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Section 1: 10-K (CTBI DECEMBER 31, 2016 FORM 10-K)

 
 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
FORM 10-K

[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
 
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 (NO FEE REQUIRED)
 
For the transition period from _____________ to _____________

Commission file number 0-11129
COMMUNITY TRUST BANCORP, INC.
(Exact Name of Registrant as Specified in its Charter)

Kentucky
61-0979818
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
346 North Mayo Trail
Pikeville, Kentucky
(Address of Principal Executive Offices)
41501
(Zip Code)
(606) 432-1414
(Registrant’s Telephone Number)

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

Common Stock, $5.00 par value
The NASDAQ Stock Market LLC
(Title of Class)
(Name of Exchange on Which Registered)

 Securities registered pursuant to Section 12(g) of the Act:
None

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

Yes
   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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 
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 
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 amendment 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 definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer 
Non-accelerated filer
Smaller reporting company
   
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes
   No

Based upon the closing price of the Common Shares of the Registrant on the NASDAQ-Stock Market LLC – Global Select Market, the aggregate market value of voting stock held by non-affiliates of the Registrant as of June 30, 2016 was $578.0 million.  For the purpose of the foregoing calculation only, all directors and executive officers of the Registrant have been deemed affiliates.  The number of shares outstanding of the Registrant’s Common Stock as of February 28, 2017 was 17,660,868.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Form 10-K incorporates by reference certain information from Registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on April 25, 2017.
 
 
 

 


 

TABLE OF CONTENTS


CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS

PART I

Item 1. Business

Item 1A. Risk Factors

Item 1B. Unresolved Staff Comments

Selected Statistical Information

Item 2. Properties

Item 3. Legal Proceedings

Item 4. Mine Safety Disclosures

PART II

Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities

Item 6. Selected Financial Data 2012-2016

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Item 8. Financial Statements and Supplementary Data

Notes to Consolidated Financial Statements

Reports of Independent Registered Public Accounting Firm

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A. Controls and Procedures

Item 9B. Other Information

PART III

Item 10. Directors, Executive Officers, and Corporate Governance of the Registrant

Item 11. Executive Compensation

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

Item 13. Certain Relationships, Related Transactions, and Director Independence

Item 14. Principal Accountant Fees and Services

PART IV

Item 15. Exhibits and Financial Statement Schedules

Signatures

Index to Exhibits




CAUTIONARY STATEMENT
REGARDING FORWARD LOOKING STATEMENTS


Certain of the statements contained herein that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Community Trust Bancorp, Inc.’s (“CTBI”) actual results may differ materially from those included in the forward-looking statements. Forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may increase,” “may fluctuate,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” and “could.” These forward-looking statements involve risks and uncertainties including, but not limited to, economic conditions, portfolio growth, the credit performance of the portfolios, including bankruptcies, and seasonal factors; changes in general economic conditions including the performance of financial markets, prevailing inflation and interest rates, realized gains from sales of investments, gains from asset sales, and losses on commercial lending activities; results of various investment activities; the effects of competitors’ pricing policies, changes in laws and regulations, competition, and demographic changes on target market populations’ savings and financial planning needs; industry changes in information technology systems on which we are highly dependent; failure of acquisitions to produce revenue enhancements or cost savings at levels or within the time frames originally anticipated or unforeseen integration difficulties; and the resolution of legal  proceedings and related matters.  In addition, the banking industry in general is subject to various monetary, operational, and fiscal policies and regulations, which include, but are not limited to, those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Consumer Financial Protection Bureau, and state regulators, whose policies, regulations, and enforcement actions could affect CTBI’s results.  These statements are representative only on the date hereof, and CTBI undertakes no obligation to update any forward-looking statements made.


PART I


Item 1.  Business

Community Trust Bancorp, Inc. (“CTBI”) is a bank holding company registered with the Board of Governors of the Federal Reserve System pursuant to Section 5(a) of the Bank Holding Company Act of 1956, as amended.  CTBI was incorporated August 12, 1980, under the laws of the Commonwealth of Kentucky for the purpose of becoming a bank holding company.  Currently, CTBI owns all the capital stock of one commercial bank and one trust company, serving small and mid-sized communities in eastern, northeastern, central, and south central Kentucky, southern West Virginia, and northeastern Tennessee.  The commercial bank is Community Trust Bank, Inc., Pikeville, Kentucky (“CTB”) and the trust company is Community Trust and Investment Company, Lexington, Kentucky.

At December 31, 2016, CTBI had total consolidated assets of $3.9 billion and total consolidated deposits, including repurchase agreements, of $3.3 billion.  Total shareholders’ equity at December 31, 2016 was $500.6 million.  Trust assets under management at December 31, 2016 were $2.1 billion, including CTB’s investment portfolio totaling $0.6 billion.

Through its subsidiaries, CTBI engages in a wide range of commercial and personal banking and trust and wealth management activities, which include accepting time and demand deposits; making secured and unsecured loans to corporations, individuals and others; providing cash management services to corporate and individual customers; issuing letters of credit; renting safe deposit boxes; and providing funds transfer services.  The lending activities of CTB include making commercial, construction, mortgage, and personal loans.  Lease-financing, lines of credit, revolving lines of credit, term loans, and other specialized loans, including asset-based financing, are also available.  Our corporate subsidiaries act as trustees of personal trusts, as executors of estates, as trustees for employee benefit trusts, as paying agents for bond and stock issues, as investment agent, as depositories for securities, and as providers of full service brokerage and insurance services.
 
COMPETITION

CTBI’s subsidiaries face substantial competition for deposit, credit, trust, wealth management, and brokerage relationships in the communities we serve.  Competing providers include state banks, national banks, thrifts, trust companies, insurance companies, mortgage banking operations, credit unions, finance companies, brokerage companies, and other financial and non-financial companies which may offer products functionally equivalent to those offered by our subsidiaries.  As financial services become increasingly dependent on technology, permitting transactions to be conducted by telephone, mobile banking, and the internet, non-bank institutions are able to attract funds and provide lending and other financial services without offices located in our market areas.  Many of our nonbank competitors have fewer regulatory constraints, broader geographic service areas, greater capital and, in some cases, lower cost structures.  In addition, competition for quality customers has intensified as a result of changes in regulation, consolidation among financial service providers, and advances in technology and product delivery systems.  Many of these providers offer services within and outside the market areas served by our subsidiaries.  We strive to offer competitively priced products along with quality customer service to build customer relationships in the communities we serve.

The United States and global markets, as well as general economic conditions, have been volatile.  Some financial institutions have failed and others have been forced to seek acquisition partners.  Larger financial institutions could strengthen their competitive position as a result of ongoing consolidation within the financial services industry.

Banking legislation in Kentucky places no limits on the number of banks or bank holding companies that a bank holding company may acquire.  Interstate acquisitions are allowed where reciprocity exists between the laws of Kentucky and the home state of the bank or bank holding company to be acquired.  Bank holding companies continue to be limited to control of less than 15% of deposits held by banks in the states where they do business (exclusive of inter-bank and foreign deposits).  Competition for deposits may be increasing as a consequence of FDIC assessments shifting from deposits to an asset based formula, as larger banks may move away from non-deposit funding sources.

No material portion of our business is seasonal.  We are not dependent upon any one customer or a few customers, and the loss of any one or a few customers would not have a material adverse effect on us.  See note 19 to the consolidated financial statements for additional information regarding concentrations of credit.

We do not engage in any operations in foreign countries.

