10-Q 1 form10q-17850_fbnc.htm 10-Q

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2017

 

 

 

Commission File Number 0-15572

 

                              FIRST BANCORP                              

(Exact Name of Registrant as Specified in its Charter)

     
North Carolina   56-1421916
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification Number)
     
300 SW Broad St., Southern Pines, North Carolina   28387
(Address of Principal Executive Offices)   (Zip Code)
     
(Registrant's telephone number, including area code)   (910)   246-2500

 

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 twelve 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. x YES o NO

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x YES o NO

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

 

o Large Accelerated Filer x Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company

 

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter). o Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o YES x NO

 

The number of shares of the registrant's Common Stock outstanding on April 30, 2017 was 24,654,711.

 

 

 

 

INDEX

FIRST BANCORP AND SUBSIDIARIES

 

   
  Page
   
Part I.  Financial Information  
   
Item 1 - Financial Statements  
   
Consolidated Balance Sheets -  March 31, 2017 and March 31, 2016  (With Comparative Amounts at December 31, 2016) 4
   
Consolidated Statements of Income - For the Periods Ended March 31, 2017 and 2016 5
   
Consolidated Statements of Comprehensive Income - For the Periods Ended March 31, 2017 and 2016 6
   
Consolidated Statements of Shareholders’ Equity -  For the Periods Ended March 31, 2017 and 2016 7
   
Consolidated Statements of Cash Flows - For the Periods Ended March 31, 2017 and 2016 8
   
Notes to Consolidated Financial Statements 9
   
Item 2 – Management’s Discussion and Analysis of Consolidated Results of Operations and Financial Condition 39
   
Item 3 – Quantitative and Qualitative Disclosures About Market Risk 55
   
Item 4 – Controls and Procedures 57
   
Part II.  Other Information  
   
Item 1 – Legal Proceedings 57
   
Item 1A – Risk Factors 57
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 57
   
Item 5 – Other Information 58
   
Item 6 – Exhibits 58
   
Signatures 60

 

Page 2

FORWARD-LOOKING STATEMENTS

 

Part I of this report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Further, forward-looking statements are intended to speak only as of the date made. Such statements are often characterized by the use of qualifying words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” or other statements concerning our opinions or judgment about future events. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, our level of success in integrating acquisitions, actions of government regulators, the level of market interest rates, and general economic conditions. For additional information about factors that could affect the matters discussed in this paragraph, see the “Risk Factors” section of our 2016 Annual Report on Form 10-K.

Page 3

 

Part I. Financial Information

Item 1 - Financial Statements

First Bancorp and Subsidiaries

Consolidated Balance Sheets

 

($ in thousands-unaudited)  March 31,
2017
   December 31,
2016 (audited)
   March 31,
2016
 
ASSETS            
Cash and due from banks, noninterest-bearing  $81,514    71,645    52,393 
Due from banks, interest-bearing   323,646    234,348    148,734 
Federal funds sold           467 
     Total cash and cash equivalents   405,160    305,993    201,594 
                
Securities available for sale   214,743    199,329    247,140 
Securities held to maturity (fair values of $134,185, $130,195, and $151,684)   133,254    129,713    148,485 
                
Presold mortgages in process of settlement   11,661    2,116    3,102 
                
Loans – non-covered   3,289,355    2,710,712    2,439,830 
Loans – covered by FDIC loss share agreement           99,523 
   Total loans   3,289,355    2,710,712    2,539,353 
   Total allowance for loan losses   (23,546)   (23,781)   (26,648)
   Net loans   3,265,809    2,686,931    2,512,705 
                
Premises and equipment   97,142    75,351    75,268 
Accrued interest receivable   10,524    9,286    8,986 
FDIC indemnification asset           6,704 
Goodwill   142,872    75,042    67,528 
Other intangible assets   12,811    4,433    1,833 
Foreclosed real estate   12,789    9,532    10,336 
Bank-owned life insurance   86,923    74,138    72,594 
Other assets   48,158    42,998    26,691 
        Total assets  $4,441,846    3,614,862    3,382,966 
                
LIABILITIES               
Deposits:  Noninterest bearing checking accounts  $958,175    756,003    679,228 
  Interest bearing checking accounts   694,898    635,431    607,617 
  Money market accounts   814,079    685,331    667,504 
  Savings accounts   415,600    209,074    194,573 
  Time deposits of $100,000 or more   486,556    422,687    391,317 
  Other time deposits   259,862    238,827    286,582 
       Total deposits   3,629,170    2,947,353    2,826,821 
Borrowings   290,403    271,394    186,394 
Accrued interest payable   691    539    554 
Other liabilities   32,121    27,475    19,365 
     Total liabilities   3,952,385    3,246,761    3,033,134 
                
Commitments and contingencies               
                
SHAREHOLDERS’ EQUITY               
Preferred stock, no par value per share.  Authorized: 5,000,000 shares               
     Series C, convertible, issued & outstanding:  none, none, and 728,706 shares           7,287 
Common stock, no par value per share.  Authorized: 40,000,000 shares               
     Issued & outstanding:  24,663,241, 20,844,505, and 19,865,779 shares   262,180    147,287    135,318 
Retained earnings   231,503    225,921    210,250 
Stock in rabbi trust assumed in acquisition   (7,688)        
Rabbi trust obligation   7,688         
Accumulated other comprehensive income (loss)   (4,222)   (5,107)   (3,023)
     Total shareholders’ equity   489,461    368,101    349,832 
          Total liabilities and shareholders’ equity  $4,441,846    3,614,862    3,382,966 

 

See accompanying notes to consolidated financial statements.

 

Page 4

First Bancorp and Subsidiaries

Consolidated Statements of Income

 

($ in thousands, except share data-unaudited)  Three Months Ended
March 31,
 
   2017   2016 
INTEREST INCOME          
Interest and fees on loans  $33,703    29,573 
Interest on investment securities:          
     Taxable interest income   1,824    1,823 
     Tax-exempt interest income   443    445 
Other, principally overnight investments   498    222 
     Total interest income   36,468    32,063 
           
INTEREST EXPENSE          
Savings, checking and money market accounts   522    394 
Time deposits of $100,000 or more   714    652 
Other time deposits   166    274 
Borrowings   770    548 
     Total interest expense   2,172    1,868 
           
Net interest income   34,296    30,195 
Provision for loan losses – non-covered   723    1,621 
Provision (reversal) for loan losses – covered       (1,363)
Total provision (reversal) for loan losses   723    258 
Net interest income after provision for loan losses   33,573    29,937 
           
NONINTEREST INCOME          
Service charges on deposit accounts   2,614    2,685 
Other service charges, commissions and fees   3,173    2,830 
Fees from presold mortgage loans   768    371 
Commissions from sales of insurance and financial products   840    938 
SBA consulting fees   1,260     
SBA loan sale gains   622     
Bank-owned life insurance income   508    508 
Foreclosed property gains (losses), net   25    210 
FDIC indemnification asset income (expense), net       (2,366)
Securities gains (losses), net   (235)   3 
Other gains (losses), net   234    (177)
     Total noninterest income   9,809    5,002 
           
NONINTEREST EXPENSES          
Salaries expense   13,950    11,475 
Employee benefits expense   3,721    2,706 
   Total personnel expense   17,671    14,181 
Net occupancy expense   2,184    1,943 
Equipment related expenses   1,058    870 
Merger and acquisition expenses   2,373    201 
Intangibles amortization expense   576    186 
Other operating expenses   8,210    7,392 
     Total noninterest expenses   32,072    24,773 
           
Income before income taxes   11,310    10,166 
Income tax expense   3,755    3,329 
           
Net income   7,555    6,837 
           
Preferred stock dividends       (58)
           
Net income available to common shareholders  $7,555    6,779 
           
Earnings per common share:          
     Basic  $0.34    0.34 
     Diluted   0.34    0.33 
           
Dividends declared per common share  $0.08    0.08 
           
Weighted average common shares outstanding:          
     Basic   21,983,963    19,783,747 
     Diluted   22,064,923    20,553,858 

 

See accompanying notes to consolidated financial statements.

Page 5

First Bancorp and Subsidiaries

Consolidated Statements of Comprehensive Income

 

   Three Months Ended
March 31,
 
($ in thousands-unaudited)  2017   2016 
         
Net income  $7,555    6,837 
Other comprehensive income (loss):          
   Unrealized gains (losses) on securities available for sale:          
Unrealized holding gains (losses) arising during the period, pretax   1,113    817 
      Tax (expense) benefit   (407)   (319)
Reclassification to realized (gains) losses   235    (3)
       Tax expense (benefit)   (87)   1 
Postretirement Plans:          
Amortization of unrecognized net actuarial (gain) loss   51    51 
       Tax expense (benefit)   (20)   (20)
Other comprehensive income (loss)   885    527 
Comprehensive income  $8,440    7,364 

 

See accompanying notes to consolidated financial statements.

Page 6

 

First Bancorp and Subsidiaries

Consolidated Statements of Shareholders’ Equity

 

 

(In thousands, except per share - unaudited)

  Preferred   Common Stock   Retained   Stock in
Directors’
Rabbi
   Directors’
Deferred
Fees
   Accumulated
Other
Compre-
hensive
Income
   Total
Share-
holders’
 
   Stock   Shares   Amount   Earnings   Trust   Obligation   (Loss)   Equity 
                                 
                                 
Balances, January 1, 2016  $7,287    19,748   $133,393    205,060            (3,550)   342,190 
                                         
Net income                  6,837                   6,837 
Cash dividends declared ($0.08 per common share)                  (1,589)                  (1,589)
Preferred dividends                  (58)                  (58)
Equity issued pursuant to acquisition        79    1,500                        1,500 
Stock option exercises        8    127                        127 
Stock-based compensation        31    298                        298 
Other comprehensive income (loss)                                 527    527 
                                         
Balances, March 31, 2016  $7,287    19,866   $135,318    210,250            (3,023)   349,832 
                                         
                                         
Balances, January 1, 2017  $    20,845   $147,287    225,921            (5,107)   368,101 
                                         
Net income                  7,555                   7,555 
Cash dividends declared ($0.08 per common share)                  (1,973)                  (1,973)
Equity issued pursuant to acquisition        3,799    114,478         (7,688)   7,688         114,478 
Stock option exercises        4    45                        45 
Stock-based compensation        15    370                        370 
Other comprehensive income (loss)                                 885    885 
                                         
Balances, March 31, 2017  $    24,663   $262,180    231,503    (7,688)   7,688    (4,222)   489,461 

 

See accompanying notes to consolidated financial statements.

 

Page 7

First Bancorp and Subsidiaries

Consolidated Statements of Cash Flows

 

   Three Months Ended
March 31,
 
($ in thousands-unaudited)  2017   2016 
Cash Flows From Operating Activities          
Net income  $7,555    6,837 
Reconciliation of net income  to net cash provided by operating activities:          
     Provision for loan losses   723    258 
     Net security premium amortization   232    680 
     Loan discount accretion   (1,360)   (1,055)
     Purchase accounting accretion and amortization, net   (48)   2,091 
     Foreclosed property (gains) losses and write-downs, net   (25)   (210)
     Loss (gain) on securities available for sale   235    (3)
     Other losses (gains)   (234)   177 
     Decrease (increase) in net deferred loan fees   655    (385)
     Depreciation of premises and equipment   1,300    1,120 
     Stock-based compensation expense   178    123 
     Amortization of intangible assets   576    186 
     Fees/gains from sale of presold mortgages and SBA loans   (1,390)   (371)
     Origination of presold mortgages and SBA loans   (48,840)   (13,988)
     Proceeds from sales of presold mortgages and SBA loans   45,454    15,601 
     Decrease in accrued interest receivable   279    180 
     Decrease in other assets   3,741    11,405 
     Decrease in accrued interest payable   (112)   (31)
     Decrease in other liabilities   (8,257)   (2,762)
          Net cash provided by operating activities   662    19,853 
           
Cash Flows From Investing Activities          
     Purchases of securities available for sale   (29,313)   (99,896)
     Proceeds from maturities/issuer calls of securities available for sale   6,632    18,852 
     Proceeds from maturities/issuer calls of securities held to maturity   7,357    5,772 
     Proceeds from sales of securities available for sale   35,333    8 
     Proceeds from sales of securities held to maturity   11,285     
     Purchases of Federal Reserve and Federal Home Loan Bank stock, net   (3,766)   (138)
     Net increase in loans   (81,048)   (23,170)
     Payments related to FDIC loss share agreements       (356)
     Proceeds from sales of foreclosed real estate   1,818    1,858 
     Purchases of premises and equipment   (873)   (925)
     Proceeds from sales of premises and equipment       21 
     Net cash received (paid) in acquisition   56,185    (1,580)
          Net cash provided (used) by investing activities   3,610    (99,554)
           
Cash Flows From Financing Activities          
     Net increase in deposits   96,519    15,536 
     Cash dividends paid – common stock   (1,669)   (1,578)
     Cash dividends paid – preferred stock       (58)
     Proceeds from stock option exercises   45    127 
          Net cash provided by financing activities   94,895    14,027 
           
Increase (decrease) in cash and cash equivalents   99,167    (65,674)
Cash and cash equivalents, beginning of period   305,993    267,268 
           
Cash and cash equivalents, end of period  $405,160    201,594 
           
Supplemental Disclosures of Cash Flow Information:          
Cash paid (received) during the period for:          
     Interest  $2,020    1,899 
     Income taxes   (1,495)   (4,305)
Non-cash transactions:          
     Unrealized gain (loss) on securities available for sale, net of taxes   854    496 
     Foreclosed loans transferred to other real estate   1,968    1,990 

 

 

See accompanying notes to consolidated financial statements.

