Table Of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the Quarterly Period Ended June 30, 2015

 

OR

 

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

 

For the transition period from                    to_________

 

Commission File Number 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland	52-2061461
State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
30 Old Georgetown Road, Third Floor, Bethesda, Maryland	20814
Address of principal executive offices)	(Zip Code)
(301) 986-1800
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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☒        No ☐

 

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

Large accelerated filer ☒

Accelerated filer ☐

Non-accelerated filer ☐

Smaller Reporting Company ☐

 

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

Yes ☐     No ☒

 

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

 

As of July 27, 2015, the registrant had 33,396,316 shares of Common Stock outstanding.

 

  

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Changes in Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	71
Item 4.	Controls and Procedures	72
PART II.	OTHER INFORMATION	72
Item 1.	Legal Proceedings	72
Item 1A.	Risk Factors	72
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	72
Item 3.	Defaults Upon Senior Securities	72
Item 4.	Mine Safety Disclosures	72
Item 5.	Other Information	72
Item 6.	Exhibits	72
Signatures		75

 

 

Item 1 – Financial Statements (Unaudited)

---

 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

	June 30, 2015			December 31, 2014			June 30, 2014
Assets
Cash and due from banks	$	10,284		$	9,097		$	8,602
Federal funds sold		6,276			3,516			9,480
Interest bearing deposits with banks and other short-term investments		380,336			243,412			97,400
Investment securities available for sale, at fair value		423,709			382,343			378,990
Federal Reserve and Federal Home Loan Bank stock		16,828			22,560			10,626
Loans held for sale		132,683			44,317			35,411
Loans		4,550,897			4,312,399			3,279,429
Less allowance for credit losses		(48,921	)		(46,075	)		(43,552	)
Loans, net		4,501,976			4,266,324			3,235,877
Premises and equipment, net		17,185			19,099			17,797
Deferred income taxes		34,164			32,511			25,586
Bank owned life insurance		57,889			56,594			40,361
Intangible assets, net		109,957			109,908			3,379
Other real estate owned		10,715			13,224			8,843
Other assets		51,801			44,975			42,092
Total Assets	$	5,753,803		$	5,247,880		$	3,914,444
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest bearing demand	$	1,370,590		$	1,175,799		$	945,485
Interest bearing transaction		220,382			143,628			128,415
Savings and money market		2,439,337			2,302,600			1,899,430
Time, $100,000 or more		430,321			393,132			186,063
Other time		364,803			295,609			208,534
Total deposits		4,825,433			4,310,768			3,367,927
Customer repurchase agreements		53,394			61,120			60,646
Other short-term borrowings		-			100,000			-
Long-term borrowings		74,050			119,300			39,300
Other liabilities		35,865			35,933			19,750
Total Liabilities		4,988,742			4,627,121			3,487,623
Shareholders' Equity
Preferred stock, par value $.01 per share, shares authorized 1,000,000, Series B, $1,000 per share liquidation preference, shares issued and outstanding 56,600 at June 30, 2015, December 31, 2014 and June 30, 2014; Series C, $1,000 per share liquidation preference, shares issued and outstanding 15,300 at June 30, 2015, and December 31, 2014, and -0- at June 30, 2014		71,900			71,900			56,600
Common stock, par value $.01 per share; shares authorized 100,000,000, shares issued and outstanding 33,394,563, 30,139,396 and 25,985,659 respectively		330			296			255
Warrant		946			946			946
Additional paid in capital		498,704			394,933			245,629
Retained earnings		190,035			150,037			121,553
Accumulated other comprehensive income		3,146			2,647			1,838
Total Shareholders' Equity		765,061			620,759			426,821
Total Liabilities and Shareholders' Equity	$	5,753,803		$	5,247,880		$	3,914,444

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data)

 

