The following is Management's Discussion and Analysis of Financial Condition and Results of Operations which analyzes the major elements of
Metro Bancorp Inc.'s(Metro or the Company) balance sheet as of June 30, 2014compared to December 31, 2013and in some instances June 30, 2013and statements of income for the three and six months ended June 30, 2014compared to the same periods in 2013. This section should be read in conjunction with the Company's consolidated financial statements and accompanying notes.
This Form 10-Q and the documents incorporated by reference contain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to as the Securities Act and Section 21E of the Securities Exchange Act of 1934, which we refer to as the Exchange Act, with respect to the financial condition, liquidity, results of operations, future performance and business of Metro. These forward-looking statements are intended to be covered by the safe harbor for "forward-looking statements" provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that are not historical facts. These forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond our control). The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements. While we believe our plans, objectives, goals, expectations, anticipations, estimates and intentions as reflected in these forward-looking statements are reasonable, we can give no assurance that any of them will be achieved. You should understand that various factors, in addition to those discussed elsewhere in this Form 10-Q, in the Company's Form 10-K and incorporated by reference in this Form 10-Q, could affect our future results and could cause results to differ materially from those expressed in these forward-looking statements, including:
• the effects of and changes in, trade, monetary and fiscal policies,
including interest rate policies of the
Reserve System, including the duration of such policies;
• interest rate, market and monetary fluctuations;
• general economic or business conditions, either nationally, regionally or
in the communities in which we do business, may be less favorable than
expected, resulting in, among other things, a deterioration in credit
quality and loan performance or a reduced demand for credit;
• the effects of ongoing short and long-term federal budget and tax
negotiations and their effects on economic and business conditions in
general and our customers in particular;
• the effects of the failure of the federal government to reach a deal to
permanently raise the debt ceiling and the potential negative results on
economic and business conditions;
• the impact of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) and other changes in financial services' laws and regulations (including laws concerning taxes, banking, securities and insurance); • possible impacts of the capital and liquidity requirements of the
BaselIII standards and other regulatory pronouncements; • continued effects of the aftermath of recessionary conditions and the impacts on the economy in general and our customers in particular, including adverse impacts on loan utilization rates as well as
delinquencies, defaults and customers' ability to meet credit obligations;
• our ability to manage current levels of impaired assets;
• continued levels of loan volume origination;
• the adequacy of the allowance for loan losses;
• the impact of changes in Regulation Z and other consumer credit protection
laws and regulations;
• changes resulting from legislative and regulatory actions with respect to
the current economic and financial industry environment;
• changes in the
and the associated premiums that banks pay to the fund;
• the results of the regulatory examination and supervision process;
28 -------------------------------------------------------------------------------- • unanticipated regulatory or legal proceedings and liabilities and other costs; • compliance with laws and regulatory requirements of federal, state and local agencies; • our ability to continue to grow our business internally or through
acquisitions and successful integration of new or acquired entities while
controlling costs; • deposit flows;
• the willingness of customers to substitute competitors' products and
services for our products and services and vice versa, based on price,
quality, relationship or otherwise;
• changes in consumer spending and saving habits relative to the financial
services we provide;
• the ability to hedge certain risks economically;
• the loss of certain key officers;
• changes in accounting principles, policies and guidelines as may be adopted by the regulatory agencies, as well as the
Public Company Accounting Oversight Board, the Financial Accounting Standards Board(FASB), and other accounting standards setters;
• the timely development of competitive new products and services by us and
the acceptance of such products and services by customers;
• rapidly changing technology;
• continued relationships with major customers;
• effect of terrorist attacks and threats of actual war;
• other economic, competitive, governmental, regulatory and technological
factors affecting the Company's operations, pricing, products and services;
• interruption or breach in security of our information systems resulting in
failures or disruptions in customer account management, general ledger
processing and loan or deposit systems;
• our ability to maintain compliance with the exchange rules of The Nasdaq
Stock Market, Inc.;
• our ability to maintain the value and image of our brand and protect our
intellectual property rights;
• disruptions due to flooding, severe weather or other natural disasters or
Acts of God; and
• our success at managing the risks involved in the foregoing.
Because such forward-looking statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. The foregoing list of important factors is not exclusive and you are cautioned not to place undue reliance on these factors or any of our forward-looking statements, which speak only as of the date of this document or, in the case of documents incorporated by reference, the dates of those documents. We do not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of us except as required by applicable law.
For the first six months of 2014, we continued our focus on the Company's profitability which resulted in the highest single quarterly net income in Metro's 29 year history. The
Also during the second quarter, we continued to strengthen the Company's balance sheet with a focus on quality, strong loan growth and a continued improvement in asset quality. Year over year, net loans grew 14% while nonperforming assets decreased by
$7.5 million, or 15%, during the past twelve months. Significant performance highlights are listed below.
Income Statement Highlights:
• The Company recorded net income of
common share, for the second quarter of 2014 compared to net income of
$4.0 million, or $0.28per diluted common share, for the same period one year ago; a $1.029
-------------------------------------------------------------------------------- million, or 26%, increase. Net income for the first six months of 2014 totaled
$10.0 million, or $0.70per diluted common share; up $2.3 million, or 30%, over $7.7 million, or $0.54per diluted common share recorded for the first half of 2013. • Total revenues (net interest income plus noninterest income) for the second quarter of 2014 were $31.5 million, up $1.6 million, or 5%, over total revenues of $29.9 millionfor the same quarter one year ago. Total revenues for the first half of 2014 increased $2.3 million, or 4%, over the first half of 2013.
• Return on average stockholders' equity was 8.30% for the second quarter of
2014, compared to 6.90% for the same period last year. ROE for the first
six months of 2014 was 8.36%, compared to 6.59% for the first half of 2013.
• The Company's net interest margin on a fully-taxable basis for the second
quarter of 2014 was 3.59%, compared to 3.62% for the second quarter of
2013. The Company's deposit cost of funds for the second quarter was 0.26%
and compared to 0.29% for the same period one year ago.
• The provision for loan losses totaled
of 2014, compared to
provision for loan losses for the first half of 2014 was down
$2.1 million, or 51%, from the first half of 2013.
• Noninterest expenses for the second quarter of 2014 were
$661,000, or 3%, over the same quarter last year. Total noninterest expenses for the first six months of 2014 were up $1.1 million, or 2%, compared to the first six months of 2013.
Balance Sheet Highlights:
• Net loans grew
$49.2 million, or 3%, on a linked quarter basis to $1.83 billionand were up $221.7 million, or 14%, over the second quarter 2013.
• Nonperforming assets were 1.42% of total assets at
to 1.81% of total assets one year ago.
• Deposits totaled
quarter last year.
• Metro's capital levels remain strong with a Tier 1 Leverage ratio of 9.57%
and a total risk-based capital ratio of 14.55%.
