Forward-Looking Information and Uncertainties Regarding Future Financial
This report, including management's discussion below, concerning earnings and financial condition, contains "forward-looking statements". Forward-looking statements are estimates of or statements about expectations or beliefs regarding the Company's future financial performance or anticipated future financial condition that are based on current information and that are subject to a number of risks and uncertainties that could cause actual operating results in the future to differ significantly from those expected at the current time. Those risks and uncertainties include, although they are not limited to, the following:
Increased Competition. Increased competition from other banks and financial service businesses, mutual funds and securities brokerage and investment banking firms that offer competitive loan and investment products and competitive market pricing, which could require us to reduce interest rates and loan fees to attract new loans or to increase interest rates that we offer on time deposits, either or both of which could, in turn, reduce interest income and net interest margins. These factors could reduce our ability to attract new deposits and loans and leases.
Liquidity Risk. The stability of funding sources and continued availability of borrowings; our ability to raise capital or incur debt on reasonable terms.
Possible Adverse Changes in Economic Conditions. Adverse changes in national or local economic conditions over an extended period of time could (i) reduce loan demand which could, in turn, reduce interest income and net interest margins; (ii) adversely affect the financial capability of borrowers to meet their loan obligations, which, in turn, could result in increases in loan losses and require increases in provisions for possible loan losses, thereby adversely affecting operating results; and (iii) lead to reductions in real property values that, due to the Company's reliance on real property to secure many of its loans, could make it more difficult to prevent losses from being incurred on non-performing loans through the sale of such real properties. Possible Adverse Changes in National Economic Conditions and Federal Reserve Board Monetary Policies. Changes in national economic policies and conditions, such as increases in inflation or declines in economic output often prompt changes in Federal Open Market Committee ("FOMC") monetary policies that could reduce interest income or increase the cost of funds to the Company, either of which could result in reduced earnings. In addition, deterioration in economic conditions that could result in increased loan and lease losses. Changes in Regulatory Policies. Changes in federal and national bank regulatory policies, such as increases in capital requirements or in loan loss reserve or asset/liability ratio requirements, liquidity requirements, and the risks associated with concentration in real estate related loans could adversely affect earnings by reducing yields on earning assets or increasing operating costs. 32 Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this report, which speak only as of the date of this report, or to make predictions based solely on historical financial performance. The Company also disclaims any obligation to update forward-looking statements contained in this report.
Critical Accounting Policies And Estimates
Management's discussion and analysis of its financial condition and results of operations are based upon the Company's financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to its loans and allowance for loan losses. The Company bases its estimates on current market conditions, historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. The Company believes the following critical accounting policy requires significant judgments and estimates used in the preparation of the consolidated financial statements. Allowance for Loan Losses The allowance for loan losses is periodically evaluated for adequacy by management. Factors considered include the Company's loan loss experience, known and inherent risks in the portfolio, current economic conditions, known adverse situations that may affect the borrower's ability to repay, regulatory policies, and the estimated value of underlying collateral. The evaluation of the adequacy of the allowance is based on the above factors along with prevailing and anticipated economic conditions that may impact our borrowers' ability to repay their loans. Determination of the allowance is based upon objective and subjective judgments by management from the information currently available. Adverse changes in information could result in higher than expected charge-offs and loan loss provisions. Goodwill
Goodwill arises when the Company's purchase price exceeds the fair value of the net assets of an acquired business. Goodwill represents the value attributable to intangible elements acquired. The value of goodwill is supported ultimately by profit from the acquired business. A decline in earnings could lead to impairment, which would be recorded as a write-down in the Company's consolidated statements of earnings. Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the acquired business or asset, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that a reporting unit will be sold or disposed of at a loss. 33
Other Than Temporary Impairment
Other than temporary impairment ("OTTI") is triggered if the Company has the intent to sell the security, it is likely that it will be required to sell the security before recovery, or if the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell the security or it is likely it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but the Company does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings as an OTTI. The credit loss is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected of a security. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment loss related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, would be recognized as a charge to other comprehensive income ("OCI"). Impairment losses related to all other factors are to be presented as a separate category within OCI. For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated accordingly based on the procedures described above.
