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Section 1: 10-K (FORM 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

(Mark One)

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

OR

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______to_______

 

Commission file number 001-36452

SERVISFIRST BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 26-0734029
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

 

 

850 Shades Creek Parkway, Birmingham, Alabama 35209
(Address of Principal Executive Offices) (Zip Code)

 

(205) 949-0302

(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Name of exchange on which registered
Common stock, par value $.001 per share The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x No ¨

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ¨ No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or Section 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.                                                                                  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and small reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

As of June 30, 2016, the aggregate market value of the voting common stock held by non-affiliates of the registrant, based on a stock price of $49.39 per share of Common Stock ($24.695 per share as adjusted for December 2016 stock split), was $1,188,636,681.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class Outstanding as of February 23, 2017
Common stock, $.001 par value 52,759,896

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its 2017 Annual Meeting of Stockholders are incorporated by reference into Part III of this annual report on Form 10-K.

 

 

 

 

SERVISFIRST BANCSHARES, INC.

 

TABLE OF CONTENTS

 

FORM 10-K

 

DECEMBER 31, 2016

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS 4
     
PART I.   5
     
ITEM 1. BUSINESS 5
ITEM 1A. RISK FACTORS 24
ITEM 1B. UNRESOLVED STAFF COMMENTS 34
ITEM 2. PROPERTIES 34
ITEM 3. LEGAL PROCEEDINGS 35
ITEM 4. MINE SAFETY DISCLOSURES 35
     
PART II.   36
     
ITEM 5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 36
ITEM 6. SELECTED FINANCIAL DATA 37
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 56
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 58
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES 99
ITEM 9A. CONTROLS AND PROCEDURES 99
ITEM 9B. OTHER INFORMATION 100
     
PART III.   100
     
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 100
ITEM 11. EXECUTIVE COMPENSATION 100
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 100
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 100
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 101
     
PART IV.   101
     
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 101
     
SIGNATURES   103
     
EXHIBIT INDEX 104

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exhange Act”). These “forward-looking statements” reflect our current views with respect to, among other things, future events and our financial performance. The words “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” and similar expressions are intended to identify such forward-looking statements, but other statements not based on historical information may also be considered forward-looking. All forward-looking statements are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements to differ materially from any results expressed or implied by such forward-looking statements. These statements should be considered subject to various risks and uncertainties, and are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Such risks include, without limitation:

 

·the effects of adverse changes in the economy or business conditions, either nationally or in our market areas;
·credit risks, including credit risks resulting from the devaluation of collateralized debt obligations (CDOs) and/or structured investment vehicles to which we currently have no direct exposure;
·the effects of governmental monetary and fiscal policies and legislative, regulatory and accounting changes applicable to banks and other financial service providers, including the potential implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);
·the effects of hazardous weather;
·the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in our market area and elsewhere, including institutions operating regionally, nationally and internationally, together with competitors offering banking products and services by mail, telephone and the internet;
·our ability to keep pace with technology changes, including with respect to cyber-security and preventing breaches of our and third-party security systems involving our customers and other sensitive and confidential data;
·our ability to attract new or retain existing deposits, or to initiate new or retain current loans;
·credit risks, including the deterioration of the credit quality of our loan portfolio, increased default rates and loan losses or adverse changes in our portfolio or in specific industry concentrations of our loan portfolio;
·the effect of any merger, acquisition or other transaction to which we or any of our subsidiaries may from time to time be a party, including our ability to successfully integrate any business that we acquire;
·deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses;
·the effect of changes in interest rates on the level and composition of deposits, loan demand and the values of loan collateral, securities and interest sensitive assets and liabilities;
·the effects of terrorism and efforts to combat it;
·an increase in the incidence or severity of fraud, illegal payments, security breaches or other illegal acts impacting our customers;
·the results of regulatory examinations;
·the effect of inaccuracies in our assumptions underlying the establishment of our loan loss reserves; and
·other factors that are discussed in the section titled “Risk Factors” in Item 1A.

 

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this annual report on Form 10-K. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

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PART I

 

Unless this Form 10-K indicates otherwise, the terms “we,” ”our,” “us,” “the Company,” “ServisFirst Bancshares” and “ServisFirst” as used herein refer to ServisFirst Bancshares, Inc., and its subsidiaries, including ServisFirst Bank, which sometimes is referred to as “our bank subsidiary” or “the Bank,” and its other subsidiaries. References herein to the fiscal years 2012, 2013, 2014, 2015 and 2016 mean our fiscal years ended December 31, 2012, 2013, 2014, 2015 and 2016, respectively.

 

ITEM 1. BUSINESS

 

Overview

 

We are a bank holding company within the meaning of the Bank Holding Company Act of 1956 and are headquartered in Birmingham, Alabama. Through our wholly-owned subsidiary bank, we operate 19 full-service banking offices located in Jefferson, Shelby, Madison, Montgomery, Houston and Mobile Counties of Alabama, Escambia and Hillsborough Counties of Florida, Cobb and Douglas Counties of Georgia, Charleston County, South Carolina and Davidson County, Tennessee in the metropolitan statistical areas (“MSAs”) of Birmingham-Hoover, Huntsville, Montgomery, Dothan and Mobile, Alabama, Pensacola-Ferry Pass-Brent and Tampa-St. Petersburg-Clearwater, Florida, Atlanta-Sandy Springs-Roswell, Georgia, Charleston-North Charleston, South Carolina and Nashville-Davidson-Murfreesboro-Franklin, Tennessee. Through our bank, we originate commercial, consumer and other loans and accept deposits, provide electronic banking services, such as online and mobile banking, including remote deposit capture, deliver treasury and cash management services and provide correspondent banking services to other financial institutions.  As of December 31, 2016, we had total assets of approximately $6.4 billion, total loans of approximately $4.9 billion, total deposits of approximately $5.4 billion and total stockholders’ equity of approximately $523 million.

 

We operate our bank using a simple business model based on organic loan and deposit growth, generated through high quality customer service, delivered by a team of experienced bankers focused on developing and maintaining long-term banking relationships with our target customers. We utilize a uniform, centralized back office risk and credit platform to support a decentralized decision-making process executed locally by our regional chief executive officers. This decentralized decision-making process allows individual lending officers varying levels of lending authority, based on the experience of the individual officer. When the total amount of loans to a borrower exceeds an officer’s lending authority, further approval must be obtained by the applicable regional chief executive officer (G. Carlton Barker – Montgomery, Andrew N. Kattos – Huntsville, B. Harrison Morris, III – Dothan, Rex D. McKinney – Pensacola, W. Bibb Lamar, Jr. – Mobile, Thomas G. Trouche – Charleston, Kenneth L. Barber – Atlanta or Gregory W. Bryant – Tampa Bay) and/or our senior management team. Rather than relying on a more typical traditional, retail bank strategy of operating a broad base of multiple brick and mortar branch locations in each market, our strategy focuses on operating a limited and efficient branch network with sizable aggregate balances of total loans and deposits housed in each branch office. We believe that this approach more appropriately addresses our customers’ banking needs and reflects a best-of-class delivery strategy for commercial banking services.

 

Our principal business is to accept deposits from the public and to make loans and other investments. Our principal sources of funds for loans and investments are demand, time, savings and other deposits and the amortization and prepayment of loans and borrowings. Our principal sources of income are interest and fees collected on loans, interest and dividends collected on other investments, and service charges. Our principal expenses are interest paid on savings and other deposits, interest paid on our other borrowings, employee compensation, office expenses and other overhead expenses.

 

We previously formed SF Holding 1, Inc. as a subsidiary of our bank. We also formed SF Realty 1, Inc., SF FLA Realty, Inc., and SF GA Realty, Inc., as subsidiaries of SF Holding 1, Inc. In February 2016, we formed SF TN Realty, Inc. as a subsidiary of SF Holding 1, Inc. Also in February of 2016, we formed SF Intermediate Holding Company, Inc. and immediately following its formation our bank assigned all of the outstanding capital stock of SF Holding 1, Inc. to SF Intermediate Holding Company, Inc., such that SF Holding 1, Inc. is now a wholly owned first-tier subsidiary of SF Intermediate Holding Company, Inc. Each of SF Realty 1, Inc., SF FLA Realty, Inc., SF GA Realty, Inc. and SF TN Realty, Inc. hold and manage participations in residential mortgages and commercial real estate loans originated by our bank in Alabama, Florida, Georgia and Tennessee, respectively, and each have elected to be treated as a real estate investment trust, or REIT, for U.S. income tax purposes. Each of these entities is consolidated into the Company.

 

As a bank holding company, we are subject to regulation by the Federal Reserve. We are required to file reports with the Federal Reserve and are subject to regular examinations by that agency.

 

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History

 

Our bank was founded by our President and Chief Executive Officer, Thomas A. Broughton, III, and commenced banking operations in May 2005 following an initial capital raise of $35 million, the largest capital raise by a de novo bank in the history of Alabama. We were incorporated as a Delaware corporation in August 2007 for the purpose of acquiring all of the common stock of our bank, and in November 2007 our holding company became the sole shareholder of the bank by virtue of a plan of reorganization and agreement of merger. In May 2008, following our filing of a registration statement on Form 10 with the SEC, we became a reporting company within the meaning of the Exchange Act and have been filing annual, quarterly, and current reports, proxy statements and other information with the SEC since 2008. On May 19, 2014, we completed our initial public offering (the “Offering’) of common stock. Since the completion of the Offering, our common stock has traded on The NASDAQ Global Select Market under the symbol “SFBS”.

 

Business Strategy

 

We are a full service commercial bank focused on providing competitive products, state of the art technology and quality service. Our business philosophy is to operate as a metropolitan community bank emphasizing prompt, personalized customer service to the individuals and businesses located in our primary markets. We aggressively market to our target customers, which include privately held businesses with $2 million to $250 million in annual sales, professionals and affluent consumers whom we believe are underserved by the larger regional banks operating in our markets. We also seek to capitalize on the extensive relationships that our management, directors, advisory directors and stockholders have with the businesses and professionals in our markets.

 

Focus on Core Banking Business. We deliver a broad array of core banking products to our customers. While many large regional competitors and national banks have chosen to develop non-traditional business lines to supplement their net interest income, we believe our focus on traditional commercial banking products driven by a high margin delivery system is a superior method to deliver returns to our stockholders. We emphasize an internal culture of keeping our operating costs as low as practical, which we believe leads to greater operational efficiency. Additionally, our centralized technology and process infrastructure contribute to our low operating costs. We believe this combination of products, operating efficiency and technology make us attractive to customers in our markets. In addition, we provide correspondent banking services to more than 300 community banks located in 12 states throughout the southern United States. We provide a source of clearing and liquidity to our correspondent bank customers, as well as a wide array of account, credit, settlement and international services.

 

Commercial Bank Emphasis. We have historically focused on people as opposed to places. This strategy translates into a smaller number of brick and mortar branch locations relative to our size, but larger overall branch sizes in terms of total deposits. As a result, as of December 31, 2016 our branches averaged approximately $285.3 million in total deposits. In the more typical retail banking model, branch banks continue to lose traffic to other banking channels which may prove to be an impediment to earnings growth for those banks that have invested in large branch networks. In addition, unlike many traditional community banks, we place a strong emphasis on originating commercial and industrial loans, which comprised approximately 40.4% of our total loan portfolio as of December 31, 2016.

 

Scalable, Decentralized Business Model. We emphasize local decision-making by experienced bankers supported by centralized risk and credit oversight. We believe that the delivery by our bankers of in-market customer decisions, coupled with risk and credit support from our corporate headquarters, allows us to serve our borrowers and depositors directly and in person, while managing risk centrally and on a uniform basis. We intend to continue our growth by repeating this scalable model in each market in which we are able to identify a strong banking team. Our goal in each market is to employ the highest quality bankers in that market. We then empower those bankers to implement our operating strategy, grow our customer base and provide the highest level of customer service possible. We focus on a geographic model of organizational structure as opposed to a line of business model employed by most regional banks. This structure assigns significant responsibility and accountability to our regional chief executive officers, who we believe will drive our growth and success. We have developed a business culture whereby our management team, from the top down, is actively involved in sales, which we believe is a key differentiator from our competition.

 

Identify Opportunities in Vibrant Markets. Since opening our original banking facility in Birmingham in 2005, as of December 31, 2016, we had expanded into nine additional markets. Our focus has been to expand opportunistically when we identify a strong banking team in a market with attractive economic characteristics and market demographics where we believe we can achieve a minimum of $300 million in deposits within five years of market entry. There are two primary factors we consider when determining whether to enter a new market:

 

·the availability of successful, experienced bankers with strong reputations in the market; and

  

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·the economic attributes of the market necessary to drive quality lending opportunities coupled with deposit-related characteristics of the potential market.

 

Prior to entering a new market, historically we have identified and built a team of experienced, successful bankers with market-specific knowledge to lead the bank’s operations in that market, including a regional chief executive officer. Generally, we or members of our senior management team are familiar with these individuals based on prior work experience and reputation, and strongly believe in the ability of such individuals to successfully execute our business model. We also often assemble a non-voting advisory board of directors in our markets, comprised of directors representing a broad spectrum of business experience and community involvement in the market. We currently have advisory boards in each of the Huntsville, Montgomery, Dothan, Mobile, Pensacola and Atlanta markets.

 

In addition to organic expansion, we may seek to expand through targeted acquisitions.

 

Markets and Competition

 

Our primary markets are broadly defined as the MSAs of Birmingham-Hoover, Huntsville, Montgomery, Dothan and Mobile, Alabama, Pensacola-Ferry Pass-Brent and Tampa-St. Petersburg-Clearwater, Florida, Atlanta-Sandy Springs-Roswell, Georgia, Charleston-North Charleston, South Carolina and Nashville-Davidson-Murfreesboro-Franklin, Tennessee. We draw most of our deposits from, and conduct most of our lending transactions in, these markets.

 

According to Federal Deposit Insurance Corporation (“FDIC”) reports, total deposits in each of our primary market areas have expanded from 2006 to 2016 (deposit data reflects totals as reported by financial institutions as of June 30th of each year) as follows:

 

   2016   2006   Compound
Annual Growth
Rate
 
   (Dollars in Billions) 
Jefferson/Shelby County, Alabama  $34.7   $19.8    5.77%
Madison County, Alabama   6.8    4.7    3.76%
Montgomery County, Alabama   6.2    5.1    1.97%
Houston County, Alabama   2.6    1.6    4.97%
Mobile County, Alabama   6.5    5.4    1.87%
Escambia County, Florida   4.1    4.1    -%
Hillsborough County, Florida   30.2    18.1    5.25%
Cobb County, Georgia   13.8    9.0    4.37%
Douglas County, Georgia   1.3    1.4    (0.74)%
Charleston County, South Carolina   9.9    6.5    4.30%
Davidson County, Tennessee   30.2    15.8    6.69%

 

Our bank is subject to intense competition from various financial institutions and other financial service providers. Our bank competes for deposits with other commercial banks, savings and loan associations, credit unions and issuers of commercial paper and other securities, such as money-market and mutual funds. In making loans, our bank competes with other commercial banks, savings and loan associations, consumer finance companies, credit unions, leasing companies, interest-based lenders and other lenders.

 

The following table illustrates our market share, by insured deposits, in our primary service areas at June 30, 2016 (the most recent date such numbers were reported by the FDIC), as reported by the FDIC:

 

Market (1)  Number of
Branches
  Our Market
Deposits
   Total Market
Deposits
   Ranking   Market
Share
Percentage
 
   (Dollars in Millions)
Alabama:                       
Birmingham-Hoover MSA  3  $2,059.7   $37,515.9    5    5.49%
Huntsville MSA  2   741.3    7,491.0    3    9.90%
Montgomery MSA  2   498.9    7,722.2    6    6.46%
Dothan MSA  2   493.2    3,206.8    2    15.38%
Mobile MSA  2   199.3    6,564.6    7    3.04%
Florida:                       
Pensacola-Ferry Pass-Brent MSA  2   294.9    5,416.1    7    5.44%
Tampa-St. Petersburg-Clearwater MSA  1   10.0    75,972.4    62    0.01%
Georgia:                       
Atlanta-Sandy Springs-Roswell MSA  3   189.0    156,210.4    43    0.12%
South Carolina:                       
Charleston-North Charleston MSA  1   61.7    12,355.8    19    0.50%
Tennessee:                       
Nashville-Davidson-Murfreesboro MSA  1   137.0    52,198.7    40    0.26%

 

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The following table illustrates the combined total deposits for all financial institutions in the counties in which we operate as a percent of the total of all deposits in each state at June 30, 2016, as reported by the FDIC:

 

Alabama   58.5%
Florida   6.4%
Georgia   6.7%
South Carolina   12.5%
Tennessee   21.8%

 

We entered our newest market, Tampa Bay, Florida, with the announcement on January 25, 2016 that we hired Gregory W. Bryant as our regional CEO to oversee our entrance and expansion there. Tampa Bay includes the cities of Tampa, St. Petersburg, Clearwater and Lakeland, with a total population of over 5 million. A number of major drivers contribute to the area’s diverse economy: MacDill Air Force Base, home to Central Command, contributes an estimated $5 billion annually to the local economy; Tampa International Airport, already home to numerous domestic and international carriers, is undergoing a $1 billion expansion; three major league sports teams call the area home; the University of South Florida is ranked 50th in the nation in research spending; the Port of Tampa is one of the country’s most diverse seaports, with a bustling cruise business, inbound and outbound bulk cargo, and large ship repair yards; and, the world class beaches mean a healthy tourism industry. Known for a vibrant base of small and mid-size businesses, the area is also home to a number of large employers, including Baycare Medical Systems, Publix Supermarkets, Home Shopping Network, Tech Data, Wellcare HMO, Moffitt Cancer Center, and Busch Gardens.

 

Our retail and commercial divisions operate in highly competitive markets. We compete directly in retail and commercial banking markets with other commercial banks, savings and loan associations, credit unions, mortgage brokers and mortgage companies, mutual funds, securities brokers, consumer finance companies, other lenders and insurance companies, locally, regionally and nationally. Many of our competitors compete by using offerings by mail, telephone, computer and/or the Internet. Interest rates, both on loans and deposits, and prices of services are significant competitive factors among financial institutions generally. Providing convenient locations, desired financial products and services, convenient office hours, quality customer service, quick local decision making, a strong community reputation and long-term personal relationships are all important competitive factors that we emphasize.

 

In our primary service areas, our five largest competitors are Regions Bank, Wells Fargo Bank, BBVA Compass, BB&T and Synovus Bank. These institutions, as well as other competitors of ours, have greater resources, serve broader geographic markets, have higher lending limits, offer various services that we do not offer and can better afford, and make broader use of, media advertising, support services, and electronic technology than we can. To offset these competitive disadvantages, we depend on our reputation for greater personal service, consistency, flexibility and the ability to make credit and other business decisions quickly.

 

Lending Services

 

Lending Policy

 

Our lending policies are established to support the credit needs of our primary market areas. Consequently, we aggressively seek high-quality borrowers within a limited geographic area and in competition with other well-established financial institutions in our primary service areas that have greater resources and lending limits than we have.

 

Loan Approval and Review

 

Our loan approval policies set various levels of officer lending authority. When the total amount of loans to a single borrower exceeds an individual officer’s lending authority, further approval, up to $3.0 million secured, must be obtained from the Regional CEO and/or our senior management team, based on our loan policies.

 

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Commercial Loans

 

Our commercial lending activity is directed principally toward businesses and professional service firms whose demand for funds falls within our legal lending limits. We make loans to small- and medium-sized businesses in our primary service areas for the purpose of upgrading plant and equipment, buying inventory and for general working capital. Typically, targeted business borrowers have annual sales between $2 million and $250 million. This category of loans includes loans made to individual, partnership and corporate borrowers, and such loans are obtained for a variety of business purposes. We offer a variety of commercial lending products to meet the needs of business and professional service firms in our service areas. These commercial lending products include seasonal loans, bridge loans and term loans for working capital, expansion of the business, or acquisition of property, plant and equipment. We also offer commercial lines of credit. The repayment terms of our commercial loans will vary according to the needs of each customer.

 

Our commercial loans usually are collateralized. Generally, collateral consists of business assets, including accounts receivable, inventory, equipment, or real estate. Collateral is subject to the risk that we may have difficulty converting it to a liquid asset if necessary, as well as risks associated with degree of specialization, mobility and general collectability in a default situation. To mitigate this risk, we underwrite collateral to strict standards, including valuations and general acceptability based on our ability to monitor its ongoing condition and value.

 

We underwrite our commercial loans primarily on the basis of the borrower’s cash flow, ability to service debt, and degree of management expertise. As a general practice, we take as collateral a security interest in any available real estate, equipment or personal property. Under limited circumstances, we may make commercial loans on an unsecured basis. Commercial loans may be subject to many different types of risks, including fraud, bankruptcy, economic downturn, deteriorated or non-existent collateral, and changes in interest rates. Perceived and actual risks may differ depending on the particular industry in which a borrower operates. General risks to an industry, such as an economic downturn or instability in the capital markets, or to a particular segment of an industry are monitored by senior management on an ongoing basis. When warranted, loans to individual borrowers who may be at risk due to an industry condition may be more closely analyzed and reviewed by the credit review committee or board of directors. Commercial and industrial borrowers are required to submit financial statements to us on a regular basis. We analyze these statements, looking for weaknesses and trends, and will assign the loan a risk grade accordingly. Based on this risk grade, the loan may receive an increased degree of scrutiny by management, up to and including additional loss reserves being required.

 

Real Estate Loans

 

We make commercial real estate loans, construction and development loans and residential real estate loans.

 

Commercial Real Estate. Commercial real estate loans are generally limited to terms of five years or less, although payments are usually structured on the basis of a longer amortization. Interest rates may be fixed or adjustable, although rates generally will not be fixed for a period exceeding five years. In addition, we generally will require personal guarantees from the principal owners of the property supported by a review by our management of the principal owners’ personal financial statements.

 

Commercial real estate lending presents risks not found in traditional residential real estate lending. Repayment is dependent upon successful management and marketing of properties and on the level of expense necessary to maintain the property. Repayment of these loans may be adversely affected by conditions in the real estate market or the general economy. Also, commercial real estate loans typically involve relatively large loan balances to a single borrower. To mitigate these risks, we closely monitor our borrower concentration. These loans generally have shorter maturities than other loans, giving us an opportunity to reprice, restructure or decline renewal. As with other loans, all commercial real estate loans are graded depending upon strength of credit and performance. A higher risk grade will bring increased scrutiny by our management, the credit review committee and the board of directors.