		Six Months Ended June 30,								Three Months Ended June 30,
		2015				2014				2015				2014
Interest Income
Interest and fees on loans		$	117,057			$	82,679			$	59,878			$	42,316
Interest and dividends on investment securities			4,444				4,656				2,305				2,323
Interest on balances with other banks and short-term investments			376				254				238				116
Interest on federal funds sold			11				7				2				4
Total interest income			121,888				87,596				62,423				44,759
Interest Expense
Interest on deposits			6,929				4,736				3,687				2,324
Interest on customer repurchase agreements			61				69				34				31
Interest on short-term borrowings			54				-				-				-
Interest on long-term borrowings			2,563				764				1,152				384
Total interest expense			9,607				5,569				4,873				2,739
Net Interest Income			112,281				82,027				57,550				42,020
Provision for Credit Losses			6,781				5,068				3,471				3,134
Net Interest Income After Provision For Credit Losses			105,500				76,959				54,079				38,886
Noninterest Income
Service charges on deposits			2,616				2,411				1,283				1,219
Gain on sale of loans			6,881				2,864				3,294				1,021
Gain on sale of investment securities			2,164				10				-				2
Loss on early extinguishment of debt			(1,130	)			-				-				-
Increase in the cash surrender value of bank owned life insurance			796				624				406				310
Other income			2,710				2,365				1,250				1,259
Total noninterest income			14,037				8,274				6,233				3,811
Noninterest Expense
Salaries and employee benefits			30,389				26,623				14,683				13,015
Premises and equipment expenses			8,082				6,196				4,072				3,107
Marketing and advertising			1,420				877				735				415
Data processing			3,622				3,020				1,838				1,432
Legal, accounting and professional fees			1,852				1,773				870				799
FDIC insurance			1,554				1,107				783				563
Merger expenses			137				576				26				576
Other expenses			7,615				5,061				3,591				2,228
Total noninterest expense			54,671				45,233				26,598				22,135
Income Before Income Tax Expense			64,866				40,000				33,714				20,562
Income Tax Expense			24,510				14,557				12,776				7,618
Net Income			40,356				25,443				20,938				12,944
Preferred Stock Dividends			359				283				179				142
Net Income Available to Common Shareholders		$	39,997			$	25,160			$	20,759			$	12,802
Earnings Per Common Share
Basic		$	1.24			$	0.97			$	0.62			$	0.49
Diluted		$	1.22			$	0.95			$	0.61			$	0.48

 

See notes to consolidated financial statements.

  

  

EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

 

		Six Months Ended June 30,								Three Months Ended June 30,
		2015				2014				2015				2014
Net Income		$	40,356			$	25,443			$	20,938			$	12,944
Other comprehensive income (loss), net of tax:
Unrealized (loss) gain on securities available for sale			(112	)			5,163				(2,043	)			2,341
Unrealized gain on derivatives			1,909				-				1,909				-
Reclassification adjustment for net gains included in net income			(1,298	)			(6	)			-				(1	)
Net change other comprehensive income (loss)			499				5,157				(134	)			2,340
Comprehensive Income		$	40,855			$	30,600			$	20,804			$	15,284

 

See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands except share data)

 

																														Accumulated
		Preferred								Common												Additional Paid				Retained				Other Comprehensive				Total Shareholders'
		Shares				Stock				Shares				Stock				Warrant				in Capital				Earnings				Income (Loss)				Equity
Balance January 1, 2015			71,900			$	71,900				30,139,396			$	296			$	946			$	394,933			$	150,037			$	2,647			$	620,759
Net Income			-				-				-				-				-				-				40,356				-				40,356
Net change in other comprehensive income, net of tax			-				-				-				-				-				-				-				499				499
Stock-based compensation			-				-				-				-				-				2,407				-				-				2,407
Issuance of common stock related to options exercised			-				-				365,622				4				-				4,530				-				-				4,534
Tax benefit on non-qualified options exercised			-				-				-				-				-				1,867				-				-				1,867
Vesting of restricted stock awards issued at date of grant, net of shares withheld for payroll taxes			-				-				(16,345	)			2				-				(2	)			-				-				-
Restricted stock awards granted			-				-				78,070				-				-				-				-				-				-
Shares issued in public offering, net of issuance costs of $5,302			-				-				2,816,900				28				-				94,605				-				-				94,633
Issuance of common stock related to employee stock purchase plan			-				-				10,920				-				-				368				-				-				368
Cash paid in lieu of fractional shares upon merger with Virginia Heritage			-				-				-				-				-				(4	)			-				-				(4	)
Preferred stock dividends			-				-				-				-				-				-				(358	)			-				(358	)
Balance June 30, 2015			71,900			$	71,900				33,394,563			$	330			$	946			$	498,704			$	190,035			$	3,146			$	765,061
Balance January 1, 2014			56,600			$	56,600				25,885,863			$	253			$	946			$	242,990			$	96,393			$	(3,319	)		$	393,863
Net Income			-				-				-				-				-				-				25,443				-				25,443
Net change in other comprehensive income, net of tax			-				-				-				-				-				-				-				5,157				5,157
Stock-based compensation			-				-				-				-				-				1,915				-				-				1,915
Issuance of common stock related to options exercised			-				-				24,897				-				-				305				-				-				305
Tax benefit on non-qualified options exercised			-				-				-				-				-				123				-				-				123
Vesting of restricted stock awards issued at date of grant, net of shares withheld for payroll taxes			-				-				(14,042	)			2				-				(2	)			-				-				-
Restricted stock awards granted			-				-				78,947				-				-				-				-				-				-
Issuance of common stock related to employee stock purchase plan			-				-				9,994				-				-				298				-				-				298
Preferred stock dividends			-				-				-				-				-				-				(283	)			-				(283	)
Balance June 30, 2014			56,600			$	56,600				25,985,659			$	255			$	946			$	245,629			$	121,553			$	1,838			$	426,821