• Stockholders' equity totaled
the end of the second quarter 2014. At
value per share was
increased by 15% from
per common share at
Summarized below are financial highlights for the three and six months ended
At or for the Three Months Ended June 30, For the Six Months Ended June 30, (in thousands, except per share data) 2014 2013 % Change 2014 2013 % Change Total assets
$ 2,868,928 $ 2,658,4058 % Total loans (net) 1,827,544 1,605,828 14 Total deposits 2,186,980 2,168,759 1
Total stockholders' equity 248,770 228,468 9 Total revenues
$ 31,490 $ 29,9335 % $ 61,903 $ 59,6434 % Provision for loan losses 1,100 1,800 (39 ) 2,000 4,100 (51 ) Total noninterest expenses 23,021 22,360 3 45,803 44,689 2 Net income 5,081 4,048 26 10,025 7,693 30 Diluted net income per common share 0.35 0.28 25 0.70 0.54 30 30
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our accounting policies are fundamental to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. Our accounting policies are more fully described in Note 1 of the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2013. Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America(GAAP). These principles require our management to make estimates and assumptions about future events that affect the amounts reported in our consolidated financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, actual results may differ from those estimates. Management makes adjustments to its assumptions and estimates when facts and circumstances dictate. We evaluate our estimates and assumptions on an ongoing basis and predicate those estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Management has identified the accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to understanding Metro's Unaudited Consolidated Financial Statements and Management's Discussion and Analysis at June 30, 2014, which were unchanged from the policies disclosed in Metro's 2013 Form 10-K. Management believes the following critical accounting policies encompass the more significant assumptions and estimates used in preparation of our consolidated financial statements. Allowance for Loan Losses. The allowance for loan losses (allowance or ALL) represents the amount available for estimated probable losses embedded in Metro Bank's(the Bank) loan portfolio. While the allowance is maintained at a level believed to be adequate by management for estimated probable losses in the loan portfolio, the determination of the allowance is inherently subjective, as it involves significant estimates by management, all of which may be susceptible to significant change. While management uses available information to make such evaluations, future adjustments to the allowance and to the provision for loan losses may be necessary if economic conditions or loan credit quality differ materially from the estimates and assumptions used in making the evaluations. The use of different assumptions could materially impact the level of the allowance and, therefore, the provision for loan losses to be charged against earnings. Such changes could impact future financial results. Monthly, systematic reviews of our loan portfolios are performed to identify probable losses and assess the overall probability of collection. These reviews include an analysis of historical loss experience, which results in the identification and quantification of loss factors. These loss factors are used in determining the appropriate level of allowance to cover estimated probable losses in specific loan types. The estimates of loss factors can be impacted by many variables, such as the number of years of actual loss history included in the evaluation. As part of the quantitative analysis of the adequacy of the ALL, management based its calculation of probable future loan losses on those loans collectively reviewed for impairment on a rolling two-year period of actual historical losses. Management may adjust the number of years used in the historical loss calculation depending on the state of the local, regional and national economies and the period of time which management believes will most accurately forecast future losses. Significant estimates are involved in the determination of any loss related to impaired loans. The evaluation of an impaired loan is based on either (1) the discounted cash flows using the loan's effective interest rate, (2) the fair value of the collateral for collateral-dependent loans, or (3) the observable market price of the impaired loan. Each of these estimates involves management's judgment. In addition to calculating the loss factors, the Bank may periodically adjust the factors for changes in levels and trends of charge-offs, delinquencies and nonaccrual loans; material changes in the mix, volume, or duration of the loan portfolio; changes in lending policies and procedures including underwriting standards; changes in the experience, ability and depth of lending management and other relevant staff; the existence and effect of any concentrations of credit and changes in the level of such concentrations; and changes in national and local economic trends and conditions, among other things. Management judgment is exercised at many levels in making these evaluations. An integral aspect of our risk management process is allocating the allowance to various components of the loan portfolio based upon an analysis of risk characteristics, demonstrated losses, industry and other segmentations and other judgmental factors. Fair Value Measurements. The Company is required to disclose the fair value of its financial instruments that are measured at fair value within a fair value hierarchy. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). Judgment is involved not only with deriving the estimated fair values but also with classifying the particular assets recorded at fair value in the fair value hierarchy. Estimating the fair value of impaired loans or the value of collateral securing foreclosed assets requires the use of significant unobservable inputs (level 3 31
-------------------------------------------------------------------------------- measurements). The fair value of collateral securing impaired loans or constituting foreclosed assets is generally determined based upon independent third party appraisals of the properties, recent offers, or prices on comparable properties in the proximate vicinity. Such estimates can differ significantly from the amounts the Company would ultimately realize from the loan or disposition of the underlying collateral. The Company's available for sale (AFS) investment security portfolio constitutes 98% of the total assets measured at fair value and all securities are classified as a level 2 fair value measurement (quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability). Management utilizes third party service providers to aid in the determination of the fair value of the portfolio. Most securities are not quoted on an exchange, but are traded in active markets and fair values were obtained from matrix pricing on similar securities. Deferred Taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be used. The Company assesses whether or not the deferred tax assets would be realized in the future if the Company would not have future taxable income to use as an offset. If future taxable income is not expected to be available to use, a valuation allowance is required to be recognized. A valuation allowance would result in additional income tax expense in the period. The Company assesses if it is more likely than not that a deferred tax asset will not be realized. The determination of a valuation allowance is subjective and dependent upon judgment concerning both positive and negative evidence to support that the net deferred tax assets will be utilized. In order to evaluate whether or not a valuation allowance is necessary, the Company uses current forecasts of future income, the ability to carryback losses to preceding years, reviews possible tax planning strategies and assesses current and future economic and business conditions. Negative evidence utilized would include any cumulative losses in previous years and general business and economic trends. At
June 30, 2014, the Company conducted such an analysis to determine if a valuation allowance was required and concluded that a valuation allowance was not necessary. A valuation allowance, if required, could have a significant impact on the Company's future earnings. RESULTS OF OPERATIONS
For the six months of 2014, total revenues were
We derive total revenues from various sources, including: • Interest income from our loan portfolio;
• Interest income from our securities portfolio;
• Fees associated with customer deposit accounts;
• Fees from issuing loan commitments and standby letters of credit;
• Fees from various cash management services;
• Electronic banking services; and
• Sales of loans and securities.
Average Balances and Average Interest Rates
Table 2 sets forth balance sheet items on a daily average basis for the three and six months ended
June 30, 2014and 2013, respectively, and presents the daily average interest rates earned on assets and the daily average interest rates paid on liabilities for these periods.
Second Quarter 2014 compared to Second Quarter 2013
Interest-earning assets averaged
$2.72 billionfor the second quarter of 2014, up 7% compared to $2.55 billionfor the second quarter in 2013. For the quarter ended June 30, 2014, total loans receivable including loans held for sale, averaged $1.83 billioncompared to $1.63 billionfor the second quarter in 2013, a 12% increase. Total securities, including restricted investments in bank stock, averaged $889.1 millionand $919.4 millionfor the second quarter of 2014 and 2013, respectively, a 3% decrease. Over the past three quarters, management has, for the most part, utilized cash flows from the Company's securities portfolio to fund strong loan growth rather than purchase additional securities. This decision was the result of higher yields on new loans than on new securities purchased combined with loan growth that has significantly outpaced deposit growth over the past twelve months. 32 -------------------------------------------------------------------------------- The fully-taxable equivalent yield on interest-earning assets for the second quarter of 2014 was 3.88%, a decrease of five basis points (bps) from the comparable period in 2013. The decrease resulted from lower yields on the Company's loans receivable portfolio, offset partially by an increase in yield on the securities portfolio. The decrease in yield on the loan portfolio was the result of the continued low level of general market interest rates as legacy loans outstanding with higher yields continue to pay down contractually and are replaced with loans at lower current market yields. Our floating rate loans currently provide lower yields than our fixed rate loans and represented approximately 45% of our total loans receivable portfolio for the quarter ended June 30, 2014. As a result of the current low level of interest rates, coupled with the Federal Reserve's stated intention to maintain this current low-level of short-term interest rates for an indefinite period of time, we expect the yields we receive on our interest-earning assets could continue at their current levels, or decline further, throughout the remainder of 2014 and in 2015 as well. The average balance of total deposits increased $73.4 million, or 4%, for the second quarter of 2014 over the second quarter of 2013, from $2.09 billionto $2.17 billion. Total average interest-bearing deposits increased by $37.4 millionand total average noninterest-bearing deposits increased by $36.0 millionfueled by 10% growth in business demand deposits. Short-term borrowings, which consist of overnight advances from the Federal Home Loan Bank(FHLB), averaged $387.6 millionfor the second quarter of 2014 compared to $325.0 millionfor the same quarter of 2013. These additional borrowings and new deposits were used to fund loan originations. The average rate paid on our total interest-bearing liabilities for the second quarter of 2014 was 0.38%, compared to 0.40% for the second quarter of 2013. Our deposit cost of funds decreased three bps from 0.29% in the second quarter of 2013 to 0.26% for the second quarter of 2014. The average rate paid on core deposits (total deposits less public time deposits and other noncore deposits) decreased across all categories except one during the second quarter of 2014 compared to second quarter of 2013. The decrease in the Company's deposit cost of funds is primarily related to the combination of time deposits that matured and renewed at lower rates as well as lower rates paid on savings accounts. These decreases were a result of the continued low level of general market interest rates. Time deposits, or certificates of deposit (CDs), have a significant impact on the Company's cost of funds. As certificates that were originated in past years at higher interest rates have matured over the past twelve months, these funds have been either renewed into new CDs with lower interest rates or shifted by our customers to their checking and/or savings accounts. As a result, our weighted-average rate paid on all time deposits, including both retail and public, decreased by 16 bps from 0.97% for the second quarter of 2013 to 0.81% for the second quarter of 2014. At June 30, 2014, $522.6 million, or 24%, of our total deposits were those of local municipalities, school districts, not-for-profit organizations or corporate cash management customers, where the interest rates paid are indexed to either a published rate such as London Interbank Offered Rate (LIBOR), the United States90-Day Treasury bill or to an internally managed index rate. If short-term market interest rates increase, the cost of these deposits will increase according to the increase in the respective index to which their interest rates are tied. The average cost of short-term borrowings was 0.28% for the second quarter of 2014 as compared to 0.22% for the second quarter of 2013. The average cost of long-term debt was 7.77% in both the second quarter of 2014 and 2013. The aggregate average cost of all funding sources for the Company was 0.31% for the second quarter of 2014, compared to 0.33% for the same quarter of the prior year.
