UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

xQUARTERLY 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

 

Commission File Number: 0-20293

 

UNION BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

VIRGINIA 54-1598552
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

1051 East Cary Street

Suite 1200

Richmond, Virginia 23219

(Address of principal executive offices) (Zip Code)

 

(804) 633-5031

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

Yes ¨ No x

 

The number of shares of common stock outstanding as of August 3, 2015 was 45,113,478.

 

 
 

 

UNION BANKSHARES CORPORATION

FORM 10-Q

INDEX

 

ITEM   PAGE
     
  PART I - FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014 2
     
  Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014 3
     
  Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014 4
     
  Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2015 and 2014 5
     
  Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014 6
     
  Notes to Consolidated Financial Statements 7
     
  Report of Independent Registered Public Accounting Firm 48
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 49
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 75
     
Item 4. Controls and Procedures 77
     
  PART II - OTHER INFORMATION  
     
Item 1. Legal Proceedings 78
     
Item 1A. Risk Factors 78
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 78
     
Item 6. Exhibits 79
     
  Signatures 80

 

ii
 

 

Glossary of Acronyms
     
AFS Available for sale
ALCO Asset Liability Committee
ALL Allowance for loan losses
ASC Accounting Standards Codification
ASU Accounting Standards Update
ATM Automated teller machine
the Bank Union Bank & Trust, formerly known as Union First Market Bank
bps Basis points
the Company Union Bankshares Corporation
Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
EPS Earnings per share
Exchange Act Securities Exchange Act of 1934
FASB Financial Accounting Standards Board
FDIC Federal Deposit Insurance Corporation
Federal Reserve Board of Governors of the Federal Reserve System
Federal Reserve Bank Federal Reserve Bank of Richmond
FHLB Federal Home Loan Bank of Atlanta
U.S. GAAP or GAAP Accounting principles generally accepted in the United States
HELOC Home equity line of credit
HTM Held to maturity
LIBOR London Interbank Offered Rate
NPA Nonperforming assets
OREO Other real estate owned
OTTI Other than temporary impairment
PCI Purchased credit impaired
SEC U.S. Securities and Exchange Commission
StellarOne StellarOne Corporation
TDR Troubled debt restructuring
UMG Union Mortgage Group, Inc.

 

 
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1 – FINANCIAL STATEMENTS

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

   June 30,   December 31, 
   2015   2014 
   (Unaudited)     
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $109,480   $112,752 
Interest-bearing deposits in other banks   26,333    19,344 
Money market investments   1    1 
Federal funds sold   1,019    1,163 
Total cash and cash equivalents   136,833    133,260 
           
Securities available for sale, at fair value   888,362    1,102,114 
Securities held to maturity, at carrying value   201,072    - 
Restricted stock, at cost   50,171    54,854 
           
Loans held for sale   39,450    42,519 
           
Loans held for investment, net of deferred fees and costs   5,510,385    5,345,996 
Less allowance for loan losses   32,344    32,384 
Net loans held for investment   5,478,041    5,313,612 
           
Premises and equipment, net   132,681    135,247 
Other real estate owned, net of valuation allowance   22,222    28,118 
Core deposit intangibles, net   27,394    31,755 
Goodwill   293,522    293,522 
Bank owned life insurance   141,284    139,005 
Other assets   86,674    84,637 
Total assets  $7,497,706   $7,358,643 
           
LIABILITIES          
Noninterest-bearing demand deposits  $1,289,676   $1,199,378 
Interest-bearing deposits   4,494,798    4,439,392 
Total deposits   5,784,474    5,638,770 
           
Securities sold under agreements to repurchase   119,680    44,393 
Other short-term borrowings   261,000    343,000 
Long-term borrowings   300,294    299,542 
Other liabilities   44,124    55,769 
Total liabilities   6,509,572    6,381,474 
           
Commitments and contingencies (Note 7)          
           
STOCKHOLDERS' EQUITY          
Common stock, $1.33 par value, shares authorized 100,000,000; issued and outstanding, 45,112,893 shares and 45,162,853 shares, respectively.   59,672    59,795 
Surplus   640,936    643,443 
Retained earnings   278,297    261,676 
Accumulated other comprehensive income   9,229    12,255 
Total stockholders' equity   988,134    977,169 
           
Total liabilities and stockholders' equity  $7,497,706   $7,358,643 

 

See accompanying notes to consolidated financial statements.