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

		Six Months Ended June 30,
		2015				2014
Cash Flows From Operating Activities:
Net Income		$	40,356			$	25,443
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for credit losses			6,781				5,068
Depreciation and amortization			6,005				2,292
Gains on sale of loans			(6,881	)			(2,864	)
Securities premium amortization (discount accretion), net			1,346				1,721
Origination of loans held for sale			(553,838	)			(221,231	)
Proceeds from sale of loans held for sale			472,353				230,714
Net increase in cash surrender value of BOLI			(796	)			(624	)
(Increase) decrease in deferred income taxes			(1,653	)			3,363
Decrease in fair value of other real estate owned			750				505
Net loss on sale of other real estate owned			165				100
Net gain on sale of investment securities			(2,164	)			(10	)
Loss on early extinguishment of debt			1,130				-
Stock-based compensation expense			2,407				1,915
Excess tax benefits from stock-based compensation			(1,867	)			(123	)
Increase in other assets			(6,826	)			(11,380	)
Decrease in other liabilities			(68	)			(12,705	)
Net cash (used in) provided by operating activities			(42,800	)			22,184
Cash Flows From Investing Activities:
Decrease in interest bearing deposits with other banks and short-term investments			436				43
Purchases of available for sale investment securities			(132,871	)			(26,852	)
Proceeds from maturities of available for sale securities			27,121				11,956
Proceeds from sale/call of available for sale securities			65,701				17,485
Purchases of Federal Reserve and Federal Home Loan Bank stock			(2,368	)			(53	)
Proceeds from redemption of Federal Reserve and Federal Home Loan Bank stock			8,100				699
Net increase in loans			(243,933	)			(336,985	)
Proceeds from sale of other real estate owned			986				108
Purchases of BOLI			(499	)			-
Purchases of annuities			(992	)			-
Bank premises and equipment acquired			(739	)			(3,194	)
Net cash used in investing activities			(279,058	)			(336,793	)
Cash Flows From Financing Activities:
Increase in deposits			514,665				142,513
Decrease in customer repurchase agreements			(7,726	)			(19,825	)
Issuance of common stock			94,633				-
Decrease in short-term borrowings			(100,000	)			-
Decrease in long-term borrowings			(45,250	)			-
Payment of dividends on preferred stock			(358	)			(283	)
Proceeds from exercise of stock options			4,534				305
Excess tax benefits from stock-based compensation			1,867				123
Payment in lieu of fractional shares			(4	)			-
Proceeds from employee stock purchase plan			368				298
Net cash provided by financing activities			462,729				123,131
Net Increase (Decrease) In Cash and Cash Equivalents			140,871				(191,478	)
Cash and Cash Equivalents at Beginning of Period			256,025				306,960
Cash and Cash Equivalents at End of Period		$	396,896			$	115,482
Supplemental Cash Flows Information:
Interest paid		$	9,913			$	5,770
Income taxes paid		$	27,950			$	20,200
Non-Cash Investing Activities
Transfers from loans to other real estate owned		$	1,500			$	330
Transfers from other real estate owned to loans		$	2,192			$	-

 

 See notes to consolidated financial statements.

