(MARK ONE) | ||
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2014
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-11204
(Exact name of registrant as specified in its charter)
PENNSYLVANIA | 25-1424278 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
MAIN & FRANKLIN STREETS, P.O. BOX 430, JOHNSTOWN, PENNSYLVANIA |
15907-0430 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code (814) 533-5300
Securities registered pursuant to Section 12(b) of the Act:
Title Of Each Class | Name Of Each Exchange On Which Registered | |
Common Stock, Par Value $0.01 Per Share | The NASDAQ Stock Market LLC | |
8.45% Beneficial Unsecured Securities, Series A (AmeriServ Financial Capital Trust I) |
The NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. þ 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 (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, non-accelerated filer or a smaller reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked prices of such common equity, as of the business day of the registrants most recently completed second fiscal quarter. The aggregate market value was $58,827,999 as of June 30, 2014.
Indicate the number of shares outstanding of each of the registrants classes of common stock, as of the latest practicable date. There were 18,853,521 shares outstanding as of January 30, 2015.
Portions of the proxy statement for the annual shareholders meeting are incorporated by reference in Parts II and III.
i
AmeriServ Financial, Inc. (the Company) is a bank holding company organized under the Pennsylvania Business Corporation Law. The Company became a holding company upon acquiring all of the outstanding shares of AmeriServ Financial Bank (the Bank) in January 1983. The Companys other wholly owned subsidiaries include AmeriServ Trust and Financial Services Company (the Trust Company), formed in October 1992, and AmeriServ Life Insurance Company (AmeriServ Life), formed in October 1987. When used in this report, the Company may refer to AmeriServ Financial, Inc. individually or AmeriServ Financial, Inc. and its direct and indirect subsidiaries.
The Companys principal activities consist of owning and operating its three wholly owned subsidiary entities. At December 31, 2014, the Company had, on a consolidated basis, total assets, deposits, and shareholders equity of $1.089 billion, $870 million, and $114 million, respectively. The Company and its subsidiaries derive substantially all of their income from banking and bank-related services. The Company functions primarily as a coordinating and servicing unit for its subsidiary entities in general management, accounting and taxes, loan review, auditing, investment accounting, marketing and risk management.
As a bank holding company, the Company is subject to supervision and regular examination by the Federal Reserve Bank of Philadelphia and the Pennsylvania Department of Banking and Securities (the PDB). The Company is also under the jurisdiction of the Securities and Exchange Commission (the SEC) for matters relating to registered offerings and sales of its securities under the Securities Act of 1933, as amended, and the disclosure and regulatory requirements of the Securities Exchange Act of 1934, as amended. The Companys common stock is listed on the NASDAQ Stock Market under the trading symbol ASRV, and the Company is subject to the NASDAQ rules applicable to listed companies.
The Bank is a state bank chartered under the Pennsylvania Banking Code of 1965, as amended (the Banking Code.) Through 17 locations in Allegheny, Cambria, Centre, Somerset, and Westmoreland counties, Pennsylvania, the Bank conducts a general banking business. It is a full-service bank offering (i) retail banking services, such as demand, savings and time deposits, checking accounts, money market accounts, secured and unsecured consumer loans, mortgage loans, safe deposit boxes, holiday club accounts, money orders, and travelers checks; and (ii) lending, depository and related financial services to commercial, industrial, financial, and governmental customers, such as commercial real estate mortgage loans (CRE), short and medium-term loans, revolving credit arrangements, lines of credit, inventory and accounts receivable financing, real estate-construction loans, business savings accounts, certificates of deposit, wire transfers, night depository, and lock box services. The Bank also operates 19 automated bank teller machines (ATMs) through its 24-hour banking network that is linked with NYCE, a regional ATM network, and CIRRUS, a national ATM network. West Chester Capital Advisors (WCCA), a SEC registered investment advisor, is also a subsidiary of the Bank. The Company also operates loan production offices (LPOs) in Monroeville and Altoona in Pennsylvania and Hagerstown in Maryland.
We believe that the Banks deposit base is such that loss of one depositor or a related group of depositors would not have a materially adverse effect on its business. The Banks business is not seasonal, nor does it have any risks attendant to foreign sources. A significant majority of the Banks customer base is located within a 150 mile radius of Johnstown, Pennsylvania, the Banks headquarters.
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The Bank is subject to supervision and regular examination by the Federal Reserve Bank of Philadelphia and the PDB. Various federal and state laws and regulations govern many aspects of its banking operations. The following is a summary of key data (dollars in thousands) and ratios of the Bank at December 31, 2014:
Headquarters | Johnstown, PA | |||
Total Assets | $ | 1,061,080 | ||
Total Investment Securities | 132,780 | |||
Total Loans and Loans Held for Sale (net of unearned income) | 832,131 | |||
Total Deposits | 870,081 | |||
Total Net Income | 3,799 | |||
Asset Leverage Ratio | 9.19 | % | ||
Return on Average Assets | 0.37 | |||
Return on Average Equity | 3.70 | |||
Total Full-time Equivalent Employees | 245 |
Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, which includes credit, interest rate and market, liquidity, operational, legal/compliance, strategic/reputational and security risk. The Company controls and monitors these risks with policies, procedures, and various levels of oversight from the Companys Board of Directors (the Board) and management. The Company has both a Management Enterprise Risk Committee and a Board Enterprise Risk Committee to help manage and monitor the Companys risk position.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the magnitude, direction, and frequency of changes in interest rates. Interest rate risk results from various repricing frequencies and the maturity structure of assets and liabilities. The Company uses its asset liability management policy to control and manage interest rate risk.
Liquidity risk represents the inability to generate cash or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers, as well as the obligations to depositors, debtholders and the funding of operating costs. The Company uses its asset liability management policy and contingency funding plan to control and manage liquidity risk.
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms resulting in an economic loss to the organization. Credit risk results from extending credit to customers, purchasing securities, and entering into certain off-balance sheet loan funding commitments. The Companys primary credit risk occurs in the loan portfolio. The Company uses its credit policy and disciplined approach to evaluating the adequacy of the allowance for loan losses (the ALL) to control and manage credit risk. The Companys investment policy and hedging policy limit the amount of credit risk that may be assumed in the investment portfolio and through hedging activities. The following summarizes and describes the Companys various loan categories and the underwriting standards applied to each:
This category includes credit extensions to commercial and industrial borrowers. Business assets, including accounts receivable, inventory and/or equipment, typically secure these credits. In appropriate instances, extensions of credit in this category are subject to collateral advance formulas. Balance sheet strength and profitability are considered when analyzing these credits, with special attention given to historical, current and prospective sources of cash flow, and the ability of the customer to sustain cash flow at acceptable levels. The Banks policy permits flexibility in determining acceptable debt service coverage ratios, with a minimum level of 1.1 to 1x desired. Personal guarantees are frequently required; however, as the financial strength of the borrower increases, the Banks ability to obtain personal guarantees decreases. In addition to economic risk, this category is impacted by the strength of the borrowers management, industry risk and portfolio concentration risk each of which are also monitored and considered during the underwriting process.
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This category includes various types of loans, including acquisition and construction of investment property, owner-occupied property and operating property. Maximum term, minimum cash flow coverage, leasing requirements, maximum amortization and maximum loan to value ratios are controlled by the Banks credit policy and follow industry guidelines and norms, and regulatory limitations. Personal guarantees are normally required during the construction phase on construction credits and are frequently obtained on mid to smaller CRE loans. In addition to economic risk, this category is subject to geographic and portfolio concentration risk, each of which are monitored and considered in underwriting.
This category includes mortgages that are secured by residential property. Underwriting of loans within this category is pursuant to Freddie Mac/Fannie Mae underwriting guidelines, with the exception of Community Reinvestment Act (CRA) loans, which have more liberal standards. The major risk in this category is that a significant downward economic trend would increase unemployment and cause payment default. The Bank does not engage and has never engaged, in subprime residential mortgage lending.
This category includes consumer installment loans and revolving credit plans. Underwriting is pursuant to industry norms and guidelines. The major risk in this category is a significant economic downturn.
The investment securities portfolio of the Company and its subsidiaries is managed primarily to provide ample liquidity to fund, for example, loan growth and secondarily for earnings in a manner that is consistent with proper bank asset/liability management and current banking practices. The objectives of portfolio management include consideration of proper liquidity levels, interest rate and market valuation sensitivity, and profitability. The investment portfolio of the Company and its subsidiaries are proactively managed in accordance with federal and state laws and regulations and in accordance with generally accepted accounting principles (GAAP).
The investment portfolio is primarily made up of AAA rated agency mortgage-backed securities and short maturity agency securities. Beginning in 2012, the Company began to add high quality corporate securities and select taxable municipal securities to the portfolio. Management strives to maintain a relatively short duration in the portfolio. All holdings must meet standards documented in the AmeriServ Financial Investment Policy.
Investment securities classified as held to maturity are carried at amortized cost while investment securities classified as available for sale are reported at fair market value. The following table sets forth the cost basis and fair value of the Companys investment portfolio as of the periods indicated:
Investment securities available for sale at:
AT DECEMBER 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(IN THOUSANDS) | ||||||||||||
U.S. Agency | $ | 5,931 | $ | 6,926 | $ | 5,848 | ||||||
Corporate bonds | 15,497 | 11,992 | 7,992 | |||||||||
U.S. Agency mortgage-backed securities | 102,888 | 121,480 | 131,425 | |||||||||
Total cost basis of investment securities available for sale | $ | 124,316 | $ | 140,398 | $ | 145,265 | ||||||
Total fair value of investment securities available for sale | $ | 127,110 | $ | 141,978 | $ | 151,538 |
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Investment securities held to maturity at:
AT DECEMBER 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(IN THOUSANDS) | ||||||||||||
Taxable municipal | $ | 3,364 | $ | 1,521 | $ | 410 | ||||||
U.S. Agency mortgage-backed securities | 12,481 | 12,671 | 9,318 | |||||||||
Corporate bonds and other securities | 3,995 | 3,995 | 3,995 | |||||||||
Total cost basis of investment securities held to maturity | $ | 19,840 | $ | 18,187 | $ | 13,723 | ||||||
Total fair value of investment securities held to maturity | $ | 20,213 | $ | 17,788 | $ | 14,266 |
The Bank has a stable core deposit base made up of traditional commercial bank products that exhibits little fluctuation, other than jumbo certificates of deposits (CDs), which demonstrate some seasonality. The Company also utilizes certain Trust Company specialty deposits related to the ERECT Fund as a funding source which serve as an alternative to wholesale borrowings and can exhibit some limited degree of volatility.
The following table sets forth the average balance of the Companys deposits and average rates paid thereon for the past three calendar years:
AT DECEMBER 31, | ||||||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||||||
(IN THOUSANDS, EXCEPT PERCENTAGES) | ||||||||||||||||||||||||
Demand: |
||||||||||||||||||||||||
Non-interest bearing | $ | 155,365 | % | $ | 158,169 | | % | $ | 147,887 | | % | |||||||||||||
Interest bearing | 97,641 | 0.20 | 75,126 | 0.18 | 60,810 | 0.19 | ||||||||||||||||||
Savings | 89,554 | 0.16 | 87,819 | 0.16 | 85,112 | 0.21 | ||||||||||||||||||
Money market | 228,150 | 0.33 | 212,735 | 0.35 | 211,744 | 0.42 | ||||||||||||||||||
Other time | 300,915 | 1.26 | 312,741 | 1.33 | 327,557 | 1.62 | ||||||||||||||||||
Total deposits | $ | 871,625 | 0.68 | % | $ | 846,590 | 0.75 | % | $ | 833,110 | 0.95 | % |
The loan portfolio of the Company consisted of the following:
AT DECEMBER 31, | ||||||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||||||
(IN THOUSANDS) | ||||||||||||||||||||||||
Commercial | $ | 139,158 | $ | 120,120 | $ | 102,864 | $ | 83,124 | $ | 78,322 | ||||||||||||||
Commercial loans secured by real estate(1) | 410,851 | 412,254 | 383,934 | 350,224 | 370,375 | |||||||||||||||||||
Real estate-mortgage(1) | 258,616 | 235,689 | 217,584 | 212,669 | 203,323 | |||||||||||||||||||
Consumer | 19,009 | 15,864 | 17,420 | 18,172 | 19,233 | |||||||||||||||||||
Total loans | 827,634 | 783,927 | 721,802 | 664,189 | 671,253 | |||||||||||||||||||
Less: Unearned income | 554 | 581 | 637 | 452 | 477 | |||||||||||||||||||
Total loans, net of unearned income | $ | 827,080 | $ | 783,346 | $ | 721,165 | $ | 663,737 | $ | 670,776 |
(1) | For each of the periods presented beginning with December 31, 2014, real estate-construction loans constituted 3.5%, 3.0%, 2.0%, 1.9% and 3.9% of the Companys total loans, net of unearned income, respectively. |
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The Residential Lending department of the Company continues to originate one-to-four family mortgage loans for customers, the majority of which are sold to outside investors in the secondary market and some of which are retained for the Banks portfolio. Mortgages sold on the secondary market are sold to investors on a flow basis; mortgages are priced and delivered on a best efforts pricing basis, with servicing released to the investor. Fannie Mae/Freddie Mac guidelines are used in underwriting all mortgages with the exception of a limited amount of CRA loans. Mortgages with longer terms, such as 20-year, 30-year, FHA, and VA loans, are usually sold. The remaining production of the department includes construction, adjustable rate mortgages, quality non-salable loans, and bi-weekly mortgages. These loans are usually kept in the Banks portfolios. New portfolio production is predominately adjustable rate mortgages.