Provision for and Deferred Income Taxes
The Company is subject to income tax laws of
the United States, its states, and the municipalities in which it operates. The Company considers its income tax provision methodology to be critical, as the determination of current and deferred taxes based on complex analyses of many factors including interpretation of federal and state laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state tax authorities.
Recent Accounting Pronouncements
April 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740). This ASU requires an entity to present in the financial statements an unrecognized tax benefit as a liability and the unrecognized tax benefit should not be combined with deferred tax assets to the extent that a net operating loss carry-forward, tax loss or credit carry-forward is also not available at the reporting date. The amendment is to be applied prospectively to all unrecognized tax benefits and are effective for annual and interim reporting periods beginning after December 15, 2013. This ASU did not have a material impact on the Company's consolidated financial statements. 34 In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual and interim reports beginning on or after December 15, 2014and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU 2014-04 is not expected to have a material impact on the Company's consolidated financial statement. Earnings Analysis
Net earnings for the quarter ended
June 30, 2014were $1,629,000, compared to net earnings of $1,379,000for the quarter ended June 30, 2013, an increase of 18%. Net earnings for the six months ended June 30, 2014were $3,463,000, an increase of $1,154,000from the same period in 2013. Net earnings during the three months and six months ended June 30, 2014compared to the same period during 2013 benefitted from favorable expense comparisons due partly to the closure of our island of Guamoffice during the 2nd quarter of 2013 and reductions in the provision for loan losses. Net earnings for the first quarter of 2014 were $1,834,000, and for the fourth quarter of 2013 were $1,999,000. Net interest income for the quarter ended June 30, 2014was $8,712,000, compared to $8,727,000for the quarter ended June 30, 2013, a decrease of $15,000, or 0.2%. Net interest income for the six months ended June 30, 2014was $17,220,000, compared to $17,434,000for the six months ended June 30, 2013. Declines in net interest during 2014 compared to 2013 were due primarily to the decline in interest rates on earning assets. Short term market interest rates are currently being held to low levels due to accommodating policy decisions made by the Federal Open Market Committeeof the Federal Reserve Bank. 35
The following tables present an analysis of net interest income and average earning assets and liabilities for the three-and six-month periods ended
TABLE 1 NET INTEREST INCOME AND AVERAGE BALANCES FNB BANCORP AND SUBSIDIARY Three months ended June 30, 2014 2013 (Dollar amounts in thousands) Annualized Annualized Average Average Average Average Balance Interest Yield Balance Interest Yield INTEREST EARNING ASSETS Loans, gross (1) (2)
$ 568,329 $ 7,8975.64 % $ 553,031 $ 8,0205.88 % Taxable securities 188,807 851 1.83 % 185,715 794 1.73 % Nontaxable securities (3) 73,331 657 3.63 % 74,548 671 3.65 % Fed funds sold 5 - n/a 59 - n/a Int time depos-other fin institutions 4,569 27 2.40 % 8,890 49 2.24 %
Total interest earning assets 835,041 9,432
4.58 % 822,243 9,534 4.70 % NONINTEREST EARNING ASSETS: Cash and due from banks 22,815 34,875 Premises 12,544 12,757 Other assets 28,417 34,546
Total noninterest earning assets 63,776
82,178 TOTAL ASSETS
$ 898,817 $ 904,421INTEREST BEARING LIABILITIES: Demand, int bearing $ 81,56618 0.09 % $ 78,80925 0.13 % Money market 331,460 314 0.38 % 315,519 359 0.46 % Savings 66,658 17 0.10 % 63,503 25 0.16 % Time deposits 109,113 135 0.50 % 157,111 230 0.59 % FHLB advances 7,846 3 0.16 % 523 - n/a Note payable 5,939 68 4.64 % - - n/a Fed funds purchased - - n/a 17 - n/a
Total interest bearing liabilities 602,582 555 0.37 % 615,482 639 0.42 % NONINTEREST BEARING LIABILITIES: Demand deposits 197,312 184,289 Other liabilities 9,860 10,712 Total noninterest bearing liabilities 207,172 195,001 TOTAL LIABILITIES 809,754 810,483 Stockholders' equity 89,063 93,938 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$ 898,817 $ 904,421NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4) $ 8,8774.31 % 206,761 $ 8,8954.39 %
1) Interest on non-accrual loans is recognized into income on a cash received
basis if the loan has demonstrated performance and full collection is considered probable.
