Quarterly Report (10-q)

Datum : 08/11/2019 @ 20h03
Quelle : Edgar (US Regulatory)
Name : Entegra Financial Corporation (ENFC)
Kurs : 29.99  0.0 (0.00%) @ 09h59
Entegra Financial share price Chart

Quarterly Report (10-q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

 

For the quarterly period ended:

September 30, 2019

Commission File Number: 001-35302

Entegra Financial Corp.

(Exact name of registrant as specified in its charter)

   
North Carolina 45-2460660
(State of Incorporation) (I.R.S. Employer Identification No.)
   
14 One Center Court,  
Franklin, North Carolina 28734
(Address of principal executive offices) (Zip Code)

(828) 524-7000

(Registrant’s telephone number, including area code)

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

Title of each class Trading Symbols Name of each exchange on which registered
Common Stock, no par value per share ENFC NASDAQ Global Market

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 x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the 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 o Accelerated filer x Non-accelerated filer o Smaller reporting company o Emerging growth company x

 

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 13(a) of the Exchange 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 x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On November 4, 2019, there were 6,927,523 shares of the issuer’s common stock (no par value) issued and outstanding.

 
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

 

FORM 10-Q

TABLE OF CONTENTS

 

    Page No.
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements (Unaudited) 3
Consolidated Balance Sheets – September 30, 2019 and December 31, 2018  3
Consolidated Statements of Income – Three and Nine Months Ended September 30, 2019 and 2018  4
Consolidated Statements of Comprehensive Income – Three and Nine Months Ended September 30, 2019 and 2018  5
Consolidated Statements of Changes in Shareholders’ Equity –Nine Months Ended September 30, 2019 and 2018  6
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2019 and 2018  7
Notes to Consolidated Financial Statements  8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 44
Item 3. Quantitative and Qualitative Disclosures About Market Risk 71
Item 4. Controls and Procedures 73
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 74
Item 1A.   Risk Factors  74
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  74
Item 3. Defaults Upon Senior Securities  74
Item 4. Mine Safety Disclosures  74
Item 5. Other Information  74
Item 6. Exhibits  75
Signatures  76
2
 

Item 1. Financial Statements

 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

    September 30,     December 31,  
    2019     2018  
    (Unaudited)     (Audited)  
Assets                
                 
Cash and due from banks   $ 17,662     $ 15,409  
Interest-earning deposits     126,534       53,710  
Cash and cash equivalents     144,196       69,119  
                 
Investments - equity securities     6,947       6,178  
Investments - available for sale     349,327       359,738  
Other investments, at cost     11,652       12,039  
Loans held for sale (includes $5,221 and $2,431 at fair value)     11,142       7,570  
Loans receivable, net     1,076,581       1,076,069  
Allowance for loan losses     (12,309 )     (11,985 )
Fixed assets, net     25,430       26,385  
Real estate owned     3,088       2,493  
Accrued interest receivable     6,163       6,443  
Bank owned life insurance     32,461       32,886  
Small Business Investment Company holdings, at cost     4,993       3,839  
Net deferred tax asset     2,871       7,551  
Loan servicing rights     2,520       2,837  
Goodwill     23,903       23,903  
Core deposit intangible     3,059       3,577  
Other assets     11,999       7,799  
                 
Total assets   $ 1,704,023     $ 1,636,441  
                 
Liabilities and Shareholders’ Equity                
                 
Liabilities:                
Core deposits   $ 905,965     $ 795,261  
Retail certificates of deposit     303,601       349,971  
Wholesale deposits     70,379       76,008  
Federal Home Loan Bank advances     205,500       213,500  
Junior subordinated notes     14,433       14,433  
Other borrowings     4,463       9,299  
Post employment benefits     9,205       9,305  
Accrued interest payable     1,730       1,647  
Other liabilities     5,771       4,145  
Total liabilities     1,521,047       1,473,569  
                 
Commitments and contingencies (Note 12)                
                 
Shareholders’ Equity:                
                 
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding            
                 
Common stock -  no par value, 50,000,000 shares authorized; 6,925,283 and 6,917,703 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively            
Common stock held by Rabbi Trust, at cost; 17,672 shares at September 30, 2019 and December 31, 2018     (379 )     (379 )
Additional paid in capital     74,816       74,051  
Retained earnings     102,600       92,624  
Accumulated other comprehensive gain (loss)     5,939       (3,424 )
Total shareholders’ equity     182,976       162,872  
                 
Total liabilities and shareholders’ equity   $ 1,704,023     $ 1,636,441  

 

The accompanying notes are an integral part of the consolidated financial statements.

3
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2019     2018     2019     2018  
    (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  
Interest income:                                
Interest and fees on loans   $ 13,444     $ 12,621     $ 39,598     $ 36,981  
Interest on tax exempt loans     102       106       314       290  
Taxable securities     1,945       1,827       6,014       5,173  
Tax-exempt securities     760       695       2,279       1,852  
Interest-earning deposits     564       528       1,520       1,309  
Other     181       201       559       544  
Total interest and dividend income     16,996       15,978       50,284       46,149  
                                 
Interest expense:                                
Deposits     3,633       2,331       9,963       5,540  
Federal Home Loan Bank advances     1,315       1,091       4,094       2,841  
Junior subordinated notes     142       141       423       421  
Other borrowings     52       123       277       352  
Total interest expense     5,142       3,686       14,757       9,154  
                                 
Net interest income     11,854       12,292       35,527       36,995  
                                 
Provision for loan losses           336       246       1,054  
Net interest income after provision for loan losses     11,854       11,956       35,281       35,941  
                                 
Noninterest income:                                
Servicing income, net     51       180       126       313  
Mortgage banking     475       233       1,079       755  
Gain on sale of SBA loans     290       257       387       547  
Loss on sale of investments                       (520 )
Equity securities (losses) gains     (30 )     191       500       183  
Service charges on deposit accounts     406       406       1,205       1,242  
Interchange fees, net     305       276       849       795  
Bank owned life insurance     189       195       554       589  
Legal settlement                 1,750        
Other     372       227       878       775  
Total noninterest income     2,058       1,965       7,328       4,679  
                                 
Noninterest expenses:                                
Compensation and employee benefits     5,802       5,882       17,532       17,151  
Net occupancy     1,052       1,128       3,256       3,342  
Federal deposit insurance     (3 )     191       280       618  
Professional and advisory     179       413       763       1,023  
Data processing     526       532       1,529       1,607  
Marketing and advertising     159       227       594       671  
Merger-related expenses     295       96       3,229       564  
Net cost of operation of real estate owned     46       59       76       202  
Other     861       1,013       2,944       2,925  
Total noninterest expenses     8,917       9,541       30,203       28,103  
                                 
Income before taxes     4,995       4,380       12,406       12,517  
                                 
Income tax expense     998       857       2,430       2,325  
                                 
Net income   $ 3,997     $ 3,523     $ 9,976     $ 10,192  
                                 
Earnings per common share:                                
Basic   $ 0.58     $ 0.51     $ 1.44     $ 1.48  
Diluted   $ 0.56     $ 0.50     $ 1.42     $ 1.45  
                                 
Weighted average common shares outstanding:                                
Basic     6,923,114       6,891,672       6,920,880       6,889,130  
Diluted     7,089,850       7,031,150       7,029,164       7,023,174  

 

The accompanying notes are an integral part of the consolidated financial statements.

4
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2019     2018     2019     2018  
                         
Net income   $ 3,997     $ 3,523     $ 9,976     $ 10,192  
                                 
Other comprehensive income (loss):                                
Change in unrealized holding gains and losses on securities available for sale     2,455       (2,318 )     12,889       (8,181 )
Reclassification adjustment for securities losses realized in net income                       947  
Change in unrealized holding gains and losses on cash flow hedge     (85 )     93       (531 )     303  
Reclassification adjustment for cash flow hedge effectiveness     (49 )     (149 )     (172 )     (347 )
Other comprehensive income (loss), before tax     2,321       (2,374 )     12,186       (7,278 )
Income tax effect related to items of other comprehensive income (loss)     (532 )     538       (2,823 )     1,635  
Other comprehensive income (loss), after tax     1,789       (1,836 )     9,363       (5,643 )
                                 
Comprehensive income   $ 5,786     $ 1,687     $ 19,339     $ 4,549  

 

The accompanying notes are an integral part of the consolidated financial statements.

