The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2013 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2013. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as "believe", "expect", "anticipate", "should", "planned", "estimated" and "potential". Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc.that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, in addition to those items contained in the Company's Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent Quarterly Reports on Form 10-Q, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.'sinterest rate spread or other income anticipated from operations and investments. Overview Unity Bancorp, Inc.(the "Parent Company") is incorporated in New Jerseyand is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the "Bank" or, when consolidated with the Parent Company, the "Company") was granted a charter by the New Jersey Department of Banking and Insuranceand commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through 15 branch offices located in Hunterdon, Somerset, Middlesex, Unionand Warrencounties in New Jersey, and Northampton Countyin Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administrationand other commercial credits. The Bank has multiple subsidiaries used to hold part of its investment and loan portfolios and other real estate owned ("OREO") properties. Unity (NJ) Statutory Trust II is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc.On July 24, 2006, the Trust issued $10.0 millionof trust preferred securities to investors. Unity (NJ) Statutory TrustIII is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc.On December 19, 2006, the Trust issued $5.0 millionof trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company's financial statements. However, they qualify as Tier I Capitalfor regulatory capital compliance purposes, subject to certain limitations. The Company does not consolidate the accounts and related activity of any of its business trust subsidiaries. Earnings Summary Net income available to common shareholders totaled $1.3 million, or $0.17per diluted share for the quarter ended March 31, 2014, a 62.4 percent increase compared to $796 thousand, or $0.10per diluted share for the same period a year ago. Return on average assets and average common equity for the quarter were 0.59% and 9.06%, respectively, compared to 0.59% and 5.65% for the same period a year ago. The continued improvement in our operating results is the product of our strategic initiatives, which include expansion of our in-market loan and deposit relationships, improving credit quality and core earnings growth.
First quarter highlights include:
× Loan growth of 0.8% since
6.3% growth in SBA 504 loans.
× Deposit growth of 3.9% since
× Core earnings growth - Net interest income increased 8.9% compared to the prior
year's quarter due to strong commercial and residential loan portfolio growth.
× A wider net interest margin of 3.57% compared to 3.52% in the prior year's
× Improved credit quality metrics due to decreased nonperforming loans and lower
net charge-offs this quarter compared to the prior year's quarter.
× Increased the dividend to common shareholders.
The Company's quarterly performance ratios may be found in the table below.
For the three months ended March 31, 2014 2013 Net income per common share - Basic (1) $ 0.17 $
Net income per common share - Diluted (1) $ 0.17 $
Return on average assets 0.59 % 0.59 % Return on average equity (2) 9.06 % 5.65 % Efficiency ratio 71.91 % 73.91 % (1) Defined as net income adjusted for dividends accrued and accretion of
discount on perpetual preferred stock divided by weighted average shares
outstanding. (2) Defined as net income adjusted for dividends accrued and accretion of
discount on perpetual preferred stock divided by average shareholders' equity
(excluding preferred stock). 32
Net Interest Income
The primary source of the Company's operating income is net interest income,
which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing demand, savings and time deposits,
Federal Home Loan Bankadvances and other borrowings. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities ("net interest spread") and the relative amounts of earning assets and interest-bearing liabilities. The Company's net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets. During the quarter ended March 31, 2014, tax-equivalent net interest income amounted to $7.3 million, an increase of $590 thousandor 8.7 percent when compared to the same period in 2013. This increase was the result of the growth in commercial and residential mortgage loans over the past year. As a result, the net interest margin increased 5 basis points to 3.57 percent for the quarter ended March 31, 2014, compared to 3.52 percent for the same period in 2013.
net interest spread was 3.38 percent for the first quarter of 2014, a 9 basis point increase compared to the same period in 2013.
During the three months ended
March 31, 2014, tax-equivalent interest income was $9.1 million, an increase of $702 thousandor 8.4 percent when compared to the same period in the prior year. This increase was driven by the increase in average loans, partially offset by a lower average yield on the loan portfolio:
× Of the
× The average volume of interest-earning assets increased
million for the first quarter of 2014 compared to
period in 2013. This was due primarily to an
loans, primarily commercial and residential mortgage loans, partially off by a
× The yield on interest-earning assets increased 6 basis points to 4.39 percent
for the three months ended
2013. This was due to increased yields on our investment portfolio as a result
of an early payoff on a FNMA DUS Bond and from FHLB stock. The yield on our
loan portfolio declined 24 basis points to 4.39 percent. Total interest expense was
$1.7 millionfor the three months ended March 31, 2014, an increase of $112 thousandor 6.9 percent compared to the same period in 2013. This increase was driven by the increase in average time deposits, partially offset by lower rates on these deposits compared to a year ago:
× Of the
increase was due to an increase in the volume of average interest-bearing
liabilities, primarily time deposits, partially offset by a
decrease due to the decrease in the rates paid on interest-bearing liabilities.
× Interest-bearing liabilities averaged
2014, an increase of
year's quarter. The increase in interest-bearing liabilities was a result of an
increase in average time deposits and interest-bearing demand deposits,
partially offset by a decrease in average savings deposits.
