MidSouth Bancorp, Inc.(the "Company") is a financial holding company headquartered in Lafayette, Louisianathat conducts substantially all of its business through its wholly owned subsidiary bank, MidSouth Bank, N.A. (the "Bank"). We offer complete banking services to commercial and retail customers in Louisianaand south and central Texaswith 60 locations and are connected to a worldwide ATM network that provides customers with access to more than 55,000 surcharge-free ATMs. We are community oriented and focus primarily on offering commercial and consumer loan and deposit services to individuals, small businesses, and middle market businesses. The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the financial statements accompanying this report. We encourage you to read this discussion in conjunction with our consolidated financial statements and the notes thereto presented herein and with the financial statements, the notes thereto, and related Management's Discussion and Analysis of Financial Condition and Results of Operation in the Company's Annual Report on Form 10-K for the year ended December 31, 2013.
Certain statements included in this Report, other than statements of historical fact, are forward-looking statements (as such term is defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the regulations thereunder), which are intended to be covered by the safe harbors created thereby. Forward-looking statements include, but are not limited to certain statements under the captions "Business," "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The words "anticipate," "believe," "estimate," "expect," "intend," "may," "plan," "will," "would," "could," "should," "guidance," "potential," "continue," "project," "forecast," "confident," and similar expressions are typically used to identify forward-looking statements. These statements are based on assumptions and assessments made by management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Any forward-looking statements are not guarantees of our future performance and are subject to risks and uncertainties and may be affected by various factors that may cause actual results, developments and business decisions to differ materially from those in the forward-looking statements. Some of the factors that may cause actual results, developments and business decisions to differ materially from those contemplated by such forward-looking statements include the factors discussed under the caption "Risk Factors" in our 2013 Annual Report on form 10-K and under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report and the following:
· changes in interest rates and market prices that could affect the net interest
margin, asset valuation, and expense levels; · changes in local economic and business conditions, including, without limitation, changes related to the oil and gas industries, that could
adversely affect customers and their ability to repay borrowings under agreed
upon terms, adversely affect the value of the underlying collateral related to
their borrowings, and reduce demand for loans;
· increased competition for deposits and loans which could affect compositions,
rates and terms; · changes in the levels of prepayments received on loans and investment
securities that adversely affect the yield and value of the earning assets;
· a deviation in actual experience from the underlying assumptions used to
determine and establish our allowance for loan losses ("ALL"), which could
result in greater than expected loan losses;
· changes in the availability of funds resulting from reduced liquidity or
· the timing, ability to complete and the impact of proposed and/or future
acquisitions, the success or failure of integrating acquired operations, and
the ability to capitalize on growth opportunities upon entering new markets;
· the timing, ability to complete and the impact of proposed and/or future
efficiency initiatives; · the ability to acquire, operate, and maintain effective and efficient operating systems;
· increased asset levels and changes in the composition of assets that would
impact capital levels and regulatory capital ratios;
· loss of critical personnel and the challenge of hiring qualified personnel at
reasonable compensation levels; 27
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· legislative and regulatory changes, including the changes in the regulatory
capital framework under the
capital reforms, the impact of regulations under the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), including
the implementation of the
changes in banking, securities and tax laws and regulations and their application by our regulators, changes in the scope and cost of
Federal Deposit Insurance Corporation("FDIC") insurance and other coverage;
· regulations and restrictions resulting from our participation in government
sponsored programs such as the U.S. Treasury's
including potential retroactive changes in such programs;
· changes in accounting principles, policies, and guidelines applicable to
financial holding companies and banking;
· acts of war, terrorism, cyber intrusion, weather, or other catastrophic events
beyond our control; and · the ability to manage the risks involved in the foregoing. We can give no assurance that any of the events anticipated by the forward-looking statements will occur or, if any of them does, what impact they will have on our results of operations and financial condition. We disclaim any intent or obligation to publicly update or revise any forward-looking statements, regardless of whether new information becomes available, future developments occur or otherwise.
Critical Accounting Policies
Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements.
significant accounting policies are described in the notes to the consolidated financial statements included in this report. The accounting principles we follow and the methods of applying these principles conform to accounting principles generally accepted in
the United States of America("GAAP") and general banking practices. Our most critical accounting policy relates to the determination of the allowance for loan losses, which reflects the estimated losses resulting from the inability of its borrowers to make loan payments.