5
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Nine Months Ended September 30, 2019 and 2018

(Unaudited)

(Dollars in thousands)

 

    Common Stock     Additional
Paid
 in Capital
    Retained
 Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Common
Stock held
by Rabbi
Trust
    Total  
    Shares     Amount                                
Balance at December 31, 2018     6,917,703     $     $ 74,051     $ 92,624     $ (3,424 )   $ (379 )   $ 162,872  
Net income                       3,815                   3,815  
Other comprehensive income, net of tax                             3,969             3,969  
Stock compensation expense                 290                         290  
Vesting of restricted stock units, net of 931 shares surrendered     1,509             (21 )                       (21 )
Balance at March 31, 2019     6,919,212             74,320       96,439       545       (379 )     170,925  
Net income                       2,164                   2,164  
Other comprehensive income, net of tax                             3,605             3,605  
Stock compensation expense                 290                         290  
Stock options exercised, net of 342 surrendered     553             (10 )                       (10 )
Vesting of restricted stock units, net of 801 shares surrendered     2,799             (24 )                       (24 )
Balance at June 30, 2019     6,922,564             74,576       98,603       4,150       (379 )     176,950  
Net income                       3,997                   3,997  
Other comprehensive income, net of tax                             1,789             1,789  
Stock compensation expense                 290                         290  
Vesting of restricted stock units, net of 1,681 shares surrendered     2,719             (50 )                       (50 )
Balance at September 30, 2019     6,925,283     $     $ 74,816     $ 102,600     $ 5,939     $ (379 )   $ 182,976  
                                                         
Balance at December 31, 2017     6,879,191     $     $ 72,997     $ 78,718     $ (23 )   $ (379 )   $ 151,313  
Net income                       3,582                   3,582  
Other comprehensive loss, net of tax                             (3,382 )           (3,382 )
Stock compensation expense                 257                         257  
Stock options exercised     8,081             117                         117  
Vesting of restricted stock units, net of 397 shares surrendered     1,143             (11 )                       (11 )
Cumulative effect of change in accounting principle                       (9 )     9              
Balance at March 31, 2018     6,888,415             73,360       82,291       (3,396 )     (379 )     151,876  
Net income                       3,087                   3,087  
Other comprehensive loss, net of tax                             (425 )           (425 )
Stock compensation expense                 258                         258  
Vesting of restricted stock units, net of 343 shares surrendered     3,257             (10 )                       (10 )
Balance at June 30, 2018     6,891,672             73,608       85,378       (3,821 )     (379 )     154,786  
Net income                       3,523                   3,523  
Other comprehensive loss, net of tax                             (1,836 )           (1,836 )
Stock compensation expense                 257                         257  
Balance at September 30, 2018     6,891,672     $     $ 73,865     $ 88,901     $ (5,657 )   $ (379 )   $ 156,730  

 

 

The accompanying notes are an integral part of the consolidated financial statements.

6
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 

    For the Nine Months
Ended September 30,
 
    2019     2018  
Cash flows from operating activities:                
Net income   $ 9,976     $ 10,192  
Adjustments to reconcile net income to net cash provided by operating activities:                
Depreciation, amortization and accretion     944       (255 )
Investment amortization, net     2,448       2,672  
Equity securities income     (500 )     (183 )
Provision for loan losses     246       1,054  
Provision for real estate owned     35       83  
Share-based compensation expense     870       772  
Deferred tax expense     1,815       1,796  
Loss on sales of investments           520  
Income on bank owned life insurance, net     (554 )     (589 )
Mortgage banking income, net     (1,079 )     (755 )
Gain on sales of SBA loans     (387 )     (547 )
Gain on sale of fixed assets     (10 )      
Gain on sale of other investment     (113 )      
Net realized gain on sale of real estate owned     (50 )     (16 )
Loans originated for sale     (35,059 )     (36,982 )
Proceeds from sale of loans originated for sale     31,242       38,159  
Net change in operating assets and liabilities:                
Accrued interest receivable     280       (753 )
Loan servicing rights     317       (15 )
Other assets     (3,168 )     (3,381 )
Postemployment benefits     (100 )     (287 )
Accrued interest payable     83       423  
Other liabilities     1,180       (4,233 )
Net cash provided by operating activities     8,416       7,675  
                 
Cash flows from investing activities:                
Activity for investment securities available for sale:                
Purchases           (107,204 )
Maturities/calls and principal repayments     20,852       32,832  
Sales           54,174  
Proceeds from sale of Visa Class B restricted shares           427  
Net increase in loans     (847 )     (62,647 )
Proceeds from sale of real estate owned     272       410  
Proceeds from settlement of BOLI policies     1,115        
Proceeds from sale of fixed assets     100        
Purchase of fixed assets     (107 )     (3,551 )
Purchase of Small Business Investment Company holdings, at cost     (1,154 )     (118 )
Proceeds from sale of other investment     122        
Purchase of other investments, at cost           (78 )
Redemption of other investments, at cost     387       425  
Net cash provided by (used in) investing activities     20,740       (85,330 )
Cash flows from financing activities:                
Net increase in deposits     56,705       92,614  
Net increase in escrow deposits     2,157       1,970  
Net (decrease) increase in other borrowings     (4,836 )     773  
Proceeds from FHLB advances     195,000       255,500  
Repayment of FHLB advances     (203,000 )     (265,500 )
Cash (paid for) received upon exercise of stock options     (10 )     117  
Cash paid for shares surrendered upon vesting of restricted stock     (95 )     (21 )
Net cash provided by financing activities     45,921       85,453  
                 
Increase in cash and cash equivalents     75,077       7,798  
                 
Cash and cash equivalents, beginning of period     69,119       109,467  
                 
Cash and cash equivalents, end of period   $ 144,196     $ 117,265  
                 
Supplemental disclosures of cash flow information:                
Cash paid during the year for:                
Interest on deposits and other borrowings   $ 14,831     $ 9,460  
Income taxes     804       4,070  
                 
Noncash investing and financing activities:                
Real estate acquired in satisfaction of mortgage loans   $ 1,061     $ 1,502  
Loans originated for the disposition of real estate owned     209       774  
Loan sales/investments to be settled     1,710       2,169  
Reclassification for adoption of Accounting Standards Update 2016-01           617  

 

The accompanying notes are an integral part of the consolidated financial statements.

7
 

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

Entegra Financial Corp. (“we,” “us,” “our,” or the “Company”) was incorporated on May 31, 2011 and became the holding company for Entegra Bank (the “Bank”) on September 30, 2014 upon the completion of Macon Bancorp’s merger with and into the Company, pursuant to which Macon Bancorp converted from a mutual to stock form of organization. The Company’s primary operation is its investment in the Bank. The Company also owns 100% of the common stock of Macon Capital Trust I (the “Trust”), a Delaware statutory trust formed in 2003 to facilitate the issuance of trust preferred securities. The Bank is a North Carolina state-chartered commercial bank and has a wholly owned subsidiary, Entegra Services, Inc. (“Entegra Services”), which holds investment securities.

The Bank operates as a community-focused retail bank, originating primarily real estate-based mortgage, consumer and commercial loans and accepting deposits from consumers and small businesses.

Estimates

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses, the valuation of acquired loans, separately identifiable intangible assets associated with mergers and acquisitions, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of deferred tax assets.

 

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company, the Bank, and Entegra Services. The accounts of the Trust are not consolidated with the Company. In consolidation, all significant intercompany accounts and transactions have been eliminated.

 

Reclassification

Certain amounts in the prior year’s financial statements may have been reclassified to conform to the current year’s presentation. The reclassifications had no effect on our results of operations or financial condition as previously reported.

 

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the Securities and Exchange Commission’s (the “SEC”) instructions for Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X under the Securities Act of 1933, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 14, 2019 (as amended, the “2018 Form 10-K”). In the opinion of management, these interim consolidated financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

 

Business Combinations

The Company accounts for business combinations under the acquisition method of accounting. Assets acquired and liabilities assumed are measured and recorded at fair value at the date of acquisition, including identifiable intangible assets. If the fair value of net assets purchased exceeds the fair value of consideration paid, a bargain purchase gain is recognized at the date of acquisition. Conversely, if the consideration paid exceeds the fair value of the net assets acquired, goodwill is recognized at the acquisition date. Fair values are subject to refinement for a period not to exceed one year after the closing date of an acquisition as information relative to closing date fair values becomes available.

The determination of the fair value of loans acquired takes into account credit quality deterioration and probability of loss; therefore, the related allowance for loan losses is not carried forward.

8
 

All identifiable intangible assets that are acquired in a business combination are recognized at fair value on the acquisition date. Identifiable intangible assets are recognized separately if they arise from contractual or other legal rights or if they are separable (i.e., capable of being sold, transferred, licensed, rented, or exchanged separately from the entity). Deposit liabilities and the related depositor relationship intangible assets may be exchanged in observable exchange transactions. As a result, the depositor relationship intangible asset is considered identifiable, because the separability criterion has been met.

In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.

 

Merger with First Citizens BancShares, Inc.

 

On April 23, 2019, Entegra entered into a definitive agreement to merge with and into BancShares (the “Merger Agreement”). Under the terms of the Merger Agreement, each outstanding share of Entegra common stock would be converted into the right to receive $30.18 in cash.

 

Previously on January 15, 2019, Entegra had entered into a definitive agreement to merge with and into SmartFinancial, Inc. (“SmartFinancial”), a Tennessee corporation. Under the terms of the SmartFinancial definitive agreement, each outstanding share of Entegra common stock would be converted into the right to receive 1.215 shares of SmartFinancial common stock.

 

On April 18, 2019, Entegra notified SmartFinancial that it had received a proposal from BancShares and certain affiliates containing the Merger Agreement described above and that the Entegra board of directors had concluded that such proposal constituted a Superior Proposal (as defined in the SmartFinancial definitive agreement). On April 23, 2019, SmartFinancial delivered a notice to Entegra waiving its rights to renegotiate its agreement with Entegra, subject to Entegra’s compliance with the SmartFinancial definitive agreement and the payment of the termination fee due to SmartFinancial simultaneously with the termination of the SmartFinancial definitive agreement.