EMPLOYEES

As of December 31, 2016, CTBI and subsidiaries had 996 full-time equivalent employees.  Our employees are provided with a variety of employee benefits.  A retirement plan, an employee stock ownership plan, group life insurance, major medical insurance, a cafeteria plan, and management and employee incentive compensation plans are available to all eligible personnel.

SUPERVISION AND REGULATION

General

We, as a registered bank holding company, are restricted to those activities permissible under the Bank Holding Company Act of 1956, as amended, and are subject to actions of the Board of Governors of the Federal Reserve System thereunder.  We are required to file an annual report with the Federal Reserve Board and are subject to an annual examination by the Board.

Community Trust Bank, Inc. is a state-chartered bank subject to state and federal banking laws and regulations and periodic examination by the Kentucky Department of Financial Institutions and the restrictions, including dividend restrictions, thereunder.  CTB is also a member of the Federal Reserve System and is subject to certain restrictions imposed by and to examination and supervision under the Federal Reserve Act.  Community Trust and Investment Company is also regulated by the Kentucky Department of Financial Institutions and the Federal Reserve.

Deposits of CTB are insured up to applicable limits by the Federal Deposit Insurance Corporation (FDIC), which subjects banks to regulation and examination under the provisions of the Federal Deposit Insurance Act.

The operations of CTBI and our subsidiaries are also affected by other banking legislation and policies and practices of various regulatory authorities.  Such legislation and policies include statutory maximum rates on some loans, reserve requirements, domestic monetary and fiscal policy, and limitations on the kinds of services that may be offered.

CTBI’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge on our website at www.ctbi.com as soon as reasonably practicable after such materials are electronically filed with or furnished to the Securities and Exchange Commission.  CTBI’s Code of Business Conduct and Ethics and other corporate governance documents are also available on our website.  Copies of our annual report will be made available free of charge upon written request to:

Community Trust Bancorp, Inc.
Jean R. Hale
Chairman, President and CEO
P.O. Box 2947
Pikeville, KY  41502-2947

Basel III

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to CTBI and CTB.  The FDIC subsequently approved these rules.  The final rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

The rules include new risk-based capital and leverage ratios, which are being phased in from 2015 to 2019, and refine the definition of what constitutes “capital” for purposes of calculating those ratios.  The new minimum capital level requirements applicable to CTBI and CTB under the final rules are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.  The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital.  The capital conservation buffer began to be phased in on January 1, 2016 at 0.625% of risk-weighted assets and will increase by 0.625% annually until fully implemented in January 2019.  An institution is subject to limitations on certain activities including payment of dividends, share repurchases, and discretionary bonuses to executive officers if its capital level is below the capital conservation buffer amount.

The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time.  However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes CTBI) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The final rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness.  These revisions took effect January 1, 2015.  Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from previous rules).

The final rules set forth certain changes for the calculation of risk-weighted assets, which we were required to utilize beginning January 1, 2015.  The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.  We currently satisfy the well-capitalized and capital conservation buffer standards, and based on our current capital composition and levels, we anticipate that our capital ratios, on a Basel III basis, will continue to exceed the well-capitalized minimum capital requirements and the capital conservation buffer standards.


Item 1A. Risk Factors

An investment in our common stock is subject to risks inherent to our business.  The material risks and uncertainties that management believes affect us are described below.  Before making an investment decision, you should carefully consider the risks and uncertainties described below, together with all of the other information included or incorporated by reference herein.  The risks and uncertainties described below are not the only ones facing us.  Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations.  This report is qualified in its entirety by these risk factors.  See also, “Cautionary Statement Regarding Forward-Looking Statements.”  If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.  If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.

Economic Risk
CTBI may continue to be adversely affected by economic and market conditions.

Beginning in 2008, the U.S. economy faced a severe economic crisis including a major recession from which it is recovering.  Commerce and business growth in certain regions in the U.S. remains reduced and local governments and many businesses continue to experience financial difficulty.  In some areas of the U.S., including certain parts of our service area, unemployment levels remain elevated.  There can be no assurance that these conditions will continue to improve and these conditions could worsen.  In addition, the level of U.S. debt, the Federal Open Market Committee’s plan for economic stabilization, potential volatility in oil prices, potential U.S. tax law modifications, and the repeal of the Patient Protection and Affordable Care Act and the implementation of replacement healthcare legislation may have a destabilizing effect on financial markets or a negative effect on the economy.

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the markets where we operate, in the states of Kentucky, West Virginia, and Tennessee and in the United States as a whole.  While unemployment rates have improved in many areas of the United States, unemployment rates remain elevated in certain markets in which we operate.  A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings.  Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity, or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.

Overall, during recent years, the business environment has been adverse for many households and businesses in the United States and worldwide.  While economic conditions in the United States and worldwide have improved since the recession, there can be no assurance that this improvement will continue or that another recession will not occur.  Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing, and savings habits.  Such conditions could adversely affect the credit quality of our loans and our business, financial condition, and results of operations.

Economy of Our Markets
Our business may continue to be adversely affected by ongoing weaknesses in the local economies on which we depend.

Our loan portfolio is concentrated primarily in eastern, northeastern, central, and south central Kentucky, southern West Virginia, and northeastern Tennessee.  Our profits depend on providing products and services to clients in these local regions.  While unemployment rates have improved in many areas of the United States, unemployment rates remain elevated in certain markets in which we operate.  Increases in unemployment, decreases in real estate values, or increases in interest rates could weaken the local economies in which we operate.  These economic indicators typically affect certain industries, such as real estate and financial services, more significantly.  High levels of unemployment and depressed real estate asset values in certain of the markets we serve would likely prolong the economic recovery period in our market area.  Also, our growth within certain of our markets may be adversely affected by the lack of population growth in such markets in recent years.  Weakness in our market area could depress our earnings and consequently our financial condition because:
·
Clients may not want, need, or qualify for our products and services;
·
Borrowers may not be able to repay their loans;
·
The value of the collateral securing our loans to borrowers may decline; and
·
The quality of our loan portfolio may decline.

Mortgage Assistance Risk
As government funded mortgage assistance programs lapse, consumer real estate defaults may increase.

During the economic recession, various legislation was enacted designed to assist those hit hardest through economic subsidies.  These subsidies most often came in the form of mortgage payment assistance or mortgage note restructuring.  Examples of these programs include: Consumer Financial Protection Bureau Alternatives to Foreclosure In House Modification Program, Kentucky Housing Unemployed Bridge Loan Program, Tennessee Hardest Hit Fund, Home Affordable Modification Program Home Affordable Refinance Program, and Freddie Mac Alternatives to Foreclosure.  As these programs sunset or as the participants complete their eligibility in the program(s), we may experience significantly higher levels of past due mortgage loans and default rates.

Interest Rate Risk
Changes in interest rates could adversely affect our earnings and financial condition.

Our earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings.  The narrowing of interest-rate spreads, meaning the difference between the interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect our earnings and financial condition.  Interest rates are highly sensitive to many factors, including:
·
The rate of inflation;
·
The rate of economic growth;
·
Employment levels;
·
Monetary policies; and
·
Instability in domestic and foreign financial markets.

Changes in market interest rates will also affect the level of voluntary prepayments on our loans and the receipt of payments on our mortgage-backed securities resulting in the receipt of proceeds that may be reinvested at a lower rate than the loan or mortgage-backed security being prepaid.

