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Section 1: 10-Q (10-Q)

Document
 

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 
 
 
FORM 10-Q
 
 
 

(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018
 
or

o         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 001-31567
 
 395660187_g119311bai001a12.jpg

CENTRAL PACIFIC FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
 
Hawaii
 
99-0212597
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
220 South King Street, Honolulu, Hawaii 96813
(Address of principal executive offices) (Zip Code)
 
(808) 544-0500
(Registrant's telephone number, including area code)
 
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 ý  No o
 
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.:
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act . o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
 
The number of shares outstanding of registrant's common stock, no par value, on October 26, 2018 was 29,172,431 shares.
 


 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
Form 10-Q
 
Table of Contents
 
Page
 
 
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

 

PART I.   FINANCIAL INFORMATION
 
Forward-Looking Statements
 
This document may contain forward-looking statements concerning: projections of revenues, income/loss, earnings/loss per share, capital expenditures, dividends, capital structure, net interest margin or other financial items, plans and objectives of management for future operations, future economic performance, or any of the assumptions underlying or relating to any of the foregoing. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts, and may include the words "believes," "plans," "intends," "expects," "anticipates," "forecasts," "hopes," "should," "estimates" or words of similar meaning. While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties, and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons, to include, but not be limited to: adverse changes in the financial performance and/or condition of our borrowers and, as a result, increased loan delinquency rates, deterioration in asset quality, and losses in our loan portfolio; the impact of local, national, and international economies and events (including natural disasters such as volcanoes, wildfires, tsunamis, storms and earthquakes) on the Company's business and operations and on tourism, the military, and other major industries operating within the Hawaii market and any other markets in which the Company does business; deterioration or malaise in domestic economic conditions, including any destabilization in the financial industry and deterioration of the real estate market, as well as the impact of declining levels of consumer and business confidence in the state of the economy in general and in financial institutions in particular; changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, changes in capital standards, other regulatory reform, including but not limited to regulations promulgated by the Consumer Financial Protection Bureau, government-sponsored enterprise reform, and any related rules and regulations on our business operations and competitiveness; the costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the effect of, and our ability to comply with, any regulatory orders or actions we are or may become subject to; ability to successfully implement our initiatives to lower our efficiency ratio; the ability to address any material weakness in our internal controls over financial reporting or disclosure controls and procedures; the effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, securities market and monetary fluctuations; negative trends in our market capitalization and adverse changes in the price of the Company's common stock; political instability; acts of war or terrorism; changes in consumer spending, borrowings and savings habits; failure to maintain effective internal control over financial reporting or disclosure controls and procedures; technological changes; changes in the competitive environment among financial holding companies and other financial service providers; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; our ability to attract and retain key personnel; changes in our organization, compensation and benefit plans; and our success at managing the risks involved in the foregoing items. For further information on factors that could cause actual results to materially differ from projections, please see the Company's publicly available Securities and Exchange Commission filings, including the Company's Form 10-K for the last fiscal year and, in particular, the discussion of "Risk Factors" set forth therein. The Company does not update any of its forward-looking statements except as required by law.


3

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
(dollars in thousands)
September 30,
2018
 
December 31,
2017
Assets
 

 
 

Cash and due from banks
$
82,668

 
$
75,318

Interest-bearing deposits in other banks
7,051

 
6,975

Investment securities:
 
 
 
Available-for-sale debt securities, at fair value
1,233,002

 
1,304,066

Held-to-maturity debt securities, at amortized cost; fair value of: $146,466 at September 30, 2018 and $189,201 at December 31, 2017
152,852

 
191,753

Equity securities, at fair value
885

 
825

Total investment securities
1,386,739

 
1,496,644

 
 
 
 
Loans held for sale
4,460

 
16,336

 
 
 
 
Loans and leases
3,978,027

 
3,770,615

Allowance for loan and lease losses
(46,826
)
 
(50,001
)
Net loans and leases
3,931,201

 
3,720,614

 
 
 
 
Premises and equipment, net
46,184

 
48,348

Accrued interest receivable
16,755

 
16,581

Investment in unconsolidated subsidiaries
15,283

 
7,088

Other real estate owned
414

 
851

Mortgage servicing rights
15,634

 
15,843

Core deposit premium

 
2,006

Bank-owned life insurance
157,085

 
156,293

Federal Home Loan Bank stock
10,965

 
7,761

Other assets
54,201

 
53,050

Total assets
$
5,728,640

 
$
5,623,708

 
 
 
 
Liabilities
 

 
 

Deposits:
 

 
 

Noninterest-bearing demand
$
1,403,534

 
$
1,395,556

Interest-bearing demand
935,130

 
933,054

Savings and money market
1,503,465

 
1,481,876

Time
1,161,551

 
1,145,868

Total deposits
5,003,680

 
4,956,354

 
 
 
 
Short-term borrowings
105,000

 
32,000

Long-term debt
92,785

 
92,785

Other liabilities
49,024

 
42,534

Total liabilities
5,250,489

 
5,123,673

 
 
 
 
Equity
 

 
 

Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding: none at September 30, 2018 and December 31, 2017

 

Common stock, no par value, authorized 185,000,000 shares; issued and outstanding: 29,270,398 at September 30, 2018 and 30,024,222 at December 31, 2017
478,721

 
503,988

Additional paid-in capital
87,939

 
86,098

Accumulated deficit
(61,406
)
 
(89,036
)
Accumulated other comprehensive income (loss)
(27,103
)
 
(1,039
)
Total shareholders' equity
478,151

 
500,011

Non-controlling interest

 
24

Total equity
478,151

 
500,035

Total liabilities and equity
$
5,728,640

 
$
5,623,708

See accompanying notes to consolidated financial statements.