The following table presents information concerning non-performing assets:
AT DECEMBER 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||
(IN THOUSANDS, EXCEPT PERCENTAGES) | ||||||||||||||||||||
Non-accrual loans: |
||||||||||||||||||||
Commercial | $ | | $ | | $ | | $ | | $ | 3,679 | ||||||||||
Commercial loans secured by real estate | 778 | 1,632 | 4,623 | 3,870 | 6,731 | |||||||||||||||
Real estate-mortgage | 1,417 | 1,239 | 1,191 | 1,205 | 1,879 | |||||||||||||||
Total | 2,195 | 2,871 | 5,814 | 5,075 | 12,289 | |||||||||||||||
Other real estate owned: |
||||||||||||||||||||
Commercial loans secured by real estate | 384 | 344 | 1,101 | 20 | 436 | |||||||||||||||
Real estate-mortgage | 128 | 673 | 127 | 104 | 302 | |||||||||||||||
Total | 512 | 1,017 | 1,228 | 124 | 738 | |||||||||||||||
Total restructured loans not in non-accrual (TDR) |
210 | 221 | 182 | | 1,337 | |||||||||||||||
Total non-performing assets including TDR | $ | 2,917 | $ | 4,109 | $ | 7,224 | $ | 5,199 | $ | 14,364 | ||||||||||
Total non-performing assets as a percent of loans, net of unearned income, and other real estate owned | 0.35 | % | 0.52 | % | 1.00 | % | 0.78 | % | 2.14 | % |
The Company is unaware of any additional loans which are required to either be charged-off or added to the non-performing asset totals disclosed above. Other real estate owned (OREO) is measured at fair value based on appraisals, less cost to sell at the date of foreclosure. The Company had no loans past due 90 days or more, still accruing, for the periods presented.
The following table sets forth, for the periods indicated, (1) the gross interest income that would have been recorded if non-accrual loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period, (2) the amount of interest income actually recorded on such loans, and (3) the net reduction in interest income attributable to such loans.
YEAR ENDED DECEMBER 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||
(IN THOUSANDS) | ||||||||||||||||||||
Interest income due in accordance with original terms | $ | 136 | $ | 178 | $ | 231 | $ | 376 | $ | 1,086 | ||||||||||
Interest income recorded | | | | (167 | ) | (458 | ) | |||||||||||||
Net reduction in interest income | $ | 136 | $ | 178 | $ | 231 | $ | 209 | $ | 628 |
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AmeriServ Trust and Financial Services Company is a trust company organized under Pennsylvania law in October 1992. Its staff of approximately 44 professionals administers assets valued at approximately $1.8 billion that are not recognized on the Companys balance sheet at December 31, 2014. The Trust Company focuses on wealth management. Wealth management includes personal trust products and services such as personal portfolio investment management, estate planning and administration, custodial services and pre-need trusts. Also, institutional trust products and services such as 401(k) plans, defined benefit and defined contribution employee benefit plans, and individual retirement accounts are included in this segment. This segment also includes financial services which include the sale of mutual funds, annuities, and insurance products. The wealth management business also includes the union collective investment funds, namely the ERECT and BUILD funds which are designed to use union pension dollars in construction projects that utilize union labor. The BUILD fund is in the process of liquidation. At December 31, 2014, the Trust Company had total assets of $4.6 million and total stockholders equity of $4.2 million. In 2014, the Trust Company contributed earnings to the corporation as its gross revenue amounted to $7.9 million and the net income contribution was $1.2 million. The Trust Company is subject to regulation and supervision by the Federal Reserve Bank of Philadelphia and the PDB.
AmeriServ Life is a captive insurance company organized under the laws of the State of Arizona. AmeriServ Life engages in underwriting as reinsurer of credit life and disability insurance within the Companys market area. Operations of AmeriServ Life are conducted in each office of the Companys banking subsidiary. AmeriServ Life is subject to supervision and regulation by the Arizona Department of Insurance, the Pennsylvania Insurance Department, and the Board of Governors of the Federal Reserve System (the Federal Reserve). At December 31, 2014, AmeriServ Life had total assets of $400,000.
Commercial banks are affected by policies of various regulatory authorities including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve are: open market operations in U.S. Government securities, changes in the federal funds rate and discount rate on member bank borrowings, and changes in reserve requirements on bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rate charges on loans or interest paid for deposits. The monetary policies of the Federal Reserve have had, and will continue to have, a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.
Our subsidiaries face strong competition from other commercial banks, savings banks, credit unions, savings and loan associations, and other financial or investment service institutions for business in the communities they serve. Several of these institutions are affiliated with major banking and financial institutions which are substantially larger and have greater financial resources than the Bank and the Trust Company. As the financial services industry continues to consolidate, the scope of potential competition affecting our subsidiaries will also increase. Brokerage houses, consumer finance companies, insurance companies, and pension trusts are important competitors for various types of financial services. In addition, personal and corporate trust investment counseling services are offered by insurance companies, other firms, and individuals.
In January 2015, the Federal Open Market Committee (the Committee) characterized economic activity as expanding at a solid pace. There has been continued improvement in labor market conditions as the Federal Reserve noted strong job gains and a lower unemployment rate. Underutilization of labor resources continues to diminish. Household spending is rising moderately as recent declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the
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housing sector remains slow. Inflation has declined further below the Committees longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation have declined substantially in recent months; survey-based measures of longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate. The Committee continues to monitor inflation developments closely.
To support continued progress toward maximum employment and price stability, the Committee reaffirmed its view that the current 0 to ¼ percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress both realized and expected toward its objectives of maximum employment and two percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committees employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committees holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
The outlook for 2015 is that the economy should grow with GDP predicted to be slightly above 3.0%. Consumers will drive economic growth with the availability of more jobs and low energy prices, which puts more money into their pockets for spending on other goods and services. According to Kiplingers, spending in the fourth quarter of 2014 grew at the fastest pace in more than eight years and, with the unemployment rate dropping, consumer confidence is at a seven year high. Increased consumer spending should result in businesses investing in new production capacity. Housing is in a recovery mode with builders expected to increase the pace of new home construction in 2015. Conversely, the strong dollar and sluggish global economic expansion will hinder sales abroad while some U.S. manufacturers will also lose sales as U.S. consumers will opt for cheaper imported products, especially autos and other durable goods.
The job market should continue to be strong in 2015 and keep incomes and consumption fueling healthy economic growth. The unemployment rate is projected to decline further in 2015 to about 5.3%. A strong job market is likely to entice more people back into the labor force which will slow the pace of the falling unemployment rate.
The expectation for business spending is to match the 5% gain obtained in 2014. The dollars soaring value and the steep decline in oil prices makes it hard to sell capital goods overseas because they cost more for foreigners to buy. At the same time, demand for energy related equipment at home is declining. Business sentiment, however, is strong, particularly among smaller companies. The housing market is expected to experience more expansion in 2015, with income and employment rising, demand for housing should increase.
The economy in Cambria and Somerset counties, Pennsylvania at the end of 2014 produced seasonally adjusted unemployment rates of 5.9% and 5.8%, respectively, as compared to national and state rates of 5.6% and 4.8%. Johnstown, Pennsylvania, where the Company is headquartered, continues to have a cost of living that is lower than the national average. On an annual average basis, the 2014 job level for the Johnstown Metropolitan Statistical Area of 58,100 increased by a very modest 100 over the previous year. Annual growth
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in the overall job market is well short of anticipated improvement. This documents the fact that the local economy continues to face a long hard climb back from the recession. The jobless rate in Johnstown MSA averaged 5.2% in 2014. Unemployment in the Johnstown labor market area has recently experienced substantial declines in comparison to previous periods. However this is a function of the declining number of labor force participants who have dropped out of the labor force.
Economic conditions are stronger in the State College market and have demonstrated the same improvement experienced in the national economy. The community is a college town, dominated economically and demographically by the presence of the University Park campus of the Pennsylvania State University. The unemployment rate for State College MSA averaged 4.2% in 2014, which represents a 1.4% improvement over 2013 and remains the lowest of all regions in the Commonwealth. Seasonally adjusted average total nonfarm jobs for the MSA increased by 800 since 2013. A large percentage of the population in State College falls into the 18 to 34 year old age group, while potential customers in the Cambria/Somerset markets tend to be over 50 years of age.
The Company also has loan production offices in Altoona in Blair county, Pennsylvania, and Hagerstown in Washington county, Maryland. Hagerstown and Washington county, Maryland offers a rare combination of business advantages providing a major crossroads location that is convenient to the entire East Coast at the intersection of I-81 and I-70. It has a workforce of over 400,000 with strengths in manufacturing and technology. It also offers an affordable cost of doing business and living within an hour of the Washington, D.C./Baltimore regions. There are also plenty of facilities and land slated for industrial/commercial development. Hagerstown has become a choice location for manufacturers, financial services, and distribution companies. The Hagerstown, MD-Martinsburg, WV MSA unemployment rate improved from a 7.1% average in 2013 to a 6.5% average in 2014.
Altoona is the business center of Blair County, Pennsylvania with a strong retail, government and manufacturing base. The top field of employment in Altoona and the metro area is healthcare. Its location along I-99 draws from a large trade area over a wide geographic area that extends to State College and Johnstown. It serves as the headquarters for Sheetz Corporation which ranks on Forbes list of the top privately owned companies. In addition to being located adjacent to I-99 and a major highway system, Altoona also has easy access to rail and air transportation. The unemployment rate in the Altoona MSA decreased from a 6.7% average in 2013 to a 5.2% average in 2014.
The Company employed 336 people as of December 31, 2014 in full- and part-time positions. Approximately 164 non-supervisory employees of the Company are represented by the United Steelworkers, AFL-CIO-CLC, Local Union 2635-06. The Company is under a four year labor contract with the United Steelworkers Local that will expire on October 15, 2017. The contract calls for annual wage increases of 3.0%. Additionally, effective January 1, 2014, the Company implemented a soft freeze of its defined benefit pension plan for union employees. A soft freeze means that all existing union employees as of December 31, 2013 currently participating will remain in the defined benefit pension plan but any new union employees hired after January 1, 2014 will no longer be part of the defined benefit plan but instead will be offered retirement benefits under an enhanced 401(k) program. The Company has not experienced a work stoppage since 1979. The Company is one of an estimated ten union-represented banks nationwide.
The banking and trust industry, and the operation of bank holding companies, is highly regulated by federal and state law, and by numerous regulations adopted by the federal banking agencies and state banking agencies. Bank regulation affects all aspects of conducting business as a bank, including such major items as minimum capital requirements, limits on types and amounts of investments, loans and other assets, as well as borrowings and other liabilities, and numerous restrictions or requirements on the loan terms and other products made available to customers, particularly consumers. Federal deposit insurance from the Federal Deposit Insurance Corporation (the FDIC) is required for all banks in the United States, and maintaining FDIC insurance requires observation of the various rules of the FDIC, as well as payment of deposit premiums. New branches, or acquisitions or mergers, are required to be pre-approved by the responsible agency, which in the case of the Company and the Bank is the Federal Reserve and the PDB. The Bank
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provides detailed financial information to its regulators, including a quarterly call report that is filed pursuant to detailed prescribed instructions to ensure that all U.S. banks report the same way. The U.S. banking laws and regulations are frequently updated and amended, especially in response to crises in the financial industry, such as the global financial crisis of 2008, which resulted in the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010 (the Dodd-Frank Act), a statute affecting many facets of the financial industry.
While it is impractical to discuss all laws and regulations that regularly affect the business of the Company and its subsidiaries, set forth below is an overview of some of the major provisions and statutes that apply.
One of the most significant regulatory requirements for banking institutions is minimal capital, imposed as a ratio of capital to assets. The Federal Deposit Insurance Act, as amended (the FDIA), identifies five capital categories for insured depository institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. It requires U.S. federal bank regulatory agencies to implement systems for prompt corrective action for insured depository institutions that do not meet minimum capital requirements based on these categories. The FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Unless a bank is well capitalized, it is subject to restrictions on its ability to utilize brokered deposits and on other aspects of its operations. Generally, a bank is prohibited from paying any dividend or making any capital distribution or paying any management fee to its holding company if the bank would thereafter be undercapitalized.