We originate residential loans for sale and for our portfolio. The origination of loans for sale is designed to meet client financing needs and earn fee income. The origination of loans for sale is highly dependent upon the local real estate market and the level and trend of interest rates.  Increasing interest rates may reduce the origination of loans for sale and consequently the fee income we earn.  While our commercial banking, construction, and income property business lines remain a significant portion of our activities, high interest rates may reduce our mortgage-banking activities and thereby our income.  In contrast, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated.  This causes the value of assets related to the servicing rights on loans sold to be lower than originally anticipated.  If this happens, we may need to write down our servicing assets faster, which would accelerate our expense and lower our earnings.

We consider interest rate risk one of our most significant market risks. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates.  Consistency of our net interest revenue is largely dependent upon the effective management of interest rate risk.  We employ a variety of measurement techniques to identify and manage our interest rate risk including the use of an earnings simulation model to analyze net interest income sensitivity to changing interest rates.  The model is based on actual cash flows and repricing characteristics for on and off-balance sheet instruments and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain financial assets and liabilities.  Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates are also incorporated into the model.  These assumptions are inherently uncertain, and as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income.  Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.

Liquidity Risk
CTBI is subject to liquidity risk.

CTBI requires liquidity to meet its deposit and debt obligations as they come due and to fund loan demands.  CTBI’s access to funding sources in amounts adequate to finance its activities or on terms that are acceptable to it could be impaired by factors that affect it specifically or the financial services industry or economy in general.  Factors that could reduce its access to liquidity sources include a downturn in the market, difficult credit markets, or adverse regulatory actions against CTBI.  CTBI’s access to deposits may also be affected by the liquidity needs of its depositors.  In particular, a substantial majority of CTBI’s liabilities are demand, savings, interest checking, and money market deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial portion of its assets are loans, which cannot be called or sold in the same time frame.  To the extent that consumer confidence in other investment vehicles, such as the stock market, increases, customers may move funds from bank deposits and products into such other investment vehicles.  Although CTBI historically has been able to replace maturing deposits and advances as necessary, it might not be able to replace such funds in the future, especially if a large number of its depositors sought to withdraw their accounts, regardless of the reason.  A failure to maintain adequate liquidity could have a material adverse effect on our financial condition and results of operations.

Banking Reform
Our business may be adversely affected by “banking reform” legislation.

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to CTBI and CTB.  The FDIC subsequently approved these rules.  The final rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

The rules include new risk-based capital and leverage ratios, which are being phased in from 2015 to 2019, and refine the definition of what constitutes “capital” for purposes of calculating those ratios.  The new minimum capital level requirements applicable to CTBI and CTB under the final rules are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions.  The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital.  The capital conservation buffer began to be phased in on January 1, 2016 at 0.625% of risk-weighted assets and will increase by 0.625% annually until fully implemented in January 2019.  An institution is subject to limitations on certain activities including payment of dividends, share repurchases, and discretionary bonuses to executive officers if its capital level is below the capital conservation buffer amount.

The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time.  However, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes CTBI) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The final rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness.  These revisions took effect January 1, 2015.  Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 5% (unchanged from previous rules).

The final rules set forth certain changes for the calculation of risk-weighted assets, which we were required to utilize beginning January 1, 2015.  The standardized approach final rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.  We currently satisfy the well-capitalized and capital conservation buffer standards, and based on our current capital composition and levels, we anticipate that our capital ratios, on a Basel III basis, will continue to exceed the well-capitalized minimum capital requirements and capital conservation buffer standards.

Government Policies and Oversight
Our business may be adversely affected by changes in government policies and oversight.

The earnings of banks and bank holding companies such as ours are affected by the policies of regulatory authorities, including the Federal Reserve Board, which regulates the money supply.  Among the methods employed by the Federal Reserve Board are open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits.  These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits.  The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial and savings banks in the past and are expected to continue to do so in the future.

Many states and municipalities are experiencing financial stress.  As a result, various levels of government have sought to increase their tax revenues through increased tax levies, which could have an adverse impact on our results of operations.

In recent years, federal banking regulators have increased regulatory scrutiny, and additional limitations (including those contained in the Dodd-Frank Act) on financial institutions have been proposed or adopted by regulators and by Congress.  Moreover, banking regulatory agencies have increasingly over the last few years used authority under Section 5 of the Federal Trade Commission Act to take supervisory or enforcement action with respect to alleged unfair or deceptive acts or practices by banks to address practices that may not necessarily fall within the scope of a specific banking or consumer finance law.  The banking industry is highly regulated and changes in federal and state banking regulations as well as policies and administration guidelines may affect our practices, growth prospects, and earnings.  In particular, there is no assurance that governmental actions designed to stabilize the economy and banking system will not adversely affect the financial position or results of operations of CTBI.

From time to time, CTBI and/or its subsidiaries may be involved in information requests, reviews, investigations, and proceedings (both formal and informal) by various governmental agencies and law enforcement authorities regarding our respective businesses.  Any of these matters may result in material adverse consequences to CTBI and its subsidiaries, including adverse judgements, findings, limitations on merger and acquisition activity, settlements, fines, penalties, orders, injunctions, and other actions.  Such adverse consequences may be material to the financial position of CTBI or its results of operations.

In particular, consumer products and services are subject to increasing regulatory oversight and scrutiny with respect to compliance with consumer laws and regulations.  We may face a greater number or wider scope of investigations, enforcement actions, and litigation in the future related to consumer practices.  In addition, any required changes to our business operations resulting from these developments could result in a significant loss of revenue, require remuneration to customers, trigger fines or penalties, limit the products or services we offer, require us to increase certain prices and therefore reduce demand for our products, impose additional compliance costs on us, cause harm to our reputation, or otherwise adversely affect our consumer business.

On February 3, 2017, President Trump issued an executive order directing the Secretary of the Treasury to consult with the heads of members agencies of the Financial Stability Oversight Council and identify federal regulations that inhibit certain core principles, including making regulation efficient, effective and appropriately tailored.  While this process may lead to the revision or easing of some regulations applicable to us, there can be no assurance that the regulatory environment for financial institutions will become more favorable.

Credit Risk
Our earnings and reputation may be adversely affected if we fail to effectively manage our credit risk.

Originating and underwriting loans are integral to the success of our business.  This business requires us to take “credit risk,” which is the risk of losing principal and interest income because borrowers fail to repay loans.  Collateral values and the ability of borrowers to repay their loans may be affected at any time by factors such as:
·
The length and severity of downturns in the local economies in which we operate or the national economy;
·
The length and severity of downturns in one or more of the business sectors in which our customers operate, particularly the automobile, hotel/motel, coal, and residential development industries; or
·
A rapid increase in interest rates.

Our loan portfolio includes loans with a higher risk of loss.

We originate commercial real estate loans, construction and development loans, consumer loans, and residential mortgage loans, primarily within our market area.  Commercial real estate, commercial, and construction and development loans tend to involve larger loan balances to a single borrower or groups of related borrowers and are most susceptible to a risk of loss during a downturn in the business cycle.  These loans also have historically had a greater credit risk than other loans for the following reasons:

·
Commercial Real Estate Loans.  Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.  As of December 31, 2016, commercial real estate loans, including multi-family loans, comprised approximately 37% of our total loan portfolio.

·
Other Commercial Loans.  Repayment is generally dependent upon the successful operation of the borrower’s business.  In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.  As of December 31, 2016, other commercial loans comprised approximately 12% of our total loan portfolio.

·
Construction and Development Loans.  The risk of loss is largely dependent on our initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.  During the construction phase, a number of factors can result in delays or cost overruns.  If our estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.  As of December 31, 2016, construction and development loans comprised approximately 4% of our total loan portfolio.