2) Amounts of interest earned included loan fees of
3) Tax equivalent adjustments recorded at the statutory rate of 34% that are
included in the nontaxable securities portfolio are
the quarters ended
nontaxable municipal interest income.
4) The annualized net interest margin is computed by dividing net interest income
by total average interest earning assets and multiplied by an annualization factor. 36 TABLE 2 NET INTEREST INCOME AND AVERAGE BALANCES FNB BANCORP AND SUBSIDIARY Six months ended June 30, 2014 2013 (Dollar amounts in thousands) Annualized Annualized Average Average Average Average Balance Interest Yield Balance Interest Yield INTEREST EARNING ASSETS Loans, gross (1) (2)
$ 565,898 $ 15,5245.53 % $ 552,493 $ 16,1785.90 % Taxable securities 188,552 1,694 1.81 % 175,963 1,478 1.69 % Nontaxable securities (3) 72,903 1,308 3.62 % 74,354 1,348 3.66 % Fed funds sold 16 - n/a 36 - n/a Int time depos-other fin institutions 4,937 46 1.88 % 10,511 90 1.73 % Tot interest earning assets 832,306 18,572 4.50 % 813,357 19,094 4.73 % NONINTEREST EARNING ASSETS: Cash and due from banks 19,238 38,544 Premises 12,533 12,733 Other assets 30,134 34,597 Totnoninterest earning assets 61,905
85,874 TOTAL ASSETS
$ 894,211 $ 899,231Demand, int bearing $ 78,93634 0.09 % $ 77,34650 0.13 % Money market 321,913 599 0.38 % 304,347 724 0.48 % Savings 65,884 33 0.10 % 65,023 57 0.18 % Time deposits 114,575 278 0.49 % 162,110 490 0.61 % FHLB advances 15,033 11 0.15 % 610 - n/a Note payable 3,152 68 4.35 % - - n/a Fed funds purchased - - n/a 14 - n/a
Tot interest bearing liabilities 599,493 1,023 0.34 % 609,450 1,321 0.44 % NONINTEREST BEARING LIABILITIES: Demand deposits 196,324 184,576 Other liabilities 9,531 10,551
Totnoninterest bearing liabilities 205,855 195,127 TOTAL LIABILITIES 805,348 804,577 Stockholders' equity 88,863 94,654 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 894,211 $ 899,231NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4) $ 17,5494.25 % $ 17,7734.41 %
(1) Interest on non-accrual loans is recognized into income on a cash received
basis if the loan has demonstrated performance and full collection is considered probable.
(2) Amounts of interest earned included loan fees of
the six months ended
(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are
included in the nontaxable securities portfolio are
the six months ended
adjustments included in the nontaxable securities portfolio were derived from
nontaxable municipal interest income.
(4) The annualized net interest margin is computed by dividing net interest
income by total average interest earning assets and multiplied by an annualization factor. Tables 1 and 2, above, show the various components that contributed to changes in net interest income for the three and six months ended
June 30, 2014and 2013. The principal interest earning assets are loans, from a volume as well as from a rate or yield perspective. For the quarter ended June 30, 2014, average loans outstanding represented 68.1% of average earning assets. For the quarter ended June 30, 2013, they represented 67.3% of average earning assets. For the six months ended June 30, 2014and 2013, average loans outstanding represented 68.0% and 67.9%, respectively, of average earning assets. 37 The taxable equivalent yield on average interest earning assets for the quarter ended June 30, 2014compared to the quarter ended June 30, 2013decreased from 4.70% to 4.58%, or 12 basis points. Average loans increased by $15,298,000, year over year, while their yield decreased from 5.88% to 5.35%, or 53 basis points. Interest income on total interest earning assets for the quarter decreased $518,000or 5.43% on a fully-taxable equivalent basis. For the three months ended June 30, 2014compared to the three months ended June 30, 2013, the cost on total interest bearing liabilities decreased from 0.42% to 0.37%, a decrease of 5 basis points. Time deposit interest cost decreased from 0.59% to 0.50%. Their average balance outstanding decreased by $47,998,000, or 30.6%, while their expense decreased $95,000. Customer deposits have been migrating out of time deposits and into money market accounts during both 2013 and 2014. The low rates being offered on term deposits coupled with the possible increase in