On April 23, 2019, in connection with the termination by Entegra of the SmartFinancial definitive agreement, BancShares, on behalf of Entegra, paid SmartFinancial a termination fee of $6.4 million as required by the terms of the SmartFinancial definitive agreement, and the SmartFinancial definitive agreement was terminated. 

Approval of the proposed merger by Entegra’s shareholders has been received. Completion of the proposed merger remains subject to the receipt of required regulatory approvals and the satisfaction or waiver of other customary conditions, and is expected to occur during the fourth quarter of 2019.

Recent Accounting Standards Updates

 

Accounting Standards Update (“ASU”) 2016-02, “Leases (Topic 842).” ASU 2016-02, among other things, requires lessees to recognize a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. We adopted ASU 2016-02, along with several other subsequent codification updates related to lease accounting, as of January 1, 2019. See Note 14 for additional information.

9
 

In September 2016, the Financial Accounting Standards Board (“FASB”) issued amendments to ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in the update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected thereby providing financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by the reporting entity. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company has formed a cross-functional committee to provide corporate governance over the implementation of this update, has evaluated data sources and made process updates to capture additional relevant data, has identified a service provider to perform the calculation, and continues to attend seminars and forums specific to this update. The Company also engaged the service provider to assist with the implementation of the standard. The preliminary measurement of life of loan credit losses was completed in the first quarter of 2019 using December 31, 2018 data. While we continue to evaluate the impact the new guidance will have on our financial position and results of operations, we currently expect the new guidance may result in an increase to our allowance for credit losses given the change to estimated losses over the contractual life of the loan portfolio. The amount of any change to our allowance will depend, in part, upon the composition of our loan portfolio at the adoption date as well as economic conditions and loss forecasts at that date.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

 

NOTE 2. INVESTMENT SECURITIES

 

 

The following table presents the holdings of our equity securities as of September 30, 2019 and December 31, 2018:

 

    September 30,     December 31,  
    2019     2018  
    (Dollars in thousands)  
             
Mutual funds   $ 6,947     $ 6,178  

 

Equity securities with a fair value of $6.3 million as of September 30, 2019 are held in a Rabbi Trust and seek to generate returns that will fund the cost of certain deferred compensation agreements. Equity securities with a fair value of $0.6 million as of September 30, 2019 are in a mutual fund that qualifies under the Community Reinvestment Act (“CRA”) as CRA activity. There were losses of $30 thousand on equity securities and gains of $0.5 million for the three and nine months ended September 30, 2019, respectively. There were gains on equity securities of $0.2 million for both the three and nine months ended September 30, 2018.

 

The amortized cost and estimated fair values of available-for-sale (“AFS”) investment securities as of September 30, 2019 and December 31, 2018 are summarized as follows:

 

    September 30, 2019  
          Gross     Gross     Estimated  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (Dollars in thousands)  
                         
U.S. Treasury & Government Agencies   $ 33,423     $ 184     $ (349 )   $ 33,258  
Municipal Securities     113,789       6,367             120,156  
Mortgage-backed Securities - Guaranteed     73,818       783       (767 )     73,834  
Collateralized Mortgage Obligations - Guaranteed     21,428       382       (36 )     21,774  
Collateralized Mortgage Obligations - Non Guaranteed     63,647       1,642       (25 )     65,264  
Collateralized Loan Obligations     15,511             (290 )     15,221  
Corporate bonds     19,412       437       (29 )     19,820  
    $ 341,028     $ 9,795     $ (1,496 )   $ 349,327  
10
 

    December 31, 2018  
          Gross     Gross     Estimated  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
    (Dollars in thousands)  
                         
U.S. Treasury & Government Agencies   $ 34,068     $ 74     $ (152 )   $ 33,990  
Municipal Securities     115,860       209       (1,667 )     114,402  
Mortgage-backed Securities - Guaranteed     86,664       98       (1,578 )     85,184  
Collateralized Mortgage Obligation - Guaranteed     22,492       47       (650 )     21,889  
Collateralized Mortgage Obligation - Non Guaranteed     69,774       125       (728 )     69,171  
Collateralized Loan Obligations     15,534       1       (458 )     15,077  
Corporate bonds     19,936       232       (143 )     20,025  
    $ 364,328     $ 786     $ (5,376 )   $ 359,738  

  

Information pertaining to the fair value of AFS investment securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

    September 30, 2019  
    Less Than 12 Months     More Than 12 Months     Total  
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
 
    (Dollars in thousands)  
Available-for-Sale:                                                
U.S. Treasury & Government Agencies   $ 19,818     $ 226     $ 6,912     $ 123     $ 26,730     $ 349  
Mortgage-backed Securities - Guaranteed     901       6       37,332       761       38,233       767  
Collateralized Mortgage Obligations - Guaranteed     1,799       8       1,797       28       3,596       36  
Collateralized Mortgage Obligations - Non Guaranteed     3,003       12       2,748       13       5,751       25  
Collateralized Loan Obligations     5,984       30       9,237       260       15,221       290  
Corporate Bonds                 1,032       29       1,032       29  
    $ 31,505     $ 282     $ 59,058     $ 1,214     $ 90,563     $ 1,496  

 

    December 31, 2018  
    Less Than 12 Months     More Than 12 Months     Total  
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
    Fair Value     Unrealized
Losses
 
    (Dollars in thousands)  
Available-for-Sale:                                                
U.S. Treasury & Government Agencies   $ 23,423     $ 152     $     $     $ 23,423     $ 152  
Municipal Securities     33,028       421       56,153       1,246       89,181       1,667  
Mortgage-backed Securities - Guaranteed     27,692       370       45,619       1,208       73,311       1,578  
Collateralized Mortgage Obligations - Guaranteed     2,042       19       15,294       631       17,336       650  
Collateralized Mortgage Obligations - Non Guaranteed     22,383       185       30,471       543       52,854       728  
Collateralized loan obligations     11,618       404       1,449       54       13,067       458  
Corporate bonds     2,492       45       3,345       98       5,837       143  
    $ 122,678     $ 1,596     $ 152,331     $ 3,780     $ 275,009     $ 5,376  
11
 

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of September 30, 2019 and December 31, 2018 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

    September 30, 2019  
    Less Than
12 Months
    More Than
12 Months
    Total  
Available-for-Sale:                        
U.S. Treasury & Government Agencies     13       5       18  
Mortgage-backed Securities - Guaranteed     1       39       40  
Collateralized Mortgage Obligations - Guaranteed     1       1       2  
Collateralized Mortgage Obligations - Non Guaranteed     2       5       7  
Collateralized loan obligation     3       5       8  
Corporate bonds           1       1  
      20       56       76  

                   
    December 31, 2018  
    Less Than
12 Months
    More Than
12 Months
    Total  
Available-for-Sale:                        
U.S. Treasury & Government Agencies     14             14  
Municipal Securities     31       52       83  
Mortgage-backed Securities - Guaranteed     21       43       64  
Collateralized Mortgage Obligations - Guaranteed     1       8       9  
Collateralized Mortgage Obligations - Non Guaranteed     12       22       34  
Collateralized loan obligation     6       1       7  
Corporate bonds     3       4       7  
      88       130       218  

 

The Company received proceeds from sales of investment securities classified as AFS and corresponding gross realized gains and losses as follows:

 

    Three Months Ended
September 30,
2018
         Nine Months
Ended
September 30,
2018
 
                 
AFS                
Gross proceeds   $     $ 54,174  
Gross realized gains           77  
Gross realized losses           1,024  
                 
Visa Class B Restricted Shares                
Gross proceeds           427  
Gross realized gains           427  
Gross realized losses            
                 
Total                
Gross proceeds   $     $ 54,601  
Gross realized gains           504  
Gross realized losses           1,024  

 

There were no investment security sales for the three or nine months ended September 30, 2019.

 

The Company had securities pledged against deposits and borrowings of approximately $160.7 million and $155.8 million at September 30, 2019 and December 31, 2018, respectively.

 

The amortized cost and estimated fair value of investments in debt securities at September 30, 2019, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

12
 

    Available-for-Sale  
    Amortized
Cost
    Fair
Value
 
    (Dollars in thousands)  
             
Less than 1 year   $ 1,990     $ 1,996  
Over 1 year through 5 years     6,952       6,107  
After 5 years through 10 years     31,457       33,331  
Over 10 years     141,736       147,021  
      182,135       188,455  
Mortgage-backed securities     158,893       160,872  
                 
Total   $ 341,028     $ 349,327  

 

NOTE 3. LOANS RECEIVABLE

Loans receivable as of September 30, 2019 and December 31, 2018 are summarized as follows:

 

    September 30,     December 31,  
    2019     2018  
    (Dollars in thousands)  
             
Real estate mortgage loans:                
One-to-four family residential   $ 336,098     $ 325,560  
Commercial real estate     482,831       498,106  
Home equity loans and lines of credit     45,822       48,679  
Residential construction     57,687       39,533  
Other construction and land     101,988       104,645  
Total real estate loans     1,024,426       1,016,523  
                 
Commercial and industrial     45,652       54,410  
Consumer     6,989       6,842  
Total commercial and consumer     52,641       61,252  
                 
Loans receivable, gross     1,077,067       1,077,775  
                 
Less:  Net deferred loan fees     (1,030 )     (1,000 )
Acquired loans fair value discount     (697 )     (1,048 )
Hedged loans basis adjustment (See Note 8)     1,088       245  
Unamortized premium     232       333  
Unamortized discount     (79 )     (236 )
                 
Loans receivable, net of deferred fees   $ 1,076,581     $ 1,076,069  

 

The Bank had $279.9 million and $256.1 million of loans pledged as collateral to secure funding availability with the Federal Home Loan Bank of Atlanta (“FHLB”) at September 30, 2019 and December 31, 2018, respectively. The Bank also had $124.0 million and $114.4 million of loans pledged as collateral to secure funding availability with the Federal Reserve Bank (“FRB”) Discount Window at September 30, 2019 and December 31, 2018, respectively.

