on sale of securities totaled $87 thousand in 2016 compared to a gain on sale of securities of $54 thousand in 2015. Comparability of results for the periods presented is impacted by the acquisitions of First Capital on January 1, 2016 and Provident Community on May 1, 2014. Results for 2016 include a full year of operating results from First Capital and Provident Community; results for 2015 include a full year of operating results from Provident Community; and results for 2014 include eight months of operating results from Provident Community. Financial performance highlights for 2016 include:

 

 

An increase in net interest income of $23.7 million for the year ended December 31, 2016 to $105 million representing a 29% increase from 2015, driven by organic loan growth as well as the acquisition of First Capital

 

Loan and loans held for sale grew by $673.4 million and total deposits rose by $561.1 million in 2016, reflecting healthy organic growth and the acquisition of First Capital

 

Growth in noninterest income of $3.2 million to $21.4 million in 2016, a 17% increase from 2015, reflecting growth in service charge income, mortgage banking fee income and capital markets activities

 

Noninterest expense rose $20.1 million in 2016 to $94.2 million, up 27% over 2015 driven by the inclusion of First Capital and $10.9 million in merger-related activities

 

Asset quality remained strong as nonperforming assets totaled 0.47% of total loans and other real estate owned at December 31, 2016

 

Our capital position was strong at year-end as our Tier I Capital ratio was 12.02%, our Total Capital ratio was 12.48%, our Common Equity Tier 1 Capital ratio was 11.04% and our Tier I Leverage Ratio was 9.92%

 

Business Overview

 

The Company, a North Carolina corporation, was formed in October 2010 to serve as the holding company for the Bank pursuant to a bank holding company reorganization effective January 1, 2011 and is a bank holding company registered with the Federal Reserve Board. The Bank was incorporated in September 2006 as a North Carolina-chartered commercial nonmember bank.

 

As part of our growth strategy, the Company has consummated several acquisitions since the bank holding company reorganization, including the acquisitions of Community Capital in November 2011, Citizens South in October 2012, Provident Community in May 2014 and First Capital in January 2016. Additionally, from an organic standpoint, over the past several years the Company has opened additional branches in North and South Carolina, and two full service branches in Richmond, Virginia.

 

On January 1, 2016, the Company acquired First Capital Bancorp, Inc. (“First Capital”), based in Glen Allen, Virginia and the parent company of First Capital Bank. As a result of the merger of First Capital into the Company, First Capital Bank, which operated eight branches in the Richmond, Virginia area, became a wholly-owned subsidiary of the Company and thereafter was merged into the Bank. The aggregate merger consideration consisted of approximately 8.4 million shares of Common Stock and approximately $25.7 million in cash. Based on the $7.32 per share closing price of the Company’s common stock on December 31, 2015, the transaction value was approximately $87.1 million.

 

The Company provides a full array of retail and commercial banking services, including wealth management and capital market activities, through its offices located in North Carolina, South Carolina, Georgia and Virginia. Our objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank.

 

 
30

 

  

Recent Accounting Pronouncements

 

See Note 2 – Summary of Significant Accounting Policies to the Consolidated Financial Statements for a description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

 

Critical Accounting Policies and Estimates

 

In the preparation of our financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and in accordance with general practices within the banking industry. Our significant accounting policies are described in Note 2 – Summary of Significant Accounting Policies to the Consolidated Financial Statements. While all of these policies are important to understanding the Consolidated Financial Statements, certain accounting policies described below involve significant judgment and assumptions by management that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and assumptions that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

PCI Loans. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as internal risk grade, past due and nonaccrual status. PCI loans are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. We estimate the cash flows expected to be collected at acquisition using specific credit review of certain loans, quantitative credit risk, interest rate risk and prepayment risk models, and qualitative economic and environmental assessments, each of which incorporate our best estimate of current key relevant factors, such as property values, default rates, loss severity and prepayment speeds.

 

Under the accounting guidance for PCI loans, the excess of the present value of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, in situations where there is a reasonable expectation about the timing and amount of cash flows to be collected. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is available to absorb future charge-offs.

 

In addition, subsequent to acquisition, we periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued usage of key assumptions and estimates, similar to the initial estimate of fair value. In the current economic environment, estimates of cash flows for PCI loans require significant judgment given the impact of home price and property value changes, changing loss severities, prepayment speeds and other relevant factors. Decreases in the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Significant increases in the expected cash flows will generally result in an increase in interest income over the remaining life of the loan, or pool of loans. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount. Trends are reviewed in terms of traditional credit metrics such as accrual status, past due status, and weighted-average grade of the loans within each of the accounting pools. In addition, the relationship between the change in the unpaid principal balance and change in the fair value mark is assessed to correlate the directional consistency of the expected loss for each pool. 