Page 8

 

First Bancorp and Subsidiaries

Notes to Consolidated Financial Statements

 

 

(unaudited) For the Periods Ended March 31, 2017 and 2016  

 

Note 1 - Basis of Presentation

 

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of the Company as of March 31, 2017 and 2016 and the consolidated results of operations and consolidated cash flows for the periods ended March 31, 2017 and 2016. All such adjustments were of a normal, recurring nature. Reference is made to the 2016 Annual Report on Form 10-K filed with the SEC for a discussion of accounting policies and other relevant information with respect to the financial statements. The results of operations for the periods ended March 31, 2017 and 2016 are not necessarily indicative of the results to be expected for the full year. The Company has evaluated all subsequent events through the date the financial statements were issued.

 

Note 2 – Accounting Policies

 

Note 1 to the 2016 Annual Report on Form 10-K filed with the SEC contains a description of the accounting policies followed by the Company and discussion of recent accounting pronouncements. The following paragraphs update that information as necessary.

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 31, 2017. The Company can apply the guidance using a full retrospective approach or a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This update is intended to improve the recognition and measurement of financial instruments and it requires an entity to: (i) measure equity investments at fair value through net income, with certain exceptions; (ii) present in other comprehensive income the changes in instrument-specific credit risk for financial liabilities measured using the fair value option; (iii) present financial assets and financial liabilities by measurement category and form of financial asset; (iv) calculate the fair value of financial instruments for disclosure purposes based on an exit price and; (v) assess a valuation allowance on deferred tax assets related to unrealized losses of available for sale debt securities in combination with other deferred tax assets. The guidance also provides an election to subsequently measure certain nonmarketable equity investments at cost less any impairment and adjusted for certain observable price changes and requires a qualitative impairment assessment of such equity investments and amends certain fair value disclosure requirements. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2016, the FASB issued new guidance on accounting for leases, which generally requires all leases to be recognized in the statement of financial position by recording an asset representing its right to use the underlying asset and recording a liability, which represents the Company’s obligation to make lease payments. The provisions of this guidance are effective for reporting periods beginning after December 15, 2018; early adoption is permitted. These provisions are to be applied using a modified retrospective approach. The Company is evaluating the effect that this new guidance will have on our consolidated financial statements, but does not expect it will have a material effect on its financial statements.

 

In March 2016, the FASB amended the Liabilities topic of the Accounting Standards Codification to address the current and potential future diversity in practice related to the derecognition of a prepaid stored-value product liability. The amendments will be effective for financial statements issued for fiscal years beginning after

Page 9

December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance using a modified retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is effective to each period presented. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB amended the Investments—Equity Method and Joint Ventures topic of the Accounting Standards Codification to eliminate the requirement to retroactively adopt the equity method of accounting and instead apply the equity method of accounting starting with the date it qualifies for that method. The amendments were effective for the Company on January 1, 2017. The Company will apply the guidance prospectively to any increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. The Company’s adoption of this amendment did not have a material effect on its financial statements.

 

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments were effective for the Company on January 1, 2017 and the adoption of this amendment did not have a material effect on its financial statements.

 

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In June 2016, the FASB issued guidance to change the accounting for credit losses. The guidance requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset.  The CECL model is expected to result in earlier recognition of credit losses.  The guidance also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years.  Early adoption is permitted.  Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.  The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

 

In August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017, including interim periods within those years. The Company does not expect these amendments to have a material effect on its financial statements.

 

In October 2016, the FASB amended the Consolidation topic of the Accounting Standards Codification to revise the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with

Page 10

the reporting entity when determining whether it is the primary beneficiary of that VIE. The amendments were effective for the Company on January 1, 2017 and the Company’s adoption of this amendment did not have a material effect on its financial statements.

 

In November 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how restricted cash is presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2017, the FASB issued guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendment to the Business Combinations Topic is intended to address concerns that the existing definition of a business has been applied too broadly and has resulted in many transactions being recorded as business acquisitions that in substance are more akin to asset acquisitions. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2017, the FASB updated the Accounting Changes and Error Corrections and the Investments—Equity Method and Joint Ventures Topics of the Accounting Standards Codification. The Accounting Standards Update incorporates into the Accounting Standards Codification recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The ASU was effective upon issuance. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

In January 2017, the FASB issued amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. The amount of goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2017, the FASB amended the Other Income Topic of the Accounting Standards Codification to clarify the scope of the guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2017, the FASB amended the requirements in the Compensation—Retirement Benefits Topic of the Accounting Standards Codification related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the Accounting Standards Codification related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

Page 11

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Note 3 – Reclassifications

 

Certain amounts reported in the period ended March 31, 2016 have been reclassified to conform to the presentation for March 31, 2017. These reclassifications had no effect on net income or shareholders’ equity for the periods presented, nor did they materially impact trends in financial information.

 

Note 4 – Acquisitions

 

Since January 1, 2016, the Company completed the acquisitions described below. The results of each acquired company/branch are included in the Company’s results beginning on its respective acquisition date.

 

(1)On January 1, 2016, First Bank Insurance completed the acquisition of Bankingport, Inc. (“Bankingport”). The results of Bankingport are included in First Bancorp’s results beginning on the January 1, 2016 acquisition date.

 

Bankingport was an insurance agency based in Sanford, North Carolina. This acquisition represented an opportunity to expand the insurance agency operations into a contiguous and significant banking market for the Company. Also, this acquisition provided the Company with a larger platform for leveraging insurance services throughout the Company’s bank branch network. The deal value was $2.2 million and the transaction was completed on January 1, 2016 with the Company paying $0.7 million in cash and issuing 79,012 shares of its common stock, which had a value of approximately $1.5 million. In connection with the acquisition, the Company also paid $1.1 million to purchase the office space previously leased by Bankingport.

 

This acquisition has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of Bankingport were recorded based on estimates of fair values as of January 1, 2016. In connection with this transaction, the Company recorded $1.7 million in goodwill, which is non-deductible for tax purposes, and $0.7 million in other amortizable intangible assets.

 

(2)On May 5, 2016, the Company completed the acquisition of SBA Complete, Inc. (“SBA Complete”). The results of SBA Complete are included in First Bancorp’s results beginning on the May 5, 2016 acquisition date. SBA Complete is a consulting firm that specializes in consulting with financial institutions across the country related to Small Business Administration (“SBA”) loan origination and servicing. The deal value was approximately $8.5 million with the Company paying $1.5 million in cash and issuing 199,829 shares of its common stock, which had a value of approximately $4.0 million. Per the terms of the agreement, the Company has also recorded an earn-out liability valued at $3.0 million, which will be paid in shares of Company stock in annual distributions over a three-year period if pre-determined goals are met for those three years.

 

This acquisition has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of SBA Complete were recorded based on estimates of fair values, which according to applicable accounting guidance, are subject to change for twelve months following the acquisition. In connection with this transaction, the Company recorded $5.6 million in goodwill, which is non-deductible for tax purposes, and $2.0 million in other amortizable intangible assets.

 

(3)On July 15, 2016, the Company completed a branch exchange with First Community Bank headquartered in Bluefield, Virginia. In the branch exchange transaction, First Bank acquired six of First Community Bank’s branches located in North Carolina, while concurrently selling seven of its branches in the southwestern area of Virginia to First Community Bank.

 

In connection with the sale, the Company sold $150.6 million in loans, $5.7 million in premises and equipment and $134.3 million in deposits to First Community Bank. In connection with the sale, the Company received a deposit premium of $3.8 million, removed $1.0 million of allowance for loan losses associated with the sold loans, allocated and wrote-off $3.5 million of previously recorded goodwill, and recorded a net gain of $1.5 million in this transaction.

 

Page 12

In connection with the purchase transaction, the Company acquired assets with a fair value of $157.2 million, including $152.2 million in loans and $3.4 million in premises and equipment. Additionally, the Company assumed $111.3 million in deposits and $0.2 million in other liabilities. In connection with the purchase, the Company recorded: i) a discount on acquired loans of $1.5 million, ii) a premium on deposits of $0.3 million, iii) a $1.2 million core deposit intangible, and iv) $5.4 million in goodwill.

 

The branch acquisition has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of the acquired branches were recorded on the Company’s balance sheet at their fair values as of July 15, 2016 and are subject to change for twelve months following the acquisition. The related results of operations for the acquired branches have been included in the Company’s consolidated statement of income since that date. The goodwill recorded in the branch exchange is deductible for tax purposes.

 

(4)On March 3, 2017, the Company completed its acquisition of Carolina Bank Holdings, Inc. (“Carolina Bank”), headquartered in Greensboro, North Carolina, pursuant to an Agreement and Plan of Merger and Reorganization dated June 21, 2016. The results of Carolina Bank are included in First Bancorp’s results for the period ended March 31, 2017 beginning on the March 3, 2017 acquisition date.

 

Carolina Bank Holdings, Inc. was the parent company of Carolina Bank, a North Carolina state-charted bank with eight bank branches located in the North Carolina cities of Greensboro, High Point, Burlington, Winston-Salem, and Asheboro, and mortgage offices in Burlington, Hillsborough, and Sanford. The acquisition complements the Company’s recent expansion into several of these high-growth markets and increases its market share in others with facilities, operations and experienced staff already in place. The Company was willing to record goodwill primarily due to the reasons just noted, as well as the positive earnings of Carolina Bank. The total merger consideration consisted of $25.3 million in cash and 3,799,471 million shares of the Company’s common stock, with each share of Carolina Bank common stock being exchanged for either $20.00 in cash or 1.002 shares of the Company’s stock, subject to the total consideration being 75% stock / 25% cash. The issuance of common stock was valued at $114,478,000 and was based on the Company’s closing stock price on March 3, 2017 of $30.13 per share.

Page 13

This acquisition has been accounted for using the purchase method of accounting for business combinations, and accordingly, the assets and liabilities of Carolina Bank were recorded based on estimates of fair values as of March 3, 2017. The Company may change its valuations of acquired Carolina Bank assets and liabilities for up to one year after the acquisition date. The table below is a condensed balance sheet disclosing the amount assigned to each major asset and liability category of Carolina Bank on March 3, 2017, and the related fair value adjustments recorded by the Company to reflect the acquisition. The $67.8 million in goodwill that resulted from this transaction is non-deductible for tax purposes.

 

 

($ in thousands)

 

  As
Recorded by
Carolina Bank
   Fair
Value
Adjustments
   As
Recorded by
First Bancorp
 
Assets               
Cash and cash equivalents  $81,466    (2)(a)  81,464 
Securities   49,629    (261)(b)  49,368 
Loans, gross   505,560    (5,469)(c)  497,376 
         (2,715)(d)    
Allowance for loan losses   (5,746)   5,746(e)   
Premises and equipment   17,967    4,251(f)  22,218 
Core deposit intangible       8,790(g)  8,790 
Other   34,976    (4,804)(h)  30,172 
   Total   683,852    5,536    689,388 
                
Liabilities               
Deposits  $584,950    431(i)  585,381 
Borrowings   21,855    (2,855)(j)  19,000 
Other   12,855    225(k)  13,080 
   Total   619,660    (2,199)   617,461 
                
Net identifiable assets acquired             71,927 
                
Total cost of acquisition               
   Value of stock issued       $114,478      
   Cash paid in the acquisition        25,279      
       Total cost of acquisition             139,757 
                
Goodwill recorded related to acquisition of Carolina Bank            $67,830 
                

 

Explanation of Fair Value Adjustments

(a)This adjustment was recorded to a short-term investment to its estimated fair value.
(b)This fair value adjustment was recorded to adjust the securities portfolio to its estimated fair value.
(c)This fair value adjustment represents the amount necessary to reduce performing loans to their fair value due to interest rate factors and credit factors. Assuming the loans continue to perform, this amount will be amortized to increase interest income over the remaining lives of the related loans.
(d)This fair value adjustment was recorded to write-down purchased credit impaired loans assumed in the acquisition to their estimated fair market value.
(e)This fair value adjustment reduced the allowance for loan losses to zero as required by relevant accounting guidance.
(f)This adjustment represents the amount necessary to increase premises and equipment from its book value on the date of acquisition to its estimated fair market value.
(g)This fair value adjustment represents the value of the core deposit base assumed in the acquisition based on a study performed by an independent consulting firm. This amount was recorded by the Company as an identifiable intangible asset and will be amortized as expense on an accelerated basis over seven years.
(h)This fair value adjustment primarily represents the net deferred tax liability associated with the other fair value adjustments made to record the transaction.
(i)This fair value adjustment was recorded because the weighted average interest rate of Carolina Bank’s time deposits exceeded the cost of similar wholesale funding at the time of the acquisition. This amount will be amortized to reduce interest expense on an accelerated basis over their remaining five year life.
(j)This fair value adjustment was primarily recorded because the interest rate of Carolina Bank’s trust preferred security was less than the current interest rate on similar instruments. This amount will be amortized on approximately a straight-line basis to increase interest expense over the remaining life of the related borrowing, which is 18 years.