Consumer loans may carry a higher degree of repayment risk than residential mortgage loans, particularly when the consumer loan is unsecured.  Repayment of a consumer loan typically depends on the borrower’s financial stability, and it is more likely to be affected adversely by job loss, illness, or personal bankruptcy.  In addition, federal and state bankruptcy, insolvency, and other laws may limit the amount we can recover when a consumer client defaults.  As of December 31, 2016, consumer loans comprised approximately 20% of our total loan portfolio.

A significant part of our lending business is focused on small to medium-sized business which may be impacted more severely during periods of economic weakness.

A significant portion of our commercial loan portfolio is tied to small to medium-sized businesses in our markets.  During periods of economic weakness, small to medium-sized businesses may be impacted more severely than larger businesses.  As a result, the ability of smaller businesses to repay their loans may deteriorate, particularly if economic challenges persist over a period of time, and such deterioration would adversely impact our results of operations and financial condition.

A large percentage of our loan portfolio is secured by real estate, in particular commercial real estate.  Weakness in the real estate market or other segments of our loan portfolio would lead to additional losses, which could have a material adverse effect on our business, financial condition, and results of operations.

As of December 31, 2016, approximately 68% of our loan portfolio is secured by real estate, 39% of which is commercial real estate.  High levels of commercial and consumer delinquencies or declines in real estate market values could require increased net charge-offs and increases in the allowance for loan and lease losses, which could have a material adverse effect on our business, financial condition, and results of operations and prospects.

Our level of other real estate owned remains above our historical norm, primarily as a result of foreclosures.  To the extent that we continue to hold a higher level of other real estate owned, related real estate expense will likely remain high.

During the economic downturn which began in 2008, we experienced an increase in nonperforming real estate loans.  As a result, we have experienced, and we continue to experience, an increased level of foreclosed properties.  Foreclosed real estate expense consists of maintenance costs, taxes, valuation adjustments to appraisal values, and gains or losses on disposition.  The amount that we may realize after a default is dependent upon factors outside of our control, including but not limited to: (i) general and local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the properties; (vi) environmental remediation liabilities; (vii) ability to obtain and maintain occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations, and fiscal policies; (x) potential vandalism; and (xi) acts of God.  Expenditures associated with the ownership of real estate, such as real estate taxes, insurance, and maintenance costs, may adversely affect income from the real estate.  The cost of operating real property may exceed the income earned from the property, and we may need to advance funds in order to protect our investment in the property, or we may be required to dispose of the property at a loss.  If our levels of other real estate owned increase or are sustained and local real estate values decline, our foreclosed real estate expense will increase, which would adversely impact our results of operations.

As of December 31, 2016, forty-two percent (based on book value) of our foreclosed properties had been held by us for over five years.  Regulatory approval is required and has been obtained to hold these properties beyond the initial period of five years.  Additional approval may be required to continue to hold these properties in the event they are not liquidated during the extension period, which is typically one year.  While we have previously received regulatory approval to continue to hold foreclosed properties for over five years, to the extent such approval is not obtained in the future with respect to a foreclosed property, we might be forced to liquidate such property at a price less than its appraised value.

Environmental Liability Risk
We are subject to environmental liability risk associated with lending activity.

A significant portion of our loan portfolio is secured by real property.  During the ordinary course of business, we may foreclose on and take title to properties securing loans.  In doing so, there is a risk that hazardous or toxic substances could be found on these properties.  If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage.  Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property.  In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.  Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards.  The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Competition
Strong competition within our market area may reduce our ability to attract and retain deposits and originate loans.

We face competition both in originating loans and in attracting deposits. Competition in the financial services industry is intense.  We compete for clients by offering excellent service and competitive rates on our loans and deposit products.  The type of institutions we compete with include commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms.  Competition arises from institutions located within and outside our market areas.  As financial services become increasingly dependent on technology, permitting transactions to be conducted by telephone, mobile banking, and the internet, non-bank institutions are able to attract funds and provide lending and other financial services without offices located in our market areas.  As a result of their size and ability to achieve economies of scale, certain of our competitors offer a broader range of products and services than we offer.  With the increased consolidation in the financial industry, larger financial institutions may strengthen their competitive positions.  In addition, to stay competitive in our markets we may need to adjust the interest rates on our products to match the rates offered by our competitors, which could adversely affect our net interest margin.  As a result, our profitability depends upon our continued ability to successfully compete in our market areas while achieving our investment objectives.

Technology and other changes are allowing consumers to complete financial transactions through alternative methods to those which historically involved banks.  For example, consumers can now hold funds that would have been held as bank deposits in mutual funds, brokerage accounts, or general purpose reloadable prepaid cards.  In addition, consumers can complete transactions, such as paying bills or transferring funds, directly without utilizing the services of a bank.  The process of eliminating banks as intermediaries (known as disintermediation), could result in the loss of fee income, as well as the loss of deposits and the income that might be generated from those deposits.  The related revenue reduction could adversely affect our financial condition, cash flows, and results of operations.

Acquisition Risk
We may have difficulty in the future continuing to grow through acquisitions.

We may experience difficulty in making acquisitions on acceptable terms due to the decreasing number of suitable acquisition targets, competition for attractive acquisitions, regulatory impediments, and certain limitations on interstate acquisitions.

Any future acquisitions or mergers by CTBI or its banking subsidiary are subject to approval by the appropriate federal and state banking regulators.  The banking regulators evaluate a number of criteria in making their approval decisions, such as:
·
Safety and soundness guidelines;
·
Compliance with all laws including the USA Patriot Act, the International Money Laundering Abatement and Anti-Terrorist Financing Act, the Sarbanes-Oxley Act and the related rules and regulations promulgated under such Act or the Exchange Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Community Reinvestment Act, the Home Mortgage Disclosure Act, and all other applicable fair lending and consumer protection laws and other laws relating to discriminatory business practices; and
·
Anti-competitive concerns with the proposed transaction.

If the banking regulators or a commenter on our regulatory application raise concerns about any of these criteria at the time a regulatory application is filed, the banking regulators may deny, delay, or condition their approval of a proposed transaction.  As more fully described under “Results of Operations and Financial Condition” in Item 7, the resolution of a Federal Reserve investigation in 2014 has resulted in impediments to CTBI’s merger and acquisition activity for an unspecified period of time.

We have grown, and, subject to regulatory approval, intend to continue to grow, through acquisitions of banks and other financial institutions.  After these acquisitions, we may experience adverse changes in results of operations of acquired entities, unforeseen liabilities, asset quality problems of acquired entities, loss of key personnel, loss of clients because of change of identity, difficulties in integrating data processing and operational procedures, and deterioration in local economic conditions.  These various acquisition risks can be heightened in larger transactions.

Integration Risk
We may not be able to achieve the expected integration and cost savings from our bank acquisition activities.

We have a long history of acquiring financial institutions and, subject to regulatory approval, we expect this acquisition activity to continue in the future.  Difficulties may arise in the integration of the business and operations of the financial institutions that agree to merge with and into CTBI and, as a result, we may not be able to achieve the cost savings and synergies that we expect will result from the merger activities.  Achieving cost savings is dependent on consolidating certain operational and functional areas, eliminating duplicative positions and terminating certain agreements for outside services.  Additional operational savings are dependent upon the integration of the banking businesses of the acquired financial institution with that of CTBI, including the conversion of the acquired entity’s core operating systems, data systems and products to those of CTBI and the standardization of business practices.  Complications or difficulties in the conversion of the core operating systems, data systems, and products of these other banks to those of CTBI may result in the loss of clients, damage to our reputation within the financial services industry, operational problems, one-time costs currently not anticipated by us, and/or reduced cost savings resulting from the merger activities.