determination of the adequacy of the allowance involves significant judgment and complexity and is based on many factors. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the estimates would be updated and additional provisions for loan losses may be required. See Asset Quality - Nonperforming Assets and Allowance for Loan Losses and Note 1 and Note 4 of the footnotes to the consolidated financial statements. Another of our critical accounting policies relates to the valuation of goodwill, intangible assets and other purchase accounting adjustments. We account for acquisitions in accordance with ASC Topic No. 805, which requires the use of the purchase method of accounting. Under this method, we are required to record assets acquired and liabilities assumed at their fair value, including intangible assets. Determination of fair value involves estimates based on internal valuations of discounted cash flow analyses performed, third party valuations, or other valuation techniques that involve subjective assumptions. Additionally, the term of the useful lives and appropriate amortization periods of intangible assets is subjective. Resulting goodwill from an acquisition under the purchase method of accounting represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized, but is evaluated for impairment annually or more frequently if deemed necessary. If the fair value of an asset exceeds the carrying amount of the asset, no charge to goodwill is made. If the carrying amount exceeds the fair value of the asset, goodwill will be adjusted through a charge to earnings. Given the instability of the economic environment, it is reasonably possible that the methodology of the assessment of potential loan losses and goodwill impairment could change in the near-term or could result in impairment going forward. A third critical accounting policy relates to deferred tax assets and liabilities. We record deferred tax assets and deferred tax liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Future tax benefits, such as net operating loss carry forwards, are recognized to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. In the event the future tax consequences of differences between the financial reporting bases and the tax bases of our assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such assets is required. A valuation allowance is provided when it is more likely than not that a portion or the full amount of the deferred tax asset will not be realized. In assessing the ability to realize the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. A deferred tax liability is not recognized for portions of the allowance for loan losses for income tax purposes in excess of the financial statement balance. Such a deferred tax liability will only be recognized when it becomes apparent that those temporary differences will reverse in the foreseeable future. A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% more likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.
Table of Contents Results of Operations Earnings Analysis We reported net earnings available to common shareholders of
$3.9 millionfor the second quarter of 2014, compared to net earnings available to common shareholders of $3.3 millionreported for the second quarter of 2013. Diluted earnings for the second quarter of 2014 were $0.34per common share, compared to $0.29per common share reported for the second quarter of 2013. Revenues from consolidated operations decreased $372,000in quarterly comparison. Interest income decreased $761,000in quarterly comparison, as a $1.2 milliondecrease in loan valuation income was partially offset by an $813,000increase in interest income earned on a higher volume of loans. Interest income on investment securities decreased $$338,000 I quarterly comparison, as cash flows from the portfolio were used to fund loan growth. Noninterest income increased $257,000in quarterly comparison, from $5.0 millionfor the three months ended June 30, 2013to $5.3 millionfor the three months ended June 30, 2014. Noninterest expenses decreased $1.1 millionfor the second quarter 2014 compared to second quarter 2013 and included approximately $107,000in non-operating efficiency consultant expenses. The provision for loan losses decreased $50,000, and income tax expense increased $369,000in quarterly comparison. Dividends paid on the Series B Preferred Stock issued to the Treasury as a result of our participation in the Small Business Lending Fund("SBLF") totaled $80,000for the second quarter of 2014 based on a dividend rate of 1.00%, compared to $292,000for the second quarter of 2013 at a rate of 3.65%. The Series C Preferred Stock issued in conjunction with the acquisition of PSB Financial Corporation("PSB") paid dividends totaling $90,000for the three months ended June 30, 2014and $100,000for the three months ended June 30, 2013. In year-over-year comparison, net earnings available to common shareholders increased $4.2 million, from $6.4 millionat June 30, 2013to $10.6 millionat June 30, 2014. The first quarter of 2014 included $3.0 millionof executive life insurance proceeds recorded in noninterest income and after-tax related noninterest expenses of $160,000, following the unexpected passing of former Vice Chairman and Chief Operating Officer Jerry Reaux. The first six months of 2014 included efficiency consultant expenses of $160,000. The first quarter of 2013 included $214,000of net merger and conversion related expenses associated with the PSB acquisition. Excluding these non-operating income and expenses, operating earnings increased $1.4 millionin year-to-date comparison and included a $743,000increase in noninterest income and a $1.0 milliondecrease in non-interest expense. A reduction in the dividend rate paid on the Series B preferred stock issued in connection with SBLF resulted in a $334,000decrease in dividends on preferred stock in year-over-year comparison, and income tax expense increased $637,000in year-over-year comparison. The earnings improvement noted in our quarterly and year-to-date comparisons resulted from a profitability initiative announced in the fourth quarter of 2013 designed primarily to improve core revenue through loan growth and reduce overhead expenses through cost reduction and containment measures and through process re-engineering. In executing the initiative, our team grew loans $86.6 millionor 7.6% over the six months ended June 30, 2014. The interest earned on the increased volume of loans offset the impact of a $2.0 milliondecrease in accretion income on purchased loans. Focused efforts to reduce overhead expenses resulted in an $873,000decrease in noninterest expenses over the same period. In comparing fourth quarter of 2013 noninterest expenses to second quarter of 2014 noninterest expenses, the decrease is $1.3 million. To further bolster our efficiency efforts, we signed an engagement letter in the first quarter of 2014 with FIS, a consulting firm specializing in helping banks improve their processes. FIS has begun a thorough review of many of the major functions and processes of the bank to identify recommendations for improvement and will assist us in implementing those process improvements we choose to make. This process review began in the first quarter of 2014 and will be substantially complete by the end of 2014. Implementation of recommendations resulting from the process will be on-going throughout 2014 and 2015.