4

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands, except per share data)
2018
 
2017
 
2018
 
2017
Interest income:
 

 
 

 
 

 
 

Interest and fees on loans and leases
$
40,531

 
$
36,289

 
$
116,620

 
$
106,777

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable interest
8,490

 
8,540

 
26,050

 
25,156

Tax-exempt interest
920

 
966

 
2,786

 
2,919

Dividends
26

 
12

 
44

 
36

Interest on deposits in other banks
109

 
163

 
310

 
298

Dividends on Federal Home Loan Bank stock
60

 
23

 
145

 
100

Total interest income
50,136

 
45,993

 
145,955

 
135,286

Interest expense:
 

 
 

 
 

 
 

Interest on deposits:
 

 
 

 
 

 
 

Demand
181

 
177

 
554

 
471

Savings and money market
593

 
281

 
1,421

 
797

Time
4,744

 
2,637

 
12,203

 
6,490

Interest on short-term borrowings
146

 
9

 
237

 
86

Interest on long-term debt
1,147

 
894

 
3,221

 
2,563

Total interest expense
6,811

 
3,998

 
17,636

 
10,407

Net interest income
43,325

 
41,995

 
128,319

 
124,879

Provision (credit) for loan and lease losses
(59
)
 
(126
)
 
262

 
(2,488
)
Net interest income after provision (credit) for loan and lease losses
43,384

 
42,121

 
128,057

 
127,367

Other operating income:
 

 
 

 
 

 
 

Mortgage banking income
1,923

 
1,531

 
5,545

 
5,431

Service charges on deposit accounts
2,189

 
2,182

 
6,169

 
6,338

Other service charges and fees
3,286

 
3,185

 
9,697

 
8,986

Income from fiduciary activities
1,159

 
911

 
3,132

 
2,739

Equity in earnings of unconsolidated subsidiaries
71

 
176

 
151

 
388

Fees on foreign exchange
220

 
101

 
708

 
394

Investment securities gains (losses)

 

 

 
(1,640
)
Income from bank-owned life insurance
1,055

 
1,074

 
1,874

 
2,774

Loan placement fees
115

 
86

 
532

 
366

Net gain on sales of foreclosed assets

 
19

 

 
205

Other
802

 
304

 
1,596

 
1,472

Total other operating income
10,820

 
9,569

 
29,404

 
27,453

Other operating expense:
 

 
 

 
 

 
 

Salaries and employee benefits
19,011

 
18,157

 
56,299

 
53,527

Net occupancy
3,488

 
3,404

 
10,114

 
10,153

Equipment
1,048

 
969

 
3,160

 
2,778

Amortization of core deposit premium
669

 
669

 
2,006

 
2,006

Communication expense
903

 
944

 
2,547

 
2,735

Legal and professional services
1,528

 
1,854

 
5,118

 
5,633

Computer software expense
2,672

 
2,346

 
7,244

 
6,788

Advertising expense
612

 
626

 
1,841

 
1,408

Foreclosed asset expense
212

 
24

 
537

 
123

Other
3,996

 
4,518

 
12,515

 
12,155

Total other operating expense
34,139

 
33,511

 
101,381

 
97,306

Income before income taxes
20,065

 
18,179

 
56,080

 
57,514

Income tax expense
4,872

 
6,367

 
12,386

 
20,598

Net income
$
15,193

 
$
11,812

 
$
43,694

 
$
36,916

Per common share data:
 

 
 

 
 

 
 

Basic earnings per common share
$
0.52

 
$
0.39

 
$
1.48

 
$
1.21

Diluted earnings per common share
$
0.52

 
$
0.39

 
$
1.47

 
$
1.20

Cash dividends declared
$
0.21

 
$
0.18

 
$
0.61

 
$
0.52

Weighted average common shares outstanding used in computation:
 
 
 
 
 
 
 
Basic shares
29,297,465

 
30,300,195

 
29,536,536

 
30,526,260

Diluted shares
29,479,812

 
30,514,459

 
29,743,238

 
30,758,989

 See accompanying notes to consolidated financial statements.

5

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
15,193

 
$
11,812

 
$
43,694

 
$
36,916

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Net change in unrealized gain (loss) on investment securities
 
(6,072
)
 
(293
)
 
(24,712
)
 
4,626

Defined benefit plans
 
217

 
285

 
623

 
111

Total other comprehensive income (loss), net of tax
 
(5,855
)
 
(8
)
 
(24,089
)
 
4,737

Comprehensive income
 
$
9,338

 
$
11,804

 
$
19,605

 
$
41,653

 
See accompanying notes to consolidated financial statements.

6

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
 
 
Common
Shares
Outstanding
 
Preferred
Stock
 
Common
Stock
 
Additional Paid-In Capital
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Non-
Controlling
Interest
 
Total
 
(dollars in thousands, except per share data)
Balance at December 31, 2017
30,024,222

 
$

 
$
503,988

 
$
86,098

 
$
(89,036
)
 
$
(1,039
)
 
$
24

 
$
500,035

Impact of the adoption of new accounting standards (1)

 

 

 

 
139

 
(139
)
 

 

Adjusted balance at January 1, 2018
30,024,222

 

 
503,988

 
86,098

 
(88,897
)
 
(1,178
)
 
24

 
500,035

Impact of the adoption of new accounting standards (2)

 

 

 

 
1,836

 
(1,836
)
 

 

Net income

 

 

 

 
43,694

 

 

 
43,694

Other comprehensive loss

 

 

 

 

 
(24,089
)
 

 
(24,089
)
Cash dividends ($0.61 per share)

 

 

 

 
(18,039
)
 

 