Six Months Ended
Interest-earning assets averaged
$2.70 billionfor the first six months of 2014, up 7%, compared to $2.52 billionfor the first half of 2013. For the same two periods, total loans receivable including loans held for sale, averaged $1.80 billionin 2014 and $1.59 billionin 2013, respectively, a 13% increase. Total securities, including restricted investments in bank stock, averaged $898.1 millionand $933.1 millionfor the first six months of 2014 and 2013, respectively. The fully-taxable equivalent yield on interest-earning assets for the first six months of 2014 was 3.87%, a decrease of 10 bps versus the comparable period in 2013. This decrease primarily resulted from the continued overall lower level of interest rates as yields declined for loans. The average fully-taxable equivalent yield on the investment portfolio increased 3 bps from 2.34% during the first six months of 2013 to 2.37% during the first six months of 2014. The average fully-taxable equivalent yield on the loan portfolio declined 31 bps from 4.93% during the first six months of 2013 to 4.62% during the first six months of 2014. The Company funded the growth in earning assets over the past twelve months both with an increase in short-term borrowings and with the growth of deposits. Short-term borrowings averaged $372.2 millionand $277.2 millionin the first six months of 2014 and 2013, respectively. Total average deposits, including noninterest-bearing funds, increased by $61.3 million, or 3%, for the first six months of 2014 over the same period of 2013 from $2.11 billionto $2.17 billion. 33
-------------------------------------------------------------------------------- The average rate paid on interest-bearing liabilities for the first six months of 2014 was 0.38%, compared to 0.42% for the first six months of 2013. Our deposit cost of funds decreased from 0.30% in the first six months of 2013 to 0.26% for the same period in 2014. The aggregate cost of all funding sources was 0.31% for the first six months of 2014, compared to 0.34% for the same period in 2013. In the following table, nonaccrual loans have been included in the average loans receivable balances. Securities include securities available for sale, securities held to maturity and restricted investments in bank stock. Securities available for sale are carried at amortized cost for purposes of calculating the average rate received on taxable securities. Yields on tax-exempt securities and loans are computed on a tax-equivalent basis, assuming a 35% tax rate for both years. TABLE 2 Three months ended, Six months ended, June 30, 2014 June 30, 2013 June 30, 2014 June 30, 2013 Average Avg. Average Avg. Average Avg. Average Avg.
(dollars in thousands) Balance Interest Rate Balance
Interest Rate Balance Interest Rate Balance Interest Rate Earning Assets Investment securities: Taxable
$ 858,174 $ 5,0182.34 % $ 889,510 $ 5,0072.25 % $ 867,161 $ 10,0642.32 % $ 903,261 $ 10,3662.30 % Tax-exempt 30,941 293 3.79 29,871 284 3.80 30,934 586 3.79 29,870 567 3.80 Total securities 889,115 5,311 2.39 919,381
5,291 2.30 898,095 10,650 2.37 933,131 10,933 2.34 Total loans receivable 1,830,846 21,222 4.60 1,628,073
19,908 4.85 1,803,564 41,756 4.62 1,591,199 39,311 4.93 Total earning assets
$ 2,719,961 $ 26,5333.88 % $ 2,547,454 $ 25,1993.93 % $ 2,701,659 $ 52,4063.87 % $ 2,524,330 $ 50,2443.97 % Sources of Funds Interest-bearing deposits: Regular savings $ 464,780 $ 3190.28 % $ 424,474
Interest checking and money market 1,033,565 709 0.28 1,039,872 733 0.28 1,051,715 1,429 0.27 1,058,702 1,535 0.29 Time deposits 124,209 318 1.03 130,015 397 1.22 125,325 647 1.04 134,298 844 1.27 Public time and other noncore deposits 69,071 55 0.32 59,894 60 0.40 66,906 105 0.32 57,423 104 0.37 Total interest-bearing deposits 1,691,625 1,401 0.33 1,654,255 1,525 0.37 1,706,510 2,835 0.34 1,669,837 3,144 0.38 Short-term borrowings 387,611 278 0.28 325,044 181 0.22 372,168 509 0.27 277,243 312 0.22 Long-term debt 15,800 307 7.77 15,800 307 7.77 15,800 614 7.77 26,297 667 5.07 Total interest-bearing liabilities 2,095,036 1,986 0.38 1,995,099 2,013 0.40 2,094,478 3,958 0.38 1,973,377 4,123 0.42 Demand deposits (noninterest-bearing) 476,605 440,573 461,452 436,850 Sources to fund earning assets 2,571,641 1,986 0.31 2,435,672 2,013 0.33 2,555,930 3,958 0.31 2,410,227 4,123 0.34 Noninterest-bearing funds (net) 148,320 111,782 145,729 114,103 Total sources to fund earning assets
$ 2,719,961 $ 1,9860.29 % $ 2,547,454 $ 2,0130.32 % $ 2,701,659 $ 3,9580.29 % $ 2,524,330 $ 4,1230.33 % Net interest income and margin on a tax-equivalent basis $ 24,5473.59 % $ 23,1863.62 % $ 48,4483.58 % $ 46,1213.64 % Tax-exempt adjustment 552 587 1,118 1,187 Net interest income and margin $ 23,9953.50 % $ 22,5993.52 % $ 47,3303.49 % $ 44,9343.55 % Other Balances: Cash and due from banks $ 42,777 $ 50,801 $ 43,262 $ 46,831Other assets 70,878 90,398 69,722 91,178 Total assets 2,833,616 2,688,653 2,814,643 2,662,339 Other liabilities 16,325 17,725 16,786 16,763 Stockholders' equity 245,650 235,256 241,927 235,349
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income earned on loans, investment securities and other interest-earning assets and the interest expense paid on deposits, borrowed funds and long-term debt. Changes in net interest income and net interest margin result from the interaction between the volume and composition of interest-earning assets and their related yields; and the volume and composition of interest-bearing liabilities and their associated funding costs. Net interest income is our primary source of earnings. There are several factors that affect net interest income, including: 34 --------------------------------------------------------------------------------
• the volume, pricing mix and maturity of interest-earning assets and interest-bearing liabilities;
• market interest rate fluctuations; and
• the level of nonperforming loans.
Net interest income on a fully-taxable equivalent basis (which adjusts for the tax-exempt status of income earned on certain loans and investment securities in order to show such income as if it were taxable) for the second quarter of 2014 increased by
$1.4 million, or 6%, over the same period in 2013. Interest income, on a fully-taxable equivalent basis, on interest-earning assets totaled $26.5 millionfor the second quarter of 2014 versus $25.2 millionfor the second quarter of 2013. Interest income on loans receivable including loans held for sale, increased by $1.3 million, or 7%, over the second quarter of 2013 from $19.9 millionto $21.2 million. This was the result of a 12% increase in average loans outstanding partially offset by a decrease of 25 bps in the yield on the total loan portfolio compared to the second quarter one year ago. Total interest expense for the second quarter decreased $27,000, or 1%, in 2014. Interest expense on deposits for the quarter decreased by $124,000, or 8%, from the second quarter of 2013 primarily due to the previously mentioned 3 bps decrease in the deposit cost of funds from 0.29% to 0.26%. Interest expense on short-term borrowings increased by $97,000as a result of an increase in the average balance of borrowings as well as a 6 bps increase in rate. Net interest income, on a fully tax-equivalent basis, for the first six months of 2014 increased by $2.3 million, or 5%, over the same period in 2013. Interest income on interest-earning assets totaled $52.4 millionfor the first six months of 2014, an increase of $2.2 million, compared to the same period in 2013. The increase in interest income earned was primarily the result of a 13% increase in the average balance of loans receivable that helped to offset a 31 bp decrease in the yield on loans receivable due to the continued low interest rate environment. Total interest expense for the first six months decreased $165,000, or 4%, from $4.1 millionin 2013 to $4.0 millionin 2014. Interest expense on deposits decreased by $309,000, or 10%, for the first six months of 2014 versus the same period of 2013 primarily due to the previously mentioned 4 bps decrease in the deposit cost of funds for the first half of 2014 compared to the first half of last year. Interest expense on short-term borrowings increased by $197,000for the first six months of 2014 compared to the same period in 2013 and interest expense on long-term debt totaled $614,000for the first six months of 2014, as compared to $667,000for the first six months of 2013. The increase in interest expense associated with short-term borrowings was due to a combination of the higher average balance of such borrowings as well as a 5 bps increase in the average rate paid on such borrowings for the first half of 2014 compared to the same period in 2013. The decrease in interest expense on long-term debt was primarily due to the maturity of a $25 millionFHLB borrowing with an interest rate of 1.01% which matured in March 2013. Overall, the decreases in the average rates earned on interest-earning assets and average rates paid on interest-bearing liabilities are a function of higher rates on both assets and liabilities rolling off, offset by lower rates going on to both sides of the balance sheet. Changes in net interest income are frequently measured by two statistics: net interest rate spread and net interest margin. Net interest rate spread is the difference between the average rate earned on interest-earning assets and the average rate incurred on interest-bearing liabilities. Our net interest rate spread on a fully tax-equivalent basis was 3.50% during the second quarter of 2014 compared to 3.53% during the same period in the previous year and was 3.49% during the first six months of 2014 versus 3.55% during the first six months of 2013. Net interest margin represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average interest-earning assets. The fully-taxable equivalent net interest margin decreased 3 bps, from 3.62% for the second quarter of 2013 to 3.59% for the second quarter of 2014, as a result of the previously discussed decrease in yield on interest-earning assets, partially offset by a decrease in the cost of funding sources. For the first six months of 2014 and 2013, the fully tax-equivalent net interest margin was 3.58% and 3.64%, respectively. 35 -------------------------------------------------------------------------------- The following table demonstrates the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. For purposes of this table, nonaccrual loans have been included in the average loan balances and tax-exempt loans and securities are reported on a fully-taxable equivalent basis. TABLE 3 Three Months Ended Six Months Ended Increase (Decrease) Increase (Decrease) 2014 versus 2013 Due to Changes in (1) Due to Changes in (1) (in thousands) Volume Rate Total Volume Rate Total Interest on securities: Taxable $ (124 ) $ 135 $ 11 $ (357 ) $ 55 $ (302 )Tax-exempt 10 (1 ) 9 21 (2 ) 19 Interest on loans receivable 2,377 (1,063 ) 1,314 4,943 (2,498 ) 2,445 Total interest income 2,263 (929 ) 1,334 4,607 (2,445 ) 2,162 Interest on deposits: Regular savings 25 (41 ) (16 ) 51 (58 ) (7 ) Interest checking and money market (22 ) (2 ) (24 ) (52 ) (54 ) (106 ) Time deposits (34 ) (45 ) (79 ) (87 ) (110 ) (197 ) Public funds time and other noncore deposits 9 (14 ) (5 ) 15 (14 ) 1 Short-term borrowings 39 58 97 121 76 197 Long-term debt - - - (27 ) (26 ) (53 ) Total interest expense 17 (44 ) (27 )
21 (186 ) (165 ) Net increase (decrease)
(1) Changes due to both volume and rate have been allocated on a pro rata basis
to either rate or volume.