13
 

Included in loans receivable and other borrowings at September 30, 2019 are $4.5 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

The following tables present the activity related to the discount on individually purchased loans for the three and nine month periods ended September 30, 2019 and 2018:

 

    For the Three Months Ended     For the Nine Months Ended  
    September 30,     September 30,  
(Dollars in thousands)   2019     2018     2019     2018  
                         
Discount on purchased loans, beginning of period   $ 180     $ 399     $ 236     $ 710  
Accretion     (101 )     (67 )     (157 )     (378 )
Discount on purchased loans, end of period   $ 79     $ 332     $ 79     $ 332  

 

 The following table presents the activity related to the fair value discount on loans from business combinations for the three and nine month periods ended September 30, 2019 and 2018:

 

    For the Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
(Dollars in thousands)   2019     2018     2019     2018  
                         
Fair value discount, beginning of period   $ 789     $ 1,395     $ 1,048     $ 2,012  
Accretion     (92 )     (193 )     (351 )     (810 )
Fair value discount, end of period   $ 697     $ 1,202     $ 697     $ 1,202  
14
 

NOTE 4. ALLOWANCE FOR LOAN LOSSES

The following tables present, by portfolio segment, the changes in the allowance for loan losses for the periods indicated:

 

    Three Months Ended September 30, 2019  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
Beginning balance   $ 3,979     $ 5,264     $ 521     $ 567     $ 1,143     $ 596     $ 124     $ 12,194  
Provision     (123 )     (118 )     18       86       89       120       (72 )      
Charge-offs           (1 )     (49 )                       (12 )     (62 )
Recoveries     85       3       25             8       18       38       177  
Ending balance   $ 3,941     $ 5,148     $ 515     $ 653     $ 1,240     $ 734     $ 78     $ 12,309  

 

    Three Months Ended September 30, 2018  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
Beginning balance   $ 3,772     $ 4,902     $ 552     $ 453     $ 1,146     $ 633     $ 67     $ 11,525  
Provision     33       141       209       12       42       26       (127 )     336  
Charge-offs     (6 )           (219 )                 (45 )     (17 )     (287 )
Recoveries     1                   1       16       2       152       172  
Ending balance   $ 3,800     $ 5,043     $ 542     $ 466     $ 1,204     $ 616     $ 75     $ 11,746  
15
 

    Nine Months Ended September 30, 2019  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
Beginning balance   $ 3,909     $ 5,130     $ 560     $ 452     $ 1,250     $ 608     $ 76     $ 11,985  
Provision     (69 )     52       62       201       (32 )     161       (129 )     246  
Charge-offs     (4 )     (93 )     (258 )           (1 )     (59 )     (105 )     (520 )
Recoveries     105       59       151             23       24       236       598  
Ending balance   $ 3,941     $ 5,148     $ 515     $ 653     $ 1,240     $ 734     $ 78     $ 12,309  

 

    Nine Months Ended September 30, 2018  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
Beginning balance   $ 4,018     $ 4,364     $ 616     $ 303     $ 1,025     $ 503     $ 58     $ 10,887  
Provision     (117 )     711       162       162       136       182       (182 )     1,054  
Charge-offs     (116 )     (35 )     (260 )                 (79 )     (75 )     (565 )
Recoveries     15       3       24       1       43       10       274       370  
Ending balance   $ 3,800     $ 5,043     $ 542     $ 466     $ 1,204     $ 616     $ 75     $ 11,746  

The following tables present, by portfolio segment and reserving methodology, the allocation of the allowance for loan losses and the net investment in loans for the periods indicated:

 

    September 30, 2019  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
Allowance for loan losses                                                                
Individually evaluated for impairment   $ 39     $ 41     $     $     $ 44     $ 226     $     $ 350  
Collectively evaluated for impairment     3,902       5,107       515       653       1,196       508       78       11,959  
    $ 3,941     $ 5,148     $ 515     $ 653     $ 1,240     $ 734     $ 78     $ 12,309  
                                                                 
Loans Receivable                                                                
Individually evaluated for impairment   $ 1,976     $ 3,489     $ 283     $     $ 1,270     $ 1,170     $     $ 8,188  
Collectively evaluated for impairment     334,715       478,013       45,708       57,629       100,501       44,738       7,089       1,068,393  
    $ 336,691     $ 481,502     $ 45,991     $ 57,629     $ 101,771     $ 45,908     $ 7,089     $ 1,076,581  
16
 

    December 31, 2018  
    One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
Allowance for loan losses                                                                
Individually evaluated for impairment   $ 79     $ 27     $     $     $ 54     $ 7     $     $ 167  
Collectively evaluated for impairment     3,830       5,103       560       452       1,196       601       76       11,818  
    $ 3,909     $ 5,130     $ 560     $ 452     $ 1,250     $ 608     $ 76     $ 11,985  
                                                                 
Loans Receivable                                                                
Individually evaluated for impairment   $ 2,900     $ 6,019     $ 313     $     $ 1,377     $ 276     $     $ 10,885  
Collectively evaluated for impairment     322,255       490,530       48,512       39,488       103,087       54,367       6,945       1,065,184  
    $ 325,155     $ 496,549     $ 48,825     $ 39,488     $ 104,464     $ 54,643     $ 6,945     $ 1,076,069  

 

Portfolio Quality Indicators

 

The Company’s loan portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. The Company’s internal credit risk grading system is based on experiences with similarly graded loans, industry best practices, and regulatory guidance. Credit risk grades are refreshed each quarter, at which time management analyzes the resulting information, as well as other external statistics and factors, to track loan performance.

 

The Company’s internally assigned grades pursuant to the Board-approved lending policy are as follows:

 

· Pass (1-5) – Acceptable loans with any identifiable weaknesses appropriately mitigated. 
· Special Mention (6) – Potential weakness or identifiable weakness present without appropriate mitigating factors; however, loan continues to perform satisfactorily with no material delinquency noted. This may include some deterioration in repayment capacity and/or loan-to-value of securing collateral.
· Substandard (7) – Significant weakness that remains unmitigated, most likely due to diminished repayment capacity, serious delinquency, and/or marginal performance based upon restructured loan terms.  
· Doubtful (8) – Significant weakness that remains unmitigated and collection in full is highly questionable or improbable.
· Loss (9) – Collectability is unlikely resulting in immediate charge-off.

 

Description of Segment and Class Risks

 

Each of our portfolio segments and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of our loan portfolio. Management has identified the most significant risks as described below which are generally similar among our segments and classes. While the list is not exhaustive, it provides a description of the risks that management has determined are the most significant.

 

One-to-four family residential

 

We centrally underwrite each of our one-to-four family residential loans using credit scoring and analytical tools consistent with the Board-approved lending policy and internal procedures based upon industry best practices and regulatory directives. Loans to be sold to secondary market investors must also adhere to investor guidelines. We also evaluate the value and marketability of that collateral. Common risks to each class of non-commercial loans, including one-to-four family residential, include risks that are not specific to individual transactions such as general economic conditions within our markets, particularly unemployment and potential declines in real estate values. Personal events such as death, disability or change in marital status also add risk to non-commercial loans.

17
 

Commercial real estate

 

Commercial mortgage loans are primarily dependent on the ability of our customers to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a customer’s business results are significantly unfavorable versus the original projections, the ability for our loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans are secured by real property and possibly other business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation. Other commercial real estate loans consist primarily of loans secured by multifamily housing and agricultural loans. The primary risk associated with multifamily loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in our customer having to provide rental rate concessions to achieve adequate occupancy rates. The performance of agricultural loans are highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.

 

Home equity and lines of credit

 

Home equity loans are often secured by first or second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render our second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lien holders that may further weaken our collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.

 

Residential construction and other construction and land

 

Residential mortgage construction loans are typically secured by undeveloped or partially developed land with funds to be disbursed as home construction is completed, contingent upon receipt and satisfactory review of invoices and inspections. Declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the collateral’s current market value. Non-commercial construction and land development loans can experience delays in completion and/or cost overruns that exceed the borrower’s financial ability to complete the project. Cost overruns can result in foreclosure of partially completed collateral with unrealized value and diminished marketability. Commercial construction and land development loans are dependent on the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and building lots. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.

 

Commercial

 

We centrally underwrite each of our commercial loans based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. We strive to gain a complete understanding of our borrower’s businesses including the experience and background of the principals of such businesses. To the extent that the loan is secured by collateral, which is a predominant feature of the majority of our commercial loans, or other assets including accounts receivable and inventory, we gain an understanding of the likely value of the collateral and what level of strength it brings to the loan transaction. To the extent that the principals or other parties are obligated under the note or guaranty agreements, we analyze the relative financial strength and liquidity of each guarantor. Common risks to each class of commercial loans include risks that are not specific to individual transactions such as general economic conditions within our markets, as well as risks that are specific to each transaction including volatility or seasonality of cash flows, changing demand for products and services, personal events such as death, disability or change in marital status, and reductions in the value of our collateral.