× The average cost of interest-bearing liabilities decreased 3 basis points to
1.01 percent. The cost of interest-bearing deposits increased 1 basis point to
0.63 percent for the first quarter of 2014 and the cost of borrowed funds and
subordinated debentures decreased 4 basis points to 3.50 percent. Our net interest income continues to be impacted by the sustained low interest rate environment. The Federal Open Market Committee ("FOMC") of the
Federal Reserve Boardforecasts the overnight federal funds rate will continue to remain at 25 basis points through late 2015. This rate environment has resulted in a tighter net interest margin as our earning assets continue to re-price at lower rates. Partially offsetting these declines are lower funding costs; however, the reduction in yield on earning assets is anticipated to exceed the benefits of further declines in the cost of funds from already low levels. The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders' equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/Yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 34 percent. 33
Consolidated Average Balance Sheets
(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis) For the three months ended March 31, 2014 March 31, 2013 Average Average Balance Interest Rate/Yield Balance Interest Rate/Yield ASSETS Interest-earning assets: Federal funds sold and interest-bearing deposits
$ 42,029 $ 90.09 % $ 62,530 $ 140.09 % Federal Home Loan Bankstock 3,988 47 4.78 3,989 44 4.47 Securities: Taxable 92,808 726 3.13 100,062 647 2.59 Tax-exempt 16,841 155 3.68 18,475 178 3.85 Total securities (A) 109,649 881 3.21 118,537 825 2.79 Loans: SBA loans 54,790 583 4.26 65,386 777 4.75 SBA 504 loans 31,719 399 5.10 41,135 651 6.42 Commercial loans 364,343 4,601 5.12 304,790 4,001 5.32 Residential mortgage loans 181,058 2,058 4.55 135,886 1,550 4.56 Consumer loans 45,939 495 4.37 46,111 509 4.48 Total loans (B) 677,849 8,136 4.85 593,308 7,488 5.09 Total interest-earning assets $ 833,515 $ 9,0734.39 % $ 778,364 $ 8,3714.33 % Noninterest-earning assets: Cash and due from banks 23,389 19,737 Allowance for loan losses (13,410) (14,998) Other assets 43,599 37,905 Total noninterest-earning assets 53,578 42,644 Total assets $ 887,093 $ 821,008LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing demand deposits $ 131,187 $ 1110.34 % $ 118,668 $ 1010.35 % Savings deposits 266,321 182 0.28 295,520 177 0.24 Time deposits 205,130 644 1.27 122,695 546 1.80 Total interest-bearing deposits 602,638 937 0.63 536,883 824 0.62 Borrowed funds and subordinated debentures 91,265 799 3.50 90,465 800 3.54 Total interest-bearing liabilities $ 693,903 $ 1,7361.01 % $ 627,348 $ 1,6241.04 % Noninterest-bearing liabilities: Noninterest-bearing demand deposits 132,167 113,000 Other liabilities 3,169 3,242 Total noninterest-bearing liabilities 135,336 116,242 Total shareholders' equity 57,854 77,418 Total liabilities and shareholders' equity $ 887,093 $ 821,008Net interest spread $ 7,3373.38 % $ 6,7473.29 % Tax-equivalent basis adjustment (50) (58) Net interest income $ 7,287 $ 6,689Net interest margin 3.57 %
(A) Yields related to securities exempt from federal and state income taxes are
stated on a fully tax-equivalent basis. They are reduced by the nondeductible
portion of interest expense, assuming a federal tax rate of 34 percent and
applicable state rates.
(B) The loan averages are stated net of unearned income, and the averages include
loans on which the accrual of interest has been discontinued. 34
-------------------------------------------------------------------------------- The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 34 percent. For the three months ended March 31, 2014 versus March 31, 2013 Increase (decrease) due to change in: (In thousands on a tax-equivalent basis) Volume Rate Net Interest income: Federal funds sold and interest-bearing deposits
$ (5)$ - $ (5) Federal Home Loan Bank stock - 3 3 Securities (64) 120 56 Loans 1,012 (364) 648 Total interest income $ 943 $ (241)$ 702 Interest expense: Demand deposits $ 13 $ (3)$ 10 Savings deposits (20) 25 5 Time deposits 291 (193) 98 Total interest-bearing deposits 284 (171) 113 Borrowed funds and subordinated debentures 7 (8) (1) Total interest expense 291 (179) 112 Net interest income - fully tax-equivalent $ 652 $ (62)$ 590 Decrease in tax-equivalent adjustment 8 Net interest income $ 598 Provision for Loan Losses
The provision for loan losses totaled
2013. Each period's loan loss provision is the result of management's analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. The reduced provision reflects a lower level of net charge-offs for the quarter and year-to-date periods, as well as a lower level of nonperforming assets. Additional information may be found under the captions "Financial Condition - Asset Quality" and "Financial Condition - Allowance for Loan Losses and Reserve for Unfunded Loan Commitments." The current provision is considered appropriate under management's assessment of the adequacy of the allowance for loan losses. Noninterest Income
The following table shows the components of noninterest income for the three months ended
For the three months ended March 31, (In thousands) 2014 2013 Branch fee income $ 377 $ 347 Service and loan fee income 295 304 Gain on sale of SBA loans held for sale, net 83 241 Gain on sale of mortgage loans, net 365 477 BOLI income 96 70 Net security gains 110 226 Other income 200 160 Total noninterest income $ 1,526 $ 1,825 Our noninterest income consists primarily of branch and loan fee income, gains on the sale of SBA and residential mortgage loans, gains on the sale of securities, and BOLI income. For the three months ended
March 31, 2014, noninterest income amounted to $1.5 million, a decrease of $299 thousandfrom the prior year period. The decrease was driven by a reduced volume of sales of residential mortgage loans and SBA loans and lower levels of security gains realized. 35
Changes in our noninterest income for the three months ended
· Branch fee income, which consists of deposit service charges and overdraft
increased overdraft fees.