 

- 2 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except share data)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30,   June 30,   June 30, 
   2015   2014   2015   2014 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
Interest and dividend income:                    
Interest and fees on loans  $62,604   $61,386   $123,056   $122,655 
Interest on federal funds sold   -    -    1    - 
Interest on deposits in other banks   24    9    41    21 
Interest and dividends on securities:                    
Taxable   3,860    3,860    7,667    7,508 
Nontaxable   3,366    3,379    6,690    6,658 
Total interest and dividend income   69,854    68,634    137,455    136,842 
                     
Interest expense:                    
Interest on deposits   3,680    2,550    7,000    4,806 
Interest on federal funds purchased   4    23    5    46 
Interest on short-term borrowings   255    146    505    265 
Interest on long-term borrowings   2,099    2,200    4,160    4,252 
Total interest expense   6,038    4,919    11,670    9,369 
                     
Net interest income   63,816    63,715    125,785    127,473 
Provision for credit losses   3,749    1,500    5,499    1,500 
Net interest income after provision for credit losses   60,067    62,215    120,286    125,973 
                     
Noninterest income:                    
Service charges on deposit accounts   4,622    4,525    8,835    8,822 
Other service charges and fees   4,051    4,164    7,634    7,508 
Fiduciary and asset management fees   2,312    2,330    4,531    4,633 
Gains on sales of mortgage loans, net of commissions   2,574    3,030    4,952    5,328 
Gains on securities transactions, net   404    426    597    455 
Bank owned life insurance income   1,134    1,183    2,269    2,272 
Other operating income   1,115    622    2,448    1,050 
Total noninterest income   16,212    16,280    31,266    30,068 
                     
Noninterest expenses:                    
Salaries and benefits   25,561    27,616    53,052    56,830 
Occupancy expenses   5,173    5,102    10,305    10,282 
Furniture and equipment expenses   2,989    2,637    5,803    5,505 
Printing, postage, and supplies   1,408    1,170    2,779    2,392 
Communications expense   1,143    1,351    2,322    2,450 
Technology and data processing   3,216    2,792    6,471    5,866 
Professional services   1,669    1,442    3,017    2,497 
Marketing and advertising expense   2,372    1,692    4,060    2,757 
FDIC assessment premiums and other insurance   1,280    1,593    2,679    2,986 
Other taxes   1,554    1,507    3,105    2,892 
Loan-related expenses   687    630    1,371    1,172 
OREO and credit-related expenses   1,965    2,244    3,152    3,694 
Amortization of intangible assets   2,138    2,455    4,361    5,071 
Acquisition and conversion costs   -    4,661    -    17,829 
Branch closure expenses   1,280    -    1,280    - 
Other expenses   2,806    2,075    5,324    4,029 
Total noninterest expenses   55,241    58,967    109,081    126,252 
                     
Income before income taxes   21,038    19,528    42,471    29,789 
Income tax expense   5,690    4,855    11,422    7,407 
Net income  $15,348   $14,673   $31,049   $22,382 
Basic earnings per common share  $0.34   $0.32   $0.69   $0.48 
Diluted earnings per common share  $0.34   $0.32   $0.69   $0.48 
Dividends declared per common share  $0.17   $0.14   $0.32   $0.28 
Basic weighted average number of common shares outstanding   45,128,698    46,194,880    45,117,396    46,583,975 
Diluted weighted average number of common shares outstanding   45,209,814    46,296,870    45,198,727    46,686,592 

 

See accompanying notes to consolidated financial statements.

 

- 3 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2015   2014   2015   2014 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
Net income  $15,348   $14,673   $31,049   $22,382 
Other comprehensive income (loss):                    
Cash flow hedges:                    
Change in fair value of cash flow hedges   1,809    (778)   319    (203)
Reclassification adjustment for losses included in net income (net of tax, $22 and $117 for the three months and $169 and $142 for the six months ended June 30, 2015 and 2014)   41    217    313    264 
AFS securities:                    
Unrealized holding gains (losses) arising during period (net of tax, $3,686 and $3,625 for the three months and $1,649 and $7,024 for the six months ended June 30, 2015 and 2014)   (6,845)   6,733    (3,062)   13,046 
Reclassification adjustment for (gains) losses included in net income (net of tax, $142 and $9 for the three months and $209 and $19 for the six months ended June 30, 2015 and 2014)   (263)   (17)   (388)   (36)
HTM securities:                    
Accretion of unrealized gain for AFS securities transferred to HTM (net of tax, $112 and $0 for the three months and $112 and $0 for the six months ended June 30, 2015 and 2014).   (208)   -    (208)   - 
Other comprehensive income (loss)   (5,466)   6,155    (3,026)   13,071 
Comprehensive income  $9,882   $20,828   $28,023   $35,453 

 

See accompanying notes to consolidated financial statements.