 

 

EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”), EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

 

The consolidated financial statements of the Company included herein are unaudited. The consolidated financial statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2014 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Operating results for the six and three months ended June 30, 2015 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Northern Virginia, Montgomery County, Maryland, and Washington, D.C. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans and the origination of small business loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. As of June 30, 2015, the Bank offers its products and services through twenty-two banking offices, four lending centers and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Eagle Commercial Ventures, LLC, a direct subsidiary of the Company, provides subordinated financing for the acquisition, development and construction of real estate projects; these transactions involve higher levels of risk, together with commensurate higher returns. Refer to Higher Risk Lending – Revenue Recognition below.

 

Business Combinations

 

Business combinations are accounted for by applying the acquisition method in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations.” Under the acquisition method, identifiable assets acquired and liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date are measured at their fair values as of that date, and are recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition.

 

On October 31, 2014, the Company completed its acquisition of Virginia Heritage Bank (“Virginia Heritage”). The acquisition of Virginia Heritage was effected through the merger (the “Merger”) of Virginia Heritage with and into EagleBank, in accordance with the Agreement and Plan of Reorganization (the “Merger Agreement”) among the Company, EagleBank and Virginia Heritage, dated June 9, 2014. The acquisition added approximately $800 million in loans, $3 million in loans held for sale, $645 million in deposits, and $95 million in borrowings. An identified intangible related to core deposits was recorded for $4.6 million, which is being amortized over its estimated useful life of approximately 6 years and an initial intangible for goodwill was recorded for approximately $102.3 million. Additionally, in connection with the transaction, the Company recorded a fair value credit mark on the loan portfolio for approximately $12.5 million.

 

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

 

Cash Flows

 

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold, and interest bearing deposits with other banks which have an original maturity of three months or less.

 

Loans Held for Sale

 

The Company regularly engages in sales of residential mortgage loans and the guaranteed portion of SBA loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the consolidated statements of operations.

 

At June 30, 2015, the Company also classified as held for sale $83.4 million of indirect consumer loans acquired in the Merger. Fair value in the case of the indirect consumer loan portfolio was computed at the contract price and terms.

  

The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of June 30, 2015, December 31, 2014 and June 30, 2014. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an Excess Servicing Asset, which is computed on a loan by loan basis with the unamortized amount being included in Intangible assets in the consolidated balance sheets. This Excess Servicing Asset is being amortized on a straight-line basis (with adjustment for prepayments) as an offset to servicing fees collected and is included in Other income in the consolidated statement of operations.

 

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. interest rate lock commitments). Such interest rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price risk inherent in residential mortgage loan commitments, the Company utilizes both “best efforts” and “mandatory delivery” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. Under a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor and the investor commits to a price that it will purchase the loan from the Company if the loan to the underlying borrower closes. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the investor commits to purchase a loan at a price representing a premium on the day the borrower commits to an interest rate with the intent that the buyer/investor has assumed the interest rate risk on the loan. As a result, the Company is not generally exposed to losses on loans sold utilizing best efforts. Nor will it realize gains related to interest rate lock commitments due to changes in interest rates. The market values of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because interest rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between interest rate lock commitments and best efforts contracts, no gain or loss should occur on the interest rate lock commitments. Under a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay the investor a “pair-off” fee, based on then-current market prices, to compensate the investor for the shortfall. The interest rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. The Company manages the interest rate risk on interest rate lock commitments by entering into forward sale contracts of mortgage backed securities, whereby the Company obtains the right to deliver securities to investors in the future at a specified price. Such contracts are accounted for as derivatives and are recorded at fair value in derivative assets or liabilities, carried on the Consolidated Balance Sheet within Other Assets or Other Liabilities with changes in fair value recorded in other income within the Consolidated Statement of Income. The period of time between issuance of a loan commitment to the customer and closing and sale of the loan to an investor generally ranges from 30 to 90 days under current market conditions. The gross gains on loan sale are recognized based on new loan commitments with adjustment for price and pair-off activity. Commission expenses on loans held for sale are recognized based on loans closed.