Provision for Loan Losses
Management undertakes a rigorous and consistently applied process in order to evaluate the ALL and to determine the level of provision for loan losses, as previously stated in the Application of Critical Accounting Policies. As stated in this policy, the Company uses a two-year period of actual historical losses. Management continuously assesses the quality of the Company's loan portfolio in conjunction with the current state of the economy and its impact on our borrowers repayment ability and on loan collateral values in order to determine the appropriate probable loss period to use in our quantitative analysis. Considering these factors, management continued to use a two-year probable loss period in the second quarter of 2014 in determining the adequacy of the ALL. During the third quarter of 2011, the Company had unusually high net charge-offs that have not repeated since that period. Those historical losses exceed the two-year inclusion period associated with the quantitative factors calculation and therefore were no longer included in the calculation for the second quarter and the first six months of 2014, however, they were included in the calculation for the second quarter and the first six months of 2013. This situation resulted in a reduction of the ALL required and in a lower provision being needed during those periods of 2014. The decrease in reserve needed due to historical loss factors was offset by an increase in the allowance needed due to the additional loans outstanding and an increase in certain qualitative factors. We recorded a provision of
$1.1 millionto the ALL for the second quarter of 2014 as compared to $1.8 millionfor the second quarter of 2013. For the six months ended June 30, 2014a total provision of $2.0 millionwas recorded versus $4.1 millionfor the six months ended June 30, 2013. The ALL was $24.3 million, or 1.31%, of total loans outstanding at June 30, 2014compared to $28.0 million, or 1.72%, of total loans outstanding at June 30, 2013and compared to $23.1 million, or 1.32%, of total loans outstanding at December 31, 2013. Net charge-offs totaled $763,000during the second quarter of 2014 compared to $1.2 millionfor the second quarter of 2013. Net charge-offs totaled $839,000during the first six months of 2014 compared to $1.3 millionfor the first six months of 2013. Management believes that the provision for loan losses for the three and six months ended June 30, 2014adequately supports the allowance balance at June 30, 2014. Nonperforming loans at June 30, 2014totaled $36.7 million, or 1.98%, of total loans, down $3.7 million, from $40.3 million, or 2.30%, of total loans at December 31, 2013and down $6.9 millionfrom $43.5 million, or 2.66%, of total loans at June 30, 2013. See the Loan and Asset Quality and the Allowance for Loan 36 --------------------------------------------------------------------------------
Losses sections presented later in this document for further discussion regarding nonperforming loans and our methodology for determining the provision for loan losses.
Noninterest Income Total noninterest income for the second quarter of 2014 increased by
$161,000, or 2%, over the same period in 2013. Noninterest income is comprised of service charges on deposit accounts, card income, gains on sales of loans, and gains or losses on sales/calls of securities. The increase was primarily the result in an increase in card income relating to automated teller machine (ATM) and checkcard transactions, partially offset by a decrease in gains on sales of loans as the volume of residential loans sold on the secondary market has decreased significantly in 2014 compared to 2013. The lower volume of residential loan sales is the direct result of a lower level of loan originations in 2014 versus 2013. Origination volumes were down due to the higher level of interest rates offered on those loans in 2014 compared to 2013. Total noninterest income for the first six months of 2014 decreased by $136,000, or 1%, from the same period in 2013. Card income increased by $647,000, or 9%, for the six months of 2014 compared to the first half of 2013 as the volume of transactions continues to increase. Conversely, service charges on deposits totaled $4.3 millionfor the first six months of 2014; decreasing $329,000, or 7%, compared to the same period 2013. This was primarily related to a decrease in nonsufficient fund (NSF) type transactions and, therefore, a decrease in fees associated with such transactions. Additionally, gains on sales of loans decreased by $389,000, or 59%, directly related to a decrease in the volume of residential loans as previously mentioned.
Second Quarter 2014 compared to Second Quarter 2013
Noninterest expenses increased by
$661,000, or 3%, for the second quarter of 2014 compared to the same period in 2013. A detailed comparison of noninterest expenses for certain categories for the three months ended June 30, 2014and June 30, 2013is presented in the following paragraphs. Salary and employee benefits expenses, which represent the largest component of noninterest expenses, increased by $664,000, or 6%, for the second quarter of 2014 compared to the second quarter of 2013. This increase was primarily a combined result of an increase in full-time equivalent employees as well as an increase in employee compensation levels. Furniture and equipment expenses totaled $994,000for the second quarter of 2014, a decrease of $191,000, or 16%, from the second quarter of 2013. This decrease was due to certain equipment the Bank had fully depreciated in 2013, resulting in less depreciation expense in the second quarter of 2014 as well as a decrease in the level of disposal of certain fixed assets during the second quarter of 2014. Loan expense totaled $881,000for the second quarter of 2014, a decrease of $163,000, or 16%, from the second quarter of 2013. This decrease resulted from the sale of the Company's credit card portfolio in the third quarter of 2013, thus eliminating credit card expenses combined with a decrease in other loan related expenses. Total other noninterest expense increased $333,000, or 17%, over the second quarter of 2013. The increase was primarily the result of increased real estate taxes paid on various foreclosed properties as well as an increase in supplies and postage expenses for customer mailings.
Each of the remaining noninterest expense categories shown on the Consolidated Statements of Income incurred minor increases or decreases for the second quarter of 2014 compared to the second quarter of 2013.
Six Months Ended
For the first six months of 2014, noninterest expenses increased by
Salary expenses and employee benefits for the first six months of 2014 were
$22.5 million, an increase of $1.3 million, or 6%, compared to the first six months of 2013. This increase was primarily a combined result of an increase in full-time equivalent employees as well as an increase in employee compensation levels. 37
-------------------------------------------------------------------------------- Occupancy expense for the first half of 2014 was
$4.6 million, an increase of $306,000, or 7%, compared to the first six months of 2013. This increase resulted from the extreme winter weather during the first quarter 2014 and therefore higher costs associated with snow and ice removal compared to the same period in 2013. Furniture and equipment expenses totaled $2.0 millionfor the first half of 2014, a decrease of $248,000, or 11%, from the first half of 2013. The decrease was due to the previously mentioned reduction in depreciation expense as well as a reduction in disposal losses. Loan expenses totaled $1.0 millionfor the first six months of 2014, a decrease of $353,000, or 26%, compared to the same period in 2013 due in large part to the recovery of legal fees and other related expenses that were expensed in prior periods on a few problem commercial real estate loans as well as a decrease in credit card expenses as a result of the Company selling its credit card portfolio in the third quarter of 2013. Each of the remaining noninterest expense categories shown on the Consolidated Statements of Income incurred minor increases or decreases for the first six months of 2014 compared to the same period in 2013. One key measure that management utilizes to monitor progress in controlling overhead expenses is the ratio of annualized net noninterest expenses to average assets. For purposes of this calculation, net noninterest expenses equal noninterest expenses less noninterest income and nonrecurring expense. For the second quarters of 2014 and 2013 this ratio equaled 2.20% and 2.24%, respectively, reflecting continued disciplined expense management in the second quarter of 2014 despite a 5% increase in average assets. For the six months ended June 30, 2014, the ratio equaled 2.24% compared to 2.27% for the six months ended June 30, 2013. Another productivity measure utilized by management is the operating efficiency ratio. This ratio expresses the relationship of noninterest expenses to net interest income plus noninterest income. For the quarter ended June 30, 2014, the operating efficiency ratio was 73.1%, compared to 74.7% for the same period in 2013. The decrease in the operating efficiency ratio relates to a 5% increase in total revenues partially offset by a 3% increase in total noninterest expenses. The efficiency ratio equaled 74.0% for the first six months of 2014, compared to 74.9% for the first six months of 2013. The decrease for the six months ended June 30, 2014versus June 30, 2013was mostly due to a 4% increase in total revenues partially offset by a 2% increase in total noninterest expenses.