· Service and loan fee income decreased
periods in the prior year, due to lower SBA servicing income and prepayment
penalties, partially offset by increased payoff charges and processing fee
· SBA loan sales amounted to
for the quarter, compared to
the prior year's quarter.
· Gains on sales of residential mortgage loans decreased
compared to the same period in the prior year. During the quarter,
million in residential mortgage loans were sold at a gain of
year's quarter. Approximately,
portfolio, with the remainder consisting of new production. Net gains on
mortgage servicing assets were approximately
· BOLI income increased
· Net realized gains on the sale of securities amounted to
compared to net gains of
year. For additional information, see Note 7 - Securities.
· Other income, which includes check card related income and miscellaneous
service charges, increased
the prior year, primarily due to an increase in VISA check card interchange and
other OREO noninterest income. Noninterest Expense
The following table presents a breakdown of noninterest expense for the three months ended
For the three months ended March 31, (In thousands) 2014 2013 Compensation and benefits $ 3,217 $ 3,176 Occupancy 659 694 Processing and communications 582 561 Furniture and equipment 357 365 Professional services 211 190 Loan costs 170 177 OREO expenses 247 127 Deposit insurance 178 149 Advertising 151 120 Other expenses 486 567 Total noninterest expense $ 6,258 $ 6,126
Noninterest expense totaled
Changes in noninterest expense for the three months ended
· Compensation and benefits expense, the largest component of noninterest
benefits expenses, partially offset by decreased mortgage commissions.
· Occupancy expense decreased
leasehold depreciation expense related to the three branch sites that were
purchased a year ago. These savings were partially offset by the increase in
snow removal expenses.
· Processing and communications expenses increased
increased data processing expense and internet expense.
· Furniture and equipment expense decreased
decreased depreciation expense on furniture and equipment and software,
partially offset by increased equipment maintenance expense.
· Professional service fees increased
· Loan costs decreased
appraisal costs, offset by higher forced place insurance and loan legal
· OREO expenses increased
prior year. OREO expenses remain elevated as we work through the collection
process and incur expenses such as maintenance expenses, delinquent taxes, and
losses on sale of OREO.
· Deposit insurance expense increased
period in the prior year due to the Company's growth in assets.
· Advertising expense increased
marketing expense and community relations expenses.
· Other expenses decreased
recruiter fees, director fees, printing and office supplies and provision for loan commitments. 36
Income Tax Expense For the quarter ended
March 31, 2014, the Company reported income tax expense of $662 thousandfor an effective tax rate of 33.9 percent, compared to an income tax expense of $538 thousandand effective tax rate of 31.0 percent for the prior year's quarter. The increase was due to state tax payments, which are generally paid in the first quarter.
Financial Condition at
Total assets increased
$40.1 millionor 4.3 percent, to $961.2 millionat March 31, 2014, compared to $921.1 millionat December 31, 2013. This increase was primarily due to increases of $28.8 millionin cash and cash equivalents, $5.3 millionin loans, and $1.9 millionin securities. Total deposits increased $28.9 million, due to the increase of $36.0 millionin noninterest-bearing demand deposits, $3.5 millionin interest-bearing demand deposits, and $2.8 millionin time deposits, partially offset by a decrease of $13.4 millionin savings deposits. The increase in noninterest-bearing demand deposits was due to a $30.0 millionshort-term deposit from one customer on March 31, 2014, of which $25.0 millionwas wired out on April 4, 2014. Borrowed funds increased $8.0 millionover year-end 2013. There were no changes to subordinated debentures. Total shareholders' equity increased $1.6 millionover year-end 2013, primarily due to retained earnings. These fluctuations are discussed in further detail in the paragraphs that follow. Securities Portfolio The Company's securities portfolio consists of available for sale ("AFS") and held to maturity ("HTM") investments. Management determines the appropriate security classification of available for sale or held to maturity at the time of purchase. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes. AFS securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS securities consist primarily of obligations of U.S. Governmentsponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.
AFS securities totaled
one corporate bond and one agency security, and
31, 2014, the portfolio had net unrealized losses of
net unrealized losses of
unrealized gains (losses) are reflected net of tax in shareholders' equity as
accumulated other comprehensive income (loss), partially offset by
securities, one asset-backed security, and one mortgage-backed security,
The weighted average life of AFS securities, adjusted for prepayments, amounted to 4.9 years at
HTM securities, which are carried at amortized cost, are investments for which there is the positive intent and ability to hold to maturity. The portfolio is comprised primarily of
U.S. Governmentsponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.