As of December 31, 2014, the Company believes that its bank subsidiary was well capitalized, based on the prompt corrective action guidelines described above. As discussed below, however, the capital requirements for all banks are being increased under the Dodd-Frank Act. Specifically, on July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The final rules implement the Basel III regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act. The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered well capitalized) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered well capitalized); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered well capitalized). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016. The Company is continuing to review the impact of these new rules and currently expects that its capital position will be more than adequate to meet the revised regulatory capital requirements.
The primary source of cash to pay dividends, if any, to the Companys shareholders and to meet the Companys obligations is dividends paid to the Company by the Bank and the Trust Company. Dividend payments by the Bank to the Company are subject to the laws of the Commonwealth of Pennsylvania, the Banking Code, the FDIA and the regulation of the PDB and of the Federal Reserve. Under the Banking Act and the FDIA, a bank may not pay any dividends if, after paying such dividends, it would be undercapitalized under applicable capital requirements. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in unsafe or unsound banking practices. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
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It is the policy of the Federal Reserve that bank holding companies should pay cash dividends on common stock only out of income available from the immediately preceding year and only if prospective earnings retention is consistent with the organizations expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividend that undermines the bank holding companys ability to serve as a source of strength to its banking subsidiary. A bank holding company may not pay dividends when it is insolvent.
The terms of our Companys Senior Non-Cumulative Perpetual Preferred Stock (the SBLF Preferred Stock) impose limits on the ability of the Company to pay dividends and repurchase shares of common stock. Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.
Under the terms of the SBLF Preferred Stock, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Companys Tier 1 Capital would be at least 90% of the Tier 1 Capital as of June 30, 2011, excluding any subsequent net charge-offs and any redemption of shares of the SBLF Preferred Stock (the Tier 1 Dividend Threshold). Beginning on the first day of the eleventh dividend period ending on June 20, 2014, the amount of the Tier 1 Dividend Threshold will be reduced by 10% for each one percent increase in qualified small business lending from the baseline level through the ninth dividend period ending on September 30, 2013.
The Company resumed paying quarterly cash dividends to common shareholders in 2013. For more information regarding quarterly cash dividends, see Part II, Item 5. Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities below.
The Sarbanes-Oxley Act of 2002 is not a banking law, but contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with Section 302(a) of the Sarbanes-Oxley Act, written certifications by the Companys principal executive officer and principal financial officer are required. These certifications attest, among other things, that the Companys quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact. In response to the Sarbanes-Oxley Act of 2002, the Company adopted a series of procedures to further strengthen its corporate governance practices. The Company also requires signed certifications from managers who are responsible for internal controls throughout the Company as to the integrity of the information they prepare. These procedures supplement the Companys Code of Conduct Policy and other procedures that were previously in place. In 2005, the Company implemented and has since maintained a program designed to comply with Section 404 of the Sarbanes-Oxley Act. This program included the identification of key processes and accounts, documentation of the design of control effectiveness over process and entity level controls, and testing of the effectiveness of key controls.
Federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about customers to non-affiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to non-affiliated third parties. The privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. The Company believes it is in compliance with the various provisions.
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A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued and, in some cases, proposed a number of regulations that apply various requirements of the USA Patriot Act to financial institutions. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the Company.
On July 21, 2010, the President signed into law the Dodd-Frank Act. This law significantly changed the previous bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.
The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress. The federal agencies are given significant discretion in drafting such rules and regulations. The due date for many of such regulations is still in the future; consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for years.
Many provisions of the Dodd-Frank Act are already in effect. For example, effective July 21, 2011, a provision of the Dodd-Frank Act eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to prior law could have an adverse impact on the Companys interest expense.
The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor.
Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, such as the Company, will be permitted to include trust preferred securities that were issued before May 19, 2010, such as the Companys 8.45% Trust Preferred Securities, as Tier 1 capital; however, trust preferred securities issued by a bank or thrift holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital. Such trust preferred securities still will be entitled to be treated as Tier 2 capital.
The Dodd-Frank Act also required publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called golden parachute payments. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
The Dodd-Frank Act created the Consumer Financial Protection Bureau (the CFPB), a new independent regulatory agency with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit unfair, deceptive or abusive acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets such as the Company will continue to be examined for compliance with the consumer laws by their primary bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations and gives state attorney generals the ability to enforce federal consumer protection laws.
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It is difficult to predict at this time what the total impact the Dodd-Frank Act will have on community banks as it continues to be subject to intensive rulemaking and public comment, which has not yet been completed with respect to the application of certain key aspects of the Dodd-Frank Act. However, it is expected that, at a minimum, it will continue to increase our capital requirements, our operating and compliance costs, and could increase our interest expense.
We file annual, quarterly and current reports, proxy statements and other information with the SEC. These filings are available to the public on the Internet at the SECs website at http://www.sec.gov. You may also read and copy any document we file with the SEC at the SECs public reference room, located at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room.
Our Internet address is http://www.ameriserv.com. We make available free of charge on http://www. ameriserv.com our annual, quarterly and current reports, and amendments to those reports, as soon as reasonably practical after we electronically file such material with, or furnish it to, the SEC.
Not applicable.
The Company has no unresolved staff comments from the SEC for the reporting periods presented.
The principal offices of the Company and the Bank occupy the five-story AmeriServ Financial building at the corner of Main and Franklin Streets in Johnstown plus twelve floors of the building adjacent thereto. The Company occupies the main office and its subsidiary entities have 13 other locations which are owned. Eight additional locations are leased with terms expiring from January 1, 2015 to August 31, 2030.
The Company is subject to a number of asserted and unasserted potential legal claims encountered in the normal course of business. In the opinion of both management and legal counsel, there is no present basis to conclude that the resolution of these claims will have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows.
Not applicable.
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ITEM 5. MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
As of January 30, 2015, the Company had 3,545 shareholders of record for its common stock. The Companys common stock is traded on the NASDAQ Global Market System under the symbol ASRV. The following table sets forth the actual high and low closing prices and the cash dividends declared per share for the periods indicated:
PRICES | CASH DIVIDENDS DECLARED |
|||||||||||
HIGH | LOW | |||||||||||
Year ended December 31, 2014: |
||||||||||||
First Quarter | $ | 3.91 | $ | 3.00 | $ | 0.01 | ||||||
Second Quarter | 3.88 | 3.40 | 0.01 | |||||||||
Third Quarter | 3.52 | 3.14 | 0.01 | |||||||||
Fourth Quarter | 3.31 | 3.02 | 0.01 | |||||||||
Year ended December 31, 2013 |
||||||||||||
First Quarter | $ | 3.23 | $ | 2.90 | $ | 0.00 | ||||||
Second Quarter | 3.17 | 2.74 | 0.01 | |||||||||
Third Quarter | 3.29 | 2.97 | 0.01 | |||||||||
Fourth Quarter | 3.26 | 2.99 | 0.01 |
The declaration of cash dividends on the Company's common stock is at the discretion of the Board, and any decision to declare a dividend is based on a number of factors, including, but not limited to, earnings, prospects, financial condition, regulatory capital levels, applicable covenants under any credit agreements and other contractual restrictions, Pennsylvania law, federal and Pennsylvania bank regulatory law, and other factors deemed relevant. Additionally, the Companys previously announced common stock repurchase programs have been completed.
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SELECTED FIVE-YEAR CONSOLIDATED FINANCIAL DATA
AT OR FOR THE YEAR ENDED DECEMBER 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA AND RATIOS) | ||||||||||||||||||||
SUMMARY OF INCOME STATEMENT DATA: |
||||||||||||||||||||
Total interest income | $ | 40,441 | $ | 39,343 | $ | 39,917 | $ | 41,964 | $ | 44,831 | ||||||||||
Total interest expense | 6,397 | 6,482 | 7,714 | 9,681 | 12,489 | |||||||||||||||
Net interest income | 34,044 | 32,861 | 32,203 | 32,283 | 32,342 | |||||||||||||||
Provision (credit) for loan losses | 375 | (1,100 | ) | (775 | ) | (3,575 | ) | 5,250 | ||||||||||||
Net interest income after provision (credit) for loan losses | 33,669 | 33,961 | 32,978 | 35,858 | 27,092 | |||||||||||||||
Total non-interest income | 14,323 | 15,744 | 14,943 | 13,569 | 13,967 | |||||||||||||||
Total non-interest expense | 43,371 | 42,223 | 40,641 | 40,037 | 39,697 | |||||||||||||||
Income before income taxes | 4,621 | 7,482 | 7,280 | 9,390 | 1,362 | |||||||||||||||
Provision for income taxes | 1,598 | 2,289 | 2,241 | 2,853 | 80 | |||||||||||||||
Net income | $ | 3,023 | $ | 5,193 | $ | 5,039 | $ | 6,537 | $ | 1,282 | ||||||||||
Net income available to common shareholders | $ | 2,813 | $ | 4,984 | $ | 4,211 | $ | 5,152 | $ | 121 | ||||||||||
PER COMMON SHARE DATA: |
||||||||||||||||||||
Basic earnings per share | $ | 0.15 | $ | 0.26 | $ | 0.21 | $ | 0.24 | $ | 0.01 | ||||||||||
Diluted earnings per share | 0.15 | 0.26 | 0.21 | 0.24 | 0.01 | |||||||||||||||
Cash dividends declared | 0.04 | 0.03 | 0.00 | 0.00 | 0.00 | |||||||||||||||
Book value at period end | 4.97 | 4.91 | 4.67 | 4.37 | 4.07 | |||||||||||||||
BALANCE SHEET AND OTHER DATA: |
||||||||||||||||||||
Total assets | $ | 1,089,263 | $ | 1,056,036 | $ | 1,000,991 | $ | 979,076 | $ | 948,974 | ||||||||||
Loans and loans held for sale, net of unearned income | 832,131 | 786,748 | 731,741 | 670,847 | 678,181 | |||||||||||||||
Allowance for loan losses | 9,623 | 10,104 | 12,571 | 14,623 | 19,765 | |||||||||||||||
Investment securities available for sale | 127,110 | 141,978 | 151,538 | 182,923 | 164,811 | |||||||||||||||
Investment securities held to maturity | 19,840 | 18,187 | 13,723 | 12,280 | 7,824 | |||||||||||||||
Deposits | 869,881 | 854,522 | 835,734 | 816,420 | 801,216 | |||||||||||||||
Total borrowed funds | 93,965 | 79,640 | 41,745 | 34,850 | 27,385 | |||||||||||||||
Stockholders equity | 114,407 | 113,307 | 110,468 | 112,352 | 107,058 | |||||||||||||||
Full-time equivalent employees | 314 | 352 | 350 | 347 | 348 | |||||||||||||||
SELECTED FINANCIAL RATIOS: |
||||||||||||||||||||
Return on average assets | 0.29 | % | 0.51 | % | 0.51 | % | 0.68 | % | 0.13 | % | ||||||||||
Return on average total equity | 2.61 | 4.69 | 4.51 | 5.90 | 1.19 | |||||||||||||||
Loans and loans held for sale, net of unearned income, as a percent of deposits, at period end | 95.66 | 92.07 | 87.56 | 82.17 | 84.64 | |||||||||||||||
Ratio of average total equity to average assets | 10.92 | 10.86 | 11.36 | 11.49 | 11.25 | |||||||||||||||
Common stock cash dividends as a percent of net income available to common shareholders | 26.73 | 11.36 | | | | |||||||||||||||
Interest rate spread | 3.36 | 3.39 | 3.43 | 3.47 | 3.51 | |||||||||||||||
Net interest margin | 3.52 | 3.56 | 3.65 | 3.72 | 3.79 | |||||||||||||||
Allowance for loan losses as a percentage of loans, net of unearned income, at period end | 1.16 | 1.29 | 1.74 | 2.20 | 2.95 | |||||||||||||||
Non-performing assets as a percentage of loans and other real estate owned, at period end | 0.35 | 0.52 | 1.00 | 0.78 | 2.14 | |||||||||||||||
Net charge-offs as a percentage of average loans | 0.14 | 0.18 | 0.19 | 0.24 | 0.74 | |||||||||||||||
Ratio of earnings to fixed charges and preferred dividends:(1) |
||||||||||||||||||||
Excluding interest on deposits | 3.30X | 5.13X | 3.80X | 4.11X | 1.49X | |||||||||||||||
Including interest on deposits | 1.67 | 2.07 | 1.80 | 1.83 | 1.10 | |||||||||||||||
Cumulative one year interest rate sensitivity gap ratio, at period end | 1.13 | 1.09 | 1.30 | 1.29 | 1.13 |
(1) | The ratio of earnings to fixed charges and preferred dividends is computed by dividing the sum of income before taxes, fixed charges, and preferred dividends by the sum of fixed charges and preferred dividends. Fixed charges represent interest expense and are shown as both excluding and including interest on deposits. |
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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
The following discussion and analysis of financial condition and results of operations of the Company should be read in conjunction with the consolidated financial statements of the Company including the related notes thereto, included elsewhere herein.