short term rates by the FOMC are, in part, the explanation for this migration. For the six months ended June 30, 2014compared to the six months ended June 30, 2013, interest income on interest earning assets decreased $523,000or 2.7% on a fully-taxable equivalent basis, and average earning assets increased $18,949,000, or 2.3%. Average loans increased by $13,405,000, or 2.4%. Interest on loans decreased $654,000or 4.0%, while the yield decreased 37 basis points, or 6.3%. The cost on total interest bearing liabilities decreased from 0.44% to 0.34%. Time deposit averages decreased $47,535,000or 29.3%. Their yield decreased 12 basis points, or 19.7%. Money market deposit average balances increased $17,566,000, or 5.8%, and their cost decreased $125,000, or 17.3%. For the three and six month periods ended June 30, 2014and June 30, 2013, respectively, the following tables show the dollar amount of change in interest income and expense and the dollar amounts attributable to: (a) changes in volume (changes in volume at the current year rate), and b) changes in rate (changes in rate times the prior year's volume). In this table, the dollar change in rate/volume is prorated to volume and rate proportionately. 38 Table 3 FNB BANCORP AND SUBSIDIARY RATE/VOLUME VARIANCE ANALYSIS Three Months Ended June 30, (Dollar amounts in thousands) 2014 Compared to 2013 Variance Interest Attributable to Income/Expense Rate Volume INTEREST EARNING ASSETS Loans $ (123 ) $ (335 ) $ 212Taxable securities 57 43 14 Nontaxable securities (1) (14 ) (3 ) (11 ) Interest on time deposits
with other financial institutions (22 ) 2
Total $ (102 ) $ (293
INTEREST BEARING LIABILITIES Demand deposits $ 7
$ 8 $ (1 )Money market 45 60 (15 ) Savings deposits 8 9 (1 ) Time deposits 95 25 70 FHLB advances (3 ) - (3 ) Note payable (68 ) - (68 ) Total $ 84 $ 102 $ (18 )NET INTEREST INCOME $ (18 ) $ (191 ) $ 173
(1) Includes tax equivalent adjustment of
Table 4 FNB BANCORP AND SUBSIDIARY RATE/VOLUME VARIANCE ANALYSIS Six Months Ended June 30, (Dollar amounts in thousands) 2014 Compared to 2013 Variance Interest Attributable to Income/Expense Rate Volume INTEREST EARNING ASSETS Loans $ (654 )
$ (1,047 ) $ 393Taxable securities 216 110 106 Nontaxable securities (1) (40 ) (14 ) (26 ) Interest on time deposits
with other financial institutions (44 ) 8
(52 ) Total $ (522 )
$ (943 ) $ 421INTEREST BEARING LIABILITIES Demand deposits $ 16 $ 17 $ (1 )Money market 125 167 (42 ) Savings deposits 24 25 (1 ) Time deposits 212 68 144 FHLB advances (11 ) - (11 ) Note payable (68 ) - (68 ) Total $ 298 $ 277 $ 21NET INTEREST INCOME $ (224 ) $ (666 ) $ 442
(1) Includes tax equivalent adjustment of
June 30, 2014and June 30, 2013, respectively. 39 Noninterest income The following table shows the principal components of noninterest income for the periods indicated. Table 5 NONINTEREST INCOME Three months ended June 30, Variance
(Dollar amounts in thousands) 2014 2013
Amount Percent Service charges
$ 647 $ 676 $ (29 )-4.3 % Credit card fees - 3 (3 ) -100.0 %
Net gain on available-for-sale of securities 28 73 (45 ) -61.6 % Bank owned life insurance policy earnings 90 94
(4 ) -4.3 % Other income 215 238 (23 ) -9.7 % Total noninterest income
$ 980 $ 1,084 $ (104 )-9.6 % Six months ended June 30, Variance (Dollars in thousands) 2014 2013 Amount Percent Service charges $ 1,284 $ 1,335 $ (51 )-3.8 % Credit card fees - 10 (10 ) -100.0 %
Gain on sale of available-for-securities 39 115 (76 ) -66.1 % Bank owned life insurance policy earnings 186 189
(3 ) -1.6 % Other income 517 419 98 23.4 % Total noninterest income
$ 2,026 $ 2,068 $ (42 )-2.0 % Noninterest income consists mainly of service charges on deposits, credit card fees, and several other miscellaneous types of income. The Bank service charges were down during the second quarter and year to date of June 30, 2014when compared to the same period during 2013 due primarily to a decrease in our overdraft fees. The decrease in credit card fees for the three and six months ended June 30, 2014was related to the sale of our merchant credit card portfolio that was completed in the fourth quarter of 2012. During the first six months of 2014, the Bank sold $5,029,000in investment securities for a pre-tax gain of $39,000. During the first six months of 2013, the Company sold approximately $8,593,000in investment securities at a pre-tax net gain of $115,000. The sale proceeds were reinvested in a variety of investment securities during the same period. 40 Noninterest expense The following table shows the principal components of noninterest expense for the periods indicated. Table 6 NONINTEREST EXPENSE Three months ended June 30, Variance (Dollar amounts in thousands) 2014 2013 Amount Percent Salaries and employee benefits $ 4,177 $ 4,312$