 
(18,039
)
16,950 net shares of common stock purchased by directors' deferred compensation plan

 

 
(504
)
 

 

 

 

 
(504
)
849,290 shares of common stock repurchased and retired and other related costs
(849,290
)
 

 
(24,763
)
 


 

 

 

 
(24,763
)
Share-based compensation
95,466

 

 

 
1,841

 

 

 

 
1,841

Distribution from variable interest entity

 

 

 

 

 

 
(24
)
 
(24
)
Balance at September 30, 2018
29,270,398

 
$

 
$
478,721

 
$
87,939

 
$
(61,406
)
 
$
(27,103
)
 
$

 
$
478,151

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
30,796,243

 
$

 
$
530,932

 
$
84,180

 
$
(108,941
)
 
$
(1,521
)
 
$
25

 
$
504,675

Net income

 

 

 

 
36,916

 

 

 
36,916

Other comprehensive income

 

 

 

 

 
4,737

 

 
4,737

Cash dividends ($0.52 per share)

 

 

 

 
(15,888
)
 

 

 
(15,888
)
12,020 net shares of common stock purchased by directors' deferred compensation plan

 

 
(385
)
 

 

 

 

 
(385
)
697,483 shares of common stock repurchased and retired and other related costs
(697,483
)
 

 
(21,304
)
 

 

 

 

 
(21,304
)
Share-based compensation
89,988

 

 

 
1,120

 

 

 

 
1,120

Net loss from variable interest entity

 

 

 

 

 

 
(1
)
 
(1
)
Balance at September 30, 2017
30,188,748

 
$

 
$
509,243

 
$
85,300

 
$
(87,913
)
 
$
3,216

 
$
24

 
$
509,870

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Represents the impact of the adoption of Accounting Standards Update ("ASU") ASU 2016-01. See Notes 1 and 2 to the consolidated financial statements for additional information.
(2) Represents the impact of the adoption of ASU 2018-02. See Note 2 to the consolidated financial statements for additional information.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.

7

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Nine Months Ended
September 30,
(dollars in thousands)
2018
 
2017
Cash flows from operating activities:
 

 
 

Net income
$
43,694

 
$
36,916

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 

Provision (credit) for loan and lease losses
262

 
(2,488
)
Depreciation and amortization of premises and equipment
4,700

 
4,768

Gain or loss on sale of other real estate, net of write-downs
431

 
(192
)
Amortization of core deposit premium and mortgage servicing rights
3,419

 
3,549

Net amortization and accretion of premium/discounts on investment securities
8,465

 
8,960

Share-based compensation expense
1,841

 
1,120

Net loss on sales of investment securities

 
1,640

Net gain on sales of residential mortgage loans
(3,013
)
 
(3,101
)
Proceeds from sales of loans held for sale
183,967

 
249,866

Originations of loans held for sale
(169,078
)
 
(225,712
)
Equity in earnings of unconsolidated subsidiaries
(151
)
 
(388
)
Net increase in cash surrender value of bank-owned life insurance
(792
)
 
(3,256
)
Deferred income taxes
12,201

 
19,984

Net tax benefits from share-based compensation
185

 
614

Net change in other assets and liabilities
(7,925
)
 
(15,701
)
Net cash provided by operating activities
78,206

 
76,579

Cash flows from investing activities:
 

 
 

Proceeds from maturities of and calls on investment securities available-for-sale
114,508

 
128,588

Proceeds from sales of investment securities available-for-sale

 
96,019

Purchases of investment securities available-for-sale
(85,334
)
 
(333,242
)
Proceeds from maturities of and calls on investment securities held-to-maturity
38,491

 
19,455

Net loan proceeds (originations)
(190,022
)
 
(63,835
)
Purchases of loan portfolios
(20,867
)
 
(50,725
)
Proceeds from sale of foreclosed loans/other real estate owned
46

 
286

Proceeds from bank-owned life insurance

 
2,921

Net purchases of premises and equipment
(2,536
)
 
(4,849
)
Net return of capital from unconsolidated subsidiaries
614

 
549

Contributions to unconsolidated subsidiaries

 
(4
)
Net (purchases of) proceeds from redemption of FHLB stock
(3,204
)
 
5,088

Net cash used in investing activities
(148,304
)
 
(199,749
)
Cash flows from financing activities:
 

 
 

Net increase in deposits
47,326

 
319,296

Net increase (decrease) in short-term borrowings
73,000

 
(135,000
)
Cash dividends paid on common stock
(18,039
)
 
(15,888
)
Repurchases of common stock and other related costs
(24,763
)
 
(21,304
)
Net cash provided by financing activities
77,524

 
147,104

Net increase (decrease) in cash and cash equivalents
7,426

 
23,934

Cash and cash equivalents at beginning of period
82,293

 
84,341

Cash and cash equivalents at end of period
$
89,719

 
$
108,275

 
 
 
 
Supplemental disclosure of cash flow information:
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
15,969

 
$
9,097

Income taxes
23

 
7,900

Supplemental disclosure of non-cash investing and financing activities:
 
 
 
Net change in common stock held by directors’ deferred compensation plan
504

 
385

Net reclassification of loans to foreclosed loans/other real estate owned
40

 
154

 See accompanying notes to consolidated financial statements.

8

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
 
The accompanying unaudited consolidated financial statements of Central Pacific Financial Corp. and Subsidiaries (herein referred to as the "Company," "we," "us" or "our") have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

These interim condensed consolidated financial statements and notes should be read in conjunction with the Company's consolidated financial statements and notes thereto filed on Form 10-K, as amended by our Form 10-K/A for the fiscal year ended December 31, 2017. In the opinion of management, all adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

In December 2015, we acquired a 50% ownership interest in a mortgage loan origination and brokerage company, One Hawaii HomeLoans, LLC. The bank concluded that the investment meets the consolidation requirements under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 810, "Consolidation." The bank concluded that the entity meets the definition of a variable interest entity and that we are the primary beneficiary of the variable interest entity. Accordingly, the investment was consolidated into our financial statements. One Hawaii HomeLoans, LLC was terminated in 2017, and final payment of taxes and distributions to members was made in March 2018.