On January 20, 2015, the Company reported its financial performance for the fourth quarter of 2014 and consequently for the full year of 2014. Net income available to shareholders was $749,000 or $0.04 per share for the fourth quarter of 2014. This was $0.05 per share less than the fourth quarter of 2013, but $0.02 per share more than the third quarter of 2014. Net income for the full year was $3,023,000, or $0.15 per share, which represents a decline from $0.26 per share in 2013.
We have previously emphasized the Companys determination to become a significant competitor in every market where the company has a presence. Loans outstanding increased in 2014 by $45 million to a new company year-end record high of $832 million. Meanwhile deposits also closed 2014 at the highest year-end total on record of $870 million. However, it is a fact that such progress has been achieved at the price of increased expense levels. The Board and management determined that 2014 would be the year to take action on this increase in expenses. These actions have included:
| A soft freeze on the defined benefit pension plan and a gradual change to a defined contribution plan, such as a qualified 401(k) plan. |
| A prominent bank-consulting firm was retained to conduct a company-wide profitability improvement program. This program has already provided more than $1 million in annual expense reduction. |
| Then, in the fourth quarter the Company offered a voluntary early retirement program to a number of our most loyal, long-term staff. The expenses of this program are part of the 2014 financials but the significant reductions will be evident in 2015 and beyond. |
The goal of these actions is to permit the Company to continue growing the business but to avoid expense increases so as to increase earnings per share and shareholder return.
Finally in 2014, the Company put behind us a costly litigation process that was previously disclosed in our regulatory filings earlier this year. This litigation concerned our registered investment advisory subsidiary, WCCA, and resulted in a $669,000 impairment charge related to Goodwill on the balance sheet.
We believe the sum of these can result in 2014 being a foundation year for the next decade. The Company has strong capital, a substantial and growing tangible book value, along with the previously mentioned success in the market place. It is also gratifying to tell you that the Trust Company has now completed four consecutive years of double digit net income increases.
We should mention that early 2015 did bring a new challenge; Glenn L. Wilson voluntarily resigned on January 9, 2015 to join a small bank close to his long-term home in Maryland. Glenn served as President and Chief Executive Officer since November 1, 2009. Jeffrey A. Stopko, our former Chief Financial Officer, is now leading an Interim Management Team.
It is enough to say that we expect another bumpy year in the U.S. and regional economies. Just when the Marcellus Shale began to promise job gains for Pennsylvania, the global price of oil has experienced a sudden and dramatic decline. Our answer to these larger issues of the national and global economy remains the same. The Company will maintain strong capital, deep liquidity and a conservative balance sheet. As we enter the seventh year of Washingtons Easy Money program, the Federal Reserve speaks of new directions. Therefore this would not seem to be the time for anything but the most basic banking and wealth management programs and careful watching of the markets. As a result of this situation, we will focus our energies on successfully executing our business plans in order to improve earnings per share and the resulting return to the common shareholder in 2015.
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PERFORMANCE OVERVIEW... The following table summarizes some of the Companys key profitability performance indicators for each of the past three years.
YEAR ENDED DECEMBER 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(IN THOUSANDS, EXCEPT PER SHARE DATA AND RATIOS) |
||||||||||||
Net income | $ | 3,023 | $ | 5,193 | $ | 5,039 | ||||||
Net income available to common shareholders | 2,813 | 4,984 | 4,211 | |||||||||
Diluted earnings per share | 0.15 | 0.26 | 0.21 | |||||||||
Return on average assets | 0.29 | % | 0.51 | % | 0.51 | % | ||||||
Return on average equity | 2.61 | 4.69 | 4.51 |
The Company reported net income available to common shareholders of $2.8 million or $0.15 per diluted common share for 2014. This represented a 42.3% decrease in earnings per share from 2013 where net income available to common shareholders totaled $5.0 million or $0.26 per diluted share. Factors contributing to this reduction in earnings were a $1.5 million unfavorable swing in the provision for loan losses, a $1.4 million reduction in non-interest revenue, and a $1.1 million increase in non-interest expense. The non-interest expense increase included a $669,000 goodwill impairment charge and a $376,000 fourth quarter pension charge related to 25 employees who elected to participate in an early retirement incentive program. These negative items were partially offset by a $1.2 million increase in net interest income due to continued growth of our loan portfolio while maintaining excellent asset quality.
The Company reported net income available to common shareholders of $5.0 million or $0.26 per diluted common share for 2013. This represented a 23.8% increase in earnings per share from 2012 where net income available to common shareholders totalled $4.2 million or $0.21 per diluted share. Growth in total revenue, improved asset quality, and effective capital management caused the increase in earnings per share in 2013. Specifically, a $658,000 increase in net interest income resulted from continued strong growth of our loan portfolio, as total loans grew by $55 million, or 7.5%. Material loan growth occurred in loan categories that qualify for the SBLF through the Companys loan production offices. As a result of this growth in SBLF qualified loans, the Company locked in the lowest preferred dividend rate available under the program of 1% until the first quarter of 2016. This lower rate saved the Company $619,000 in preferred stock dividend payments in 2013 and was a key factor contributing to the earnings per share growth. Additionally, the calculation of earnings per share benefitted from a 713,000 or 3.6% reduction in average shares outstanding due to the success of the Companys common stock repurchase program that was completed in the second quarter of 2013. There was also $325,000 more earnings benefit from negative loan loss provisions in 2013 due to the Companys improved asset quality. These positive items were partially offset by a $1.6 million or 3.9% increase in non-interest expense and slightly higher income tax expense.
The Company reported net income available to common shareholders of $4.2 million or $0.21 per diluted common share for 2012. This represented a 12.5% decline in earnings per share from 2011 where net income available to common shareholders totalled $5.2 million or $0.24 per diluted share. The largest factor causing the reduction in net income available to common shareholders was the provision for loan losses. The Company recorded a negative provision of $775,000 but this was at a lesser level than the $3,575,000 negative provision for 2011. Non-interest income increased by $1.4 million or 10.1% largely due to increased revenue from residential mortgage banking activities and the Trust Companys wealth management businesses. Continued focus on expense control helped contain the increase in non-interest expense to $604,000 or 1.5%.
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NET INTEREST INCOME AND MARGIN... The Companys net interest income represents the amount by which interest income on earning assets exceeds interest paid on interest bearing liabilities. Net interest income is a primary source of the Companys earnings; it is affected by interest rate fluctuations as well as changes in the amount and mix of earning assets and interest bearing liabilities. The following table summarizes the Companys net interest income performance for each of the past three years:
YEAR ENDED DECEMBER 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(IN THOUSANDS, EXCEPT RATIOS) | ||||||||||||
Interest income | $ | 40,441 | $ | 39,343 | $ | 39,917 | ||||||
Interest expense | 6,397 | 6,482 | 7,714 | |||||||||
Net interest income | 34,044 | 32,861 | 32,203 | |||||||||
Net interest margin | 3.52 | % | 3.56 | % | 3.65 | % |
2014 NET INTEREST PERFORMANCE OVERVIEW... The Companys net interest income for the full year 2014 increased by $1,183,000, or 3.6%, when compared to the full year 2013. The Companys net interest margin of 3.52% for the full year 2014 was four basis points lower than the net interest margin of 3.56% for the full year 2013. The Company has been able to mitigate this net interest margin pressure and to increase net interest income by both growing its earning assets and reducing its cost of funds. Specifically, the earning asset growth has occurred in the loan portfolio as total loans averaged a record $805 million for the full year 2014 which is $58 million, or 7.8%, higher than the $746 million average for the 2013 year. This loan growth reflects the successful results of the Companys more intensive sales calling efforts, with an emphasis on generating commercial loans and owner occupied CRE loans, which qualify as SBLF loans. Interest income in 2014 has also benefitted from reduced premium amortization on mortgage backed securities due to slower mortgage prepayment speeds. Overall, total interest income has increased by $1,098,000 in 2014. Additionally, the increase in loans caused the Companys loan to deposit ratio to average 92.3% in 2014 compared to 88.2% in 2013.
Total interest expense for the 2014 year declined by $85,000 from the full year 2013 due to the Companys proactive efforts to reduce deposit costs. Even with this reduction in deposit costs, the Company still experienced growth in deposits which reflects the loyalty of our core deposit base and ongoing efforts to cross sell new loan customers into deposit products. Specifically, total deposits averaged a record level of $872 million for the full year 2014 which is $25 million, or 3.0%, higher than the $847 million average for the full year 2013. This decreased interest expense for deposits has been partially offset by a $190,000 increase in the interest cost for borrowings as the Company has utilized more Federal Home Loan Bank (FHLB) term advances to extend borrowings and provide protection against rising interest rates.
Overall, the Company expects that it will need to continue to grow earning assets to achieve net interest income growth in 2015 as little net interest margin improvement is expected given the ongoing challenges of the exceptionally low interest rate environment. Solid commercial loan pipelines suggest that the Company should be able to again grow the loan portfolio in 2015 although we expect pricing pressures on new commercial loans to continue to be intense.
COMPONENT CHANGES IN NET INTEREST INCOME: 2014 VERSUS 2013... Regarding the separate components of net interest income, the Company's total interest income in 2014 increased by $1.1 million when compared to 2013. This increase was due to a $44.1 million increase in average earning assets due to an increase in average loans partially offset by a nine basis point decline in the earning asset yield from 4.27% to 4.18%. Within the earning asset base, the yield on the total loan portfolio decreased by 19 basis points from 4.71% to 4.52% as new loans typically have yields that are below the rate on the maturing instruments that they are replacing. However, the yield on total investment securities increased by 10 basis points from 2.50% to 2.60% due primarily to a reduction in premium amortization on mortgage backed securities due to a slowdown in mortgage prepayment speeds in 2014. Investment securities interest revenue declined by $122,000 in 2014 due to an $11 million decrease in the average investment securities portfolio as the Company has utilized cash flow from securities to help fund the previously mentioned loan growth.
17
The Company's total interest expense for 2014 decreased by $85,000, or 1.3%, when compared to 2013. This decrease in interest expense was due to a lower cost of funds as the cost of interest bearing liabilities declined by six basis points to 0.82%. Managements decision to further reduce interest rates paid on all deposit categories has not had a negative impact on deposit growth and reflects the loyalty of the banks core deposit base. This decrease in funding costs occurred in spite of a $43.4 million increase in the volume of average interest bearing liabilities. The Company has utilized term advances from the FHLB, with maturities ranging between three and five years, to help fund its earning asset growth and manage interest rate risk. The average balance of FHLB term advances has increased by $15 million while the average cost of these advances has increased by only 17 basis points to 1.01%. Overall, total FHLB borrowings averaged $52 million or 4.9% of total assets during 2014.
2013 NET INTEREST PERFORMANCE OVERVIEW... The Companys net interest income in 2013 increased by 658,000, or 2.0%, when compared to 2012. The Companys 2013 net interest margin of 3.56% was nine basis points lower than the net interest margin of 3.65% for 2012. The lower net interest margin demonstrates the impact of the Federal Reserve low interest rate policies which have pressured interest revenue. The Company has been able to overcome this net interest margin pressure and increase net interest income by reducing its cost of funds and growing its earning assets, particularly loans. Specifically, these efforts resulted in total loans averaging $746 million in 2013, which was $58 million or 8.4% higher than the $689 million average for 2012. This loan growth reflects the successful results of the Companys more intensive sales calling efforts with an emphasis on generating commercial loans and owner occupied CRE loans which qualify as SBLF loans, particularly through its loan production offices. Overall, the increase in loans caused the Companys loan to deposit ratio to average 88.2% in 2013 compared to 82.7% in 2012.
Total interest expense for 2013 declined by $1.2 million from 2012 due to the Companys proactive efforts to reduce deposit costs. Even with this reduction in deposit costs, the Company still experienced growth in deposits which reflects the loyalty of its core deposit base and its ongoing efforts to cross sell new loan customers into deposit products. Specifically, total deposits averaged $847 million in 2013, which is $14 million or 1.6% higher than the $833 million average in 2012.
COMPONENT CHANGES IN NET INTEREST INCOME: 2013 VERSUS 2012... Regarding the separate components of net interest income, the Company's total interest income in 2013 decreased by $574,000 when compared to 2012. This decrease was due to a 25 basis point decline in the earning asset yield from 4.52% to 4.27%, partially offset by additional interest income from a $38.3 million increase in average earning assets due to an increase in average loans. Within the earning asset base, the yield on the total loan portfolio decreased by 35 basis points from 5.06% to 4.71%, while the yield on total investment securities dropped by 22 basis points from 2.72% to 2.50%. This earning asset yield drop reflects the fact that new investment securities and loans typically have yields that are below the rate on the maturing instruments that they are replacing. Investment securities interest revenue also declined by $865,000 in 2013 due to an $18 million decrease in the average investment securities portfolio as the Company has utilized cash flow from securities to help fund the previously mentioned loan growth.