(135 ) -3.1 % Occupancy expense 694 846 (152 ) -18.0 % Equipment expense 406 386 20 5.2 % Professional fees 501 444 57 12.8 % FDIC assessment 180 180 - n/a
Telephone, postage & supplies 313 277
36 13.0 % Advertising expense 136 121 15 12.4 % Data processing expense 134 170 (36 ) -21.2 % Low income housing expense 110 109 1 0.9 % Surety insurance 67 67 - n/a Directors expense 63 63 - n/a
Other real estate owned expense 11 28 (17 ) -60.7 % Loss on sale of other real estate owned 60 -
60 100.0 % Other expense 358 382 (24 ) -6.3 % Total noninterest expense
$ 7,210 $ 7,385 $ (175 )-2.4 % NONINTEREST EXPENSE Six months ended June 30, Variance (Dollars in thousands) 2014 2013 Amount Percent
Salaries and employee benefits
$ 8,395 $ 8,728$
(333 ) -3.8 % Occupancy expense 1,374 1,808 (434 ) -24.0 % Equipment expense 797 784 13 1.7 % Professional fees 1,032 807 225 27.9 % FDIC assessment 360 360 - n/a
Telephone, postage & supplies 599 714
(115 ) -16.1 % Advertising expense 221 293 (72 ) -24.6 % Data processing expense 279 326 (47 ) -14.4 % Low income housing expense 220 219 1 0.5 % Surety insurance 134 121 13 10.7 % Directors expense 126 126 - n/a
Other real estate owned expense 88 78 10 12.8 % Gain on sale of other real estate owned (220 ) -
(220 ) 100.0 % Other expense 647 760 (113 ) -14.9 % Total noninterest expense
$ 14,052 $ 15,124 $ (1,072 )-7.1 %
Noninterest expense consists mainly of salaries and employee benefits. For the three months ended
June 30, 2014compared to three months ended June 30, 2013, salaries and benefits represented 58% and 58% of total noninterest expenses. During the six months ended June 30, 2014compared to the six months ended June 30, 2013, salaries and benefits represented 60% and 58%. During the first six months of 2013, the Bank's occupancy expense increase was due to the acquired Oceanic Bankbranches, and a Company rebranding effort and the related signage changes. During the first quarter of 2013, the Bank recorded a one-time expense accrual related to the closure of our island of Guamoffice, which was effective June 14, 2013. In connection with this office closure, the Bank accrued $76,000in anticipated severance payments and $176,000in estimated future lease payments. 41 Provision for Loan Losses During the six months ended June 30, 2014, there was a provision for loan losses of $75,000compared to $1,110,000for the same period in 2013. The allowance for loan losses was $10,859,000or 1.90% of total gross loans at June 30, 2014, compared to $9,879,000or 1.76% of total gross loans at December 31, 2013. During the six months ended June 30, 2014, $276,000in loans were charged off, compared to $565,000in the same period in 2013. The overall quality of the remaining portfolio did not warrant a provision for loan losses during the three month period ended June 30, 2014. The allowance for loan losses is maintained at a level considered adequate for management to provide for probable loan losses inherent in the loan portfolio as of June 30, 2014. Loans charged-off during the first six months of 2014 were significantly lower than during the same time period during 2013, reflecting the improvement in the level of problem loans within our loan portfolio on a year over year basis. Income Taxes The effective tax rate for the quarter ended June 30, 2014was 34.4% compared to 28.0% for the quarter ended June 30, 2013. The effective tax rate for the six months ended June 30, 2014and June 30, 2013was an effective tax rate of 32.4% and 29.3%, respectively. Tax preference items which have a significant effect on our effective tax rate are changing amounts invested in tax-advantaged securities, available Low Income Housing Credits, and amounts of interest income on tax advantaged municipal debt securities.