We have 50% ownership interests in three other mortgage loan origination and brokerage companies which are accounted for using the equity method and are included in investment in unconsolidated subsidiaries: Gentry HomeLoans, LLC, Haseko HomeLoans, LLC and Island Pacific HomeLoans, LLC. We also had 50% ownership interest in one additional mortgage loan origination and brokerage company, Pacific Access Mortgage, LLC, which was also accounted for using the equity method and was included in investment in unconsolidated subsidiaries. Pacific Access Mortgage, LLC was terminated in 2017, and final payment of taxes and distributions to members was made in March 2018.

We also have non-controlling equity investments in affiliates that are accounted for under the cost method and are included in investment in unconsolidated subsidiaries.

Our investments in unconsolidated subsidiaries accounted for under the equity and cost methods were $0.2 million and $15.1 million, respectively, at September 30, 2018 and $0.6 million and $6.5 million, respectively, at December 31, 2017. Our policy for determining impairment of these investments includes an evaluation of whether a loss in value of an investment is other than temporary. Evidence of a loss in value includes absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. We perform impairment tests whenever indicators of impairment are present. If the value of an investment declines and it is considered other than temporary, the investment is written down to its respective fair value in the period in which this determination is made.

The Company sponsors the Central Pacific Bank Foundation, which is not consolidated in the Company's financial statements.

Reclassifications

The Company's equity investment securities in the prior year have been reclassified from available-for-sale debt securities to conform to the current year's presentation in accordance with Accounting Standards Update ("ASU") 2016-01, "Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Liabilities." The reclassification had no impact on the Company's reported net income or shareholders' equity.

9

 


2.   RECENT ACCOUNTING PRONOUNCEMENTS
 
Accounting Standards Adopted in 2018

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This ASU replaces most existing revenue recognition guidance in GAAP. ASU 2014-09 was initially effective for the Company's reporting period beginning on January 1, 2017. However, in August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" which deferred the effective date by one year. For financial reporting purposes, the standard allows for either a full retrospective or modified retrospective adoption. The FASB has also issued additional updates to provide further clarification to specific implementation issues associated with ASU 2014-09. These updates include ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations," ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing," ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," and ASU 2016-20 "Technical Corrections and Improvements to Topic 606." Our revenue is comprised of net interest income on financial assets and financial liabilities, which is our main source of income, and other operating income. The scope of ASU 2014-09 explicitly excludes net interest income, as well as other revenues associated with financial assets and liabilities, including loans, leases, securities and derivatives. With respect to other operating income, the Company conducted a comprehensive scoping exercise to determine the revenue streams that are in scope of the guidance. This included reviewing the contracts potentially impacted by the standard in revenue streams such as deposit-related fees, merchant fees, bank card fees, interchange fees, commissions income, trust and asset management fees, foreign exchange fees, and loan placement fees. We adopted ASU 2014-09 and all subsequent amendments to the standard beginning January 1, 2018 under the modified retrospective approach. Based on our analysis, the standard required us to change how we recognize certain recurring revenue streams on a gross versus net basis. This resulted in an increase in other service charges and fees totaling $0.2 million and $0.5 million during the three and nine months ended September 30, 2018, respectively, and the resultant increase in other operating expense-other for the same amount. These changes did not have an impact to our net income; as such a cumulative effect adjustment to opening accumulated deficit was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606 while prior period amounts continue to be recorded in accordance with legacy GAAP. Refer to Note 11 - Revenue from Contracts with Customers for further discussion on the Company's accounting policies for revenue sources within the scope of Accounting Standards Codification ("ASC") 606.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Liabilities." The amendments in ASU 2016-01 made targeted improvements to GAAP as follows: 1) required equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, 2) simplified the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, 3) eliminated the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities, 4) eliminated the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, 5) required public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, 6) required an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, 7) required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements, and 8) clarified that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The Company adopted ASU 2016-01 beginning January 1, 2018, which resulted in a reclassification of the Company's equity investment securities portfolio of $0.9 million and $0.8 million as of September 30, 2018 and December 31, 2017, respectively, from available-for-sale debt securities to equity securities on the Company's consolidated balance sheets. Changes in fair value are recognized in net income. In addition, during the first quarter of 2018, the Company recorded a cumulative effect adjustment which increased opening retained earnings (or reduced opening accumulated deficit) and decreased accumulated other comprehensive income (loss) ("AOCI") by $0.1 million related to the unrealized gains on the equity investment securities portfolio and changes in the fair value of the equity investment securities portfolio were recognized in net income. The Company also engaged a third-party consultant, who used a refined calculation to determine the fair value of our loans held for investment portfolio using the exit price notion, which is included in our fair value disclosures in Note 17 - Fair Value of Financial Assets and Liabilities. The refined calculation did not have a material impact on our fair value disclosures.

10

 


In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provided guidance on eight statement of cash flow classification issues and was intended to reduce the current and future diversity in practice described in the amendments. Current GAAP is either unclear or does not include specific guidance on the eight statement of cash flow classification issues included in ASU 2016-15. The Company adopted ASU 2016-15 effective January 1, 2018. The amendments in ASU 2016-15 did not impact the Company's financial statements as our current practice was consistent with the update.