The Company's total interest expense for 2013 decreased by $1.2 million, or 16.0%, when compared to 2012. This decrease in interest expense was due to a lower cost of funds as the cost of interest bearing liabilities declined by 21 basis points to 0.88%. Managements decision to further reduce interest rates paid on all deposit categories has not had a negative impact on deposit growth and reflects the loyalty of the banks core deposit base. This decrease in funding costs occurred in spite of a $28.3 million increase in the volume of interest bearing liabilities. The Company has utilized term advances from the FHLB, with maturities ranging between three and five years, to help fund its earning asset growth and manage interest rate risk over the past year. The average balance of FHLB term advances has increased by $13 million while the average cost of these advances declined by 60 basis points to 0.84%. Overall, total FHLB borrowings averaged $36 million or 3.5% of total assets during 2013.
The table that follows provides an analysis of net interest income on a tax-equivalent basis setting forth (i) average assets, liabilities, and stockholders equity, (ii) interest income earned on interest earning assets and interest expense paid on interest bearing liabilities, (iii) average yields earned on interest earning assets and average rates paid on interest bearing liabilities, (iv) interest rate spread (the difference between the average
18
yield earned on interest earning assets and the average rate paid on interest bearing liabilities), and (v) net interest margin (net interest income as a percentage of average total interest earning assets). For purposes of these tables loan balances include non-accrual loans, and interest income on loans includes loan fees or amortization of such fees which have been deferred, as well as interest recorded on certain non-accrual loans as cash is received. Regulatory stock is included within available for sale investment securities for this analysis. Additionally, a tax rate of approximately 34% is used to compute tax-equivalent yields.
YEAR ENDED DECEMBER 31, | ||||||||||||||||||||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||||||||||||||||||||
AVERAGE BALANCE | INTEREST INCOME/ EXPENSE |
YIELD/ RATE |
AVERAGE BALANCE |
INTEREST INCOME/ EXPENSE |
YIELD/ RATE |
AVERAGE BALANCE |
INTEREST INCOME/ EXPENSE |
YIELD/ RATE |
||||||||||||||||||||||||||||
(IN THOUSANDS, EXCEPT PERCENTAGES) | ||||||||||||||||||||||||||||||||||||
Interest earning assets: |
||||||||||||||||||||||||||||||||||||
Loans, net of unearned income |
$ | 804,721 | $ | 36,366 | 4.52 | % | $ | 746,490 | $ | 35,145 | 4.71 | % | $ | 688,736 | $ | 34,842 | 5.06 | % | ||||||||||||||||||
Deposits with banks | 7,227 | 5 | 0.07 | 8,027 | 6 | 0.08 | 9,634 | 10 | 0.18 | |||||||||||||||||||||||||||
Federal funds sold | | | | 79 | | 0.05 | | | | |||||||||||||||||||||||||||
Short-term investment in money market funds | 1,243 | 7 | 0.49 | 3,260 | 8 | 0.24 | 2,889 | 18 | 0.61 | |||||||||||||||||||||||||||
Investment securities: |
||||||||||||||||||||||||||||||||||||
Available for sale | 137,839 | 3,528 | 2.56 | 150,621 | 3,701 | 2.46 | 172,947 | 4,634 | 2.68 | |||||||||||||||||||||||||||
Held to maturity | 19,399 | 559 | 2.88 | 17,900 | 508 | 2.84 | 13,828 | 440 | 3.18 | |||||||||||||||||||||||||||
Total investment securities | 157,238 | 4,087 | 2.60 | 168,521 | 4,209 | 2.50 | 186,775 | 5,074 | 2.72 | |||||||||||||||||||||||||||
TOTAL INTEREST EARNING ASSETS/INTEREST INCOME | 970,429 | 40,465 | 4.18 | 926,377 | 39,368 | 4.27 | 888,034 | 39,944 | 4.52 | |||||||||||||||||||||||||||
Non-interest earning assets: |
||||||||||||||||||||||||||||||||||||
Cash and due from banks | 16,919 | 16,795 | 17,136 | |||||||||||||||||||||||||||||||||
Premises and equipment | 13,282 | 12,839 | 11,055 | |||||||||||||||||||||||||||||||||
Other assets | 69,423 | 75,360 | 81,796 | |||||||||||||||||||||||||||||||||
Allowance for loan losses | (9,951 | ) | (11,434 | ) | (13,500 | ) | ||||||||||||||||||||||||||||||
TOTAL ASSETS | $ | 1,060,102 | $ | 1,019,937 | $ | 984,521 | ||||||||||||||||||||||||||||||
Interest bearing liabilities: |
||||||||||||||||||||||||||||||||||||
Interest bearing deposits: |
||||||||||||||||||||||||||||||||||||
Interest bearing demand | $ | 97,641 | $ | 191 | 0.20 | % | $ | 75,126 | $ | 138 | 0.18 | % | $ | 60,810 | $ | 116 | 0.19 | % | ||||||||||||||||||
Savings | 89,554 | 144 | 0.16 | 87,819 | 139 | 0.16 | 85,112 | 181 | 0.21 | |||||||||||||||||||||||||||
Money market | 228,150 | 761 | 0.33 | 212,735 | 736 | 0.35 | 211,744 | 895 | 0.42 | |||||||||||||||||||||||||||
Other time | 300,915 | 3,793 | 1.26 | 312,741 | 4,151 | 1.33 | 327,557 | 5,310 | 1.62 | |||||||||||||||||||||||||||
Total interest bearing deposits | 716,260 | 4,889 | 0.68 | 688,421 | 5,164 | 0.75 | 685,223 | 6,502 | 0.95 | |||||||||||||||||||||||||||
Federal funds purchased and other short-term borrowings | 18,783 | 55 | 0.29 | 17,973 | 46 | 0.26 | 5,342 | 11 | 0.21 | |||||||||||||||||||||||||||
Advances from Federal Home Loan Bank | 32,885 | 333 | 1.01 | 18,170 | 152 | 0.84 | 5,661 | 81 | 1.44 | |||||||||||||||||||||||||||
Guaranteed junior subordinated deferrable interest debentures | 13,085 | 1,120 | 8.57 | 13,085 | 1,120 | 8.57 | 13,085 | 1,120 | 8.57 | |||||||||||||||||||||||||||
TOTAL INTEREST BEARING LIABILITIES/INTEREST EXPENSE | 781,013 | 6,397 | 0.82 | 737,649 | 6,482 | 0.88 | 709,311 | 7,714 | 1.09 | |||||||||||||||||||||||||||
Non-interest bearing liabilities: |
||||||||||||||||||||||||||||||||||||
Demand deposits | 155,365 | 158,169 | 147,887 | |||||||||||||||||||||||||||||||||
Other liabilities | 7,969 | 13,378 | 15,517 | |||||||||||||||||||||||||||||||||
Stockholders equity | 115,755 | 110,741 | 111,806 | |||||||||||||||||||||||||||||||||
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY | $ | 1,060,102 | $ | 1,019,937 | $ | 984,521 | ||||||||||||||||||||||||||||||
Interest rate spread | 3.36 | 3.39 | 3.43 | |||||||||||||||||||||||||||||||||
Net interest income/net interest margin | 34,068 | 3.52 | % | 32,886 | 3.56 | % | 32,230 | 3.65 | % | |||||||||||||||||||||||||||
Tax-equivalent adjustment | (24 | ) | (25 | ) | (27 | ) | ||||||||||||||||||||||||||||||
Net interest income | $ | 34,044 | $ | 32,861 | $ | 32,203 |
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Net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The table below sets forth an analysis of volume and rate changes in net interest income on a tax-equivalent basis. For purposes of this table, changes in interest income and interest expense are allocated to volume and rate categories based upon the respective percentage changes in average balances and average rates. Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.
2014 vs. 2013 | 2013 vs. 2012 | |||||||||||||||||||||||
INCREASE (DECREASE) DUE TO CHANGE IN: |
INCREASE (DECREASE) DUE TO CHANGE IN: |
|||||||||||||||||||||||
AVERAGE VOLUME | RATE | TOTAL | AVERAGE VOLUME |
RATE | TOTAL | |||||||||||||||||||
(IN THOUSANDS) | ||||||||||||||||||||||||
INTEREST EARNED ON: |
||||||||||||||||||||||||
Loans, net of unearned income | $ | 3,853 | $ | (2,632 | ) | $ | 1,221 | $ | 1,730 | $ | (1,427 | ) | $ | 303 | ||||||||||
Deposits with banks | | (1 | ) | (1 | ) | (1 | ) | (3 | ) | (4 | ) | |||||||||||||
Short-term investments in money market funds | (1 | ) | | (1 | ) | 3 | (13 | ) | (10 | ) | ||||||||||||||
Investment securities: |
||||||||||||||||||||||||
Available for sale | (332 | ) | 159 | (173 | ) | (570 | ) | (363 | ) | (933 | ) | |||||||||||||
Held to maturity | 44 | 7 | 51 | 107 | (39 | ) | 68 | |||||||||||||||||
Total investment securities | (288 | ) | 166 | (122 | ) | (463 | ) | (402 | ) | (865 | ) | |||||||||||||
Total interest income | 3,564 | (2,467 | ) | 1,097 | 1,269 | (1,845 | ) | (576 | ) | |||||||||||||||
INTEREST PAID ON: |
||||||||||||||||||||||||
Interest bearing demand deposits | 39 | 14 | 53 | 28 | (6 | ) | 22 | |||||||||||||||||
Savings deposits | 5 | | 5 | 6 | (48 | ) | (42 | ) | ||||||||||||||||
Money market | 118 | (93 | ) | 25 | 5 | (164 | ) | (159 | ) | |||||||||||||||
Other time deposits | (150 | ) | (208 | ) | (358 | ) | (234 | ) | (925 | ) | (1,159 | ) | ||||||||||||
Federal funds purchased and other short-term borrowings | 3 | 6 | 9 | 36 | (1 | ) | 35 | |||||||||||||||||
Advances from Federal Home Loan Bank | 145 | 36 | 181 | 87 | (16 | ) | 71 | |||||||||||||||||
Total interest expense | 160 | (245 | ) | (85 | ) | (72 | ) | (1,160 | ) | (1,232 | ) | |||||||||||||
Change in net interest income | $ | 3,404 | $ | (2,222 | ) | $ | 1,182 | $ | 1,341 | $ | (685 | ) | $ | 656 |
LOAN QUALITY... The Companys written lending policies require underwriting, loan documentation, and credit analysis standards to be met prior to funding any loan. After the loan has been approved and funded, continued periodic credit review is required. The Companys policy is to individually review, as circumstances warrant, each of its commercial and commercial mortgage loans to determine if a loan is impaired. At a minimum, credit reviews are mandatory for all commercial and commercial mortgage loan relationships with aggregate balances in excess of $250,000 within a 12-month period. The Company has also identified three pools of small dollar value homogeneous loans which are evaluated collectively for impairment. These separate pools are for small business relationships with aggregate balances of $250,000 or less, residential mortgage loans and consumer loans. Individual loans within these pools are reviewed and removed from the pool if factors such as significant delinquency in payments of 90 days or more, bankruptcy, or other negative economic concerns indicate impairment. The following table sets forth information concerning the Companys loan delinquency and other non-performing assets.
20
AT DECEMBER 31, | ||||||||||||
2014 | 2013 | 2012 | ||||||||||
(IN THOUSANDS, EXCEPT PERCENTAGES) | ||||||||||||
Total accruing loans past due 30 to 89 days | $ | 2,643 | $ | 3,264 | $ | 3,456 | ||||||
Total non-accrual loans | 2,196 | 2,871 | 5,814 | |||||||||
Total non-performing assets including TDRs(1) | 2,917 | 4,109 | 7,224 | |||||||||
Loan delinquency as a percentage of total loans, net of unearned income | 0.32 | % | 0.42 | % | 0.48 | % | ||||||
Non-accrual loans as a percentage of total loans, net of unearned income | 0.27 | 0.37 | 0.81 | |||||||||
Non-performing assets as a percentage of total loans, net of unearned income, and other real estate owned | 0.35 | 0.52 | 1.00 | |||||||||
Non-performing assets as a percentage of total assets | 0.27 | 0.39 | 0.72 | |||||||||
Total classified loans (loans rated substandard or doubtful) | $ | 11,229 | $ | 11,779 | $ | 22,717 |
(1) | Non-performing assets are comprised of (i) loans that are on a non-accrual basis, (ii) loans that are contractually past due 90 days or more as to interest and principal payments, (iii) performing loans classified as troubled debt restructuring and (iv) other real estate owned. |
As a result of successful ongoing problem credit resolution efforts, the Company realized further asset quality improvements in 2014. Each of the metrics in the above table demonstrated improvement in 2014 as particularly evidenced by reduced levels of non-accrual loans, non-performing assets, classified loans and low loan delinquency levels that continue to be well below 1% of total loans. We continue to closely monitor the loan portfolio given the uneven recovery in the economy and the number of relatively large-sized commercial and CRE loans within the portfolio. As of December 31, 2014, the 25 largest credits represented 26.6% of total loans outstanding.