HTM securities were
The weighted average life of HTM securities, adjusted for prepayments, amounted to 6.8 years and 8.5 years at
March 31, 2014and December 31, 2013, respectively. As of March 31, 2014and December 31, 2013, the fair value of HTM securities was $22.7 millionand $25.5 million, respectively. The average balance of taxable securities amounted to $92.8 millionfor the three months ended March 31, 2014, compared to $100.1 millionfor the same period in 2013. The average yield earned on taxable securities increased 54 basis points, to 3.13 percent for the three months ended March 31, 2014, from 2.59 percent for the same period in the prior year. The change in yield was related to the early prepayment of $105 thousandon a FNMA DUS bond. The average balance of tax-exempt securities amounted to $16.8 millionfor the three months ended March 31, 2014, compared to $18.5 millionfor the same period in 2013. The average yield earned on tax-exempt securities decreased 17 basis points, to 3.68 percent for the three months ended March 31, 2014, from 3.85 percent for the same period in 2013. Securities with a carrying value of $72.2 millionand $74.5 millionat March 31, 2014and December 31, 2013, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law. 37
Approximately 87 percent of the total investment portfolio had a fixed rate of interest at
See Note 7 to the accompanying Consolidated Financial Statements for more information regarding Securities.
Loan Portfolio The loan portfolio, which represents the Company's largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, SBA 504, commercial, residential mortgage and consumer loans. Each of these segments is subject to differing levels of credit and interest rate risk. Total loans increased
$5.3 millionor 0.8 percent to $684.0 millionat March 31, 2014, compared to $678.7 millionat year-end 2013. Commercial loans, SBA 504 loans, and consumer loans increased $5.6 million, $2.0 million, and $970 thousand, respectively, partially offset by declines of $1.9 millionand $1.3 millionin residential mortgages and SBA loans, respectively. The following table sets forth the classification of loans by major category, including unearned fees and deferred costs and excluding the allowance for loan losses as of March 31, 2014and December 31, 2013: March 31, 2014 December 31, 2013 (In thousands, except percentages) Amount % of total Amount % of total SBA loans held for investment $ 47,7377.0 % $ 48,9187.2 % SBA 504 loans 33,550 4.9 31,564 4.7 Commercial loans 368,909 53.9 363,340 53.5 Residential mortgage loans 180,129 26.3 182,067 26.8 Consumer loans 47,109 6.9 46,139 6.8 Total loans held for investment 677,434 99.0 672,028 99.0 SBA loans held for sale 6,517 1.0 6,673 1.0 Total loans $ 683,951100.0 % $ 678,701100.0 % Average loans increased $84.5 millionor 14.2 percent from $593.3 millionfor the three months ended March 31, 2013, to $677.8 millionfor the same period in 2014. The increase in average loans was due to increases in commercial and residential mortgage loans, partially offset by declines in all other portfolio types. The yield on the overall loan portfolio fell 24 basis points to 4.85 percent for the three months ended March 31, 2014, compared to 5.09 percent for the same period in the prior year. This decrease was the result of new loan volume at lower rates and existing variable rate loan products repricing lower as rates remain low. SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made for the purposes of providing working capital or financing the purchase of equipment, inventory or commercial real estate. Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee. The deficiency may be a higher loan to value ("LTV") ratio, lower debt service coverage ("DSC") ratio or weak personal financial guarantees. In addition, many SBA 7(a) loans are for start up businesses where there is no history or financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction. The guaranteed portion of the Company's SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $6.5 millionat March 31, 2014, a decrease of $156 thousandfrom $6.7 million December 31, 2013. SBA 7(a) loans held to maturity amounted to $47.7 millionat March 31, 2014, a decrease of $1.2 millionfrom $48.9 millionat December 31, 2013. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 4.26 percent for the three months ended March 31, 2014, compared to 4.75 percent in the prior year. The guarantee rates on SBA 7(a) loans range from 50 percent to 90 percent, with the majority of the portfolio having a guarantee rate of 75 percent at origination. The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program. The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market. The carrying value of SBA loans held to maturity represents the unguaranteed portion, which is the Company's portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market. Approximately $95.1 millionand $96.4 millionin SBA loans were sold but serviced by the Company at March 31, 2014and December 31, 2013, respectively, and are not included on the Company's balance sheet. There is no relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company's SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination. At March 31, 2014, SBA 504 loans totaled $33.6 million, an increase of $2.0 millionfrom $31.6 millionat December 31, 2013. The yield on SBA 504 loans decreased 132 basis points to 5.10 percent for the three months ended March 31, 2014, from 6.42 percent for the same period in 2013. Commercial loans are generally made in the Company's marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $368.9 millionat 38
March 31, 2014, an increase of $5.6 millionfrom year-end 2013. The yield on commercial loans was 5.12 percent for the three months ended March 31, 2014, compared to 5.32 percent for the same period in 2013. Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $180.1 millionat March 31, 2014, a decrease of $1.9 millionfrom year-end 2013. Sales of mortgage loans totaled $17.4 millionfor the three months ended March 31, 2014. Approximately, $7.5 millionof the sold loans were from our portfolio, with the remainder consisting of new production. The yield on residential mortgages was 4.55 percent for the three months ended March 31, 2014, compared to 4.56 percent for the same period in 2013. Consumer loans consist of home equity loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $47.1 million, an increase of $970 thousandfrom year-end 2013. The yield on consumer loans was 4.37 percent for the three months ended March 31, 2014, compared to 4.48 percent for the three months ended March 31, 2013. There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio. As a preferred SBA lender, a portion of the SBA portfolio is to borrowers outside the Company's lending area. During late 2008, the Company withdrew from SBA lending outside of its primary trade area, but continues to offer SBA loan products as an additional credit product within its primary trade area. In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV ratios, construction loans with payments made from interest reserves and multiple loans supported by the same collateral (e.g. home equity loans) are examples of such products. However, these products are not material to the Company's financial position and are closely managed via credit controls that mitigate their additional inherent risk. Management does not believe that these products create a concentration of credit risk in the Company's loan portfolio. The Company does not have any option adjustable rate mortgage loans. The majority of the Company's loans are secured by real estate. Declines in the market values of real estate in the Company's trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At March 31, 2014and December 31, 2013, approximately 96 percent of the Company's loan portfolio was secured by real estate. Troubled Debt Restructurings Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor's financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms. At March 31, 2014, there were ten loans totaling $7.8 millionthat were classified as TDRs by the Company and deemed impaired, compared to ten loans totaling $7.9 millionat December 31, 2013. Nonperforming loans included $448 thousandof TDRs as of March 31, 2014, compared to $467 thousandat December 31, 2013. Restructured loans that are placed in nonaccrual status may be removed after 6 months of contractual payments and the business showing the ability to service the debt going forward. The remaining TDRs are in accrual status since they are performing in accordance with the restructured terms. There are no commitments to lend additional funds on these loans. 39
The following table presents a breakdown of performing and nonperforming TDRs by class as of
March 31, 2014 December 31, 2013 (In thousands) Performing TDRs Nonperforming TDRs Total TDRs Performing TDRs Nonperforming TDRs Total TDRs SBA loans held for investment $ 530 $ 448
$ 978$ 534 $ 467 $ 1,001SBA 504 loans 1,813 - 1,813 1,827 - 1,827 Commercial real estate 5,020 - 5,020 5,091 - 5,091 Total $ 7,363$ 448 $ 7,811 $ 7,452$ 467 $ 7,919Through March 31, 2014, our TDRs consisted of interest rate reductions, interest only periods and maturity extensions. There has been no principal forgiveness. The following table shows the types of modifications done to date by class through March 31, 2014: March 31, 2014 SBA held for Commercial (In thousands) investment SBA 504 real estate Total Type of modification: Principal only $ 21$ - $ - $ 21Interest only with reduced interest rate - - 2,684 2,684 Interest only with nominal principal 94 - - 94 Interest with extra principal - - 1,479 1,479 Previously modified back to original terms 863 1,813 857 3,533 Total TDRs $ 978 $ 1,813 $ 5,020 $ 7,811Asset Quality Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower's inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower's credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The current state of the economy and the downturn in the real estate market has resulted in increased loan delinquencies and defaults. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market. In response to the credit risk in its portfolio, the Company has increased staffing in its credit monitoring department and increased efforts in the collection and analysis of borrowers' financial statements and tax returns. Nonperforming assets consist of nonperforming loans and other real estate owned ("OREO"). Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans. Loans past due 90 days or more and still accruing generally represent loans that are well collateralized and in a continuing process that are expected to result in repayment or restoration to current status. 40
The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at each of the periods presented:
(In thousands) March 31, 2014 December 31, 2013 March 31, 2013 Nonperforming by category: SBA loans held for investment (1)
$ 3,876$ 2,746 $ 4,441SBA 504 loans 424 1,101 1,235 Commercial loans 1,374 4,029 4,372 Residential mortgage loans 4,988 5,727 4,554 Consumer loans 1,384 1,680 302
Total nonperforming loans (2)
$ 14,904OREO 2,467 633 1,052 Total nonperforming assets $ 14,513$ 15,916 $ 15,956Past due 90 days or more and still accruing interest: SBA loans held for investment $ - $ - $ 212 SBA 504 loans - - 415 Commercial loans - 14 - Residential mortgage loans 5 5 4 Consumer loans - - 1 Total past due 90 days or more and still accruing interest $ 5 $ 19 $ 632 Nonperforming loans to total loans 1.76 % 2.25 % 2.50 % Nonperforming loans and TDRs to total loans (3) 2.84 3.35 5.02 Nonperforming assets to total loans and OREO 2.11 2.34 2.67 Nonperforming assets to total assets 1.51 1.73 1.93 (1) Guaranteed SBA loans included above $ 1,320$ 540 $ 1,863(2) Nonperforming TDRs included above 448 467 1,084 (3) Performing TDRs 7,363 7,452 15,068 Nonperforming loans were $12.0 millionat March 31, 2014, a $3.2 milliondecrease from $15.3 millionat year-end 2013 and a $2.9 milliondecrease from $14.9 millionat March 31, 2013. Since year-end 2013, nonperforming loans in all segments decreased, except SBA loans held for investment. Included in nonperforming loans at March 31, 2014are approximately $1.3 millionof loans guaranteed by the SBA, compared to $540 thousandat December 31, 2013and $1.8 millionat March 31, 2013. In addition, there were $5 thousandin loans past due 90 days or more and still accruing interest at March 31, 2014, compared to $19 thousandand $632 thousandat December 31, 2013and March 31, 2013, respectively. Other real estate owned ("OREO") properties totaled $2.5 millionat March 31, 2014, an increase of $1.8 millionfrom $633 thousandat year-end 2013. During the three months ended March 31, 2014, the Company took title to four new properties totaling $2.4 millionand there were no valuation writedowns. Three OREO properties were sold, resulting in a net loss of $128 thousandon the sales. The Company also monitors potential problem loans. Potential problem loans are those loans where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms. These loans are not included in nonperforming loans as they continue to perform. Potential problem loans totaled $9.3 millionat March 31, 2014, an increase of $3.5 millionfrom $5.7 millionat December 31, 2013. The increase is due to the addition of four loans totaling $5.3 millionduring the year, partially offset by the removal of two loans totaling $1.4 million.
