This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company's operations, pricing, products and services. Any use of "we" or "our" in the following discussion refers to the Company on a consolidated basis.
Comparison of Financial Condition at
During the three months ended
March 31, 2014, the Company's total assets decreased $1.7 million, from $517.3 millionto $515.6 million. During the same period, cash and cash equivalents decreased $11.5 millionand loans held for investment decreased $2.6 million, while, securities available for sale increased $11.2 million.
Cash and cash equivalents decreased
Investment securities increased
$11.2 millionto $111.5 millionfor the period ended March 31, 2014. During the first three months of 2014, the Company purchased securities of $12.8 million. The increase from new purchases was reduced by sales of $328,000and normal reductions stemming from principal payments on mortgage backed securities. The Company is investing the funds generated from the pay downs in the loan portfolio in lower duration securities as well as variable rate securities. These sectors should provide better protection in a rising rate environment, and mitigate the downside risk embedded in the current portfolio and improve the yield on earning assets. At March 31, 2014, the Company had net unrealized losses of $354,000. Loans held for investment decreased from $307.3 millionto $304.7 million, a decrease of $2.6 million. The commercial real estate, home equity and consumer loan segments of the loan portfolio decreased during the first quarter of 2014 with the commercial real estate segment experiencing the largest decline of 3.3%. The Company experienced growth in the remaining segments of its loan portfolio during the first quarter of 2014 with the commercial loan segment having the largest increase of 2.3%. The Company had four relationships that were foreclosed on for $496,000. The remainder of the decrease has related loan payoffs and normal payment activity. Loans held for sale decreased 68.0% or $775,000. The allowance for loan losses was $4.2 millionat March 31, 2014, which represented 1.38% of the loan portfolio. Other changes in our consolidated assets are related to premises and equipment, interest receivable, restricted stock, bank owned life insurance, other real estate owned and other assets. Bank owned life insurance increased $41,000, while premises and equipment increased $1.6 million. The increase in premises and equipment was related to the purchase of a piece of property that was currently being leased. Accrued interest receivable declined $96,000. Restricted stock which is comprised of Federal Home Loan Bankstock and Federal Reserve Bankstock decreased $146,000. Federal Home Loan Bankmember institutions are required to increase or decrease their ownership as their utilization of FHLB borrowings change. The Company's required ownership in FHLB stock decreased $211,000, while the Company's required ownership in Federal Reserve Bankstock increased $65,000to $532,000during the first quarter of 2014. Other real estate owned increased $277,000. The Company foreclosed on four loan relationships during the first quarter of 2014 totaling $496,000and sold three pieces of property totaling $210,000. The Company recorded net valuation write-down adjustments of $9,000. Other assets decreased $596,000. -28-
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Customer deposits, our primary funding source, experienced a
$1.5 milliondecrease during the three month period ended March 31, 2014, decreasing from $453.7 millionto $452.2 million. Demand noninterest bearing checking increased $5.6 million. This increase was offset by declines in interest checking and money market accounts of $1.2 million, savings deposits of $2.8 million, time deposits over $100,000of $514,000and other time deposits of $2.6 million. Total borrowings decreased $1.2 millionfor the period and consist of both short-term and long-term borrowed funds. During the first quarter of 2014, the Company conducted a private placement offering of fixed rate junior subordinated debt securities at $1,000per security with a required minimum investment of $50,000. The offering raised $9.5 million. These securities have a final maturity date of March 31, 2024and may be redeemed by the Company after March 31, 2019. The junior subordinated debt pays interest quarterly at an annual fixed rate of 5.75%. All proceeds of this private placement were issued and outstanding at March 31, 2014. All proceeds also qualify for and are included in the calculation of Tier 2 capital. On March 31, 2014, the Company called its entire $11.1 millionprivate outstanding issue of fixed rate junior subordinated debt that had a final maturity of December 31, 2018. These two events had a net reduction in total borrowings of $1.6 millionat March 31, 2014. Other components of total borrowings include $1.5 millionin Federal Home Loan Bankadvances and $4.3 millionin master notes and other secured borrowings.