 

- 4 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

SIX MONTHS ENDED JUNE 30, 2015 AND 2014

(Dollars in thousands, except share amounts)

 

    Common
Stock
    Surplus     Retained
Earnings (1)
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  
    (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  
Balance - December 31, 2013   $ 33,020     $ 170,770     $ 236,210     $ (2,190 )   $ 437,810  
Net income - 2014                     22,382               22,382  
Other comprehensive income (net of taxes of $7,147)                             13,071       13,071  
Issuance of common stock in regard to acquisition (22,147,874 shares)     29,457       520,066                       549,523  
Dividends on common stock ($0.28 per share)                     (12,503 )             (12,503 )
Stock purchased under stock repurchase plan (1,342,075 shares)     (1,785 )     (32,121 )                     (33,906 )
Issuance of common stock under Dividend Reinvestment Plan (23,187 shares)     31       522       (553 )             -  
Issuance of common stock under Equity Compensation Plans (60,470 shares)     80       863                       943  
Vesting of restricted stock under Equity Compensation Plans (8,254 shares)     11       (11 )                     -  
Net settle for taxes on Restricted Stock Awards (62,287 shares)     (83 )     (1,464 )                     (1,547 )
Stock-based compensation expense             554                       554  
Balance - June 30, 2014   $ 60,731     $ 659,179     $ 245,536     $ 10,881     $ 976,327  
                                         
Balance - December 31, 2014   $ 59,795     $ 643,443     $ 261,676     $ 12,255     $ 977,169  
Net income - 2015                     31,049               31,049  
Other comprehensive income (net of taxes of $1,801)                             (3,026 )     (3,026 )
Dividends on common stock ($0.32 per share)                     (13,727 )             (13,727 )
Stock purchased under stock repurchase plan (181,356 shares)     (240 )     (3,890 )                     (4,130 )
Issuance of common stock under Dividend Reinvestment Plan (33,710 shares)     45       656       (701 )             -  
Issuance of common stock under Equity Compensation Plans (25,873 shares)     34       386                       420  
Issuance of common stock for services rendered (9,200 shares)     12       188                       200  
Vesting of restricted stock under Equity Compensation Plans (30,401 shares)     40       (40 )                     -  
Net settle for taxes on Restricted Stock Awards (10,352 shares)     (14 )     (210 )                     (224 )
Stock-based compensation expense             403                       403  
Balance - June 30, 2015   $ 59,672     $ 640,936     $ 278,297     $ 9,229     $ 988,134  

(1) Retained earnings as of December 31, 2013 and 2014 includes the cumulative impact of $429,000 and $856,000, respectively, resulting from the adoption of ASU 2014-01 “Accounting For Investments in Qualified Affordable Housing Projects.” See “Note 1 - Accounting Policies” for additional information.

 

See accompanying notes to consolidated financial statements.

 

- 5 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2015 AND 2014

(Dollars in thousands)

 

   2015   2014 
   (Unaudited)   (Unaudited) 
Operating activities:          
Net income  $31,049   $22,382 
Adjustments to reconcile net income to net cash and cash equivalents provided by (used in) operating activities:          
Depreciation of bank premises and equipment   5,374    5,470 
Writedown of OREO   1,300    1,073 
Amortization, net   6,946    7,129 
Amortization related to acquisition, net   705    306 
Provision for credit losses   5,499    1,500 
Gains on securities transactions, net   (597)   (455)
Decrease in loans held for sale, net   3,069    940 
Losses (gains) on sales of other real estate owned, net   100    (30)
Losses on sales of bank premises, net   74    304 
Stock-based compensation expenses   403    554 
Issuance of common stock for services   200    - 
Net (increase) decrease in other assets   (2,799)   13,062 
Net decrease in other liabilities   (11,213)   (3,341)
Net cash and cash equivalents provided by operating activities   40,110    48,894 
Investing activities:          
Purchases of securities available for sale   (122,049)   (291,070)
Proceeds from sales of securities available for sale   58,157    259,077 
Proceeds from maturities, calls and paydowns of securities available for sale   70,086    68,448 
Net (increase) decrease in loans   (168,449)   41,555 
Net increase in bank premises and equipment   (3,284)   (4,879)
Proceeds from sales of other real estate owned   5,609    7,713 
Improvements to other real estate owned   (299)   (59)
Cash paid for equity-method investments   (355)   - 
Cash acquired in bank acquisitions   -    49,989 
Net cash and cash equivalents (used in) provided by investing activities   (160,584)   130,774 
Financing activities:          
Net increase in noninterest-bearing deposits   90,298    95,205 
Net increase (decrease) in interest-bearing deposits   57,096    (71,978)
Net decrease in short-term borrowings   (6,713)   (70,906)
Net increase in long-term borrowings   1,027    881 
Cash dividends paid - common stock   (13,727)   (12,503)
Repurchase of common stock   (4,130)   (33,906)
Issuance of common stock   420    943 
Taxes paid related to net share settlement of equity awards   (224)   (1,547)
Net cash and cash equivalents provided by (used in) financing activities   124,047    (93,811)
Increase in cash and cash equivalents   3,573    85,857 
Cash and cash equivalents at beginning of the period   133,260    73,023 
Cash and cash equivalents at end of the period  $136,833   $158,880 
           