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost." ASU 2017-07 requires an entity to present the service cost component of the net periodic benefit cost in the same line item or items in the statement of income as other employee compensation costs arising from services rendered by the pertinent employees during the period. In addition, only the service cost component is eligible for capitalization. The other components of net benefit costs should be presented in the statement of income separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item is used to present the other components, that line item shall be described appropriately. The line items used in the income statement to present the components other than the service cost component shall be disclosed if a Company elects to not present them in a separate line item. The Company adopted ASU 2017-07 effective January 1, 2018. The amendments in ASU 2017-07 did not impact the Company's financial statements.

In March 2017, the FASB issued ASU 2017-08, "Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities." ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to the earliest call date. ASU 2017-08 does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. Although ASU 2017-08 is effective for the Company's reporting period beginning on January 1, 2019, the Company elected to early adopt the standard effective January 1, 2018. The amendments in ASU 2017-08 did not have a material impact to the Company's financial statements.

In May 2017, the FASB issued ASU 2017-09, "Compensation-Stock Compensation (Topic 718): Scope of Modification." ASU 2017-09 was issued to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation - Stock Compensation, to a change to the terms or conditions of a share-based payment award. Diversity in practice has arisen in part because some entities apply modification accounting under Topic 718 for modifications to terms and conditions that they consider substantive, but do not when they conclude that particular modifications are not substantive. Others apply modification accounting for any change to an award, except for changes that they consider purely administrative in nature. Still others apply modification accounting when a change to an award changes the fair value, the vesting, or the classification of the award. In practice, it appears that the evaluation of a change in fair value, vesting, or classification may be used to evaluate whether a change is substantive. ASU 2017-09 includes guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The Company adopted ASU 2017-09 effective January 1, 2018. The amendments in ASU 2017-09 did not impact the Company's financial statements as the Company has not historically had any scope modifications and has no plans to do so in the near future.

In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." ASU 2018-02 was issued to address certain stranded tax effects in AOCI as a result of H.R.1., commonly referred to as the Tax Cuts and Jobs Act ("Tax Reform"). ASU 2018-02 provides companies the option to reclassify stranded tax effects within AOCI to retained earnings (or accumulated deficit) in each period in which the effect of the change from the newly enacted corporate tax rate is recorded. The amount of the reclassification is calculated on the basis of the difference between the historical and newly enacted tax rates for deferred tax assets and liabilities related to items within AOCI. ASU 2018-02 requires companies to disclose its accounting policy related to releasing income tax effects from accumulated other comprehensive income, whether it has elected to reclassify the stranded tax effects, and information about the other income tax effects that are reclassified. Although ASU 2018-02 is effective for the Company's reporting period beginning on January 1, 2019, the Company elected to early adopt the standard effective January 1, 2018. As a result, the Company recorded cumulative effect adjustments which increased opening retained earnings (or reduced opening accumulated deficit) and decreased AOCI for the stranded tax effects related to the Company's defined benefit pension and supplemental retirement plan obligations and the unrealized loss on the Company's investment securities portfolio by $1.4 million and $0.5 million, respectively.

Impact of Other Recently Issued Accounting Pronouncements on Future Filings

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key

11

 

information about leasing arrangements. The ASU establishes a right-of-use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term of longer than 12 months. The FASB has also made available several practical expedients to assist entities with the adoption of ASU 2016-02. Among other things, these practical expedients require no reassessment of whether existing contracts are or contain leases as well as no reassessment of lease classification for current leases. In July 2018, the FASB released ASU 2018-11, "Leases (Topic 842 Targeted Improvements)," which adds an additional practical expedient that allows entities to elect not to recast comparative periods presented when transitioning to Topic 842. During the quarter ended September 30, 2018, the Company has engaged a software vendor to assist in the implementation of ASU 2016-02 and has completed testing of completeness and accuracy of the lease population. The ASU is effective for the Company's reporting period beginning January 1, 2019 and must be applied using the modified retrospective approach. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements as the projected minimum lease payments under existing leases subject to the ASU are less than one percent of our total assets as of September 30, 2018.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s “incurred loss” guidance delays the recognition of credit losses on loans, leases, held-to-maturity debt securities, loan commitments, and financial guarantees, and instead provides for a current expected credit loss (“CECL”) approach to determine the allowance for credit losses. CECL requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, this guidance modifies the accounting treatment for other-than-temporary impairment for available-for-sale debt securities. Organizations will continue to use judgment to determine which loss estimation methods are appropriate for their circumstances. This guidance requires entities to record a cumulative effect adjustment to the consolidated balance sheet as of the beginning of the first reporting period in which the guidance is effective. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with earlier adoption permitted. As such, the Company will implement CECL for the reporting period beginning January 1, 2020. The new guidance will require significant operational changes, particularly in data collection and analysis.

The Company has formed a steering committee that is responsible for oversight of the Company’s implementation strategy for compliance with provisions of the new standard. The Company has also established a project management governance process to manage the implementation across affected disciplines. An external provider specializing in community bank loss driver and CECL reserving model design as well as other related consulting services has been retained, and we have begun to evaluate potential CECL modeling alternatives. As part of this process, the Company has determined potential loan pool segmentation and sub-segmentation under CECL, as well as evaluated the key economic loss drivers for each segment. Further, the Company has engaged a third party economic forecasting service to utilize in developing the Company's reasonable and supportable forecasts under CECL. The Company presently plans to generate and evaluate model scenarios under CECL in tandem with its current reserving processes for interim and annual reporting periods in 2019. While the Company is currently unable to reasonably estimate the impact of adopting this new guidance, management expects the impact of adoption will be significantly influenced by the composition and quality of the Company’s loans and investment securities as well as the economic conditions as of the date of adoption. The Company also anticipates significant changes to the processes and procedures for calculating the reserve for credit losses and continues to evaluate the potential impact on our consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 was issued to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The FASB believes that such amendments will: 1) improve the transparency of information about an entity’s risk management activities and 2) simplify the application of hedge accounting. The ASU allows an entity that qualifies for the last-of-layer method to reclassify securities from the held-to-maturity category to the available-for-sale category. The ASU is effective for the the Company's reporting period beginning on January 1, 2019. Early adoption is permitted. We are currently in the process of evaluating the potential impact the amendments will have on our consolidated financial statements, but we do not expect the adoption of the ASU to have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement." The ASU is part of the FASB's disclosure framework project to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by generally accepted accounting principles. The ASU modifies disclosure requirements on fair value