Page 14

(k)This fair value adjustment represents miscellaneous adjustments needed to record assets and liabilities at their fair value.

 

The following unaudited pro forma financial information presents the combined results of the Company and Carolina Bank as if the acquisition had occurred as of January 1, 2016, after giving effect to certain adjustments, including amortization of the core deposit intangible, and related income tax effects. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Carolina Bank constituted a single entity during such period.

 

($ in thousands, except share data)  Carolina Bank Only -
March 3, 2017-March
31, 2017
   Pro Forma Combined
Three Months Ended
March 31, 2017
   Pro Forma
Combined Three
Months Ended
March 31, 2016
 
Net interest income  $1,886    38,209    35,966 
Noninterest income   503    10,999    7,291 
Total revenue   2,389    49,208    43,257 
                
Net income available to common shareholders   210    5,377    7,880 
                
Earnings per common share               
     Basic       $0.22    0.33 
     Diluted        0.22    0.32 

 

The above pro forma results for the three months ended March 31, 2017 include merger-related expenses and charges recorded by Carolina Bank prior to the merger that are nonrecurring in nature and amounted to $4.6 million pretax, or $3.1 million after-tax ($0.12 per basic and diluted share).

 

Note 5 – Equity-Based Compensation Plans

 

The Company recorded total stock-based compensation expense of $178,000 and $123,000 for the three months ended March 31, 2017 and 2016, respectively. Stock based compensation is reflected as an adjustment to cash flows from operating activities on the Company’s Consolidated Statement of Cash Flows. The Company recognized $66,000 and $48,000 of income tax benefits related to stock based compensation expense in the income statement for the three months ended March 31, 2017 and 2016, respectively.

 

At March 31, 2017, the Company had the following equity-based compensation plans: the First Bancorp 2014 Equity Plan and the First Bancorp 2007 Equity Plan. The Company’s shareholders approved all equity-based compensation plans. The First Bancorp 2014 Equity Plan became effective upon the approval of shareholders on May 8, 2014. As of March 31, 2017, the First Bancorp 2014 Equity Plan was the only plan that had shares available for future grants, and there were 845,596 shares remaining available for grant.

 

The First Bancorp 2014 Equity Plan is intended to serve as a means to attract, retain and motivate key employees and directors and to associate the interests of the plans’ participants with those of the Company and its shareholders. The First Bancorp 2014 Equity Plan allows for both grants of stock options and other types of equity-based compensation, including stock appreciation rights, restricted stock, restricted performance stock, unrestricted stock, and performance units.

 

Recent equity grants to employees have either had performance vesting conditions, service vesting conditions, or both. Compensation expense for these grants is recorded over the various service periods based on the estimated number of equity grants that are probable to vest. No compensation cost is recognized for grants that do not vest and any previously recognized compensation cost will be reversed. The Company issues new shares of common stock when options are exercised.

 

Certain of the Company’s stock option grants contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period. The Company recognizes compensation expense for awards with graded vesting schedules on a straight-line basis over the requisite service period for each incremental award. Compensation expense is based on the estimated number of stock options and awards that will ultimately vest. Over the past five years, there have only been minimal amounts of forfeitures, and therefore the Company assumes that all awards granted without performance conditions will become vested.

 

Page 15

As it relates to director equity grants, the Company grants common shares, valued at approximately $32,000 to each non-employee director (currently 10 in total) in June of each year. Compensation expense associated with these director grants is recognized on the date of grant since there are no vesting conditions.

 

The Company’s senior officers receive their annual bonus earned under the Company’s annual incentive plan in a mix of 50% cash and 50% stock, with the stock being subject to a three year vesting term. In the last three years, a total of 55,648 shares of restricted stock have been granted related to performance in the preceding fiscal years. Total compensation expense associated with those grants was $757,000 and is being recognized over the respective vesting periods. The Company recorded $69,000 and $55,000 in compensation expense during the three months ended March 31, 2017 and 2016, respectively, related to these grants and expects to record $69,000 in compensation expense during each remaining quarter of 2017.

 

In the last three years, the Compensation Committee also granted 105,616 shares of stock to various employees of the Company to promote retention. The total value associated with these grants amounted to $1.9 million, which is being recorded as an expense over their three year vesting periods. For the three months ended March 31, 2017 and 2016, total compensation expense related to these grants was $109,000 and $68,000, respectively. The Company expects to record $86,500 in compensation expense during each remaining quarter of 2017. All grants were issued based on the closing price of the Company’s common stock on the date of the grant.

 

Under the terms of the predecessor plans and the First Bancorp 2014 Equity Plan, stock options can have a term of no longer than 10 years. In a change in control (as defined in the plans), unless the awards remain outstanding or substitute equivalent awards are provided, the awards become immediately vested.

 

At March 31, 2017, there were 53,198 stock options outstanding related to the two First Bancorp plans, with exercise prices ranging from $14.35 to $20.80.

 

The following table presents information regarding the activity for the first three months of 2017 related to the Company’s stock options outstanding:

 

   Options Outstanding 
   Number of
Shares
   Weighted-
Average
Exercise
Price
   Weighted-
Average
Contractual
Term (years)
   Aggregate
Intrinsic
Value
 
                 
Balance at January 1, 2017   59,948   $17.18           
                     
   Granted                  
   Exercised   (6,750)   19.61        $69,548 
   Forfeited                  
   Expired                  
                     
Outstanding at March 31, 2017   53,198   $16.87    1.3   $664,154 
                     
Exercisable at March 31, 2017   53,198   $16.87    1.3   $664,154 

 

During the three months ended March 31, 2017 and 2016, the Company received $45,000 and $127,000, respectively, as a result of stock option exercises.

 

Page 16

The following table presents information regarding the activity the first three months of 2017 related to the Company’s outstanding restricted stock:

 

   Long-Term Restricted Stock 
   Number of Units   Weighted-Average
Grant-Date Fair Value
 
         
Nonvested at January 1, 2017   91,790   $18.65 
           
Granted during the period   15,344    30.03 
Vested during the period   (2,282)   18.27 
Forfeited or expired during the period   (4,496)   19.32 
           
Nonvested at March 31, 2017   100,356   $20.37 

 

Note 6 – Earnings Per Common Share

 

Basic Earnings Per Common Share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period, excluding unvested shares of restricted stock. Diluted Earnings Per Common Share is computed by assuming the issuance of common shares for all potentially dilutive common shares outstanding during the reporting period. For the periods presented, the Company’s potentially dilutive common stock issuances related to unvested shares of restricted stock and stock option grants under the Company’s equity-based plans and the Company’s Series C Preferred stock, which was exchanged for common stock at a one-for-one ratio on December 22, 2016 - see Note 19 of the Company’s 2016 Annual Report on Form 10-K for additional detail.

 

In computing Diluted Earnings Per Common Share, adjustments are made to the computation of Basic Earnings Per Common shares, as follows. As it relates to unvested shares of restricted stock, the number of shares added to the denominator is equal to the number of unvested shares less the assumed number of shares bought back by the Company in the open market at the average market price with the amount of proceeds being equal to the average deferred compensation for the reporting period. As it relates to stock options, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is included in the calculation of dilutive securities. As it relates to the preferred stock that was outstanding during the periods in 2016, dividends on the preferred stock were added back to net income and the preferred shares assumed to be converted were included in the number of shares outstanding.

 

If any of the potentially dilutive common stock issuances have an anti-dilutive effect, the potentially dilutive common stock issuance is disregarded.

 

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Earnings Per Common Share:

 

   For the Three Months Ended March 31, 
   2017   2016 

 

($ in thousands except per

   share amounts)

  Income
(Numer-
ator)
   Shares
(Denom-
inator)
   Per Share
Amount
   Income
(Numer-
ator)
   Shares
(Denom-
inator)
   Per Share
Amount
 
                         
Basic EPS                              
Net income available to common shareholders  $7,555    21,983,963   $0.34   $6,779    19,783,747   $0.34 
                               
Effect of Dilutive Securities       80,960         58    770,111      
                               
Diluted EPS per common share  $7,555    22,064,923   $0.34   $6,837    20,553,858   $0.33 

 

For the three months ended March 31, 2017, there were no options that were antidilutive. For the three months ended March 31, 2016, there were 50,000 options that were antidilutive because the exercise price exceeded the average market price for the period, and thus are not included in the calculation to determine the effect of dilutive securities.

Page 17

Note 7 – Securities

 

The book values and approximate fair values of investment securities at March 31, 2017 and December 31, 2016 are summarized as follows:

 

   March 31, 2017   December 31, 2016 
   Amortized   Fair   Unrealized   Amortized   Fair   Unrealized 
($ in thousands)  Cost   Value   Gains   (Losses)   Cost   Value   Gains   (Losses) 
                                 
Securities available for sale:                                        
  Government-sponsored enterprise securities  $19,498    19,426    8    (80)   17,497    17,490        (7)
  Mortgage-backed securities   162,660    160,786    220    (2,094)   151,001    148,065    155    (3,091)
  Corporate bonds   34,322    34,531    286    (77)   33,833    33,600    91    (324)
  Equity securities                   83    174    96    (5)
Total available for sale  $216,480    214,743    514    (2,251)   202,414    199,329    342    (3,427)
                                         
Securities held to maturity:                                        
  Mortgage-backed securities  $76,201    75,264        (937)   80,585    79,283        (1,302)
  State and local governments   57,053    58,921    1,897    (29)   49,128    50,912    1,815    (31)
Total held to maturity  $133,254    134,185    1,897    (966)   129,713    130,195    1,815    (1,333)

 

All of the Company’s mortgage-backed securities were issued by government-sponsored corporations.

 

The following table presents information regarding securities with unrealized losses at March 31, 2017:

 

($ in thousands)

 

  Securities in an Unrealized
Loss Position for
Less than 12 Months
   Securities in an Unrealized
Loss Position for
More than 12 Months
   Total 
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
  Government-sponsored enterprise securities  $13,917    80            13,917    80 
  Mortgage-backed securities   167,034    2,513    17,862    518    184,896    3,031 
  Corporate bonds   8,021    17    940    60    8,961    77 
  Equity securities                        
  State and local governments   7,057    29            7,057    29 
      Total temporarily impaired securities  $196,029    2,639    18,802    578    214,831    3,217 

 

The following table presents information regarding securities with unrealized losses at December 31, 2016:

 

($ in thousands)

 

  Securities in an Unrealized
Loss Position for
Less than 12 Months
   Securities in an Unrealized
Loss Position for
More than 12 Months
   Total 
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
  Government-sponsored enterprise securities  $7,990    7            7,990    7 
  Mortgage-backed securities   196,999    3,841    19,001    552    216,000    4,393 
  Corporate bonds   27,027    259    935    65    27,962    324 
  Equity securities           7    5    7    5 
  State and local governments   801    31            801    31 
      Total temporarily impaired securities  $232,817    4,138    19,943    622    252,760    4,760 

 

In the above tables, all of the non-equity securities that were in an unrealized loss position at March 31, 2017 and December 31, 2016 are bonds that the Company has determined are in a loss position due primarily to interest rate factors and not credit quality concerns. The Company has evaluated the collectability of each of these bonds and has concluded that there is no other-than-temporary impairment. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities before recovery of the amortized cost.

 

The Company also concluded that each of the equity securities in an unrealized loss position at December 31, 2016 was in such a position due to temporary fluctuations in the market prices of the securities. The Company’s policy is to record an impairment charge for any of these equity securities that remains in an unrealized loss position for twelve consecutive months unless the amount is insignificant.

 

Page 18

The book values and approximate fair values of investment securities at March 31, 2017, by contractual maturity, are summarized in the table below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Securities Available for Sale   Securities Held to Maturity 
   Amortized   Fair   Amortized   Fair 
($ in thousands)  Cost   Value   Cost   Value 
                 
Debt securities                    
Due within one year  $        2,123    2,144 
Due after one year but within five years   19,498    19,426    21,815    22,527 
Due after five years but within ten years   29,322    29,411    27,398    28,600 
Due after ten years   5,000    5,120    5,717    5,650 
Mortgage-backed securities   162,660    160,786    76,201    75,264 
Total debt securities   216,480    214,743    133,254    134,185 
                     
Equity securities                
Total securities  $216,480    214,743    133,254    134,185 

 

At March 31, 2017 and December 31, 2016 investment securities with carrying values of $193,673,000 and $147,009,000, respectively, were pledged as collateral for public deposits.