Supplemental Disclosure of Cash Flow Information          
Cash payments for:          
Interest  $13,784   $13,788 
Income taxes   12,400    5,800 
           
Supplemental schedule of noncash investing and financing activities          
Unrealized (losses) gains on securities available for sale  $(5,308)  $20,015 
Transfer from securities available for sale to securities held to maturity   201,822    - 
Changes in fair value of interest rate swap loss   632    61 
Transfers between loans and other real estate owned   412    2,704 
Transfers from bank premises to other real estate owned   402    6,052 
Issuance of common stock in exchange for net assets in acquisition   -    549,523 
           
Transactions related to bank acquisition          
Assets acquired   -    2,957,521 
Liabilities assumed   -    2,642,120 

 

See accompanying notes to consolidated financial statements.

 

- 6 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

 

1.ACCOUNTING POLICIES

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant inter-company accounts and transactions have been eliminated in consolidation.

 

The unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

 

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2014 Annual Report on Form 10-K. If needed, certain previously reported amounts have been reclassified to conform to current period presentation.

 

Adoption of New Accounting Standards

The Company adopted ASU 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects” as of January 1, 2015. As permitted by the guidance, the Company adopted the proportional amortization method of accounting for qualified affordable housing projects. The proportional amortization method amortizes the cost of the investment over the period in which the Company will receive tax credits and other tax benefits, and the resulting amortization is recognized as a component of income taxes attributable to continuing operations. Historically, these investments were accounted for under the equity method of accounting and the passive losses related to the investments were recognized within noninterest expense. The Company adopted this guidance in the first quarter of 2015 with retrospective application as required by the ASU. Prior period results and related metrics have been recast to conform to this presentation. The recast of prior period information did not have a material impact on the Company’s financial condition or results of operations.

 

For the three and six months ended June 30, 2015, the Company recognized amortization of $104,000 and $279,000, respectively, and tax credits of $170,000 and $427,000, respectively, associated with these investments within “Income tax expense” on the Company’s Consolidated Statements of Income. The carrying value of the Company’s investments in these qualified affordable housing projects was $9.7 million and $10.4 million as of June 30, 2015 and December 31, 2014, respectively. The Company recorded a liability of $5.1 million for the related unfunded commitments as of June 30, 2015, which are expected to be paid from 2015 to 2018.

 

Recent Accounting Pronouncements

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The amendments in this ASU eliminate from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.

 

 

- 7 -
 

 

In February 2015, the FASB issued ASU No. 2015-02, “Amendments to the Consolidation Analysis.” The amendments in this ASU amend the consolidation requirements in ASC 810, Consolidation, and significantly change the consolidation analysis required under U.S. GAAP. Under this guidance, limited partnerships will be considered variable interest entities (“VIEs”) unless the limited partners have either substantive kick-out or participating rights; this amendment will result in more partnerships being considered VIEs, but it will be less likely that a general partner will consolidate a limited partnership. The amendments also change the effect that fees paid to a decision maker or service provider have on the consolidation analysis; it is less likely that the fees themselves will be considered a variable interest, that an entity will be a VIE, or that consolidation will result. The changes modify how a reporting entity considers how its variable interests affect its consolidation process; the related party tiebreaker test and mandatory consolidation by one of the related parties will have to be performed less frequently than under current U.S. GAAP. For entities other than limited partnerships, the amendments clarify how to determine whether the equity holders have power over the entity and could affect whether the entity is a VIE. The amendments are expected to result in the deconsolidation of many entities. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company is currently assessing the impact that ASU 2015-02 will have on its consolidated financial statements.