12

 

measurements in Topic 820 and is effective for the Company's reporting period beginning January 1, 2020. Early adoption is permitted. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, "Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans." Like ASU 2018-13, this ASU is part of the FASB's disclosure framework project. This ASU modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The ASU is effective for the Company's reporting period beginning January 1, 2021. Early adoption is permitted. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, "Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," which requires an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an “other asset”). The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service. ASU 2018-15 is effective for the Company's reporting period beginning January 1, 2020 and early adoption is permitted. We are currently in the process of evaluating the potential impact the amendments will have on our consolidated financial statements, but we do not expect the adoption of the ASU to have a material impact on our consolidated financial statements.

3. INVESTMENT SECURITIES
 
A summary of our investment portfolio is as follows:
 
(dollars in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
September 30, 2018
 

 
 

 
 

 
 

Held-to-maturity:
 

 
 

 
 

 
 

Mortgage-backed securities:
 

 
 

 
 

 
 

Residential - U.S. Government-sponsored entities
$
87,356

 
$

 
$
(4,339
)
 
$
83,017

Commercial - U.S. Government-sponsored entities
65,496

 

 
(2,047
)
 
63,449

Total held-to-maturity securities
$
152,852

 
$

 
$
(6,386
)
 
$
146,466

 
 
 
 
 
 
 
 
Available-for-sale:
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

States and political subdivisions
$
175,495

 
$
788

 
$
(2,731
)
 
$
173,552

Corporate securities
65,587

 
23

 
(477
)
 
65,133

U.S. Treasury obligations and direct obligations of U.S Government agencies
34,566

 

 
(647
)
 
33,919

Mortgage-backed securities:
 

 
 

 
 

 
 

Residential - U.S. Government-sponsored entities
763,635

 
297

 
(29,575
)
 
734,357

Commercial - U.S. Government agencies and sponsored entities
53,618

 

 
(2,413
)
 
51,205

Residential - Non-government agencies
42,069

 
132

 
(831
)
 
41,370

Commercial - Non-government agencies
134,914

 
321

 
(1,769
)
 
133,466

Total available-for-sale securities
$
1,269,884

 
$
1,561

 
$
(38,443
)
 
$
1,233,002

 
 
 
 
 
 
 
 
Equity securities
$
712

 
$
173

 
$

 
$
885



13

 

(dollars in thousands)
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
December 31, 2017
 

 
 

 
 

 
 

Held-to-maturity:
 

 
 

 
 

 
 

Mortgage-backed securities:
 

 
 

 
 

 
 

Residential - U.S. Government-sponsored entities
$
100,279

 
$
106

 
$
(2,222
)
 
$
98,163

Commercial - U.S. Government-sponsored entities
91,474

 

 
(436
)
 
91,038

Total held-to-maturity securities
$
191,753

 
$
106

 
$
(2,658
)
 
$
189,201

 
 
 
 
 
 
 
 
Available-for-sale:
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

States and political subdivisions
$
178,459

 
$
2,041

 
$
(719
)
 
$
179,781

Corporate securities
73,772

 
582

 
(76
)
 
74,278

U.S. Treasury obligations and direct obligations of U.S Government agencies
25,519

 
60

 
(69
)
 
25,510

Mortgage-backed securities:
 
 
 
 
 
 
 

Residential - U.S. Government-sponsored entities
808,242

 
2,230

 
(9,789
)
 
800,683

Commercial - U.S. Government agencies and sponsored entities
40,012

 

 
(287
)
 
39,725

Residential - Non-government agencies
45,679

 
1,084

 

 
46,763

Commercial - Non-government agencies
135,058

 
2,461

 
(193
)
 
137,326

Total available-for-sale securities
$
1,306,741

 
$
8,458

 
$
(11,133
)
 
$
1,304,066

 
 
 
 
 
 
 
 
Equity securities
$
686

 
$
139

 
$

 
$
825



14

 

The amortized cost and estimated fair value of investment securities at September 30, 2018 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
September 30, 2018
(dollars in thousands)
Amortized Cost
 
Fair Value
Held-to-maturity:
 

 
 

Mortgage-backed securities:
 

 
 

Residential - U.S. Government-sponsored entities
$
87,356

 
$
83,017

Commercial - U.S. Government-sponsored entities
65,496

 
63,449

Total held-to-maturity securities
$
152,852

 
$
146,466

 
 
 
 
Available-for-sale:
 

 
 

Due in one year or less
$
63,878

 
$
63,916

Due after one year through five years
103,852

 
103,115

Due after five years through ten years
50,639

 
49,629

Due after ten years
57,279

 
55,944

 
 
 
 
Mortgage-backed securities:
 
 
 
Residential - U.S. Government-sponsored entities
763,635

 
734,357

Commercial - U.S. Government agencies and sponsored entities
53,618

 
51,205

Residential - Non-government agencies
42,069

 
41,370

Commercial - Non-government agencies
134,914

 
133,466

Total available-for-sale securities
$
1,269,884

 
$
1,233,002

 
 
 
 
Equity securities
$
712

 
$
885

 
We did not sell any available-for-sale securities during the three and nine months ended September 30, 2018.