 

Construction and Development Loans. We make construction and development loans both on a pre-sold and speculative basis. If the borrower has entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a pre-sold basis. If the borrower has not entered into an agreement to sell the property prior to beginning construction, then the loan is considered to be on a speculative basis. Construction and development loans are generally made with a term of 12 to 24 months, with interest payable monthly. The ratio of the loan principal to the value of the collateral as established by independent appraisal typically will not exceed 80% of residential construction loans. Speculative construction loans will be based on the borrower’s financial strength and cash flow position. Development loans are generally limited to 75% of appraised value. Loan proceeds will be disbursed based on the percentage of completion and only after the project has been inspected by an experienced construction lender or third-party inspector. During times of economic stress, construction and development loans typically have a greater degree of risk than other loan types.

 

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To mitigate the risk of construction loan defaults in our portfolio, the board of directors and management tracks and monitors these loans closely. Total construction loans increased $91.8 million in 2016. Our allocation of loan loss reserve for these loans decreased $0.3 million to $5.1 million at December 31, 2016 compared to $5.4 million at the end 2015. Charge-offs increased slightly from $0.7 million for 2015 to $0.8 million for 2016, and the overall quality of the construction loan portfolio has remained consistent with $4.3 million rated as substandard at December 31, 2016 compared to $4.0 million at December 31, 2015.

 

Residential Real Estate Loans. Our residential real estate loans consist primarily of residential second mortgage loans, residential construction loans and traditional mortgage lending for one-to-four family residences. We will originate fixed-rate mortgages with long-term maturities. The majority of our fixed-rate loans are sold in the secondary mortgage market. All loans are made in accordance with our appraisal policy, with the ratio of the loan principal to the value of collateral as established by independent appraisal generally not exceeding 85%. Risks associated with these loans are generally less significant than those of other loans and involve bankruptcies, economic downturn, customer financial problems and fluctuations in the value of real estate, and homes in our primary service areas may experience significant price declines in the future. We have not made and do not expect to make any “Alt-A” or subprime loans.

 

Consumer Loans

 

We offer a variety of loans to retail customers in the communities we serve. Consumer loans in general carry a moderate degree of risk compared to other loans. They are generally more risky than traditional residential real estate loans but less risky than commercial loans. Risk of default is usually determined by the well-being of the local economies. During times of economic stress, there is usually some level of job loss both nationally and locally, which directly affects the ability of the consumer to repay debt. Risk on consumer-type loans is generally managed through policy limitations on debt levels consumer borrowers may carry and limitations on loan terms and amounts depending upon collateral type.

 

Our consumer loans include home equity loans (open- and closed-end), vehicle financing, loans secured by deposits, and secured and unsecured personal loans. These various types of consumer loans all carry varying degrees of risk.

 

Commitments and Contingencies

 

As of December 31, 2016, we had commitments to extend credit beyond current fundings of approximately $1.7 billion, had issued standby letters of credit in the amount of approximately $41.0 million, and had commitments for credit card arrangements of approximately $100.7 million.

 

Policy for Determining the Loan Loss Allowance

 

The allowance for loan losses represents our management’s assessment of the risk associated with extending credit and its evaluation of the quality of the loan portfolio. In calculating the adequacy of the loan loss allowance, our management evaluates the following factors:

 

·the asset quality of individual loans;
·changes in the national and local economy and business conditions/development, including underwriting standards, collections, and charge-off and recovery practices;
·changes in the nature and volume of the loan portfolio;
·changes in the experience, ability and depth of our lending staff and management;
·changes in the trend of the volume and severity of past-due loans and classified loans, and trends in the volume of non-accrual loans, troubled debt restructurings and other modifications, as has occurred in the residential mortgage markets and particularly for residential construction and development loans;
·possible deterioration in collateral segments or other portfolio concentrations;
·historical loss experience (when available) used for pools of loans (i.e., collateral types, borrowers, purposes, etc.);
·changes in the quality of our loan review system and the degree of oversight by our board of directors; and
·the effect of external factors such as competition and the legal and regulatory requirement on the level of estimated credit losses in our current loan portfolio.

 

These factors are evaluated quarterly, and changes in the asset quality of individual loans are evaluated as needed.

 

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We assign all of our loans individual risk grades when they are underwritten. We have established minimum general reserves based on the risk grade of the loan. We also apply general reserve factors based on historical losses, management’s experience and common industry and regulatory guidelines.

 

After a loan is underwritten and booked, it is monitored by the account officer, management, internal loan review, and representatives of our independent external loan review firm over the life of the loan. Payment performance is monitored monthly for the entire loan portfolio; account officers contact customers during the regular course of business and may be able to ascertain whether weaknesses are developing with the borrower; independent loan consultants perform a review annually; and federal and state banking regulators perform annual reviews of the loan portfolio. If we detect weaknesses that have developed in an individual loan relationship, we downgrade the loan and assign higher reserves based upon management’s assessment of the weaknesses in the loan that may affect full collection of the debt. We have established a policy to discontinue accrual of interest (non-accrual status) after any loan has become 90 days delinquent as to payment of principal or interest unless the loan is considered to be well collateralized and is actively in process of collection. In addition, a loan will be placed on non-accrual status before it becomes 90 days delinquent if management believes that the borrower’s financial condition is such that the collection of interest or principal is doubtful. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. Interest income on non-accrual loans is recognized only as received. If a loan will not be collected in full, we increase the allowance for loan losses to reflect our management’s estimate of any potential exposure or loss.

 

Our net loan losses to average total loans decreased to 0.11% for the year ended December 31, 2016 from 0.13% for the year ended December 31, 2015, which was down from 0.17% for the year ended December 31, 2014. Historical performance, however, is not an indicator of future performance, and our future results could differ materially. As of December 31, 2016, we had $10.6 million of non-accrual loans. We have allocated approximately $5.1 million of our allowance for loan losses to real estate construction, acquisition and development, and lot loans, $28.9 million to commercial and industrial loans, $17.5 million to real estate mortgage loans and $0.4 million to consumer loans and have a total loan loss reserve as of December 31, 2016 of $51.9 million. The loan loss reserve methodology incorporates qualitative factors which are based on management’s judgment regarding various external and internal factors including macroeconomic trends, management’s assessment of the Company’s loan growth prospects and evaluations of internal risk controls. Our management believes, based upon historical performance, known factors, overall judgment, and regulatory methodologies, that the current methodology used to determine the adequacy of the allowance for loan losses is reasonable.

 

Our allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, regulatory agencies may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management.

 

While it is our policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, our management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

 

Investments

 

In addition to loans, we purchase investments in securities, primarily in mortgage-backed securities and state and municipal securities. No investment in any of those instruments will exceed any applicable limitation imposed by law or regulation. Our board of directors reviews the investment portfolio on an ongoing basis in order to ensure that the investments conform to the policy as set by the board of directors. Our investment policy provides that no more than 60% of our total investment portfolio may be composed of municipal securities. All securities held are traded in liquid markets, and we have no auction-rate securities. We had no investments in any one security, restricted or liquid, in excess of 10% of our stockholders’ equity at December 31, 2016.

 

Deposit Services

 

We seek to establish solid core deposits, including checking accounts, money market accounts, savings accounts and a variety of certificates of deposit and IRA accounts. To attract deposits, we employ an aggressive marketing plan throughout our service areas that features a broad product line and competitive services. The primary sources of core deposits are residents of, and businesses and their employees located in, our market areas. We have obtained deposits primarily through personal solicitation by our officers and directors, through reinvestment in the community, and through our stockholders, who have been a substantial source of deposits and referrals. We make deposit services accessible to customers by offering direct deposit, wire transfer, night depository, banking-by-mail and remote capture for non-cash items. Our bank is a member of the FDIC, and thus our deposits (subject to applicable FDIC limits) are FDIC-insured.

 

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Other Banking Services

 

Given client demand for increased convenience and account access, we offer a range of products and services, including 24-hour telephone banking, direct deposit, Internet banking, mobile banking, traveler’s checks, safe deposit boxes, attorney trust accounts and automatic account transfers. We also participate in a shared network of automated teller machines and a debit card system that our customers are able to use throughout Alabama and in other states and, in certain accounts subject to certain conditions, we rebate to the customer the ATM fees automatically after each business day. Additionally, we offer Visa® credit cards.

 

Asset, Liability and Risk Management

 

We manage our assets and liabilities with the aim of providing an optimum and stable net interest margin, a profitable after-tax return on assets and return on equity, and adequate liquidity. These management functions are conducted within the framework of written loan and investment policies. To monitor and manage the interest rate margin and related interest rate risk, we have established policies and procedures to monitor and report on interest rate risk, devise strategies to manage interest rate risk, monitor loan originations and deposit activity and approve all pricing strategies. We attempt to maintain a balanced position between rate-sensitive assets and rate-sensitive liabilities. Specifically, we chart assets and liabilities on a matrix by maturity, effective duration, and interest adjustment period, and endeavor to manage any gaps in maturity ranges.

 

Seasonality and Cycles

 

We do not consider our commercial banking business to be seasonal.

 

Employees

 

We had 420 employees as of December 31, 2016. We consider our employee relations to be good, and we have no collective bargaining agreements with any employees.

 

Supervision and Regulation

 

Both we and our bank are subject to extensive state and federal banking laws and regulations that impose restrictions on, and provide for general regulatory oversight of, our operations. These laws and regulations require compliance with various consumer protection provisions applicable to lending, deposits, brokerage and fiduciary activities. They also impose capital adequacy requirements and restrict our ability to repurchase our stock and receive dividends from our bank. These laws and regulations generally are intended to protect customers, rather than stockholders. The following discussion describes material elements of the regulatory framework that applies to us. However, the description below is not intended to summarize all laws and regulations applicable to us.

 

Bank Holding Company Supervision and Regulation

 

Since we own all of the capital stock of the bank, we are a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “BHC Act”). As a result, we are primarily subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.

 

Acquisition of Banks

 

The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:

 

·acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will, directly or indirectly, own or control more than 5% of the bank’s voting shares;
·acquiring all or substantially all of the assets of any bank; or
·merging or consolidating with any other bank holding company.

 

Additionally, the BHC Act provides that the Federal Reserve may not approve any of these transactions if such transaction would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve also is required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed in the section below titled “Supervision and Regulation—Bank Supervision and Regulation – Capital Adequacy.”

 

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Under the BHC Act, if adequately capitalized and adequately managed, we or any other bank holding company located in Alabama may purchase a bank located outside of Alabama. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Alabama may purchase a bank located inside Alabama. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.

 

Change in Bank Control

 

Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person’s or company’s acquiring “control” of a bank holding company. Under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting stock of a bank holding company would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company. In addition, any person or group of persons must obtain the approval of the Federal Reserve under the BHC Act before acquiring 25% (5% in the case of an acquirer that is already a bank holding company) or more of the outstanding common stock of a bank holding company, or otherwise obtaining control or a “controlling influence” over the bank holding company.

 

Permitted Activities

 

Under the BHC Act, a bank holding company is generally permitted to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

 

·banking or managing or controlling banks; and
·any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

 

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include: factoring accounts receivable; making, acquiring, brokering or servicing loans and usual related activities; leasing personal property; operating a non-bank depository institution, such as a savings association; trust company functions; financial and investment advisory activities; certain agency securities brokerage activities; underwriting and dealing in government obligations and money market instruments; providing specified management consulting and counseling activities; performing selected data processing services and support services; acting as an agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and performing selected insurance underwriting activities. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.

 

In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, permitting the bank holding company to engage in activities that are financial in nature or incidental or complementary to financial activity. The BHC Act expressly lists the following activities as financial in nature: lending, trust and other banking activities; insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state; providing financial, investment, or advisory services; issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; underwriting, dealing in or making a market in securities; other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks; activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking operations abroad; merchant banking through securities or insurance affiliates; and insurance company portfolio investments. For us to qualify to become a financial holding company, the bank and any other depository institution subsidiary of ours must be well-capitalized and well-managed and must have a Community Reinvestment Act (“CRA”) rating of at least “satisfactory”. Additionally, we must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. We have not elected to become a financial holding company at this time.

 

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Support of Subsidiary Institutions

 

The Federal Deposit Insurance Act and Federal Reserve policy require a bank holding company to act as a source of financial and managerial strength to its bank subsidiaries and to take measures to preserve and protect its bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. In addition, where a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions is responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result, a bank holding company may be required to loan money to a bank subsidiary in the form of subordinate capital notes or other instruments which qualify as capital under bank regulatory rules. However, any loans from the holding company to such subsidiary banks likely will be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of the bank.

 

Repurchase or Redemption of Securities

 

A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of its own then-outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. The Federal Reserve has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain conditions.

 

Bank Supervision and Regulation

 

Generally

 

The bank is an Alabama state-chartered bank and, as such, is subject to examination and regulation by the Alabama State Banking Department (the “Alabama Banking Department”). The bank is not a member of the Federal Reserve System but is subject to various regulations and requirements promulgated by the Federal Reserve, the Consumer Financial Protection Bureau (the “CFPB”), the Federal Trade Commission, the Financial Crimes Enforcement Network, the Office of Foreign Assets Control (“OFAC”), and other federal regulatory agencies. State non-member banks are, in addition to regulation by the applicable state regulatory authority, subject to supervision and regular examination by the FDIC. The FDIC and the Alabama Banking Department regularly examine the bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to prevent the development or continuance of unsafe or unsound banking practices or other violations of law. Additionally, the bank’s deposits are insured by the FDIC to the maximum extent provided by law. The extensive state and federal banking laws and regulations to which the bank is subject are generally intended to protect the bank’s customers, rather than our stockholders. The following discussion describes the material elements of the regulatory framework that applies to the bank.

 

Branching

 

Under current Alabama law, the bank may open branch offices throughout Alabama with the prior approval of the Alabama Banking Department. In addition, with prior regulatory approval, the bank may acquire branches of existing banks located in Alabama. While prior law imposed various limits on the ability of banks to establish new branches in states other than their home state, the Dodd-Frank Act allows a bank to branch into a new state by acquiring a branch of an existing institution or by setting up a new branch, without merging with an existing institution in the target state, if, under the laws of the state in which the branch is to be located, a bank chartered by that state would be permitted to establish the branch. This makes it much simpler for banks to open de novo branches in other states. We opened our initial offices in Pensacola, Florida, Nashville, Tennessee, Charleston, South Carolina, and Tampa Bay, Florida, using this mechanism.

 

FDIC Insurance Assessments

 

The bank’s deposits are insured by the FDIC to the full extent provided in the Federal Deposit Insurance Act, and the bank pays assessments to the FDIC for that coverage. Under the FDIC’s risk-based deposit insurance assessment system, an insured institution’s deposit insurance premium is computed by multiplying the institution’s assessment base by the institution’s assessment rate. An institution’s assessment base equals the institution’s average consolidated total assets during a particular assessment period, minus the institution’s average tangible equity capital (that is, Tier 1 capital) during such period. An institution’s assessment rate is assigned by the FDIC on a quarterly basis and is based on a number of factors related to the risk the institution poses to the Deposit Insurance Fund. Those factors include, among other things, the institution’s capital adequacy, liquidity, loan and deposit portfolio characteristics, asset quality, earnings, and rate of growth. For the fourth quarter of 2016, the bank’s assessment rate was set at $0.0137, or $0.055 annually, per $100 of assessment base.

 

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In addition to its risk-based insurance assessments, the FDIC also imposes Financing Corporation (“FICO”) assessments to help pay the $780 million in annual interest payments on the $8 billion of bonds issued in the late 1980s as part of the government rescue of the savings and loan industry. For the fourth quarter of 2016, the bank’s FICO assessment was equal to $0.0014, or $0.0056 annually, per $100 of assessment base. These assessments will continue until the bonds mature in 2019.

 

The FDIC is responsible for maintaining the adequacy of the Deposit Insurance Fund, and the amount the bank pays for deposit insurance is affected not only by the risk the bank poses to the Deposit Insurance Fund, but also by the adequacy of the fund to cover the risk posed by all insured institutions. From 2008 to 2013, the United States experienced an unusually high number of bank failures, resulting in significant losses to the Deposit Insurance Fund. Moreover, the Dodd-Frank Act permanently increased the standard maximum deposit insurance amount from $100,000 to $250,000, and raised the minimum required Deposit Insurance Fund reserve ratio (i.e., the ratio of the amount on reserve in the Deposit Insurance Fund to the total estimated insured deposits) from 1.15% to 1.35%. To support the Deposit Insurance Fund in response to those circumstances, the FDIC took several extraordinary actions, including imposing a one-time special assessment on insured institutions and requiring institutions to prepay quarterly assessments attributable to a three-year period. If the FDIC were to take those types of actions again in the future, they could have a negative impact on the bank’s earnings.

 

Termination of Deposit Insurance

 

The FDIC may terminate its insurance of deposits of a bank if it finds that the bank has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

Liability of Commonly Controlled Depository Institutions

 

Under the Federal Deposit Insurance Act, an FDIC-insured depository institution can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC-insured depository institution in danger of default. “Default” is defined generally as the appointment of a conservator or receiver, and “in danger of default” is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. The FDIC’s claim for damage is superior to claims of stockholders of the insured depository institution but is subordinate to claims of depositors, secured creditors, other general and senior creditors, and holders of subordinated debt (other than affiliates) of the institution.

 

Community Reinvestment Act

 

The CRA requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve or the FDIC will evaluate the record of each financial institution in meeting the needs of its local community, including low and moderate-income neighborhoods. These factors are also considered in evaluating mergers, acquisitions, and applications to open an office or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the bank. Additionally, we must publicly disclose the terms of various CRA-related agreements.

 

Interest Rate Limitations

 

Interest and other charges collected or contracted for by the bank are subject to state usury laws and federal laws concerning interest rates.

 

Federal Laws Applicable to Consumer Credit and Deposit Transactions

 

The bank’s loan and deposit operations are subject to a number of federal consumer protection laws and regulations, including, among others:

 

·the Federal Truth-In-Lending Act, as implemented by Regulation Z issued by the CFPB, governing, among other things, the disclosure of credit terms to consumers;
   
·the Real Estate Settlement Procedures Act, as implemented by Regulation X issued by the CFPB, prescribing, among other things, requirements in connection with residential mortgage loan applications, settlements, and servicing;
   
·the Home Mortgage Disclosure Act, as implemented by Regulation C issued by the CFPB, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

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·the Equal Credit Opportunity Act, as implemented by Regulation B issued by the CFPB, prohibiting discrimination on the basis of race, color, religion, national origin, sex, marital status, age, or certain other prohibited factors in all aspects of credit transactions, imposing certain requirements regarding credit applications, and prescribing certain disclosure obligations;
   
·the Fair Credit Reporting Act, as implemented in part by Regulation V issued by the CFPB, governing the use and provision of information to credit reporting agencies by imposing, among other things, requirements for financial institutions to develop policies and procedures to identify potential identity theft, requirements for entities that furnish information to consumer reporting agencies (which would include the bank) to implement procedures and policies regarding the accuracy and integrity of the furnished information and respond to disputes from consumers regarding credit reporting issues, requirements for mortgage lenders to disclose credit scores to consumers, and limitations on the ability of a business that receives consumer information from an affiliate to use that information for marketing purposes;
   
·the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by debt collectors;
   
·the Servicemembers’ Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service;
   
·the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
   
·the Electronic Funds Transfer Act, as implemented by Regulation E issued by the CFPB, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

Capital Adequacy

 

General Information. The federal banking regulators view capital levels as important indicators of an institution’s financial soundness. In this regard, we and the bank are required to comply with the capital adequacy standards established by the Federal Reserve (in our case) and the FDIC and the Alabama Banking Department (in the case of the bank). Such standards are based on the December 2010 final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision (the “Basel Committee”). The implementation of Basel III for United States institutions began on January 1, 2015. Prior to that date, the risk-based capital rules applicable to us and the bank were based on the 1988 Capital Accord, known as Basel I, of the Basel Committee

 

Current capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

 

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. Significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

 

United States Implementation of Basel III. In July 2013, the federal banking agencies published final rules (the “Basel III Capital Rules”) to implement, in part, the Basel III framework issued by the Basel Committee and certain provisions of the Dodd-Frank Act. The Basel III Capital Rules apply to banking organizations, including us and the bank.

 

Among other things, the Basel III Capital Rules: (i) emphasize common equity tier 1 capital, or “CET1,” which is predominately made up of retained earnings and common stock instruments; (ii) specify that an institution’s tier 1 capital consists of CET1 and additional financial instruments satisfying specified requirements that permit inclusion in tier 1 capital; (iii) define CET1 narrowly by requiring that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions or adjustments from capital as compared to the previous regulations. The Basel III Capital Rules also provide a permanent exemption from a proposed phase out of existing trust preferred securities and cumulative perpetual preferred stock from regulatory capital for banking organizations with less than $15 billion in total consolidated assets as of December 31, 2009.

 

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The Basel III Capital Rules provide for the following minimum capital to risk-weighted assets ratios:

 

·4.5% based upon CET1;
·6.0% based upon tier 1 capital; and
·8.0% based upon total regulatory capital.

 

A minimum leverage ratio (tier 1 capital as a percentage of total assets) of 4.0% is also required under the Basel III Capital Rules. The Basel III Capital Rules additionally require institutions to retain a capital conservation buffer of 2.5% above these required minimum capital ratio levels. The capital conservation buffer, which must consist of CET1, is designed to absorb losses during periods of economic stress. Banking organizations that fail to maintain the minimum 2.5% capital conservation buffer could face restrictions on capital distributions or discretionary bonus payments to executive officers.

 

The Basel III Capital Rules became effective as applied to us and the bank on January 1, 2015, with a phase in period that generally extends from January 1, 2015 through January 1, 2019. We and the bank are currently in compliance with Basel III Capital Rules.

 

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of “prompt corrective action” to resolve the problems of undercapitalized financial institutions. Under this system, which was modified by the Basel III Capital Rules, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) into which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital thresholds for each of those categories. At December 31, 2016, the bank was well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the bank had to maintain minimum total risk-based, tier 1 risk-based, CET1 risk-based, and tier 1 leverage ratios of 10%, 8%, 6.5% and 5%, respectively.

 

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

 

An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of (i) 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized and (ii) the amount required to meet regulatory capital requirements. An undercapitalized institution also is generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

 

Liquidity

 

Financial institutions are subject to significant regulatory scrutiny regarding their liquidity positions. This scrutiny has increased during recent years, as the economic downturn that began in the late 2000s negatively affected the liquidity of many financial institutions. Various bank regulatory publications, including FDIC Financial Institution Letter FIL-13-2010 (Funding and Liquidity Risk Management) and FDIC Financial Institution Letter FIL-84-2008 (Liquidity Risk Management), address the identification, measurement, monitoring and control of funding and liquidity risk by financial institutions.