Other liabilities increased from
The Company has an Employee Stock Ownership Plan (ESOP) in place. Late in 2011, the Internal Revenue Service issued
IRSnotice 2011-19 that drew a clear line between what stock exchanges are considered public and which are not. The Company historically trades its stock on the OTC Bulletin Board, which is a publically traded exchange, however, the IRSno longer recognizes the Bulletin Board as a public exchange. The result of this ruling is that companies that have ESOP plans in place are required to set aside funds to handle allocated shares put back to the company. The plan that the Company has, does include a put option that requires the Company to repurchase allocated shares of participants at the participants' option. The Company reclassed capital from additional paid-in capital to set aside the liability to cover all allocated shares that the Company may be requested to buy back. During the first quarter of 2014, the Company reclassed an additional $148,000to this liability from additional paid-in capital. As disclosed in Note 4 to the financial statement filed with as this report, the Company voted to terminate its ESOP effective March 1, 2014. In connection with this termination, the ESOP trustees transferred the 252,446 remaining unallocated shares to the Company to partially satisfy the term loan and lines of credit the ESOP had outstanding at the time. The effect this had on equity was minimal with total outstanding shares being reduced. The remaining balance of $8,600on the loans was expensed by the Company to completely satisfy the loans. At March 31, 2014, the Company and its subsidiary bank exceeded all applicable regulatory capital requirements. At March 31, 2014, total shareholders' equity was $41.1 million, an increase of $608,000from December 31, 2013. Net income for the period was $537,000. Unrealized gains and losses on investment securities, net of tax, increased $328,000. The Company paid $146,000in dividends attributed to noncontrolling interest. -29-
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Comparison of Results of Operations for the Three Months Ended
Net Income and Net Income Available to Common Shareholders
Uwharrie Capital Corpreported net income of $537,000for the three months ended March 31, 2014, as compared to $763,000for the three months ended March 31, 2013, a decrease of $226,000. Net income available to common shareholders was $391,000or $0.05per common share at March 31, 2014, compared at $499,000or $0.07per common share at March 31, 2013. For the three months ending March 31, 2013, net income available to common shareholders is net income less any dividends on preferred stock related to the $10.0 millionof capital received from the United States Department of the Treasuryunder the Capital Purchase Program in December 2008and dividends on the aforementioned noncontrolling interest. For the three months ending March 31, 2014, net income available to common shareholders is net income less dividends on the aforementioned noncontrolling interest. The entire $10.0 millionof preferred stock capital was redeemed and retired during 2013.
Net Interest Income
As with most financial institutions, the primary component of earnings for our subsidiary bank is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and wholesale borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of noninterest-bearing liabilities and capital. Net interest income for the three months ended
March 31, 2014and March 31, 2013was $4.0 millionfor both periods. During the current quarter, our decline in the volume of interest-earning assets outpaced the decline in volume of interest-bearing liabilities by $267,000. The average yield on our interest-earning assets increased three basis points to 4.04%, while the average rate we paid for our interest-bearing liabilities decreased twenty basis points. The Company's assets that are interest rate sensitive adjust at the time the Federal Reserve Open Market Committee adjusts interest rates, while interest-bearing time deposits adjust at the time of maturity. The aforementioned changes resulted in an increase of 23 basis points in our interest rate spread, from 3.24% in the first quarter of 2013 to 3.47% in the first quarter of 2014. Our net interest margin was 3.55% and 3.35% for the comparable periods in 2014 and 2013, respectively. -30-
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The following table presents average balance sheets and a net interest income analysis for the three months ended
Average Balance Sheet and Net Interest Income Analysis For the Three Months Ended March 31, (dollars in thousands) Average Balance Income/Expenses Rate/Yield 2014 2013 2014 2013 2014 2013 Interest-earning assets: Taxable securities
$ 94,599 $ 98,792 $ 410 $ 2721.76 % 1.12 % Nontaxable securities (1) 8,122 7,393 65 66 5.26 % 5.90 % Short-term investments 63,258 63,337 45 55 0.29 % 0.35 % Taxable loans 288,798 314,693 3,946 4,324 5.54 % 5.57 % Non-taxable loans (1) 16,481 14,210 113 103 4.53 % 4.80 % Total interest-earning assets 471,258 498,425
4,579 4,820 4.04 % 4.01 %
Interest-bearing liabilities: Interest-bearing deposits 374,427 388,197 373 545 0.40 % 0.57 % Short-term borrowed funds 5,930 17,033 18 80 1.23 % 1.90 % Long-term debt 11,141 12,674 157 171 5.72 % 5.47 % Total interest bearing liabilities 391,498 417,904 548 796 0.57 % 0.77 % Net interest spread
$ 79,760 $ 80,521 $ 4,031 $ 4,0243.47 % 3.24 % Net interest margin (1) (% of earning assets) 3.55 % 3.35 %
(1) Yields related to securities and loans exempt from income taxes are stated on
a fully tax-equivalent basis, assuming a 38.55% tax rate.