In the second quarter of 2017, we completed an investment portfolio repositioning strategy designed to enhance potential prospective earnings and improve net interest margin. In connection with the repositioning, we sold $97.7 million in lower-yielding available-for-sale securities, and purchased $97.4 million in higher yielding, longer duration investment securities. The
investment securities sold had an average yield of 1.91%. Gross proceeds of the sale of $96.0 million were immediately reinvested back into investment securities with an average yield of 2.57%. The new securities were classified in the available-for-sale portfolio. There were no gross realized gains on the sale of the investment securities. Gross realized losses on the sale of the investment securities were $1.6 million. The specific identification method was used as the basis for determining the cost of all securities sold.

We did not sell any available-for-sale securities during the three months ended March 31, 2017 and September 30, 2017.

Investment securities of $1.00 billion and $1.08 billion at September 30, 2018 and December 31, 2017, respectively, were pledged to secure public funds on deposit and other long-term debt and short-term borrowings.


15

 

Provided below is a summary of the 379 and 223 investment securities which were in an unrealized or unrecognized loss position at September 30, 2018 and December 31, 2017, respectively, aggregated by major security type and length of time in a continuous unrealized or unrecognized loss position.
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
(dollars in thousands)
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
September 30, 2018
 

 
 

 
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
$
87,069

 
$
(1,225
)
 
$
26,654

 
$
(1,506
)
 
$
113,723

 
$
(2,731
)
Corporate securities
54,275

 
(301
)
 
5,130

 
(176
)
 
59,405

 
(477
)
U.S. Treasury obligations and direct obligations of U.S Government agencies
31,220

 
(602
)
 
2,699

 
(45
)
 
33,919

 
(647
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Residential - U.S. Government-sponsored entities
285,808

 
(7,950
)
 
513,681

 
(25,964
)
 
799,489

 
(33,914
)
Residential - Non-government agencies
24,690

 
(831
)
 

 

 
24,690

 
(831
)
Commercial - U.S. Government agencies and sponsored entities
57,509

 
(1,873
)
 
57,145

 
(2,587
)
 
114,654

 
(4,460
)
Commercial - Non-government agencies
93,778

 
(1,769
)
 

 

 
93,778

 
(1,769
)
Total temporarily impaired securities
$
634,349

 
$
(14,551
)
 
$
605,309

 
$
(30,278
)
 
$
1,239,658

 
$
(44,829
)

 
Less Than 12 Months
 
12 Months or Longer
 
Total
(dollars in thousands)
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
December 31, 2017
 

 
 

 
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

 
 

 
 

States and political subdivisions
$
53,811

 
$
(305
)
 
$
15,403

 
$
(414
)
 
$
69,214

 
$
(719
)
Corporate securities

 

 
5,307

 
(76
)
 
5,307

 
(76
)
U.S. Treasury obligations and direct obligations of U.S Government agencies
10,740

 
(69
)
 

 

 
10,740

 
(69
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 
 

 
 

Residential - U.S. Government-sponsored entities
335,883

 
(3,372
)
 
340,219

 
(8,639
)
 
676,102

 
(12,011
)
Residential - Non-government agencies

 

 

 

 

 

Commercial - U.S. Government-sponsored entities
130,763

 
(723
)
 

 

 
130,763

 
(723
)
Commercial - Non-government agencies
28,490

 
(193
)
 

 

 
28,490

 
(193
)
Total temporarily impaired securities
$
559,687

 
$
(4,662
)
 
$
360,929

 
$
(9,129
)
 
$
920,616

 
$
(13,791
)

Other-Than-Temporary Impairment ("OTTI")
 
Management evaluates investment securities for OTTI on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation, to determine whether the unrealized losses on investment securities, or the decline in their value below amortized cost is "other-than-temporary." The term "other-than-temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. In conducting this assessment, for securities in an unrealized loss position we evaluate a number of factors including, but not limited to:
 
The length of time and the extent to which fair value has been less than the amortized cost basis;
Adverse conditions specifically related to the security, an industry, or a geographic area;
The historical and implied volatility of the fair value of the security;
The payment structure of the debt security and the likelihood of the issuer being able to make payments;
Failure of the issuer to make scheduled interest or principal payments;
Any rating changes by a rating agency; and

16

 

Recoveries or additional declines in fair value subsequent to the balance sheet date.
 
Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding impairment charge to earnings is recognized for anticipated credit losses.
 
For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

The declines in market value were primarily attributable to changes in interest rates and volatility in the credit and financial markets. Because we have no intent to sell securities in an unrealized loss position and it is not more likely than not that we will be required to sell such securities before recovery of its amortized cost basis, we do not consider our investments to be other-than-temporarily impaired.

Visa and MasterCard Class B Common Stock

As of September 30, 2018, the Company owns 34,631 shares and 11,170 shares of Class B common stock of Visa, Inc. ("Visa") and MasterCard, Inc. ("MasterCard"), respectively. Due to transfer restrictions and the lack of readily determinable fair values of Class B common stock of Visa and MasterCard, the Company chooses to carry the shares on the Company's consolidated balance sheets at zero cost basis.