 

In the first quarter of 2017, the Company received proceeds from sales of securities of $46,618,000 and recorded losses of $235,000 from the sales. In the first quarter of 2016, the Company received proceeds from sales of securities of $8,000 and recorded $3,000 in gains from the sales.

 

Included in “other assets” in the Consolidated Balance Sheets are cost method investments in Federal Home Loan Bank (“FHLB”) stock and Federal Reserve Bank of Richmond (“FRB”) stock totaling $23,694,000 and $19,826,000 at March 31, 2017 and December 31, 2016, respectively. The FHLB stock had a cost and fair value of $14,043,000 and $12,588,000 at March 31, 2017 and December 31, 2016, respectively, and serves as part of the collateral for the Company’s line of credit with the FHLB and is also a requirement for membership in the FHLB system. The FRB stock had a cost and fair value of $9,651,000 and $7,238,000 at March 31, 2017 and December 31, 2016, respectively. Periodically, both the FHLB and FRB recalculate the Company’s required level of holdings, and the Company either buys more stock or redeems a portion of the stock at cost. The Company determined that neither stock was impaired at either period end.

 

Page 19

Note 8 – Loans and Asset Quality Information

 

Prior to September 22, 2016, the Company’s banking subsidiary, First Bank, had certain loans and foreclosed real estate that were covered by loss share agreements between the FDIC and First Bank which afforded First Bank significant loss protection - see Note 2 to the financial statements included in the Company’s 2011 Annual Report on Form 10-K for detailed information regarding FDIC-assisted purchase transactions. On September 22, 2016, the Company terminated all of the loss share agreements with the FDIC, such that all future losses and recoveries on loans and foreclosed real estate associated with the failed banks acquired through FDIC-assisted transactions will be borne solely by First Bank.

 

In the information presented below, the term “covered” is used to describe assets that were subject to FDIC loss share agreements, while the term “non-covered” refers to the Company’s legacy assets, which were not included in any type of loss share arrangement. As discussed previously, all loss share agreements were terminated during 2016 and thus the entire loan portfolio is now classified as non-covered. Certain prior period disclosures will continue to present the breakout of the loan portfolio between covered and non-covered.

 

On March 3, 2017, the Company acquired Carolina Bank (see Note 4 for more information). As a result of this acquisition, the Company recorded loans with a fair value of $497.4 million. Of those loans, $19.3 million were considered to be purchased credit impaired (“PCI”) loans, which are loans for which it is probable at acquisition date that all contractually required payments will not be collected. The remaining loans are considered to be purchased non-impaired loans and their related fair value discount or premium is recognized as an adjustment to yield over the remaining life of each loan.

 

The following table relates to Carolina Bank PCI loans and summarizes the contractually required payments, which includes principal and interest, expected cash flows to be collected, and the fair value of acquired PCI loans at the acquisition date.

 

($ in thousands)

 

  Carolina Bank Acquisition
on March 3, 2017
 
Contractually required payments  $27,108 
Nonaccretable difference   (4,237)
Cash flows expected to be collected at acquisition   22,871 
Accretable yield   (3,617)
Fair value of PCI loans at acquisition date  $19,254 

 

 
       

The following table relates to acquired Carolina Bank purchased non-impaired loans and provides the contractually required payments, fair value, and estimate of contractual cash flows not expected to be collected at the acquisition date.

 

($ in thousands)

 

  Carolina Bank Acquisition
on March 3, 2017
 
Contractually required payments  $569,980 
Fair value of acquired loans at acquisition date   478,122 
Contractual cash flows not expected to be collected   3,650 

 

 

Page 20

The following is a summary of the major categories of total loans outstanding:

 

($ in thousands)  March 31, 2017   December 31, 2016   March 31, 2016 
   Amount   Percentage   Amount   Percentage   Amount   Percentage 
All  loans (non-covered and covered):                              
                               
Commercial, financial, and agricultural  $363,219    11%   $261,813    9%   $228,867    9% 
Real estate – construction, land development & other land loans   424,539    13%    354,667    13%    302,052    12% 
Real estate – mortgage – residential (1-4 family) first mortgages   792,791    24%    750,679    28%    757,696    30% 
Real estate – mortgage – home equity loans / lines of credit   317,336    10%    239,105    9%    235,380    9% 
Real estate – mortgage – commercial and other   1,335,924    40%    1,049,460    39%    966,937    38% 
Installment loans to individuals   56,250    2%    55,037    2%    47,163    2% 
    Subtotal   3,290,059    100%    2,710,761    100%    2,538,095    100% 
Unamortized net deferred loan costs (fees)   (704)        (49)        1,258      
    Total loans  $3,289,355        $2,710,712        $2,539,353      

 

The following is a summary of the major categories of loans outstanding allocated to the non-covered and covered loan portfolios for periods when the FDIC loss share agreements were in effect at March 31, 2016. There were no covered loans at March 31, 2017 or December 31, 2016.

 

($ in thousands)  March 31, 2016 
   Non-covered   Covered   Total 
             
Commercial, financial, and agricultural  $228,124    743   $228,867 
Real estate – construction, land development & other land loans   298,410    3,642    302,052 
Real estate – mortgage – residential (1-4 family) first mortgages   684,085    73,611    757,696 
Real estate – mortgage – home equity loans / lines of credit   225,245    10,135    235,380 
Real estate – mortgage – commercial and other   955,550    11,387    966,937 
Installment loans to individuals   47,158    5    47,163 
    Subtotal   2,438,572    99,523    2,538,095 
Unamortized net deferred loan costs   1,258        1,258 
    Total  $2,439,830    99,523   $2,539,353 

 

 

The following presents the carrying amount of the covered loans at March 31, 2016 detailed by purchased credit impaired and purchased non-impaired loans (as determined on the date of the acquisition). There were no covered loans at March 31, 2017 or December 31, 2016.

 

 

 

($ in thousands)

  Purchased
Credit
Impaired
Loans –
Carrying
Value
   Purchased
Credit
Impaired
Loans –
Unpaid
Principal
Balance
   Non-impaired
Purchased
Loans –
Carrying
Value
   Non-impaired
Purchased
Loans -
Unpaid
Principal
Balance
   Total
Covered
Loans –
Carrying
Value
   Total
Covered
Loans –
Unpaid
Principal
Balance
 
Covered loans:                              
Commercial, financial, and agricultural  $        743    748    743    748 
Real estate – construction, land development & other land loans   207    332    3,435    3,384    3,642    3,716 
Real estate – mortgage – residential (1-4 family) first mortgages   80    564    73,531    85,962    73,611    86,526 
Real estate – mortgage – home equity loans / lines of credit   7    14    10,128    11,516    10,135    11,530 
Real estate – mortgage – commercial and other   873    1,973    10,514    11,105    11,387    13,078 
Installment loans to individuals           5    35    5    35 
     Total  $1,167    2,883    98,356    112,750    99,523    115,633 

Page 21

The following table presents information regarding covered purchased non-impaired loans since December 31, 2015. The amounts include principal only and do not reflect accrued interest as of the date of the acquisition or beyond. All balances of covered loans were transferred to non-covered as of the termination of the loss share agreements.

 

($ in thousands)

 

    
Carrying amount of nonimpaired covered loans at December 31, 2015  $101,252 
Principal repayments   (7,997)
Transfers to foreclosed real estate   (1,036)
Net loan recoveries   1,784 
Accretion of loan discount   1,908 
Transfer to non-covered loans due to expiration of loss-share agreement, April 1, 2016   (17,530)
Transfer to non-covered loans due to termination of loss-share agreements, September 22, 2016   (78,381)
Carrying amount of nonimpaired covered loans at December 31, 2016  $ 

 

During the first quarter of 2017, the Company accreted $1,360,000 into interest income of loan discount on non-covered non-impaired purchased loans.

 

As of March 31, 2017, there was a remaining loan discount of $18,410,000 related to purchased accruing loans, which is expected to be accreted into interest income over the lives of the respective loans. At March 31, 2017, the Company also had $402,000 of loan discount related to purchased nonaccruing loans, which the Company does not expect will be accreted into income.

 

The following table presents information regarding all PCI loans since December 31, 2015.

 

 

($ in thousands)

 

 

 

Purchased Credit Impaired Loans

  Accretable
Yield
   Carrying
Amount
 
Balance at December 31, 2015  $    1,970 
Change due to payments received       (1,386)
Change due to loan charge-off       (70)
Balance at December 31, 2016  $    514 
Additions due to acquisition of Carolina Bank   3,617    19,254 
Accretion   (85)   85 
Change due to payments received       (126)
Transfer to foreclosed real estate       (69)
Other       7 
Balance at March 31, 2017  $3,532    19,665 

 

The remaining accretable yield associated with PCI loans at March 31, 2017 and 2016 was $3.5 million and $0, respectively. Accretable yield recognized during the three months ended March 31, 2017 and 2016 was $85,000 and $0, respectively. Also, during the first quarter of 2016, the Company received $46,000 in payments that exceeded the carrying amount of the related purchased credit impaired loans, of which $39,000 was recognized as loan discount accretion income and $7,000 was recorded as additional loan interest income.

 

Page 22

Nonperforming assets are defined as nonaccrual loans, restructured loans, loans past due 90 or more days and still accruing interest, nonperforming loans held for sale, and foreclosed real estate. Nonperforming assets are summarized as follows:

 

 

ASSET QUALITY DATA ($ in thousands)

  March 31,
2017
   December 31,
2016
   March 31, 2016 
             
Nonperforming assets               
Nonaccrual loans  $25,684    27,468    41,411 
Restructured loans - accruing   21,559    22,138    30,514 
Accruing loans > 90 days past due            
     Total nonperforming loans   47,243    49,606    71,925 
Foreclosed real estate   12,789    9,532    10,336 
Total nonperforming assets  $60,032    59,138    82,261 
                
Total covered nonperforming assets included above (1)  $        10,698 
Purchased credit impaired loans not included above (2)  $19,167         

 

(1) All FDIC loss share agreements were terminated effective September 22, 2016 and, accordingly, assets previously covered under those agreements become non-covered on that date.

(2) In the March 3, 2017 acquisition of Carolina Bank Holdings, Inc., the Company acquired $19.3 million in purchased credit impaired loans in accordance with ASC 310-30 accounting guidance. These loans are excluded from nonperforming loans, including $1.7 million in purchased credit impaired loans at March 31, 2017 that are contractually past due 90 days or more.

 

At March 31, 2017 and December 31, 2016, the Company had $1.6 million and $1.7 million in residential mortgage loans in process of foreclosure, respectively.

 

The following is a summary of the Company’s nonaccrual loans by major categories.

 

($ in thousands)

 

  March 31,
2017
   December 31,
2016
 
Commercial, financial, and agricultural  $1,368    1,842 
Real estate – construction, land development & other land loans   1,607    2,945 
Real estate – mortgage – residential (1-4 family) first mortgages   15,833    16,017 
Real estate – mortgage – home equity loans / lines of credit   2,238    2,355 
Real estate – mortgage – commercial and other   4,577    4,208 
Installment loans to individuals   61    101 
  Total  $25,684    27,468 
           

 

The following table presents an analysis of the payment status of the Company’s loans as of March 31, 2017.

 

($ in thousands)  Accruing
30-59
Days Past
Due
   Accruing
60-89 Days
Past Due
   Accruing
90 Days or
More Past
Due
   Nonaccrual
Loans
   Accruing
Current
   Total Loans
Receivable
 
                         
Commercial, financial, and agricultural  $519    416        1,368    360,633    362,936 
Real estate – construction, land development & other land loans   1,309    166        1,607    421,003    424,085 
Real estate – mortgage – residential (1-4 family) first mortgages   11,794    591        15,833    760,896    789,114 
Real estate – mortgage – home equity loans / lines of credit   586    243        2,238    313,526    316,593 
Real estate – mortgage – commercial and other   3,123    78        4,577    1,313,638    1,321,416 
Installment loans to individuals   192    144        61    55,853    56,250 
Purchased credit impaired   323    62    1,744        17,536    19,665 
  Total  $17,846    1,700    1,744    25,684    3,243,085    3,290,059 
Unamortized net deferred loan fees                            (704)
           Total loans                           $3,289,355 

 

Page 23

The following table presents an analysis of the payment status of the Company’s loans as of December 31, 2016.