Provision for Federal Income Taxes
The provision for federal income taxes was
$2.3 millionfor the second quarter of 2014 compared to $1.7 millionfor the same period in 2013. For the six months ended June 30, the tax expense was $4.1 millionfor 2014 compared to $3.2 millionin 2013. The Company's statutory tax rate was 35% in both 2014 and 2013. The effective tax rates were 31% and 30% for the respective quarters ended June 30, 2014and June 30, 2013and 29% for both the six months ended June 30, 2014and 2013, respectively.
Net Income and Net Income per Common Share
A summary income statement for the three and six months ended
For the Three Months Ended June 30, For the Six Months Ended June 30, (in thousands, except per share data) 2014 2013 $ Change % Change 2014 2013 $ Change % Change Net interest income
$ 23,995 $ 22,599 $ 1,3966 % $ 47,330 $ 44,934 $ 2,3965 % Provision for loan losses 1,100 1,800 (700 ) (39 ) 2,000 4,100 (2,100 ) (51 ) Noninterest income 7,495 7,334 161 2 14,573 14,709 (136 ) (1 ) Noninterest expenses 23,021 22,360 661 3 45,803 44,689 1,114 2 Provision for income taxes 2,288 1,725 563 33 4,075 3,161 914 29 Net income $ 5,081 $ 4,048 $ 1,03326 % $ 10,025 $ 7,693 $ 2,33230 % Net Income per Common Share Basic $ 0.36 $ 0.28 $ 0.0829 % $ 0.70 $ 0.54 $ 0.1630 % Diluted 0.35 0.28 0.07 25 0.70 0.54 0.16 30 Net income for the second quarter of 2014 was $5.1 millioncompared to $4.0 millionrecorded in the second quarter of 2013. The 26% increase was primarily due to a $1.4 millionincrease in net interest income, a $700,000decrease in the provision for loan 38
losses and a
Net income for the first six months of 2014 was
$10.0 million, an increase of $2.3 million, or 30%, compared to $7.7 millionrecorded in the first six months of 2013. The higher net income in 2014 was due to a $2.4 millionincrease in net interest income and a $2.1 milliondecrease in the provision for loan losses, partially offset by a $136,000decrease in noninterest income, a $1.1 millionincrease in noninterest expenses and a $914,000increase in the provision for income taxes. Basic net income per common share was $0.36and fully-diluted net income per common share was $0.35for the second quarter of 2014 compared to basic and fully-diluted net income per common share of $0.28for the second quarter of 2013. The increase was directly related to the 26% increase in net income as stated above. For the first six months of 2014, basic and fully-diluted net income per common share was $0.70compared to basic and fully-diluted net income per common share of $0.54for the six months ended June 30, 2013.
Return on Average Assets and Average Equity
Return on average assets (ROA) measures our net income in relation to our total average assets. Our annualized ROA for the second quarter of 2014 was 0.72%, compared to 0.60% for the second quarter of 2013. The ROA for the first six months of 2014 and 2013 was 0.72% and 0.58%, respectively. Return on average equity (ROE) indicates how effectively we can generate net income on the capital invested by our stockholders. ROE is calculated by dividing annualized net income by average stockholders' equity. The ROE was 8.30% for the second quarter of 2014, compared to 6.90% for the second quarter of 2013. The ROE for the first six months of 2014 was 8.36%, compared to 6.59% for the first six months of 2013. FINANCIAL CONDITION Securities The Company maintains a securities portfolio in order to provide liquidity, a way to manage interest rate risk and to use as collateral on certain deposits and borrowings. The investment securities portfolio totaled
$844.9 millionat June 30, 2014a $24.9 milliondecrease from $869.7 millionat December 31, 2013primarily due to normal principal payments. Net of tax, the unrealized loss position on AFS securities included in stockholders' equity as accumulated other comprehensive loss decreased by $7.7 millionfrom an unrealized loss of $16.5 millionat December 31, 2013to an unrealized loss of $8.8 millionat June 30, 2014as the general level of interest rates declined during the first half of 2014. See Note 3 of the Notes to the Interim Consolidated Financial Statements for the period ended June 30, 2014, included herein, for further analysis regarding the Company's securities portfolio.
Commercial loans outstanding are comprised of commercial and industrial, tax-exempt, owner occupied real estate, commercial construction and land development and commercial real estate loans. Consumer type loans consist of residential real estate mortgages, home equity loans, consumer lines of credit and other consumer-related loans. We manage risk associated with our loan portfolio in part through diversification, with what we believe are sound policies and underwriting procedures that are reviewed, updated and approved at least annually, as well as through our ongoing loan monitoring efforts. Additionally, we monitor concentrations of loans or loan relationships by purpose, collateral or industry. During the first six months of 2014, total gross loans receivable increased by
$100.9 million, or 6% (nonannualized), from $1.75 billionat December 31, 2013to $1.85 billionat June 30, 2014. Gross loans receivable represented 85% of total deposits and 65% of total assets at June 30, 2014, as compared to 78% and 63%, respectively, at December 31, 2013. The Bank experienced growth in all but two loan categories over the first six months of 2014 primarily as a result of continued general economic improvement in the markets we serve. 39 --------------------------------------------------------------------------------
The following table reflects the composition of the Company's loan portfolio as of
$ % (dollars in thousands) June 30, 2014 % of Total December 31, 2013 % of Total Change Change Commercial and industrial
$ 467,58725 % $ 447,144 25 % $ 20,4435 % Commercial tax-exempt 76,674 4 81,734 5 (5,060 ) (6 ) Owner occupied real estate 308,708 17 302,417 17 6,291 2 Commercial construction and land development 130,449 7 133,176 8 (2,727 ) (2 ) Commercial real estate 544,544 29 473,188 27 71,356 15 Residential 103,564 6 97,766 6 5,798 6 Consumer 220,289 12 215,447 12 4,842 2 Gross loans $ 1,851,815100 % $ 1,750,872 100 % $ 100,9436 % Less: ALL 24,271 23,110 1,161 5 Net loans receivable $ 1,827,544$ 1,727,762 $ 99,7826 % Loan and Asset Quality Nonperforming Assets Nonperforming assets include nonperforming loans, loans past due 90 days or more and still accruing interest and foreclosed assets. Nonaccruing troubled debt restructurings (TDRs) are included in nonperforming loans. A TDR is a loan in which the contractual terms have been modified resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties in order for the Bank to have a greater opportunity of collecting the indebtedness from the borrower. 40
-------------------------------------------------------------------------------- The table that follows presents information regarding nonperforming assets at
June 30, 2014and at the end of the previous four quarters. Nonaccruing and accruing TDRs are broken out at the bottom portion of the table. Additionally, relevant asset quality ratios are presented. TABLE 5 (dollars in thousands) June 30, 2014 March 31, 2014
Commercial and industrial
$ 4,291 $ 9,014$ 10,217 $ 9,967 $ 12,053Commercial tax-exempt - - - - - Owner occupied real estate 6,401 6,005 4,838 4,924 4,999 Commercial construction and land development 9,028 10,734 8,587 11,723 12,027 Commercial real estate 5,793 6,043 6,705 6,904 3,893 Residential 6,341 6,551 7,039 7,316 7,133 Consumer 2,479 2,524 2,577 2,541 3,422 Total nonaccrual loans 34,333 40,871 39,963 43,375 43,527 Loans past due 90 days or more and still accruing 2,335 - 369 119 - Total nonperforming loans 36,668 40,871 40,332 43,494 43,527 Foreclosed assets 4,020 3,990 4,477 3,556 4,611 Total nonperforming assets $ 40,688 $ 44,861$ 44,809 $ 47,050 $ 48,138Troubled Debt Restructurings Nonaccruing TDRs (included in nonaccrual loans above) $ 17,748 $ 19,862$ 17,149 $ 23,621 $ 18,817Accruing TDRs 11,309 9,970 12,091 11,078 14,888 Total TDRs $ 29,057 $ 29,832$ 29,240 $ 34,699 $ 33,705Nonperforming loans to total loans 1.98 % 2.27 % 2.30 % 2.55 % 2.66 % Nonperforming assets to total assets 1.42 % 1.57 % 1.61 % 1.71 % 1.81 % Nonperforming loan coverage 66 % 59 % 57 % 63 % 64 % Nonperforming assets / capital plus ALL 15 % 17 % 18 % 18 % 19 % Nonperforming assets at June 30, 2014, were $40.7 million, or 1.42%, of total assets, as compared to $44.8 million, or 1.61%, of total assets at December 31, 2013and compared to $48.1 million, or 1.81%, of total assets at June 30, 2013. The Bank continues to manage nonperforming assets to either exit the relationship, work with the borrower to return the relationship to a performing status, or sell the collateral in the case of foreclosed real estate. At June 30, 2014, one loan for $2.3 millionunder the loans past due 90 days or more and still accruing category has been brought current post quarter end. The Bank's nonperforming assets and the reasons for changes in the balances of those components between December 31, 2013and June 30, 2014are discussed in the paragraphs that follow.