Table of Contents Net Interest Income Our primary source of earnings is net interest income, which is the difference between interest earned on loans and investments and interest paid on deposits and other interest-bearing liabilities. Changes in the volume and mix of earning assets and interest-bearing liabilities combined with changes in market rates of interest greatly affect net interest income. Our net interest margin on a taxable equivalent basis, which is net interest income as a percentage of average earning assets, was 4.58% and 4.87% for the three months ended
June 30, 2014and 2013, respectively. Tables 1 and 3 and tables 2 and 4 below analyze the changes in net interest income in the three months ended June 30, 2014and 2013 and the six months ended June 30, 2014and 2013, respectively. Fully taxable-equivalent ("FTE") net interest income totaled $19.5 millionand $20.1 millionfor the quarters ended June 30, 2014and 2013, respectively. The FTE net interest income decreased $620,000in prior year quarterly comparison primarily due to a reduction in purchase accounting adjustments on acquired loans. The average volume of loans increased $125.6 millionin quarterly comparison, and the average yield on loans decreased 85 basis points, from 6.76% to 5.91%. The purchase accounting adjustments added 23 basis points to the average yield on loans for the second quarter of 2014 and 75 basis points to the average yield on loans for the second quarter of 2013. Net of the impact of the purchase accounting adjustments, average loan yields declined 33 basis points in prior year quarterly comparison, from 6.01% to 5.68%. Loan yields have declined primarily as the result of a sustained low interest rate environment.
Investment securities totaled
investment portfolio had an effective duration of 3.9 years and an unrealized gain of
$4.2 millionat June 30, 2014. The average volume of investment securities decreased $72.4 millionin prior year quarterly comparison. The average tax equivalent yield on investment securities increased 11 basis points, from 2.52% to 2.63%. The $72.4 milliondecrease in investment securities combined with a $23.7 millionincrease in short-term FHLB advances over the past twelve months primarily funded the increase in loans during the same period. The average yield on all earning assets decreased 33 basis points in prior year quarterly comparison, from 5.26% for the second quarter of 2013 to 4.93% for the second quarter of 2014. Net of the impact of purchase accounting adjustments, the average yield on total earning assets decreased 1 basis point, from 4.78% to 4.77% for the three month periods ended June 30, 2013and 2014, respectively. The impact to interest expense of a $43.3 millionincrease in the average volume of interest bearing liabilities was offset by a 5 basis point decrease in the average rate paid on interest bearing liabilities, from 0.51% at June 30, 2013to 0.46% at June 30, 2014. Net of purchase accounting adjustments on acquired certificates of deposit and FHLB borrowings, the average rate paid on interest bearing liabilities was 0.60% for the second quarter of 2013 and declined to 0.51% for the second quarter of 2014. Included in notes payable is an average of $27.2 millionof borrowed funds, which consists of FHLB advances and a note payable with First National Bankers Bank. The FHLB advances are fixed rate advances with rates ranging from 1.99% to 5.06% and have a range of maturities from July 2014to January 2019. The FHLB advances are collateralized by a blanket lien on first mortgages and other qualifying loans. The note payable with First National Bankers Bankrequires annual payments of $250,000and bears an interest rate equal to New York Prime. Short-term FHLB advances totaled $35.0 millionat June 30, 2014. The rate on these short-term advances range from 0.17% to 0.18%, and they mature in August 2014and September 2014. The short-term advances partially funded the loan growth we experienced in the first and second quarter of 2014. The average rate paid on our junior subordinated debentures decreased 21 basis points in prior year quarterly comparison, from 4.52% for the second quarter of 2013 to 4.31% for the second quarter of 2014. The variable rate debentures carry a floating rate tied to the 3-month LIBOR with added rate variances ranging from plus 170 basis points to plus 330 basis points, adjustable and payable quarterly. We also have $7.2 millionof junior subordinated debentures outstanding that carry a fixed interest rate of 10.20%. We have received regulatory approval for full redemption of the $7.2 millionfixed rate junior subordinated debentures effective August 22, 2014. As a result of these changes in volume and yield on earning assets and interest bearing liabilities, the FTE net interest margin decreased 29 basis points, from 4.87% for the second quarter of 2013 to 4.58% for the second quarter of 2014. Net of purchase accounting adjustments on loans, deposits and FHLB borrowings, the FTE margin increased 6 basis points, from 4.33% for the second quarter of 2013 to 4.39% for the second quarter of 2014. In year-to-date comparison, FTE net interest income decreased $132,000primarily due to a decrease in purchase accounting adjustments that resulted in a decrease in the average yield on loans, from 6.70% at June 30, 2013to 6.04% at June 30, 2014. The average yield on earning assets decreased in year-to-date comparison, from 5.14% at June 30, 2013to 4.98% at June 30, 2014. The purchase accounting adjustments added 77 basis points to the average yield on loans for the first six months of 2013 and 32 basis points for the first six months of 2014. Net of purchase accounting adjustments, the average yield on earning assets increased 9 basis points, from 4.66% at June 30, 2013to 4.75% at June 30, 2014. Interest expense decreased in year-over-year comparison primarily due to a decrease in the average rate paid on interest bearing liabilities. The average rate paid on interest-bearing liabilities decreased 7 basis points, from 0.54% at June 30, 2013to 0.47% at June 30, 2014. Net of purchase accounting adjustments, the average rate paid on interest-bearing liabilities decreased 11 basis points, from 0.63% at June 30, 2013to 0.52% at June 30, 2014. The FTE net interest margin decreased 12 basis points, from 4.74% for the six months ended June 30, 2013to 4.62% for the six months ended June 30, 2014. Net of purchase accounting adjustments, the FTE net interest margin increased 18 basis points, from 4.18% to 4.36% for the six months ended June 30, 2013and 2014, respectively.