 

Consumer

 

The consumer loan portfolio includes loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles, including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since the date of loan origination in excess of principal repayment.

18
 

The following tables present the recorded investment in gross loans by loan grade as of the dates indicated:

  

September 30, 2019
                                                 
Loan Grade   One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
1   $ 2,778     $ 9,441     $     $ 200     $ 715     $ 713     $ 116     $ 13,963  
2           10,253                         925             11,178  
3     30,315       85,865       4,773       10,758       20,902       13,019       16       165,648  
4     136,075       278,495       3,546       28,060       54,123       18,525       411       519,235  
5     24,948       83,575       687       3,619       15,208       10,908       4       138,949  
6     375       8,541             1       1,239       478             10,634  
7     624       4,668                   182       1,292             6,766  
      195,115       480,838       9,006       42,638       92,369       45,860       547       866,373  
                                                                 
Ungraded Loan Exposure:                                                                
                                                                 
Performing     140,800       664       36,916       14,991       9,351       48       6,541       209,311  
Nonperforming     776             69             51             1       897  
Subtotal     141,576       664       36,985       14,991       9,402       48       6,542       210,208  
                                                                 
Total   $ 336,691     $ 481,502     $ 45,991     $ 57,629     $ 101,771     $ 45,908     $ 7,089     $ 1,076,581  

 

December 31, 2018
                                                 
Loan Grade   One-to-four
Family
Residential
    Commercial
Real Estate
    Home Equity and
Lines of Credit
    Residential
Construction
    Other
Construction
and Land
    Commercial     Consumer     Total  
    (Dollars in thousands)  
                                                 
1   $     $ 7,569     $     $     $     $ 1,264     $ 7     $ 8,840  
2           7,860                         20             7,880  
3     31,623       87,756       5,212       9,365       12,111       15,685       264       162,016  
4     121,688       280,630       4,014       18,358       61,646       22,374       245       508,955  
5     24,738       88,698       615       3,404       17,630       12,307       5       147,397  
6     321       7,867             1       1,303       495             9,987  
7     674       5,725                   376       487             7,262  
      179,044       486,105       9,841       31,128       93,066       52,632       521       852,337  
                                                                 
Ungraded Loan Exposure:                                                                
                                                                 
Performing     145,470       10,420       38,806       8,360       11,334       2,011       6,424       222,825  
Nonperforming     641       24       178             64                   907  
Subtotal     146,111       10,444       38,984       8,360       11,398       2,011       6,424       223,732  
                                                                 
Total   $ 325,155     $ 496,549     $ 48,825     $ 39,488     $ 104,464     $ 54,643     $ 6,945     $ 1,076,069  

 

Delinquency Analysis of Loans by Class

 

The following tables include an aging analysis of the recorded investment of past-due financing receivables by class. The Company does not accrue interest on loans greater than 90 days past due.

19
 
    September 30, 2019  
    30-59 Days
Past Due
    60-89 Days
Past Due
    90 Days and
Over Past Due
    Total
Past Due
    Current     Total Loans
Receivable
 
    (Dollars in thousands)  
                                     
One-to-four family residential   $ 3,440     $ 404     $ 652     $ 4,496     $ 332,195     $ 336,691  
Commercial real estate     773       2,909       587       4,269       477,233       481,502  
Home equity and lines of credit     264             69       333       45,658       45,991  
Residential construction                 1       1       57,628       57,629  
Other construction and land     175       16       198       389       101,382       101,771  
Commercial     15       6       969       990       44,918       45,908  
Consumer     70             1       71       7,018       7,089  
Total   $ 4,737     $ 3,335     $ 2,477     $ 10,549     $ 1,066,032     $ 1,076,581  
       
    December 31, 2018  
    30-59 Days
Past Due
    60-89 Days
Past Due
    90 Days and Over
Past Due
    Total
Past Due
    Current     Total Loans
Receivable
 
    (Dollars in thousands)  
                                     
One-to-four family residential   $ 3,562     $ 1,317     $ 84     $ 4,963     $ 320,192     $ 325,155  
Commercial real estate     2,615             1,782       4,397       492,152       496,549  
Home equity and lines of credit     400       457       73       930       47,895       48,825  
Residential construction                 1       1       39,487       39,488  
Other construction and land     613       32       64       709       103,755       104,464  
Commercial     307       25       121       453       54,190       54,643  
Consumer     27       4             31       6,914       6,945  
Total   $ 7,524     $ 1,835     $ 2,125     $ 11,484     $ 1,064,585     $ 1,076,069  
20
 

Impaired Loans

 

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of September 30, 2019 and December 31, 2018.

 

    September 30, 2019     December 31, 2018  
    Recorded
Balance
    Unpaid
Principal
Balance
    Specific
Allowance
    Recorded
Balance
    Unpaid
Principal
Balance
    Specific
Allowance
 
    (Dollars in thousands)  
Loans without a valuation allowance                                                
One-to-four family residential   $ 1,440     $ 1,593     $     $ 845     $ 923     $  
Commercial real estate     1,896       4,279             3,835       6,207        
Home equity and lines of credit     283       283             283       283        
Other construction and land     537       676             365       366        
    $ 4,156     $ 6,831     $     $ 5,328     $ 7,779     $  
                                                 
Loans with a valuation allowance                                                
One-to-four family residential   $ 536     $ 536     $ 39     $ 2,055     $ 2,055     $ 79  
Commercial real estate     1,593       1,593       41       2,184       2,184       27  
Home equity and lines of credit                       30       30        
Other construction and land     733       733       44       1,012       1,012       54  
Commercial     1,170       1,170       226       276       276       7  
    $ 4,032     $ 4,032     $ 350     $ 5,557     $ 5,557     $ 167  
                                                 
Total                                                
One-to-four family residential   $ 1,976     $ 2,129     $ 39     $ 2,900     $ 2,978     $ 79  
Commercial real estate     3,489       5,872       41       6,019       8,391       27  
Home equity and lines of credit     283       283             313       313        
Other construction and land     1,270       1,409       44       1,377       1,378       54  
Commercial     1,170       1,170       226       276       276       7  
    $ 8,188     $ 10,863     $ 350     $ 10,885     $ 13,336     $ 167  

21
 

The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated:

  

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2019     2018     2019     2018  
    Average
Investment in
Impaired Loans
    Interest
Income
Recognized
    Average
Investment in
Impaired Loans
    Interest
Income
Recognized
    Average
Investment in
Impaired Loans
    Interest
Income
Recognized
    Average
Investment in
Impaired Loans
    Interest
Income
Recognized
 
    (Dollars in thousands)     (Dollars in thousands)  
Loans without a valuation allowance                                                                
One-to-four family residential   $ 1,597     $ 20     $ 2,247     $ 23     $ 1,607     $ 62     $ 2,264     $ 69  
Commercial real estate     4,280       20       4,790       32       4,286       62       5,920       97  
Home equity and lines of credit     283       4       428       4       283       13       428       13  
Other construction and land     677       6       692       6       681       18       695       16  
    $ 6,837     $ 50     $ 8,157     $ 65     $ 6,857     $ 155     $ 9,307     $ 195  
                                                                 
Loans with a valuation allowance                                                                
One-to-four family residential   $ 540     $ 8     $ 825     $ 11     $ 545     $ 24     $ 831     $ 32  
Commercial real estate     1,598       22       2,172       22       1,610       66       2,184       68  
Other construction and land     762       11       842       11       796       34       854       34  
Commercial     1,158       5       281       5       1,166       16       285       17  
    $ 4,058     $ 46     $ 4,120     $ 49     $ 4,117     $ 140     $ 4,154     $ 151  
                                                                 
Total                                
One-to-four family residential   $ 2,137     $ 28     $ 3,072     $ 34     $ 2,152     $ 86     $ 3,095     $ 101  
Commercial real estate     5,878       42       6,962       54       5,896       128       8,104       165  
Home equity and lines of credit     283       4       428       4       283       13       428       13  
Other construction and land     1,439       17       1,534       17       1,477       52       1,549       50  
Commercial     1,158       5       281       5       1,166       16       285       17  
    $ 10,895     $ 96     $ 12,277     $ 114     $ 10,974     $ 295     $ 13,461     $ 346  

 

Nonperforming Loans

 

The following table summarizes the balances of non-performing loans as of September 30, 2019 and December 31, 2018. Certain loans classified as troubled debt restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

 

    September 30,
2019
    December 31,
2018
 
    (Dollars in thousands)  
             
One-to-four family residential   $ 1,132     $ 1,037  
Commercial real estate     1,859       3,266  
Home equity loans and lines of credit     69       178  
Residential construction     1        
Other construction and land     233       256  
Commercial     975       120  
Consumer     1        
Non-performing loans   $ 4,270     $ 4,857  
22
 

TDRs

 

The following tables summarize TDR loans as of the dates indicated:

 

    September 30, 2019  
    Performing     Nonperforming     Total  
    TDRs     TDRs     TDRs  
    (Dollars in thousands)  
                   
One-to-four family residential   $ 1,617     $     $ 1,617  
Commercial real estate     2,332       1,152       3,484  
Home equity and lines of credit     283             283  
Other construction and land     1,087       182       1,269  
Commercial     263             263  
                         
    $ 5,582     $ 1,334     $ 6,916  

 

    December 31, 2018  
    Performing     Nonperforming     Total  
    TDRs     TDRs     TDRs  
    (Dollars in thousands)  
                   
One-to-four family residential   $ 2,154     $ 361     $ 2,515  
Commercial real estate     3,690       1,462       5,152  
Home equity and lines of credit     283       30       313  
Other construction and land     1,185       192       1,377  
Commercial     276             276  
                         
    $ 7,588     $ 2,045     $ 9,633  

 

Loan modifications that were deemed TDRs at the time of the modification during the periods presented are summarized in the table below:

 

    Three Months Ended
September 30, 2018
    Nine Months Ended
September 30, 2018
 
(Dollars in thousands)   Number of
Loans
    Recorded
Investment
    Number of
Loans
    Recorded
Investment
 
Extended payment terms                                
Commercial real estate         $       1     $ 206  

 

There were no loan modifications that were deemed TDRs at the time of the modification during the three or nine month periods ended September 30, 2019.