 

($ in thousands)  Accruing
30-59
Days Past
Due
   Accruing
60-89
Days Past
Due
   Accruing
90 Days or
More Past
Due
   Nonaccrual
Loans
   Accruing
Current
   Total Loans
Receivable
 
                         
Commercial, financial, and agricultural  $92            1,842    259,879    261,813 
Real estate – construction, land development & other land loans   473    168        2,945    351,081    354,667 
Real estate – mortgage – residential (1-4 family) first mortgages   4,487    443        16,017    729,732    750,679 
Real estate – mortgage – home equity loans / lines of credit   1,751    178        2,355    234,821    239,105 
Real estate – mortgage – commercial and other   1,482    449        4,208    1,042,807    1,048,946 
Installment loans to individuals   186    193        101    54,557    55,037 
Purchased credit impaired                   514    514 
  Total  $8,471    1,431        27,468    2,673,391    2,710,761 
Unamortized net deferred loan fees                            (49)
           Total loans                           $2,710,712 

 

The following table presents the activity in the allowance for loan losses for all loans for the three months ended March 31, 2017.

 

 

($ in thousands)

  Commercial,
Financial,
and
Agricultural
   Real Estate

Construction,
Land
Development,
& Other
Land Loans
   Real Estate

Residential
(1-4 Family)
First
Mortgages
   Real Estate
– Mortgage
– Home
Equity
Lines of
Credit
   Real Estate
– Mortgage

Commercial
and Other
   Installment
Loans to
Individuals
   Unallo-
cated
   Total 
                     
As of and for the three months ended March 31, 2017                    
Beginning balance  $3,829    2,691    7,704    2,420    5,098    1,145    894    23,781 
Charge-offs   (390)   (177)   (894)   (231)   (326)   (187)       (2,205)
Recoveries   298    490    196    65    143    55        1,247 
Provisions   55    (240)   370    (116)   1,064    54    (464)   723 
Ending balance  $3,792    2,764    7,376    2,138    5,979    1,067    430    23,546 
                                         
Ending balances as of March 31, 2017:  Allowance for loan losses            
Individually evaluated for impairment  $205    180    1,351    8    310            2,054 
Collectively evaluated for impairment  $3,587    2,584    6,025    2,130    5,669    1,067    430    21,492 
Purchased credit impaired  $                             
                                         
Loans receivable as of March 31, 2017:                     
Ending balance – total  $363,219    424,539    792,791    317,336    1,335,924    56,250        3,290,059 
Unamortized net deferred loan fees                                      (704)
Total loans                                     $3,289,355 
                                         
Ending balances as of March 31, 2017: Loans                     
Individually evaluated for impairment  $504    3,445    18,047    223    9,074    2        31,295 
Collectively evaluated for impairment  $362,433    420,640    771,067    316,370    1,312,341    56,248        3,239,099 
Purchased credit impaired  $282    454    3,677    743    14,509            19,665 

 

Page 24

 

The following table presents the activity in the allowance for loan losses for the year ended December 31, 2016. There were no covered loans at December 31, 2016 and all reserves associated with previously covered loans have been transferred to the non-covered allowance.

 

 

($ in thousands)

  Commercial,
Financial,
and
Agricultural
   Real Estate

Construction,
Land
Development,
& Other
Land Loans
   Real Estate

Residential
(1-4 Family)
First
Mortgages
   Real Estate
– Mortgage
– Home
Equity
Lines of
Credit
   Real Estate
– Mortgage

Commercial
and Other
   Installment
Loans to
Individuals
   Unallo-
cated
   Covered   Total 
                         
As of and for the year ended December 31, 2016
Beginning balance  $4,742    3,754    7,832    2,893    5,816    1,051    696    1,799    28,583 
Charge-offs   (2,271)   (1,101)   (3,815)   (969)   (1,005)   (1,008)   (1)   (244)   (10,414)
Recoveries   805    1,422    1,060    250    836    354        1,958    6,685 
Transfer from covered status   56    65    839    293    127        1    (1,381)    
Removed due to branch loan sale   (263)   (39)   (347)   (110)   (228)   (63)          (1,050)
Provisions   760    (1,410)   2,135    63    (448)   811    198    (2,132)   (23)
Ending balance  $3,829    2,691    7,704    2,420    5,098    1,145    894        23,781 
                                              
Ending balances as of December 31, 2016:  Allowance for loan losses
Individually evaluated for impairment  $7    184    1,339    5    105                1,640 
Collectively evaluated for impairment  $3,822    2,507    6,365    2,415    4,993    1,145    894        22,141 
Purchased credit impaired  $                                 
                                              
Loans receivable as of December 31, 2016:
Ending balance – total  $261,813    354,667    750,679    239,105    1,049,460    55,037            2,710,761 
Unamortized net deferred loan fees                                           (49)
Total loans                                          $2,710,712 
                                              
Ending balances as of December 31, 2016: Loans
Individually evaluated for impairment  $644    4,001    20,807    280    6,494                32,226 
Collectively evaluated for impairment  $261,169    350,666    729,872    238,825    1,042,452    55,037            2,678,021 
Purchased credit impaired  $                514                514 

 

Page 25

The following table presents the activity in the allowance for loan losses for all loans for the three months ended March 31, 2016.

 

 

($ in thousands)

  Commercial,
Financial,
and
Agricultural
   Real Estate

Construction,
Land
Development,
& Other
Land Loans
   Real Estate

Residential
(1-4 Family)
First
Mortgages
   Real Estate
– Mortgage
– Home
Equity
Lines of
Credit
   Real Estate
– Mortgage

Commercial
and Other
   Installment
Loans to
Individuals
   Unallo-
cated
   Covered   Total 
                         
As of and for the three month ended March 31, 2016
Beginning balance  $4,742    3,754    7,832    2,893    5,816    1,051    696    1,799    28,583 
Charge-offs   (677)   (340)   (1,951)   (449)   (166)   (280)       (241)   (4,104)
Recoveries   86    90    233    55    130    113        1,204    1,911 
Provisions   528    (159)   1,260    (232)   160    318    (254)   (1,363)   258 
Ending balance  $4,679    3,345    7,374    2,267    5,940    1,202    442    1,399    26,648 
                                              
Ending balances as of March 31, 2016:  Allowance for loan losses
Individually evaluated for impairment  $43    214    1,280    111    559    75        438    2,720 
Collectively evaluated for impairment  $4,636    3,131    6,094    2,156    5,381    1,127    442    961    23,928 
Purchased credit impaired  $                                 
                                              
Loans receivable as of March 31, 2016:
Ending balance – total  $228,124    298,410    684,085    225,245    955,550    47,158        99,523    2,538,095 
Unamortized net deferred loan costs                                           1,258 
Total loans                                          $2,539,353 
                                              
Ending balances as of March 31, 2016: Loans
Individually evaluated for impairment  $818    4,735    20,925    538    14,334    104        5,105    46,559 
Collectively evaluated for impairment  $227,306    293,675    663,160    224,707    940,652    47,054        93,250    2,489,804 
Purchased credit impaired  $                564            1,168    1,732 
                                              

 

Page 26

 

The following table presents loans individually evaluated for impairment by class of loans, excluding PCI loans, as of March 31, 2017.

 

 

($ in thousands)

  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
 
Impaired loans with no related allowance recorded:                    
                     
Commercial, financial, and agricultural  $230    281        412 
Real estate – mortgage – construction, land development & other land loans   2,716    3,903        2,969 
Real estate – mortgage – residential (1-4 family) first mortgages   6,954    7,676        8,495 
Real estate – mortgage –home equity loans / lines of credit   59    83        86 
Real estate – mortgage –commercial and other   3,589    3,845        4,093 
Installment loans to individuals   2    2        1 
Total impaired loans with no allowance  $13,550    15,790        16,056 
                     
                     
Impaired loans with an allowance recorded:                    
                     
Commercial, financial, and agricultural  $274    288    205    163 
Real estate – mortgage – construction, land development & other land loans   729    777    180    754 
Real estate – mortgage – residential (1-4 family) first mortgages   11,093    11,401    1,351    10,933 
Real estate – mortgage –home equity loans / lines of credit   164    164    8    165 
Real estate – mortgage –commercial and other   5,485    5,496    310    3,690 
Installment loans to individuals                
Total impaired loans with allowance  $17,745    18,126    2,054    15,705 

 

The Company recorded interest income of $295,000 and discount accretion of $443,000 on impaired loans during the three months ended March 31, 2017 related to an impaired loan relationship that was resolved during the quarter.

 

The following table presents loans individually evaluated for impairment by class of loans, excluding PCI loans, as of December 31, 2016.

 

 

($ in thousands)

  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
 
Impaired loans with no related allowance recorded:                    
                     
Commercial, financial, and agricultural  $593    706        816 
Real estate – mortgage – construction, land development & other land loans   3,221    4,558        3,641 
Real estate – mortgage – residential (1-4 family) first mortgages   10,035    12,220        11,008 
Real estate – mortgage –home equity loans / lines of credit   114    146        139 
Real estate – mortgage –commercial and other   5,112    5,722        8,713 
Installment loans to individuals       2        1 
Total impaired loans with no allowance  $19,075    23,354        24,318 
                     
                     
Impaired loans with an allowance recorded:                    
                     
Commercial, financial, and agricultural  $51    51    7    202 
Real estate – mortgage – construction, land development & other land loans   780    798    184    844 
Real estate – mortgage – residential (1-4 family) first mortgages   10,772    11,007    1,339    13,314 
Real estate – mortgage –home equity loans / lines of credit   166    166    5    324 
Real estate – mortgage –commercial and other   1,896    1,929    105    4,912 
Installment loans to individuals               49 
Total impaired loans with allowance  $13,665    13,951    1,640    19,645 

 

Page 27

Interest income recorded on impaired loans during the year ended December 31, 2016 was insignificant.

 

The Company tracks credit quality based on its internal risk ratings. Upon origination, a loan is assigned an initial risk grade, which is generally based on several factors such as the borrower’s credit score, the loan-to-value ratio, the debt-to-income ratio, etc. Loans that are risk-graded as substandard during the origination process are declined. After loans are initially graded, they are monitored regularly for credit quality based on many factors, such as payment history, the borrower’s financial status, and changes in collateral value. Loans can be downgraded or upgraded depending on management’s evaluation of these factors. Internal risk-grading policies are consistent throughout each loan type.

 

The following describes the Company’s internal risk grades in ascending order of likelihood of loss:

 

  Risk Grade Description
Pass:  
  1 Loans with virtually no risk, including cash secured loans.
  2 Loans with documented significant overall financial strength.  These loans have minimum chance of loss due to the presence of multiple sources of repayment – each clearly sufficient to satisfy the obligation.
  3 Loans with documented satisfactory overall financial strength.  These loans have a low loss potential due to presence of at least two clearly identified sources of repayment – each of which is sufficient to satisfy the obligation under the present circumstances.
  4 Loans to borrowers with acceptable financial condition.  These loans could have signs of minor operational weaknesses, lack of adequate financial information, or loans supported by collateral with questionable value or marketability.  
  5 Loans that represent above average risk due to minor weaknesses and warrant closer scrutiny by management.  Collateral is generally required and felt to provide reasonable coverage with realizable liquidation values in normal circumstances.  Repayment performance is satisfactory.
 

P

(Pass)

Consumer loans (<$500,000) that are of satisfactory credit quality with borrowers who exhibit good personal credit history, average personal financial strength and moderate debt levels.  These loans generally conform to Bank policy, but may include approved mitigated exceptions to the guidelines.  
Special Mention:  
  6 Existing loans with defined weaknesses in primary source of repayment that, if not corrected, could cause a loss to the Bank.
Classified:  
  7 An existing loan inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged, if any.  These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.
  8 Loans that have a well-defined weakness that make the collection or liquidation in full highly questionable and improbable.  Loss appears imminent, but the exact amount and timing is uncertain.
  9 Loans that are considered uncollectible and are in the process of being charged-off.  This grade is a temporary grade assigned for administrative purposes until the charge-off is completed.
 

F

(Fail)

Consumer loans (<$500,000) with a well-defined weakness, such as exceptions of any kind with no mitigating factors, history of paying outside the terms of the note, insufficient income to support the current level of debt, etc.  

 

Page 28

The following table presents the Company’s recorded investment in loans by credit quality indicators as of March 31, 2017.

 

($ in thousands)    
   Pass   Special
Mention Loans
   Classified
Accruing Loans
   Classified
Nonaccrual
Loans
   Total 
                     
Commercial, financial, and agricultural  $350,286    9,366    1,917    1,368    362,937 
Real estate – construction, land development & other land loans   407,155    7,759    7,564    1,607    424,085 
Real estate – mortgage – residential (1-4 family) first mortgages   721,622    15,978    35,681    15,833    789,114 
Real estate – mortgage – home equity loans / lines of credit   304,093    1,413    8,849    2,238    316,593 
Real estate – mortgage – commercial and other   1,281,368    23,748    11,722    4,577    1,321,415 
Installment loans to individuals   55,727    253    209    61    56,250 
Purchased credit impaired   7,337    8,159    4,169        19,665 
  Total  $3,127,588    66,676    70,111    25,684    3,290,059 
Unamortized net deferred loan fees                       (704)
            Total loans                       3,289,355 

 

The following table presents the Company’s recorded investment in loans by credit quality indicators as of December 31, 2016.