 

Basel III also addresses liquidity management by proposing two new liquidity metrics for financial institutions. The first metric is the “Liquidity Coverage Ratio”, and it aims to require a financial institution to maintain sufficient high quality liquid resources to survive an acute stress scenario that lasts for one month. The second metric is the “Net Stable Funding Ratio,” and its objective is to require a financial institution to maintain a minimum amount of stable sources relative to the liquidity profiles of the institution’s assets, as well as the potential for contingent liquidity needs arising from off-balance sheet commitments, over a one-year horizon.

 

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In the Basel III Capital Rules, the federal banking regulators did not address either the Liquidity Coverage Ratio or the Net Stable Funding Ratio. However, in September 2014, the federal banking agencies adopted final rules implementing a Liquidity Coverage Ratio requirement in the United States for larger banking organizations. In May 2016, the federal banking agencies issued proposed rules implementing a Net Stable Funding Ratio requirement, also for larger U.S. banking organizations. Neither we nor the bank is subject to either set of rules.

 

The Liquidity Coverage Ratio and the Net Stable Funding Ratio continue to be monitored for implementation, and we cannot yet provide concrete estimates as to how those requirements, or any other regulatory positions regarding liquidity and funding, might affect us or our bank. However, increased liquidity requirements generally would be expected to cause the bank to invest its assets more conservatively—and therefore at lower yields—than it otherwise might invest. Such lower-yield investments likely would reduce the bank’s revenue stream, and in turn its earnings potential.

 

Payment of Dividends

 

We are a legal entity separate and distinct from the bank. Our principal source of cash flow, including cash flow to pay dividends to our stockholders, is dividends the bank pays to us as the bank’s sole shareholder. Statutory and regulatory limitations apply to the bank’s payment of dividends to us as well as to our payment of dividends to our stockholders. The requirement that a bank holding company must serve as a source of strength to its subsidiary banks also results in the position of the Federal Reserve that a bank holding company should not maintain a level of cash dividends to its stockholders that places undue pressure on the capital of its bank subsidiaries or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company’s ability to serve as such a source of strength. Our ability to pay dividends is also subject to the provisions of Delaware corporate law.

 

The Alabama Banking Department also regulates the bank’s dividend payments. Under Alabama law, a state-chartered bank may not pay a dividend in excess of 90% of its net earnings until the bank’s surplus is equal to at least 20% of its capital (our bank’s surplus currently exceeds 20% of its capital). Moreover, our bank is also required by Alabama law to obtain the prior approval of the Superintendent of Banks (“Superintendent”) for its payment of dividends if the total of all dividends declared by the bank in any calendar year will exceed the total of (i) the bank’s net earnings (as defined by statute) for that year, plus (ii) its retained net earnings for the preceding two years, less any required transfers to surplus. Based on this, our bank would be limited to paying $189.1 million in dividends as of December 31, 2016. In addition, no dividends, withdrawals or transfers may be made from the bank’s surplus without the prior written approval of the Superintendent.

 

The bank’s payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividends if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. If, in the opinion of the federal banking regulators, the bank were engaged in or about to engage in an unsafe or unsound practice, the federal banking regulators could require, after notice and a hearing, that the bank stop or refrain from engaging in the questioned practice.

 

Restrictions on Transactions with Affiliates and Insiders

 

We are subject to Section 23A of the Federal Reserve Act, which places limits on the amount of: a bank’s loans or extensions of credit to affiliates; a bank’s investment in affiliates; assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve; loans or extensions of credit made by a bank to third parties collateralized by the securities or obligations of affiliates; a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate; a bank’s transactions with an affiliate involving the borrowing or lending of securities to the extent they create credit exposure to the affiliate; and a bank’s derivative transactions with an affiliate to the extent they create credit exposure to the affiliate. The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, certain of these transactions must also meet specified collateral requirements. The bank must also comply with other provisions designed to avoid the taking of low-quality assets.

 

We are also subject to Section 23B of the Federal Reserve Act, which, among other things, prohibits an institution from engaging in these transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

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The bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. Alabama state banking laws also have similar provisions.

 

Lending Limits

 

Under Alabama law, the amount of loans which may be made by a bank in the aggregate to one person is limited. Alabama law provides that unsecured loans by a bank to one person may not exceed an amount equal to 10% of the capital and unimpaired surplus of the bank or 20% in the case of secured loans. For purposes of calculating these limits, loans to various business interests of the borrower, including companies in which a substantial portion of the stock is owned or partnerships in which a person is a partner, must be aggregated with those made to the borrower individually. Loans secured by certain readily marketable collateral are exempt from these limitations, as are loans secured by deposits and certain government securities.

 

Commercial Real Estate Concentration Limits

 

In December 2006, the U.S. bank regulatory agencies issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in commercial real estate (“CRE”) loans. The guidance describes the criteria the agencies will use as indicators to identify institutions potentially exposed to CRE concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total CRE loans representing 300% or more of the institution’s capital, and the outstanding balance of the institution’s CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level and nature of its CRE concentration risk.

 

In December 2015, the U.S. bank regulatory agencies issued guidance titled “Statement on Prudent Risk Management for Commercial Real Estate Lending” to remind financial institutions of existing guidance on prudent risk management practices for CRE lending activity, including the 2006 guidance described above. In the 2015 guidance, the agencies noted their belief that financial institutions had eased CRE underwriting standards in recent years. The 2015 guidance went on to identify actions that financial institutions should take to protect themselves from CRE-related credit losses during difficult economic cycles. The 2015 guidance also indicated that the agencies would pay special attention in the future to potential risks associated with CRE lending.

 

Privacy and Data Security

 

Under federal law as implemented by Regulation P, financial institutions are required to disclose their policies for collecting and protecting the non-public personal information of their consumer customers. Consumer customers generally may prevent financial institutions from sharing non-public personal information with nonaffiliated third parties except under certain circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly offering a product or service with a nonaffiliated financial institution. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. In addition, financial institutions are subject to various state privacy laws that may, among other things, impose data security requirements on all customer information, whether consumer or commercial customer information, and impose data breach notification obligations. The state data breach notification requirements generally apply based on the residence of the consumer and not on the bank’s presence in the state, location of the collateral property, or other variables.

 

Anti-Terrorism and Money Laundering Legislation

 

Our bank is subject to the USA Patriot Act, the Bank Secrecy Act, and the requirements of OFAC. These statutes and related rules and regulations impose requirements and limitations on specified financial transactions and account and other relationships intended to guard against money laundering and terrorism financing. Our bank has established a customer identification program pursuant to Section 326 of the USA Patriot Act and maintains records of cash purchases of negotiable instruments, files reports of certain cash transactions exceeding $10,000 (daily aggregate amount), and reports suspicious activity that might signify money laundering, tax evasion, or other criminal activities pursuant to the Bank Secrecy Act. Our bank otherwise has implemented policies and procedures to comply with the foregoing requirements.

 

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Effect of Governmental Monetary Policies

 

Our bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict, and have no control over, the nature or impact of future changes in monetary and fiscal policies.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered, or that file reports, under the Exchange Act. In particular, the act established (i) requirements for audit committees, including independence, expertise and responsibilities; (ii) responsibilities regarding financial statements for the chief executive officer and chief financial officer of the reporting company and new requirements for them to certify the accuracy of periodic reports; (iii) standards for auditors and regulation of audits; (iv) disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) civil and criminal penalties for violations of the federal securities laws. The legislation also established a new accounting oversight board to enforce auditing standards and restrict the scope of services that accounting firms may provide to their public company audit clients.

 

Overdraft Fees

 

The Federal Reserve has adopted amendments under its Regulation E that impose restrictions on banks’ abilities to charge overdraft fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions.

 

Interchange Fees

 

The Dodd-Frank Act, through a provision known as the Durbin Amendment, required the Federal Reserve to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. Institutions like the bank with less than $10 billion in assets are exempt. However, while the bank is under the $10 billion level that caps income per transaction, the bank has been affected by federal regulations that prohibit network exclusivity arrangements and routing restrictions. Essentially, issuers and networks must allow transaction processing through a minimum of two unaffiliated networks.

 

The Volcker Rule

 

On December 10, 2013, five U.S. financial regulators, including the Federal Reserve and the FDIC, adopted a final rule implementing the so-called “Volcker Rule.” The Volcker Rule was created by Section 619 of the Dodd-Frank Act and prohibits “banking entities” from engaging in “proprietary trading” and making investments and conducting certain other activities with “private equity funds and hedge funds.” Although the final rule provides some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including us and the bank. Banking institutions generally were required to comply with the Volcker Rule by July 2015, although certain parts of the rule did not (or do not) take effect until later dates.

 

While the final rule and its accompanying materials comprise approximately 1,000 pages, banking entities that do not engage in any of the activities covered by the Volcker Rule (other than with respect to certain U.S. government obligations) are not required to adopt any formal compliance program specific to the Volcker Rule. We have reviewed the scope of the final rule and have concluded that it does not impact our operations.

 

The Dodd-Frank Act

 

In July 2010, the Dodd-Frank Act was signed into law. As final rules and regulations implementing the Dodd-Frank Act continue to be adopted and implemented, this new law is significantly changing the bank regulatory environment and affecting the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, the full impact of the Dodd-Frank Act may not be known for many years.

 

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A number of the effects of the Dodd-Frank Act are described or otherwise accounted for in various parts of this Supervision and Regulation section. The following items provide a brief description of certain other provisions of the Dodd-Frank Act that may be relevant to us and the bank.

 

·The Dodd-Frank Act created the CFPB and gave it broad powers to supervise and enforce consumer protection laws. The CFPB now has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks with more than $10 billion in assets. Institutions with less than $10 billion in assets will continue to be examined for compliance with consumer laws by their primary bank regulator.

 

·The Dodd-Frank Act imposed new requirements regarding the origination and servicing of residential mortgage loans. The law created a variety of new consumer protections, including limitations on the manner by which loan originators may be compensated and an obligation on the part of lenders to verify a borrower’s “ability to repay” a residential mortgage loan. Final rules implementing these latter statutory requirements became effective in 2014.

 

·The Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits effective one year after the date of its enactment, thus allowing businesses to have interest-bearing checking accounts. Depending on competitive responses, this significant change to prior law could have an adverse impact on our interest expense.

 

·The Dodd-Frank Act imposes many investor protection, corporate governance and executive compensation rules that have affected most U.S. publicly traded companies. The Dodd-Frank Act (i) requires publicly traded companies to give stockholders a non-binding vote on executive compensation and golden parachute payments; (ii) enhances independence requirements for compensation committee members; (iii) requires companies listed on national securities exchanges to adopt incentive-based compensation clawback policies for executive officers; (iv) authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials; and (v) directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks.

 

·Although insured depository institutions have long been subject to the FDIC’s resolution process, the Dodd-Frank Act creates a new mechanism for the FDIC to conduct the orderly liquidation of certain “covered financial companies,” including bank holding companies and systemically significant non-bank financial companies. Upon certain findings being made, the FDIC may be appointed receiver for a covered financial company, and would conduct an orderly liquidation of the entity. The FDIC liquidation process is modeled on the existing Federal Deposit Insurance Act bank resolution process, and generally gives the FDIC more discretion than in the traditional bankruptcy context. The FDIC has issued final rules implementing the orderly liquidation authority.

 

As noted above, many of the requirements under the Dodd-Frank Act were subject to rulemaking, and such rulemaking is either in place and effective or continuing to take effect over the next several years, making it difficult to anticipate the overall financial impact on the bank and us. However, compliance with the Dodd-Frank Act and its implementing regulations has resulted in and will continue to result in additional operating and compliance costs that could have a material adverse effect on our business, financial condition and results of operations.

 

Other Legislation and Regulatory Action relating to Financial Institutions

 

Recent government efforts to strengthen the United States financial system, including the Dodd-Frank Act and its related rules and regulations, subject us and the bank to a number of new regulatory compliance obligations, many of which may impose additional fees, costs, requirements, and restrictions. These fees, costs, requirements, and restrictions, as well as any others that may be imposed in the future, may have a material adverse effect on our business, financial condition, and results of operations.

 

New proposals to change the laws and regulations governing the banking industry are frequently introduced in the United States Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on us and the bank, however, cannot be determined at this time. In this regard, bills are presently pending before Congress and certain state legislatures, and additional bills may be introduced in the future in Congress and state legislatures, to alter the structure, regulation and competitive relationships of financial institutions. We cannot predict whether or in what form any of these proposals will be adopted or the extent to which our business may be affected by any new regulation or statute.

 

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Available Information

 

Our corporate website is www.servisfirstbank.com. We have direct links on this website to our Code of Ethics and the charters for our Audit, Compensation and Corporate Governance and Nominations Committees by clicking on the “Investor Relations” tab. We also have direct links to our filings with the Securities and Exchange Commission (SEC), including, but not limited to, our annual reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and any amendments to these filings. You may also obtain a copy of any such report from us free of charge by requesting such copy in writing to 850 Shades Creek Parkway, Suite 200, Birmingham, Alabama 35209, Attention: Chief Financial Officer.

 

Executive Officers of the Registrant

 

A brief description of the background of each of our named executive officers is set forth below.

 

Thomas A. Broughton, III (61) – Mr. Broughton has served as our President and Chief Executive Officer and a director since 2007 and as President, Chief Executive Officer and a director of the Bank since its inception in May 2005. Mr. Broughton has spent the entirety of his banking career in the Birmingham area. In 1985, Mr. Broughton was named President of the de novo First Commercial Bank. When First Commercial Bank was acquired by Synovus Financial Corp. in 1992, Mr. Broughton continued as President and was named Chief Executive Officer of First Commercial Bank. In 1998, he became Regional Chief Executive Officer of Synovus Financial Corp., responsible for the Alabama and Florida markets. In 2001, Mr. Broughton’s Synovus region shifted, and he became Regional Chief Executive Officer for the markets of Alabama, Tennessee and parts of Georgia. He continued his work in this position until his retirement from Synovus in August 2004. Mr. Broughton’s experience in banking has afforded him opportunities to work in many areas of banking and has given him exposure to all bank functions. Mr. Broughton served on the Board of Directors of Cavalier Homes, Inc. from 1986 until 2009, when the company was sold to a subsidiary of Berkshire Hathaway.

 

Clarence C. Pouncey, III (60) – Mr. Pouncey has served as our Executive Vice President and Chief Operating Officer since 2007 and Executive Vice President and Chief Operating Officer of the Bank since November 2006. Prior to joining the Company, Mr. Pouncey was employed by SouthTrust Bank (subsequently, Wachovia Bank and now Wells Fargo Bank) at its corporate headquarters in Birmingham, in various capacities from 1978 to 2006, most recently as the Senior Vice President and Regional Manager of Real Estate Financial Services. During his employment with SouthTrust, Mr. Pouncey oversaw various operational and production functions in its nine-state footprint of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Texas and Virginia, and while employed by Wachovia, Mr. Pouncey oversaw various operational and production functions in Alabama, Arizona, Tennessee and Texas.

 

William M. Foshee (62) – Mr. Foshee has served as our Executive Vice President, Chief Financial Officer, Treasurer and Secretary since 2007 and as Executive Vice President, Chief Financial Officer, Treasurer and Secretary of the Bank since 2005. Mr. Foshee served as the Chief Financial Officer of Heritage Financial Holding Corporation, a publicly traded bank holding company headquartered in the Huntsville MSA, from 2002 until it was acquired in 2005. Mr. Foshee is a Certified Public Accountant.

 

Rodney E. Rushing (59) – Mr. Rushing has served as the Executive Vice President and Executive for Correspondent Banking for us and the bank since 2011. Prior to joining us, Mr. Rushing was employed at BBVA Compass from 1982 to 2011, most recently serving as Executive Vice President of Correspondent Banking. At the time of his departure in March 2011, the correspondent banking division of BBVA Compass provided correspondent banking services to over 600 financial institutions.

 

Don G. Owens (65) – Mr. Owens has served as the Senior Vice President and Chief Credit Officer for us and the bank since 2012. Prior to joining us, Mr. Owens served as a retail branch manager of First Alabama Bank from 1973 to 1978, worked for C&I Bank (now Bank of America) from 1978 to 1982, including as a branch manager and commercial lender, worked for Republic Bank (now Bank of America) from 1982 to 1988, including as a commercial lender and credit administrator, and served as a Senior Vice President and Senior Loan Administrator for BBVA Compass from 1988 to 2012.

 

A brief description of the background of each of our regional chief executive officers is set forth below.

 

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Kenneth L. Barber (62) – Mr. Barber has served as Executive Vice President and Atlanta President and Chief Executive Officer of the Bank since February 1, 2015 when the Company acquired Metro Bancshares, Inc. Mr. Barber chartered Metro Bank in 2007, growing total assets to approximately $230 million before being acquired by the Company. Prior to Metro Bank, Mr. Barber served as the President and Chief Executive Officer of Georgian Bancorporation and its subsidiary, Georgian Bank. Prior to Georgian Bancorporation, Mr. Barber served as the President and Chief Executive Officer of Citizens & Merchants State Bank in Douglasville, Georgia. From 1976 to 1986, Mr. Barber served in various capacities for Wachovia Corporation, including Vice President of Commercial Lending. Mr. Barber has over 40 years of banking experience in Georgia. Mr. Barber has served on the Boards of Directors for the Douglas County and Cobb County Chambers of Commerce. He is actively involved in many church and civic activities. Mr. Barber holds a degree in Business Administration and Economics from the University of West Georgia and is a graduate of the University of Georgia’s banking school.

 

G. Carlton Barker (68) – Mr. Barker has served as Executive Vice President and Montgomery President and Chief Executive Officer of the Bank since February 1, 2007. Prior to joining the Company, Mr. Barker was employed by Regions Bank for 19 years in various capacities, most recently as the Regional President for the Southeast Alabama Region. Mr. Barker serves on the Huntingdon College Board of Trustees.

 

Gregory W. Bryant (53) – Mr. Bryant serves as Executive Vice President and Tampa Bay Area President and Chief Executive Officer of the Bank. His arrival at the Company was announced on January 25, 2016. Previously, Mr. Bryant was the President and CEO of Bay Cities Bank in Tampa, Florida from 2000 until its sale to Centennial Bank in October 2015. While at Bay Cities, Mr. Bryant was a member of the bank’s loan committee, compensation committee, audit committee, and ALCO committee. Mr. Bryant also served as the President of Florida Business BancGroup, the parent company of Bay Cities Bank. From 2005 to 2015, Mr. Bryant served as a Director of the Independent Banker’s Bank (Lake Mary, FL), a correspondent bank serving over 100 banks in Florida and South Georgia. While at IBB, Mr. Bryant served on the loan and executive committees. Prior to Bay Cities Bank, Mr. Bryant worked in various management capacities with GE Capital and SouthTrust Bank. Mr. Bryant served as Chair of the Florida Banker’s Association in 2012, and is active in the CEO Council of Tampa Bay and the Greater Tampa Chamber of Commerce.

 

Andrew N. Kattos (47) – Mr. Kattos has served as Executive Vice President and Huntsville President and Chief Executive Officer of the Bank since April 2006. Prior to joining the Company, Mr. Kattos was employed by First Commercial Bank for 14 years, most recently as an Executive Vice President and Senior Lender in the Commercial Lending Department. Mr. Kattos also serves on the Advisory Board for the Junior League as a Board Member and Finance Committee Member for the Huntsville Hospital Foundation.

 

William Bibb Lamar, Jr. (72) – Mr. Lamar has served as the Mobile Regional Chief Executive Officer of the bank since March 2013. Mr. Lamar is a seasoned Mobile banker with over 40 years of leadership responsibilities. Mr. Lamar graduated from the University of Mobile. Mr. Lamar began his banking career with Merchants National, now Regions Bank where he spent more than 20 years in various leadership roles. Most recently, Mr. Lamar was the CEO of BankTrust for over 20 years. Mr. Lamar has served on the State Banking Board for 16 years and was formerly President of the Alabama Bankers Association.

 

Rex D. McKinney (54) – Mr. McKinney has served as Executive Vice President and Pensacola President and Chief Executive Officer of the Bank since January 2011. Prior to joining the Company, Mr. McKinney held several leadership positions, including the senior lender position, at First American Bank/Coastal Bank and Trust (owned by Synovus Financial Corporation) starting in 1997. Mr. McKinney is a Past Board Member of the Rotary Club of Pensacola. He is Past President of the Pensacola Sports Association, a Past President of the Irish Politicians Club, a Member of the Pensacola Sports Association Foundation, Vice President of the Pensacola Country Club Board of Directors and also a Board Member of the Florida Bankers Association.

 

B. Harrison Morris, III (40) – Mr. Morris has served as Dothan Regional Chief Executive Officer since February 2015 when the outgoing CEO, Ronald DeVane, retired from the Company. Prior to his promotion, Mr. Morris served as Executive Vice President and Dothan President since June 2010, following his promotion from Senior Lending Officer of the Dothan Region. Mr. Morris joined the Company in September 2008. Prior to joining the Company, Mr. Morris held various positions with Wachovia Bank and SouthTrust Bank since 1998. Mr. Morris is a trustee of the Wallace Community College Foundation Board, a member of the Dothan Area Chamber of Commerce Board, a member of the Wiregrass United Way Board and a member of the Wiregrass Chapter of the American Red Cross.

 

Thomas G. Trouche (52) – Mr. Trouche has served as Executive Vice President and Charleston President and Chief Executive Officer of the Bank since December 2014. Prior to joining the Company, Mr. Trouche served in various roles with First Citizens Bank for over 13 years, most recently as their Coastal Division Executive. Mr. Trouche currently serves on the Board of Directors for the American Red Cross, and previously served as Chairman of the Board for Mason Preparatory School in Charleston. Mr. Trouche received his Bachelor of Arts degree in History from the College of Charleston.

 

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ITEM 1A. RISK FACTORS.

 

Our business, financial condition and results of operation could be harmed by any of the following risks or by other risks identified in this annual report, as well as by other risks we may not have anticipated or viewed as material. Such risks and uncertainties could cause actual results to differ materially from those contained in forward-looking statements presented elsewhere by management. The following list identifies and briefly summarizes certain risk factors. This list should not be viewed as complete or comprehensive, and the risks identified below are not the only risks facing our company. See also “Cautionary Note Regarding Forward-Looking Statements.”

 

Risks Related To Our Business

 

As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by weak economic conditions.

 

Our businesses and operations are sensitive to general business and economic conditions in the United States. If the U.S. economy weakens, our growth and profitability could be constrained. Uncertainty about the federal fiscal policymaking process, the medium and long-term fiscal outlook of the federal government, and future tax rates is a concern for businesses, consumers and investors in the United States. In addition, economic conditions in foreign countries could affect the stability of global financial markets, which could hinder U.S. economic growth. Weak economic conditions are characterized by deflation, fluctuations in debt and equity capital markets, a lack of liquidity and/or depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and commercial loans, residential and commercial real estate price declines and lower home sales and commercial activity. The current economic environment is characterized by interest rates at historically low levels, which impacts our ability to attract deposits and to generate attractive earnings through our investment portfolio. An increase in interest rates could increase competition for deposits, decrease customer demand for loans due to the higher cost of obtaining credit, result in an increased number of delinquent loans and defaults or reduce the value of securities held for investment. All of these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Our business also is significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions, including a return of recessionary conditions, and government policy responses to such conditions could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We are dependent on the services of our management team and board of directors, and the unexpected loss of key officers or directors may adversely affect our business and operations.