4. LOANS AND LEASES
 
Loans and leases, excluding loans held for sale, consisted of the following:
 
(dollars in thousands)
September 30, 2018
 
December 31, 2017
Commercial, financial and agricultural
$
564,900

 
$
503,738

Real estate:


 


Construction
69,065

 
64,525

Residential mortgage
1,388,925

 
1,337,193

Home equity
455,599

 
412,230

Commercial mortgage
1,034,951

 
979,239

Consumer
462,198

 
470,819

Leases
170

 
362

Gross loans and leases
3,975,808

 
3,768,106

Net deferred costs
2,219

 
2,509

Total loans and leases, net of deferred costs
$
3,978,027

 
$
3,770,615

 
 
 
 
 
During the nine months ended September 30, 2018, we foreclosed on one loan totaling $40 thousand, which was sold at a small premium to book value.

During the nine months ended September 30, 2017, we foreclosed on one loan totaling $0.1 million.

During the nine months ended September 30, 2018 and 2017, we did not transfer any loans to the held-for-sale category.


17

 

We did not sell any portfolio loans during the nine months ended September 30, 2018 and 2017.

In May 2018, we purchased an auto loan portfolio totaling $20.6 million which included a $0.1 million premium over the $20.5 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 63 months and a weighted average yield, net of the premium paid and servicing costs, of 3.89%.

In November 2017, we purchased an auto loan portfolio totaling $33.1 million which included a $1.1 million premium over the $31.9 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 76 months and a weighted average yield, net of the premium paid and servicing costs, of 3.04%.

In May 2017, we purchased an auto loan portfolio totaling $26.6 million which included a $0.9 million premium over the $25.7 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 77 months and a weighted average yield, net of the premium paid and servicing costs, of 2.67%.

In March 2017, we purchased an auto loan portfolio totaling $24.1 million which included a $0.4 million premium over the $23.8 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 55 months and a weighted average yield, net of the premium paid and servicing costs, of 2.60%.

Impaired Loans
 
The following tables present by class, the balance in the allowance for loan and lease losses (the "Allowance") and the recorded investment in loans and leases based on the Company's impairment measurement method as of September 30, 2018 and December 31, 2017:
 
 
 
 
Real Estate
 
 
 
 
 
 
(dollars in thousands)
Comml, Fin & Ag
 
Constr
 
Resi Mortgage
 
Home Equity
 
Comml Mortgage
 
Consumer
 
Leases
 
Total
September 30, 2018
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Allowance:
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Individually evaluated for impairment
$

 
$

 
$
87

 
$

 
$

 
$

 
$

 
$
87

Collectively evaluated for impairment
7,867

 
1,291

 
14,048

 
3,718

 
13,470

 
6,345

 

 
46,739

Total ending balance
$
7,867

 
$
1,291

 
$
14,135

 
$
3,718

 
$
13,470

 
$
6,345

 
$

 
$
46,826

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Individually evaluated for impairment
$
388

 
$
2,355

 
$
12,660

 
$
415

 
$
3,439

 
$

 
$

 
$
19,257

Collectively evaluated for impairment
564,512

 
66,710

 
1,376,265

 
455,184

 
1,031,512

 
462,198

 
170

 
3,956,551

Subtotal
564,900

 
69,065

 
1,388,925

 
455,599

 
1,034,951

 
462,198

 
170

 
3,975,808

Net deferred costs (income)
464

 
(424
)
 
3,744

 

 
(1,501
)
 
(64
)
 

 
2,219

Total loans and leases, net of deferred costs (income)
$
565,364

 
$
68,641

 
$
1,392,669

 
$
455,599

 
$
1,033,450

 
$
462,134

 
$
170

 
$
3,978,027


 
 
 
Real Estate
 
 
 
 
 
 
(dollars in thousands)
Comml, Fin & Ag
 
Constr
 
Resi Mortgage
 
Home Equity
 
Comml Mortgage
 
Consumer
 
Leases
 
Total
December 31, 2017
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Allowance:
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Individually evaluated for impairment
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Collectively evaluated for impairment
7,594

 
1,835

 
14,328

 
3,317

 
16,801

 
6,126

 

 
50,001

Total ending balance
$
7,594

 
$
1,835

 
$
14,328

 
$
3,317

 
$
16,801

 
6,126

 
$

 
$
50,001

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Individually evaluated for impairment
$
491

 
$
2,597

 
$
13,862

 
$
416

 
$
3,914

 
$

 
$

 
$
21,280

Collectively evaluated for impairment
503,247

 
61,928

 
1,323,331

 
411,814

 
975,325

 
470,819

 
362

 
3,746,826

Subtotal
503,738

 
64,525

 
1,337,193

 
412,230

 
979,239

 
470,819

 
362

 
3,768,106

Net deferred costs (income)
281

 
(285
)
 
4,028

 

 
(1,442
)
 
(73
)
 

 
2,509

Total loans and leases, net of deferred costs (income)
$
504,019

 
$
64,240

 
$
1,341,221

 
$
412,230

 
$
977,797

 
$
470,746

 
$
362

 
$
3,770,615



18

 

There was one impaired loan with an allowance of $0.1 million recorded as of September 30, 2018. There were no impaired loans with an allowance recorded as of December 31, 2017. The following table presents by class, information related to impaired loans as of September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance
Allocated
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance
Allocated
 
(dollars in thousands)
Impaired loans:
 

 
 

 
 

 
 

 
 

 
 

Commercial, financial and agricultural
$
498

 
$
388

 
$

 
$
602

 
$
491

 
$

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Construction
7,705

 
2,355

 

 
7,947

 
2,597

 

Residential mortgage
13,689

 
12,660

 
87

 
14,920

 
13,862

 

Home equity
415

 
415

 

 
416

 
416

 

Commercial mortgage
3,439

 
3,439

 

 
3,914

 
3,914

 

Total impaired loans
$
25,746

 
$
19,257

 
$
87

 
$
27,799

 
$
21,280

 
$


The following table presents by class, the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2018 and 2017:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2018
 
September 30, 2017
 
September 30, 2018
 
September 30, 2017