 

There were no TDRs that defaulted during the three month and nine month periods ending September 30, 2019 and 2018 and which were modified as TDRs within the previous 12 months.

 

 
23
 

NOTE 5. GOODWILL AND OTHER INTANGIBLES

 

The Company had $23.9 million of goodwill as of September 30, 2019 and December 31, 2018.

 

The Company had $3.1 million and $3.6 million of core deposit intangibles as of September 30, 2019 and December 31, 2018, respectively. The following is a summary of gross carrying amounts and accumulated amortization of core deposit intangibles:

 

    As of and for the
Nine Months Ending
          As of and for
the Year Ending
 
    September 30,     December 31,  
    2019     2018  
    Dollars in thousands  
Gross balance at beginning of period   $ 4,840     $ 4,840  
Additions from acquisitions            
Gross balance at end of period     4,840       4,840  
Less accumulated amortization     (1,781 )     (1,263 )
Core deposit intangible, net   $ 3,059     $ 3,577  

 

Core deposit intangibles are amortized using the straight-line method over their estimated useful lives of seven years. Estimated amortization expense for core deposit intangibles is $0.7 million for 2019 and each of the next three years, $0.6 million in the fifth year, and $0.3 million in the final year.

 

NOTE 6. DEPOSITS

 

The following table summarizes deposit balances and interest expense by type of deposit as of and for the nine months ended September 30, 2019 and 2018 and the year ended December 31, 2018:

 

    As of and for the     As of and for the Year Ended  
    Nine Months Ended September 30,     December 31,  
    2019     2018     2018  
(Dollars in thousands)   Balance     Interest
Expense
    Balance     Interest
Expense
    Balance     Interest
Expense
 
Noninterest-bearing demand   $ 211,356     $     $ 199,224     $     $ 184,404     $  
Interest-bearing demand     186,201       273       206,967       282       209,085       374  
Money Market     463,289       4,185       372,428       1,687       356,086       2,637  
Savings     45,119       41       52,874       44       50,716       59  
Time Deposits     373,980       5,464       424,539       3,527       420,949       5,048  
    $ 1,279,945     $ 9,963     $ 1,256,032     $ 5,540     $ 1,221,240     $ 8,118  

                                                

The following table indicates wholesale deposits included in the money market and time deposits amounts above:

 

    September 30,     December 31,  
(Dollars in thousands)   2019     2018     2018  
Wholesale money market   $     $ 49,595     $ 5,030  
Wholesale time deposits     70,379       71,880       70,978  
    $ 70,379     $ 121,475     $ 76,008  
24
 

NOTE 7. BORROWINGS

 

The scheduled maturities and respective weighted average rates of outstanding FHLB advances are as follows for the dates indicated (dollars in thousands):

 

    September 30, 2019     December 31, 2018  
Year of Maturity   Balance     Weighted
Average Rate
    Balance     Weighted
Average Rate
 
2019   $ 50,500       2.53 %   $ 168,500       2.52 %
2020     150,000       2.34 %     45,000       2.80 %
2024     5,000       2.81 %            
    $ 205,500       2.40 %   $ 213,500       2.58 %

 

The Company has a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. The Company had no balance outstanding on the revolving credit loan facility as of September 30, 2019 and had drawn $5.0 million as of December 31, 2018.

 

The Company also had other borrowings of $4.5 million and $4.3 million at September 30, 2019 and December 31, 2018, respectively, which is comprised of participated loans that did not qualify for sale accounting. Interest expense on these other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

 

NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

 

Interest Rate Swaps

 

Risk Management Objective of Interest Rate Swaps

 

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedging relationship. The Company's hedging strategies involving interest rate derivatives are classified as either “Fair Value Hedges” or “Cash Flow Hedges,” depending upon the rate characteristic of the hedged item.

 

Fair Value Hedge: As a result of interest rate fluctuations, fixed-rate assets and liabilities will appreciate or depreciate in fair value. When effectively hedged, this appreciation or depreciation will generally be offset by fluctuations in the fair value of the derivative instruments that are linked to the hedged assets and liabilities. This strategy is referred to as a fair value hedge.

 

Cash Flow Hedge: Cash flows related to floating-rate assets and liabilities will fluctuate with changes in an underlying rate index. When effectively hedged, the increases or decreases in cash flows related to the floating rate asset or liability will generally be offset by changes in cash flows of the derivative instrument designated as a hedge. This strategy is referred to as a cash flow hedge.

25
 

Credit and Collateral Risks for Interest Rate Swaps

 

The Company manages credit exposure on interest rate swap transactions by entering into a bilateral credit support agreement with each counterparty. The credit support agreements allow for collateralization of exposures beyond specified minimum threshold amounts.

 

The Company’s agreements with its interest rate swap counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivative counterparties also include provisions, that if not met, could result in the Company being declared in default. If the Company were to be declared in default, the counterparty could terminate the derivative positions and the Company and the counterparty would be required to settle their obligations under the agreements. At September 30, 2019, the Company had two derivatives in a total net liability position of $1.8 million under these agreements and recognized the right to reclaim cash collateral of $1.8 million which was included in the consolidated balance sheets in “Other assets.” The Company had one derivative in a net liability position of $0.2 million at December 31, 2018.

 

Mortgage Derivatives

 

Risk Management Objective of Mortgage Lending Activities

 

The Company also maintains a risk management program to manage interest rate risk and pricing risk associated with its mortgage lending activities. The risk management program includes the use of forward contracts and other derivatives that are recorded in the financial statements at fair value and are used to offset changes in value of the mortgage inventory due to changes in market interest rates. As a normal part of our operations, we enter into derivative contracts to economically hedge risks associated with overall price risk related to interest rate lock commitments (”IRLCs”) and mortgage loans held-for-sale for which the fair value option has been elected. Fair value changes occur as a result of interest rate movements as well as changes in the value of the associated servicing. Derivative instruments used include forward sales commitments and IRLCs.

 

Credit and Collateral Risks for Mortgage Lending Activities

 

The Company’s underlying risks are primarily related to interest rates and forward sales commitments entered into as part of its mortgage banking activities. Forward sales commitments are contracts for the delayed delivery or net settlement of an underlying instrument, such as a mortgage loan, in which the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. These hedges are used to preserve the Company’s position relative to future sales of mortgage loans to third parties in an effort to minimize the volatility of the expected gain on sale from changes in interest rate and the associated pricing changes.

 

The table below presents the fair value of the Company’s derivative financial instruments as of the dates indicated as well as their classification on the consolidated balance sheets (in thousands).

 

    Derivative Assets (1)     Derivative Liabilities (1)  
    September 30,
2019
    December 31,
2018
    September 30,
2019
    December 31,
2018
 
Derivatives designated as hedging instruments:                                
Interest rate swaps   $ 97     $ 354     $ 1,760     $ 462  
Total   $ 97     $ 354     $ 1,760     $ 462  
                                 
Derivatives not designated as hedging instruments:                                
Mortgage derivatives   $ 79     $ 34     $ 16     $ 22  
Total   $ 79     $ 34     $ 16     $ 22  

 

 

(1) All derivative assets are located in “Other assets” on the consolidated balance sheets and all derivative liabilities are located in “Other liabilities” on the consolidated balance sheets.

26
 

The table below presents the effect of fair value and cash flow hedge accounting on the consolidated statements of income:

 

Derivatives Designated as Hedging Instruments

 

    Three months ended September 30,  
    2019     2018  
(dollars in thousands)   Interest
income
    Interest
expense
    Interest
income
    Interest
expense
 
Total amounts of income and expense line items presented in the consolidated statements of income   $ 16,996     $ 5,142     $ 15,978     $ 3,686  
                                 
Amounts related to fair value hedging relationships                                
Interest rate swaps:                                
Hedged items     120             (182 )      
Derivatives designated as hedging instruments     (148 )           187        
                                 
Amounts related to cash flow hedging relationships                                
Interest rate swaps:                                
Amount reclassified from accumulated other comprehensive income into income           (49 )           (149 )

 

    Nine months ended September 30,  
    2019     2018  
(dollars in thousands)   Interest
income
    Interest
expense
    Interest
income
    Interest
expense
 
Total amounts of income and expense line items presented in the consolidated statements of income   $ 50,284     $ 14,757     $ 46,149     $ 9,154  
                                 
Amounts related to fair value hedging relationships                              
Interest rate swaps:                                
Hedged items     843             (263 )      
Derivatives designated as hedging instruments     (893 )           261        
                                 
Amounts related to cash flow hedging relationships                                
Interest rate swaps:                                
Amount reclassified from accumulated other comprehensive loss into income           (172 )           (347 )

 

Fair Value Hedges

 

The Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps, designated as fair value hedges, involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed payments over the life of the agreements without the exchange of the underlying notional amount. The gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings. The Company entered into a pay-fixed/receive-variable interest rate swap with a notional amount of $25.0 million which was designated as a fair value hedge associated with the Company’s fixed rate loan program.