 

We are led by an experienced core management team with substantial experience in the markets that we serve, and our operating strategy focuses on providing products and services through long-term relationship managers. Accordingly, our success depends in large part on the performance of our key personnel, as well as on our ability to attract, motivate and retain highly qualified senior and middle management. Competition for employees is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. If any of our or the bank’s executive officers, other key personnel, or directors leaves us or the bank, our operations may be adversely affected. In particular, we believe that our named executive officers and our regional chief executive officers are extremely important to our success and the success of our bank. If any of them leaves for any reason, our results of operations could suffer in such markets. With the exception of the key officers in charge of our Atlanta, Huntsville and Montgomery banking offices, we do not have employment agreements or non-competition agreements with any of our executive officers, including our named executive officers. In the absence of these types of agreements, our executive officers are free to resign their employment at any time and accept an offer of employment from another company, including a competitor. Additionally, our directors’ and advisory board members’ community involvement and diverse and extensive local business relationships are important to our success. Any material change in the composition of our board of directors or the respective advisory boards of the bank could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We may not be able to expand successfully into new markets.

 

We have opened new offices and operations in five primary markets (Mobile, Alabama, Atlanta, Georgia, Nashville, Tennessee, Charleston, South Carolina and Tampa Bay, Florida) in the past four years. We may not be able to successfully manage this growth with sufficient human resources, training and operational, financial and technological resources. Any such failure could limit our ability to be successful in these new markets and may have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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A prolonged downturn in the real estate market, especially in our primary markets, could result in losses and adversely affect our profitability.

 

As of December 31, 2016, 51.7% of our loan portfolio was composed of commercial and consumer real estate loans, of which 67.3% was owner-occupied commercial or 1-4 family mortgage loans. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value after the time the credit is initially extended. A decline in real estate values, either in the regions we serve or across the country as occurred in the U.S. recession from 2007 to 2009, could impair the value of our collateral and our ability to sell the collateral upon foreclosure, which would likely require us to increase our provision for loan losses. In the event of a default with respect to any of these loans, the amounts we receive upon sale of the collateral may be insufficient to recover the outstanding principal and interest on the loan. If we are required to re-value the collateral securing a loan to satisfy the debt during a period of reduced real estate values or to increase our allowance for loan losses, our profitability could be adversely affected, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future.

 

In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because of our recent growth, a large portion of our portfolio is relatively new, and therefore the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our largest loan relationships currently make up a significant percentage of our total loan portfolio.

 

As of December 31, 2016, our 10 largest borrowing relationships totaled over $212 million in commitments (including unfunded commitments), or approximately 4% of our total loan portfolio. The concentration risk associated with having a small number of relatively large loan relationships is that, if one or more of these relationships were to become delinquent or suffer default, we could be at risk of material losses. The allowance for loan losses may not be adequate to cover losses associated with any of these relationships, and any loss or increase in the allowance could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our decisions regarding credit risk could be inaccurate and our allowance for loan losses may be inadequate, which could have a material adverse effect on our business, financial condition, results of operations and future prospects.

 

Our earnings are affected by our ability to make loans, and thus we could sustain significant loan losses and consequently significant net losses if we incorrectly assess either the creditworthiness of our borrowers resulting in loans to borrowers who fail to repay their loans in accordance with the loan terms or the value of the collateral securing the repayment of their loans, or we fail to detect or respond to a deterioration in our loan quality in a timely manner. Management makes various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses that we consider adequate to absorb losses inherent in the loan portfolio based on our assessment of the information available. In determining the size of our allowance for loan losses, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. We target small and medium-sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. Also, as we expand into new markets, our determination of the size of the allowance could be understated due to our lack of familiarity with market-specific factors. Despite the effects of sustained economic weakness, we believe our allowance for loan losses is adequate. Our allowance for loan losses as of December 31, 2016 was $51.9 million, or 1.06% of total gross loans. If our assumptions are inaccurate, we may incur loan losses in excess of our current allowance for loan losses and be required to make material additions to our allowance for loan losses, which could have a material adverse effect on our business, financial condition, results of operations and prospects. However, even if our assumptions are accurate, federal and state regulators periodically review our allowance for loan losses and could require us to materially increase our allowance for loan losses or recognize further loan charge-offs based on judgments different than those of our management. Any material increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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The internal controls that we have implemented in order to mitigate risks inherent to the business of banking might fail or be circumvented, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Management regularly reviews and updates our internal controls and procedures that are designed to manage the various risks in our business, including credit risk, operational risk, and interest rate risk. No system of controls, however well-designed and operated, can provide absolute assurance that the objectives of the system will be met. If there were a failure of such a system, or if a system were circumvented, there could be a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our corporate structure provides for decision-making authority by our regional chief executive officers and banking teams. Our business, financial condition, results of operations and prospects could be negatively affected if our employees do not follow our internal policies or are negligent in their decision-making.

 

We attract and retain our management talent by empowering them to make certain business decisions on a local level. Lending authorities are assigned to regional chief executive officers and their banking teams based on their experience. Additionally, all loans in excess of $2.0 million with some sample loans below this amount are reviewed by our centralized credit administration department in Birmingham. Moreover, for decisions that fall outside of the assigned authorities, our regional chief executive officers are required to obtain approval from our senior management team. Our local bankers may not follow our internal procedures or otherwise act in our best interests with respect to their decision-making. A failure of our employees to follow our internal policies, or actions taken by our employees that are negligent could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our business strategy includes the continuation of our growth plans, and our business, financial condition, results of operations and prospects could be negatively affected if we fail to grow or fail to manage our growth effectively.

 

Our current strategy is to grow organically and, if appropriate, supplement that growth with select acquisitions. Our ability to grow organically depends primarily on generating loans and deposits of acceptable risk and expense, and we may not be successful in continuing this organic growth. Our ability to identify appropriate markets for expansion, recruit and retain qualified personnel, and fund growth at a reasonable cost depends upon prevailing economic conditions, maintenance of sufficient capital, competitive factors, and changes in banking laws, among other factors. Failure to manage our growth effectively could adversely affect our ability to successfully implement our business strategy, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Our continued pace of growth may require us to raise additional capital in the future to fund such growth, and the unavailability of additional capital on terms acceptable to us could adversely affect our growth and/or our financial condition and results of operations.

 

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. To support our recent and ongoing growth, we have completed a series of capital transactions during the past three years, including:

 

·the sale of an aggregate of 3,750,000 shares of our common stock at $15.167 per share, or $56,874,000, exclusive of underwriting discounts, in our initial public offering completed May 19, 2014; and
·the sale of $34,750,000 in 5% subordinated notes due July 15, 2025 to accredited investor purchasers in July 2015.

 

After giving effect to these transactions, we believe that we will have sufficient capital to meet our capital needs for our immediate growth plans. However, we will continue to need capital to support our longer-term growth plans. Our ability to access the capital markets, if needed, on a timely basis or at all will depend on a number of factors, such as the state of the financial markets, a loss of confidence in financial institutions generally, negative perceptions of our business or our financial strength, or other factors that would increase our cost of borrowing. If capital is not available on favorable terms when we need it, we will either have to issue common stock or other securities on less than desirable terms or reduce our rate of growth until market conditions become more favorable. Either of such events could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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Competition from financial institutions and other financial service providers may adversely affect our profitability.

 

The banking business is highly competitive, and we experience competition in our markets from many other financial institutions. We compete with these other financial institutions both in attracting deposits and in making loans. In addition, we must attract our customer base from other existing financial institutions and from new residents. Many of these competitors have substantially greater financial resources, larger lending limits, larger branch networks and less regulatory oversight than we do, and are able to offer a broader range of products and services than we can. Our profitability depends upon our continued ability to successfully compete with an array of financial institutions in our service areas.

 

Our ability to compete successfully will depend on a number of factors, including, among other things:

 

·our ability to build and maintain long-term customer relationships while ensuring high ethical standards and safe and sound banking practices;
·the scope, relevance and pricing of products and services that we offer;
·customer satisfaction with our products and services;
·industry and general economic trends; and
·our ability to keep pace with technological advances and to invest in new technology.

 

Increased competition could require us to increase the rates that we pay on deposits or lower the rates that we offer on loans, which could reduce our profitability. Our failure to compete effectively in our markets could restrain our growth or cause us to lose market share, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Unpredictable economic conditions or a natural disaster in any of our market areas may have a material adverse effect on our financial performance.

 

Substantially all of our borrowers and depositors are individuals and businesses located and doing business in our markets. Therefore, our success will depend on the general economic conditions in these areas, and more particularly in Birmingham, Huntsville, Dothan, Montgomery and Mobile, Alabama, Pensacola and Tampa Bay, Florida, Atlanta, Georgia, Charleston, South Carolina and Nashville, Tennessee, which we cannot predict with certainty. Unlike with many of our larger competitors, the majority of our borrowers are commercial firms, professionals and affluent consumers located and doing business in such local markets. As a result, our operations and profitability may be more adversely affected by a local economic downturn or natural disaster in such markets than those of larger, more geographically diverse competitors. Our entry into Pensacola and Tampa Bay, Florida, Mobile, Alabama and Charleston, South Carolina increased our exposure to potential losses associated with hurricanes and similar natural disasters that are more common in coastal areas than in our other markets. Accordingly, any regional or local economic downturn, or natural or man-made disaster, that affects any of the markets in which we operate, including existing or prospective property or borrowers in such markets may affect us and our profitability more significantly and more adversely than our more geographically diversified competitors, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We encounter technological change continually and have fewer resources than many of our competitors to invest in technological improvements.

 

The banking and financial services industries are undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to serving customers better, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our success will depend in part on our ability to address our customers’ needs by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have greater resources to invest in technological improvements, and we may not be able to implement new technology-driven products and services, which could reduce our ability to effectively compete or increase our overall expenses and have a material adverse effect on our net income.

 

Our information systems may experience a failure or interruption.

 

We rely heavily on communications and information systems to conduct our business. Any failure or interruption in the operation of these systems could impair or prevent the effective operation of our customer relationship management, general ledger, deposit, lending, or other functions. While we have policies and procedures designed to prevent or limit the effect of a failure or interruption in the operation of our information systems, there can be no assurance that any such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures or interruptions impacting our information systems could damage our reputation, result in a loss of customer business, and expose us to additional regulatory scrutiny, civil litigation, and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

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We use information technology in our operations and offer online banking services to our customers, and unauthorized access to our or our customers’ confidential or proprietary information as a result of a cyber-attack or otherwise could expose us to reputational harm and litigation and adversely affect our ability to attract and retain customers.

 

Information security risks for financial institutions have generally increased in recent years, in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. We are under continuous threat of loss due to hacking and cyber-attacks, especially as we continue to expand customer capabilities to utilize internet and other remote channels to transact business. Our risk and exposure to these matters remains heightened because of the evolving nature and complexity of these threats from cybercriminals and hackers, our plans to continue to provide internet banking and mobile banking channels, and our plans to develop additional remote connectivity solutions to serve our customers. Therefore, the secure processing, transmission, and storage of information in connection with our online banking services are critical elements of our operations. However, our network could be vulnerable to unauthorized access, computer viruses and other malware, phishing schemes, human error or other security failures. In addition, our customers may use personal smartphones, tablet PCs, or other mobile devices that are beyond our control systems in order to access our products and services. Our technologies, systems and networks, and our customers’ devices, may become the target of cyber-attacks, electronic fraud, or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ confidential, proprietary, and other information, or otherwise disrupt our or our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may be required to spend significant capital and other resources to protect against these threats or to alleviate or investigate problems caused by such threats. To the extent that our activities or the activities of our customers involve the processing, storage, or transmission of confidential customer information, any breaches or unauthorized access to such information could present significant regulatory costs and expose us to litigation and other possible liabilities. Any inability to prevent these types of security threats could also cause existing customers to lose confidence in our systems and could adversely affect our reputation and ability to generate deposits. While we have not experienced any material losses relating to cyber-attacks or other information security breaches to date, we may suffer such losses in the future. The occurrence of any cyber-attack or information security breach could result in potential liability to clients, reputational damage, damage to our competitive position, and the disruption of our operations, all of which could adversely affect our financial condition or results of operations.

 

We are dependent upon outside third parties for the processing and handling of our records and data.

 

We rely on software developed by third-party vendors to process various transactions. In some cases, we have contracted with third parties to run their proprietary software on our behalf. These systems include, but are not limited to, general ledger, payroll, employee benefits, loan and deposit processing, and securities portfolio accounting. While we perform a review of controls instituted by the applicable vendors over these programs in accordance with industry standards and perform our own testing of user controls, we must rely on the continued maintenance of controls by these third-party vendors, including safeguards over the security of customer data. In addition, we maintain, or contract with third parties to maintain, daily backups of key processing outputs in the event of a failure on the part of any of these systems. Nonetheless, we may incur a temporary disruption in our ability to conduct business or process transactions, or incur damage to our reputation, if the third-party vendor fails to adequately maintain internal controls or institute necessary changes to systems. Such a disruption or breach of security may have a material adverse effect on our business.

 

Our recent results may not be indicative of our future results, and may not provide guidance to assess the risk of an investment in our common stock.

 

We may not be able to sustain our historical rate of growth and may not even be able to expand our business at all. In addition, our recent growth may distort some of our historical financial ratios and statistics. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may impede or prohibit our ability to expand our market presence. We have different lending risks than larger banks. We provide services to our local communities; thus, our ability to diversify our economic risks is limited by our own local markets and economies. We lend primarily to small to medium-sized businesses, which may expose us to greater lending risks than those faced by banks lending to larger, better-capitalized businesses with longer operating histories. We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through our loan approval and review procedures. Our use of historical and objective information in determining and managing credit exposure may not be accurate in assessing our risk. Our failure to sustain our historical rate of growth or adequately manage the factors that have contributed to our growth could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate, subjecting us to the costs associated with the ownership of the real property.

 

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. As of December 31, 2016, we held $4.9 million in other real estate owned. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to: general or local economic conditions; environmental cleanup liability; neighborhood assessments; interest rates; real estate tax rates; operating expenses of the mortgaged properties; supply of, and demand for, rental units or properties; ability to obtain and maintain adequate occupancy of the properties; zoning laws; governmental and regulatory rules; fiscal policies; and natural disasters. Our inability to manage the amount of costs or size of the risks associated with the ownership of real estate could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability.

 

The federal bank regulatory agencies have indicated their view that banks with high concentrations of loans secured by commercial real estate are subject to increased risk and should hold higher capital than regulatory minimums to maintain an appropriate cushion against loss that is commensurate with the perceived risk. Because a significant portion of our loan portfolio is dependent on commercial real estate, a change in the regulatory capital requirements applicable to us as a result of these policies could limit our ability to leverage our capital, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We are subject to interest rate risk, which could adversely affect our profitability.

 

Our profitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest bearing liabilities, such as deposits and borrowings. We have positioned our asset portfolio to benefit in a higher or lower interest rate environment, but this may not remain true in the future. Our interest sensitivity profile was somewhat liability sensitive as of December 31, 2016, meaning that our net interest income and economic value of equity would decrease more from rising interest rates than from falling interest rates. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System (or, the “Federal Reserve”). Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could also affect our ability to originate loans and obtain or retain deposits, customer demand for loans, the fair value of our financial assets and liabilities, and the average duration of our assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our business, financial condition, results of operations and prospects. The continuation of the current low interest rate environment or a deflationary environment with the possibility of negative interest rates could affect consumer and business behavior in ways that are adverse to us and could affect our ability to increase net interest income.

 

In addition, an increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also necessitate further increases to the allowance for loan losses which could have a material adverse effect on our business, results of operations, financial condition and prospects.

 

Liquidity risk could impair our ability to fund operations and meet our obligations as they become due.

 

Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain adequate funding. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. In particular, approximately 84% of the bank’s liabilities as of December 31, 2016 were checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, 77% of the assets of the bank were loans, which cannot be called or sold in the same time frame. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, satisfy regulatory capital requirements, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Any substantial, unexpected or prolonged change in the level or cost of liquidity could have a material adverse effect on our ability to meet deposit withdrawals and other customer needs, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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The fair value of our investment securities can fluctuate due to factors outside of our control.

 

As of December 31, 2016, the fair value of our investment securities portfolio was approximately $485.7 million. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates or instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could materially and adversely affect our business, results of operations, financial condition and prospects. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Our failure to assess any currency impairments or losses with respect to our securities could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Deterioration in the fiscal position of the U.S. federal government and downgrades in Treasury and federal agency securities could adversely affect us and our banking operations.

 

The long-term outlook for the fiscal position of the U.S. federal government is uncertain, as illustrated by the 2011 downgrade by certain rating agencies of the credit rating of the U.S. government and federal agencies. However, in addition to causing economic and financial market disruptions, any future downgrade, failure to raise the U.S. statutory debt limit, or deterioration in the fiscal outlook of the U.S. federal government, could, among other things, materially adversely affect the market value of the U.S. and other government and governmental agency securities that we hold, the availability of those securities as collateral for borrowing, and our ability to access capital markets on favorable terms. In particular, it could increase interest rates and disrupt payment systems, money markets, and long-term or short-term fixed income markets, adversely affecting the cost and availability of funding, which could negatively affect our profitability. Also, the adverse consequences of any downgrade could extend to those to whom we extend credit and could adversely affect their ability to repay their loans. Any of these developments could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We may be adversely affected by the soundness of other financial institutions.

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties, and through transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. These losses or defaults could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We are subject to environmental liability risk associated with our lending activities.

 

In the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. As a result, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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Risks Related to Our Industry

 

We are subject to extensive regulation in the conduct of our business, which imposes additional costs on us and adversely affects our profitability.

 

As a bank holding company, we are subject to federal regulation under the BHC Act, as amended, and the examination and reporting requirements of various federal and state agencies including the Federal Reserve, the FDIC and the Alabama Banking Department. Federal regulation of the banking industry, along with tax and accounting laws, regulations, rules, and standards, may limit our operations significantly and control the methods by which we conduct business, as they limit those of other banking organizations. Banking regulations are primarily intended to protect depositors, deposit insurance funds, and the banking system as a whole, and not stockholders or other creditors. These regulations affect lending practices, capital structure, investment practices, dividend policy, and overall growth, among other things. For example, federal and state consumer protection laws and regulations limit the manner in which we may offer and extend credit. In addition, the laws governing bankruptcy generally favor debtors, making it more expensive and more difficult to collect from customers who become subject to bankruptcy proceedings.

 

We also may be required to invest significant management attention and resources to evaluate and make any changes necessary to comply with applicable laws and regulations, particularly as a result of regulations adopted under the Dodd-Frank Act. This allocation of resources, as well as any failure to comply with applicable requirements, may negatively impact our financial condition and results of operations.

 

Changes in laws, government regulation, monetary policy or accounting standards may have a material adverse effect on our results of operations.

 

Financial institutions have been the subject of significant legislative and regulatory changes and may be the subject of further significant legislation or regulation in the future, none of which is within our control. New proposals for legislation continue to be introduced in the United States Congress that could further substantially increase regulation of the bank and non-bank financial services industries, impose restrictions on the operations and general ability of firms within the industry to conduct business consistent with historical practices, including in the areas of compensation, interest rates, financial product offerings, and disclosures, and have an effect on bankruptcy proceedings with respect to consumer residential real estate mortgages, among other things. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. Changes to statutes, regulations, accounting standards or regulatory policies, including changes in their interpretation or implementation by regulators, could affect us in substantial and unpredictable ways. Such changes could, among other things, subject us to additional costs and lower revenues, limit the types of financial services and products that we may offer, ease restrictions on non-banks and thereby enhance their ability to offer competing financial services and products, increase compliance costs, and require a significant amount of management’s time and attention. Changes in accounting standards could materially impact, potentially even retroactively, how we report our financial condition and results of our operations. Failure to comply with statutes, regulations, or policies could result in sanctions by regulatory agencies, civil monetary penalties, or reputational damage, each of which could have a material adverse effect on our business, financial condition, and results of operations.

 

A reduction in future corporate tax rates could have a material impact on the value of our deferred tax assets.

 

The effects of future changes in tax laws or rates are not anticipated in the determination of the value of our net deferred tax assets. Changes in tax rates, such as those proposed by President Trump that, among other things, would lower the federal corporate tax rate from its current 35%, would decrease the amount of our net deferred tax assets, though uncertainty regarding the timing and magnitude of any reduction make it difficult to predict the overall impact on the Company of such a decrease. If a reduction in the federal tax rate occurs, we likely would recognize an income tax expense to reduce the deferred tax asset, which could adversely impact the price of our common stock.

 

Federal and state regulators periodically examine our business and we may be required to remediate adverse examination findings.

 

The Federal Reserve, the FDIC and the Alabama Banking Department periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, a federal or state banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity, compliance with various regulations or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. Any regulatory action against us could have a material adverse effect on our business, results of operations, financial condition and prospects.

 

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FDIC deposit insurance assessments may continue to materially increase in the future, which would have an adverse effect on earnings.

 

As a member institution of the FDIC, the bank is assessed a quarterly deposit insurance premium. Failed banks nationwide have significantly depleted the insurance fund and reduced the ratio of reserves to insured deposits. The FDIC has adopted a Deposit Insurance Fund Restoration Plan, which requires the fund to attain a 1.35% reserve ratio by September 30, 2020. As a result of this requirement, the bank could be required to pay significantly higher premiums or additional special assessments that would adversely affect its earnings, thereby reducing the availability of funds to pay dividends to us.

 

We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.

 

The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The U.S. Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Legal and regulatory proceedings and related matters with respect to the financial services industry, including those directly involving the Company or the Bank, could adversely affect us or the financial services industry in general.

 

The Company has been, and may in the future be, subject to various legal and regulatory proceedings. It is inherently difficult to assess the outcome of these matters, and there can be no assurance that we will prevail in any proceeding or litigation. Any such matter could result in substantial cost and diversion of our management’s efforts, which could have a material adverse effect on our financial condition and operating results. Further, adverse determinations in such matters could result in actions by our regulators that could materially adversely affect our business, financial condition or results of operations.

 

The Company establishes reserves for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The Company may still incur legal costs for a matter even if it has not established a reserve. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, the actual cost of resolving a legal claim may be substantially higher than any amounts reserved for that matter. The ultimate resolution of a pending legal proceeding, depending on the remedy sought and granted, could adversely affect our financial condition and results of operations.