 

 

In circumstances where the Company does not deliver the whole loan to an investor, but rather elects to retain the loan in its portfolio, the loan is transferred from held for sale to loans at fair value at date of transfer.

 

Investment Securities

 

The Company has no securities classified as trading, or as held to maturity. Marketable equity securities and debt securities not classified as held to maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company’s asset/liability management strategy and may be sold in response to changes in interest rates, current market conditions, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income/(loss), a separate component of shareholders’ equity, net of deferred income tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income in the consolidated statements of operations.

 

Premiums and discounts on investment securities are amortized/accreted to the earlier of call or maturity based on expected lives, which lives are adjusted based on prepayment assumptions and call optionality if any. Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

 

The entire amount of an impairment loss is recognized in earnings only when (1) the Company intends to sell the security, or (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes.

 

Loans

 

Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Deferred fees and costs are being amortized on the interest method over the term of the loan.

 

Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company’s portfolio monitoring and ongoing risk assessment procedures.  Management considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which are evaluated collectively for impairment and are generally placed on nonaccrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (ninety days or less) provided eventual collection of all amounts due is expected.  The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral.  In appropriate circumstances, interest income on impaired loans may be recognized on a cash basis.

 

 

Higher Risk Lending – Revenue Recognition

 

The Company has occasionally made higher risk acquisition, development, and construction (“ADC”) loans that entail higher risks than ADC loans made following normal underwriting practices (“higher risk loan transactions”). These higher risk loan transactions are currently made through the Company’s subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts, based on capital levels, and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standard Executive Committee (“AcSEC”) guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSEC’s guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). Certain additional interest is included as a component of noninterest income.  ECV had six higher risk lending transactions outstanding as of June 30, 2015, as compared to four higher risk lending transactions outstanding as of December 31, 2014, amounting to $11.8 million and $6.2 million, respectively.

 

Allowance for Credit Losses

 

The allowance for credit losses represents an amount which, in management’s judgment, is adequate to absorb probable losses on loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance. Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management’s judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. The allowance for credit losses consists of allocated and unallocated components.

 

The components of the allowance for credit losses represent an estimation done pursuant to ASC Topic 450, “Contingencies,” or ASC Topic 310, “Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors. These factors are set by management and approved by the appropriate Board committee to reflect its assessment of the relative level of risk inherent in each risk grade. A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management’s evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

 

 

Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank, periodically review the Bank’s loan portfolio and allowance for credit losses. Such review may result in recognition of additions to the allowance based on their judgments of information available to them at the time of their examination.

 

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes. Premises and equipment are depreciated over the useful lives of the assets, which generally range from five to seven years for furniture, fixtures and equipment, to three to five years for computer software and hardware, and to ten to forty years for buildings and building improvements. Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the consolidated statements of operations.

 

Other Real Estate Owned (OREO)

 

Assets acquired through loan foreclosure are held for sale and are recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by appraisals that are no more than twelve months old. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through noninterest expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in market conditions or appraised values.

 

Goodwill and Other Intangible Assets

 

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Other intangible assets represent purchased assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights. Intangible assets that have finite lives, such as core deposit intangibles are amortized over their estimated useful lives and subject to periodic impairment testing. Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives.

 

Goodwill and other intangibles are subject to impairment testing at the reporting unit level, which must be conducted at least annually. The Company performs impairment testing during the fourth quarter of each year or when events or changes in circumstances indicate the assets might be impaired.

 

The Company performs a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing updated qualitative factors, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it does not have to perform the two-step goodwill impairment test. Determining the fair value of a reporting unit under the first step of the goodwill impairment test and determining the fair value of individual assets and liabilities of a reporting unit under the second step of the goodwill impairment test are judgmental and often involve the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the fair value of other intangible assets. Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions. These approaches use significant estimates and assumptions including projected future cash flows, discount rates reflecting the market rate of return, projected growth rates and determination and evaluation of appropriate market comparables. Based on the results of quantitative assessments of all reporting units, the Company concluded that no impairment existed at December 31, 2014. However, future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss. Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

  

 

Interest Rate Swap Derivatives

 

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 its assets and liabilities and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. With the exception of forward commitment contracts discussed above under Loans Held for Sale, the Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate deposits.