See Note 8 to the accompanying Consolidated Financial Statements for more information regarding Asset Quality.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
Management reviews the level of the allowance for loan losses on a quarterly basis. The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs. The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily. The Company believes using this approach is more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate, and high risk. The factors are evaluated separately for each type of loan. For example, commercial loans are broken down further into commercial and industrial loans, commercial mortgages, construction loans, etc. Each type of loan is risk weighted for each environmental factor based on its individual characteristics. According to the Company's policy, a loss ("charge-off") is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company's ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. Beginning in 2013 and continuing in 2014, the Company has decreased its loan loss provision in response to improvements in the inherent credit risk within its loan portfolio. The improved inherent credit risk was evidenced by a decrease in delinquent and nonperforming loans, as the economy continued to improve. The allowance for loan losses totaled
$12.8 millionat March 31, 2014, compared to $14.3 million March 31, 2013with resulting allowance to total loan ratios of 1.87 percent, and 2.40 percent, respectively. Net charge-offs amounted to $934 thousandfor the three months ended March 31, 2014, compared to $1.1 millionfor the same period in 2013. Net charge-offs to average loan ratios are shown in the table below for each major loan category. For the three months ended March 31, (In thousands, except percentages) 2014
Balance, beginning of period $ 13,141 $
Provision for loan losses charged to expense 600 650 Less: Chargeoffs SBA loans held for investment 53 570 SBA 504 loans 92 200 Commercial loans 454 375 Residential mortgage loans 172 125 Consumer loans 179 59 Total chargeoffs 950 1,329 Add: Recoveries SBA loans held for investment 7 137 SBA 504 loans - 25 Commercial loans 9 101 Residential mortgage loans - 2 Consumer loans - 1 Total recoveries 16 266 Net chargeoffs 934 1,063 Balance, end of period $ 12,807 $ 14,345 Selected loan quality ratios: Net chargeoffs to average loans: SBA loans held for investment 0.34 % 2.69 % SBA 504 loans 1.18 1.73 Commercial loans 0.50 0.36 Residential mortgage loans 0.39 0.37 Consumer loans 1.58 0.51 Total loans 0.56 0.73 Allowance to total loans 1.87 2.40 Allowance to nonperforming loans 106.32 96.25 42
-------------------------------------------------------------------------------- In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is maintained in other liabilities. At
March 31, 2014, a $120 thousandcommitment reserve was reported on the balance sheet as an "other liability", compared to an $103 thousandcommitment reserve at December 31, 2013.
See Note 9 to the accompanying Consolidated Financial Statements for more information regarding the Allowance for Loan Losses and Reserve for Unfunded Loan Commitments.
Deposits Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits and time deposits, are the primary source of the Company's funds. The Company offers a variety of products designed to attract and retain customers, with primary focus on building and expanding relationships. The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships. Total deposits increased
$28.9 millionto $767.6 millionat March 31, 2014, from $738.7 millionat December 31, 2013. This increase in deposits was due to increases of $36.0 millionin noninterest-bearing demand deposits, $3.5 millionin interest-bearing demand deposits, and $2.8 millionin time deposits, partially offset a decrease of $13.4 millionin savings deposits. The increase in noninterest-bearing demand deposits was due to a $30.0 millionshort-term deposit that came into the Bank on March 31, 2014, of which $25.0 millionwas wired out on April 4, 2014. The decrease in savings deposits was due to a decline of $14.1 millionin municipal savings deposits from year-end. The Company's deposit composition at March 31, 2014, consisted of 33.0 percent savings deposits, 27.1 percent time deposits, 22.4 percent noninterest-bearing demand deposits and 17.5 percent interest-bearing demand deposits.