 

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

 

The Bank Secrecy Act, the USA Patriot Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to increased scrutiny of compliance with the rules enforced by the OFAC. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Changes in monetary policies may have a material adverse effect on our business.

 

Like all regulated financial institutions, we are affected by monetary policies implemented by the Federal Reserve and other federal instrumentalities. A primary instrument of monetary policy employed by the Federal Reserve is the restriction or expansion of the money supply through open market operations. This instrument of monetary policy frequently causes volatile fluctuations in interest rates, and it can have a direct, material adverse effect on the operating results of financial institutions including our business. Borrowings by the United States government to finance government debt may also cause fluctuations in interest rates and have similar effects on the operating results of such institutions. We do not have any control over monetary policies implemented by the Federal Reserve or otherwise and any changes in these policies could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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Risks Related to Our Common Stock

 

The market price of our common stock may be subject to substantial fluctuations, which may make it difficult for you to sell your shares at the volume, prices and times desired.

 

The market price of our common stock may be highly volatile, which may make it difficult for you to resell your shares at the volume, prices and times desired. There are many factors that may impact the market price and trading volume of our common stock, including, without limitation:

 

 

·actual or anticipated fluctuations in our operating results, financial condition or asset quality;
·changes in economic or business conditions;
·the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;
·publication of research reports about us, our competitors, or the financial services industry generally, or changes in, or failure to meet, securities analysts’ estimates of our financial and operating performance, or lack of research reports by industry analysts or ceasing of coverage;
·operating and stock price performance of companies that investors deemed comparable to us;
·future issuances of our common stock or other securities;
·additions to or departures of key personnel;
·proposed or adopted changes in laws, regulations or policies affecting us;
·perceptions in the marketplace regarding our competitors and/or us;
·significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our competitors or us;
·other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and
·other news, announcements or disclosures (whether by us or others) related to us, our competitors, our core market or the financial services industry.

 

The stock market and, in particular, the market for financial institution stocks, have experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our common stock, which could make it difficult to sell your shares at the volume, prices and times desired.

 

The rights of our common stockholders are subordinate to the rights of the holders of any preferred or any debt securities that we may issue.

 

Our board of directors has the authority to issue in the aggregate up to 1,000,000 shares of preferred stock, and to determine the terms of each issue of preferred stock, without stockholder approval. Accordingly, you should assume that any shares of preferred stock that we may issue in the future will also be senior to our common stock. Because our decision to issue debt or equity securities or incur other borrowings in the future will depend on market conditions and other factors beyond our control, the amount, timing, nature or success of our future capital raising efforts is uncertain. Because our ability to pay dividends on our common stock in the future will depend on our and our bank’s financial condition as well as factors outside of our control, our common stockholders bear the risk that no dividends will be paid on our common stock in future periods or that, if paid, such dividends will be reduced or eliminated, which may negatively impact the market price of our common stock.

 

 33 

 

 

We and our bank are subject to capital and other requirements which restrict our ability to pay dividends.

 

In 2014, we began paying quarterly cash dividends. Future declarations of quarterly dividends will be subject to the approval of our board of directors, subject to limits imposed on us by our regulators. In order to pay any dividends, we will need to receive dividends from our bank or have other sources of funds. Under Alabama law, a state-chartered bank may not pay a dividend in excess of 90% of its net earnings until the bank’s surplus is equal to at least 20% of its capital (our bank’s surplus currently exceeds 20% of its capital). Moreover, our bank is also required by Alabama law to obtain the prior approval of the Superintendent for its payment of dividends if the total of all dividends declared by our bank in any calendar year will exceed the total of (1) our bank’s net earnings (as defined by statute) for that year, plus (2) its retained net earnings for the preceding two years, less any required transfers to surplus. In addition, the bank must maintain certain capital levels, which may restrict the ability of the bank to pay dividends to us and our ability to pay dividends to our stockholders. As of December 31, 2016, our bank could pay approximately $189.1 million of dividends to us without prior approval of the Superintendent. However, the payment of dividends is also subject to declaration by our board of directors, which takes into account our financial condition, earnings, general economic conditions and other factors, including statutory and regulatory restrictions. There can be no assurance that dividends will in fact be paid on our common stock in future periods or that, if paid, such dividends will not be reduced or eliminated.

 

Alabama and Delaware law limit the ability of others to acquire the bank, which may restrict your ability to fully realize the value of your common stock.

 

In many cases, stockholders receive a premium for their shares when one company purchases another. Alabama and Delaware law make it difficult for anyone to purchase the bank or us without approval of our board of directors. Thus, your ability to realize the potential benefits of any sale by us may be limited, even if such sale would represent a greater value for stockholders than our continued independent operation.

 

An investment in our common stock is not an insured deposit and is subject to risk of loss.

 

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and is subject to the same market forces that affect the price of common stock in any company. As a result, an investor may lose some or all of such investor’s investment in our common stock.

 

Our corporate governance documents, and certain corporate and banking laws applicable to us, could make a takeover more difficult.

 

Certain provisions of our certificate of incorporation, as amended (or our “charter”), and bylaws, as amended, and corporate and federal banking laws, could make it more difficult for a third party to acquire control of our organization, even if those events were perceived by many of our stockholders as beneficial to their interests. These provisions, and the corporate and banking laws and regulations applicable to us:

 

·provide that special meetings of stockholders may be called at any time by the Chairman of our board of directors, by the President or by order of the board of directors;
·enable our board of directors to issue preferred stock up to the authorized amount, with such preferences, limitations and relative rights, including voting rights, as may be determined from time to time by the board;
·enable our board of directors to increase the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at the meeting;
·enable our board of directors to amend our bylaws without stockholder approval; and
·do not provide for cumulative voting rights (therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose).

 

These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including under circumstances in which our stockholders might otherwise receive a premium over the market price of our shares.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

None.

 

ITEM 2. PROPERTIES.

 

As of December 31, 2016, we operated through 19 banking offices. Our Shades Creek Parkway office also includes our corporate headquarters. We believe that our banking offices are in good condition, are suitable to our needs and, for the most part, are relatively new or refurbished. The following table gives pertinent details about our banking offices.

 

 34 

 

 

State, MSA, Office Address  City  Zip Code  Owned or
Leased
  Date Opened 
Alabama:              
Birmingham-Hoover:              
850 Shades Creek Parkway, Suite 200 (1)  Birmingham  35209  Leased   3/2/2005 
324 Richard Arrington Jr. Boulevard North  Birmingham  35203  Leased   12/19/2005 
5403 Highway 280, Suite 401  Birmingham  35242  Leased   8/15/2006 
Total     3 Offices        
               
Huntsville:              
401 Meridian Street, Suite 100  Huntsville  35801  Leased   11/21/2006 
1267 Enterprise Way, Suite A (1)  Huntsville  35806  Leased   8/21/2006 
Total     2 Offices        
               
Montgomery:              
1 Commerce Street, Suite 200  Montgomery  36104  Leased   6/4/2007 
8117 Vaughn Road, Unit 20  Montgomery  36116  Leased   9/26/2007 
Total     2 Offices        
               
Dothan:              
4801 West Main Street (1)  Dothan  36305  Leased   10/17/2008 
1640 Ross Clark Circle, Suite 307  Dothan  36301  Leased   2/1/2011 
Total     2 Offices        
               
Mobile:              
100 St. Joseph Street (1)  Mobile  36602  Leased   7/9/2012 
4400 Old Shell Road  Mobile  36608  Leased   9/3/2014 
Total     2 Offices        
               
Total Offices in Alabama     11 Offices        
               
Florida:              
Pensacola-Ferry Pass-Brent:              
316 South Baylen Street, Suite 100  Pensacola  32502  Leased   4/1/2011 
4980 North 12th Avenue  Pensacola  32504  Owned   8/27/2012 
      2 Offices        
Tampa-St. Petersburg-Clearwater:              
2009 Osprey Lane  Tampa  33549  Leased   1/4/2016 
Total     1 Office        
               
Total Offices in Florida     3 Offices        
               
Georgia:              
Atlanta-Sandy Springs-Roswell              
300 Galleria Parkway SE, Suite 100  Atlanta  30339  Leased   7/1/2015 
2801 Chapel Hill Road  Douglasville  30135  Owned   1/28/2008 
2454 Kennesaw Due West Road  Kennesaw  30152  Owned   12/12/2011 
Total     3 Offices        
               
South Carolina:              
Charleston-North Charleston              
1156 Bowman Road, Suite 200  Mount Pleasant  29464  Leased   4/20/2015 
               
Tennessee:              
Nashville:              
1801 West End Avenue, Suite 850 (1)  Nashville  37203  Leased   6/4/2013 
               
Total offices     19 Offices        

 

(1) Offices relocated to this address. Original offices opened on date indicated.

 

ITEM 3. LEGAL PROCEEDINGS.

 

Neither we nor the bank is currently subject to any material legal proceedings. In the ordinary course of business, the bank is involved in routine litigation, such as claims to enforce liens, claims involving the making and servicing of real property loans, and other issues incident to the bank’s business. Management does not believe that there are any threatened proceedings against us or the bank which will have a material effect on our or the bank’s business, financial position or results of operations.

 

ITEM 4. MINE SAFETY DISCLOSURE.

 

Not applicable.

 

 35 

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

Our common stock is listed on the NASDAQ Global Select Market under the symbol “SFBS.” As of February 23, 2017, there were 602 holders of record of our common stock. As of the close of business on February 23, 2017, the price of our common stock was $42.61 per share. All share and per share data in this Annual Report on Form 10-K is adjusted to reflect our two-for-one stock split in the form of a stock dividend effective on December 20, 2016 for stockholders of record on December 5, 2016.

 

The following table sets forth the reported high and low sales prices of our common stock as quoted on the NASDAQ during each quarter of 2016 and 2015.

 

   Year Ended December 31, 
   2016   2015 
    High    Low    Cash
Dividends
Declared
    High    Low    Cash
Dividends
Declared
 
First quarter  $23.39   $17.06   $0.04   $16.50   $14.94   $0.03 
Second quarter   26.36    21.66    0.04    19.00    16.20    0.03 
Third quarter   26.79    23.46    0.04    21.58    12.39    0.03 
Fourth quarter   38.65    25.00    0.04    24.94    18.97    0.03 
             $0.16             $0.12 

 

Dividends

 

The principal source of our cash flow, including cash flow to pay dividends, comes from dividends that the bank pays to us as its sole shareholder. Statutory and regulatory limitations apply to the bank’s payment of dividends to us, as well as our payment of dividends to our stockholders. For a more complete discussion on the restrictions on dividends, see “Supervision and Regulation - Payment of Dividends” in Item 1.

 

Recent Sales of Unregistered Securities

 

We had no sales of unregistered securities in 2016 other than those previously reported in our reports filed with the Securities and Exchange Commission.

 

Purchases of Equity Securities by the Registrant and Affiliated Purchasers

 

We made no repurchases of our equity securities, and no “affiliated purchasers” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) purchased any shares of our equity securities during the fourth quarter of the fiscal year ended December 31, 2016.

 

Equity Compensation Plan Information

 

The following table sets forth certain information as of December 31, 2016 relating to stock options granted under our 2005 Amended and Restated Stock Incentive Plan and our 2009 Amended and Restated Stock Incentive Plan and other options or warrants issued outside of such plans, if any.

 

Plan Category  Number of Securities
Issued/To Be Issued
Upon Exercise of
Outstanding Awards
   Weighted-average
Exercise Price of
Outstanding Awards
   Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans
 
Equity Compensation Plans Approved by Security Holders   2,026,334   $9.00    3,947,020 
Equity Compensation Plans Not Approved by Security Holders   -    -    - 
Total   2,026,334   $9.00    3,947,020 

 

 36 

 

 

We award stock options as incentive to employees, officers, directors and consultants to attract or retain these individuals, to maintain and enhance our long-term performance and profitability, and to allow these individuals to acquire an ownership interest in our Company. Our compensation committee administers this program, making all decisions regarding grants and amendments to these awards. An incentive stock option may not be exercised later than 90 days after an option holder terminates his or her employment with us unless such termination is a consequence of such option holder’s death or disability, in which case the option period may be extended for up to one year after termination of employment. All of our issued options will vest immediately upon a transaction in which we merge or consolidate with or into any other corporation (unless we are the surviving corporation), or sell or otherwise transfer our property, assets or business substantially in its entirety to a successor corporation. At that time, upon the exercise of an option, the option holder will receive the number of shares of stock or other securities or property, including cash, to which the holder of a like number of shares of common stock would have been entitled upon the merger, consolidation, sale or transfer if such option had been exercised in full immediately prior thereto. All of our issued options have a term of 10 years. This means the options must be exercised within 10 years from the date of the grant.

 

We have granted 483,176 shares (post-stock split) of restricted stock under the 2009 Amended and Restated Stock Incentive Plan. These shares generally vest between three and five years from the date of grant, subject to earlier vesting in the event of a merger, consolidation, sale or transfer of the Company or substantially all of its assets and business.

 

ITEM 6. SELECTED FINANCIAL DATA.

 

The following table sets forth selected historical consolidated financial data from our consolidated financial statements and should be read in conjunction with our consolidated financial statements including the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are included below. Except for the data under “Selected Performance Ratios,” “Core Performance Ratios,” “Asset Quality Ratios,” “Liquidity Ratios,” “Capital Adequacy Ratios” and “Growth Ratios,” the selected historical consolidated financial data as of December 31, 2016, 2015, 2014, 2013 and 2012 and for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 are derived from our audited consolidated financial statements and related notes.

 

   As of and for the years ended December 31, 
   2016   2015   2014   2013   2012 
   (Dollars in thousands except for share and per share data) 
Selected Balance Sheet Data:                         
Total Assets  $6,370,448   $5,095,509   $4,098,679   $3,520,699   $2,906,314 
Total Loans   4,911,770    4,216,375    3,359,858    2,858,868    2,363,182 
Loans, net   4,859,877    4,172,956    3,324,229    2,828,205    2,336,924 
Securities available for sale   422,375    342,938    298,310    265,728    233,877 
Securities held to maturity   62,564    27,426    29,355    32,274    25,967 
Cash and due from banks   56,855    46,614    48,519    61,370    58,031 
Interest-bearing balances with banks   566,707    270,836    248,054    188,411    119,423 
Fed funds sold   160,435    34,785    891    8,634    3,291 
Mortgage loans held for sale   4,675    8,249    5,984    8,134    25,826 
Restricted equity securities   1,024    4,954    3,921    4,230    3,941 
Premises and equipment, net   40,314    19,434    7,815    8,351    8,847 
Deposits   5,420,311    4,223,888    3,398,160    3,019,642    2,511,572 
Federal funds purchased   355,944    352,360    264,315    174,380    117,065 
Other borrowings   55,262    55,637    19,973    19,940    19,917 
Subordinated debentures   -    -    -    -    15,050 
Other liabilities   16,042    14,477    9,018    9,545    9,453 
Stockholders' Equity   522,889    449,147    407,213    297,192    233,257 
Selected Income Statement Data:                         
Interest income  $212,902   $179,975   $144,725   $126,081   $109,023 
Interest expense   25,805    17,704    14,119    13,619    14,901 
Net interest income   187,097    162,271    130,606    112,462    94,122 
Provision for loan losses   13,398    12,847    10,259    13,008    9,100 
Net interest income after provision  for loan losses   173,699    149,424    120,347    99,454    85,022 
Noninterest income   18,112    13,963    11,229    10,010    9,643 
Noninterest expense   80,993    74,382    57,598    47,489    43,100 
Income before income taxes   110,818    89,005    73,978    61,975    51,565 
Income tax expense   29,339    25,465    21,601    20,358    17,120 
Net income   81,479    63,540    52,377    41,617    34,445 
Net income available to common stockholders   81,432    63,260    51,946    41,201    34,045 
Per Common Share Data:                         
Net income, basic  $1.55   $1.23   $1.09   $1.00   $0.95 
Net income, diluted   1.52    1.20    1.05    0.95    0.82 
Book value   9.93    8.65    7.40    5.83    5.14 
Weighted average shares outstanding:                         
Basic   52,450,896    51,426,466    47,710,002    41,214,426    35,978,622 
Diluted   53,608,372    52,885,108    49,636,442    43,612,050    41,650,512 
Actual shares outstanding   52,636,896    51,945,396    49,603,036    44,100,072    37,612,872 
Selected Performance Ratios:                         
Return on average assets   1.42%   1.38%   1.39%   1.32%   1.31%
Return on average stockholders' equity   16.64%   14.56%   14.43%   15.70%   15.99%
Dividend payout ratio   10.53%   10.04%   9.57%   8.79%   10.02%
Net interest margin (1)   3.42%   3.75%   3.68%   3.80%   3.80%
Efficiency ratio (2)   39.47%   42.21%   40.61%   38.78%   41.54%
Core Performance Data (3)                         
Core net income available to common stockholders       $65,027   $53,558           
Core earnings per share, basic        1.27    1.12           
Core earnings per share, diluted        1.23    1.08           
Core return on average assets        1.42%   1.43%          
Core return on average stockholders'                         
 equity        14.96%   14.88%          
Core return on average common  stockholders' equity        15.73%   16.74%          
Core efficiency ratio        40.73%   38.86%          
Asset Quality Ratios:                         
Net charge-offs to average loans outstanding   0.11%   0.13%   0.17%   0.33%   0.24%
Non-performing loans to totals loans   0.34%   0.18%   0.30%   0.34%   0.44%
Non-performing assets to total assets   0.34%   0.26%   0.41%   0.64%   0.69%
Allowance for loan losses to total gross loans   1.06%   1.03%   1.06%   1.07%   1.11%
Allowance for loan losses to total non-performing loans   307.30%   559.02%   354.52%   314.94%   253.50%
Liquidity Ratios:                         
Net loans to total deposits   89.66%   98.79%   97.82%   93.66%   93.05%
Net average loans to average earning assets   80.44%   86.24%   83.94%   84.65%   79.82%
Noninterest-bearing deposits to total deposits   23.64%   24.94%   23.85%   21.54%   21.71%
Capital Adequacy Ratios:                         
Stockholders' equity to total assets   8.21%   8.81%   9.94%   8.44%   8.03%
CET1 capital (4)   9.78%   9.72%    NA     NA    NA 
Tier 1 capital (5)   9.78%   9.73%   11.75%   10.00%   9.89%
Total capital (6)   11.84%   11.95%   13.38%   11.73%   11.78%
Leverage ratio (7)   8.22%   8.55%   9.91%   8.48%   8.43%
Growth Ratios:                         
Percentage change in net income   28.23%   21.31%   25.85%   20.82%   46.96%
Percentage change in diluted net income per share   26.67%   14.35%   10.00%   14.46%   40.68%
Percentage change in assets   25.02%   24.32%   16.42%   21.14%   18.11%
Percentage change in net loans   16.46%   25.53%   17.54%   21.02%   29.20%
Percentage change in deposits   28.32%   24.30%   12.54%   20.23%   17.15%
Percentage change in equity   16.41%   10.30%   37.02%   27.41%   18.83%

 

(1) Net interest margin is the net yield on interest earning assets and is the difference between the interest yield earned on interest-earning assets and the interest rate paid on interest-bearing liabilities, divided by average earning assets.

(2) Efficiency ratio is the result of noninterest expense divided by the sum of net interest income and noninterest income.

(3) Core metrics for 2015 exclude a non-routine expense related to our acquisition of Metro Bancshares, Inc. and the merger of Metro Bank with and into the Bank, and a non-routine expense resulting from the initial funding of reserves for unfunded loan commitments consistent with guidance provided in the Federal Reserve Bank's Interagency Policy Statement SR 06-17. Core metrics for 2014 exclude a non-routine expense related to the correction of our accounting for vested stock options granted to our advisory board members in our Huntsville, Montgomery and Dothan, Alabama markets, and non-routine expense related to the acceleration of vesting of stock options previously granted to our advisory board members in our Mobile, Alabama and Pensacola, Florida markets. For a reconciliation of these non-GAAP measures to the most comparable GAAP measure, see "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures." None of the other periods included in our selected consolidated financial information are affected by such non-routine expenses.

(4) CET1 capital ratio includes common stockholders' equity excluding unrealized gains/(losses) on securities available for sale, net of taxes, and intangible assets divided by total risk-weighted assets.

(5) Tier 1 capital ratio includes CET1 and qualifying minority interest divided by total risk-weighted assets.

(6) Total capital ratio includes Tier 1 capital plus qualifying portions of subordinated debt and allowance for loan losses (limited to 1.25% of risk-weighted assets) divided by total risk-weighted assets.

(7) Tier 1 leverage ratio includes Tier 1 capital divided by average assets less intangible assets.

 

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GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

 

We recorded expenses of $2.1 million for the first quarter of 2015 related to the acquisition of Metro Bancshares, Inc. and the merger of Metro Bank with and into the bank, and recorded an expense of $500,000 resulting from the initial funding of reserves for unfunded loan commitments for the first quarter of 2015, consistent with guidance provided in the Federal Reserve Bank’s Interagency Policy Statement SR 06-17. We recorded a non-routine expense of $0.7 million for the first quarter of 2014 resulting from the correction of our accounting for vested stock options previously granted to members of our advisory boards in our Huntsville, Montgomery and Dothan, Alabama markets, and we recorded a non-routine expense of $1.8 million for the second quarter of 2014 resulting from an acceleration of vesting of stock options previously granted to members of our advisory boards in our Mobile, Alabama and Pensacola, Florida markets. This change in accounting treatment is a non-cash item and does not impact our operating activities or cash from operations. The non-GAAP financial measures included in this annual report on Form 10-K results for the year ended December 31, 2016 are “core net income available to common stockholders,” “core earnings per share, basic,” “core earnings per share, diluted,” “core return on average assets,” “core return on average stockholders’ equity,” “core return on average common stockholders’ equity” and “core efficiency ratio.” Each of these seven core financial measures excludes the impact of the non-routine expense attributable to the correction of our accounting for stock options, the acceleration of vesting of stock options, expenses related to the acquisition of Metro and the initial funding of reserves for unfunded loan commitments. None of the other periods included in our selected financial data are affected by this correction and acceleration of vesting.

 

“Core net income available to common stockholders” is defined as net income available to common stockholders, adjusted by the net effect of the non-routine expense.

 

“Core earnings per share, basic” is defined as net income available to common stockholders, adjusted by the net effect of the non-routine expense, divided by weighted average shares outstanding.

 

“Core earnings per share, diluted” is defined as net income available to common stockholders, adjusted by the net effect of the non-routine expense, divided by weighted average diluted shares outstanding.

 

“Core return on average assets” is defined as net income, adjusted by the net effect of the non-routine expense, divided by average total assets.