Asset and Liability Management
Ongoing management of the Company's interest rate sensitivity limits interest rate risk through monitoring the mix and maturity of loans, investments and deposits. Management regularly reviews the Company's position and evaluates alternative sources and uses of funds as well as changes in external factors. Various methods are used to achieve and maintain the desired interest rate sensitivity position including the sale or purchase of assets and product pricing. In order to ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, the Company must maintain an adequate level of liquidity. Asset liquidity comes from the Company's ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. Liability liquidity comes from the Company's customer base, which provides core deposit growth. The overall liquidity position of the Company is closely monitored and evaluated regularly. Management believes the Company's liquidity sources at
June 30, 2014, are adequate to meet its operating needs in 2014 and our liquidity positions are sufficient to meet our liquidity needs in the near term. Financial Condition Assets. Total assets increased to $905,430,000at June 30, 2014from $891,930,000at December 31, 2013, an increase of $13,500,000. The principal source of this increase was an increase of $8,089,000in net loans, an increase of $7,675,000in cash and due from banks, an increase of $3,807,000in securities available for sale, and a decrease of $4,564,000in other real estate owned. Asset growth occurs primarily from the retention of net earnings and increases in the deposit portfolio or our borrowing positions. 42 Loans. Gross loans (before net loan fees) at June 30, 2014were $571,768,000, an increase of $9,051,000or 1.61% from December 31, 2013. Gross commercial real estate loans decreased $5,538,000, real estate construction loans increased $5,442,000, real estate multi- family loans increased $7,356,000, real estate loans secured by 1 to 4 family residences increased $7,966,000, commercial and industrial loans decreased $5,959,000, and consumer loans decreased by $216,000. The loan portfolio breakdown was as follows: TABLE 7 LOAN PORTFOLIO June 30 Percent December 31 Percent (Dollar amounts in thousands) 2014 2013 Commercial real estate $ 319,66156 % $ 325,19958 % Real estate construction 39,760 7 % 34,318 6 % Real estate multi family 53,499 9 % 46,143 8 % Real estate 1 to 4 family 114,869 20 % 106,903 19 % Commercial and industrial 42,545 8 % 48,504 9 % Consumer loans 1,434 - % 1,650 - % Gross loans 571,768 100 % 562,717 100 % Net deferred loan fees (477 ) - % (495 ) - % Total $ 571,291100 % $ 562,222100 % Allowance for loan losses. Management of the Company is responsible for assessing the overall risks within the Bank's loan portfolio, assessing the specific loss expectancy, and determining the adequacy of the allowance for loan losses. The level of the allowance is determined by internally generating credit quality ratings, reviewing economic conditions in the Company's market area, and considering the Company's historical loan loss experience. The Company's management considers changes in national and local economic conditions, as well as the condition of various market segments. It also reviews any changes in the nature and volume of the portfolio. Management watches for the existence and effect of any concentrations of credit, and changes in the level of such concentrations. It also reviews the effect of external factors, such as competition and legal and regulatory requirements. Finally, the Company is committed to maintaining an adequate allowance, identifying credit weaknesses by consistent review of loans, and maintaining the ratings and changing those ratings in a timely manner as circumstances change.
A summary of transactions in the allowance for loan losses for the six months ended
TABLE 8 ALLOWANCE FOR LOAN LOSSES Six months ended Six months ended (Dollar amounts in thousands) June 30, 2014 June 30, 2013 Balance, beginning of period $ 9,879 $ 9,124
Provision for loan losses 75 1,110 Recoveries 1,181 76 Amounts charged off (276 ) (565 ) Balance, end of period $ 10,859 $ 9,745 During the six months ended
June 30, 2014, there was a provision of $75,000, compared to $1,110,000for the same period in 2013. Loan charge-off levels have declined significantly year over year, and remain close to historic norms.