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ALLOWANCE AND PROVISION FOR LOAN LOSSES... As described in more detail in the Critical Accounting Policies and Estimates section of this MD&A, the Company uses a comprehensive methodology and procedural discipline to maintain an ALL to absorb inherent losses in the loan portfolio. The Company believes this is a critical accounting policy since it involves significant estimates and judgments. The following table sets forth changes in the ALL and certain ratios for the periods ended.
YEAR ENDED DECEMBER 31, | ||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||
(IN THOUSANDS, EXCEPT RATIOS AND PERCENTAGES) | ||||||||||||||||||||
Balance at beginning of year | $ | 10,104 | $ | 12,571 | $ | 14,623 | $ | 19,765 | $ | 19,685 | ||||||||||
Charge-offs: |
||||||||||||||||||||
Commercial | (172 | ) | (50 | ) | (345 | ) | (953 | ) | (835 | ) | ||||||||||
Commercial loans secured by real estate | (708 | ) | (1,777 | ) | (796 | ) | (1,700 | ) | (4,221 | ) | ||||||||||
Real estate-mortgage | (322 | ) | (139 | ) | (420 | ) | (85 | ) | (293 | ) | ||||||||||
Consumer | (121 | ) | (154 | ) | (200 | ) | (203 | ) | (282 | ) | ||||||||||
Total charge-offs | (1,323 | ) | (2,120 | ) | (1,761 | ) | (2,941 | ) | (5,631 | ) | ||||||||||
Recoveries: |
||||||||||||||||||||
Commercial | 141 | 80 | 138 | 831 | 226 | |||||||||||||||
Commercial loans secured by real estate |
231 | 481 | 245 | 331 | 48 | |||||||||||||||
Real estate-mortgage | 71 | 122 | 54 | 53 | 42 | |||||||||||||||
Consumer | 24 | 70 | 47 | 159 | 145 | |||||||||||||||
Total recoveries | 467 | 753 | 484 | 1,374 | 461 | |||||||||||||||
Net charge-offs | (856 | ) | (1,367 | ) | (1,277 | ) | (1,567 | ) | (5,170 | ) | ||||||||||
Provision (credit) for loan losses | 375 | (1,100 | ) | (775 | ) | (3,575 | ) | 5,250 | ||||||||||||
Balance at end of year | $ | 9,623 | $ | 10,104 | $ | 12,571 | $ | 14,623 | $ | 19,765 | ||||||||||
Loans and loans held for sale, net of unearned income: |
||||||||||||||||||||
Average for the year | $ | 804,721 | $ | 746,490 | $ | 688,736 | $ | 662,746 | $ | 701,502 | ||||||||||
At December 31 | 832,131 | 786,748 | 731,741 | 670,847 | 678,181 | |||||||||||||||
As a percent of average loans: |
||||||||||||||||||||
Net charge-offs | 0.11 | % | 0.18 | % | 0.19 | % | 0.24 | % | 0.74 | % | ||||||||||
Provision (credit) for loan losses | 0.05 | (0.15 | ) | (0.11 | ) | (0.54 | ) | 0.75 | ||||||||||||
Allowance as a percent of each of the following: |
||||||||||||||||||||
Total loans, net of unearned income | 1.16 | 1.29 | 1.74 | 2.20 | 2.95 | |||||||||||||||
Total accruing delinquent loans (past due 30 to 89 days) | 364.09 | 309.56 | 363.74 | 440.58 | 708.17 | |||||||||||||||
Total non-accrual loans | 438.21 | 351.93 | 216.22 | 288.14 | 160.83 | |||||||||||||||
Total non-performing assets | 329.89 | 245.90 | 174.02 | 281.27 | 137.60 | |||||||||||||||
Allowance as a multiple of net charge-offs | 11.24x | 7.39x | 9.84x | 9.33x | 3.82x |
For 2014, the Company recorded a $375,000 provision for loan losses compared to a $1.1 million negative provision for the 2013 year. This represents an unfavorable swing of $1.5 million between years and is a significant factor contributing to the lower earnings in 2014. The positive provision in 2014 was needed to partially cover net loan charge-offs and support the continuing growth of the loan portfolio. In 2014 actual credit losses realized through net charge-offs totaled $856,000, or 0.11% of average total loans, which represents a decrease from the 2013 year when net charge-offs totaled $1.4 million, or 0.18% of average total loans. Overall, for the 2014 year, the Company continued to maintain outstanding asset quality. At December 31, 2014, non-performing assets totaled $2.9 million, or only 0.35% of total loans, which represents
22
the first time that our non-performing assets have been under $3 million since 2007. In summary, the ALL provided a strong 400% coverage of non-performing loans, and 1.16% of total loans, at December 31, 2014, compared to 327% coverage of non-performing loans, and 1.29% of total loans, at December 31, 2013. The Company presently expects that it will have greater positive loan loss provisions in 2015 to support the expected growth of the loan portfolio.
The Company recorded for the 2013 year a negative loan loss provision of $1.1 million compared to a $775,000 negative provision for the 2012 year. There was $325,000 more earnings benefit from negative loan loss provisions in 2013. The 2013 negative provision primarily resulted from the release of reserves due to the fourth quarter pay-off of a large classified loan and a continued reduction in the level of criticized loans and non-performing assets. At December 31, 2013, non-performing assets totaled $4.1 million or 0.52% of total loans which is $3.1 million lower than they were at the end of 2012. Net loan charge-offs for 2013 totaled $1.4 million or 0.18% of average total loans which is comparable with 2012 when net charge-offs totaled $1.3 million or 0.19% of average total loans.
The following schedule sets forth the allocation of the ALL among various loan categories. This allocation is determined by using the consistent quarterly procedural discipline that was previously discussed. The entire ALL is available to absorb future loan losses in any loan category.
AT DECEMBER 31, | ||||||||||||||||||||||||||||||||||||||||
2014 | 2013 | 2012 | 2011 | 2010 | ||||||||||||||||||||||||||||||||||||
AMOUNT | PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS |
AMOUNT | PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS |
AMOUNT | PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS |
AMOUNT | PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS |
AMOUNT | PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS |
|||||||||||||||||||||||||||||||
(IN THOUSANDS, EXCEPT PERCENTAGES) | ||||||||||||||||||||||||||||||||||||||||
Commercial | $ | 3,262 | 16.8 | % | $ | 2,844 | 15.3 | % | $ | 2,596 | 14.3 | % | $ | 2,365 | 12.5 | % | $ | 3,851 | 11.5 | % | ||||||||||||||||||||
Commercial loans secured by real estate | 3,902 | 49.6 | 4,885 | 52.6 | 7,796 | 53.2 | 9,400 | 52.8 | 12,717 | 54.6 | ||||||||||||||||||||||||||||||
Real estate-mortgage | 1,310 | 31.3 | 1,260 | 30.1 | 1,269 | 30.2 | 1,270 | 32.0 | 1,117 | 31.1 | ||||||||||||||||||||||||||||||
Consumer | 190 | 2.3 | 136 | 2.0 | 150 | 2.3 | 174 | 2.7 | 206 | 2.8 | ||||||||||||||||||||||||||||||
Allocation to general risk | 959 | | 979 | | 760 | | 1,414 | | 1,874 | | ||||||||||||||||||||||||||||||
Total | $ | 9,623 | 100.0 | % | $ | 10,104 | 100.0 | % | $ | 12,571 | 100.0 | % | $ | 14,623 | 100.0 | % | $ | 19,765 | 100.0 | % |
Even though residential real estate-mortgage loans comprise 31.3% of the Companys total loan portfolio, only $1.3 million or 13.6% of the total ALL is allocated against this loan category. The residential real estate-mortgage loan allocation is based upon the Companys three-year historical average of actual loan charge-offs experienced in that category and other qualitative factors. The disproportionately higher allocations for commercial loans and commercial loans secured by real estate reflect the increased credit risk associated with this type of lending, the Companys historical loss experience in these categories, and other qualitative factors. The large decline in the part of the allowance allocated to commercial loans secured by real estate reflects the continued asset quality improvements in this sector.
Based on the Companys ALL methodology and the related assessment of the inherent risk factors contained within the Companys loan portfolio, we believe that the ALL is adequate at December 31, 2014 to cover losses within the Companys loan portfolio.
NON-INTEREST INCOME... Non-interest income for 2014 totalled $14.3 million, a decrease of $1.4 million, or 9.0%, from 2013. Factors contributing to this lower level of non-interest income in 2014 included:
| Reduced revenue from residential mortgage banking activities was caused by both lower refinance activity due to higher mortgage rates and reduced purchase activity in 2014. As a result, gains realized on residential mortgage loan sales into the secondary market declined by $341,000 or 31.3% and mortgage related fees dropped by $183,000 due largely to lower mortgage origination and underwriting fees. |
23
| a $216,000, or 9.9% decrease in service charges on deposit accounts due to fewer overdraft charges and account analysis fees as customers have generally maintained higher balances in their checking accounts in 2014. |
| a $250,000, or 25.1%, decrease in Bank Owned Life Insurance (BOLI) revenue due largely to the receipt of a death claim payment in 2013. |
| a $357,000 decrease in other income due to a $226,000 reduction in financial services commission revenue and a net unfavorable swing of $140,000 on OREO property transactions. |
Non-interest income for 2013 totalled $15.7 million, an increase of $801,000, or 5.4%, from 2012. Factors contributing to this higher level of non-interest income in 2013 included:
| a $544,000, or 7.5%, increase in trust and investment advisory fees due to increased assets under management which reflects both successful new business development efforts and market appreciation of existing assets given the strong equity market performance in 2013. |
| a $204,000 investment security gain realized on the sale of certain rapidly prepaying mortgage backed securities in 2013. There was only $12,000 of investment security gains realized in 2012. |
| a $135,000, or 15.6%, increase in BOLI due to the receipt of a death claim payment in 2013. |
| a $43,000, or 3.8%, decrease in gains realized on residential mortgage loan sales into the secondary market due to a reduced level of mortgage loan production and refinance activity in the second half of 2013. |
NON-INTEREST EXPENSE... Non-interest expense for 2014 totalled $43.4 million, a $1.1 million, or 2.7%, increase from 2013. Factors contributing to the higher non-interest expense in 2014 included:
| professional fees increased by $1.1 million in 2014 due to higher legal costs related to litigation against the former CEO of WCCA, the consulting costs associated with our profitability improvement project and new recurring costs related to outsourcing our computer operations and statement processing to a third party vendor. The overall cost savings benefit from outsourcing these services is captured in lower personnel costs in these departments and reduced software expense, which is a key factor contributing to the decline in other expenses of $199,000 in 2014. |
| the recognition of a $669,000 goodwill impairment charge during the third quarter of 2014. The voluntary departure of WCCAs former CEO, and the related litigation against him for violations of his employment agreement, caused disruption within the WCCA customer base during 2014. This disruption ultimately led to the loss of certain clients and a reduction in the projected earnings capacity of WCCA which caused the Company to incur the goodwill impairment charge. |
| a $293,000 decrease in miscellaneous taxes and insurance due to reduced Pennsylvania bank shares tax expense resulting from a change in the calculation methodology that took effect January 1, 2014. |
| a $155,000, or 0.6%, decrease in salaries and employee benefits expense due to lower salaries and incentive compensation in 2014. This reduction occurred even with a $376,000 pension charge in the fourth quarter of 2014 related to 25 employees who elected to participate in an early retirement incentive program. Since the majority of these retired employees will not be replaced, the Company expects to achieve meaningful salary and benefits expense savings in 2015. |
Non-interest expense for 2013 totalled $42.2 million, a $1.6 million, or 3.9%, increase from 2012. Factors contributing to the higher non-interest expense in 2013 included:
| a $691,000, or 2.8%, increase in salaries and employee benefits expense due to higher salaries expense and pension expense in 2013. |
| a $457,000 increase in professional fees due largely to higher legal costs, recruitment fees, and increases in several other professional fee categories which included the cost for outsourcing the computer operations function for part of the year. |
| a $170,000 increase in FDIC insurance expense due largely to the Banks increased asset size. |
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INCOME TAX EXPENSE... The Company recorded income tax expense of $1.6 million or an effective tax rate of 34.6% for 2014 compared to income tax expense of $2.3 million or an effective tax rate of 30.6% for 2013. The higher effective tax rate in 2014 was primarily due to the non-deductibility of the goodwill impairment charge for tax purposes. The income tax expense recorded in 2012 was $2.2 million or an effective tax rate of 30.8% which was comparable with 2013. BOLI is the Companys largest source of tax-free earnings. The Companys deferred tax asset was $9.6 million at December 31, 2014 and relates primarily to net operating loss carryforwards and the ALL.