 

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 ASU does not change the existing recognition and measurement guidance for debt issuance costs but requires that debt issuance costs related to a debt liability recorded on the balance sheet be present in the balance sheet as a direct deduction from the carrying amount of that debt liability. The amendments should be disclosed consistent with the disclosure requirement of a change in accounting principle and applied on a retrospective basis. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40: Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” This ASU clarifies the circumstances under which a cloud computing customer would account for the arrangement as a license of internal-use software. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses; otherwise, the customer should account for the arrangement as a service contract. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The Company is currently assessing the impact of ASU 2015-05 will have on its consolidated financial statements.

 

- 8 -
 

 

2.ACQUISITIONS

 

The Company’s merger and acquisition strategy focuses on high-growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance, and good asset quality, among other factors. On January 1, 2014, the Company completed the acquisition of StellarOne, a bank holding company based in Charlottesville, Virginia, in an all-stock transaction. StellarOne’s common shareholders received 0.9739 shares of the Company’s common stock in exchange for each share of StellarOne’s common stock, resulting in the Company issuing 22,147,874 shares of common stock at a fair value of $549.5 million. The fair value of assets acquired totaled $2.96 billion and liabilities assumed totaled $2.64 billion. As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. On May 9, 2014, StellarOne Bank was merged with and into the Bank. Information regarding this acquisition is included in the Company’s 2014 Annual Report on Form 10-K. The Company did not complete any acquisitions of businesses in 2015.

 

The net effect of the amortization and accretion of premiums and discounts associated with the Company’s acquisition accounting adjustments had the following impact on the Consolidated Statements of Income during the three and six months ended June 30, 2015 and 2014 (dollars in thousands):

 

    For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
    2015     2014     2015     2014  
Loans (1)   $ 1,052     $ (219 )   $ 1,691     $ (765 )
Core deposit intangible (2)     (2,138 )     (2,456 )     (4,361 )     (5,072 )
Borrowings (3)     137       75       275       150  
Time deposits (4)     614       2,460       1,690       5,381  
Net impact to income before taxes   $ (335 )   $ (140 )   $ (705 )   $ (306 )

(1) Loan discount (premium) accretion (amortization) is included in “Interest and fees on loans” in the “Interest and dividend income” section of the Company's Consolidated Statements of Income.

(2) Core deposit intangible premium amortization is included in “Amortization of intangible assets” in the “Noninterest expense” section of the Company's Consolidated Statements of Income.

(3) Borrowings discount accretion is included in “Interest on long-term borrowings” in the “Interest Expense” section of the Company's Consolidated Statements of Income.

(4) Certificate of deposit discount accretion is included in “Interest on deposits” in the “Interest expense” section of the Company's Consolidated Statements of Income.

 

- 9 -
 

 

3.SECURITIES

 

Available for Sale

The amortized cost, gross unrealized gains and losses, and estimated fair values of securities available for sale as of June 30, 2015 and December 31, 2014 are summarized as follows (dollars in thousands):

 

   Amortized   Gross Unrealized   Estimated 
   Cost   Gains   (Losses)   Fair Value 
June 30, 2015                    
U.S. government and agency securities  $8,149   $231   $-   $8,380 
Obligations of states and political subdivisions   241,323    7,811    (1,493)   247,641 
Corporate bonds   75,551    67    (464)   75,154 
Mortgage-backed securities   539,665    9,094    (1,765)   546,994 
Other securities   10,181    28    (16)   10,193 
Total available for sale securities  $874,869   $17,231   $(3,738)  $888,362 
                     
December 31, 2014                    
U.S. government and agency securities  $8,313   $166   $(25)  $8,454 
Obligations of states and political subdivisions   427,483    18,885    (721)   445,647 
Corporate bonds   78,744    244    (308)   78,680 
Mortgage-backed securities   550,716    9,411    (798)   559,329 
Other securities   9,979    31    (6)   10,004 
Total available for sale securities  $1,075,235   $28,737   $(1,858)  $1,102,114 

 

- 10 -
 

 

The following table shows the gross unrealized losses and fair value (in thousands) of the Company’s available for sale investments with unrealized losses that are not deemed to be other-than-temporarily impaired. These are aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

   Less than 12 months   More than 12 months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
June 30, 2015                              
Obligations of states and political subdivisions  $46,361   $(1,107)  $6,491   $(386)  $52,852   $(1,493)
Mortgage-backed securities   175,493    (1,344)   29,589    (421)   205,082    (1,765)
Corporate bonds and other securities   33,808    (201)   23,470    (279)   57,278    (480)
Total available for sale  $255,662   $(2,652)  $59,550   $(1,086)  $315,212   $(3,738)
                               