 

PCI loans at December 31, 2016 represent loans acquired in connection with the acquisitions of Community Capital, Citizens South, Provident Community and First Capital that were deemed credit impaired at the time of acquisition. PCI loans that were classified as nonperforming loans by the acquired institutions are no longer classified as nonperforming so long as, at acquisition and quarterly re-estimation periods, we are able to reasonably project expected cash flows. It is important to note that judgment regarding the timing and amount of cash flows to be collected is required to classify PCI loans as performing, even if the loan is contractually past due.

 

 

 
31

 

 

Allowance for Loan Losses. The allowance for loan losses is based upon management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be its best estimate of known and inherent losses in the portfolio as of the balance sheet date. The determination of the allowance for loan losses involves a high degree of judgment and complexity. In making the evaluation of the adequacy of the allowance for loan losses, management considers current economic and market conditions, independent loan reviews performed periodically by third parties, portfolio trends and concentrations, delinquency information, management's internal review of the loan portfolio, internal historical loss rates and other relevant factors. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require us to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Although provisions have been established by loan segments based upon management's assessment of their differing inherent loss characteristics, the entire allowance for losses on loans, other than the portion related to PCI loans and specific reserves on impaired loans, is available to absorb further loan losses in any segment. Further information regarding our policies and methodology used to estimate the allowance for possible loan losses is presented in Note 5 – Loans and Allowance for Loan Losses to the Consolidated Financial Statements.

  

FDIC Indemnification Asset. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, the FDIC indemnification asset was initially recorded at its fair value, and is measured separately from the related covered assets because the indemnification asset is not contractually embedded in the covered assets or transferrable. The FDIC indemnification asset is measured at carrying value subsequent to initial measurement. Improved cash flows of the underlying covered assets will result in impairment of the FDIC indemnification asset and thus amortization through non-interest income. Impairment of the underlying covered assets will increase the cash flows of the FDIC indemnification asset and result in a credit to the provision for loan losses for acquired loans. Impairment and, when applicable, its subsequent reversal are included in the provision for loan losses in the consolidated statements of income.

 

The purchase and assumption agreements between the Bank and the FDIC, as discussed in Note 6 – FDIC Loss Share Agreements to the Consolidated Financial Statements, each contained a provision that obligated the Bank to make a true-up payment to the FDIC if the realized losses of each of the applicable acquired banks were less than expected. These amounts are recorded in other liabilities on the balance sheet. The actual payment would be determined at the end of the term of the loss sharing agreements based on the negative bid, expected losses, intrinsic loss estimate and assets covered under the loss sharing agreements.

 

On August 26, 2016, the Bank entered into an early termination agreement with the FDIC (the “Termination Agreement”) pursuant to which it terminated the loss share agreements associated with these purchase and assumption agreements. Under the terms of the Termination Agreement, the Bank made a net payment of $4.4 million to the FDIC as consideration for early termination of the loss share agreements. The early termination resulted in a net one-time after-tax charge of approximately $15 thousand during the third quarter of 2016. As a result of entering into the Termination Agreement, assets that were covered by the loss share agreements were reclassified as non-covered at September 30, 2016.

  

All rights and obligations of the Bank and the FDIC under the loss share agreements, including the clawback provisions and the settlement of outstanding loss share claims, were resolved and terminated under the Termination Agreement. The termination of the FDIC loss share agreements had no impact on the yields of the loans that were previously covered under these agreements. The Bank will recognize all future recoveries, losses and expenses related to the previously covered assets since the FDIC will no longer share in those amounts.

 

Income Taxes. Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets (“DTAs”) and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, we record a DTA when the event giving rise to the tax benefit has been recognized in the Consolidated Financial Statements. Further information regarding income taxes is presented in Note 12 —Income Taxes to the Consolidated Financial Statements.

 

 
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Non-GAAP Financial Measures

 

In addition to traditional measures, management provides information it considers useful to investors in understanding the Company’s operating performance and trends, and to facilitate comparisons with the performance of its peers. Management also uses these measures internally to assess and better understand the Company’s underlying business performance and trends related to core business activities. The non-GAAP financial measures and key performance indicators used by the Company may differ from the non-GAAP financial measures and performance indicators used by other financial institutions to assess their performance and trends.