SEGMENT RESULTS... Retail bankings net income contribution was $2.2 million in 2014 compared to $2.8 million in 2013 and $3.2 million in 2012. This decline in earnings in 2014 was due primarily to lower non-interest income resulting from the previously discussed decrease in residential mortgage banking related revenues, lower deposit service charges and reduced revenue from BOLI in 2014. Net interest income was also down modestly in this segment reflecting the ongoing net interest margin pressure from the continued low interest rate environment which causes the funding benefit for deposits provided by this segment to be lower. These negative items were partially offset by reduced non-interest expense due largely to lower personnel costs. The reduced earnings in 2013 was due largely to lower net interest income resulting from the previously discussed net interest margin pressure, modestly lower non-interest income and higher non-interest expense. The decline in non-interest income reflects decreased residential mortgage banking related revenues resulting from the reduced mortgage production in the second half of the year. The increase in non-interest expense was largely due to a $170,000 increase in FDIC deposit insurance expense in 2013.
The commercial banking segment reported net income of $4.2 million in 2014 compared to net income of $5.0 million in 2013 and $4.7 million in 2012. The reduced net income contribution was due to a net unfavorable swing of $1.3 million in the provision for loan losses from a negative provision of $1.0 million in 2013 to a positive provision of $318,000 in 2014. Non-interest expense also increased in this segment due higher salaries and employee benefit costs as we have increased staffing levels within this segment to generate and support the solid commercial loan growth that we have achieved. These negative items were partially offset by higher net interest income as a result of the previously discussed strong growth in commercial and CRE loans over the past year. Continued improvements in asset quality resulted in a negative provision for loan losses in 2013. Overall, there has been $393,000 additional earnings benefit from negative loan loss provisions in this segment in 2013. This segment also benefitted from a $1.2 million increase in net interest income due to growth in commercial loans in 2013. These positive items were partially offset by a $1.2 million increase in non-interest expense due to higher personnel costs, the costs associated with all three new loan production offices being operational for the entire year and a $238,000 increase in the reserve for unfunded commitments due to increased loan approval activity.
The trust segments net income contribution was $564,000 in 2014 compared to $1.2 million in 2013 and $945,000 in 2012. The 2014 year was negatively impacted by the previously discussed $669,000 goodwill impairment charge at WCCA due to the loss of certain clients and a reduction in the projected earnings capacity of WCCA. Non-interest revenue for this segment was also negatively impacted by client attrition at WCCA and lower financial services revenue due to fewer production personnel in 2014. However, non-interest expense in this segment (excluding the goodwill impairment charge) was also down due to reduced personnel cost at WCCA which has helped mitigate a significant portion of the revenue decline. The higher net income contribution in 2013 was due to $607,000 more revenue from increased assets under management which reflects both successful new business development efforts and market appreciation of existing assets given the strong equity market performance in 2013. This more than offset higher non-interest expense from increased personnel costs and professional fees. Overall, the fair market value of trust assets under administration totaled $1.784 billion at December 31, 2014, an increase of $115.6 million, or 6.9%, from the December 31, 2013 total of $1.669 billion.
The investment/parent segment reported a net loss of $3.9 million in 2014 which was comparable with the net loss of $3.8 million in 2013 and $3.7 million in 2012. Overall this segment has felt the most earnings pressure from the continued low interest rate environment and declining investment security balances which have been utilized to help fund loan growth. Additionally, all of the interest expense is allocated to this
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segment. The Company did generate investment security gains of $177,000 in 2014 and $204,000 in 2013 from the sale of certain rapidly prepaying mortgage backed securities which had a favorable impact on earnings in this segment.
For greater discussion on the future strategic direction of the Companys key business segments, see Managements Discussion and Analysis Forward Looking Statements.
BALANCE SHEET... The Company's total consolidated assets of $1.089 billion at December 31, 2014 grew by $33 million or 3.2% from the $1.056 billion level at December 31, 2013. This asset growth was due primarily to a $43.7 million or 5.6% increase in total loans in 2014. This loan growth reflects the successful results of the Companys more intensive sales calling efforts with an emphasis on generating commercial loans and owner occupied CRE loans particularly through its loan production offices. This loan increase was partially offset by a $13.2 million decrease in investment securities as the Company utilized this item to help fund the loan growth.
The Company also funded the previously mentioned asset growth with a combination of both increased deposits ($15 million) and FHLB advances ($17 million). The FHLB term advances, with maturities between 3 and 5 years, now total $42 million as the Company has utilized these advances to help manage interest rate risk in a rising rate environment. Other liabilities increased by $2.4 million due to an increase in the Companys pension liability. Total stockholders equity increased by $1.1 million since year-end 2013 mainly due to increased retained earnings as the Companys net income available to common shareholders more than exceeded funds used for common stock cash dividend payments. The Company continues to be considered well capitalized for regulatory purposes with a risk based capital ratio of 14.80% and an asset leverage ratio of 11.34% at December 31, 2014. The Companys book value per common share was $4.97, its tangible book value per common share was $4.33 and its tangible common equity to tangible assets ratio was 7.56% at December 31, 2014.
LIQUIDITY... The Companys liquidity position has been strong during the last several years. Our core retail deposit base has grown over the past three years and has been adequate to fund the Companys operations. Cash flow from maturities, prepayments and amortization of securities was also used to help fund loan growth over the past two years. We strive to operate our loan to deposit ratio in a range of 85% to 100%. At December 31, 2014, the Companys loan to deposit ratio was 95.7%. We are optimistic that we can further increase the loan to deposit ratio in 2015 given current commercial loan pipelines, the continued development of our three existing loan production offices, and the opening of a new loan production office in Harrisonburg Virginia in 2015.
Liquidity can also be analyzed by utilizing the Consolidated Statement of Cash Flows. Cash and cash equivalents increased by $2.8 million from December 31, 2013, to December 31, 2014, due to $28.7 million of cash provided by financing activities and $5.0 of cash provided by operating activities. This was partially offset by $30.9 million of cash used in investing activities. Within investing activities, cash advanced for new loan fundings and purchases totalled $182.7 million and was $41.4 million higher than the $141.3 million of cash received from loan principal payments and sales. Within financing activities, deposits increased by $15.4 million, which was used to help fund the overall loan growth experienced in 2014. Total FHLB borrowings increased as advances, both short-term and long term, exceeded pay downs by $14 million and was also utilized to fund earning asset growth.
The holding company had a total of $17.6 million of cash, short-term investments, and investment securities at December 31, 2014. Additionally, dividend payments from our subsidiaries can also provide ongoing cash to the holding company. At December 31, 2014, our subsidiary Bank had $514,000 of cash available for immediate dividends to the holding company under applicable regulatory formulas. As such, the holding company has strong liquidity to meet its trust preferred debt service requirements, its SBLF preferred stock dividends, and its common stock dividends, which in total should approximate $2 million over the next twelve months.
Financial institutions must maintain liquidity to meet day-to-day requirements of depositors and borrowers, take advantage of market opportunities, and provide a cushion against unforeseen needs. Liquidity needs can be met by either reducing assets or increasing liabilities. Sources of asset liquidity are provided by
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short-term investment securities, time deposits with banks, federal funds sold, and short-term investments in money market funds. These assets totaled $33 million and $30 million at December 31, 2014 and 2013, respectively. Maturing and repaying loans, as well as the monthly cash flow associated with mortgage-backed securities and security maturities are other significant sources of asset liquidity for the Company.
Liability liquidity can be met by attracting deposits with competitive rates, using repurchase agreements, buying federal funds, or utilizing the facilities of the Federal Reserve or the FHLB systems. The Company utilizes a variety of these methods of liability liquidity. Additionally, the Companys subsidiary bank is a member of the FHLB, which provides the opportunity to obtain short- to longer-term advances based upon the Companys investment in assets secured by one- to four-family residential real estate. At December 31, 2014, the Company had $347 million of overnight borrowing availability at the FHLB, $40 million of short-term borrowing availability at the Federal Reserve Bank and $39 million of unsecured federal funds lines with correspondent banks. The Company believes it has ample liquidity available to fund outstanding loan commitments if they were fully drawn upon.
CAPITAL RESOURCES... The Company meaningfully exceeds all regulatory capital ratios for each of the periods presented and is considered well capitalized. The asset leverage ratio was 11.34% and the risk based capital ratio was 14.80% at December 31, 2014. We anticipate that we will maintain our strong capital ratios throughout 2015. Capital generated from earnings will be utilized to pay the SBLF preferred dividend, common stock cash dividend and will also support anticipated balance sheet growth. Our common dividend payout ratio for the full year 2014 was 26.7%. Even after satisfying these obligations, we believe that we will still be able to build the holding companys cash position in 2015 which currently stands at $17.6 million. We are presently planning to utilize a meaningful part of this cash to redeem a portion of the SBLF preferred stock in the first quarter of 2016 when the interest rate is scheduled to increase from 1% to 9%.
On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. The final rules implement the Basel III regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act. The July 2013 final rules generally implement higher minimum capital requirements, add a new common equity tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity tier 1 capital, additional tier 1 capital or tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered well capitalized) and a tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered well capitalized); the total capital ratio remains at 8.0% under the new rules (10.0% to be considered well capitalized). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements are effective for the Company and the Bank on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016.
The July 2013 final rules include three significant changes from the proposals initially made by federal banking regulators in September 2012: (i) the final rules do not change the current risk weighting for residential mortgage exposures; (ii) the final rules permit institutions, other than certain large institutions, to elect to continue to treat certain components of accumulated other comprehensive income as permitted under the current general risk-based capital rules, and not reflect unrealized gains and losses on available-for-sale securities in common equity tier 1 calculations; and (iii) the final rules permit institutions with less than $15.0 billion in assets to grandfather certain non-qualifying capital instruments (including trust preferred securities) issued prior to May 19, 2009 into tier 1 capital.
The Company is continuing to review the impact of these new rules and currently expects that its capital position will be more than adequate to meet the revised regulatory capital requirements.
INTEREST RATE SENSITIVITY... Asset/liability management involves managing the risks associated with changing interest rates and the resulting impact on the Companys net interest income, net income and capital. The management and measurement of interest rate risk at the Company is performed by using the following tools: 1) simulation modeling, which analyzes the impact of interest rate changes on net interest
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income, net income and capital levels over specific future time periods. The simulation modeling forecasts earnings under a variety of scenarios that incorporate changes in the absolute level of interest rates, the shape of the yield curve, prepayments and changes in the volumes and rates of various loan and deposit categories. The simulation modeling incorporates assumptions about reinvestment and the repricing characteristics of certain assets and liabilities without stated contractual maturities; 2) market value of portfolio equity sensitivity analysis, and 3) static GAP analysis, which analyzes the extent to which interest rate sensitive assets and interest rate sensitive liabilities are matched at specific points in time. The overall interest rate risk position and strategies are reviewed by senior management and the Companys Board on an ongoing basis.
The following table presents a summary of the Companys static GAP positions at December 31, 2014:
INTEREST SENSITIVITY PERIOD | 3 MONTHS OR LESS |
OVER 3 MONTHS THROUGH 6 MONTHS |
OVER 6 MONTHS THROUGH 1 YEAR |
OVER 1 YEAR |
TOTAL | |||||||||||||||
(IN THOUSANDS, EXCEPT RATIOS AND PERCENTAGES) | ||||||||||||||||||||
RATE SENSITIVE ASSETS: |
||||||||||||||||||||
Loans and loans held for sale | $ | 226,727 | $ | 56,024 | $ | 90,390 | $ | 458,990 | $ | 832,131 | ||||||||||
Investment securities | 25,969 | 7,658 | 15,389 | 97,934 | 146,950 | |||||||||||||||
Short-term assets | 9,092 | | | | 9,092 | |||||||||||||||
Regulatory stock | 4,048 | | | 2,125 | 6,173 | |||||||||||||||
Bank owned life insurance | | | 37,417 | | 37,417 | |||||||||||||||
Total rate sensitive assets | $ | 265,836 | $ | 63,682 | $ | 143,196 | $ | 559,049 | $ | 1,031,763 | ||||||||||
RATE SENSITIVE LIABILITIES: |
||||||||||||||||||||
Deposits: |
||||||||||||||||||||
Non-interest bearing deposits | $ | | $ | | $ | | $ | 167,551 | $ | 167,551 | ||||||||||
NOW | | | | 89,676 | 89,676 | |||||||||||||||
Money market | 179,827 | | | 41,551 | 221,378 | |||||||||||||||
Other savings | 22,504 | | | 67,516 | 90,020 | |||||||||||||||
Certificates of deposit of $100,000 or more | 4,483 | 23,171 | 13,927 | 8,948 | 50,529 | |||||||||||||||
Other time deposits | 68,273 | 31,312 | 30,505 | 120,637 | 250,727 | |||||||||||||||
Total deposits | 275,087 | 54,483 | 44,432 | 495,879 | 869,881 | |||||||||||||||
Borrowings | 38,880 | | 4,000 | 51,085 | 93,965 | |||||||||||||||
Total rate sensitive liabilities | $ | 313,967 | $ | 54,483 | $ | 48,432 | $ | 546,964 | $ | 963,846 | ||||||||||
INTEREST SENSITIVITY GAP: |
||||||||||||||||||||
Interval | (48,131 | ) | 9,199 | 94,764 | 12,085 | | ||||||||||||||
Cumulative | $ | (48,131 | ) | $ | (38,932 | ) | $ | 55,832 | $ | 67,917 | $ | 67,917 | ||||||||
Period GAP ratio | 0.85X | 1.17X | 2.96X | 1.02X | ||||||||||||||||
Cumulative GAP ratio | 0.85 | 0.89 | 1.13 | 1.07 | ||||||||||||||||
Ratio of cumulative GAP to total assets | (4.42 | )% | (3.57 | )% | 5.13 | % | 6.24 | % |
When December 31, 2014 is compared to December 31, 2013, the Companys cumulative GAP ratio through one year indicates that the Companys balance sheet is still asset sensitive with some improvement noted between years. We continue to see loan customer preference for fixed rate loans given the overall low level of interest rates. Also, we have extended some term advances with the FHLB to help manage our interest rate risk position. Overall, the absolute low level of short interest rates makes this table more difficult to analyze since there is little room for certain deposit liabilities to reprice downward further.