December 31, 2014                              
U.S. government and agency securities  $7,055   $(25)  $-   $-   $7,055   $(25)
Obligations of states and political subdivisions   13,602    (93)   42,514    (628)   56,116    (721)
Mortgage-backed securities   60,151    (362)   49,581    (436)   109,732    (798)
Corporate bonds and other securities   43,923    (244)   4,309    (70)   48,232    (314)
Total available for sale  $124,731   $(724)  $96,404   $(1,134)  $221,135   $(1,858)

 

As of June 30, 2015, there were $59.6 million, or 24 issues, of individual available for sale securities that had been in a continuous loss position for more than 12 months. Additionally, these securities had an unrealized loss of $1.1 million and consisted of municipal obligations, mortgage-backed securities, and corporate bonds. As of December 31, 2014, there were $96.4 million, or 60 issues, of individual securities that had been in a continuous loss position for more than 12 months. Additionally, these securities had an unrealized loss of $1.1 million and consisted of municipal obligations, mortgage-backed securities, corporate bonds, and other securities. The Company has determined that these securities are temporarily impaired as of June 30, 2015 and December 31, 2014 for the reasons set out below:

 

U.S. Government agencies and corporations. The unrealized losses in this category of investments were caused by interest rate fluctuations. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments and the accounting standard of “more likely than not” has not been met for the Company to be required to sell any of these investments before recovery of its amortized cost basis, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired.

 

Mortgage-backed securities. This category’s unrealized losses are primarily the result of interest rate fluctuations. Since the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not intend to sell the investments, and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired. Also, the majority of the Company’s mortgage-backed securities are agency-backed securities, which have a government guarantee.

 

State and political subdivisions. This category’s unrealized losses are primarily the result of interest rate fluctuations and also a certain few ratings downgrades brought about by the impact of the economic downturn on states and political subdivisions. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments and the accounting standard of “more likely than not” has not been met for the Company to be required to sell any of the investments before recovery of its amortized cost basis, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired.

 

- 11 -
 

 

Corporate debt securities. The Company’s unrealized losses in corporate debt securities are related to both interest rate fluctuations and ratings downgrades for a limited number of securities. The majority of the securities remain investment grade and the Company’s analysis did not indicate the existence of a credit loss. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments before recovery of its amortized cost basis, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired.

 

The following table presents the amortized cost and estimated fair value of available for sale securities as of June 30, 2015 and December 31, 2014, by contractual maturity (dollars in thousands). Expected maturities may 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 
   Cost   Fair Value   Cost   Fair Value 
Due in one year or less  $22,204   $22,302   $19,345   $19,434 
Due after one year through five years   57,278    58,826    41,545    43,070 
Due after five years through ten years   234,339    239,495    306,900    314,044 
Due after ten years   561,048    567,739    707,445    725,566 
Total securities available for sale  $874,869   $888,362   $1,075,235   $1,102,114 

 

The following table presents available for sale securities which were pledged to secure public deposits, repurchase agreements, and for other purposes as permitted or required by law as of June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   June 30, 2015   December 31, 2014 
   Fair Value   Fair Value 
Public deposits  $149,354   $312,793 
Repurchase agreements   125,731    51,842 
Other purposes   32,087    32,360 
Total pledged securities  $307,172   $396,995 

 

Held to Maturity

During the second quarter of 2015, the Company transferred securities, which it intends and has the ability to hold until maturity, with a fair value of $201.8 million on the date of transfer, from securities available for sale to securities held to maturity. The Company transferred these securities to held to maturity to reduce the impact of price volatility on capital and in consideration of changes to the regulatory environment. The securities included net pre-tax unrealized gains of $8.1 million at the date of transfer with a remaining balance of $7.8 million as of June 30, 2015.

 

The Company reports securities held to maturity on the Consolidated Balance Sheets at carrying value. Carrying value is amortized cost which includes any unamortized unrealized gains and losses recognized in accumulated other comprehensive income prior to reclassifying the securities from securities available for sale to securities held to maturity. Investment securities transferred into the held to maturity category from the available for sale category are recorded at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer is retained in accumulated other comprehensive income and in the carrying value of the securities held to maturity. Such unrealized gains/(losses) are accreted over the remaining life of the security with no impact on future net income.

 

- 12 -
 

 

The carrying value, gross unrealized gains and losses, and estimated fair values of securities held to maturity as of June 30, 2015 are summarized as follows (dollars in thousands):

 

   Carrying   Gross Unrealized   Estimated 
   Value (1)   Gains   (Losses)   Fair Value 
June 30, 2015                    
Obligations of states and political subdivisions  $201,072   $2,127   $(3,724)  $199,475 

 

(1) The carrying value includes $7.8 million of unrealized gains and losses present at the time of transfer from available for securities, net of any accretion.