 

“Core return of average stockholders’ equity” is defined as net income, adjusted by the net effect of the non-routine expense, divided by average total stockholders’ equity.

 

“Core return of average common stockholders’ equity” is defined as net income, adjusted by the net effect of the non-routine expense, divided by average common stockholders’ equity.

 

“Core efficiency ratio” is defined as non-interest expense, adjusted by the effect of the non-routine expense, divided by the sum of net interest income and non-interest income.

 

We believe these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that these non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies, including those in our industry, use. The following reconciliation table provides a more detailed analysis of the non-GAAP financial measures for the years ended December 31, 2015 and 2014. All amounts are in thousands, except share and per share data.

 

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   2015   2014 
Provision for income taxes - GAAP  $25,465   $21,601 
Adjustments:          
Adjustment for non-routine expense   829    865 
Core income tax expense - non-GAAP  $26,294   $22,466 
Net income available to common stockholders - GAAP  $63,260   $51,946 
Adjustments:          
Adjustment for non-routine expense   1,767    1,612 
Core net income available to common stockholders - non-GAAP  $65,027   $53,558 
Earnings per share, basic - GAAP  $2.46   $2.18 
Weighted average shares outstanding, basic   51,426,466    47,710,002 
Core earnings per share, basic - non-GAAP  $1.27   $1.13 
Earnings per share, diluted - GAAP  $1.20   $1.05 
Weighted average shares outstanding, diluted   52,885,108    49,636,442 
Core earnings per share, diluted - non-GAAP  $1.23   $1.08 
Return on average assets - GAAP   1.38%   1.39%
Net income - GAAP  $63,540   $52,377 
Adjustments:          
Adjustment for non-routine expense   1,767    1,612 
Core net income - non-GAAP   65,307    53,989 
Average assets  $4,591,861   $3,758,184 
Core return on average assets - non-GAAP   1.42%   1.44%
Return on average stockholders' equity - GAAP   14.56%   14.43%
Average stockholders' equity  $436,544   $359,963 
Core return on average stockholders' equity - non-GAAP   14.96%   15.00%
Return on average common stockholders' equity   15.30%   16.23%
Average common stockholders' equity  $413,445   $320,005 
Core return on average common stockholders' equity - non-GAAP   15.73%   16.74%
Efficiency ratio - GAAP   42.21%   40.61%
Non-interest expense - GAAP  $74,382   $57,598 
Adjustments:          
Adjustment for non-routine expense   2,596    2,477 
Core non-interest expense - non-GAAP   71,786    55,121 
Net interest income   162,271    130,606 
Non-interest income   13,963    11,229 
Total net interest income and non-interest income  $176,234   $141,835 
Core efficiency ratio - non-GAAP   40.73%   38.86%

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following is a narrative discussion and analysis of significant changes in our results of operations and financial condition. The purpose of this discussion is to focus on information about our financial condition and results of operations that is not otherwise apparent from the audited financial statements. Analysis of the results presented should be made in the context of our relatively short history. This discussion should be read in conjunction with the financial statements and selected financial data included elsewhere in this document.

 

Overview

 

We are a bank holding company within the meaning of the BHC Act headquartered in Birmingham, Alabama. Through our wholly-owned subsidiary bank, we operate 19 full service banking offices located in Jefferson, Shelby, Madison, Montgomery, Mobile and Houston Counties in Alabama, Escambia and Hillsborough Counties in Florida, Cobb and Douglas County in Georgia, Charleston County in South Carolina and Davidson County in Tennessee. These offices operate in the Birmingham-Hoover, Huntsville, Montgomery, Mobile and Dothan, Alabama MSAs, the Pensacola-Ferry Pass-Brent and Tampa-St. Petersburg-Clearwater, Florida MSAs, the Atlanta-Sandy Springs-Roswell, Georgia MSA, the Charleston-North Charleston, South Carolina MSA and the Nashville-Davidson-Murfreesboro-Franklin, Tennessee MSA. Our principal business is to accept deposits from the public and to make loans and other investments. Our principal source of funds for loans and investments are demand, time, savings, and other deposits and the amortization and prepayment of loans and borrowings. Our principal sources of income are interest and fees collected on loans, interest and dividends collected on other investments and service charges. Our principal expenses are interest paid on savings and other deposits, interest paid on our other borrowings, employee compensation, office expenses and other overhead expenses.

 

Critical Accounting Policies

 

Our consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in the Notes to the Consolidated Financial Statements. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect our reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on our future financial condition and results of operations.

 

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Allowance for Loan Losses

 

The allowance for loan losses, sometimes referred to as the “ALLL,” is established through periodic charges to income. Loan losses are charged against the ALLL when management believes that the future collection of principal is unlikely. Subsequent recoveries, if any, are credited to the ALLL. If the ALLL is considered inadequate to absorb future loan losses on existing loans for any reason, including but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan losses is increased.

 

Loans are considered impaired when, based on current information and events, it is probable that the bank will be unable to collect all amounts due according to the original terms of the loan agreement. The collection of all amounts due according to contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or, as a practical expedient, at the loan’s observable market price, or the fair value of the underlying collateral. The fair value of collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral-dependent.

 

Investment Securities Impairment

 

Periodically, we may need to assess whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. In any such instance, we would consider many factors, including the severity and duration of the impairment, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value, with the write-down recorded as a realized loss in securities gains (losses).

 

Other Real Estate Owned

 

Other real estate owned (“OREO”), consisting of assets that have been acquired through foreclosure, is recorded at the lower of cost or estimated fair value less the estimated cost of disposition. Fair value is based on independent appraisals and other relevant factors. Other real estate owned is revalued on an annual basis or more often if market conditions necessitate. Valuation adjustments required at foreclosure are charged to the ALLL. Subsequent to foreclosure, losses on the periodic revaluation of the property are charged to net income as OREO expense. Significant judgments and complex estimates are required in estimating the fair value of other real estate, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility, as experienced in recent years. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other real estate.

 

Goodwill and Other Identifiable Intangible Assets

 

Other identifiable intangible assets include a core deposit intangible recorded in connection with the acquisition of Metro. The core deposit intangible is being amortized over 7 years and the estimated useful life is periodically reviewed for reasonableness.

 

The Company has recorded $13.6 million of goodwill in connection with the acquisition of Metro Bancshares, Inc. The Company tests its goodwill for impairment annually unless interim events or circumstances make it more likely than not that an impairment loss has occurred. Impairment is defined as the amount by which the implied fair value of the goodwill is less than the goodwill’s carrying value. Impairment losses, if incurred, would be charged to operating expense. For the purposes of evaluating goodwill, the Company has determined that it operates only one reporting unit.

 

Results of Operations

 

Net Income

 

Net income available to common stockholders was $81.4 million for the year ended December 31, 2016, compared to $63.3 million for the year ended December 31, 2015. This increase in net income is primarily attributable to an increase in net interest income, which increased $24.8 million, or 15.3%, to $187.1 million in 2016 from $162.3 million in 2015. Noninterest income increased $4.5 million, or 33.1%, to $18.1 million in 2016 from $13.6 million in 2015. Noninterest expense increased by $7.0 million, or 9.5%, to $81.0 million in 2016 from $74.0 million in 2015. Basic and diluted net income per common share were $1.55 and $1.52, respectively, for the year ended December 31, 2016, compared to $1.23 and $1.20, respectively, for the year ended December 31, 2015. Return on average assets was 1.42% in 2016, compared to 1.38% in 2015, and return on average stockholders’ equity was 16.64% in 2016, compared to 14.56% in 2015.

 

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Net income available to common stockholders for the year ended December 31, 2015 was $63.3 million, compared to $51.9 million for the year ended December 31, 2014. This increase in net income is primarily attributable to an increase in net interest income, which increased $31.7 million, or 24.3%, to $162.3 million in 2015 from $130.6 million in 2014. Noninterest income increased $2.6 million, or 23.6%, to $13.6 million in 2015 from $11.0 million in 2014. Noninterest expense increased by $16.7 million, or 29.1%, to $74.0 million in 2015 from $57.3 million in 2014. Basic and diluted net income per common share were $1.23 and $1.20, respectively, for the year ended December 31, 2015, compared to $1.09 and $1.05, respectively, for the year ended December 31, 2014. Return on average assets was 1.38% in 2015, compared to 1.39% in 2014, and return on average stockholders’ equity was 14.56% in 2015, compared to 14.43% in 2014.

 

The following table presents some ratios of our results of operations for the years ended December 31, 2016, 2015 and 2014.

 

   For the years ended December 31, 
   2016   2015   2014 
Return on average assets   1.42%   1.38%   1.39%
Return on average stockholders' equity   16.64%   14.56%   14.43%
Dividend payout ratio   10.53%   10.04%   9.57%
Average stockholders' equity to average total assets   8.52%   9.51%   9.58%

 

The following tables present a summary of our statements of income, including the percent change in each category, for the years ended December 31, 2016 compared to 2015, and for the years ended December 31, 2015 compared to 2014, respectively.

 

   Year Ended December 31,     
   2016   2015   Change from
the Prior Year
 
   (Dollars in Thousands)     
Interest income  $212,902   $179,975    18.30%
Interest expense   25,805    17,704    45.76%
Net interest income   187,097    162,271    15.30%
Provision for loan losses   13,398    12,847    4.29%
Net interest income after provision for loan losses   173,699    149,424    16.25%
Noninterest income   18,112    13,577    33.40%
Noninterest expense   80,993    73,996    9.46%
Income before income taxes   110,818    89,005    24.51%
Income taxes   29,339    25,465    15.21%
Net income   81,479    63,540    28.23%
Dividends on preferred stock   47    280    (83.21)%
Net income available to common stockholders  $81,432   $63,260    28.73%

 

   Year Ended December 31,     
   2015   2014   Change from
the Prior Year
 
   (Dollars in Thousands)     
Interest income  $179,975   $144,725    24.36%
Interest expense   17,704    14,119    25.39%
Net interest income   162,271    130,606    24.24%
Provision for loan losses   12,847    10,259    25.23%
Net interest income after provision for loan losses   149,424    120,347    24.16%
Noninterest income   13,577    11,492    18.14%
Noninterest expense   73,996    57,335    29.06%
Income before income taxes   89,005    73,978    20.31%
Income taxes   25,465    21,601    17.89%
Net income   63,540    52,377    21.31%
Dividends on preferred stock   280    431    (35.03)%
Net income available to common stockholders  $63,260   $51,946    21.78%

 

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Net Interest Income

 

Net interest income is the difference between the income earned on interest-earning assets and interest paid on interest-bearing liabilities used to support such assets. The major factors which affect net interest income are changes in volumes, the yield on interest-earning assets and the cost of interest-bearing liabilities. Our management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of our primary source of earnings.

 

Net interest income increased $24.8 million, or 15.3%, to $187.1 million for the year ended December 31, 2016 from $162.3 million for the year ended December 31, 2015. This was due to an increase in total interest income of $32.9 million, or 18.3%, partially offset by an increase in total interest expense of $8.1 million, or 45.8%. The increase in total interest income was primarily attributable to a 17.3% increase in average loans outstanding from 2015 to 2016, which was the result of growth in all of our markets, including in Nashville, Tennessee, Charleston, South Carolina and Tampa Bay, Florida, our newest markets.

 

Net interest income increased $31.7 million, or 24.3%, to $162.3 million for the year ended December 31, 2015 from $130.6 million for the year ended December 31, 2014. This was due to an increase in total interest income of $35.3 million, or 24.4%, partially offset by an increase in total interest expense of $3.6 million, or 25.4%. The increase in total interest income was primarily attributable to a 25.2% increase in average loans outstanding from 2014 to 2015, which was the result of growth in all of our markets.

 

Net Interest Margin Analysis

 

The net interest margin is impacted by the average volumes of interest-sensitive assets and interest-sensitive liabilities and by the difference between the yield on interest-sensitive assets and the cost of interest-sensitive liabilities (spread). Loan fees collected at origination represent an additional adjustment to the yield on loans. Our spread can be affected by economic conditions, the competitive environment, loan demand, and deposit flows. The net yield on earning assets is an indicator of effectiveness of our ability to manage the net interest margin by managing the overall yield on assets and cost of funding those assets.

 

The following table shows, for the years ended December 31, 2016, 2015 and 2014, the average balances of each principal category of our assets, liabilities and stockholders’ equity, and an analysis of net interest revenue, and the change in interest income and interest expense segregated into amounts attributable to changes in volume and changes in rates. This table is presented on a taxable equivalent basis, if applicable.

 

Average Balance Sheets and Net Interest Analysis

On a Fully Taxable-Equivalent Basis

For the Year Ended December 31,

(In thousands, except Average Yields and Rates)

 

   2016   2015   2014 
   Average
Balance
   Interest
Earned /
Paid
   Average
Yield /
Rate
   Average
Balance
   Interest
Earned /
Paid
   Average
Yield /
Rate
   Average
Balance
   Interest
Earned /
Paid
   Average
Yield /
Rate
 
Assets:                                             
Interest-earning assets:                                             
Loans, net of unearned income:                                             
Taxable (1)  $4,467,713   $199,598    4.47%  $3,815,202   $170,723    4.47%  $3,042,968   $135,487    4.45%
Tax-exempt (2)   18,749    911    4.86    9,905    496    5.01    13,176    527    4.00 
Total loans, net of unearned income   4,486,462    200,509    4.47    3,825,107    171,219    4.48    3,056,144    136,014    4.45 
Mortgage loans held for sale   6,600    253    3.83    7,912    237    3.00    5,704    210    3.68 
Debt securities:                                             
Taxable   237,699    5,343    2.25    193,803    4,332    2.24    186,376    4,464    2.40 
Tax-exempt (2)   135,929    5,035    3.70    136,305    5,448    4.00    125,269    5,329    4.25 
Total debt securities (3)   373,628    10,378    2.78    330,108    9,780    2.96    311,645    9,793    3.14 
Federal funds sold   163,356    1,007    0.62    31,014    128    0.41    55,680    159    0.29 
Restricted equity securities   4,827    218    4.52    4,798    183    3.81    4,002    131    3.27 
Interest-bearing balances with banks   490,301    2,571    0.52    189,361    530    0.28    167,782    416    0.25 
Total interest-earning assets  $5,525,174   $214,936    3.89%  $4,388,300   $182,077    4.15%  $3,600,957   $146,723    4.07%
Non-interest-earning assets:                                             
Cash and due from banks   60,321              60,778              57,894           
Net premises and equipment   24,937              17,206              8,430           
Allowance for loan losses, accrued interest and other assets   135,251              125,577              90,903           
Total assets  $5,745,683             $4,591,861             $3,758,184           
                                              
Interest-bearing liabilities:                                             
Interest-bearing deposits:                                             
Checking  $697,109   $2,526    0.36%  $584,756   $1,656    0.28%  $489,210   $1,294    0.26%
Savings   44,521    137    0.31    37,683    109    0.29    26,480    75    0.28 
Money market   2,308,065    12,379    0.54    1,786,045    8,302    0.46    1,523,120    6,775    0.44 
Time deposits   513,183    5,127    1.00    478,819    4,828    1.01    401,182    4,276    1.07 
Total interest-bearing deposits   3,562,878    20,169    0.57    2,887,303    14,895    0.52    2,439,992    12,420    0.51 
Federal funds purchased   433,743    2,766    0.64    272,031    860    0.32    202,690    567    0.28 
Other borrowings   55,468    2,870    5.17    37,272    1,948    5.23    19,957    1,132    5.67 
Total interest-bearing liabilities  $4,052,089   $25,805    0.64%  $3,196,606   $17,703    0.55%  $2,662,639   $14,119    0.53%
Non-interest-bearing liabilities:                                             
Non-interest-bearing checking   1,190,372              944,019              723,338           
Other liabilities   13,582              14,692              12,244           
Stockholders' equity   485,543              432,064              355,060           
Unrealized gains on securities and derivatives   4,097              4,480              4,903           
Total liabilities and stockholders' equity  $5,745,683             $4,591,861             $3,758,184           
Net interest income       $189,131             $164,374             $132,604      
Net interest spread             3.25%             3.60%             3.54%
Net interest margin             3.42%             3.75%             3.68%

 

(1)Non-accrual loans are included in average loan balances in all periods. Loan fees of $2,273,000, $1,384,000 and $1,025,000 are included in interest income in 2016, 2015 and 2014, respectively.
(2)Interest income and yields are presented on a fully taxable equivalent basis using a tax rate of 35%.
(3)Net unrealized gains of $6,301,000, $6,679,000 and $7,545,000 are excluded from the yield calculation in 2016, 2015 and 2014, respectively.

 

The following table reflects changes in our net interest margin as a result of changes in the volume and rate of our interest-bearing assets and liabilities.

 

   For the Year Ended December 31, 
   2016 Compared to 2015 Increase (Decrease) in
Interest Income and Expense Due to Changes in:
   2015 Compared to 2014 Increase (Decrease) in
Interest Income and Expense Due to Changes in:
 
    Volume    Rate    Total    Volume    Rate    Total 
Interest-earning assets:                              
Loans, net of unearned income:                              
Taxable  $29,151   $(276)  $28,875   $34,553   $683   $35,236 
Tax-exempt   430    (15)   415    (147)   116    (31)
Total loans, net of unearned income   29,581    (291)   29,290    34,406    799    35,205 
Mortgage loans held for sale   (43)   59    16    71    (44)   27 
Debt securities:                              
Taxable   988    24    1,012    174    (306)   (132)
Tax-exempt   (15)   (398)   (413)   452    (333)   119 
Total debt securities   973    (374)   599    626    (639)   (13)
Federal funds sold   788    91    879    (86)   55    (31)
Equity securities   1    34    35    28    24    52 
Interest-bearing balances with banks   1,317    724    2,041    56    58    114 
Total interest-earning assets   32,617    243    32,860    35,101    253    35,354 
                               
Interest-bearing liabilities:                              
Interest-bearing demand deposits   354    516    870    266    96    362 
Savings   21    7    28    32    2    34 
Money market   2,671    1,406    4,077    1,211    316    1,527 
Time deposits   343    (44)   299    793    (241)   552 
Total interest-bearing deposits   3,389    1,885    5,274    2,302    173    2,475 
Federal funds purchased   703    1,203    1,906    212    81    293 
Other borrowed funds   941    (19)   922    911    (95)   816 
Total interest-bearing   -    -    -    -    -    - 
liabilities   5,033    3,069    8,102    3,425    159    3,584 
Increase in net interest income  $27,584   $(2,826)  $24,758   $31,676   $94   $31,770 

 

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In the table above, changes in net interest income are attributable to (a) changes in average balances (volume variance), (b) changes in rates (rate variance), or (c) changes in rate and average balances (rate/volume variance). The volume variance is calculated as the change in average balances times the old rate. The rate variance is calculated as the change in rates times the old average balance. The rate/volume variance is calculated as the change in rates times the change in average balances. The rate/volume variance is allocated on a pro rata basis between the volume variance and the rate variance in the table above.

 

From 2015 to 2016, we experienced an unfavorable variance relating to the interest rate component because average yields on loans decreased by one basis point, while average rates paid on interest-bearing deposits increased by nine basis points. From 2014 to 2015, we experienced a favorable variance relating to the interest rate component because average yields on loans increased more than average rates paid on interest-bearing deposits. Our growth in loans was the primary driver of our favorable volume component change and overall change in both 2016 and 2015.

 

The two primary factors that make up the spread are the interest rates received on loans and the interest rates paid on deposits. We have been disciplined in raising interest rates on deposits only as the market demanded and thereby managing our cost of funds. Also, we have not competed for new loans on interest rate alone, but rather we have relied significantly on effective marketing to business customers.

 

Our net interest spread and net interest margin were 3.25% and 3.42%, respectively, for the year ended December 31, 2016, compared to 3.60% and 3.75%, respectively, for the year ended December 31, 2015. The decrease in net interest spread and net interest margin in 2016 resulted from the maintenance of higher levels of liquidity. Our average interest-earning assets for the year ended December 31, 2016 increased $1.1 billion, or 25.9%, to $5.5 billion from $4.4 billion for the year ended December 31, 2015. This increase in our average interest-earning assets was due to continued core growth in all of our markets and increased loan production. Our average interest-bearing liabilities increased $855.5 million, or 26.8%, to $4.1 billion for the year ended December 31, 2016 from $3.2 billion for the year ended December 31, 2015. All of our markets had an increase in total deposits during 2016. The ratio of our average interest-earning assets to average interest-bearing liabilities was 136.4% and 137.3% for the years ended December 31, 2016 and 2015, respectively, as average noninterest-bearing deposits grew by $246.4 million, or 26.1%, from 2015 to 2016.

 

Our average interest-earning assets produced a taxable equivalent yield of 3.89% for the year ended December 31, 2016, compared to 4.15% for the year ended December 31, 2015. The average rate paid on interest-bearing liabilities was 0.64% for the year ended December 31, 2016, compared to 0.55% for the year ended December 31, 2015.

 

Our net interest spread and net interest margin were 3.60% and 3.75%, respectively, for the year ended December 31, 2015, compared to 3.54% and 3.68%, respectively, for the year ended December 31, 2014. Our average interest-earning assets for the year ended December 31, 2015 increased $787.3 million, or 21.9%, to $4.4 billion from $3.6 billion for the year ended December 31, 2014. This increase in our average interest-earning assets was attributable to the Metro acquisition, which included $182.4 million in earnings assets as of the closing date on January 31, 2015, continued core growth in all of our markets and increased loan production. Our average interest-bearing liabilities increased $534.0 million, or 20.1%, to $3.2 billion for the year ended December 31, 2015 from $2.7 billion for the year ended December 31, 2014. This increase in our average interest-bearing liabilities was primarily due to an increase in interest-bearing deposits in all our markets. The ratio of our average interest-earning assets to average interest-bearing liabilities was 137.3% and 135.2% for the years ended December 31, 2015 and 2014, respectively, as average noninterest-bearing deposits grew by $220.7 million, or 30.5%, from 2014 to 2015.

 

Our average interest-earning assets produced a taxable equivalent yield of 4.15% for the year ended December 31, 2015, compared to 4.07% for the year ended December 31, 2014. The average rate paid on interest-bearing liabilities was 0.55% for the year ended December 31, 2015, compared to 0.53% for the year ended December 31, 2014.