27
 

As of September 30, 2019, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:

 

(dollars in thousands)   Carrying amount of the
hedged assets
         Cumulative amount of fair
value hedging adjustment
included in the carrying
amount of the hedged assets
 
Line item in the balance sheet in which the hedged item is included   September 30,
2019
    September 30,
2019
 
Loans receivable (1)   $ 90,639     $ 1,088  

               
(1) These amounts include the amortized cost basis of the closed portfolio used to designate the hedging relationship in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship.  At September 30, 2019, the amortized cost basis of the closed portfolio used in the the hedging relationship was $90.6 million, the cumulative basis adjustment associated with the hedging relationship was $1.1 million, and the amount of the designated hedged items was $25.0 million.

 

Cash Flow Hedges

 

Interest rate swap contracts, designated as cash flow hedges, involve the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments without exchange of the underlying notional amounts. The forward starting interest rate swap begins exchanging cash flows in 2020 when the current interest rate swap agreement expires.

 

The structure of the swap agreements designated as cash flow hedges is described in the table below (dollars in thousands):

 

Underlyings   Designation   Notional     Payment Provision   Life of Swap Contract
Junior Subordinated Debt   Cash Flow Hedge   $ 14,000     Pay 0.958%/Receive 3 month LIBOR   4 yrs
Junior Subordinated Debt   Cash Flow Hedge   $ 14,000     Pay 3.02%/Receive 3 month LIBOR   3 yrs

 

 

The table below presents the effect of the Company's derivatives in cash flow hedging relationships for the periods presented (dollars in thousands):

                     

        As of and for the     As of and for the     As of and for the  
        Three Months Ended
September 30,
    Nine Months Ended
September 30,
    Year Ended
December 31,
 
Interest rate swaps   Location   2019     2018     2019     2018     2018  
Amounts recognized in AOCI on derivatives   OCI   $ (85 )   $ 93     $ (531 )   $ 303     $ 2  
Amounts reclassified from AOCI into income   Interest expense     (49 )     (149 )     (172 )     (347 )     (431 )
Amounts recognized in consolidated statement of comprehensive income       $ (134 )   $ (56 )   $ (703 )   $ (44 )   $ (429 )

 

Derivatives Not Designated as Hedging Instruments

Mortgage Derivatives

 

Mortgage derivative fair value assets and liabilities are described above. At September 30, 2019 and December 31, 2018, the Company had the following IRLCs and forward commitments for the future delivery of residential mortgage loans.

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    As of
September 30,
    As of
December 31,
 
(Dollars in thousands)   2019     2018  
Mortgage derivatives                
Interest rate lock commitments   $ 8,003     $ 1,627  
Forward sales commitment     12,750       3,500  

 

The table below presents the effect of the Company’s derivatives not designated as hedging instruments for the periods presented:

 

        Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
Interest rate products   Location   2019     2018     2019     2018  
        (Dollars in thousands)  
Amount of gain (loss) recognized in income on forward commitments   Noninterest income   $ (29 )   $ 12     $ (124 )   $ (33 )
Amount of gain (loss) recognized in income on interest rate lock commitments   Noninterest income     (15 )     (46 )     30       (17 )
Amount of loss recognized in income on derivatives not designated as hedging instruments       $ (44 )   $ (34 )   $ (94 )   $ (50 )
29
 

NOTE 9. INCOME TAXES

 

The components of net deferred taxes as of September 30, 2019 and December 31, 2018 are summarized as follows:

 

    September 30,     December 31,  
    2019     2018  
    (Dollars in thousands)  
Deferred tax assets:                
Allowance for loan losses   $ 2,817     $ 2,703  
Deferred compensation and post-employment benefits     1,820       1,854  
Non-accrual interest     259       245  
Valuation reserve for other real estate     253       191  
North Carolina NOL carryover     91       293  
Federal NOL carryover           1,231  
AMT credit carryover           316  
General federal business credit carryover     310       691  
Unrealized losses on securities     344       1,061  
Loan basis differences     42       50  
Fixed assets     144       123  
Core deposit intangible     186       129  
Derivative instruments     121        
Other     1,542       1,207  
Total deferred tax assets     7,929       10,094  
                 
Deferred tax liabilities:                
Loan servicing rights     579       653  
Goodwill     754       495  
Core deposit intangible     61       74  
Deferred loan costs     1,018       1,001  
Prepaid expenses     14       14  
Unrealized gains on securities     2,448       105  
Derivative instruments     14       29  
Investment in partnerships     170       155  
Other           17  
Total deferred tax liabilities     5,058       2,543  
                 
Net deferred tax asset   $ 2,871     $ 7,551  

 

The following table summarizes the amount and expiration dates of the Company’s unused net operating losses as of September 30, 2019:

 

(Dollars in thousands)   Amount     Expiration Dates  
North Carolina   $ 6,311       2026-2029  
Federal General Business Credit Carryforwards   $ 310       2038  
30
 

NOTE 10. EARNINGS PER SHARE

 

The following is a reconciliation of the numerator and denominator of basic and diluted net income per share of common stock as of the dates indicated:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(Dollars in thousands, except per share amounts)   2019     2018     2019     2018  
Numerator:                                
Net income   $ 3,997     $ 3,523     $ 9,976     $ 10,192  
Denominator:                                
Weighted-average common shares outstanding - basic     6,923,114       6,891,672       6,920,880       6,889,130  
Effect of dilutive securities:                                
Stock options     121,076       90,580       75,283       92,465  
Restricted stock units     45,660       48,898       33,001       42,119  
Weighted-average common shares outstanding - diluted     7,089,850       7,031,150       7,029,164       7,023,714  
                                 
Earnings per share - basic   $ 0.58     $ 0.51     $ 1.44     $ 1.48  
Earnings per share - diluted   $ 0.56     $ 0.50     $ 1.42     $ 1.45  

 

The following table presents stock options that are not deemed dilutive in calculating diluted earnings per share for the respective periods in the table above:

 

    Average Stock Price     Anti-dilutive Shares  
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2019     2018     2019     2018     2019     2018     2019     2018  
Stock options   $ 29.93     $ 28.25     $ 27.08     $ 28.44       11,900       30,438       44,900       23,721  
31
 

NOTE 11. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following table summarizes the components of accumulated other comprehensive income (“AOCI”) and changes in those components as of and for the three and nine months ended September 30, 2019 and 2018.

 

    Three Months Ended September 30, 2019  
    Available for
Sale Securities
    Cash Flow
Hedge
    Total  
(Dollars in thousands)                  
Balance, beginning of period   $ 4,496     $ (346 )   $ 4,150  
                         
Change in net unrealized holding gains on securities available for sale     2,455             2,455  
Change in unrealized holding losses on cash flow hedge           (85 )     (85 )
Reclassification adjustment for cash flow hedge effectiveness           (49 )     (49 )
Income tax effect     (560 )     28       (532 )
                         
Balance, end of period   $ 6,391     $ (452 )   $ 5,939  
                   
    Three Months Ended September 30, 2018  
(Dollars in thousands)                  
Balance, beginning of period   $ (4,271 )   $ 450     $ (3,821 )
                         
Change in net unrealized holding losses on securities available for sale     (2,318 )           (2,318 )
Change in unrealized holding gains on cash flow hedge           93       93  
Reclassification adjustment for cash flow hedge effectiveness           (149 )     (149 )
Income tax effect     524       14       538  
                         
Balance, end of period   $ (6,065 )   $ 408     $ (5,657 )
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    Nine Months Ended September 30, 2019  
    Available for
Sale Securities
    Cash Flow
Hedge
    Total  
    (Dollars in thousands)  
Balance, beginning of period   $ (3,528 )   $ 104     $ (3,424 )
                         
Change in net unrealized holding losses on securities available for sale     12,889             12,889  
Change in unrealized holding gains on cash flow hedge           (531 )     (531 )
Reclassification adjustment for cash flow effectiveness           (172 )     (172 )
Income tax effect     (2,970 )     147       (2,823 )
                         
Balance, end of period   $ 6,391     $ (452 )   $ 5,939  
       
    Nine Months Ended September 30, 2018  
    (Dollars in thousands)  
Balance, beginning of period   $ (455 )   $ 432     $ (23 )
                         
Change in net unrealized holding losses on securities available for sale     (8,181 )           (8,181 )
Reclassification adjustment for net securities gains realized in net income     947             947  
Change in unrealized holding gains on cash flow hedge           303       303  
Reclassification adjustment for cash flow effectiveness           (347 )     (347 )
Cumulative effect of change in accounting principle     9             9  
Income tax effect     1,615       20       1,635  
                         