 

The following table shows the gross unrealized losses and fair value (in thousands) of the Company’s held to maturity investments with unrealized losses that are not deemed to be other-than-temporarily impaired. These are aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

   Less than 12 months   More than 12 months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
June 30, 2015                              
Obligations of states and political subdivisions  $181,093   $(3,680)  $4,209   $(44)  $185,302   $(3,724)

 

As of June 30, 2015, there were $4.2 million, or 4 issues, of individual held to maturity securities that had been in a continuous loss position for more than 12 months. Additionally, these securities had an unrealized loss of $44,000 and consisted of municipal obligations. The Company has determined that these securities are temporarily impaired as of June 30, 2015, as the related unrealized losses are primarily the result of interest rate fluctuations.

 

The following table presents the amortized cost and estimated fair value of held to maturity securities as of June 30, 2015, by contractual maturity (dollars in thousands). Expected maturities may 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 
   Carrying   Estimated 
   Value (1)   Fair Value 
Due in one year or less  $1,322   $1,334 
Due after one year through five years   5,268    5,276 
Due after five years through ten years   31,977    31,709 
Due after ten years   162,505    161,156 
Total securities held to maturity  $201,072   $199,475 

 

(1) The carrying value includes $7.8 million of unrealized gains and losses present at the time of transfer from available for securities, net of any accretion.

 

The following table presents held to maturity securities which were pledged to secure public deposits as permitted or required by law as of June 30, 2015 (dollars in thousands):

 

   June 30, 2015 
   Fair 
   Value 
Public deposits  $199,475 
Total pledged securities  $199,475 

 

- 13 -
 

 

Restricted Stock, at cost

Due to restrictions placed upon the Bank’s common stock investment in the Federal Reserve Bank and FHLB, these securities have been classified as restricted equity securities and carried at cost. These restricted securities are not subject to the investment security classifications and are included as a separate line item on the Company’s Consolidated Balance Sheets. At June 30, 2015, the FHLB required the Bank to maintain stock in an amount equal to 4.25% of outstanding borrowings and a specific percentage of the Bank’s total assets. At December 31, 2014, the FHLB required the Bank to maintain stock in an amount equal to 4.5% of outstanding borrowings and a specific percentage of the Bank’s total assets. The Federal Reserve Bank required the Bank to maintain stock with a par value equal to 6% of its outstanding capital at both June 30, 2015 and December 31, 2014. Restricted equity securities consist of Federal Reserve Bank stock in the amount of $23.8 million for both June 30, 2015 and December 31, 2014 and FHLB stock in the amount of $26.4 million and $31.0 million as of June 30, 2015 and December 31, 2014, respectively.

 

Other-Than-Temporary-Impairment

During each quarter, the Company conducts an assessment of the securities portfolio for OTTI consideration. The assessment considers factors such as external credit ratings, delinquency coverage ratios, market price, management’s judgment, expectations of future performance, and relevant industry research and analysis. An impairment is other-than-temporary if any of the following conditions exist: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other-than-temporary and should be separated into a credit portion to be recognized in earnings and the remaining amount relating to all other factors recognized as other comprehensive loss. Based on the assessment for the quarter ended June 30, 2015, and in accordance with the guidance, no OTTI was recognized.

 

Realized Gains and Losses

The following table presents the gross realized gains and losses on the sale of securities available for sale and the proceeds from the sale of securities available for sale during the three and six months ended June 30, 2015 (dollars in thousands). The Company did not sell any investment securities that are held to maturity.

 

   Three months ended   Six months ended 
   June 30, 2015   June 30, 2015 
Realized gains (losses):          
Gross realized gains  $491   $684 
Gross realized losses   (87)   (87)
Net realized gains  $404   $597 

 

The following table presents the gross realized gains and losses on the sale of securities available for sale and the proceeds from the sale of securities available for sale during the three and six months ended June 30, 2014 (dollars in thousands).