The Bank generally places a loan on nonaccrual status and ceases accruing interest when the loan is past due 90 days or more, unless the loan is both well-secured and in the process of collection.
Loans which have been partially charged off remain on nonaccrual status and are subject to the Bank's standard recovery policies and procedures, including, but not limited to, foreclosure proceedings, a forbearance agreement, or restructuring that results in classification as a TDR, unless collectibility of the entire balance of principal and interest is no longer in doubt and the loan is current or will be brought current within a short period of time.
Total nonaccrual loans decreased by
The following table details the change in the total of nonaccrual loan balances for the three and six months ended
Three Months Ended Six Months Ended (in thousands) June 30, 2014 Nonaccrual loans beginning balance $ 40,871
$ 39,963Additions 3,643 9,600 Principal charge-offs (1,298 ) (2,776 ) Pay downs (5,414 ) (8,612 ) Upgrades to accruing status (3,337 ) (3,337 ) Transfers to foreclosed assets (132 ) (505 ) Nonaccrual loans ending balance $ 34,333 $ 34,333During the second quarter of 2014, the additions to nonaccrual status consisted of 6 commercial loans ranging from $9,000to approximately $871,000and 10 consumer loans averaging $84,000each of unpaid principal balances. The Company received significant pay downs totaling $5.4 millionon the nonaccrual portfolio during the second quarter to reduce total nonaccrual loans. Current nonaccrual commercial loans are not concentrated in any particular industry or business. As reflected above, the portfolio is frequently changing with new additions, pay downs, upgrades, transfers to foreclosed real estate, and charge-offs when necessary.
The table and discussion that follow provide additional details of the components of our nonaccrual commercial loan categories.
Nonaccrual Loans (dollars in thousands) June 30, 2014 March 31, 2014
28 36 35 38 49 Number of loans greater than
$1 million1 2 3 3 4 Average outstanding balance of those loans: Greater than $1 million$ 1,079 $ 1,918 $ 1,807 $ 1,824 $ 1,872 Less than $1 million$ 130 $ 153 $ 150 $ 129 $ 102 Owner Occupied Real Estate: Number of loans 19 18 13 16 16 Number of loans greater than $1 million1 3 2 2 2 Average outstanding balance of those loans: Greater than $1 million$ 1,317 $ 1,253 $ 1,448 $ 1,475 $ 1,487 Less than $1 million$ 297 $ 166 $ 199 $ 160 $ 163 Commercial Constructionand Land Development: Number of loans 7 7 4 10 10 Number of loans greater than $1 million3 4 3 4 4 Average outstanding balance of those loans: Greater than $1 million$ 2,556 $ 2,508 $ 2,798 $ 2,704 $ 2,714 Less than $1 million$ 342 $ 237 $ 203 $ 153 $ 197 Commercial Real Estate: Number of loans 27 28 29 29 26 Number of loans greater than $1 million1 1 1 1 - Average outstanding balance of those loans: Greater than $1 million$ 1,793 $ 1,846 $ 2,346 $ 2,257 $ - Less than $1 million$ 155 $ 156 $ 157 $ 167 $ 151 42
-------------------------------------------------------------------------------- Foreclosed Assets Foreclosed assets totaled
$4.0 millionat June 30, 2014compared to $4.5 millionat December 31, 2013. The total was comprised of eight properties at June 30, 2014with the largest property carried at $2.0 million. The decrease in foreclosed real estate during the first six months of 2014 is the result of the sale of seven properties with a combined carrying value of $961,000. The sales of these properties resulted in a net gain of $61,000. The impact of these sales was partially offset by the transfer of three properties into this category totaling approximately $505,000. The Bank obtains third party appraisals on foreclosed real estate. To support the fair market value of the collateral. Appraisals are ordered by the Company's Real Estate Loan Administration Departmentwhich is independent of both the loan workout and loan production functions. All appraisals are performed by a Board approved, certified general appraiser. The Company charges down loans based on the fair value of the collateral as determined by the current appraisal less any unpaid real estate taxes and any costs to sell before the properties are transferred to foreclosed real estate. Subsequent to transferring a property to foreclosed real estate, the Company may incur additional write-down expense based on updated appraisals, offers for purchase or prices on comparable properties in the proximate vicinity. Troubled Debt Restructurings As mentioned previously, a troubled debt restructuring (TDR) is a loan in which the contractual terms have been modified, resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties, in order for the Bank to have a greater opportunity of collecting the indebtedness from the borrower. Concessions could include, but are not limited to, granting a material extension of time, entering into a forbearance agreement, adjusting the interest rate, accepting interest only payments for an extended period of time, a change in the amortization period or a combination of any of these concessions. An additional benefit to Metro in granting a concession is to avoid foreclosure or repossession of collateral in an attempt to minimize losses. All TDRs are impaired loans, however, a loan may still be accruing even though it has been restructured. Management evaluates these loans using the same guidelines it uses for all loans to determine if there is reasonable assurance of repayment. For further discussion of these guidelines, see the following section on Impaired and Other Problem Loans. Nonaccrual TDRs may be reclassified as accruing TDRs when the borrower has consistently made full payments of principal and interest for at least six consecutive months and the Bank expects full repayment of the modified loan's principal and interest. The loan will no longer be classified as a TDR when the interest rate is equal to or greater than the rate that the Bank was willing to accept at the time of the restructuring for a new loan with comparable risk and the loan is no longer impaired based on the terms specified by the restructuring agreement. Impaired and Other Problem Loans Impaired loans include nonaccrual loans in addition to loans which the Bank, based on current information, does not expect to receive both the principal and interest amounts due from a borrower according to the contractual terms of the original loan agreement. These loans totaled $46.5 millionat June 30, 2014with an aggregate specific allowance allocation of $5.6 millioncompared to impaired loans totaling $52.6 millionat December 31, 2013with a $5.6 millionaggregate specific allowance allocation. The total combined specific allowance allocations at June 30, 2014related to six loan relationships compared to four loan relationships at December 31, 2013. Impaired loans have been evaluated as to risk exposure in determining the adequacy of the ALL. See Note 4 of Notes to Consolidated Financial Statements for the period ended June 30, 2014, included herein, for an age analysis of loans receivable and tables that detail impaired loans and credit quality indicators. The past due portfolio is constantly moving through collection efforts which include: restructures when appropriate, foreclosures or ultimately charged off. During the first six months of 2014, $16.4 millionof past due loans at December 31, 2013improved to current status at June 30, 2014. Another $5.6 millionof past due loan balances paid off during the first six months of 2014. Additionally, $1.8 millionand $505,000of those loans past due at December 31, 2013, were charged off and moved to foreclosed real estate, respectively. A total of $11.7 millionin current loans at December 31, 2013, subsequently became delinquent and were reported as past due at June 30, 2014. Out of the $11.7 millionof loans that became past due after December 31, 2013, $4.9 millionwere 30-59 days past due, $2.2 millionwere 60-89 days past due while the remainder, or $4.7 millionwere 90 days past due or greater at June 30, 2014, with $3.3 millionof those loans classified as nonaccrual. The Bank generally obtains third party appraisals ordered by the Real Estate Loan Administration Departmenton nonperforming loans secured by real estate at the time the loan is determined to be impaired. The Bank charges down loans based on the appropriate discounted fair value of the collateral as determined by the current appraisal or other collateral valuations less any unpaid real estate taxes and any costs to sell. The charge-down of any impaired loan is done upon receipt and satisfactory review of the 43 -------------------------------------------------------------------------------- appraisal or other collateral valuation and, in no event, later than the end of the quarter in which the appraisal or valuation was accepted by the Bank. No significant time lapses during this process have occurred for any period presented. The Bank also considers the volatility of the fair value of the collateral, timing and reliability of the appraisal, timing of the third party's inspection of the collateral, confidence in the Bank's lien on the collateral, historical losses on similar loans and other factors based on the type of real estate securing the loan. As deemed necessary, the Bank will perform inspections of the collateral to determine if an adjustment of the value of the collateral is necessary. The Bank may create a specific allowance for all or a part of a particular loan in lieu of a charge-off as a result of management's evaluation of the impaired loan. In these instances, the Bank has determined that a loss is probable, but not imminent based upon available information surrounding the credit at the time of the analysis, however, management believes a reserve is appropriate to acknowledge the probable risk of loss. Management's ALL Committee has performed a detailed review of the impaired loans and of the collateral related to these credits and believes, to the best of its knowledge, that the ALL remains adequate for the level of risk inherent in these loans at June 30, 2014. Any criticized or classified loan not considered impaired is reviewed to determine if impairment exists. Such loan classifications totaled $48.6 millionat June 30, 2014compared to $38.6 millionat December 31, 2013and were comprised of $24.4 millionof special mention rated loans and $24.2 millionof substandard accruing loans which were not deemed impaired. At March 31, 2014, special mention rate loans that were not impaired totaled $9.4 million. The increase from March 31, 2014to June 30, 2014includes $4.2 millionof loans that were upgraded from substandard accruing to the special mention