Borrowed Funds and Subordinated Debentures
Borrowed funds consist primarily of fixed rate advances from the
Federal Home Loan Bank("FHLB") of New Yorkand repurchase agreements. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and investment securities collateralize the borrowings from the FHLB, while investment securities are pledged against the repurchase agreements. Borrowed funds and subordinated debentures totaled $130.5 millionand $122.5 millionat March 31, 2014and December 31, 2013, respectively, and are broken down in the following table: (In thousands) March 31, 2014 December 31, 2013 FHLB borrowings: Fixed rate advances $ 30,000 $ 30,000Overnight advances 40,000 32,000 Repurchase agreements 30,000 30,000 Other repurchase agreements 15,000 15,000 Subordinated debentures 15,465 15,465 At March 31, 2014, the Company had $58.2 millionof additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages or investment securities can increase the line with the FHLB. Interest Rate Sensitivity The principal objectives of the asset and liability management function are to establish prudent risk management guidelines, evaluate and control the level of interest-rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within the Board approved guidelines. The Company seeks to reduce the vulnerability of the operations to changes in interest rates, and actions in this regard are taken under the guidance of the Asset/Liability Management Committee ("ALCO") of the Board of Directors. The ALCO reviews the maturities and re-pricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels. 43
-------------------------------------------------------------------------------- The Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity ("EVPE") models to measure the impact of longer-term asset and liability mismatches beyond two years. The modified duration of equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of 200 basis points. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by the ALCO. The Company's variance in the economic value of equity, as a percentage of assets with rate shocks of 200 basis points at
March 31, 2014, is a decline of 0.88 percent in a rising-rate environment and an increase of 0.29 percent in a falling-rate environment. The variances in the EVPE at March 31, 2014are within the Board-approved guidelines of +/- 3.00 percent. At December 31, 2013, the economic value of equity as a percentage of assets with rate shocks of 200 basis points was a decline of 1.09 percent in a rising-rate environment and an increase of 0.45 percent in a falling-rate environment. Liquidity Consolidated Bank Liquidity Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank's liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Our liquidity is monitored by management and the Board of Directors through a Risk Management Committee, which reviews historical funding requirements, our current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets. The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and loan principal, sales and maturities of investment securities and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company's sources and uses of cash, as well as an indication of the Company's ability to maintain an adequate level of liquidity. At March 31, 2014, the balance of cash and cash equivalents was $128.2 million, an increase of $28.8 millionfrom December 31, 2013. A discussion of the cash provided by and used in operating, investing and financing activities follows. Operating activities provided $2.1 millionand $2.0 millionin net cash for the three months ended March 31, 2014and 2013, respectively. The primary sources of funds were net income from operations and adjustments to net income, such as the provision for loan losses, depreciation and amortization, and proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale. Investing activities used $10.2 millionand $19.3 millionin net cash for the three months ended March 31, 2014and 2013, respectively. Cash was primarily used to purchase securities, and fund new loans, partially offset by cash inflows from maturities and paydowns on securities and proceeds from the sale of securities and OREO.
2013, respectively. This excludes the Parent Company's securities discussed
under the heading "Parent Company Liquidity" below. Projected cash flows from
securities over the next twelve months are
× Loans. The SBA loans held for sale portfolio amounted to
loans provide an additional source of liquidity for the Company.
× Outstanding Commitments. The Company was committed to advance approximately
commitments expire within one year, compared to
2013. The Company had
31, 2014 and
noted above. The estimated fair value of these guarantees is not
significant. The Company believes it has the necessary liquidity to honor all
commitments. Many of these commitments will expire and never be funded. Financing activities provided
$36.8 millionin net cash for the three months ended March 31, 2014, compared to $3.1 millionfor the same period in the prior year, primarily due to an increase in the Company's deposits and proceeds from new borrowings partially offset by repayments of borrowings.
× Deposits. As of
deposits, as compared to
generally short in duration and are very sensitive to price competition. The
Company believes that the current level of these types of deposits is
appropriate. Included in the portfolio were
municipalities. The withdrawal of these deposits, in whole or in part, would
not create a liquidity shortfall for the Company. 44
× Borrowed Funds. Total FHLB borrowings amounted to
million as of
repurchase agreements totaled
("FHLB"), the Company can borrow additional funds based on the market value of
collateral pledged. At
million in borrowing potential from the FHLB. In addition, the Company can
pledge additional collateral in the form of 1 to 4 family residential mortgages
or investment securities to increase this line with the FHLB. Parent Company Liquidity
The Parent Company'scash needs are funded by dividends paid by the Bank. Other than its investment in the Bank and Unity Statutory Trusts II and III, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses and, prior to the redemption of the preferred stock issued as part of the CPP, cash dividends on the preferred stock issued to the U.S. Treasury.