 

Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company’s reported results prepared in accordance with GAAP. Non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. Although these non-GAAP financial measures frequently are used by shareholders in the evaluation of a company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP. We encourage readers to consider the Consolidated Financial Statements in their entirety and not to rely on any single financial measure.

 

In particular, management uses tangible assets, tangible common equity, adjusted allowance for loan losses, adjusted net income, adjusted noninterest income and adjusted noninterest expenses, and related ratios and per-share measures, each of which is a non-GAAP financial measure. Management uses (i) tangible assets and tangible common equity (which exclude goodwill and other intangibles from equity and assets) and related ratios to evaluate the adequacy of shareholders' equity and to facilitate comparisons with peers; (ii) adjusted allowance for loan losses (which includes net fair market value adjustments related to acquired loans) as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired portfolios (fair market value adjustments are available only for losses on acquired loans), to evaluate both asset quality and asset quality trends, and to facilitate comparisons with peers; and (iii) adjusted net income, adjusted noninterest income and adjusted noninterest expense (which exclude merger-related expenses and gain or loss on sale of securities, as applicable), in each case to evaluate core earnings and to facilitate comparisons with peers.

 

 
33

 

  

The following table presents these non-GAAP financial measures and provides a reconciliation of these non-GAAP measures to the most directly comparable GAAP measure reported in the Company’s Consolidated Financial Statements at or for the year-ended December 31:

 

Reconciliation of Non-GAAP Financial Measures

 
                                         
   

2016

   

2015

      2014 (1)        2013       2012  

 

 

(dollars in thousands, except share and per share data)

 
Tangible assets:      

Total assets (as reported)

  $ 3,255,395     $ 2,514,264     $ 2,359,230     $ 1,960,790     $ 2,032,794  

Less: intangible assets

    74,755       38,768       40,157       35,049       36,078  

Tangible assets

  $ 3,180,640     $ 2,475,496     $ 2,319,073     $ 1,925,741     $ 1,996,716  
                                         

Tangible common equity:

                                       

Total common equity (as reported)

  $ 355,844     $ 284,704     $ 275,105     $ 262,083     $ 255,202  

Less: intangible assets

    74,755       38,768       40,157       35,049       36,078  

Tangible common equity

  $ 281,089     $ 245,936     $ 234,948     $ 227,034     $ 219,124  
                                         

Tangible common equity to tangible assets:

                                       

Tangible common equity

  $ 281,089     $ 245,936     $ 234,948     $ 227,034     $ 219,124  

Divided by: tangible assets

    3,180,640       2,475,496       2,319,073       1,925,741       1,996,716  

Tangible common equity to tangible assets

    8.84 %     9.93 %     10.13 %     11.79 %     10.97 %

Total equity to total assets

    10.93 %     11.32 %     11.66 %     13.37 %     12.55 %
                                         

Adjusted allowance for loan losses (2):

                                       

Allowance for loan losses (as reported)

  $ 12,125     $ 9,064     $ 8,262     $ 8,831     $ 10,591  

Plus: acquisition accounting net FMV adjustments to acquired loans

    27,773       28,173       35,419       37,783       53,719  

Adjusted allowance for loan losses

  $ 39,898     $ 37,237     $ 43,681     $ 46,614     $ 64,310  

Divided by: total loans (excluding LHFS)

    2,412,186       1,741,815       1,580,693       1,295,808       1,356,707  

Adjusted allowance for loan losses to total loans

    1.65 %     2.14 %     2.76 %     0.68 %     0.78 %

Allowance for loan losses to total loans

    0.51 %     0.52 %     0.52 %     3.60 %     4.74 %
                                         

Adjusted net income:

                                       

Net income (as reported)

  $ 19,948     $ 16,606     $ 12,889     $ 15,305     $ 4,343  

Plus: merger-related expenses

    10,932       1,715       3,616       2,211       5,895  

Less: loss (gain) on sale of securities

    87       (54 )     (180 )     (98 )     (1,478 )