 

($ in thousands)    
   Pass   Special
Mention Loans
   Classified
Accruing Loans
   Classified
Nonaccrual
Loans
   Total 
                     
Commercial, financial, and agricultural  $247,451    10,560    1,960    1,842    261,813 
Real estate – construction, land development & other land loans   335,068    8,762    7,892    2,945    354,667 
Real estate – mortgage – residential (1-4 family) first mortgages   678,878    16,998    38,786    16,017    750,679 
Real estate – mortgage – home equity loans / lines of credit   226,159    1,436    9,155    2,355    239,105 
Real estate – mortgage – commercial and other   1,005,687    26,032    13,019    4,208    1,048,946 
Installment loans to individuals   54,421    256    259    101    55,037 
Purchased credit impaired       514            514 
  Total  $2,547,664    64,558    71,071    27,468    2,710,761 
Unamortized net deferred loan fees                       (49)
            Total loans                       2,710,712 

 

 

Troubled Debt Restructurings

 

The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses.

 

The vast majority of the Company’s troubled debt restructurings modified related to interest rate reductions combined with restructured amortization schedules. The Company does not generally grant principal forgiveness.

 

All loans classified as troubled debt restructurings are considered to be impaired and are evaluated as such for determination of the allowance for loan losses. The Company’s troubled debt restructurings can be classified as either nonaccrual or accruing based on the loan’s payment status. The troubled debt restructurings that are nonaccrual are reported within the nonaccrual loan totals presented previously.

Page 29

The following table presents information related to loans modified in a troubled debt restructuring during the three months ended March 31, 2017 and 2016.

 

($ in thousands)  For three months ended
March 31, 2017
   For the three months ended
March 31, 2016
 
   Number of
Contracts
   Pre-
Modification
Restructured
Balances
   Post-
Modification
Restructured
Balances
   Number of
Contracts
   Pre-
Modification
Restructured
Balances
   Post-
Modification
Restructured
Balances
 
TDRs – Accruing                              
Commercial, financial, and agricultural      $   $       $   $ 
Real estate – construction, land development & other land loans                        
Real estate – mortgage – residential (1-4 family) first mortgages                        
Real estate – mortgage – home equity loans / lines of credit                        
Real estate – mortgage – commercial and other   2    2,550    2,525             
Installment loans to individuals                        
                               
TDRs – Nonaccrual                              
Commercial, financial, and agricultural                        
Real estate – construction, land development & other land loans                        
Real estate – mortgage – residential (1-4 family) first mortgages                        
Real estate – mortgage – home equity loans / lines of credit                        
Real estate – mortgage – commercial and other                        
Installment loans to individuals                        
                               
Total TDRs arising during period   2   $2,550   $2,525       $   $ 
                               
Total covered TDRs arising during period included above      $   $       $   $ 

 

Accruing restructured loans that were modified in the previous 12 months and that defaulted during the three months ended March 31, 2017 and 2016 are presented in the table below. The Company considers a loan to have defaulted when it becomes 90 or more days delinquent under the modified terms, has been transferred to nonaccrual status, or has been transferred to foreclosed real estate.

 

($ in thousands)  For the three months ended
March 31, 2017
   For the three months ended
March 31, 2016
 
   Number of
Contracts
   Recorded
Investment
   Number of
Contracts
   Recorded
Investment
 
                 
Accruing TDRs that subsequently defaulted                    
Commercial, financial, and agricultural      $    1   $44 
Real estate – mortgage – residential (1-4 family first mortgages)   1    626         
Real estate – mortgage – commercial and other           1    21 
                      
Total accruing TDRs that subsequently defaulted   1   $626    2   $65 
Total covered accruing TDRs that subsequently defaulted included above      $    1   $44 

 

Page 30

 

Note 9 – Deferred Loan (Fees) Costs

 

The amount of loans shown on the Consolidated Balance Sheets includes net deferred loan (fees) costs of approximately ($704,000), ($49,000), and $1,258,000 at March 31, 2017, December 31, 2016, and March 31, 2016, respectively.

 

Note 10 – FDIC Indemnification Asset

 

As discussed previously in Note 4 to the Company’s 2016 Annual Report on Form 10-K, the Company terminated all loss share agreements with the FDIC during 2016. As a result, the remaining balance in the FDIC Indemnification Asset, which represented the estimated amount to be received from the FDIC under the loss share agreements, was written off as indemnification asset expense as of the termination date.

 

The FDIC indemnification asset was comprised of the following components as of the dates shown:

 

($ in thousands)  March 31,
2017
   December 31,
2016
   March 31,
2016
 
Receivable (payable) related to loss claims incurred (recoveries), not yet received (paid), net  $        (1,143)
Receivable related to estimated future claims on loans           7,422 
Receivable related to estimated future claims on foreclosed real estate           425 
     FDIC indemnification asset  $        6,704 

 

 

The following presents a rollforward of the FDIC indemnification asset for the first quarter of 2016.

 

($ in thousands)    
Balance at January 1, 2016  $8,439 
Decrease related to favorable changes in loss estimates   (1,230)
Increase related to reimbursable expenses   99 
Cash paid (received)   356 
Related to accretion of loan discount   (965)
Other   5 
Balance at March 31, 2016  $6,704 
      

 

Page 31

Note 11 – Goodwill and Other Intangible Assets

 

The following is a summary of the gross carrying amount and accumulated amortization of amortizable intangible assets as of March 31, 2017, December 31, 2016, and March 31, 2016 and the carrying amount of unamortized intangible assets as of those same dates.

 

   March 31, 2017   December 31, 2016   March 31, 2016 
($ in thousands)  Gross Carrying
Amount
   Accumulated
Amortization
   Gross Carrying
Amount
   Accumulated
Amortization
   Gross Carrying
Amount
   Accumulated
Amortization
 
Amortizable intangible assets:                              
   Customer lists  $2,369    806    2,369    746    1,269    572 
   Core deposit premiums   18,520    8,580    9,730    8,143    8,560    7,506 
   Other   1,032    303    1,032    224    92    10 
        Total  $21,921    9,689    13,131    9,113    9,921    8,088 
                               
SBA servicing asset  $579         415               
                               
Unamortizable intangible assets:                              
   Goodwill  $142,872         75,042         67,528      

 

Activity related to transactions during the periods includes the following:

 

(1)In connection with the January 1, 2016 acquisition of Bankingport, Inc., an insurance agency located in Sanford, North Carolina, the Company recorded $1,693,000 in goodwill, $591,000 in a customer list intangible, and $92,000 in other amortizable intangible assets.
(2)In connection with the May 5, 2016 acquisition of SBA Complete, Inc., an SBA loan consulting firm, the Company recorded $5,553,000 in goodwill, $1,100,000 in a customer list intangible, and $940,000 in other amortizable intangible assets.
(3)In connection with the branch exchange transaction with First Community Bank in Bluefield, Virginia, on July 15, 2016, the Company recorded a net increase of $1,961,000 in goodwill and $1,170,000 in core deposit premiums.
(4)In connection with the Carolina Bank acquisition on March 3, 2017, the Company recorded a net increase of $67,830,000 in goodwill and $8,790,000 in core deposit premiums.

 

In addition to the above acquisition related activity, the Company recorded $415,000 in servicing assets associated with the guaranteed portion of SBA loans originated and sold during the third and fourth quarters of 2016. During the first quarter of 2017, the Company recorded an additional $195,000 in servicing assets, as well as $31,000 in amortization expense. Servicing assets are recorded at fair value and amortized as a reduction of service fee income over the expected life of the related loans.

 

Amortization expense of all intangible assets totaled $576,000 and $186,000 for the three months ended March 31, 2017 and 2016, respectively.

 

The following table presents the estimated amortization expense for the last three quarters of calendar year 2017 and for each of the four calendar years ending December 31, 2021 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets.

 

($ in thousands)

 

  Estimated Amortization
Expense
 
April 1 to December 31, 2017  $2,579 
2018   2,862 
2019   2,314 
2020   1,750 
2021   1,288 
Thereafter   1,439 
         Total  $12,232 
      

 

Page 32

Note 12 – Pension Plans

 

The Company has historically sponsored two defined benefit pension plans – a qualified retirement plan (the “Pension Plan”) which was generally available to all employees, and a Supplemental Executive Retirement Plan (the “SERP”), which was for the benefit of certain senior management executives of the Company. Effective December 31, 2012, the Company froze both plans for all participants. Although no previously accrued benefits were lost, employees no longer accrue benefits for service subsequent to 2012.

 

The Company recorded pension income totaling $162,000 for each of the three months ended March 31, 2017 and 2016, which primarily related to investment income from the Pension Plan’s assets. The following table contains the components of the pension income.

 

   For the Three Months Ended March 31, 
   2017   2016   2017   2016   2017 Total   2016 Total 
($ in thousands)  Pension Plan   Pension Plan   SERP   SERP   Both Plans   Both Plans 
Service cost  $        27    27    27    27 
Interest cost   375    376    60    59    435    435 
Expected return on plan assets   (675)   (675)           (675)   (675)
Amortization of transition obligation                        
Amortization of net (gain)/loss   60    60    (9)   (9)   51    51 
Amortization of prior service cost                        
   Net periodic pension (income)/cost  $(240)   (239)   78    77    (162)   (162)

 

The Company’s contributions to the Pension Plan are based on computations by independent actuarial consultants and are intended to be deductible for income tax purposes. The contributions are invested to provide for benefits under the Pension Plan. The Company does not expect to contribute to the Pension Plan in 2017.

 

The Company’s funding policy with respect to the SERP is to fund the related benefits from the operating cash flow of the Company.

 

Note 13 – Comprehensive Income (Loss)

 

Comprehensive income (loss) is defined as the change in equity during a period for non-owner transactions and is divided into net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of accumulated other comprehensive income (loss) for the Company are as follows:

 

($ in thousands)

 

  March 31, 2017   December 31, 2016   March 31, 2016 
Unrealized gain (loss) on securities available for sale  $(1,737)   (3,085)   (349)
     Deferred tax asset (liability)   644    1,138    136 
Net unrealized gain (loss) on securities available for sale   (1,093)   (1,947)   (213)
                
Additional pension asset (liability)   (4,961)   (5,012)   (4,606)
     Deferred tax asset (liability)   1,832    1,852    1,796 
Net additional pension asset (liability)   (3,129)   (3,160)   (2,810)
                
Total accumulated other comprehensive income (loss)  $(4,222)   (5,107)   (3,023)

 

The following table discloses the changes in accumulated other comprehensive income (loss) for the three months ended March 31, 2017 (all amounts are net of tax).

 

($ in thousands)

 

  Unrealized Gain
(Loss) on
Securities
Available for Sale
   Additional
Pension Asset
(Liability)
   Total 
Beginning balance at January 1, 2017  $(1,947)   (3,160)   (5,107)
     Other comprehensive income (loss) before reclassifications   706        706 
     Amounts reclassified from accumulated other comprehensive income   148    31    179 
Net current-period other comprehensive income (loss)   854    31    885 
                
Ending balance at March 31, 2017  $(1,093)   (3,129)   (4,222)

 

Page 33

The following table discloses the changes in accumulated other comprehensive income (loss) for the three months ended March 31, 2016 (all amounts are net of tax).

 

($ in thousands)

 

  Unrealized Gain
(Loss) on
Securities
Available for Sale
   Additional
Pension Asset
(Liability)
   Total 
Beginning balance at January 1, 2016  $(709)   (2,841)   (3,550)
     Other comprehensive income (loss) before reclassifications   498        498 
     Amounts reclassified from accumulated other comprehensive income   (2)   31    29 
Net current-period other comprehensive income (loss)   496    31    527 
                
Ending balance at March 31, 2016  $(213)   (2,810)   (3,023)

 

 

Note 14 – Fair Value

 

Relevant accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

 

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

 

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

 

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

 

The following table summarizes the Company’s financial instruments that were measured at fair value on a recurring and nonrecurring basis at March 31, 2017.

 

($ in thousands)        
Description of Financial Instruments  Fair Value at
March 31,
2017
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
 
Recurring                    
     Securities available for sale:                    
        Government-sponsored enterprise securities  $19,426        19,426     
        Mortgage-backed securities   160,786        160,786     
        Corporate bonds   34,531        34,531     
          Total available for sale securities  $214,743        214,743     
                     
Nonrecurring                    
     Impaired loans   15,797            15,797 
     Foreclosed real estate   12,789            12,789 
                     

 

The following table summarizes the Company’s financial instruments that were measured at fair value on a recurring and nonrecurring basis at December 31, 2016.

Page 34

($ in thousands)        
Description of Financial Instruments  Fair Value at
December 31,
2016
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Recurring                    
Securities available for sale:                    
Government-sponsored enterprise securities  $17,490        17,490     
Mortgage-backed securities   148,065        148,065     
Corporate bonds   33,600        33,600     
Equity securities   174        174     
Total available for sale securities  $199,329        199,329     
                     
Nonrecurring                    
     Impaired loans   12,284            12,284 
     Foreclosed real estate   9,532            9,532 

 

 

The following is a description of the valuation methodologies used for instruments measured at fair value.