Operational Risk
An extended disruption of vital infrastructure or a security breach could negatively impact our business, results of operations, and financial condition.

Our operations depend upon, among other things, our infrastructure, including equipment and facilities.  Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking or viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of our control could have a material adverse impact on the financial services industry as a whole and on our business, results of operations, cash flows, and financial condition in particular.  Our business recovery plan may not work as intended or may not prevent significant interruption of our operations.  The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in the loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have an adverse effect on our financial condition and results of operation.

Third party vendors provide key components of our business infrastructure, such as processing, internet connections, and network access.  While CTBI has selected these third party vendors carefully through its vendor management process, it does not control their actions and generally is not able to obtain satisfactory indemnification provisions in its third party vendor written contracts.  Any problems caused by third parties or arising from their services, such as disruption in service, negligence in the performance of services or a breach of customer data security with regard to the third parties’ systems, could adversely affect our ability to deliver services, negatively impact our business reputation, cause a loss of customers, or result in increased expenses, regulatory fines and sanctions, or litigation.

Market Risk
Community Trust Bancorp, Inc.’s stock price is volatile.

Our stock price has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future.  These factors include:
·
Actual or anticipated variations in earnings;
·
Changes in analysts’ recommendations or projections;
·
CTBI’s announcements of developments related to our businesses;
·
Operating and stock performance of other companies deemed to be peers;
·
New technology used or services offered by traditional and non-traditional competitors;
·
News reports of trends, concerns, and other issues related to the financial services industry; and
·
Additional governmental policies and enforcement of current laws.

Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to CTBI’s performance.  Although investor confidence in financial institutions has strengthened, the financial crisis adversely impacted investor confidence in the financial institutions sector.  General market price declines or market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

Technology Risk
CTBI continually encounters technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services.  The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.  Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations.  Many of our competitors have substantially greater resources to invest in technological improvements.  We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.  Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Cyber Risk
A breach in the security of our systems could disrupt our business, result in the disclosure of confidential information, damage our reputation, and create significant financial and legal exposure for us.

Our businesses are dependent on our ability and the ability of our third party service providers to process, record, and monitor a large number of transactions.  If the financial, accounting, data processing, or other operating systems and facilities fail to operate properly, become disabled, experience security breaches, or have other significant shortcomings, our results of operations could be materially adversely affected.

Although we and our third party service providers devote significant resources to maintain and upgrade our systems and processes that are designed to protect the security of computer systems, software, networks, and other technology assets and the confidentiality, integrity, and availability of information belonging to us and our customers, there is no assurance that our security systems and those of our third party service providers will provide absolute security.  Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks, and other means.  Despite our efforts and those of our third party service providers to ensure the integrity of these systems, it is possible that we or our third party service providers may not be able to anticipate or to implement effective preventive measures against all security breaches of these types, especially because techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources.

A successful breach of the security of our systems or those of our third party service providers could cause serious negative consequences to us, including significant disruption of our operations, misappropriation of our confidential information or the confidential information of our customers, or damage to our computers or operating systems, and could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss in confidence in our security measures, customer dissatisfaction, litigation exposure, and harm to our reputation, all of which could have a material adverse effect on us.  While we maintain insurance coverage that should, subject to policy terms and conditions, cover certain aspects of our cyber risks, this insurance coverage may be insufficient to cover all losses we could experience resulting from a cyber security breach.

We could incur increased costs or reductions in revenue or suffer reputational damage in the event of misuse of information.

Our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks regarding our customers and their accounts.  To provide these products and services, we use information systems and infrastructure that we and third party service providers operate.  As a financial institution, we also are subject to and examined for compliance with an array of data protection laws, regulations, and guidance, as well as to our own internal privacy and information security policies and programs.

Information security risks for financial institutions like us 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, and other external parties.  Our technologies and systems may become the target of cyber-attacks or other attacks that could result in the misuse or destruction of our or our customers’ confidential, proprietary, or other information or that could result in disruptions to the business operations of us or our customers or other third parties.  Also, our customers, in order to access some of our products and services, may use personal computers, smart mobile phones, tablet PCs, and other devices that are beyond our controls and security systems.  Further, a breach or attack affecting one of our third-party service providers or partners could impact us through no fault of our own.  In addition, because the methods and techniques employed by perpetrators of fraud and others to attack systems and applications change frequently and often are not fully recognized or understood until after they have been launched, we and our third-party service providers and partners may be unable to anticipate certain attack methods in order to implement effective preventative measures.

While we have policies and procedures designed to prevent or limit the effect of the possible security breach of our information systems, if unauthorized persons were somehow to get access to confidential or proprietary information in our possession or to our proprietary information, it could result in significant legal and financial exposure, damage to our reputation, or a loss of confidence in the security of our systems that could materially adversely affect our business.

Counterparty Risk
The soundness of other financial institutions could adversely affect CTBI.

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, or other relationships.  We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional counterparties. 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.  Many of these transactions expose us to credit risk in the event of default of our counterparty or client.  In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us.  There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition, or results of operations.


Item 1B. Unresolved Staff Comments

None.


 
SELECTED STATISTICAL INFORMATION

The following tables set forth certain statistical information relating to CTBI and subsidiaries on a consolidated basis and should be read together with our consolidated financial statements.


Consolidated Average Balance Sheets and Taxable Equivalent Income/Expense and Yields/Rates

   
2016
   
2015
   
2014
 
(in thousands)
 
Average
Balances
   
Interest
   
Average
Rate
   
Average
Balances
   
Interest
   
Average
Rate
   
Average
Balances
   
Interest
   
Average
Rate
 
Earning assets:
                                                     
Loans (1)(2)(3)
 
$
2,916,031
   
$
134,455
     
4.61
%
 
$
2,791,871
   
$
131,304
     
4.70
%
 
$
2,642,231
   
$
128,929
     
4.88
%
Loans held for sale
   
728
     
101
     
13.87
     
1,075
     
95
     
8.84
     
943
     
74
     
7.85
 
Securities:
                                                                       
U.S. Treasury and agencies
   
445,500
     
6,669
     
1.50
     
446,081
     
7,425
     
1.66
     
474,062
     
9,302
     
1.96
 
Tax exempt state and political subdivisions (3)
   
99,086
     
4,182
     
4.22
     
101,382
     
4,162
     
4.11
     
95,460
     
3,963
     
4.15
 
Other securities
   
53,492
     
1,596
     
2.98
     
59,705
     
1,728
     
2.89
     
66,793
     
2,012
     
3.01
 
Federal Reserve Bank and Federal Home Loan Bank stock
   
22,814
     
1,011
     
4.43
     
22,812
     
1,010
     
4.43
     
23,978
     
1,136
     
4.74
 
Federal funds sold
   
3,121
     
19
     
0.61
     
3,344
     
13
     
0.39
     
4,007
     
15
     
0.37
 
Interest bearing deposits
   
108,546
     
538
     
0.50
     
90,106
     
219
     
0.24
     
103,823
     
248
     
0.24
 
Other investments
   
1,550
     
17
     
1.10
     
6,285
     
56
     
0.89
     
9,307
     
87
     
0.93
 
Investment in unconsolidated subsidiaries
   
1,846
     
43
     
2.33
     
1,845
     
35
     
1.90
     
1,846
     
34
     
1.84
 
Total earning assets
   
3,652,714
   
$
148,631
     
4.07
%
   
3,524,506
   
$
146,047
     
4.14
%
   
3,422,450
   
$
145,800
     
4.26
%
Allowance for loan and lease losses
   
(36,681
)
                   
(35,735
)
                   
(34,544
)
               