Less: tax impact of merger-related expenses and gain on sale of securities

    -       -       -       -       -  

Adjusted net income

    30,967       18,267       16,325       17,418       8,760  

Preferred dividends

    -       -       -       353       51  

Adjusted net income available to common shareholders

  $ 30,967     $ 18,267     $ 16,325     $ 17,065     $ 8,709  
                                         

Divided by: weighted average diluted shares

    52,850,617       44,304,888       44,247,000       44,053,253       35,108,229  

Adjusted net income available to common shareholders per share

  $ 0.59     $ 0.41     $ 0.37     $ 0.39     $ 0.25  

Estimated tax rate

    32.92 %     32.62 %     32.18 %     32.65 %     38.55 %
                                         
                                         

Adjusted noninterest income:

                                       

Noninterest income (as reported)

  $ 21,394     $ 18,243     $ 13,953     $ 15,086     $ 11,372  

Less: loss (gain) on sale of securities

    87       (54 )     (180 )     (98 )     (1,478 )

Adjusted noninterest income

  $ 21,481     $ 18,189     $ 13,773     $ 14,988     $ 9,894  
                                         

Adjusted noninterest expense:

                                       

Noninterest expense (as reported)

  $ 94,236     $ 74,153     $ 73,934     $ 64,099     $ 54,076  

Less: merger-related expenses

    (10,932 )     (1,715 )     (3,616 )     (2,211 )     (5,895 )

Adjusted noninterest expense

  $ 83,304     $ 72,438     $ 70,318     $ 61,888     $ 48,181  

 

(1)

Revised to reflect measurement period adjustments to goodwill.

(2)

Provided merely as supplemental information for comparing the combined allowance and fair market value adjustments to the combined acquired and non-acquired loan portfolios; fair market value adjustments are available only for losses on acquired loans.

 

 
34 

 

 

Results of Operations

 

Summary. The Company recorded net income of $19.9 million, or $0.38 per diluted common share, for the year ended December 31, 2016, compared to net income of $16.6 million, or $0.37 per diluted common share, for the year ended December 31, 2015 and net income of $12.9 million, or $0.29 per diluted common share, for the year ended December 31, 2014. Excluding merger-related expenses and gain on sale of securities, the Company reported adjusted net income (non-GAAP) of $27.2 million, or $0.52 per share, for the year ended December 31, 2016 compared to adjusted net income (non-GAAP) of $17.8 million, or $0.40 per share, for the year ended December 31, 2015 and adjusted net income (non-GAAP) of $15.2 million, or $0.34 per share, for the year ended December 31, 2014.

 

Merger-related expenses totaled $10.9 million in 2016 compared to $1.7 million in 2015 and $3.6 million in 2014. Losses on sale of securities totaled $87 thousand in 2016 compared to gains on sale of securities of $54 thousand in 2015 and $180 thousand in 2014.

 

The following table presents selected ratios for the Company for the years ended December 31:  

 

   

Year ended December 31,

 
   

2016

   

2015

   

2014

 

Return on Average Assets

    0.63%       0.68%       0.59%  
                         

Return on Average Equity

    5.62%       5.90%       4.78%  
                         

Period End Equity to Total Assets

    10.93%       11.32%       11.66%  

 

Net Income. The following table summarizes components of net income and the changes in those components for the years ended December 31:

  

   

Components of Net Income

 
   

2016

   

2015

   

2014

   

Change 2016 vs. 2015

   

Change 2015 vs. 2014

 
   

(dollars in thousands)

 

Interest income

  $ 119,516     $ 89,312     $ 85,297     $ 30,204       34 %   $ 4,015       5 %

Interest expense

    14,475       7,931       7,655       6,544       83 %     276       4 %

Net interest income

    105,041       81,381       77,642       23,660       29 %     3,739       5 %

Provision for loan losses

    2,630       723       (1,286 )     1,907       264 %     2,009       -156 %

Noninterest income

    21,394       18,243       13,953       3,151       17 %     4,290       31 %

Noninterest expense

    94,236       74,153       73,934       20,083       27 %     219       0 %

Net income before taxes

    29,569       24,748       18,947       4,821       19 %     5,801       31 %

Income tax expense

    9,621       8,142       6,058       1,479       18 %     2,084       34 %

Net income

  $ 19,948     $ 16,606     $ 12,889     $ 3,342       20 %   $ 3,717       29 %

 

For the year ended December 31, 2016, we generated net income of $19.9 million, compared to net income of $16.6 million for the year ended December 31, 2015. The change in our results of operations in 2016 includes an increase of $23.6 million in net interest income and a $3.2 million increase in noninterest income, partially offset by an increase of $1.9 million in the provision for loan losses as well as an increase of $20.1 million in noninterest expense due mainly to the First Capital acquisition. We also recorded tax expense of $9.6 million in 2016 compared to $8.1 million in 2015. Results for 2016 include a full year of operations from the merger with First Capital, which occurred on January 1, 2016.