 

Securities Available for Sale — When quoted market prices are available in an active market, the securities are classified as Level 1 in the valuation hierarchy. If quoted market prices are not available, but fair values can be estimated by observing quoted prices of securities with similar characteristics, the securities are classified as Level 2 on the valuation hierarchy. Most of the fair values for the Company’s Level 2 securities are determined by our third-party bond accounting provider using matrix pricing. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. For the Company, Level 2 securities include mortgage-backed securities, collateralized mortgage obligations, government-sponsored enterprise securities, and corporate bonds. In cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

 

The Company reviews the pricing methodologies utilized by the bond accounting provider to ensure the fair value determination is consistent with the applicable accounting guidance and that the investments are properly classified in the fair value hierarchy. Further, the Company validates the fair values for a sample of securities in the portfolio by comparing the fair values provided by the bond accounting provider to prices from other independent sources for the same or similar securities. The Company analyzes unusual or significant variances and conducts additional research with the portfolio manager, if necessary, and takes appropriate action based on its findings.

 

Impaired loans — Fair values for impaired loans in the above table are measured on a non-recurring basis and are based on the underlying collateral values securing the loans, adjusted for estimated selling costs, or the net present value of the cash flows expected to be received for such loans. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined using an income or market valuation approach based on an appraisal conducted by an independent, licensed third party appraiser (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable borrower’s financial statements if not considered significant. Likewise, values for inventory and accounts receivable collateral are based on borrower financial statement balances or aging reports on a discounted basis as appropriate (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

Foreclosed real estate – Foreclosed real estate, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at the lower of cost or fair value. Fair value is measured on a non-recurring basis and is based upon independent market prices or current appraisals that are generally prepared using an income or market valuation approach and conducted by an independent, licensed third party appraiser, adjusted for estimated selling costs (Level 3). At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. For any real estate valuations subsequent to foreclosure, any excess of the real estate recorded value over the fair value of the real estate is treated as a foreclosed real estate write-down on the Consolidated Statements of Income.

 

Page 35

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2017, the significant unobservable inputs used in the fair value measurements were as follows:

 

($ in thousands)       
Description  Fair Value at
March 31,
2017
   Valuation
Technique
  Significant Unobservable
Inputs
  General Range
of Significant
Unobservable
Input Values
Impaired loans  $15,797   Appraised value; PV of expected cash flows  Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell  0-10%
Foreclosed real estate   12,789   Appraised value; List or contract price  Discounts to reflect current market conditions, abbreviated holding period and estimated costs to sell  0-10%

 

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

 

($ in thousands)       
Description  Fair Value at
December 31,
2016
   Valuation
Technique
  Significant Unobservable
Inputs
  General Range
of Significant
Unobservable
Input Values
Impaired loans  $12,284   Appraised value; PV of expected cash flows  Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell  0-10%
Foreclosed real estate   9,532   Appraised value; List or contract price  Discounts to reflect current market conditions, abbreviated holding period and estimated costs to sell  0-10%

 

Transfers of assets or liabilities between levels within the fair value hierarchy are recognized when an event or change in circumstances occurs. There were no transfers between Level 1 and Level 2 for assets or liabilities measured on a recurring basis during the three months ended March 31, 2017 or 2016.

 

For the three months ended March 31, 2017 and 2016, the increase in the fair value of securities available for sale was $1,120,000 and $817,000, respectively, which is included in other comprehensive income (net of tax expense of $414,000 and $319,000, respectively). Fair value measurement methods at March 31, 2017 and 2016 are consistent with those used in prior reporting periods.

 

The carrying amounts and estimated fair values of financial instruments at March 31, 2017 and December 31, 2016 are as follows:

 

      March 31, 2017   December 31, 2016 

 

($ in thousands)

  Level in Fair
Value
Hierarchy
  Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value
 
                    
Cash and due from banks, noninterest-bearing  Level 1  $81,514    81,514    71,645    71,645 
Due from banks, interest-bearing  Level 1   323,646    323,646    234,348    234,348 
Securities available for sale  Level 2   214,743    214,743    199,329    199,329 
Securities held to maturity  Level 2   133,254    134,185    129,713    130,195 
Presold mortgages in process of settlement  Level 1   11,661    11,661    2,116    2,116 
Total loans, net of allowance  Level 3   3,265,809    3,225,919    2,686,931    2,650,820 
Accrued interest receivable  Level 1   10,524    10,524    9,286    9,286 
Bank-owned life insurance  Level 1   86,923    86,923    74,138    74,138 
                        
Deposits  Level 2   3,629,170    3,627,052    2,947,353    2,944,968 
Borrowings  Level 2   290,403    280,182    271,394    263,255 
Accrued interest payable  Level 2   691    691    539    539 

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Index 

 

 

Fair value methods and assumptions are set forth below for the Company’s financial instruments.

 

Cash and Amounts Due from Banks, Presold Mortgages in Process of Settlement, Accrued Interest Receivable, and Accrued Interest Payable - The carrying amounts approximate their fair value because of the short maturity of these financial instruments.

 

Available for Sale and Held to Maturity Securities - Fair values are provided by a third-party and are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or matrix pricing.

 

Loans - For nonimpaired loans, fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, financial and agricultural, real estate construction, real estate mortgages and installment loans to individuals. Each loan category is further segmented into fixed and variable interest rate terms. The fair value for each category is determined by discounting scheduled future cash flows using current interest rates offered on loans with similar risk characteristics. Fair values for impaired loans are primarily based on estimated proceeds expected upon liquidation of the collateral or the present value of expected cash flows.

 

Bank-Owned Life Insurance – The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer.

 

Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing checking accounts, savings accounts, interest-bearing checking accounts, and money market accounts, is equal to the amount payable on demand as of the valuation date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered in the marketplace for deposits of similar remaining maturities.

 

Borrowings - The fair value of borrowings is based on the discounted value of the contractual cash flows. The discount rate is estimated using the rates currently offered by the Company’s lenders for debt of similar maturities.

 

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include net premises and equipment, intangible and other assets such as deferred income taxes, prepaid expense accounts, income taxes currently payable and other various accrued expenses. In addition, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

 

Note 15 – Shareholders’ Equity Transactions

 

Stock Issuance

 

On December 21, 2012, the Company issued 2,656,294 shares of its common stock and 728,706 shares of the Company’s Series C Preferred Stock to certain accredited investors, each at the price of $10.00 per share, pursuant to a private placement transaction. Net proceeds from this sale of common and preferred stock were $33.8 million and were used to strengthen and remove risk from the Company’s balance sheet in anticipation of a planned disposition of certain classified loans and write-down of foreclosed real estate.

 

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Index 

 

On December 22, 2016, the Company and the holder of the Series C Preferred Stock entered into an agreement to effectively convert the preferred stock into common stock. The Company exchanged 728,706 shares of preferred stock for the same number of shares of the Company’s common stock. As a result of the exchange, the Company has no shares of preferred stock currently outstanding.

 

The Series C Preferred Stock qualified as Tier 1 capital and was Convertible Perpetual Preferred Stock, with dividend rights equal to the Company’s Common Stock. The Series C Preferred Stock was non-voting, except in limited circumstances.

 

The Series C Preferred Stock paid a dividend per share equal to that of the Company’s common stock. During the first quarter of 2016, the Company accrued approximately $58,000 in preferred dividend payments for the Series C Preferred Stock.

 

Note 16 – Subsequent Event – Entry into an Acquisition Agreement

 

On May 1, 2017, the Company announced the signing of a definitive merger agreement to acquire ASB Bancorp, Inc. the parent company of Asheville Savings Bank, SSB, in a cash and stock transaction with a total value of approximately $175 million, or $43.12 per share based on the Company’s closing share price on April 28, 2017. Subject to the terms of the merger agreement, ASB Bancorp shareholders will receive 1.44 shares of First Bancorp's common stock or $41.90 in cash, or a combination thereof, for each share of ASB Bancorp common stock. The total consideration will be prorated as necessary to ensure that 90% of the total outstanding shares of ASB Bancorp common stock will be exchanged for First Bancorp common stock and 10% of the total outstanding shares of ASB Bancorp common stock will be exchanged for cash, provided that the maximum number of shares of First Bancorp common stock to be issued in exchange for ASB Bancorp common stock will not exceed 19.9% of the number of shares of First Bancorp common stock issued and outstanding immediately before the closing of the merger.

 

Asheville Savings Bank currently operates 13 banking locations in the Asheville, Marion and Brevard markets. Asheville Savings Bank reported assets of $803 million, gross loans of $606 million and deposits of $682 million as of March 31, 2017.  The acquisition complements the Company’s existing three branches in the Asheville market.

 

The merger agreement has been unanimously approved by the boards of directors of each company.  The transaction is expected to close in the fourth quarter of 2017 and is subject to customary conditions, including regulatory approvals and approval by ASB Bancorp’s shareholders.

 

 

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Index 

 

Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition

 

Critical Accounting Policies

 

The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. The allowance for loan losses, intangible assets, and the fair value and discount accretion of acquired loans are three policies we have identified as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to our consolidated financial statements.

 

Allowance for Loan Losses

 

Due to the estimation process and the potential materiality of the amounts involved, we have identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to our consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio.

 

Our determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has two components. The first component involves the estimation of losses on individually evaluated “impaired loans.” A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is specifically evaluated for an appropriate valuation allowance if the loan balance is above a prescribed evaluation threshold (which varies based on credit quality, accruing status, troubled debt restructured status, and type of collateral) and the loan is determined to be impaired. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that we expect to receive from the borrower discounted at the loan’s effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral.

 

The second component of the allowance model is an estimate of losses for all loans not considered to be impaired loans (“general reserve loans”). General reserve loans are segregated into pools by loan type and risk grade and estimated loss percentages are assigned to each loan pool based on historical losses.  The historical loss percentage is then adjusted for any environmental factors used to reflect changes in the collectability of the portfolio not captured by historical data.

 

The reserves estimated for individually evaluated impaired loans are then added to the reserve estimated for general reserve loans. This becomes our “allocated allowance.” The allocated allowance is compared to the actual allowance for loan losses recorded on our books and any adjustment necessary for the recorded allowance to absorb losses inherent in the portfolio is recorded as a provision for loan losses. The provision for loan losses is a direct charge to earnings in the period recorded. Any remaining difference between the allocated allowance and the actual allowance for loan losses recorded on our books is our “unallocated allowance.”

 

Purchased loans are recorded at fair value at acquisition date. Therefore, amounts deemed uncollectible at acquisition date represent a discount to the loan value and become a part of the fair value calculation and are excluded from the allowance for loan losses. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected are accreted into income over the life of the loan and this accretion is referred to as “loan discount accretion.”

 

Although we use the best information available to make evaluations, future material adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on the examiners’ judgment about information available to them at the time of their examinations.

 

For further discussion, see “Nonperforming Assets” and “Summary of Loan Loss Experience” below.

 

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Index 

  

Intangible Assets

 

Due to the estimation process and the potential materiality of the amounts involved, we have also identified the accounting for intangible assets as an accounting policy critical to our consolidated financial statements.

 

When we complete an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. We must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to our future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill.

 

The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when we acquire an insurance agency or a consulting firm, as we did in 2016, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. We typically engage a third party consultant to assist in each analysis. For the whole bank and bank branch transactions recorded to date, the core deposit intangibles have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. For insurance agency acquisitions, the identifiable intangible assets related to the customer lists were determined to have a life of ten to fifteen years, with amortization occurring on a straight-line basis. For the SBA consulting firm we acquired in 2016, the identifiable intangible asset related to the customer list was determined to have a life of approximately seven years, with amortization occurring on a straight-line basis.

 

Subsequent to the initial recording of the identifiable intangible assets and goodwill, we amortize the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of our reporting units to their related carrying value, including goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, we would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions.

 

In our 2016 goodwill impairment evaluation, we concluded that our goodwill was not impaired.

 

We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.

 

Fair Value and Discount Accretion of Acquired Loans

 

We consider the determination of the initial fair value of acquired loans and the subsequent discount accretion of the purchased loans to involve a high degree of judgment and complexity.

 

We determine fair value accounting estimates of newly assumed assets and liabilities in accordance with relevant accounting guidance. However, the amount that we realize on these assets could differ materially from the carrying value reflected in our financial statements, based upon the timing of collections on the acquired loans in future periods. Because of inherent credit losses and interest rate marks associated with acquired loans, the amount that we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the “discount” on the acquired loans. For non-impaired purchased loans, we accrete the discount over the lives of the loans in a manner consistent with the guidance for accounting for loan origination fees and costs.

 

Page 40

Index 

  

For purchased credit-impaired (“PCI”) loans, the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) is accreted into interest income over the estimated remaining life of the loans using the effective yield method, provided that the timing and the amount of future cash flows is reasonably estimable. Accordingly, such loans are not classified as nonaccrual and they are considered to be accruing because their interest income relates to the accretable yield recognized under accounting for PCI loans and not to contractual interest payments. 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.