Table of Contents Table 1 Consolidated Average Balances, Interest and Rates (in thousands) Three Months Ended June 30, 2014 2013 Average Average Average Average Volume Interest Yield/Rate Volume Interest Yield/Rate Assets Investment securities1 Taxable
$ 379,124 $ 2,0642.18 % $ 434,730 $ 2,2512.07 % Tax exempt2 87,964 1,007 4.58 % 104,747 1,149 4.39 % Total investment securities 467,088 3,071 2.63 % 539,477 3,400 2.52 % Federal funds sold 2,260 1 0.18 % 1,593 1 0.25 % Time and interest bearing deposits in other banks 16,789 11 0.26 % 23,346 17 0.29 % Other investments 11,679 89 3.05 % 10,056 78 3.10 % Total loans3 1,205,930 17,769 5.91 % 1,080,295 18,197 6.76 % Total earning assets 1,703,746 20,941 4.93 % 1,654,767 21,693 5.26 % Allowance for loan losses (8,533 ) (7,425 ) Nonearning assets 192,513 203,141 Total assets $ 1,887,726 $ 1,850,483Liabilities and shareholders' equity Total interest bearing deposits $ 1,156,638 $ 8580.30 % $ 1,149,285 $ 9900.35 % Securities sold under repurchase agreements 62,322 199 1.28 % 47,667 182 1.53 % Federal funds purchased 679 1 0.58 % 1,466 3 0.81 % Short-term FHLB advances 25,110 9 0.14 % - - - Notes payable 27,218 95 1.38 % 30,259 103 1.35 % Junior subordinated debentures 29,384 320 4.31 % 29,384 336 4.52 % Total interest bearing liabilities 1,301,351 1,482 0.46 % 1,258,061 1,614 0.51 % Demand deposits 376,272 389,035 Other liabilities 8,846 11,103 Shareholders' equity 201,257 192,284 Total liabilities and shareholders' equity $ 1,887,726 $ 1,850,483Net interest income and net interest spread $ 19,4594.47 % $ 20,0794.75 % Net yield on interest earning assets 4.58 % 4.87 %
-------------------------------------------------------------------------------- 1 Securities classified as available-for-sale are included in average balances. Interest income figures reflect interest earned on such securities. 2 Interest income of
$346,000for 2014 and $337,000for 2013 is added to interest earned on tax-exempt obligations to reflect tax equivalent yields using a tax rate of 35%. 3 Interest income includes loan fees of $1,397,000for 2014 and $1,517,000for 2013. Nonaccrual loans are included in average balances and income on such loans is recognized on a cash basis.
Table of Contents Table 2 Consolidated Average Balances, Interest and Rates (in thousands) Six Months Ended June 30, 2014 2013 Average Average Average Average Volume Interest Yield/Rate Volume Interest Yield/Rate Assets Investment securities1 Taxable
$ 388,332 $ 4,2002.16 % $ 430,397 $ 4,3102.00 % Tax exempt2 89,867 2,066 4.60 % 105,859 2,349 4.44 % Total investment securities 478,199 6,266 2.62 % 536,256 6,659 2.48 % Federal funds sold 2,589 2 0.15 % 4,789 5 0.21 % Time and interest bearing deposits in other banks 21,315 27 0.25 % 40,492 55 0.27 % Other investments 11,604 159 2.74 % 9,688 150 3.10 % Total loans3 1,176,632 35,252 6.04 % 1,062,141 35,314 6.70 % Total earning assets 1,690,339 41,706 4.98 % 1,653,366 42,183 5.14 % Allowance for loan losses (8,610 ) (7,291 ) Nonearning assets 191,820 205,642 Total assets $ 1,873,549 $ 1,851,717Liabilities and shareholders' equity Total interest bearing deposits $ 1,155,829 $ 1,7290.30 % $ 1,141,230 $ 2,0680.37 % Securities sold under repurchase agreements 55,406 379 1.38 % 46,661 361 1.56 % Federal funds purchased 425 1 0.47 % 737 3 0.81 % Short-term FHLB advances 25,055 18 0.14 % 564 1 0.35 % Notes payable 27,396 192 1.39 % 28,915 208 1.41 % Other borrowings/payables - - - 1,116 18 3.21 % Junior subordinated debentures 29,384 667 4.51 % 29,384 672 4.55 % Total interest bearing liabilities 1,293,495 2,986 0.47 % 1,248,607 3,331 0.54 % Demand deposits 374,319 399,276 Other liabilities 7,599 12,405 Shareholders' equity 198,136 191,429 Total liabilities and shareholders' equity $ 1,873,549 $ 1,851,717Net interest income and net interest spread $ 38,7204.51 % $ 38,8524.60 % Net yield on interest earning assets 4.62 % 4.74 %
-------------------------------------------------------------------------------- 1 Securities classified as available-for-sale are included in average balances. Interest income figures reflect interest earned on such securities. 2 Interest income of
$712,000for 2014 and $698,000for 2013 is added to interest earned on tax-exempt obligations to reflect tax equivalent yields using a tax rate of 35%. 3 Interest income includes loan fees of $2,742,000for 2014 and $2,598,000for 2013. Nonaccrual loans are included in average balances and income on such loans is recognized on a cash basis.