Provision and Allowance for Loan Losses
The Company recovered
$424,000for the three months ending March 31, 2014compared to adding $369,000of recovered provision for the same period in 2013. There were net loan charge-offs of $473,000for the three months ended March 31, 2014, as compared with net loan charge-offs of $458,000during the same period of 2013. Refer to the Asset Quality discussion on page 32 for further information.
The Company generates most of its revenue from net interest income; however, like all financial institutions, diversification of our revenue base is of major importance in our long term success. Total noninterest income decreased
$818,000for the three month period ending March 31, 2014as compared to the same period in 2013. The primary factor contributing to the overall decrease was a decline in income from mortgage loan sales of $678,000, declining from $840,000for the quarter ended March 31, 2013to $162,000for the same period in 2014. Service charges on deposit accounts produced revenue of $378,000, a decrease of $27,000for the three months ended March 31, 2014. The primary factor leading to this decrease was a decrease in NSF (non-sufficient funds) fees for the comparable periods. Other service fees and commissions experienced a $144,000or 18.2% increase for the comparable three month period, primarily due to an increase in brokerage commissions and asset management fees. The Company realized gains on the sale of investment securities during the three months ended March 31, 2014of $21,000as compared to realized gains of $14,000for the same period in 2013. Also, during the first quarter of 2013, the Company realized a gain on the sale of a piece of property being held in premises and equipment in the amount of $229,000. Noninterest Expense Noninterest expense for the quarter ended March 31, 2014was $5.2 millioncompared to $5.6 millionfor the same period of 2013, a decrease of $383,000. Salaries and employee benefits, the largest component of noninterest expense, decreased $86,000for the quarter ending March 31, 2014. This decrease is attributable to a reduction in staff related to the consolidation of the Company's subsidiary banks during 2013. Professional fees and services decreased $81,000during the three months ending March 31, 2014as compared to the same period in 2013. The improvement the Company is experiencing in asset quality is attributable to this decrease with lower legal fees associated with loan collections fees. FDICdeposit insurance premiums also declined $59,000for the comparable periods. Foreclosed real estate expense increased $53,000for the three months ending March 31, 2014. The major factor related to the increase in foreclosed real estate expense was expenses related to a prior year sale of other real estate owned. Write-downs on properties held in other real estate owned are attributed to updated appraisals and the lowering of list prices, which declined from $30,000for the three month period ending March 31, 2013to $3,000for the same period in 2014. Other noninterest expense decreased $169,000for the comparable three month periods. The table below reflects the composition of other noninterest expense. -31-
Table of Contents Other noninterest expense Three Months Ended March 31, 2014 2013 (in thousands) Postage
$ 51 $ 47Telephone and data lines 34 54 Shareholder relations expense 62 42 Dues and subscriptions 33 40 Other 360 526 Total $ 540 $ 709Income Tax Expense
The Company had income tax expense of
The Company's allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance is increased by provisions charged to operations and by recoveries of amounts previously charged off and is reduced by recovery of provisions and loans charged off. Management continuously evaluates the adequacy of the allowance for loan losses. In evaluating the adequacy of the allowance, management considers the following: the growth, composition and industry diversification of the portfolio; historical loan loss experience; current delinquency levels; adverse situations that may affect a borrower's ability to repay; estimated value of any underlying collateral; prevailing economic conditions and other relevant factors. The Company's credit administration function, through a review process, periodically validates the accuracy of the initial risk grade assessment. In addition, as a given loan's credit quality improves or deteriorates, the credit administration department has the responsibility to change the borrower's risk grade accordingly. For loans determined to be impaired, the allowance is based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the estimated fair value of the underlying collateral less the selling costs. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require additions for estimated losses based upon judgments different from those of management. Management uses a risk-grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers and reviewed and monitored by credit administration. The Company strives to maintain its loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of its market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies. The Company has no foreign loans and does not engage in significant lease financing or highly leveraged transactions. The Company follows a loan review program designed to evaluate the credit risk in the loan portfolio. This process includes the maintenance of an internally classified loan list that is designed to help management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower's ability to repay, the borrower's payment history and the current delinquent status. Because of this process, certain loans are deemed as impaired and evaluated as an impaired loan. -32-
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The allowance for loan losses represents management's best estimate of an appropriate amount to provide for inherent risk in the loan portfolio in the normal course of business. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the Company's portfolio, will not require an adjustment to the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary, should the quality of any loans deteriorate because of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect the Company's financial condition and results of operations. The recovery of loan losses was (
$424,000) for the three months ended March 31, 2014as compared to a recovery of ( $369,000) for the same period in 2013. At March 31, 2014the levels of our impaired loans, which includes all loans in nonaccrual status, TDRs and other loans deemed by management to be impaired, were $15.6 millioncompared to $17.6 millionat December 31, 2013, a decrease of $2.0 million. Total nonaccrual loans, which are a component of impaired loans, decreased from $4.7 millionat December 31, 2013to $3.6 millionat March 31, 2014. During the first quarter of 2014, the Company transferred $496,000in impaired loans to other real estate owned. This coupled with relationship upgrades of $811,000and these relationships no longer being deemed impaired by management, along with $526,000in payoffs were the primary factors contributing to the decrease in impaired loans. The upgrades and payoffs resulted in $163,000in recovered reserves during the quarter. The Company had net loan charge-offs for the first quarter of 2014 of $473,000compared to net loan charge-offs of $458,000for the same period in 2013. The allowance expressed as a percentage of gross loans held for investment decreased 28 basis points from 1.66% at December 31, 2013to 1.38% at March 31, 2014. The collectively evaluated reserve allowance as a percentage of collectively evaluated loans was 0.93% at December 31, 2013and 0.85% at March 31, 2014, while the individually evaluated allowance as a percentage of individually evaluated loans decreased from 13.60% to 11.16% for the same periods. The portion of the Company's allowance for loan loss model related to general reserves captures the mean loss of individual loans and the rare event of severe loss that can occur within the loan portfolio. Specifically, the Company calculates probable losses on loans by computing a probability of loss and expected loss scenario by FDICcall report codes. Together, these expected components as well as a level of more extreme unexpected losses form the basis of the allowance model. The loans that are impaired and included in the specific reserve are excluded from these calculations. The Company assesses the probability of losses inherent in the loan portfolio using probability of default data, acquired from a third party vendor representing a one year loss horizon for each obligor. The Company updates the data inputs into the model; specifically the loss given default and the probability of defaults obtained from the vendor annually during the second quarter. The Company updates the beacon scores that are one of the components used within the allowance model semi-annually, during the first and third quarters. For the first time in several updates, beacon scores experienced significant improvement during 2013. This trend continued during the first quarter of 2014 with beacon scores continuing to show improvement. The average beacon score increased nine basis points from 702 to 712 during the first quarter. This increase resulted in approximately $235,000in recovered reserves during the first quarter. During second and third quarters of 2013, the Company updated its allowance for loan loss model to more accurately assess the probability of losses inherent in the loan portfolio. Two -33-
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alterations were made: the previous "VaR" calculation was replaced by an improved "VaR" that more adequately reflected the risk in the loan portfolio, and the least squares regression was replaced by a simple average.