CapitalA significant measure of the strength of a financial institution is its capital base. Federal regulators have classified and defined capital into the following components: (1) tier 1 capital, which includes tangible shareholders' equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, subject to limitations, certain qualifying long-term debt, preferred stock and hybrid instruments, which do not qualify for tier 1 capital. The parent company and its subsidiary bank are subject to various regulatory capital requirements administered by banking regulators. Quantitative measures of capital adequacy include the leverage ratio (tier 1 capital as a percentage of tangible assets), tier 1 risk-based capital ratio (tier 1 capital as a percent of risk-weighted assets) and total risk-based capital ratio (total risk-based capital as a percent of total risk-weighted assets). Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require the Company and the Bank to maintain certain capital as a percentage of assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-weighted assets). Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines. However, prompt corrective action provisions are not applicable to bank holding companies. At a minimum, tier 1 capital as a percentage of risk-weighted assets of 4 percent and combined tier 1 and tier 2 capital as a percentage of risk-weighted assets of 8 percent must be maintained. In addition to the risk-based guidelines, regulators require that a bank or holding company, which meets the regulator's highest performance and operation standards, maintain a minimum leverage ratio of 3 percent. For those institutions with higher levels of risk or that are experiencing or anticipating significant growth, the minimum leverage ratio will be proportionately increased. Minimum leverage ratios for each institution are evaluated through the ongoing regulatory examination process. On April 15, 2014, the Company filed an S-1 registration statement announcing a common stock rights offering to existing shareholders. This purpose of this rights offering is to provide the Company with additional capital to grow its earning assets. The offering is expected to be completed late in the second quarter or early in the third quarter. To be well-capitalized For capital under prompt corrective Actual adequacy purposes action provisions (In thousands) Amount Ratio Amount Ratio Amount Ratio As of March 31, 2014 Leverage ratio $ 72,5358.19 % ? $ 35,4434.00 % N/A N/A Tier I risk-based capital ratio 72,535 10.77 26,942 4.00 N/A N/A Total risk-based capital ratio 81,010 12.03 53,884 8.00 N/A N/A As of December 31, 2013 Leverage ratio $ 70,8528.08 % ? $ 35,0844.00 % N/A N/A Tier I risk-based capital ratio 70,852 10.74 26,400 4.00 N/A N/A Total risk-based capital ratio 79,164 11.99 52,800 8.00 N/A N/A 45
The Bank's capital amounts and ratios are presented in the following table:
To be well-capitalized For capital under prompt corrective Actual adequacy purposes action provisions (In thousands) Amount Ratio Amount Ratio Amount Ratio As of March 31, 2014 Leverage ratio
$ 63,1777.14 % ? $ 35,4174.00 % ? $ 44,2725.00 % Tier I risk-based capital ratio 63,177 9.39 26,915 4.00 40,373 6.00 Total risk-based capital ratio 80,144 11.91 53,831 8.00 67,288 10.00 As of December 31, 2013 Leverage ratio $ 61,4937.02 % ? $ 35,0584.00 % ? $ 43,8235.00 % Tier I risk-based capital ratio 61,493 9.33 26,373 4.00 39,560 6.00 Total risk-based capital ratio 78,296 11.88 52,747 8.00 65,933 10.00 The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a set of capital reform measures designed to strengthen the regulation, supervision and risk management of banking organizations worldwide. In order to implement Basel III and certain additional capital changes required by the Dodd-Frank Act, on July 9, 2013, the FDICapproved, as an interim final rule, the regulatory capital requirements for U.S. state nonmember banks, such as us, substantially similar to final rules issued by the Board of Governorsof the Federal Reserve System("Federal Reserve") and the Office of the Comptroller of the Currency. The interim final rule includes new risk-based capital and leverage ratios that will be phased-in from 2015 to 2019 for most state nonmember banks, including us. The rule includes a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Total risk-based capital requirements. The interim final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requires a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for the Bank on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers. The following chart compares the risk-based capital required under existing rules to those prescribed under the interim final rule under the phase-in period described above: Current Treatment Treatment in Final Rule Leverage ratio 4.00 % 4.00 % Common equity tier 1 capital N/A 4.50 % (CET1) ratio Additional tier 1 N/A 1.50 % Tier 1 capital ratio 4.00 % 6.00 % Tier 2 4.00 % 2.00 % Total capital ratio 8.00 % 8.00 % Capital conservation buffer N/A 2.50 % The interim final rule also implements revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The interim final rule also sets forth certain changes for the calculation of risk-weighted assets that the Bank will be required to implement beginning January 1, 2015. Management is currently evaluating the provisions of the interim final rule and its expected impact. Based on our current capital composition and levels, management does not presently anticipate that the interim final rule presents a material risk to our financial condition or results of operations. Shareholders' Equity Shareholders' equity increased $1.6 millionto $58.8 millionat March 31, 2014compared to $57.2 millionat December 31, 2013. Items impacting shareholders' equity included net income of $1.3 million, $174 thousandfrom the issuance of common stock under employee benefit plans, and a $310 thousandincrease in other comprehensive income related to unrealized gains on available for sale securities, partially offset by a decrease of $140 thousandin dividends accrued on common stock. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised. Repurchase Plan On October 21, 2002, the Company authorized the repurchase of up to 10 percent of its outstanding common stock. The amount and timing of purchases is dependent upon a number of factors, including the price and availability of the Company's shares, general market conditions and competing alternate uses of funds. There were no shares repurchased during the three month periods ended March 31, 2014or 2013. 46
Impact of Inflation and Changing Prices
The financial statements and notes thereto, presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the operations. Unlike most industrial companies, nearly all the Company's assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.