Table of Contents Table 3 Changes in Taxable-Equivalent Net Interest Income (in thousands) Three Months Ended June 30, 2014 compared to June 30, 2013 Total Change Increase Attributable To (Decrease) Volume Rates Taxable-equivalent earned on: Investment securities Taxable
$ (187 ) $ (299 )$ 112 Tax exempt (142 ) (190 ) 48 Time and interest bearing deposits in other banks (6 ) (4 ) (2 ) Other investments 11 12 (1 ) Loans, including fees (428 ) 1,989 (2,417 ) Total (752 ) 1,508 (2,260 ) Interest paid on: Interest bearing deposits (132 ) 6 (138 ) Securities sold under repurchase agreements 17 50 (33 ) Federal funds purchased (1 ) (2 ) 1 Short-term FHLB advances 8 10 (2 ) Notes payable (8 ) (8 ) - Junior subordinated debentures (16 ) - (16 ) Total (132 ) 56 (188 ) Taxable-equivalent net interest income $ (620 )$
Note: In Table 3, changes due to volume and rate have generally been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts to the changes in each. Table 4 Changes in Taxable-Equivalent Net Interest Income (in thousands) Six Months Ended June 30, 2014 compared to June 30, 2013 Total Change Increase Attributable To (Decrease) Volume Rates Taxable-equivalent earned on: Investment securities Taxable
$ (110 ) $ (440 )$ 330 Tax exempt (283 ) (366 ) 83 Federal funds sold (3 ) (2 ) (1 ) Time and interest bearing deposits in other banks (28 ) (24 ) (4 ) Other investments 9 27 (18 ) Loans, including fees (62 ) 3,611 (3,673 ) Total (477 ) 2,806 (3,283 ) Interest paid on: Interest bearing deposits (339 ) 26 (365 ) Securities sold under repurchase agreements 18 63 (45 ) Federal funds purchased (2 ) (1 ) (1 ) Short-term FHLB advances 17 18 (1 ) Notes payable (16 ) (8 ) (8 ) Other borrowings/payable (18 ) (18 ) - Junior subordinated debentures (5 ) - (5 ) Total (345 ) 80 (425 ) Taxable-equivalent net interest income $ (132 )$
Note: In Table 4, changes due to volume and rate have generally been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts to the changes in each.
Table of Contents Non-interest Income Non-interest income increased
$257,000in quarterly comparison, from $5.0 millionfor the three months ended June 30, 2013to $5.3 millionfor the three months ended June 30, 2014. Increases in non-interest income consisted primarily of $177,000in service charges on deposit accounts, $128,000in gain on sales of securities and $215,000in ATM/debit card income, which were partially offset by decreases of $145,000in fees earned from credit-related products and $89,000in mortgage banking fees. For the six-month period ended June 30, 2014, non-interest income totaled $13.2 millioncompared to $9.4 million, a net increase of $3.8 millionyear-over-year. The first six months of 2014 included $3.0 millionof executive life insurance proceeds recorded in non-interest income. Excluding the $3.0 millionof life insurance income, increases in non-interest income consisted primarily of $386,000in service charges on deposit accounts and $573,000in ATM and debit card income due to higher transaction volume. Non-interest Expense Non-interest expenses decreased $1.1 millionfor the second quarter 2014 compared to second quarter 2013 and included approximately $107,000of non-operating efficiency consultant expenses. Excluding these non-operating expenses in 2014, non-interest expenses decreased $1.3 millionfor the second quarter 2014 compared to second quarter 2013 and consisted primarily of decreases of $351,000in expenses on ORE and other repossessed assets, $155,000in marketing expenses, $209,000in legal and professional fees, $122,000in corporate development expense, $124,000in courier expense and $155,000in the cost of printing and supplies. The decreased costs were partially offset by a $119,000increase in salaries and benefits costs and a $110,000increase in ATM/debit card expense. The increase in salaries and benefits costs was driven by an increase in group health insurance expense of $248,000due to a higher volume of claims. Net of the increase in group health insurance, salary and benefits costs declined $129,000. Non-interest expenses decreased $873,000in year-to-date comparison, from $35.7 millionfor the six months ended June 30, 2013to $34.8 millionfor the six months ended June 30, 2014. The first six months of 2014 included approximately $189,000in non-operating expenses related primarily to expenses associated with incentive compensation plans for Mr. Reauxand $160,000of non-operating efficiency consultant expenses. The first six months of 2013 included $214,000of net merger and conversion related expenses associated with the PSB acquisition. Excluding the non-operating expenses in 2014 and 2013, decreases in noninterest expense included $321,000in marketing expenses, $303,000in legal and professional fees, $250,000in the cost of printing and supplies, $159,000in courier expense, $112,000in fraud losses and $312,000in expenses on ORE and repossessed assets. The decrease was partially offset by a $401,000increase in salaries and benefits costs (primarily increased group health insurance costs) and a $366,000increase in ATM/debit card expense.