     
3,616,033
                     
3,488,771
                     
3,387,906
                 
Nonearning assets:
                                                                       
Cash and due from banks
   
50,946
                     
53,641
                     
55,658
                 
Premises and equipment, net
   
48,138
                     
49,103
                     
50,923
                 
Other assets
   
205,140
                     
198,767
                     
185,044
                 
Total assets
 
$
3,920,257
                   
$
3,790,282
                   
$
3,679,531
                 
                                                                         
Interest bearing liabilities:
                                                                       
Deposits:
                                                                       
Savings and demand deposits
 
$
1,088,291
   
$
2,566
     
0.24
%
 
$
1,018,866
   
$
2,299
     
0.23
%
 
$
956,389
   
$
2,141
     
0.22
%
Time deposits
   
1,203,081
     
8,355
     
0.69
     
1,217,225
     
7,317
     
0.60
     
1,291,896
     
7,657
     
0.59
 
Repurchase agreements and  federal funds purchased
   
262,361
     
1,155
     
0.44
     
256,091
     
938
     
0.37
     
233,431
     
841
     
0.36
 
Advances from Federal Home Loan Bank
   
14,410
     
62
     
0.43
     
15,821
     
49
     
0.31
     
4,210
     
27
     
0.64
 
Long-term debt
   
61,341
     
1,417
     
2.31
     
61,341
     
1,170
     
1.91
     
61,341
     
1,131
     
1.84
 
Total interest bearing liabilities
   
2,629,484
   
$
13,555
     
0.52
%
   
2,569,344
   
$
11,773
     
0.46
%
   
2,547,267
   
$
11,797
     
0.46
%
                                                                         
Noninterest bearing liabilities:
                                                                       
Demand deposits
   
758,555
                     
720,508
                     
660,833
                 
Other liabilities
   
37,820
                     
34,748
                     
36,141
                 
Total liabilities
   
3,425,859
                     
3,324,600
                     
3,244,241
                 
                                                                         
Shareholders’ equity
   
494,398
                     
465,682
                     
435,290
                 
Total liabilities and shareholders’ equity
 
$
3,920,257
                   
$
3,790,282
                   
$
3,679,531
                 
                                                                         
Net interest income, tax equivalent
         
$
135,076
                   
$
134,274
                   
$
134,003
         
Less tax equivalent interest income
           
2,055
                     
2,027
                     
1,933
         
Net interest income
         
$
133,021
                   
$
132,247
                   
$
132,070
         
Net interest spread
                   
3.55
%
                   
3.68
%
                   
3.80
%
Benefit of interest free funding
                   
0.15
                     
0.13
                     
0.12
 
Net interest margin
                   
3.70
%
                   
3.81
%
                   
3.92
%

(1) Interest includes fees on loans of $1,717, $1,782, and $1,848 in 2016, 2015, and 2014, respectively.
(2) Loan balances include deferred loan origination costs and principal balances on nonaccrual loans.
(3) Tax exempt income on securities and loans is reported on a fully taxable equivalent basis using a 35% rate.

Net Interest Differential

The following table illustrates the approximate effect of volume and rate changes on net interest differentials between 2016 and 2015 and also between 2015 and 2014.

   
Total Change
   
Change Due to
   
Total Change
   
Change Due to
 
(in thousands)
   
2016/2015
   
Volume
   
Rate
     
2015/2014
   
Volume
   
Rate
 
Interest income:
                                       
Loans
 
$
3,151
   
$
5,760
   
$
(2,609
)
 
$
2,375
   
$
7,141
   
$
(4,766
)
Loans held for sale
   
6
     
(24
)
   
30
     
21
     
11
     
10
 
U.S. Treasury and agencies
   
(756
)
   
(10
)
   
(746
)
   
(1,877
)
   
(572
)
   
(1,305
)
Tax exempt state and political subdivisions
   
20
     
(93
)
   
113
     
199
     
244
     
(45
)
Other securities
   
(132
)
   
(176
)
   
44
     
(284
)
   
(220
)
   
(64
)
Federal Reserve Bank and Federal Home Loan Bank stock
   
1
     
0
     
1
     
(126
)
   
(57
)
   
(69
)
Federal funds sold
   
6
     
(1
)
   
7
     
(2
)
   
(2
)
   
0
 
Interest bearing deposits
   
319
     
52
     
267
     
(29
)
   
(32
)
   
3
 
Other investments
   
(39
)
   
(35
)
   
(4
)
   
(31
)
   
(29
)
   
(2
)
Investment in unconsolidated subsidiaries
   
8
     
0
     
8
     
1
     
0
     
1
 
Total interest income
   
2,584
     
5,473
     
(2,889
)
   
247
     
6,484
     
(6,237
)
                                                 
Interest expense:
                                               
Savings and demand deposits
   
267
     
161
     
106
     
158
     
141
     
17
 
Time deposits
   
1,038
     
(84
)
   
1,122
     
(340
)
   
(438
)
   
98
 
Repurchase agreements and federal funds purchased
   
217
     
23
     
194
     
97
     
83
     
14
 
Advances from Federal Home Loan Bank
   
13
     
(4
)
   
17
     
22
     
42
     
(20
)
Long-term debt
   
247
     
0
     
247
     
39
     
0
     
39
 
Total interest expense
   
1,782
     
96
     
1,686
     
(24
)
   
(172
)
   
148
 
                                                 
Net interest income
 
$
802
   
$
5,377
   
$
(4,575
)
 
$
271
   
$
6,656
   
$
(6,385
)

For purposes of the above table, changes which are due to both rate and volume are allocated based on a percentage basis, using the absolute values of rate and volume variance as a basis for percentages.  Income is stated at a fully taxable equivalent basis, assuming a 35% tax rate.

Investment Portfolio

The maturity distribution and weighted average interest rates of securities at December 31, 2016 are as follows:

Available-for-sale

   
Estimated Maturity at December 31, 2016
 
   
Within 1 Year
   
1-5 Years
   
5-10 Years
   
After 10 Years
   
Total Fair Value
   
Amortized Cost
 
(in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
 
U.S. Treasury, government agencies, and government sponsored agency mortgage-backed securities
 
$
101,616
     
0.79
%
 
$
95,908
     
1.66
%
 
$
85,877
     
1.71
%
 
$
164,119
     
1.93
%
 
$
447,520
     
1.57
%
 
$
450,588
 
State and political subdivisions
   
2,800
     
2.99
     
44,225
     
3.66
     
46,283
     
4.33
     
40,208
     
4.36
     
133,516
     
4.09
     
133,351
 
Other securities
   
0
     
0.00
     
0
     
0.00
     
0
     
0.00
     
24,358
     
2.28
     
24,358
     
2.28
     
25,000
 
Total
 
$
104,416
     
0.85
%
 
$
140,133
     
2.29
%
 
$
132,160
     
2.63
%
 
$
228,685
     
2.40
%
 
$
605,394
     
2.15
%
 
$
608,939
 

Held-to-maturity

   
Estimated Maturity at December 31, 2016
 
   
Within 1 Year
   
1-5 Years
   
5-10 Years
   
After 10 Years
   
Total
Amortized Cost
   
Fair
Value
 
(in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
 
U.S. Treasury, government agencies, and government sponsored agency mortgage-backed securities
 
$
0
     
0.00
%
 
$
0
     
0.00
%
 
$
0
     
0.00
%
 
$
0
     
0.00
%
 
$
0
     
0.00
%
 
$
0
 
State and political subdivisions
   
0
     
0.00
     
866
     
4.30
     
0
     
0.00
     
0
     
0.00
     
866
     
4.30
     
867
 
Total
 
$
0
     
0.00
%
 
$
866
     
4.30
%
 
$
0
     
0.00
%
 
$
0
     
0.00
%
 
$
866
     
4.30
%
 
$
867
 

Total Securities

   
Estimated Maturity at December 31, 2016
 
   
Within 1 Year
   
1-5 Years
   
5-10 Years
   
After 10 Years
   
Total
Book Value
   
Fair
Value
 
(in thousands)
 
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
   
Yield
   
Amount
 
Total
 
$
104,416
     
0.85
%
 
$
140,999
     
2.30
%
 
$
132,160
     
2.63
%
 
$
228,685
     
2.40
%
 
$
606,260
     
2.16
%
 
$
606,261
 

The calculations of the weighted average interest rates for each maturity category are based upon yield weighted by the respective costs of the securities.  The weighted average rates on state and political subdivisions are computed on a taxable equivalent basis using a 35% tax rate.