 

The Company generated net income of $16.6 million for the year ended December 31, 2015, compared to net income of $12.9 million for the year ended December 31, 2014. The change in our results of operations in 2015 includes an increase of $3.7 million in net interest income and a $4.3 million increase in noninterest income, partially offset by an increase of $2.0 million in the provision for loan losses and an increase of $219 thousand in noninterest expense. We also recorded tax expense of $8.1 million in 2015 compared to $6.1 million in 2014. Results for 2015 include a full year of operations from the merger with Provident Community, while results for 2014 include only eight months of operations from the merger with Provident Community.

 

Details of the changes in the various components of net income are further discussed below.

 

Net Interest Income. Our largest source of earnings is net interest income, which is the difference between interest income on interest-earning assets and interest expense paid on deposits and other interest-bearing liabilities. The primary factors that affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected in part by management’s responses to changes in interest rates through asset/liability management.

 

Net interest income increased $23.6 million, or 29%, to $105 million in 2016 compared to $81.4 million in 2015, and increased $3.7 million, or 5%, to $81.4 million in 2015 compared to $77.6 million in 2014. Average interest-earning assets increased by $669 million in 2016 primarily driven by organic loan growth and the addition of First Capital assets following the merger on January 1, 2016. Average interest-earning assets increased by $243 million in 2015 primarily driven by organic loan growth and the addition of Provident Community assets following the merger on May 1, 2014. 

 

 
35

 

  

The following table summarizes the average volume of interest-earning assets and interest-bearing liabilities and average yields and rates for the years ended December 31: 

 

   

Net Interest Margin

 
   

2016

   

2015

   

2014

 
   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

   

Average

   

Income/

   

Yield/

 
   

Balance

   

Expense

   

Rate

   

Balance

   

Expense

   

Rate

   

Balance

   

Expense

   

Rate

 

 

 

(dollars in thousands)

 
Assets                                                                        

Interest-earning assets:

                                                                       

Loans with fees (1)(2)(3)

  $ 2,332,205     $ 107,612       4.61 %   $ 1,658,657     $ 77,729       4.69 %   $ 1,445,691     $ 75,045       5.19 %

Federal funds sold

    3,118       15       0.48 %     799       2       0.25 %     564       1       0.18 %

Investment securities - taxable

    495,305       10,703       2.16 %     483,352       10,612       2.20 %     430,557       9,318       2.16 %

Investment securities - tax-exempt (2)(3)

    14,416       770       5.34 %     14,222       802       5.64 %     20,887       874       4.19 %

Nonmarketable equity securities

    14,122       621       4.40 %     11,986       500       4.17 %     7,619       362       4.75 %

Other interest-earning assets

    22,659       181       0.80 %     43,903       82       0.19 %     64,903       118       0.18 %

Total interest-earning assets

    2,881,825       119,903       4.16 %     2,212,919       89,727       4.05 %     1,970,221       85,718       4.35 %

Allowance for loan losses

    (10,655 )                     (8,700 )                     (9,535 )                

Cash and due from banks

    35,371                       19,982                       18,187                  

Premises and equipment

    65,613                       58,100                       58,330                  

Other assets

    198,987                       154,114                       162,124                  

Total assets

  $ 3,171,141                     $ 2,436,415                     $ 2,199,327                  
                                                                         

Liabilities and shareholders' equity

                                                                       
                                                                         
                                                                         

Interest-bearing liabilities:

                                                                       

Interest-bearing demand

  $ 428,933     $ 314       0.07 %   $ 398,731     $ 259       0.06 %   $ 348,314     $ 294       0.08 %

Savings and money market

    739,265       3,194       0.43 %     549,713       1,945       0.35 %     509,640       1,934       0.38 %

Time deposits - core

    676,302       4,874       0.72 %     464,423       2,729       0.59 %     473,509       2,620       0.55 %

Brokered deposits

    143,939       1,164       0.81 %     136,489       718       0.53 %     150,497       577       0.38 %

Total interest-bearing deposits

    1,988,439       9,546       0.48 %     1,549,356       5,651       0.36 %     1,481,960       5,425       0.37 %

Short-term borrowings

    209,004       1,251       0.60 %     142,890