Analysis of Balance Sheet
Total consolidated assets at
June 30, 2014and December 31, 2013were $1.9 billion. Deposits totaled $1.5 billionat June 30, 2014and December 31, 2013. Our stable core deposit base, which excludes time deposits, grew $25.5 millionand accounted for 85.5% of deposits at June 30, 2014compared to 84.2% of deposits at year end 2013. Securities available-for-sale totaled $301.0 millionat June 30, 2014, a decrease of $40.7 millionfrom $341.7 millionat December 31, 2013. The securities available-for-sale portfolio declined primarily due to $22.2 millionin sales of securities and $21.6 millionin calls, maturities and pay-downs that offset a $4.4 millionincrease in the unrealized gain on the available-for-sale portfolio. Securities held-to-maturity decreased $6.6 million, from $155.5 millionat December 31, 2013to $148.9 millionat June 30, 2014, primarily due to $7.2 millionin calls, maturities and pay-downs for the held-to-maturity portfolio that offset $1.1 millionin purchases. The investment securities portfolio had an effective duration of 3.9 years and an unrealized gain of $4.2 millionat June 30, 2014. Net loans totaled $1.2 billionat June 30, 2014, compared to $1.1 billionat December 31, 2013. Total loans grew $86.6 million, or 7.6%, from year end 2013. An increase of $50.3 millionin the commercial loan portfolio accounted for the majority of the increase in total loans. The composition of the Company's loan portfolio is reflected in Table 5 below.
Table of Contents Table 5 Composition of Loans (in thousands) June 30, 2014 December 31, 2013 Commercial, financial, and agricultural
$ 454,310$ 403,976 Real estate - construction 86,238 82,691 Real estate - commercial 413,565 397,135 Real estate - residential 153,082 146,841 Installment loans to individuals 108,581 97,459 Lease financing receivable 4,750 5,542 Other 3,656 3,910 $ 1,224,182$ 1,137,554 Less allowance for loan losses (9,075 ) (8,779 ) Net loans $ 1,215,107$ 1,128,775 Within the $413.6 millioncommercial real estate portfolio, $379.2 millionis secured by commercial property, $15.1 millionis secured by multi-family property, and $19.2 millionis secured by farmland. Of the $379.2 millionsecured by commercial property, $241.1 million, or 63.6%, is owner-occupied. Of the $153.1 millionresidential real estate portfolio, 86.8% represented loans secured by first liens. We believe our risk within the real estate and construction portfolios is diversified throughout our markets and that current exposure within the two portfolios is sufficiently provided for within the ALL at June 30, 2014.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded in the financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments, letters of credit and lines of credit. For the period ended
June 30, 2014, we did not engage in any off-balance sheet transactions reasonably likely to have a material impact on our financial condition, results of operations, or cash flows. Liquidity and Capital Bank Liquidity Liquidity is the availability of funds to meet maturing contractual obligations and to fund operations. The Bank's primary liquidity needs involve its ability to accommodate customers' demands for deposit withdrawals as well as customers' requests for credit. Liquidity is deemed adequate when sufficient cash to meet these needs can be promptly raised at a reasonable cost to the Bank. Liquidity is provided primarily by three sources: a stable base of funding sources, an adequate level of assets that can be readily converted into cash, and borrowing lines with correspondent banks. Although the Bank historically has not utilized brokered deposits, this is a fourth potential source of liquidity, albeit one that is more costly and volatile. Our core deposits are our most stable and important source of funding. Cash deposits at other banks, federal funds sold, and principal payments received on loans and mortgage-backed securities provide additional primary sources of liquidity. Approximately $38.3 millionin projected cash flows from securities repayments for the remainder of 2014 provides an additional source of liquidity. The Bank also has significant borrowing capacity with the FRB-Atlanta and with the FHLB-Dallas. As of June 30, 2014, we had no borrowings with the FRB-Atlanta. Long-term FHLB-Dallas advances totaled $26.5 millionat June 30, 2014and are fixed rate advances with rates ranging from 1.99% to 5.06% and have a range of maturities from July 2014to January 2019. Short-term FHLB-Dallas advances totaled $35.0 millionat June 30, 2014. The rate on these advances at June 30, 2014range from 0.17% to 0.18%, and they mature in August 2014and September 2014. The Bank has the ability to post additional collateral of approximately $165.4 millionif necessary to meet liquidity needs. Additionally, $241.7 millionin loan collateral is pledged under a Borrower-in-Custody line with the FRB-Atlanta. Under existing agreements with the FHLB-Dallas, our borrowing capacity totaled $286.7 millionat June 30, 2014. Additional unsecured borrowing lines totaling $33.5 millionare available through correspondent banks. We utilize these contingency funding alternatives to meet deposit volatility, which is more likely in the current environment, given unusual competitive offerings within our markets.