 

At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”),or (3) an instrument with no hedging designation (“stand-alone derivative”). The Company has no fair value hedges or stand-alone derivatives, only cash flow hedges. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income (a Consolidated Balance Sheet component of Shareholders Equity) and is reclassified into earnings in the same period(s) during which the hedged transaction affects earnings (i.e. the period when cash flows are exchanged between counterparties). For both fair value and cash flow hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income.

 

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

 

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

 

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income or expense. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

 

Customer Repurchase Agreements

 

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, securities sold under agreements to repurchase are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The agreements are entered into primarily as accommodations for large commercial deposit customers. The obligation to repurchase the securities is reflected as a liability in the Company’s consolidated balance of sheets, while the securities underlying the securities sold under agreements to repurchase remain in the respective assets accounts and are delivered to and held as collateral by third party trustees.

 

 

Marketing and Advertising

 

Marketing and advertising costs are generally expensed as incurred.

 

Income Taxes

 

The Company employs the liability method of accounting for income taxes as required by ASC Topic 740, “Income Taxes.” Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain, although no such reserves exist at June 30, 2015, December 31, 2014, or June 30, 2014.

 

Transfer of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.

 

Earnings per Common Share

 

Basic net income per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured. Diluted earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents.

 

Stock-Based Compensation

 

In accordance with ASC Topic 718, “Compensation,” the Company records as compensation expense an amount equal to the amortization (over the remaining service period) of the fair value of option and restricted stock awards computed at the date of grant. Compensation expense on variable stock option grants (i.e. performance based grant) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 9 for a description of stock-based compensation awards, activity and expense.

 

New Authoritative Accounting Guidance

 

In April 2015, the FASB issued ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The update simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this update. This update will be effective for interim and annual periods beginning after December 15, 2015, and is to be applied retrospectively. Early adoption is permitted. The Company is currently assessing the impact that this guidance will have on its consolidated financial statements, but does not expect the guidance to have a material impact.

 

 

Note 2. Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2015, the Bank maintained balances at the Federal Reserve sufficient to meet reserve requirements, as well as significant excess reserves. Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held, which interest on excess reserves was increased under provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act passed in July 2010.

 

Additionally, the Bank maintains interest-bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with six domestic correspondent banks as compensation for services they provide to the Bank.

 

Note 3. Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

						Gross					Gross				Estimated
June 30, 2015		Amortized				Unrealized					Unrealized				Fair
(dollars in thousands)		Cost				Gains					Losses				Value
U. S. Government agency securities		$	59,360			$	637		#		$	294			$	59,703
Residential mortgage backed securities			256,196				1,517					2,050				255,663
Municipal bonds			90,593				2,872					627				92,838
Corporate bonds			15,100				-					59				15,041
Other equity investments			396				68					-				464
		$	421,645			$	5,094				$	3,030			$	423,709

 

						Gross					Gross				Estimated
December 31, 2014		Amortized				Unrealized					Unrealized				Fair
(dollars in thousands)		Cost				Gains					Losses				Value
U. S. Government agency securities		$	29,434			$	500		#		$	40			$	29,894
Residential mortgage backed securities			241,120				1,716					2,516				240,320
Municipal bonds			106,983				4,850					121				111,712
Other equity investments			396				21					-				417
		$	377,933			$	7,087				$	2,677			$	382,343

 

 

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

		Less than									12 Months
		12 Months									or Greater								Total
		Estimated									Estimated								Estimated
June 30, 2015		Fair					Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value					Losses				Value				Losses				Value				Losses
U. S. Government agency securities		$	25,511				$	294			$	-			$	-			$	25,511			$	294
Residential mortgage backed securities			59,378					425				70,155				1,625				129,533				2,050
Municipal bonds			31,814					627				-				-				31,814				627
Corporate bonds			11,307					59				-				-				11,307				59
		$	128,010				$	1,405			$	70,155			$	1,625			$	198,165			$	3,030

 

		Less than									12 Months
		12 Months									or Greater								Total
		Estimated									Estimated								Estimated
December 31, 2014		Fair					Unrealized				Fair				Unrealized				Fair				Unrealized
(dollars in thousands)		Value					Losses				Value				Losses				Value				Losses
U. S. Government agency securities		$	2,001				$	7			$	1,750			$	33			$	3,751			$	40
Residential mortgage backed securities			49,644					221				86,028				2,295				135,672				2,516
Municipal bonds			4,974					14				10,915				107				15,889				121
		$	56,619				$	242			$	98,693			$	2,435			$	155,312			$	2,677

  

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 3.9 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of June 30, 2015 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at June 30, 2015, the Company held $16.8 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes, and which are not marketable.