Management places primary emphasis on simulation modeling to manage and measure interest rate risk. The Companys asset/liability management policy seeks to limit net interest income variability over the first twelve months of the forecast period to +/-7.5%, which include interest rate movements of 200 basis points. Additionally, the Company also uses market value sensitivity measures to further evaluate the balance sheet
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exposure to changes in interest rates. The Company monitors the trends in market value of portfolio equity sensitivity analysis on a quarterly basis.
The following table presents an analysis of the sensitivity inherent in the Companys net interest income and market value of portfolio equity. The interest rate scenarios in the table compare the Companys base forecast, which was prepared using a flat interest rate scenario, to scenarios that reflect immediate interest rate changes of 100 and 200 basis points. Note that we suspended the 200 basis point downward rate shock since it has little value due to the absolute low level of interest rates. Each rate scenario contains unique prepayment and repricing assumptions that are applied to the Companys existing balance sheet that was developed under the flat interest rate scenario.
INTEREST RATE SCENARIO | VARIABILITY OF NET INTEREST INCOME |
CHANGE IN MARKET VALUE OF PORTFOLIO EQUITY |
||||||
200 bp increase | 0.8 | % | 9.2 | % | ||||
100 bp increase | 0.6 | 6.3 | ||||||
100 bp decrease | (3.8 | ) | (14.4 | ) |
The Company believes that its overall interest rate risk position is well controlled. The variability of net interest income is modestly positive in the upward rate shocks due to the Companys short duration investment securities portfolio and scheduled repricing of loans tied to LIBOR or prime. Also, the Company expects that it will not have to reprice its core deposit accounts up as quickly when interest rates rise. The variability of net interest income is negative in the 100 basis point downward rate scenario as the Company has more exposure to assets repricing downward to a greater extent than liabilities due to the absolute low level of interest rates with the fed funds rate currently at 0.25%. The market value of portfolio equity increases in the upward rate shocks due to the improved value of the Companys core deposit base. Negative variability of market value of portfolio equity occurs in the downward rate shock due to a reduced value for core deposits.
Within the investment portfolio at December 31, 2014, 86% of the portfolio is classified as available for sale and 14% as held to maturity. The available for sale classification provides management with greater flexibility to manage the securities portfolio to better achieve overall balance sheet rate sensitivity goals and provide liquidity if needed. The mark to market of the available for sale securities does inject more volatility in the book value of equity, but has no impact on regulatory capital. There are 38 securities that are temporarily impaired at December 31, 2014. The Company reviews its securities quarterly and has asserted that at December 31, 2014, the impaired value of securities represents temporary declines due to movements in interest rates and the Company does have the ability and intent to hold those securities to maturity or to allow a market recovery. Furthermore, it is the Companys intent to manage its long-term interest rate risk by continuing to sell newly originated fixed-rate 30-year mortgage loans into the secondary market (excluding construction and any jumbo loans). The Company also sells 15-year fixed-rate mortgage loans into the secondary market as well, depending on market conditions. For the year 2014, 59% of all residential mortgage loan production was sold into the secondary market.
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The amount of loans outstanding by category as of December 31, 2014, which are due in (i) one year or less, (ii) more than one year through five years, and (iii) over five years, are shown in the following table. Loan balances are also categorized according to their sensitivity to changes in interest rates.
ONE YEAR OR LESS |
MORE THAN ONE YEAR THROUGH FIVE YEARS |
OVER FIVE YEARS |
TOTAL LOANS |
|||||||||||||
(IN THOUSANDS, EXCEPT RATIOS) | ||||||||||||||||
Commercial | $ | 41,663 | $ | 42,388 | $ | 55,075 | $ | 139,126 | ||||||||
Commercial loans secured by real estate | 46,254 | 145,941 | 218,134 | 410,329 | ||||||||||||
Real estate-mortgage | 46,570 | 85,850 | 131,247 | 263,667 | ||||||||||||
Consumer | 6,272 | 8,654 | 4,083 | 19,009 | ||||||||||||
Total | $ | 140,759 | $ | 282,833 | $ | 408,539 | $ | 832,131 | ||||||||
Loans with fixed-rate | $ | 82,788 | $ | 149,392 | $ | 227,768 | $ | 459,948 | ||||||||
Loans with floating-rate | 57,971 | 133,441 | 180,771 | 372,183 | ||||||||||||
Total | $ | 140,759 | $ | 282,833 | $ | 408,539 | $ | 832,131 | ||||||||
Percent composition of maturity | 16.9 | % | 34.0 | % | 49.1 | % | 100.0 | % | ||||||||
Fixed-rate loans as a percentage of total loans | 55.3 | % | ||||||||||||||
Floating-rate loans as a percentage of total loans | 44.7 | % |
The loan maturity information is based upon original loan terms and is not adjusted for principal paydowns and rollovers. In the ordinary course of business, loans maturing within one year may be renewed, in whole or in part, as to principal amount at interest rates prevailing at the date of renewal.
CONTRACTUAL OBLIGATIONS... The following table presents, as of December 31, 2014, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.
PAYMENTS DUE IN | ||||||||||||||||||||||||
NOTE REFERENCE |
ONE YEAR OR LESS |
ONE TO THREE YEARS |
THREE TO FIVE YEARS |
OVER FIVE YEARS |
TOTAL | |||||||||||||||||||
(IN THOUSANDS) | ||||||||||||||||||||||||
Deposits without a stated maturity | 8 | $ | 568,625 | $ | | $ | | $ | | $ | 568,625 | |||||||||||||
Certificates of deposit* | 8 | 173,817 | 55,644 | 41,247 | 40,645 | 311,353 | ||||||||||||||||||
Borrowed funds* | 10 | 43,176 | 24,727 | 14,707 | | 82,610 | ||||||||||||||||||
Guaranteed junior subordinated deferrable interest debentures* | 10 | | | | 25,524 | 25,524 | ||||||||||||||||||
Pension obligation | 14 | 2,500 | | | | 2,500 | ||||||||||||||||||
Lease commitments | 15 | 711 | 1,011 | 439 | 1,561 | 3,722 |
* | Includes interest based upon interest rates in effect at December 31, 2014. Future changes in market interest rates could materially affect contractual amounts to be paid. |
OFF BALANCE SHEET ARRANGEMENTS... The Company incurs off-balance sheet risks in the normal course of business in order to meet the financing needs of its customers. These risks derive from commitments to extend credit and standby letters of credit. Such commitments and standby letters of credit involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated financial statements. The Companys exposure to credit loss in the event of nonperformance by the other party to these commitments to extend credit and standby letters of credit is represented by their contractual amounts. The Company uses the same credit and collateral policies in making commitments and conditional obligations as for all other lending. The Company had various outstanding commitments to extend credit
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approximating $188.0 million and standby letters of credit of $7.2 million as of December 31, 2014. The Company can also use various interest rate contracts, such as interest rate swaps, caps, floors and swaptions to help manage interest rate and market valuation risk exposure, which is incurred in normal recurrent banking activities. The Company had no interest rate contracts outstanding as of December 31, 2014.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES... The accounting and reporting policies of the Company are in accordance with GAAP and conform to general practices within the banking industry. Accounting and reporting policies for the ALL, goodwill, income taxes, and investment securities are deemed critical because they involve the use of estimates and require significant management judgments. Application of assumptions different than those used by the Company could result in material changes in the Companys financial position or results of operation.
ACCOUNT Allowance for loan losses
BALANCE SHEET REFERENCE Allowance for loan losses
INCOME STATEMENT REFERENCE Provision (credit) for loan losses
DESCRIPTION
The allowance for loan losses is calculated with the objective of maintaining reserve levels believed by management to be sufficient to absorb estimated probable credit losses. Managements determination of the adequacy of the allowance is based on periodic evaluations of the credit portfolio and other relevant factors. However, this quarterly evaluation is inherently subjective as it requires material estimates, including, among others, likelihood of customer default, loss given default, exposure at default, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on consumer loans and residential mortgages, and general amounts for historical loss experience. This process also considers economic conditions, uncertainties in estimating losses and inherent risks in the various credit portfolios. All of these factors may be susceptible to significant change. Also, the allocation of the allowance for credit losses to specific loan pools is based on historical loss trends and managements judgment concerning those trends.
Commercial and CRE loans are the largest category of credits and the most sensitive to changes in assumptions and judgments underlying the determination of the ALL. Approximately $7.2 million, or 74%, of the total ALL at December 31, 2014 has been allocated to these two loan categories. This allocation also considers other relevant factors such as actual versus estimated losses, economic trends, delinquencies, levels of non-performing and Troubled Debt Restructured (TDR) loans, concentrations of credit, trends in loan volume, experience and depth of management, examination and audit results, effects of any changes in lending policies and trends in policy, financial information and documentation exceptions. To the extent actual outcomes differ from management estimates, additional provision for loan losses may be required that would adversely impact earnings in future periods.
ACCOUNT Goodwill
BALANCE SHEET REFERENCE Goodwill
INCOME STATEMENT REFERENCE Goodwill impairment
DESCRIPTION
The Company considers our accounting policies related to goodwill to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions or judgment could have a significant impact on our financial condition or results of operations.
The fair value of acquired assets and liabilities, including the resulting goodwill, was based either on quoted market prices or provided by other third party sources, when available. When third party information was not available, estimates were made in good faith by management primarily through the use of internal cash flow modeling techniques. The assumptions that were used in the cash flow modeling were subjective and are susceptible to significant changes. The Company routinely utilizes the services of an independent third party that is regarded within the banking industry as an expert in valuing core deposits to monitor the ongoing
31
value and changes in the Companys core deposit base. These core deposit valuation updates are based upon specific data provided from statistical analysis of the Companys own deposit behavior to estimate the duration of these non-maturity deposits combined with market interest rates and other economic factors.
Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. The Companys goodwill relates to value inherent in the banking and wealth management businesses, and the value is dependent upon the Companys ability to provide quality, cost-effective services in the face of free competition from other market participants on a regional basis. This ability relies upon continuing investments in processing systems, the development of value-added service features and the ease of use of the Companys services. As such, goodwill value is supported ultimately by revenue that is driven by the volume of business transacted and the loyalty of the Companys deposit and customer base over a longer time frame. The quality and value of a Companys assets is also an important factor to consider when performing goodwill impairment testing. A decline in earnings as a result of a lack of growth or the inability to deliver cost-effective value added services over sustained periods can lead to impairment of goodwill.
Goodwill which has an indefinite useful life is tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value.
The Company recorded a $669,000 impairment charge as a result of a goodwill impairment analysis performed in the third quarter of 2014. A qualitative assessment of WCCA indicated that it was more likely than not that the carrying value of WCCA exceeded it fair value. As such, the Company then performed the necessary two-step impairment test. In Step 1, we determined the carrying value of WCCA, including the goodwill, and compared it to the estimated fair value of WCCA. The results of Step 1 indicated that the carrying value of the goodwill exceeded the fair value so it was necessary to move to Step 2 where we measured the amount of the impairment loss. After performing Step 2, we determined that the implied value of the goodwill was less than its carrying costs which caused us to record an impairment charge of $669,000 in the third quarter of 2014. Overall, the voluntary departure of WCCAs former CEO and the related litigation against him for violations of his employment agreement, caused disruption within the WCCA customer base during 2014. This disruption ultimately led to the loss of certain clients and a reduction in the projected earnings capacity of WCCA. These were the key facts and circumstances that led to the goodwill impairment charge in the third quarter of 2014. The Company utilized a discounted cash flow model along with a valuation technique based upon a multiple of revenues to estimate the fair value of WCCA.