Table of Contents Company Liquidity At the Company level, cash is needed primarily to meet interest payments on the junior subordinated debentures, dividends on our common stock and dividend payments on the Series B and Series C Preferred Stocks. The dividend rate on the Series B Preferred Stock issued to the U.S. Treasury for participation in the
Small Business Lending Fund("SBLF") was 1.00% for the three months ended June 30, 2014and December 31, 2013. The dividend rate was set at 1.00% for the fourth quarter of 2013 due to attaining the target 10% growth rate in qualified small business loans during the second quarter of 2013. Beginning February 2016, the dividend rate will increase to 9% per annum. On December 28, 2012, the Company issued 756,511 shares of common stock and 99,971 shares of Series C Preferred Stock in connection with the PSB acquisition. During the first six months of 2014, 5,410 shares of Series C Preferred Stock were converted into 30,057 shares of the Company's common stock. The Series C Preferred Stock is entitled to the payment of noncumulative dividends, if and when declared by the Company's Board of Directors, at the rate of 4.00% per annum, payable quarterly in arrears on January 15, April 15, July 15and October 15of each year. The Series C Preferred Stock paid dividends totaling $90,000for the three months ended June 30, 2014. Dividends from the Bank totaling $9.0 millionprovided additional liquidity for the Company during the six months ended June 30, 2014. As of June 30, 2014, the Bank had the ability to pay dividends to the Company of approximately $18.7 millionwithout prior approval from its primary regulator. As a publicly traded company, the Company also has the ability, subject to market conditions, to issue additional shares of common stock and other securities to provide funds as needed for operations and future growth of the Company.
The Company and the Bank are required to maintain certain minimum capital levels. Risk-based capital requirements are intended to make regulatory capital more sensitive to the risk profile of an institution's assets. At
June 30, 2014, the Company and the Bank were in compliance with statutory minimum capital requirements and were classified as "well capitalized." Minimum capital requirements include a total risk-based capital ratio of 8.0%, with Tier 1 capital not less than 4.0%, and a Tier 1 leverage ratio (Tier 1 to total average adjusted assets) of 4.0% based upon the regulators latest composite rating of the institution. As of June 30, 2014, the Company's Tier 1 leverage ratio was 9.81%, Tier 1 capital to risk-weighted assets was 13.34% and total capital to risk-weighted assets was 14.03%. The Bank had a Tier 1 leverage capital ratio of 8.99% at June 30, 2014. As of June 30, 2014, proforma ratios reflecting the payoff of the Statutory Trust1 resulted in a 40 basis point decrease in the Tier 1 leverage ratio, from 9.81% to 9.41%. Proforma Tier 1 risk-based capital ratio and total risk based capital ratios decrease 52 basis points, to 12.82% and 13.51%, respectively. In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and for calculating risk-weighted assets, as modified by the U.S. federal bank regulators. These rules, known as " BaselIII", create a new regulatory capital standard based on Tier 1 common equity and increase the minimum leverage and risk-based capital ratios applicable to all banking organization. The Basel III rules include new minimum risk-based and leverage ratios, and modify capital and asset definitions for purposes of calculating these ratios. Among other things, the Basel III rules will impact regulatory capital ratios of banking organizations in the following manner, when fully phased in: create a new requirement to maintain a ratio of common equity Tier 1 capital to total risk-weighted assets of not less than 4.5%; increase the minimum leverage capital ratio to 4.0% for all banking organizations (currently 3.0% for certain banking organizations); increase the minimum Tier 1 risk-based capital ratio from 4.0% to 6.0%; and maintain the minimum total risk-based capital ratio at 8.0%. In addition, the Basel III rules subject banking organizations to certain limitations on capital distributions and discretionary bonus payments to executive officers if the organization does not maintain a capital conservation buffer of 2.5% above the new regulatory minimum capital ratios. The effect of the capital conservation buffer will be to increase the minimum common equity Tier 1 capital ratio to 7.0%, the minimum Tier 1 risk-based capital ratio to 8.5% and the minimum total risk-based capital ratio to 10.5%, for banking organizations seeking to avoid the limitations on capital distributions and discretionary bonus payments to executive officers. The new minimum capital requirements are effective on January 1, 2015for community banking organizations, such as MidSouth, whereas other requirements of the Basel III rules phase in over time. While we believe our current capital levels would be adequate under the new rules, the ultimate impact of these rules on the Company and the Bank is unknown at this time.