 

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Provision for Loan Losses

 

The provision for loan losses represents the amount determined by management to be necessary to maintain the ALLL at a level capable of absorbing inherent losses in the loan portfolio. Our management reviews the adequacy of the ALLL on a quarterly basis. The ALLL calculation is segregated into various segments that include classified loans, loans with specific allocations and pass rated loans. A pass rated loan is generally characterized by a very low to average risk of default and in which management perceives there is a minimal risk of loss. Loans are rated using a nine-point risk grade scale with loan officers having the primary responsibility for assigning risk grades and for the timely reporting of changes in the risk grades. Based on these processes, and the assigned risk grades, the criticized and classified loans in the portfolio are segregated into the following regulatory classifications: Special Mention, Substandard, Doubtful or Loss, with some general allocation of reserve based on these grades. At December 31, 2016, total loans rated Special Mention, Substandard, and Doubtful were $128.8 million, or 2.6% of total loans, compared to $117.0 million, or 2.8% of total loans, at December 31, 2015. Impaired loans are reviewed specifically and separately under FASB ASC 310-30-35, Subsequent Measurement of Impaired Loans, to determine the appropriate reserve allocation. Our management compares the investment in an impaired loan with the present value of expected future cash flow discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral-dependent, to determine the specific reserve allowance. Reserve percentages assigned to non-impaired loans are based on historical charge-off experience adjusted for other risk factors. To evaluate the overall adequacy of the allowance to absorb losses inherent in our loan portfolio, our management considers historical loss experience based on volume and types of loans, trends in classifications, volume and trends in delinquencies and nonaccruals, economic conditions and other pertinent information. Based on future evaluations, additional provisions for loan losses may be necessary to maintain the allowance for loan losses at an appropriate level. The allowance for loan losses as a percentage of loans was diluted in 2015 by the acquisition of $149 million of loans of Metro Bank which were recorded at net fair value.

 

The provision expense for loan losses was $13.4 million for the year ended December 31, 2016, an increase of $0.6 million from $12.8 million in 2015. This increase in provision expense for loan losses for 2016 is primarily attributable to loan growth. Also, nonperforming loans increased to $16.9 million, or 0.34% of total loans, at December 31, 2016 from $7.8 million, or 0.18% of total loans, at December 31, 2015. During 2016, we had net charged-off loans totaling $4.9 million, compared to net charged-off loans of $5.1 million for 2015. The ratio of net charged-off loans to average loans was 0.11% for 2016 compared to 0.13% for 2015. The ALLL totaled $51.9 million, or 1.06% of loans, net of unearned income, at December 31, 2016, compared to $43.4 million, or 1.03% of loans, net of unearned income, at December 31, 2015.

 

The provision expense for loan losses was $12.8 million for the year ended December 31, 2015, an increase of $2.5 million from $10.3 million in 2014. This increase in provision expense for loan losses for 2015 is primarily attributable to loan growth. Also, nonperforming loans decreased to $7.8 million, or 0.18% of total loans, at December 31, 2015 from $10.1 million, or 0.30% of total loans, at December 31, 2014. During 2015, we had net charged-off loans totaling $5.1 million, compared to net charged-off loans of $5.3 million for 2014. The ratio of net charged-off loans to average loans was 0.13% for 2015 compared to 0.17% for 2014. The allowance for loan losses totaled $43.4 million, or 1.03% of loans, net of unearned income, at December 31, 2015, compared to $35.6 million, or 1.06% of loans, net of unearned income, at December 31, 2014.

 

Noninterest Income

 

Noninterest income increased $4.5 million, or 33.1%, to $18.1 million in 2016 from $13.6 million in 2015. Service charges on deposit accounts increased $0.3 million, or 5.9%, to $5.4 million in 2016 compared to 2015 due to increases in the number of accounts. Mortgage banking income increased $1.0 million, or 37.0%, to $3.7 million in 2016 compared to 2015 due to a 10% increase in the number of loans originated and improved operations, translating to an increase in net gains on sales. The cash surrender value of bank-owned life insurance contracts increased $0.2 million, or 7.7%, to $2.8 million in 2016 compared to 2015 which is the result of additional investment of $20.0 million in such contracts during 2016. Interchange income and other credit card revenue increased $1.1 million, or 52.4%, to $3.2 million in 2016 compared to 2015. A gain on sale of fixed assets of $1.4 million was recognized during 2016. Excluding this gain, other operating income increased $0.5 million, or 45.5%, to $1.1 million in 2016 compared to 2015.

 

Noninterest income increased $2.6 million, or 23.6%, to $13.6 million in 2015 from $11.0 million in 2014. Service charges on deposit accounts increased $0.8 million, or 18.6%, to $5.1 million in 2015 compared to 2014 due to increases in the number of accounts resulting from organic growth and the acquisition of Metro Bancshares, Inc. in February 2015. The cash surrender value of bank-owned life insurance contracts increased $0.3 million, or 15.0%, to $2.6 million in 2015 compared to 2014 which is the result of additional investment of $15.0 million in such contracts in September 2014 and $2.7 million in contracts from the acquisition of Metro. Other operating income increased $0.9 million, or 34.5%, to $3.5 million in 2015 compared to 2014 due to loan growth. Mortgage banking income increased $0.6 million, or 31.0%, to $2.7 million in 2015 compared to 2014. The number of mortgages closed and sold increased by 21% from 2014 to 2015.

 

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Noninterest Expense

 

Noninterest expenses increased $7.0 million, or 9.5%, to $81.0 million for the year ended December 31, 2016 from $74.0 million for the year ended December 31, 2015. Higher salary and employee benefits expenses, equipment and occupancy expenses and professional services expenses drove this increase in total noninterest expense. Salary and employee benefits expenses increased $5.1 million, or 13.1%, to $44.0 million in 2016 compared to 2015. We had 412 full-time equivalent employees at December 31, 2016 compared to 371 at December 31, 2015, a 11.1% increase. Staffing the new Tampa Bay, Florida office and new hires in operations staffing in our Birmingham headquarters drove this increase in the number of employees during 2016. Equipment and occupancy expense increased $1.6 million, or 25.0%, to $8.0 million in 2016 compared to $6.4 million in 2015. This increase is the fully phased in expenses associated with the addition of our new office in the Cobb Galleria area of Atlanta and our relocation to larger offices in our newer markets of Nashville and Charleston during 2015, accelerating depreciation of leasehold improvements in anticipation of our move to our new headquarters building being constructed in Birmingham, and our new office in Tampa, Florida. Professional services expense increased $1.4 million, or 53.8%, to $4.0 million in 2016 compared to 2015. Most of this increase is the result of legal accruals for pending litigation in which we are defendants, which amounted to $1.1 million in 2016. FDIC assessments were up $0.7 million, or 25.9%, to $3.4 million in 2016 from $2.7 million in 2015, a result of increases in total assets, which is the major component of our assessment base, and higher assessment rates implemented by the FDIC starting with the second quarter of 2016 assessment. Expenses on other real estate owned decreased $0.4 million, or 33.3%, to $0.8 million in 2016 compared to 2015, a result of fewer properties owned during 2016. Other operating expenses increased $0.8 million, or 4.0%, to $20.9 million in 2016 compared to 2015. Higher data processing and loan expenses were the result of our organic growth and expansion into the Tampa, Florida region. Higher service charges from the Federal Reserve Bank of Atlanta were the result of increased processing of transactions by us for our correspondent banking clients. Changes in other operating expenses from 2015 to 2016 are detailed in Note 17, “Other Operating Income and Expenses,” to the Consolidated Financial Statements.

 

Noninterest expenses increased $16.7 million, or 29.1%, to $74.0 million for the year ended December 31, 2015 from $57.3 million for the year ended December 31, 2014. This increase is largely attributable to increased salary and employee benefits expense and the write-down of investments in tax credit partnerships. Increases in salary and benefit expenses occurred as a result of Metro employees coming over in February 2015, staff additions related to our expansion into other new markets, increased incentive pay and general merit increases, offset by non-routine expenses in 2014 associated with the correction of accounting for vested stock options and acceleration of vesting of stock options previously granted to members of our advisory boards in our markets as explained further below. We had 371 full-time equivalent employees at December 31, 2015 compared to 298 at December 31, 2014, a 24.5% increase. The increase in number of employees is the result of Metro employees coming over, our continued expansion into new markets, additional sales and sales support staff in our existing regional markets and added support staff in our headquarters in Birmingham. Equipment and occupancy expense increased $0.8 million, or 15.2%, to $6.4 million in 2015 compared to $5.5 million in 2014. This increase is the result of the addition of the Metro Bank offices, our new office in the Cobb Galleria area of Atlanta and our relocation to larger offices in our newer markets of Nashville and Charleston. FDIC assessments were up $0.6 million, or 27.0%, to $2.7 million in 2015 from $2.1 million in 2014, mostly a result of increases in total assets, which is the major component of our assessment base. We incurred $2.1 million in expenses related to our acquisition and merger of Metro during 2015. Other operating expenses increased $5.5 million, or 36.8%, to $20.5 million in 2015 compared to $15.0 million in 2014. Write-downs and losses of our investments in tax credit partnerships were $4.1 million in 2015 in connection with tax credits recognized during the year. This compared to write-downs and losses in 2014 of $2.8 million. Tax credits increased by $2.0 million in 2015 compared to 2014, which is reflected in a lower effective tax rate for 2015. Changes in other operating expenses from 2014 to 2015 are detailed in Note 17, “Other Operating Income and Expenses,” to the Consolidated Financial Statements.

 

Income Tax Expense

 

Income tax expense was $29.3 million for the year ended December 31, 2016 compared to $25.5 million in 2015 and $21.6 million in 2014. Our effective tax rates for 2016, 2015 and 2014 were 26.47%, 28.61% and 29.20%, respectively. The decrease in the effective tax rate for 2015 and 2016 primarily relates to historic rehabilitation tax credits recognized in those years. Our primary permanent differences are related to tax exempt income on debt securities, state income tax benefit on real estate investment trust dividends, various qualifying tax credits and change in cash surrender value of bank-owned life insurance.

 

We have invested $102.5 million in bank-owned life insurance for certain named officers of the Bank. The periodic increases in cash surrender value of those policies are tax exempt and therefore contribute to a larger permanent difference between book income and taxable income.

 

We own real estate investment trusts for the purpose of holding and managing participations in residential mortgages and commercial real estate loans originated by the bank. The trusts are majority-owned subsidiaries of a trust holding company, which in turn is a wholly-owned subsidiary of the bank. The trusts earn interest income on the loans they hold and incur operating expenses related to their activities. They pay their net earnings, in the form of dividends, to the bank, which receives a deduction for state income taxes.

 

 45 

 

 

Financial Condition

 

Assets

 

Total assets at December 31, 2016, were $6.4 billion, an increase of $1.3 billion, or 25.5%, over total assets of $5.1 billion at December 31, 2015. Average assets for the year ended December 31, 2016 were $5.7 billion, an increase of $1.1 billion, or 23.9%, over average assets of $4.6 billion for the year ended December 31, 2015. Loan growth was the primary reason for the increase in ending and average total assets. Year-end 2016 loans were $4.9 billion, up $0.7 billion, or 16.7%, over year-end 2015 total loans of $4.2 billion.

 

Total assets at December 31, 2015, were $5.1 billion, an increase of $1.0 billion, or 24.4%, over total assets of $4.1 billion at December 31, 2014. Average assets for the year ended December 31, 2015 were $4.6 billion, an increase of $0.8 billion, or 21.1%, over average assets of $3.8 billion for the year ended December 31, 2014. Loan growth was the primary reason for the increase in ending and average total assets. Year-end 2015 loans were $4.2 billion, up $0.8 billion, or 23.5%, over year-end 2014 total loans of $3.4 billion.

 

Earning assets include loans, securities, short-term investments and bank-owned life insurance contracts.  We maintain a higher level of earning assets in our business model than do our peers because we allocate fewer of our resources to facilities, ATMs, cash and due-from-bank accounts used for transaction processing. Earning assets at December 31, 2016 were $6.2 billion, or 96.9% of total assets of $6.4 billion. Earning assets at December 31, 2015 were $5.0 billion, or 98.0% of total assets of $5.1 billion. We believe this ratio is expected to generally continue at these levels, although it may be affected by economic factors beyond our control.

 

Investment Portfolio

 

We view the investment portfolio as a source of income and liquidity. Our investment strategy is to accept a lower immediate yield in the investment portfolio by targeting shorter term investments. Our investment policy provides that no more than 60% of our total investment portfolio should be composed of municipal securities. At December 31, 2016, mortgage-backed securities represented 51% of the investment portfolio, state and municipal securities represented 30% of the investment portfolio, U.S. Treasury and government agencies represented 9% of the investment portfolio, and corporate debt represented 10% of the investment portfolio.

 

All of our investments in mortgage-backed securities are pass-through mortgage-backed securities. We do not currently, and did not have at December 31, 2016, any structured investment vehicles or any private-label mortgage-backed securities. The amortized cost of securities in our portfolio totaled $485.9 million at December 31, 2016, compared to $365.7 million at December 31, 2015. The following table presents the amortized cost of securities available for sale and held to maturity by type at December 31, 2016, 2015 and 2014.

 

   December 31, 
   2016   2015   2014 
   (In Thousands) 
Securities Available for Sale               
U.S. Treasury and government agencies  $45,998   $44,581   $50,363 
Mortgage-backed securities   228,843    135,363    92,439 
State and municipal securities   139,504    143,403    132,780 
Corporate debt   8,985    14,902    15,821 
Total  $423,330   $338,249   $291,403 
Securities Held to Maturity               
Mortgage-backed securities  $19,164   $21,666   $23,804 
State and municipal securities   5,888    5,760    5,551 
Corporate debt   37,512    -    - 
Total  $62,564   $27,426   $29,355 

 

The following table presents the amortized cost of our securities as of December 31, 2016 by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the taxable equivalent yields for each maturity range.

 

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Maturity of Debt Securities - Amortized Cost
   Less Than One
Year
   One Year through
Five Years
   Six Years
through Ten
Years
   More Than Ten
Years
   Total 
   (In Thousands) 
At December 31, 2016:                         
Securities Available for Sale:                         
U.S. Treasury and government agencies  $2,994   $39,826   $3,178   $-   $45,998 
Mortgage-backed securities   28    5,131    34,271    189,413    228,843 
State and municipal securities   16,290    112,521    10,693    -    139,504 
Corporate debt   8,985    -    -    -    8,985 
Total  $28,297   $157,478   $48,142   $189,413   $423,330 
                          
Tax-equivalent Yield (1)                         
U.S. Treasury and government agencies   2.17%   1.92%   1.77%   -%   1.93%
Mortgage-backed securities   5.24    3.41    2.29    2.12    2.17 
State and municipal securities   3.63    3.04    3.84    -    3.17 
Corporate debt   1.92    -    -    -    1.92 
Weighted average yield   2.93%   2.77%   2.60%   2.12%   2.47%
                          
Securities Held to Maturity:                         
Mortgage-backed securities  $-   $-   $-   $19,164   $19,164 
State and municipal securities   -    250    738    4,900    5,888 
Corporate debt   -    -    33,512    4,000    37,512 
Total  $-   $250   $34,250   $28,064   $62,564 
                          
Tax-equivalent Yield (1)                         
Mortgage-backed securities   -%   -%   -%   2.93%   2.93%
State and municipal securities   -    1.60    4.90    6.01    5.68 
Corporate debt   -    -    5.38    5.75    5.42 
Weighted average yield   -%   1.60%   5.37%   3.87%   4.68%

 

(1) Yields are presented on a fully-taxable equivalent basis using a tax rate of 35%.

 

At December 31, 2016, we had $160.4 million in federal funds sold, compared with $34.8 million at December 31, 2015. At year-end 2016, there were no holdings of securities of any issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

The objective of our investment policy is to invest funds not otherwise needed to meet our loan demand to earn the maximum return, yet still maintain sufficient liquidity to meet fluctuations in our loan demand and deposit structure. In doing so, we balance the market and credit risks against the potential investment return, make investments compatible with the pledge requirements of any deposits of public funds, maintain compliance with regulatory investment requirements, and assist certain public entities with their financial needs. The investment committee has full authority over the investment portfolio and makes decisions on purchases and sales of securities. The entire portfolio, along with all investment transactions occurring since the previous board of directors meeting, is reviewed by the board at each monthly meeting. The investment policy allows portfolio holdings to include short-term securities purchased to provide us with needed liquidity and longer term securities purchased to generate level income for us over periods of interest rate fluctuations.

 

Loan Portfolio

 

We had total loans of approximately $4.9 billion at December 31, 2016. The following table shows the percentage of our total loan portfolio assigned to each of our markets. A large majority of our loan customers are located within our market MSAs, and so is the collateral for their loans. With our loan portfolio concentrated in a limited number of markets, there is a risk that our borrowers’ ability to repay their loans from us could be affected by changes in local and regional economic conditions.

 

   Percentage of
Total Loans
Assigned to
Market
 
Birmingham, AL   44%
Huntsville, AL   10%
Dothan, AL   10%
Montgomery, AL   7%
Mobile, AL   6%
Total Alabama Markets   77%
Pensacola, FL   7%
Tampa Bay, FL   1%
Total Florida Markets   8%
Nashville, TN   8%
Atlanta, GA   4%
Charleston, SC   3%

 

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The following table details our loans at December 31, 2016, 2015, 2014, 2013 and 2012:

 

   2016   2015   2014   2013   2012 
   (Dollars in Thousands) 
Commercial, financial and agricultural  $1,982,267   $1,760,479   $1,504,652   $1,285,878   $1,036,618 
Real estate - construction   335,085    243,267    208,769    151,868    158,361 
Real estate - mortgage:                         
Owner-occupied commercial   1,171,719    1,014,669    793,917    710,372    568,041 
1-4 family mortgage   536,805    444,134    333,455    278,621    235,909 
Other mortgage   830,683    698,779    471,363    391,396    323,599 
Total real estate - mortgage   2,539,207    2,157,582    1,598,735    1,380,389    1,127,549 
Consumer   55,211    55,047    47,702    40,733    40,654 
Total Loans   4,911,770    4,216,375    3,359,858    2,858,868    2,363,182 
Less: Allowance for loan losses   (51,893)   (43,419)   (35,629)   (30,663)   (26,258)
Net Loans  $4,859,877   $4,172,956   $3,324,229   $2,828,205   $2,336,924 

 

The following table details the percentage composition of our loan portfolio by type at December 31, 2016, 2015, 2014, 2013 and 2012:

 

   2016   2015   2014   2013   2012 
                          
Commercial, financial and agricultural   40.36%   41.75%   44.78%   44.98%   43.87%
Real estate - construction   6.82    5.77    6.21    5.31    6.70 
Real estate - mortgage:                         
Owner-occupied commercial   23.86    24.07    23.63    24.85    24.04 
1-4 family mortgage   10.93    10.53    9.92    9.74    9.98 
Other mortgage   16.91    16.57    14.03    13.69    13.69 
Total real estate - mortgage   51.70    51.17    47.58    48.28    47.71 
Consumer   1.12    1.31    1.43    1.43    1.72 
Total Loans   100.00%   100.00%   100.00%   100.00%   100.00%

 

The following table details maturities and sensitivity to interest rate changes for our loan portfolio at December 31, 2016:

 

   Due in 1   Due in 1 to 5   Due after 5     
   year or less   years   years   Total 
   (in Thousands) 
Commercial, financial and agricultural  $868,229   $946,565   $167,473   $1,982,267 
Real estate - construction   153,377    153,488    28,220    335,085 
Real estate - mortgage:                    
Owner-occupied commercial   114,292    752,525    304,902    1,171,719 
1-4 family mortgage   104,610    229,754    202,441    536,805 
Other mortgage   135,201    543,203    152,279    830,683 
Total real estate - mortgage   354,103    1,525,482    659,622    2,539,207 
Consumer   28,850    25,358    1,003    55,211 
Total Loans  $1,404,559   $2,650,893   $856,318   $4,911,770 
Less: Allowance for loan losses                  (51,893)
Net Loans                 $4,859,877 
                     
Interest rate sensitivity:                    
Fixed interest rates  $340,909   $1,662,103   $457,824   $2,460,836 
Floating or adjustable rates   1,063,650    988,790    398,494    2,450,934 
Total  $1,404,559   $2,650,893   $856,318   $4,911,770 

 

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Asset Quality

 

The following table presents a summary of changes in the allowance for loan losses over the past five fiscal years. Our net charge-offs as a percentage of average loans for 2016 was 0.11%, compared to 0.13% for 2015.

 

Analysis of the Allowance for Loan Losses

   2016   2015   2014   2013   2012 
   (Dollars in Thousands) 
Allowance for loan losses:                         
Beginning of year  $43,419   $35,629   $30,663   $26,258   $22,030 
Charge-offs:                         
Commercial, financial and agricultural   (3,791)   (3,802)   (2,311)   (1,932)   (1,106)
Real estate - construction   (815)   (667)   (1,267)   (4,829)   (3,088)
Real estate - mortgage:                         
Owner occupied commercial   (2)   (211)   (36)   (1,100)   (250)
1-4 family mortgage   (269)   (446)   (1,529)   (941)   (311)
Other mortgage   (109)   (447)   (400)   -    (99)
Total real estate mortgage   (380)   (1,104)   (1,965)   (2,041)   (660)
Consumer   (212)   (171)   (228)   (210)   (901)
Total charge-offs   (5,198)   (5,744)   (5,771)   (9,012)   (5,755)
Recoveries:                         
Commercial, financial and agricultural   49    279    48    66    125 
Real estate - construction   76    238    322    296    58 
Real estate - mortgage:                         
Owner occupied commercial   -    -    -    32    - 
1-4 family mortgage   114    169    65    4    692 
Other mortgage   32    -    9    -    - 
Total real estate mortgage   146    169    74    36    692 
Consumer   3    1    34    11    8 
Total recoveries   274    687    478    409    883 
                          
Net charge-offs   (4,924)   (5,057)   (5,293)   (8,603)   (4,872)
                          
Provision for loan losses charged to expense   13,398    12,847    10,259    13,008    9,100 
                          
Allowance for loan losses at end of period  $51,893   $43,419   $35,629   $30,663   $26,258 
                          
As a percent of year to date average loans:                         
Net charge-offs   0.11%   0.13%   0.17%   0.33%   0.24%
Provision for loan losses   0.30%   0.34%   0.34%   0.50%   0.45%
Allowance for loan losses as a percentage of:                         
Year-end loans   1.06%   1.03%   1.06%   1.07%   1.11%
Nonperforming assets   237.23%   329.96%   210.95%   135.70%   130.77%

 

The allowance for loan losses is established and maintained at levels needed to absorb anticipated credit losses from identified and otherwise inherent risks in the loan portfolio as of the balance sheet date. In assessing the adequacy of the allowance for loan losses, management considers its evaluation of the loan portfolio, past due loan experience, collateral values, current economic conditions and other factors considered necessary to maintain the allowance at an adequate level. Our management feels that the allowance was adequate at December 31, 2016.

 

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The following table presents the allocation of the allowance for loan losses for each respective loan category with the corresponding percent of loans in each category to total loans.