The previous "VaR" calculation measured the size of exposures within the loan portfolio while the current "VaR" calculation measures the potential loss to the portfolio in aggregate. The previous "VaR" could not be larger than the largest loan in the portfolio while the current "VaR" has no such restriction. In addition the current "VaR" reflects correlations within the loan portfolio as well as the exposure to large individual credits Nonperforming loans, which consist of nonaccrual loans and loans past due 90 days and still accruing, to total loans decreased from 1.66% at
December 31, 2013, to 1.38% at March 31, 2014. Other real estate owned increased $277,000during the first quarter of 2014. The Company sold three pieces of foreclosed property totaling $210,000realizing a gain of $1,000The Company also had write downs and changes in reserves totaling $9,000on the remaining existing property. The Company did have one write down totaling $678,000. These decreases in other real estate owned were offset by four new pieces of property being foreclosed on totaling $496,000. Management believes the current level of the allowance for loan losses is appropriate in light of the risk inherent in the loan portfolio.
Restructured loans at
The following nonperforming assets table shows the comparison of
March 31, 2014to December 31, 2013: Nonperforming Assets (dollars in thousands) March 31, December 31, 2014 2013 Nonperforming assets: Loans past due 90 days or more $ - $ - Nonaccrual loans 3,611 4,717 Other real estate owned 7,447 7,170 Total nonperforming assets $ 11,058 $ 11,887Allowance for loans losses $ 4,198 $ 5,095Nonperforming loans to total loans 1.19 %
Allowance for loan losses to total loans 1.38 %
Nonperforming assets to total assets 2.15 %
Allowance for loan losses to nonperforming loans 116.26 %
Liquidity and Capital Resources
The objective of the Company's liquidity management policy is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on any opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature and to fund new loans and investments as opportunities arise. -34-
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The Company's primary sources of internally generated funds are principal and interest payments on loans, cash flows generated from operations and cash flow generated by investments. Growth in deposits is typically the primary source of funds for loan growth. The Company and its subsidiary bank have multiple funding sources, in addition to deposits that can be used to increase liquidity and provide additional financial flexibility. These sources are the subsidiary bank's established federal funds lines with correspondent banks aggregating
$15.8 millionat March 31, 2014, with available credit of $15.8 million; established borrowing relationships with the Federal Home Loan Bank, with available credit of $40.9 million; access to borrowings from the Federal Reserve Bankdiscount window, with available credit of $29.9 millionand the issuance of commercial paper. The Company has also secured long-term debt from other sources. Total debt from these sources aggregated $15.5 millionat March 31, 2014, compared to $16.7 millionat December 31, 2013. Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve, the primary federal regulator of the Company and its subsidiary bank, has adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Regulatory guidelines require a minimum of total capital to risk-adjusted assets ratio of 8 percent and a Tier 1 leverage ratio of 4 percent. Banks are considered "well capitalized" by regulatory standards when they meet or exceed a Tier 1 risk-based capital ratio of 6 percent, a total risk-based capital ratio of 10 percent and a leverage ratio of 5 percent. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with those guidelines. The Company and its subsidiary bank have each maintained capital levels exceeding minimum levels for "well capitalized" banks and bank holding companies. The Company expects to continue to exceed minimum capital requirements without altering current operations or strategy. As previously discussed, the Company's subsidiary bank has a net total of $10.5 millionin outstanding fixed Rate Noncumulative Perpetual Preferred Stock. The preferred stock qualifies as Tier 1 capital at the bank and will pay dividends at an annual rate of 5.30%. The net total of $10.5 millionis presented as noncontrolling interest at the Company level and does qualify as Tier 1 capital at the Company. At March 31, 2014, the Company had $9.5 millionin subordinated debt outstanding that qualifies as Tier 2 capital. The Company has made all interest and dividend payments in a timely manner.