Excluding those holdings of the investment portfolio in U.S. Treasury securities, government agencies, and government sponsored agency mortgage-backed securities, there were no securities of any one issuer that exceeded 10% of our shareholders’ equity at December 31, 2016.

The book values of securities available-for-sale and securities held-to-maturity as of December 31, 2016 and 2015 are presented in note 3 to the consolidated financial statements.

The book value of securities at December 31, 2014 is presented below:

(in thousands)
 
Available-for-Sale
   
Held-to-Maturity
 
U.S. Treasury and government agencies
 
$
190,563
   
$
480
 
State and political subdivisions
   
133,951
     
1,182
 
U.S. government sponsored agency mortgage-backed securities
   
288,881
     
0
 
Total debt securities
   
613,395
     
1,662
 
CRA investment funds
   
25,000
     
0
 
Total securities
 
$
638,395
   
$
1,662
 

Loan Portfolio

(in thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
Commercial:
                             
Construction
 
$
66,998
   
$
78,020
   
$
121,942
   
$
110,779
   
$
119,447
 
Secured by real estate
   
1,085,428
     
1,052,919
     
948,626
     
872,542
     
807,213
 
Equipment lease financing
   
5,512
     
8,514
     
10,344
     
8,840
     
9,246
 
Commercial other
   
350,159
     
358,898
     
352,048
     
374,881
     
376,348
 
Total commercial
   
1,508,097
     
1,498,351
     
1,432,960
     
1,367,042
     
1,312,254
 
                                         
Residential:
                                       
Real estate construction
   
57,966
     
61,750
     
62,412
     
56,075
     
55,041
 
Real estate mortgage
   
702,969
     
707,874
     
712,465
     
697,601
     
696,928
 
Home equity
   
91,511
     
89,450
     
88,335
     
84,880
     
82,292
 
Total residential
   
852,446
     
859,074
     
863,212
     
838,556
     
834,261
 
                                         
Consumer:
                                       
Consumer direct
   
133,093
     
126,406
     
122,136
     
122,215
     
122,581
 
Consumer indirect
   
444,735
     
390,130
     
315,516
     
287,541
     
281,477
 
Total consumer
   
577,828
     
516,536
     
437,652
     
409,756
     
404,058
 
                                         
Total loans
 
$
2,938,371
   
$
2,873,961
   
$
2,733,824
   
$
2,615,354
   
$
2,550,573
 
                                         
Percent of total year-end loans
                                       
Commercial:
                                       
Construction
   
2.28
%
   
2.71
%
   
4.46
%
   
4.24
%
   
4.68
%
Secured by real estate
   
36.94
     
36.64
     
34.70
     
33.36
     
31.65
 
Equipment lease financing
   
0.18
     
0.30
     
0.38
     
0.34
     
0.36
 
Commercial other
   
11.92
     
12.49
     
12.88
     
14.33
     
14.76
 
Total commercial
   
51.32
     
52.14
     
52.42
     
52.27
     
51.45
 
                                         
Residential:
                                       
Real estate construction
   
1.97
     
2.15
     
2.28
     
2.15
     
2.16
 
Real estate mortgage
   
23.93
     
24.63
     
26.06
     
26.67
     
27.32
 
Home equity
   
3.11
     
3.11
     
3.23
     
3.25
     
3.23
 
Total residential
   
29.01
     
29.89
     
31.57
     
32.07
     
32.71
 
                                         
Consumer:
                                       
Consumer direct
   
4.53
     
4.40
     
4.47
     
4.67
     
4.80
 
Consumer indirect
   
15.14
     
13.57
     
11.54
     
10.99
     
11.04
 
Total consumer
   
19.67
     
17.97
     
16.01
     
15.66
     
15.84
 
                                         
Total loans
   
100.00
%
   
100.00
%
   
100.00
%
   
100.00
%
   
100.00
%

The total loans above are net of deferred loan fees and costs.

The following table shows the amounts of loans (excluding residential mortgages of 1-4 family residences, consumer loans and lease financing) which, based on the remaining scheduled repayments of principal are due in the periods indicated.  Also, the amounts are classified according to sensitivity to changes in interest rates (fixed, variable).

   
Maturity at December 31, 2016
 
(in thousands)
 
Within One Year
   
After One but Within Five Years
   
After Five Years
   
Total
 
Commercial secured by real estate and commercial other
 
$
203,129
   
$
211,021
   
$
1,021,437
   
$
1,435,587
 
Commercial and real estate construction
   
78,507
     
18,358
     
28,099
     
124,964
 
   
$
281,636
   
$
229,379
   
$
1,049,536
   
$
1,560,551
 
                                 
Rate sensitivity:
                               
Fixed rate
 
$
70,554
   
$
72,075
   
$
25,355
   
$
167,984
 
Adjustable rate
   
211,082
     
157,304
     
1,024,181
     
1,392,567
 
   
$
281,636
   
$
229,379
   
$
1,049,536
   
$
1,560,551
 

Nonperforming Assets

(in thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
Nonaccrual loans
 
$
16,623
   
$
16,563
   
$
20,971
   
$
19,958
   
$
16,791
 
90 days or more past due and still accruing interest
   
10,847
     
12,046
     
17,985
     
23,599
     
19,215
 
Total nonperforming loans
   
27,470
     
28,609
     
38,956
     
43,557
     
36,006
 
                                         
Other repossessed assets
   
103
     
183
     
90
     
0
     
5
 
Foreclosed properties
   
35,856
     
40,674
     
36,776
     
39,188
     
46,986
 
Total nonperforming assets
 
$
63,429
   
$
69,466
   
$
75,822
   
$
82,745
   
$
82,997
 
                                         
Nonperforming assets to total loans and foreclosed properties
   
2.13
%
   
2.38
%
   
2.74
%
   
3.12
%
   
3.20
%
Allowance to nonperforming loans
   
130.81
%
   
126.16
%
   
88.43
%
   
78.08
%
   
92.33
%

Nonaccrual and Past Due Loans

(in thousands)
 