rated category and $12.7 millionof downgrades on 14 loans associated with five relationships. The majority of the increase was in the commercial and industrial portfolio, totaling $10.2 million. These problem loans were included in the general pool of loans to determine the adequacy of the ALL at June 30, 2014. While it is difficult to forecast impaired loans due to numerous variables, the Bank, through its credit risk management tools and other credit metrics, believes it has currently identified the material problem loans in the portfolio. As a result of continued economic uncertainty affecting unemployment, consumer spending, home sales and collateral values, it is possible that the Company may experience increased levels of nonperforming assets and additional losses in the future. Allowance for Loan Losses The majority of the Company's charge-offs come from loans deemed impaired. Nonaccrual loans are all considered impaired. Once a loan is impaired, an analysis is performed specifically on the loan and loan relationships to determine whether or not a probable loss exists. Regardless of whether a charge-off is recorded or a specific reserve has been allocated, both are taken into consideration when calculating the adequacy of the allowance. At June 30, 2014, a significant portion, approximately 75%, of the $5.6 millionspecific reserves were already included in the allowance as a specific reserve at December 31, 2013. The ALL as a percentage of total loans receivable was 1.31% at June 30, 2014, compared to 1.32% at December 31, 2013. The increase in the ALL balance from December 31, 2013to June 30, 2014was primarily the result of the overall increase in total loans receivable. The nonperforming loan coverage, defined as the ALL as a percentage of total nonperforming loans, was 66% as of June 30, 2014compared to 57% at December 31, 2013. See the Application of Critical Accounting Policies earlier in this Management's Discussion and Analysis for a detailed discussion of the calculation of the ALL. 44
Total deposits at
June 30, 2014were $2.19 billion, down $52.6 million, or 2% (nonannualized), from total deposits of $2.24 billionat December 31, 2013. The composition of the Bank's deposits at June 30, 2014and December 31, 2013are as follows: TABLE 8 (in thousands) June 30, 2014 December 31, 2013 $ Change % Change (non-annualized) Noninterest-bearing demand $ 508,012$ 443,287 $ 64,72515 % Interest checking and money market 1,020,894 1,110,568 (89,674 ) (8 )% Savings 474,416 496,495 (22,079 ) (4 )% Time 183,658 189,271 (5,613 ) (3 )% Total $ 2,186,980$ 2,239,621 $ (52,641 )(2 )% Short-Term Borrowings Short-term borrowings consist of short-term and overnight advances from the FHLB. At June 30, 2014, short-term borrowings totaled $401.7 millionas compared to $277.8 millionat December 31, 2013. This large increase was the result of the previously mentioned $100.9 milliongrowth in loans outstanding combined with the above mentioned $52.6 milliondecrease in deposit balances. Average short-term borrowings for the first six months of 2014 were $372.2 millionas compared to $277.2 millionfor the first six months of 2013. The year over year increase was the result of utilizing such borrowings to supplement deposit growth in order to fund the year over year increase in average earning assets. The average rate paid on the short-term borrowings was 0.27% for the first six months of 2014 compared to 0.22% for the first six months of 2013.
June 30, 2014, stockholders' equity totaled $248.8 million, up $18.6 million, or 8% (nonannualized), over $230.2 millionat December 31, 2013. Net income of $10.0 millionfor the six months ended June 30, 2014contributed to the majority of the increase in stockholders' equity. The increase in stockholders' equity was also partially the result of a decrease of $7.7 millionin other comprehensive loss as the increase in quoted market prices on the Company's AFS securities portfolio decreased their unrealized loss position, net of income tax impacts, from $16.5 millionat December 31, 2013to $8.8 millionat June 30, 2014. Total stockholders' equity to total assets was 8.67% at June 30, 2014compared to 8.28% at December 31, 2013. Tangible common equity to tangible assets was 8.64% at June 30, 2014compared to 8.24% at December 31, 2013.
Supplemental Reporting of Non-GAAP Based Financial Measures
Tangible common equity to tangible assets is a non-GAAP based financial measure calculated using non-GAAP based amounts. Total stockholders' equity to total assets is the most directly comparable measure, which is calculated using GAAP-based amounts. The Company calculates the tangible common equity to tangible assets by excluding the balance of preferred stock and any intangible assets; however, the Company did not have any intangible assets at either
June 30, 2014or December 31, 2013. Management believes that tangible common equity to tangible assets has been a focus for some investors and assists in analyzing Metro's capital position without regard to the effect of preferred stock. Although this non-GAAP financial measure is frequently used by investors to evaluate a company, non-GAAP financial measurements have inherent limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. A reconciliation of tangible common equity to tangible assets is set forth in the table that follows: TABLE 9 June 30, 2014 December 31, 2013 Total stockholders' equity to assets (GAAP) 8.67 % 8.28 % Less: Effect of excluding preferred stock 0.03 % 0.04 % Tangible common equity to tangible assets 8.64 % 8.24 % 45
Banks are evaluated for capital adequacy based on the ratio of capital to risk-weighted assets and total assets. The risk-based capital standards require all banks to have Tier 1 capital of at least 4% and total capital (including Tier 1 capital) of at least 8% of risk-weighted assets. Tier 1 capital includes common stockholders' equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. Total capital includes total Tier 1 capital, limited life preferred stock, qualifying debt instruments and the ALL. The capital standard based on average assets, also known as the "leverage ratio", requires all, but the most highly-rated, banks to have Tier 1 capital of at least 4% of total average assets. At
June 30, 2014, the Bank met the definition of a "well-capitalized" institution.
The following tables provide a comparison of the Company's and the Bank's risk-based capital ratios and leverage ratios to the minimum regulatory requirements for the periods indicated:
TABLE 10 Regulatory Company Bank Guidelines Minimum Regulatory for "Well June 30, 2014 December 31, 2013 June 30, 2014 December 31, 2013 Requirements Capitalized" Total Capital 14.55 % 14.59 % 14.11 % 14.09 % 8.00 % 10.00 % Tier 1 Capital 13.36 13.41 12.92 12.91 4.00 6.00 Leverage ratio (to total average assets) 9.57 9.39 9.25 9.04 4.00 5.00 Regulatory Capital Changes In
July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The phase-in period for community banking organizations begins January 1, 2015, while larger institutions (generally those with assets of $250 billionor more) began compliance on January 1, 2014. The final rules call for the following capital requirements: • A minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%.
• A minimum ratio of tier 1 capital to risk-weighted assets of 6%.
• A minimum ratio of total capital to risk-weighted assets of 8% (no change
from the current rule).
• A minimum leverage ratio of 4%.
In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments. The phase-in period for the capital conservation and countercyclical capital buffers for all banking organizations will begin on
January 1, 2016. The Company is in the process of assessing the impact of these changes on the regulatory ratios as well as on the capital, operations, liquidity and earnings of the Company and the Bank. Interest Rate Sensitivity
The management of interest rate sensitivity seeks to avoid fluctuating net interest margins and to provide consistent net interest income through periods of changing interest rates.
Our risk of loss arising from adverse changes in the fair value of financial instruments, or market risk, is composed primarily of interest rate risk. The primary objective of our asset/liability management activities is to maximize net interest income while maintaining acceptable levels of interest rate risk. Our Asset/Liability Committee (ALCO) is responsible for establishing policies to limit exposure to interest rate risk and to ensure procedures are established to monitor compliance with those policies. Our board of directors reviews the guidelines established by ALCO. Our management believes the simulation of net interest income in different interest rate environments provides a meaningful measure of interest rate risk. Income simulation analysis captures not only the potential of all assets and liabilities to mature or 46
-------------------------------------------------------------------------------- reprice, but also the probability that they will do so. Income simulation also attends to the relative interest rate sensitivities of these items and projects their behavior over an extended period of time. Finally, income simulation permits management to assess the probable effects on the balance sheet not only of changes in interest rates, but also of proposed strategies for responding to them. Our income simulation model analyzes interest rate sensitivity by projecting net interest income over the next 24 months in a flat rate scenario versus net interest income in alternative interest rate scenarios. Our management continually reviews and refines its interest rate risk management process in response to the changing economic climate. Currently, our model projects up to a plus 500 bp increase and a 100 bp decrease during the next year, with rates remaining constant in the second year. The minus 100 bp scenario is not considered very likely, given the low absolute level of short-term interest rates. Our ALCO policy has established that income sensitivity will be considered acceptable in the 100 bp and 200 bp scenarios if overall net interest income volatility is within 4% of forecasted net interest income in the first year and within 5% using a two-year time frame. In the 300 bp and 400 bp scenarios income sensitivity will be considered acceptable if net interest income volatility is within 5% of forecasted net interest income in the first year and within 6% using a two-year time frame. In the 500 bp scenario income sensitivity will be considered acceptable if net interest income volatility is within 6% of forecasted net interest income in the first year and within 7% using a two-year time frame.