Balance, end of period   $ (6,065 )   $ 408     $ (5,657 )

 

The following table shows the line items in the Consolidated Statements of Income affected by amounts reclassified from AOCI as of the dates indicated:

 

    Three Months Ended
September 30
    Nine Months Ended
September 30,
     
(Dollars in thousands)   2019     2018     2019     2018     Income Statement Line Item Affected
Available-for-sale securities                                    
Losses recognized   $     $     $     $ (947 )   Loss on sale of investments, net
Income tax effect                       213     Income tax expense
Reclassified out of AOCI, net of tax                       (734 )   Net income
                                     
Cash flow hedge                                    
Interest expense- effective portion           99             223     Interest expense - FHLB advances
Interest expense- effective portion     49       50       172       124     Interest expense - Junior subordinated notes
Income tax effect     (11 )     (33 )     (39 )     (78 )   Income tax expense
Reclassified out of AOCI, net of tax     38       116       133       269     Net income
                                     
Total reclassified out of AOCI, net of tax   $ 38     $ 116     $ 133     $ (465 )   Net income
33
 

NOTE 12. COMMITMENTS AND CONTINGENCIES

 

To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

 

The following summarizes the Company’s approximate commitments to extend credit:

 

    September 30, 2019  
    (Dollars in thousands)  
Lines of credit   $ 159,801  
Standby letters of credit     1,078  
    $ 160,879  

  

As of September 30, 2019, the Company had outstanding commitments to originate loans as follows:

 

    September 30, 2019  
    Amount     Range of Rates  
    (Dollar in thousands)  
             
Fixed   $ 20,965       3.13% to 6.99%  
Variable     4,869       2.88% to 6.49%  
    $ 25,834          

 

The allowance for unfunded commitments was $0.1 million at September 30, 2019 and December 31, 2018.

 

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to

Fannie Mae and maintained a reserve of $0.3 million as of September 30, 2019 and December 31, 2018.

 

In the normal course of business, the Company is periodically involved in litigation and other matters. In the opinion of the Company’s management, none of the litigation and other matters are expected to have a material adverse effect on the accompanying consolidated financial statements.

 

NOTE 13. FAIR VALUE

 

Overview

 

Fair value measurements are determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).

34
 

Fair Value Hierarchy

 

Level 1

 

Valuation is based on inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

Level 2

 

Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as interest rates, yield curves observable at commonly quoted intervals, and other market-corroborated inputs.

 

Level 3

 

Valuation is generated from techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon models that primarily use, as inputs, observable market-based parameters. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company's valuation process.

 

Fair Value Option

 

ASC 820 allows companies to report selected financial assets and liabilities at fair value using the fair value option. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. The Company made the election in September 2018 to record mortgage loans held-for-sale at fair value under the fair value option, which allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to hedge them without the burden of complying with the requirements for hedge accounting.

 

Financial Assets and Financial Liabilities Measured on a Recurring Basis

 

The Company uses the following methods and assumptions in estimating the fair value of its financial assets and financial liabilities on a recurring basis:

 

Investment Securities Available-for-Sale

 

We obtain fair values for debt securities from a third-party pricing service, which utilizes several sources for valuing fixed-income securities. The market evaluation sources for debt securities include observable inputs rather than significant unobservable inputs and are classified as Level 2. The service provider utilizes pricing models that vary by asset class and include available trade, bid and other market information. Generally, the methodologies include broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

 

Included in AFS investment securities are investments in an exchange traded bond fund and U.S. Treasury bonds, which are valued by reference to quoted market prices and considered a Level 1 security.

35
 

Also included in AFS investment securities are corporate bonds, which are valued using significant unobservable inputs and are classified as Level 2 or Level 3 based on market information available during the period.

 

Equity Securities

 

Equity securities represent investments in exchange traded mutual funds, which are valued by reference to quoted market prices and considered a Level 1 security.

 

Mortgage Loans Held-for-Sale

 

Mortgage loans held-for-sale are recorded at fair value on a recurring basis. The estimated fair value is determined using Level 3 inputs based on observable data such as the existing forward commitment terms or the current market value of similar loans.

 

Loan Servicing Rights

 

Loan servicing rights are carried at fair value as determined by a third party valuation firm. The valuation model utilizes a discounted cash flow analysis using discount rates and prepayment speed assumptions used by market participants. The Company classifies loan servicing rights fair value measurements as Level 3.

 

Derivative Instruments

 

Derivative instruments include IRLCs, forward sale commitments, and interest rate swaps. IRLCs and forward sale commitments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. The Company classifies these instruments as Level 3.

 

Interest rate swaps are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. The Company classifies interest rate swaps as Level 2.

36
 

The following tables present financial assets and financial liabilities measured at fair value on a recurring basis at the dates indicated, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

 

    September 30, 2019  
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  
Assets:                                
Equity securities   $ 6,947     $     $     $ 6,947  
Securities available for sale:                                
U.S. Treasury & Government Agencies     5,079       28,179             33,258  
Municipal Securities           120,156             120,156  
Mortgage-backed Securities - Guaranteed           73,834             73,834  
Collateralized Mortgage Obligations - Guaranteed           21,774             21,774  
Collateralized Mortgage Obligations - Non Guaranteed           65,264             65,264  
Collateralized Loan Obligations           15,221               15,221  
Corporate bonds           19,326       494       19,820  
Total securities available for sale     5,079       343,754       494       349,327  
                                 
Mortgage loans held for sale                 5,221       5,221  
Loan servicing rights                 2,520       2,520  
Interest rate swaps           97             97  
Mortgage derivatives                 79       79  
                                 
Total recurring assets at fair value   $ 12,026     $ 343,851     $ 8,314     $ 364,191  
                                 
Liabilities:                                
Interest rate swaps   $     $ 1,760     $     $ 1,760  
Mortgage derivatives                 16       16  
                                 
Total recurring liabilities at fair value   $     $ 1,760     $ 16     $ 1,776  
37
 

    December 31, 2018  
    Level 1     Level 2     Level 3     Total  
    (Dollars in thousands)  
Assets                                
Equity securities   $ 6,178     $     $     $ 6,178  
Securities available for sale:                                
U.S. Treasury & Government Agencies     4,949       29,041             33,990  
Municipal Securities           114,402             114,402  
Mortgage-backed Securities - Guaranteed           85,184             85,184  
Collateralized Mortgage Obligations - Guaranteed           21,889             21,889  
Collateralized Mortgage Obligations - Non Guaranteed           69,171               69,171  
Collateralized Loan Obligations             15,077             15,077  
Corporate bonds           19,532       493       20,025  
Total securities available for sale     4,949       354,296       493       359,738  
                                 
Mortgage loans held for sale                 2,431       2,431  
Loan servicing rights                 2,837       2,837  
Interest rate swaps           354             354  
Mortgage derivatives                 34       34  
                                 
Total recurring assets at fair value   $ 11,127     $ 354,650     $ 5,795     $ 371,572  
                                 
Liabilities                                
Interest rate swaps   $     $ 462     $     $ 462  
Mortgage derivatives                 22       22  
                                 
Total recurring liabilities at fair value   $     $ 462     $ 22     $ 484  
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The following table presents the changes in assets and liabilities measured at fair value on a recurring basis for which we have utilized Level 3 inputs to determine fair value:

 

    Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
    2019     2018     2019     2018  
    (Dollars in thousands)     (Dollars in thousands)  
Balance at beginning of period   $ 6,683     $ 4,404     $ 5,773     $ 3,321  
                                 
AFS securities                                
Fair value adjustment                 1        
                                 
Mortgage loans held for sale     1,647       651       2,790       1,821  
                                 
Loan servicing right activity, included in servicing income, net                                
Capitalization from loans sold     133       129       225       374  
Fair value adjustment     (176 )     (43 )     (542 )     (359 )
                                 
Mortgage derivative gains(losses) included in other income     11       (34 )     51       (50 )
                                 
Balance at end of period   $ 8,298     $ 5,107     $ 8,298     $ 5,107  

  

Financial Assets Measured on a Nonrecurring Basis

 

The Company uses the following methods and assumptions in estimating the fair value of its financial assets on a nonrecurring basis:

 

Small Business Administration (“SBA”) Loans Held for Sale

 

SBA loans held for sale are carried at the lower of cost or fair value. The fair value of SBA loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics and are classified as Level 2.

 

Impaired Loans

 

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of collateral dependent impaired loans is estimated using the value of the collateral less selling costs if repayment is expected from liquidation of the collateral. Appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or our knowledge of the borrower and the borrower’s business. Impaired loans carried at fair value are classified as Level 3. Impaired loans measured using the present value of expected future cash flows are not deemed to be measured at fair value.

 

Real Estate Owned (“REO”)

 

REO obtained in partial or total satisfaction of a loan is recorded at the lower of recorded investment in the loan or fair value less cost to sell. Subsequent to foreclosure, these assets are carried at the lower of the amount recorded at acquisition date or fair value less cost to sell. Accordingly, it may be necessary to record nonrecurring fair value adjustments. Fair value, when recorded, is generally based upon appraisals by approved, independent, state certified appraisers. Like impaired loans, appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. REO carried at fair value is classified as Level 3.

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Small Business Investment Company (“SBIC”) Holdings

 

SBIC h