 

   For the Years Ended December 31, 
   2016   2015   2014   2013   2012 
                                         
       Percentage       Percentage       Percentage       Percentage       Percentage 
       of loans in       of loans in       of loans in       of loans in       of loans in 
       each       each       each       each       each 
       category to       category to       category to       category to       category to 
   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans   Amount   total loans 
                                         
   (Dollars in Thousands) 
Commercial, financial and agricultural  $28,872    40.36%  $21,495    41.75%  $16,079    44.78%  $13,576    44.98%  $11,061    43.87%
Real estate - construction   5,125    6.82    5,432    5.77    6,395    6.21    6,078    5.31    6,907    6.70 
Real estate - mortgage   17,504    51.70    16,061    51.17    12,112    47.58    10,065    48.28    7,964    47.71 
                                                   
Consumer   392    1.12    431    1.31    1,043    1.43    944    1.43    326    1.72 
Total  $51,893    100.00%  $43,419    100.00%  $35,629    100.00%  $30,663    100.00%  $26,258    100.00%

 

We target small and medium-sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. If loan losses occur at a level where the loan loss reserve is not sufficient to cover actual loan losses, our earnings will decrease. We use an independent consulting firm to review our loans annually for quality in addition to the reviews that may be conducted by bank regulatory agencies as part of their examination process.

 

As of December 31, 2016, we had impaired loans of $45.6 million, an increase of $12.1 million from $33.5 million as of December 31, 2015. We allocated $8.2 million of our allowance for loan losses at December 31, 2016 to these impaired loans compared to $5.7 million at December 31, 2015. We had previous write-downs against impaired loans of $5.7 million at December 31, 2016, compared to $2.9 million at December 31, 2015. The recorded investment in impaired loans at December 31, 2016 is also inclusive of a purchase loan discount associated with the acquisition of Metro Bank totaling $0.2 million. The average recorded balance for 2016 of impaired loans was $45.7 million. A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the original loan agreement. Impairment does not always indicate credit loss, but provides an indication of collateral exposure based on prevailing market conditions and third-party valuations. Impaired loans are measured by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent. The amount of any initial impairment and subsequent changes in impairment are included in the allowance for loan losses. Our credit administration group performs verification and testing to ensure appropriate identification of impaired loans and that proper reserves are allocated to these loans.

 

Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status. If further credit deterioration occurs and the criteria for nonaccrual status is met, all interest accrued but not collected is reversed against current interest income. Loans included as impaired and in nonaccrual status totaled $10.6 million at December 31, 2016, an increase of $2.8 million compared to $7.8 million at December 31, 2015. Interest income foregone throughout the year on nonaccrual loans was $516,000, and we recognized $629,000 of interest income on nonaccrual loans for the year ended December 31, 2016, compared to interest income foregone in 2015 of $678,000 and $602,000 of interest income recognized on nonaccrual loans for the year ended December 31, 2015.

 

Of the $45.6 million of impaired loans reported as of December 31, 2016, $27.9 million were commercial and industrial loans, $13.4 million were real estate mortgage loans, $4.3 million were real estate construction loans and $3,000 were consumer loans. Of the $4.3 million of impaired real estate construction loans, $2.7 million were residential construction loans.

 

The bank has procedures and processes in place intended to ensure that losses do not exceed the potential amounts documented in the bank’s impairment analyses and reduce potential losses in the remaining performing loans within our real estate construction portfolio. These include the following:

 

·We closely monitor the past due and overdraft reports on a weekly basis to identify deterioration as early as possible and the placement of identified loans on the watch list.
·We perform extensive monthly credit review for all watch list/classified loans, including formulation of aggressive workout or action plans. When a workout is not achievable, we move to collection/foreclosure proceedings to obtain control of the underlying collateral as rapidly as possible to minimize the deterioration of collateral and/or the loss of its value.
·We require updated financial information, global inventory aging and interest carry analysis for existing customers to help identify potential future loan payment problems.

·We generally limit loans for new construction to established builders and developers that have an established record of turning their inventories, and we restrict our funding of undeveloped lots and land.

 

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Nonperforming Assets

 

The table below summarizes our nonperforming assets at December 31, 2016, 2015, 2014, 2013 and 2012:

   2016   2015   2014   2013   2012 
       Number       Number       Number       Number       Number 
   Balance   of Loans   Balance   of Loans   Balance   of Loans   Balance   of Loans   Balance   of Loans 
   (Dollars in Thousands) 
Nonaccrual loans:                                                  
Commercial, financial and agricultural  $7,282    13   $1,918    7   $172    4   $1,714    9   $276    2 
Real estate - construction   3,268    5    4,000    7    5,049    11    3,749    14    6,460    19 
Real estate - mortgage:                                                  
Owner-occupied commercial   -    -    -    -    683    2    1,435    3    2,786    3 
1-4 family mortgage   74    1    198    2    1,596    3    1,878    3    453    2 
Other mortgage   -    -    1,619    5    959    1    243    1    240    1 
Total real estate - mortgage   74    1    1,817    7    3,238    6    3,556    7    3,479    6 
Consumer   -    -    31    1    666    4    602    4    135    2 
Total nonaccrual loans  $10,624    19   $7,766    22   $9,125    25   $9,621    34   $10,350    29 
                                                   
90+ days past due and accruing:                                                  
Commercial, financial and agricultural  $10    1   $-    -   $925    1   $-    -   $-    - 
Real estate - construction   -    -    -    -    -    -    -    -    -    - 
Real estate - mortgage:                                                  
Owner-occupied commercial   (1) 6,208    1    -    -    -    -    -    -    -    - 
1-4 family mortgage   -    -    -    -    -    -    19    1    -    - 
Other mortgage   -    -    -    -    -    -    -    -    -    - 
Total real estate - mortgage   6,208    1    -    -    -    -    19    1    -    - 
Consumer   45    10    1    1    -    -    96    1    8    4 
Total 90+ days past due and accruing  $6,263    12   $1    1   $925    1   $115    2   $8    4 
Total nonperforming loans  $16,887    31   $7,767    23   $10,050    26   $9,736    36   $10,358    33 
Plus: Other real estate owned and repossessions   4,988    12    5,392    18    6,840    22    12,861    51    9,721    38 
Total nonperforming assets  $21,875    43   $13,159    41   $16,890    48   $22,597    87   $20,079    71 
                                                   
Restructured accruing loans:                                                  
Commercial, financial and agricultural  $354    1   $6,618    8   $6,632    8   $962    2   $1,168    2 
Real estate - construction   -    -    -    -    -    -    217    1    3,213    15 
Real estate - mortgage:                                                  
Owner-occupied commercial   -    -    -    -    -    -    -    -    3,121    3 
1-4 family mortgage   -    -    -    -    -    -    8,225    2    1,709    5 
Other mortgage   204    1    253    1    1,663    2    285    1    302    1 
                                                   
Total real estate - mortgage   204    1    253    1    1,663    2    8,510    3    5,132    9 
Consumer   -    -    -    -    -    -    -    -    -    - 
Total restructured accruing loans  $558    2   $6,871    9   $8,295    10   $9,689    6   $9,513    26 
Total nonperforming assets and restructured accruing loans  $22,433    45   $20,030    50   $25,185    58   $32,286    93   $29,592    97 
                                                   
Gross interest income foregone on nonaccrual loans throughout year  $516        $678        $750        $972        $850      
Interest income recognized on nonaccrual loans throughout year  $629        $602        $255        $433        $155      
                                                   
Ratios:                                                  
Nonperforming loans to total loans   0.34%        0.18%        0.30%        0.34%        0.44%     
Nonperforming assets to total loans plus other real estate owned and repossessions   0.44%        0.31%        0.50%        0.85%        0.85%     
Nonperforming assets and restructured accruing loans to total loans plus other real estate owned and repossessions   0.46%        0.47%        0.75%        1.12%        1.25%     

 

(1) $6.2 million commercial real estate loan that carries a 70% guarantee from the United States Department of Agriculture (USDA). The loan has paid current as of the date of this report and represents 28% of total nonperforming assets at December 31, 2016.

 

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The balance of nonperforming assets can fluctuate due to changes in economic conditions. We have established a policy to discontinue accruing interest on a loan (i.e., place the loan on nonaccrual status) after it has become 90 days delinquent as to payment of principal or interest, unless the loan is considered to be well-collateralized and is actively in the process of collection. In addition, a loan will be placed on nonaccrual status before it becomes 90 days delinquent unless management believes that the collection of interest is expected. As of December 31, 2016, one commercial real estate loan with a balance of $6.2 million, of which 70% is guaranteed by the United States Department of Agriculture, was past due more than 90 days and still accruing interest. This loan, which comprises 28% of total nonperforming assets, has paid current as of the date of this report. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. Interest income on nonaccrual loans is recognized only as received. If we believe that a loan will not be collected in full, we will increase the allowance for loan losses to reflect management’s estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal. There are not any loans, outside of those included in the table above, that cause management to have serious doubts as to the ability of borrowers to comply with present repayment terms.

 

Deposits

 

We rely on increasing our deposit base to fund loan and other asset growth. Each of our markets is highly competitive. We compete for local deposits by offering attractive products with competitive rates.  We expect to have a higher average cost of funds for local deposits than competitor banks due to our lack of an extensive branch network.  Our management’s strategy is to offset the higher cost of funding with a lower level of operating expense and firm pricing discipline for loan products.  We have promoted electronic banking services by providing them without charge and by offering in-bank customer training. The following table presents the average balance and average rate paid on each of the following deposit categories at the bank level for years ended December 31, 2016, 2015 and 2014:

 

   Average Deposits 
   Average for Years Ended December 31, 
   2016   2015   2014 
   Average
Balance
   Average Rate
Paid
   Average
Balance
   Average Rate
Paid
   Average
Balance
   Average Rate
Paid
 
Types of Deposits:  (Dollars in Thousands) 
Non-interest-bearing demand deposits  $1,190,372    -%  $944,019    -%  $723,338    -%
Interest-bearing demand deposits   697,109    0.36%   584,756    0.28%   489,210    0.26%
Money market accounts   2,308,065    0.54%   1,786,045    0.46%   1,523,120    0.44%
Savings accounts   44,521    0.31%   37,683    0.29%   26,480    0.28%
Time deposits, $250,000 and under   238,565    0.92%   237,086    0.98%   209,361    1.04%
Time deposits, over $250,000   274,618    1.07%   241,730    1.04%   191,821    1.09%
Total deposits  $4,753,250        $3,831,319        $3,163,330      

 

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The following table presents the maturities of our certificates of deposit as of December 31, 2016 and 2015.

 

At December 31, 2016  Over $250,000   Less than or equal to
$250,000
   Total 
Maturity  (In Thousands)         
Three months or less  $39,050   $45,136   $84,186 
Over three through six months   33,207    38,601    71,808 
Over six months through one year   70,802    62,695    133,497 
Over one year   150,607    87,725    238,332 
Total  $293,666   $234,157   $527,823 

 

At December 31, 2015  Over $250,000   Less than or equal to
$250,000
   Total 
Maturity  (In Thousands)         
Three months or less  $40,265   $41,128   $81,393 
Over three through six months   36,578    45,128    81,706 
Over six months through one year   66,098    65,463    131,561 
Over one year   122,541    85,242    207,783 
Total  $265,482   $236,961   $502,443 

 

Total average deposits for the year ended December 31, 2016 were $4.8 billion, an increase of $1.0 billion, or 24.1%, over total average deposits of $3.8 billion for the year ended December 31, 2015. Average noninterest-bearing deposits increased by $0.3 billion, or 26.1%, from $0.9 billion for the year ended December 31, 2015 to $1.2 billion for the year ended December 31, 2016.

 

Total average deposits for the year ended December 31, 2015 were $3.8 billion, an increase of $0.6 billion, or 18.8%, over total average deposits of $3.2 billion for the year ended December 31, 2014. Average noninterest-bearing deposits increased by $0.2 billion, or 28.6%, from $0.7 billion for the year ended December 31, 2014 to $0.9 billion for the year ended December 31, 2015.

 

Borrowed Funds

 

We had available $378.0 million in unused federal funds lines of credit with regional banks as of December 31, 2016, compared to $180.0 million as of December 31, 2015. The increase was attributable to additional lines of credit initiated with new banks during 2016. These lines are subject to certain restrictions and in some cases collateral requirements.

 

Federal funds purchased from correspondent banks of $433.7 million, $272.0 million and $202.6 million for 2016, 2015 and 2014, respectively. We paid average interest rates on these funds of 0.64%, 0.32% and 0.28% for the same three years, respectively. The maximum amount outstanding at month-end during 2016 and 2015 was $514.8 million and $352.4 million, respectively.

 

Stockholders’ Equity

 

Stockholders’ equity increased $73.8 million during 2016, to $522.9 million at December 31, 2016 from $449.1 million at December 31, 2015. The increase in stockholders’ equity resulted from net income of $81.5 million during the year ended December 31, 2016.

 

Off-Balance Sheet Arrangements

 

In the normal course of business, we are a party to financial credit arrangements with off-balance sheet risk to meet the financing needs of our customers.  These financial credit arrangements include commitments to extend credit beyond current fundings, credit card arrangements, standby letters of credit and financial guarantees.  Those credit arrangements involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement we have in those particular financial credit arrangements. All such credit arrangements bear interest at variable rates and we have no such credit arrangements which bear interest at fixed rates.

 

Our exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, credit card arrangements and standby letters of credit is represented by the contractual or notional amount of those instruments.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

 

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The following table sets forth our credit arrangements and financial instruments whose contract amounts represent credit risk as of December 31, 2016, 2015 and 2014:

 

   2016   2015   2014 
   (In Thousands) 
Commitments to extend credit  $1,667,015   $1,409,425   $1,156,682 
Credit card arrangements   100,678    62,462    45,155 
Standby letters of credit and financial guarantees   40,991    38,224    33,280 
Total  $1,808,684   $1,510,111   $1,235,117 

 

Commitments to extend credit beyond current fundings are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Such commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  We evaluate each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by us upon extension of credit is based on our management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

 

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions.  All letters of credit are due within one year or less of the original commitment date.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

 

Derivatives

 

The bank has entered into agreements with secondary market investors to deliver loans on a “best efforts delivery” basis. When a rate is committed to a borrower, it is based on the best price that day and locked with our investor for our customer for a 30-day period. In the event the loan is not delivered to the investor, the bank has no risk or exposure with the investor. The interest rate lock commitments related to loans that are originated for later sale are classified as derivatives. The fair values of our agreements with investors and rate lock commitments to customers as of December 31, 2016 and 2015 were not material.

 

Asset and Liability Management

 

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.

 

Our asset liability and investment committee is charged with monitoring our liquidity and funds position. The committee regularly reviews the rate sensitivity position on a three-month, six-month and one-year time horizon; loans-to-deposits ratios; and average maturities for certain categories of liabilities. The asset liability committee uses a model to analyze the maturities of rate-sensitive assets and liabilities. The model measures the “gap” which is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. Gap is also expressed as the ratio of rate-sensitive assets divided by rate-sensitive liabilities. If the ratio is greater than “one,” then the dollar value of assets exceeds the dollar value of liabilities and the balance sheet is “asset sensitive.” Conversely, if the value of liabilities exceeds the dollar value of assets, then the ratio is less than one and the balance sheet is “liability sensitive.” Our internal policy requires our management to maintain the gap such that net interest margins will not change more than 10% if interest rates change by 100 basis points or more than 15% if interest rates change by 200 basis points. As of December 31, 2016, our gap was within such ranges. See “—Quantitative and Qualitative Analysis of Market Risk” below in Item 7A for additional information.

 

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Liquidity and Capital Adequacy

 

Liquidity

 

Liquidity is defined as our ability to generate sufficient cash to fund current loan demand, deposit withdrawals, or other cash demands and disbursement needs, and otherwise to operate on an ongoing basis.

 

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the bank. The management of liquidity at both levels is critical, because the Company and the bank have different funding needs and sources, and each are subject to regulatory guidelines and requirements. We are subject to general FDIC guidelines which require a minimum level of liquidity. Management believes our liquidity ratios meet or exceed these guidelines. Our management is not currently aware of any trends or demands that are reasonably likely to result in liquidity increasing or decreasing in any material manner.

 

The retention of existing deposits and attraction of new deposit sources through new and existing customers is critical to our liquidity position. In the event of compression in liquidity due to a run-off in deposits, we have a liquidity policy and procedure that provides for certain actions under varying liquidity conditions. These actions include borrowing from existing correspondent banks, selling or participating loans and the curtailment of loan commitments and funding. At December 31, 2016, our liquid assets, represented by cash and due from banks, federal funds sold and unpledged available-for-sale securities, totaled $1.0 billion. Additionally, at such date we had available to us approximately $378.0 million in unused federal funds lines of credit with regional banks, subject to certain restrictions and collateral requirements, to meet short term funding needs. We believe these sources of funding are adequate to meet immediate anticipated funding needs. Our management meets on a weekly basis to review sources and uses of funding to determine the appropriate strategy to ensure an appropriate level of liquidity, and we have increased our focus on the generation of core deposit funding to supplement our liquidity position. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals.

 

Our regular sources of funding are from the growth of our deposit base, repayment of principal and interest on loans, the sale of loans and the renewal of time deposits. We also may continue periodic offerings of debt and equity securities.

 

The following table reflects the contractual maturities of our term liabilities as of December 31, 2016. The amounts shown do not reflect any early withdrawal or prepayment assumptions.

 

   Payments due by Period 
           Over 1 - 3   Over 3 - 5     
   Total   1 year or less   years   years   Over 5 years 
   (In Thousands) 
Contractual Obligations (1)                         
                          
Deposits without a stated maturity  $4,892,488   $4,892,488   $-   $-   $- 
Certificates of deposit (2)   527,823    289,491    169,883    66,103    2,346 
Federal funds purchased   355,944    355,944    -    -    - 
Other borrowings   55,350    -    600    -    54,750 
Operating lease commitments   20,510    3,986    6,984    4,442    5,098 
Total  $5,852,115   $5,541,909   $177,467   $70,545   $62,194 

 

(1) Excludes interest.

(2) Certificates of deposit give customers the right to early withdrawal. Early withdrawals may be subject to penalties.

The penalty amount depends on the remaining time to maturity at the time of early withdrawal.

 

Capital Adequacy

 

As of December 31, 2016, our most recent notification from the FDIC categorized us as well-capitalized under the regulatory framework for prompt corrective action. To remain categorized as well-capitalized, we must maintain minimum common equity tier 1 risk-based, Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios as disclosed in the table below. Our management believes that we are well-capitalized under the prompt corrective action provisions as of December 31, 2016. In addition, the Alabama Banking Department has required that the bank maintain a leverage ratio of 8.00%.

 

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The following table sets forth (i) the capital ratios of the bank required by the FDIC to maintain “well-capitalized” status and (ii) our actual ratios of capital to total regulatory or risk-weighted assets, as of December 31, 2016.

 

   Well-Capitalized   Actual at
December 31,
2016
 
CET 1 Capital Ratio   6.50%   10.77%
Tier 1 Capital Ratio   8.00%   10.78%
Total Capital Ratio   10.00%   11.79%
Leverage ratio   5.00%   9.06%

 

For a description of capital ratios see Note 16 to “Notes to Consolidated Financial Statements.”

 

Impact of Inflation

 

Our consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which require the measure of financial position and operating results in terms of historic dollars, without considering changes in the relative purchasing power of money over time due to inflation.

 

Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects financial institutions’ cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings and stockholders’ equity. Mortgage originations and refinancing tend to slow as interest rates increase, and likely will reduce our volume of such activities and the income from the sale of residential mortgage loans in the secondary market.

 

Adoption of Recent Accounting Pronouncements

 

New accounting standards are discussed in Note 1 to “Notes to Consolidated Financial Statements.”

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Like all financial institutions, we are subject to market risk from changes in interest rates. Interest rate risk is inherent in the balance sheet due to the mismatch between the maturities of rate-sensitive assets and rate-sensitive liabilities. If rates are rising, and the level of rate-sensitive liabilities exceeds the level of rate-sensitive assets, the net interest margin will be negatively impacted. Conversely, if rates are falling, and the level of rate-sensitive liabilities is greater than the level of rate-sensitive assets, the impact on the net interest margin will be favorable. Managing interest rate risk is further complicated by the fact that all rates do not change at the same pace; in other words, short term rates may be rising while longer term rates remain stable. In addition, different types of rate-sensitive assets and rate-sensitive liabilities react differently to changes in rates.

 

To manage interest rate risk, we must take a position on the expected future trend of interest rates. Rates may rise, fall, or remain the same. Our asset liability committee develops its view of future rate trends and strives to manage rate risk within a targeted range by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of our balance sheet. Our annual budget reflects the anticipated rate environment for the next twelve months. The asset liability committee conducts a quarterly analysis of the rate sensitivity position and reports its results to our board of directors.

 

The asset liability committee employs multiple modeling scenarios to analyze the maturities of rate-sensitive assets and liabilities. The model measures the “gap” which is defined as the difference between the dollar amount of rate-sensitive assets repricing during a period and the volume of rate-sensitive liabilities repricing during the same period. The gap is also expressed as the ratio of rate-sensitive assets divided by rate-sensitive liabilities. If the ratio is greater than “one,” the dollar value of assets exceeds the dollar value of liabilities; the balance sheet is “asset sensitive.” Conversely, if the value of liabilities exceeds the value of assets, the ratio is less than one and the balance sheet is “liability sensitive.” Our internal policy requires management to maintain the gap such that net interest margins will not change more than 10% if interest rates change 100 basis points or more than 15% if interest rates change 200 basis points. As of December 31, 2016, our gap was within such ranges.

 

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The model measures scheduled maturities in periods of three months, four to twelve months, one to five years and over five years. The chart below illustrates our rate-sensitive position at December 31, 2016. Management uses the one-year gap as the appropriate time period for setting strategy.

 

   Rate Sensitive Gap Analysis         
   1-3 Months   4-12 Months   1-5 Years   Over 5 Years   Total 
   (Dollars in Thousands) 
Interest-earning assets:                         
Loans, including mortgages held for sale  $2,512,235   $443,125   $1,721,690   $239,395   $4,916,445 
Securities   32,055    56,569    306,475    90,864    485,963 
Federal funds sold   158,950    -    1,485    -    160,435 
Interest bearing balances with banks   566,707    -    -    -    566,707 
Total interest-earning assets  $3,269,947   $499,694   $2,029,650   $330,259   $6,129,550 
                          
Interest-bearing liabilities:                         
Deposits:                         
Interest-bearing checking  $799,577   $-   $-   $-   $799,577 
Money market and savings   2,811,340    -    -    -    2,811,340 
Time deposits   84,182    205,295    235,968    2,344    527,789 
Federal funds purchased   355,944    -    -    -    355,944 
Other borrowings   100    300    200    54,662    55,262 
Total interest-bearing liabilities   4,051,143    205,595    236,168    57,006