 

Subsequent to acquisition, estimates of cash flows expected to be collected are updated periodically based on updated assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. If there is a decrease in cash flows expected to be collected, the provision for loan losses is charged, resulting in an increase to the allowance for loan losses. If the Company has probable increase in cash flows expected to be collected, we will first reverse any previously established allowance for loan losses and then increase interest income as a prospective yield adjustment over the remaining life of the loan. The impact of changes in variable interest rates is recognized prospectively as adjustments to interest income.

 

Current Accounting Matters

 

See Note 2 to the Consolidated Financial Statements above for information about accounting standards that we have recently adopted.

 

FINANCIAL OVERVIEW

 

Net income available to common shareholders for the first quarter of 2017 was $7.6 million, or $0.34 per diluted common share, an increase of 3.0% in earnings per share from the $6.8 million, or $0.33 per diluted common share, recorded in the first quarter of 2016. The quarterly results were impacted by strong balance sheet growth and favorable earnings trends.

 

Acquisition of Carolina Bank Holdings, Inc.

 

On March 3, 2017, we acquired Carolina Bank Holdings, Inc. (“Carolina Bank”), which operated through eight branches and three mortgage loan offices, primarily in the Triad region of North Carolina. As of the acquisition date, Carolina Bank had total assets of $682 million, including $497 million in loans and $585 million in deposits. In connection with the acquisition, we paid a total of $25.3 million in cash and issued 3,799,472 shares of First Bancorp common stock to the shareholders of Carolina Bank.

 

Also in connection with the acquisition, we recorded $67.8 million in goodwill and an $8.8 million core deposit intangible asset.

 

Our operating results for the period ended March 31, 2017 include the results of Carolina Bank subsequent to the acquisition date of March 3, 2017. The conversion of Carolina Bank’s computer systems to First Bank’s systems is scheduled to occur in August 2017.

 

Net Interest Income and Net Interest Margin

 

Net interest income for the first quarter of 2017 was $34.3 million, a 13.6% increase from the $30.2 million recorded in the first quarter of 2016. The increase in net interest income was primarily due to growth in our loans outstanding.

 

Our net interest margin (tax-equivalent net interest income divided by average earning assets) was 4.07% for both the first quarters of 2017 and 2016. The first quarter of 2017 net interest margin was positively impacted by approximately $295,000, or four basis points, in previously foregone interest that was recognized related to a nonaccrual loan relationship that was acquired in a 2011 failed bank acquisition and was resolved during the quarter, as well as $443,000 in discount accretion interest income related to that same relationship, which impacted the margin by an additional five basis points.

 

Page 41

Index 

  

We recorded $1.4 million and $1.1 million in loan discount accretion during the quarters ended March 31, 2017 and 2016, respectively, which positively affected our net interest income. As noted above, the 2017 amount was impacted by the resolution of a loan relationship.

 

Provision for Loan Losses and Asset Quality

 

We recorded a provision for loan losses of $0.7 million in the first quarter of 2017 compared to $0.3 million in the first quarter of 2016.

 

For periods prior to the third quarter of 2016, our provision for loan losses was disclosed in separate line items between covered loans and non-covered loans. Generally, we recorded provisions for loan losses on non-covered loans as a result of net charge-offs and loan growth, while significant recoveries in our covered loan portfolios resulted in negative provisions for loan losses. Upon the termination of the FDIC loss share agreements, effective September 22, 2016, all loans are classified as non-covered.

 

Our provision for loan loss levels have been impacted by continued improvement in asset quality. Nonperforming assets amounted to $60.0 million at March 31, 2017, a decrease of 27.0% from the $82.3 million one year earlier. Nonperforming assets increased by $0.9 million since December 31, 2016, which reflects the addition of $3.1 million in foreclosed real estate assumed in the Carolina Bank acquisition. Our nonperforming assets to total assets ratio was 1.35% at March 31, 2017 compared to 2.43% at March 31, 2016. Annualized net charge-offs as a percentage of average loans for the three months ended March 31, 2017 was 0.13%, compared to 0.35% for the comparable period of 2016.

 

Noninterest Income

 

Total noninterest income was $9.8 million and $5.0 million for the three months ended March 31, 2017 and March 31, 2016, respectively.

 

Core noninterest income for the first quarter of 2017 was $9.8 million, an increase of 33.5% from the $7.3 million reported for the first quarter of 2016. Core noninterest income includes i) service charges on deposit accounts, ii) other service charges, commissions, and fees, iii) fees from presold mortgage loans, iv) commissions from sales of insurance and financial products, v) SBA consulting fees, vi) SBA loan sale gains, and vii) bank-owned life insurance income.

 

The primary reason for the increase in core noninterest income in 2017 was the addition of SBA consulting fees and SBA loan sale gains. On May 5, 2016, the Company completed the acquisition of a firm that specializes in consulting with financial institutions across the country related to SBA loan origination and servicing. We recorded $1.3 million in SBA consulting fees in the first quarter of 2017 compared to none in 2016. In the third quarter of 2016, we launched a national SBA lending division, which offers SBA loans to small business owners throughout the United States. This division earned $0.6 million from gains on the sales of the guaranteed portions of these loans during the first quarter of 2017 compared to none in 2016.

 

In the first quarter of 2017, we recorded no indemnification asset expense compared to $2.4 million in indemnification asset expense in the first quarter of 2016.

 

Noninterest Expenses

 

Noninterest expenses amounted to $32.1 million in the first quarter of 2017 compared to $24.8 million recorded in the first quarter of 2016. The majority of the increase in noninterest expense in 2017 related to increases in salaries expense and merger and acquisition expense, as discussed below.

 

Salaries expense increased to $14.0 million in the first quarter of 2017 from the $11.5 million recorded in the first quarter of 2016. The primary reason for the increase in salaries expense in 2017 is due to the addition of the SBA consulting firm and the hiring of personnel related to our SBA division. Also impacting salaries expense was the addition of personnel acquired from Carolina Bank.

 

Merger and acquisition expenses amounted to $2.4 million for the three months ended March 31, 2017, compared to $0.2 million in the comparable period of 2016.

 

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Index 

  

Balance Sheet and Capital

 

Total assets at March 31, 2017 amounted to $4.4 billion, a 31.3% increase from a year earlier. Total loans at March 31, 2017 amounted to $3.3 billion, a 29.5% increase from a year earlier, and total deposits amounted to $3.6 billion at March 31, 2017, a 28.4% increase from a year earlier.

 

In addition to the growth realized from the acquisition of Carolina Bank, we experienced strong organic loan and deposit growth for the three and twelve months ended March 31, 2017. For the first quarter of 2017, organic loan growth amounted to $81.3 million, or 12.0% annualized, and for the twelve months ended March 31, 2017, organic loan growth amounted to $251.1 million, or 9.9%. For the first quarter of 2017, organic deposit growth amounted to $96.4 million, or 13.1% annualized, and for the twelve months ended March 31, 2017, organic deposit growth amounted to $239.9 million, or 8.5%. The strong growth was a result of ongoing internal initiatives to drive loan and deposit growth, including our recent expansion into higher growth markets.

 

We remain well-capitalized by all regulatory standards, with a Total Risk-Based Capital Ratio at March 31, 2017 of 12.56%, a decline from 14.47% at March 31, 2016, but still in excess of the 10.00% minimum to be considered well-capitalized. Our tangible common equity to tangible assets ratio was 7.79% at March 31, 2017, a decrease of 45 basis points from a year earlier. The decreases in the capital ratios are due to the acquisition of Carolina Bank.

 

Note Regarding Components of Earnings

 

For the period in 2016 presented, our results of operations were significantly affected by the accounting for two FDIC-assisted failed bank acquisitions. In the discussion above and elsewhere in this report, the term “covered” is used to describe assets that were included in FDIC loss share agreements, while the term “non-covered” refers to our legacy assets, which are not included in any type of loss share arrangement. As previously discussed, all loss share agreements were terminated in the third quarter of 2016 and thus the entire loan portfolio is now classified as non-covered. Certain prior period disclosures will continue to present the breakout of the loan portfolio between covered and non-covered.

 

Certain covered, as well as newly acquired loans, have an unaccreted discount associated with them. Such loans that experience favorable changes in credit quality compared to what was expected at the acquisition date, including loans that pay off, will continue to result in positive adjustments to interest income being recorded over the life of the respective loan – also referred to as loan discount accretion.

 

For periods prior to September 22, 2016, because favorable changes in covered assets resulted in lower expected FDIC claims, and unfavorable changes in covered assets resulted in higher expected FDIC claims, the FDIC indemnification asset was adjusted to reflect those expectations. The net increase or decrease in the indemnification asset was reflected within noninterest income, with the net impact being that pretax income was generally only impacted by 20% of the income or expense associated with provisions for loan losses on covered loans, discount accretion, and losses from covered foreclosed properties.

 

Components of Earnings

 

Net interest income is the largest component of earnings, representing the difference between interest and fees generated from earning assets and the interest costs of deposits and other funds needed to support those assets. Net interest income for the three month period ended March 31, 2017 amounted to $34.3 million, an increase of $4.1 million, or 13.6%, from the $30.2 million recorded in the first quarter of 2016. Net interest income on a tax-equivalent basis for the three month period ended March 31, 2017 amounted to $34.9 million, an increase of $4.2 million, or 13.8%, from the $30.7 million recorded in the first quarter of 2016. We believe that analysis of net interest income on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest income amounts in different periods without taking into account the different mix of taxable versus non-taxable investments that may have existed during those periods.

 

   Three Months Ended March 31, 
($ in thousands)  2017   2016 
Net interest income, as reported  $34,296    30,195 
Tax-equivalent adjustment   585    459 
Net interest income, tax-equivalent  $34,881    30,654 

 

Page 43

Index 

  

There are two primary factors that cause changes in the amount of net interest income we record - 1) changes in our loans and deposits balances, and 2) our net interest margin (tax-equivalent net interest income divided by average interest-earning assets).

 

For the three months ended March 31, 2017, the higher net interest income compared to the same period of 2016 was due to growth in loans outstanding.

 

The following table presents net interest income analysis on a tax-equivalent basis.

 

   For the Three Months Ended March 31, 
   2017   2016 
($ in thousands)  Average
Volume
   Average
Rate
   Interest
Earned
or Paid
   Average
Volume
   Average
Rate
   Interest
Earned
or Paid
 
Assets                        
Loans (1)  $2,903,279    4.71%   $33,703   $2,528,317    4.70%   $29,573 
Taxable securities   285,887    2.59%    1,824    284,865    2.57%    1,823 
Non-taxable securities (2)   53,418    7.80%    1,028    51,351    7.08%    904 
Short-term investments, principally federal funds   235,941    0.86%    498    164,242    0.54%    222 
Total interest-earning assets   3,478,525    4.32%    37,053    3,028,775    4.32%    32,522 
                               
Cash and due from banks   67,296              55,543           
Premises and equipment   82,177              75,710           
Other assets   228,590              172,464           
   Total assets  $3,856,588             $3,332,492           
                               
Liabilities                              
Interest bearing checking  $652,672    0.07%   $107   $587,944    0.07%   $98 
Money market deposits   728,723    0.19%    336    650,314    0.17%    273 
Savings deposits   273,114    0.12%    79    189,889    0.05%    23 
Time deposits >$100,000   436,779    0.66%    714    397,750    0.66%    652 
Other time deposits   244,798    0.28%    166    291,154    0.38%    274 
     Total interest-bearing deposits   2,336,086    0.24%    1,402    2,117,051    0.25%    1,320 
Borrowings   244,864    1.28%    770    186,394    1.18%    548 
Total interest-bearing liabilities   2,580,950    0.34%    2,172    2,303,445    0.33%    1,868 
                               
Noninterest bearing checking   816,692              658,340           
Other liabilities   32,104              21,223           
Shareholders’ equity   426,842              349,484           
Total liabilities and
shareholders’ equity
  $3,856,588             $3,332,492           
                               
Net yield on interest-earning
assets and net interest income
        4.07%   $34,881         4.07%   $30,654 
Interest rate spread        3.98%              3.99%      
                               
Average prime rate        3.79%              3.50%      
(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown.
(2)Includes tax-equivalent adjustments of $585,000 and $459,000 in 2017 and 2016, respectively, to reflect the tax benefit that we receive related to tax-exempt securities, which carry interest rates lower than similar taxable investments due to their tax exempt status. This amount has been computed assuming a 39% tax rate and is reduced by the related nondeductible portion of interest expense.

 

Average loans outstanding for the first quarter of 2017 were $2.903 billion, which was $375 million, or 14.8%, higher than the average loans outstanding for the first quarter of 2016 ($2.528 billion). The higher amount of average loans outstanding in 2017 is partially due to the acquisition of Carolina Bank on March 3, 2017, which had $497 million in loans at the acquisition date. Also, due to our loan growth initiatives, including expansion into higher growth markets, and improved loan demand in our market areas, we have grown loan balances organically by $251 million over the past year.