43 In management's judgment, the allowance is adequate to absorb probable losses currently inherent in the loan portfolio at
June 30, 2014. However, changes in prevailing economic conditions in the Company's markets or in the financial condition of its customers could result in changes in the level of nonperforming assets and charge-offs in the future and, accordingly, changes in the allowance. The allowance is affected by a number of factors, and does not necessarily move in tandem with the level of gross loans outstanding. Management continues to monitor the factors that affect the allowance, and is prepared to make adjustments as they become necessary. Nonperforming assets. Nonperforming assets consist of nonaccrual loans, loans that are 90 days or more past due but are still accruing interest and other real estate owned. At June 30, 2014, there was $6,217,000in nonperforming assets, compared to $12,669,000at December 31, 2013. Nonaccrual loans were $5,463,000at June 30, 2014, compared to $7,351,000at December 31, 2013. There were no loans past due 90 days and still accruing at either date. There was one property value at $754,000in Other Real Estate Owned at June 30, 2014, and four properties valued at $5,318,000at December 31, 2013. Three of these were sold in the first six months of 2014, for a net gain of $220,000. Management intends to aggressively market our Other Real Estate Owned. While management believes these properties will sell, there can be no assurance that these properties will sell quickly given the current real estate market, nor can the expected sales price be accurately predicted. At June 30, 2014the Other Real Estate Owned consisted of one commercial real estate building located in South San Franciscothat is currently leased. Deposits. Total deposits at June 30, 2014, were $790,222,000compared to $773,615,000on December 31, 2013. Of these totals, noninterest-bearing demand deposits were $203,854,000or 25.8% of the total on June 30, 2014, and $198,523,000or 25.7% on December 31, 2013. Time deposits were $106,748,000on June 30, 2014, and $124,152,000on December 31, 2013.
The following table sets forth the maturity schedule of the time certificates of deposit on
(Dollar amounts in thousands) Under
$100,000or more Total Three months or less $ 8,783 $ 25,803 $ 34,586
Over three through six months 7,431 17,527 24,958 Over six through twelve months 9,486 14,818 24,304 Over twelve months
9,984 12,916 22,900 Total
$ 35,684 $ 71,064 $ 106,748
44 TABLE 10 Minimum "Well June 30, December 31, Capitalized" Regulatory Capital Ratios 2014 2013 Requirements
Total Regulatory Capital Ratio 14.35 % 14.12 % ?
10.00 % Tier 1 Capital Ratio 13.09 % 12.86 % ? 6.00 % Leverage Ratios 10.06 % 9.67 % ? 5.00 % Liquidity. Liquidity is a measure of the Company's ability to convert assets into cash with minimal loss. As of
June 30, 2014, liquid assets were $293,938,000, or 32.5% of total assets. As of December 31, 2013, liquid assets were $283,538,000, or 31.8% of total assets. Liquidity consists of cash and due from banks, federal funds sold, and securities available-for-sale. The Company's primary uses of funds are loans, and the primary sources of funds are deposits. The Company also has federal funds borrowing facilities totaling $30,000,000, a Federal Home Loan Bankline up to 30% of total eligible assets, and a Federal Reserve Bankborrowing facility. Also please see the Company's consolidated statements of cash flows for further information, given that the cash flow statement is the primary statement disclosing the company's cash transactions. The relationship between total net loans and total deposits is a useful additional measure of liquidity. A higher loan to deposit ratio may lead to a loss of liquid assets in the future. This must be balanced against the fact that loans represent the highest interest earning assets. A lower loan to deposit ratio means lower potential income. On June 30, 2014, and December 31, 2013, respectively, net loans were at 70.9% and 71.4% of deposits. Off-Balance Sheet Items The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. As of June 30, 2014and December 31, 2013, commitments to extend credit and letters of credit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments. Loan commitments and letters of credit were $139,097,000and $132,041,000at June 30, 2014and December 31, 2013, respectively. As a percentage of net loans, these off-balance sheet items represent 24.81% and 23.91% respectively. The Company does not expect all commitments to be funded.