 

The amortized cost and estimated fair value of investments available-for-sale by contractual maturity are shown in the table below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		June 30, 2015								December 31, 2014
		Amortized				Estimated				Amortized				Estimated
(dollars in thousands)		Cost				Fair Value				Cost				Fair Value
U. S. Government agency securities maturing:
One year or less		$	30,957			$	30,813			$	2,998			$	3,051
After one year through five years			21,905				22,266				19,947				20,276
Five years through ten years			6,498				6,624				6,489				6,567
Residential mortgage backed securities			256,196				255,663				241,120				240,320
Municipal bonds maturing:
One year or less			1,530				1,534				2,410				2,438
After one year through five years			39,733				41,838				47,038				49,607
Five years through ten years			44,028				44,081				54,983				56,927
After ten years			5,302				5,385				2,552				2,740
Corporate bonds
After one year through five years			15,100				15,041				-				-
Other equity investments			396				464				396				417
		$	421,645			$	423,709			$	377,933			$	382,343

 

 

In 2015, gross realized gains on sales of investments securities were $2.5 million and gross realized losses on sales of investment securities were $294 thousand. In 2014, gross realized gains on sales of investment securities were $116 thousand and gross realized losses on sales of investment securities were $106 thousand.

 

Process from sales and calls of investment securities in 2015 were $65.7 million, and in 2014 were $17.5 million.

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at June 30, 2015 was $368.5 million, which is well in excess of required amounts in order to operationally provide significant reserve amounts for new business. As of June 30, 2015 and December 31, 2014, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities, which exceeded ten percent of shareholders’ equity.

 

Note 4. Mortgage Banking Derivative

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then commits the specific loan for sale with an investor if and only if settlement occurs (“best efforts”) or alternatively commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”) which provides a hedge against interest rate changes between the time the individual loan interest rate is locked with the borrower and the time the loan is sold to the investor. Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 

Certain additional risks arise from forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it may have a mismatch in its hedged position which could negatively impact earnings.

 

The fair value of the derivatives is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

 

At June 30, 2015 the Bank had derivative financial instruments with a notional value of $48.6 million related to its forward contracts. The net fair value of these derivative instruments at June 30, 2015 was $165 thousand, which is included in other assets and $15 thousand included in other liabilities. At June 30, 2014 the Bank had derivative financial instruments with a notional value of $25.3 million related to its forward contracts. The net fair value of these derivative instruments at June 30, 2014 was $223 thousand included in other assets and $159 thousand included in other liabilities.

 

Included in other noninterest income for the three and six months ended June 30, 2015 was a net loss of $101 thousand and $71 thousand, relating to derivative instruments. The amount included in other noninterest income for the three and six months ended June 30, 2015 pertaining to its hedging activities was a gain of $147 thousand and $318 thousand. For the three and six months ended June 30, 2014 was a net gain of $241 thousand, relating to derivative instruments. The amount included in other noninterest income for the three and six months ended June 30, 2014 pertaining to its hedging activities was a net realized loss of $159 thousand.

 

 

Note 5. Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, DC metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

Loans, net of unamortized net deferred fees, at June 30, 2015, December 31, 2014, and June 30, 2014 are summarized by type as follows:

 