Table of Contents Asset Quality Credit Risk Management We manage credit risk primarily by observing written, board approved policies that govern all credit underwriting and approval activities. Our Chief Credit Officer ("CCO") is responsible for credit underwriting and loan operations for the Bank. The role of the CCO includes on-going review and development of lending policies, commercial credit analysis, centralized consumer underwriting, loan operations documentation and funding, and overall credit risk management procedures. The current risk management process requires that each individual loan officer review his or her portfolio on a quarterly basis and assign recommended credit ratings on each loan. These efforts are supplemented by independent reviews performed by the loan review officer and other validations performed by the internal audit department. The results of the reviews are reported directly to the Audit Committee of the Board of Directors. We believe the conservative nature of our underwriting practices has resulted in strong credit quality in our loan portfolio. Completed loan applications, credit bureau reports, financial statements, and a committee approval process remain a part of credit decisions. Documentation of the loan decision process is required on each credit application, whether approved or denied, to ensure thorough and consistent procedures. Additionally, we have historically recognized and disclosed significant problem loans quickly and taken prompt action to address material weaknesses in those credits. Credit concentrations are monitored and reported quarterly whereby individual customer and aggregate industry leverage, profitability, risk rating distributions, and liquidity are evaluated for each major standard industry classification segment. At
June 30, 2014, one industry segment concentration, the oil and gas industry, aggregated more than 10% of our loan portfolio. Our exposure in the oil and gas industry, including related service and manufacturing industries, totaled approximately $261.8 million, or 21.4% of total loans. Additionally, we monitor our exposure to loans secured by commercial real estate. At June 30, 2014, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $476.3 million, with $3.4 million, or 0.7% on nonaccrual status. Of the $476.3 million, $379.2 millionrepresent CRE loans, 64% of which are secured by owner-occupied commercial properties. Additional information regarding credit quality by loan classification is provided in Note 3 - Credit Quality of Loans and Allowance for Loan Losses and Note 8 - Fair Value Measurement in the notes to the interim consolidated financial statements.
Nonperforming Assets and Allowance for Loan Loss
Table 6 summarizes the Company's nonperforming assets for the quarters ending
Table of Contents Table 6 Nonperforming Assets and Loans Past Due 90 Days or More and Still Accruing (in thousands) December 31, June 30, 2014 2013 June 30, 2013 Nonaccrual loans $ 6,913
$ 5,099$ 6,772 Loans past due 90 days and over and still accruing 203 178 117 Total nonperforming loans 7,116 5,277 6,889 Other real estate 6,314 6,687 6,900 Other foreclosed assets 81 20 - Total nonperforming assets $ 13,511$
Troubled debt restructurings $ 417 $ 412 $ 535 Nonperforming assets to total assets 0.71 % 0.65 % 0.74 % Nonperforming assets to total loans + ORE + other assets repossessed 1.10 % 1.05 % 1.23 % ALL to nonperforming loans 127.53 % 166.36 % 123.84 % ALL to total loans 0.74 % 0.77 % 0.76 % QTD charge-offs $ 990 $ 740 $ 267 QTD recoveries 100 53 91 QTD net charge-offs $ 890 $ 687 $ 176 Annualized net charge-offs to total loans 0.29 % 0.24 % 0.06 % Nonperforming assets totaled
$13.5 millionat June 30, 2014, an increase of $1.5 millionfrom the $12.0 millionreported at year-end 2013 and a decrease of $278,000from the $13.8 millionreported at June 30, 2013. The increase in the first six months of 2014 resulted from a $1.8 millionincrease in nonaccrual loans. Allowance coverage for nonperforming loans was 127.53% at June 30, 2014compared to 166.36% at December 31, 2013and 123.84% at June 30, 2013. The ALL/total loans ratio remained relatively constant at 0.74% compared to 0.77% at year-end 2013 and 0.76% at June 30, 2013. Including valuation accounting adjustments on acquired loans, the total adjustments and ALL was 1.29% of loans at June 30, 2014. The ratio of annualized net charge-offs to total loans was 0.29% for the three months ended June 30, 2014, compared to 0.24% for the three months ended December 31, 2013, and 0.06% for the three months ended June 30, 2013. Total nonperforming assets to total loans plus ORE and other assets repossessed remained relatively constant at 1.10% at June 30, 2014from 1.05% at December 31, 2013, down from the 1.23% at June 30, 2013. Loans classified as troubled debt restructurings ("TDRs") totaled $417,000at June 30, 2014compared to $412,000at December 31, 2013and $535,000at June 30, 2013. Classified assets, including ORE, increased $2.2 million, or 7.1%, to $33.1 millioncompared to $30.9 millionat December 31, 2013. Additional information regarding impaired loans is included in Note 4 - Credit Quality of Loans and Allowance for Loan Losses and Note 9 - Fair Value Measurement in the notes to the interim consolidated financial statements. Quarterly evaluations of the allowance for loan losses are performed in accordance with GAAP and regulatory guidelines. The ALL is comprised of specific reserves assigned to each impaired loan for which a probable loss has been identified as well as general reserves to maintain the allowance at an acceptable level for other loans in the portfolio where historical loss experience is available that indicates certain probable losses may exist. Factors considered in determining provisions include estimated losses in significant credits; known deterioration in concentrations of credit; historical loss experience; trends in nonperforming assets; volume, maturity and composition of the loan portfolio; off-balance sheet credit risk; lending policies and control systems; national and local economic conditions; the experience, ability and depth of lending management; and the results of examinations of the loan portfolio by regulatory agencies and others. The processes by which we determine the appropriate level of the ALL, and the corresponding provision for probable credit losses, involves considerable judgment; therefore, no assurance can be given that future losses will not vary from current estimates. We believe the $9.1 millionin the ALL as of June 30, 2014is sufficient to cover probable losses in the loan portfolio.
Table of Contents Impact of Inflation and Changing Prices The consolidated financial statements and notes thereto, presented herein, have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are financial. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.