The following table compares the impact on forecasted net interest income at
TABLE 11 June 30, June 30, 2014 2013 12 Months 24 Months 12 Months 24 Months Plus 300 (1.58 )% 1.38 % (0.23 )% 3.51 % Plus 200 (1.35 ) 0.53 (0.39 ) 2.06 Plus 100 (0.95 ) (0.16 ) (0.47 ) 0.58 This quarter's net interest income changes as shown above, indicate negative first year impacts to net interest income in all scenarios presented, but positive two year impacts in all scenarios except the plus 100 bp scenario. The negative one year impacts reflect the funding of a portion of fixed rate investment and loan growth that has occurred over the last two years with overnight borrowings with rates that increase immediately in rising interest rate scenarios and result in shrinking net interest margins. The Company's current projections call for the extension of a portion of its borrowing position into three to five year maturity term advances to provide long-term protection from rising interest rates. In addition, the Company is aggressively attracting reasonably-priced, long-term CD accounts to further insulate its future interest expense from any negative impacts of rising rates. The combination of these actions is projected to contribute to the positive two year impact to net interest income in the plus 200 and plus 300 bp scenarios as shown above. Management continues to evaluate additional strategies in conjunction with the Company's ALCO to effectively manage the interest rate risk position. Such strategies could include the sale of a portion of our AFS investment portfolio, purchasing floating rate securities, altering the mix of our deposits by type and therefore rate paid, the use of risk management tools such as interest rate swaps and caps, adjusting the investment leverage position funded by short-term borrowings and further extending the maturity structure of the Bank's short-term borrowing position. Management uses many assumptions to calculate the impact of changes in interest rates. Actual results may not be similar to our projections due to several factors including the timing and frequency of rate changes, market conditions and the shape of the yield curve. In general, a flattening of the interest rate yield curve would result in reduced net interest income compared to a normal-shaped interest rate curve scenario and proportionate rate shift assumptions. Actual results may also differ due to management's actions, if any, in response to the changing rates. Management also monitors interest rate risk by utilizing a market value of equity model. The model assesses the impact of a change in interest rates on the market value of all our assets and liabilities, as well as any off balance sheet items. Market value of equity is defined as the market value of assets less the market value of liabilities plus the market value of off-balance sheet items. The model calculates the market value of equity in the current rate scenario and then compares the market value of equity given immediate increases and decreases in rates. Our ALCO policy indicates that the level of interest rate risk is unacceptable in the 47 -------------------------------------------------------------------------------- 100 bp immediate interest rate change scenarios if there is a resulting loss of more than 15% of the market value calculated in the current rate scenario. In the 200 bp immediate interest rate change scenario a loss of more than 25% loss of market value is deemed unacceptable. A loss of more than 35% is defined as unacceptable in the 300 bp immediate interest rate change scenario, while a loss of more than 40% is unacceptable in immediate interest rate change scenarios of 400 bps or more. At
June 30, 2014the market value of equity calculation indicated acceptable levels of interest rate risk in all scenarios per the policies established by our ALCO. The market value of equity model reflects certain estimates and assumptions regarding the impact on the market value of our assets and liabilities given immediate changes in rates. One of the key assumptions is the market value assigned to our core deposits, or the core deposit premiums. Using an independent consultant, we have completed and updated comprehensive core deposit studies in order to assign our own core deposit premiums as permitted by regulation. The studies have consistently confirmed management's assertion that our core deposits have stable balances over long periods of time, are generally insensitive to changes in interest rates and have significantly longer average lives and durations than our loans and investment securities. Thus, these core deposit balances provide an internal hedge to market fluctuations in our fixed rate assets. Management believes the core deposit premiums produced by its market value of equity model at June 30, 2014provide an accurate assessment of our interest rate risk. The most recent study calculates an average life of our core deposit transaction accounts of 9.6 years.
The objective of liquidity risk management is to ensure our ability to meet our financial obligations. These obligations include the payment of deposits on demand at their contractual maturity; the repayment of borrowings as they mature; the payment of lease obligations as they become due; the ability to fund new and existing loans and other funding commitments; and the ability to take advantage of new business opportunities. There are two fundamental risks in our liquidity risk management. The first is if we are unable to meet our funding requirements at a reasonable and profitable cost. The second is the potential inability to operate our business because adequate contingency liquidity is not available in a stressed environment or under adverse conditions. We manage liquidity risk at both the Bank and the holding company (the Parent) levels to help ensure that we can obtain cost-effective funding to meet current and future obligations and to help ensure that we maintain an appropriate level of contingent liquidity. The board of directors is responsible for approving our Liquidity Policy to be managed by the ALCO and management. Liquidity is measured and monitored daily, allowing management to better understand and react to balance sheet trends. On a quarterly basis, a comprehensive liquidity analysis is reviewed by our board of directors. The analysis provides a summary of the current liquidity measurements, projections and future liquidity positions given various levels of liquidity stress. Management also maintains a detailed Liquidity Contingency Plan designed to respond to an overall decline in the financial condition of the banking industry or a problem specific to the Company.
Bank Level Liquidity - Uses
At the bank level, primary liquidity obligations include funding loan commitments, satisfying deposit withdrawal requests and maturities and debt service related to bank borrowings. We also maintain adequate bank liquidity to meet future potential loan demand, purchase investment securities and provide for other business needs as necessary.
Bank Level Liquidity - Sources
Liquidity sources are found on both sides of the balance sheet. Our single largest source of bank liquidity is the deposit base that comes from our retail, commercial business and government deposit customers. Liquidity is also provided on a continuous basis through scheduled and unscheduled principal reductions and interest payments on outstanding loans and investments, maturing short-term assets, the ability to sell marketable securities and from borrowings. Our investment portfolio consists primarily of
U.S. Governmentagency collateralized mortgage obligations (CMOs) and mortgage-backed securities (MBSs). Cash flows from such investments are dependent upon the performance of the underlying mortgage loans and may be influenced by the level of interest rates. As rates increase, cash flows generally decrease as prepayments on the underlying mortgage loans slow. As rates decrease, cash flows generally increase as prepayments increase. The current market environment has negatively impacted the fair market value of certain securities in the Company's investment portfolio and therefore the Company is not inclined to act on a sale of such securities for liquidity purposes at this time. With short-term interest rates at or near record-lows, the Company would more likely be inclined to borrow from one of the sources discussed in the following paragraph.
We also maintain secondary sources of liquidity which can be drawn upon if needed. These secondary sources of liquidity as of
48 -------------------------------------------------------------------------------- correspondent bank and
$726.8 millionof borrowing capacity at the FHLB. The Bank is a member of the FHLB-Pittsburgh and, as such, has access to advances secured generally by residential mortgage and other mortgage-related loans. In addition we have the ability to borrow at the Federal Reserve Bank of Philadelphia's(FRB) Discount Window to meet short-term liquidity requirements. The FRB, however, is not viewed as the primary source of our borrowings, but rather as a potential source of liquidity under certain circumstances, in a stressed environment or during a market disruption. This potential source is secured by agency residential MBSs and CMOs, as well as agency debentures. At June 30, 2014, our total potential liquidity through FHLB and other secondary sources was $761.8 million, of which $284.9 millionwas available, as compared to $369.6 millionavailable out of our total potential liquidity of $722.5 millionat December 31, 2013. The $39.4 millionincrease in potential liquidity in the first six months of 2014 was due to an increase in the Bank's borrowing capacity primarily as a result of a higher level of qualifying collateral. FHLB borrowing capacity is determined based on asset levels on a quarterly lag basis. The $84.7 milliondecrease in available liquidity occurred as a result of the need for a higher borrowing level in the first six months of 2014 primarily due to loan growth coupled with a slight decline in deposit balances.
The Parent Company Liquidity - Uses
At the parent level, primary liquidity obligations include debt service related to parent company long-term debt or borrowings, unallocated corporate expenses, funding its subsidiaries, and could also include paying dividends to Metro shareholders, common stock or preferred stock share repurchases or acquisitions if Metro chose to do so.
The Parent Company Liquidity - Sources
The principal source of the Parent's liquidity is dividends it receives from the subsidiary Bank, which may be impacted by: Bank-level capital needs, laws and regulations, corporate policies, or other factors. The Bank did not issue dividends to the Parent during the first six months of 2014. The Bank is subject to regulatory restrictions on its ability to pay dividends to the Parent. In addition to dividends from
Metro Bank, other sources of liquidity for the parent company include proceeds from common stock options exercised as well as proceeds from the issuance of common stock under Metro's stock purchase plan. We could also generate liquidity for Metro and its subsidiaries through the issuance of debt and equity securities.