		June 30, 2015								December 31, 2014								June 30, 2014
(dollars in thousands)		Amount				%				Amount				%				Amount				%
Commercial		$	960,506				21	%		$	916,226				21	%		$	726,611				22	%
Income producing - commercial real estate			1,863,583				41	%			1,703,172				40	%			1,302,479				40	%
Owner occupied - commercial real estate			497,834				11	%			461,581				11	%			330,073				10	%
Real estate mortgage - residential			149,842				3	%			148,018				3	%			123,587				4	%
Construction - commercial and residential			901,617				20	%			793,432				18	%			642,264				20	%
Construction - C&I (owner occupied)			54,134				1	%			58,032				1	%			38,368				1	%
Home equity			118,544				3	%			122,536				3	%			108,931				3	%
Other consumer			4,837				-				109,402				3	%			7,116				-
Total loans			4,550,897				100	%			4,312,399				100	%			3,279,429				100	%
Less: Allowance for Credit Losses			(48,921	)							(46,075	)							(43,552	)
Net loans		$	4,501,976							$	4,266,324							$	3,235,877

 

Unamortized net deferred fees amounted to $16.1 million, $15.6 million, and $14.5 million at June 30, 2015, December 31, 2014, and June 30, 2014, respectively.

 

As of June 30, 2015 and December 31, 2014, the Bank serviced $31.4 million and $67.9 million, respectively, of SBA loans which are not reflected as loan balances on the consolidated balance sheets.

 

Loan Origination / Risk Management

 

The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

 

The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and investment real estate. The combination of owner occupied commercial real estate and owner occupied commercial real estate construction represents 12% of the loan portfolio. At June 30, 2015, the combination of commercial real estate and real estate construction loans represents approximately 73% of the loan portfolio. When owner occupied commercial real estate and owner occupied commercial construction loans are excluded, the percentage of commercial real estate and construction loans to total loans decreases to 61%. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank’s policy requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.00. Personal guarantees are generally required, but may be limited.  In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

 

The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 21% of the loan portfolio at June 30, 2015 and was generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent 1% of the commercial loan category of loans. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA.

 

 

Approximately 3% of the loan portfolio at June 30, 2015 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a smaller portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

 

Approximately 3% of the loan portfolio consists of residential mortgage loans. These are typically loans underwritten to shorter terms, generally less than 10 years.

 

Loans are secured primarily by duly recorded first deeds of trust. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.

 

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

 

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.

 

Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

 

Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or its Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

 

Commercial permanent loans are secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.00. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

 

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

 

 

The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $955.8 million at June 30, 2015. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans containing loan funded interest reserves represent approximately 41% of the outstanding ADC loan portfolio at June 30, 2015. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (i) the feasibility of the project; (ii) the experience of the sponsor; (iii) the creditworthiness of the borrower and guarantors; (iv) borrower equity contribution; and (v) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company does not significantly utilize interest reserves in other loan products. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (i) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (ii) a construction loan administration department independent of the lending function; (iii) third party independent construction loan inspection reports; (iv) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (v) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.

 

From time to time the Company may make loans for its own portfolio or through its higher risk loan affiliate, ECV. Such loans, which are made to finance projects (which may also be financed at the Bank level), may have higher risk characteristics than loans made by the Bank, such as lower priority interests and/or higher loan to value ratios. The Company seeks an overall financial return on these transactions commensurate with the risks and structure of each individual loan. Certain transactions may bear current interest at a rate with a significant premium to normal market rates. Other loan transactions may carry a standard rate of current interest, but also earn additional interest based on a percentage of the profits of the underlying project or a fixed accrued rate of interest.

 

 

The following tables detail activity in the allowance for credit losses by portfolio segment for the three and six months ended June 30, 2015 and 2014. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

						Income				Owner								Construction
						Producing Commercial				Occupied Commercial				Real Estate Mortgage				Commercial and				Home				Other
(dollars in thousands)		Commercial				Real Estate				Real Estate				Residential				Residential				Equity				Consumer				Total
Three months ended June 30, 2015
Allowance for credit losses:
Balance at beginning of period		$	13,777			$	11,652			$	3,127			$	1,055			$	16,383			$	1,509			$	276			$	47,779
Loans charged-off			(2,307	)			(79	)			-				-				-				-				(16	)			(2,402	)
Recoveries of loans previously charged-off			24				18				1				1				9				2				18				73
Net loans charged-off			(2,283	)			(61	)			1				1				9				2				2				(2,329	)
Provision for credit losses			1,417				820				(15	)			26				1,241				(15	)			(3	)			3,471
Ending balance		$	12,911			$	12,411			$	3,113			$	1,082			$	17,633			$	1,496			$	275			$	48,921
Six months ended June 30, 2015