Nonaccrual loans
   
As a % of Loan Balances by Category
   
Accruing Loans Past Due 90 Days or More
   
As a % of Loan Balances by Category
   
Balances
 
December 31, 2016
                             
Commercial construction
 
$
1,912
     
2.85
%
 
$
28
     
0.04
%
 
$
66,998
 
Commercial secured by real estate
   
6,326
     
0.58
     
3,015
     
0.28
     
1,085,428
 
Equipment lease financing
   
0
     
0.00
     
0
     
0.00
     
5,512
 
Commercial other
   
1,559
     
0.45
     
141
     
0.04
     
350,159
 
Real estate construction
   
11
     
0.02
     
152
     
0.26
     
57,966
 
Real estate mortgage
   
6,260
     
0.89
     
6,295
     
0.90
     
702,969
 
Home equity
   
555
     
0.61
     
467
     
0.51
     
91,511
 
Consumer direct
   
0
     
0.00
     
68
     
0.05
     
133,093
 
Consumer indirect
   
0
     
0.00
     
681
     
0.15
     
444,735
 
Total
 
$
16,623
     
0.57
%
 
$
10,847
     
0.37
%
 
$
2,938,371
 
                                         
December 31, 2015
                                       
Commercial construction
 
$
3,402
     
4.36
%
 
$
30
     
0.04
%
 
$
78,020
 
Commercial secured by real estate
   
5,928
     
0.56
     
3,757
     
0.36
     
1,052,919
 
Equipment lease financing
   
0
     
0.00
     
0
     
0.00
     
8,514
 
Commercial other
   
1,485
     
0.41
     
310
     
0.09
     
358,898
 
Real estate construction
   
249
     
0.40
     
55
     
0.09
     
61,750
 
Real estate mortgage
   
5,206
     
0.74
     
6,925
     
0.98
     
707,874
 
Home equity
   
183
     
0.20
     
448
     
0.50
     
89,450
 
Consumer direct
   
110
     
0.09
     
126
     
0.10
     
126,406
 
Consumer indirect
   
0
     
0.00
     
395
     
0.10
     
390,130
 
Total
 
$
16,563
     
0.58
%
 
$
12,046
     
0.42
%
 
$
2,873,961
 

Discussion of the Nonaccrual Policy

The accrual of interest income on loans is discontinued when management believes, after considering economic and business conditions, collateral value, and collection efforts, that the borrower’s financial condition is such that the collection of interest is doubtful.  Cash payments received on nonaccrual loans generally are applied against principal, and interest income is only recorded once principal recovery is reasonably assured.  Any loans greater than 90 days past due must be well secured and in the process of collection to continue accruing interest.  See note 1 for further discussion on our nonaccrual policy.

Potential Problem Loans

Interest accrual is discontinued when we believe, after considering economic and business conditions, collateral value, and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful.

Foreign Outstandings

None

Loan Concentrations

We had no concentration of loans exceeding 10% of total loans at December 31, 2016.  See note 19 to the consolidated financial statements for further information.

Analysis of the Allowance for Loan and Lease Losses

 (in thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
Allowance for loan and lease losses, beginning of year
 
$
36,094
   
$
34,447
   
$
34,008
   
$
33,245
   
$
33,171
 
Loans charged off:
                                       
Commercial construction
   
(316
)
   
(3
)
   
(15
)
   
(1,135
)
   
(1,034
)
Commercial secured by real estate
   
(1,641
)
   
(1,379
)
   
(2,163
)
   
(1,607
)
   
(2,035
)
Commercial other
   
(2,136
)
   
(1,961
)
   
(3,141
)
   
(2,265
)
   
(3,233
)
Real estate construction
   
(192
)
   
(135
)
   
(123
)
   
(89
)
   
(189
)
Real estate mortgage
   
(1,043
)
   
(1,421
)
   
(1,058
)
   
(744
)
   
(1,123
)
Home equity
   
(54
)
   
(129
)
   
(115
)
   
(241
)
   
(248
)
Consumer direct
   
(1,236
)
   
(1,306
)
   
(1,326
)
   
(1,166
)
   
(1,245
)
Consumer indirect
   
(5,050
)
   
(3,536
)
   
(3,495
)
   
(3,802
)
   
(3,483
)
Total charge-offs
   
(11,668
)
   
(9,870
)
   
(11,436
)
   
(11,049
)
   
(12,590
)
                                         
Recoveries of loans previously charged off:
                                       
Commercial construction
   
36
     
13
     
28
     
309
     
35
 
Commercial secured by real estate
   
178
     
60
     
305
     
163
     
303
 
Commercial other
   
439
     
585
     
621
     
557
     
764
 
Real estate construction
   
7
     
4
     
2
     
4
     
28
 
Real estate mortgage
   
101
     
117
     
40
     
56
     
151
 
Home equity
   
9
     
54
     
5
     
11
     
11
 
Consumer direct
   
615
     
435
     
566
     
495
     
538
 
Consumer indirect
   
2,250
     
1,599
     
1,553
     
1,649
     
1,384
 
Total recoveries
   
3,635
     
2,867
     
3,120
     
3,244
     
3,214
 
                                         
Net charge-offs:
                                       
Commercial construction
   
(280
)
   
10
     
13
     
(826
)
   
(999
)
Commercial secured by real estate
   
(1,463
)
   
(1,319
)
   
(1,858
)
   
(1,444
)
   
(1,732
)
Commercial other
   
(1,697
)
   
(1,376
)
   
(2,520
)
   
(1,708
)
   
(2,469
)
Real estate construction
   
(185
)
   
(131
)
   
(121
)
   
(85
)
   
(161
)
Real estate mortgage
   
(942
)
   
(1,304
)
   
(1,018
)
   
(688
)
   
(972
)
Home equity
   
(45
)
   
(75
)
   
(110
)
   
(230
)
   
(237
)
Consumer direct
   
(621
)
   
(871
)
   
(760
)
   
(671
)
   
(707
)
Consumer indirect
   
(2,800
)
   
(1,937
)
   
(1,942
)
   
(2,153
)
   
(2,099
)
Total net charge-offs
   
(8,033
)
   
(7,003
)
   
(8,316
)
   
(7,805
)
   
(9,376
)
                                         
Provisions charged against operations
   
7,872
     
8,650
     
8,755
     
8,568
     
9,450
 
                                         
Balance, end of year
 
$
35,933
   
$
36,094
   
$
34,447
   
$
34,008
   
$
33,245
 
                                         
Allocation of allowance, end of year:
                                       
Commercial construction
 
$
884
   
$
2,199
   
$
2,896
   
$
3,396
   
$
4,033
 
Commercial secured by real estate
   
14,191
     
14,434
     
13,618
     
14,535
     
13,541
 
Equipment lease financing
   
42
     
79
     
119
     
121
     
126
 
Commercial other
   
4,656
     
4,225
     
4,263
     
5,238
     
5,469
 
Real estate construction
   
629
     
550
     
534
     
397
     
376
 
Real estate mortgage
   
6,027
     
6,678
     
6,094
     
4,939
     
4,767
 
Home equity
   
774
     
839
     
756
     
601
     
563
 
Consumer direct
   
1,885
     
1,594
     
1,574
     
1,127
     
1,102
 
Consumer indirect
   
6,845
     
5,496
     
4,593
     
3,654
     
3,268
 
Balance, end of year
 
$
35,933
   
$
36,094
   
$
34,447
   
$
34,008
   
$
33,245
 
                                         
Average loans outstanding, net of deferred loan costs and fees
 
$
2,916,031
   
$
2,791,871
   
$
2,642,231
   
$
2,579,805
   
$
2,549,459
 
Loans outstanding at end of year, net of deferred loan costs and fees
 
$
2,938,371
   
$
2,873,961
   
$
2,733,824
   
$
2,615,354
   
$
2,550,573
 
                                         
Net charge-offs to average loan type:
                                       
Commercial construction
   
0.40
%
   
(0.01
)%
   
(0.01
)%
   
0.77
%
   
0.86
%
Commercial secured by real estate
   
0.14
     
0.13
     
0.21
     
0.17
     
0.21
 
Commercial other
   
0.47
     
0.39
     
0.70
     
0.46