 

   Three months ended   Six months ended 
   June 30, 2014   June 30, 2014 
Realized gains (losses):          
Gross realized gains  $432   $464 
Gross realized losses   (6)   (9)
Net realized gains  $426   $455 

 

- 14 -
 

 

4.LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans are stated at their face amount, net of deferred fees and costs, and consist of the following at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   June 30,   December 31, 
   2015   2014 
Commercial:          
Commercial Construction  $378,204   $341,280 
Commercial Real Estate - Owner Occupied   874,582    875,443 
Commercial Real Estate - Non-Owner Occupied   1,569,306    1,509,159 
Raw Land and Lots   201,630    211,225 
Single Family Investment Real Estate   435,068    412,494 
Commercial and Industrial   450,682    393,776 
Other Commercial   90,556    81,106 
Consumer:          
Mortgage   470,707    478,151 
Consumer Construction   65,105    74,168 
Indirect Auto   208,195    199,411 
Indirect Marine   42,306    43,190 
HELOCs   488,891    500,579 
Credit Card   26,349    24,225 
Other Consumer   208,804    201,789 
 Total  $5,510,385   $5,345,996 

 

The following table shows the aging of the Company’s loan portfolio, by class, at June 30, 2015 (dollars in thousands):

 

   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days and
still Accruing
   PCI   Nonaccrual   Current   Total Loans 
Commercial:                                   
Commercial Construction  $-   $-   $126   $2,921   $1,907   $373,250   $378,204 
Commercial Real Estate - Owner Occupied   169    341    705    29,838    3,625    839,904    874,582 
Commercial Real Estate - Non-Owner Occupied   3,336    1,199    798    20,016    200    1,543,757    1,569,306 
Raw Land and Lots   135    207    128    5,103    403    195,654    201,630 
Single Family Investment Real Estate   487    232    515    15,504    782    417,548    435,068 
Commercial and Industrial   1,727    285    509    3,025    1,074    444,062    450,682 
Other Commercial   566    10    -    1,112    65    88,803    90,556 
Consumer:                                   
Mortgage   1,760    3,872    4,329    6,605    1,054    453,087    470,707 
Consumer Construction   -    -    819    508    -    63,778    65,105 
Indirect Auto   1,631    229    215    -    -    206,120    208,195 
Indirect Marine   374    -    -    -    48    41,884    42,306 
HELOCs   2,516    387    1,289    1,840    161    482,698    488,891 
Credit Card   161    70    180    -    -    25,938    26,349 
Other Consumer   2,285    612    1,290    1,369    202    203,046    208,804 
Total  $15,147   $7,444   $10,903   $87,841   $9,521   $5,379,529   $5,510,385 

 

- 15 -
 

 

The following table shows the aging of the Company’s loan portfolio, by class, at December 31, 2014 (dollars in thousands):

 

  30-59 Days
Past Due
  60-89 Days
Past Due
  Greater Than
90 Days and
still Accruing
  PCI  Nonaccrual  Current  Total Loans
Commercial:                                   
Commercial Construction  $815   $-   $-   $3,782   $968   $335,715   $341,280 
Commercial Real Estate - Owner Occupied   621    1,542    1,683    31,167    1,060    839,370    875,443 
Commercial Real Estate - Non-Owner Occupied   3,984    237    91    28,869    5,902    1,470,076    1,509,159 
Raw Land and Lots   145    44    194    7,427    2,359    201,056    211,225 
Single Family Investment Real Estate   2,825    338    734    16,879    2,070    389,648    412,494 
Commercial and Industrial   1,250    529    549    3,855    3,286    384,307    393,776 
Other Commercial   42    2    -    2,256    74    78,732    81,106 
Consumer:                                   
Mortgage   12,851    4,300    4,095    7,394    2,485    447,026    478,151 
Consumer Construction   120    -    844    516    -    72,688    74,168 
Indirect Auto   1,593    263    317    -    -    197,238    199,411 
Indirect Marine   150    -    -    -    201    42,839    43,190 
HELOCs   3,082    955    820    2,000    258    493,464    500,579 
Credit Card   232    108    219    -    -    23,666    24,225 
Other Consumer   1,587    412    501    1,643    592    197,054    201,789 
Total  $29,297   $8,730   $10,047   $105,788   $19,255   $5,172,879   $5,345,996 

 

The following table shows the PCI commercial and consumer loan portfolios, by class and their delinquency status, at June 30, 2015 (dollars in thousands):

 

  30-89 Days
Past Due
  Greater than
90 Days
  Current  Total
Commercial:                    
Commercial Construction  $-   $609   $2,312   $2,921 
Commercial Real Estate - Owner Occupied   1,029    1,484    27,325    29,838 
Commercial Real Estate - Non-Owner Occupied   1,775    321    17,920    20,016 
Raw Land and Lots   376    105    4,622    5,103 
Single Family Investment Real Estate   425    686    14,393    15,504 
Commercial and Industrial   226    68    2,731    3,025 
Other Commercial   120    184    808    1,112 
Consumer:                    
Mortgage   916    2,557    3,132    6,605 
Consumer Construction   -    508    -    508 
HELOCs   210    501    1,129    1,840 
Other Consumer   48    152    1,169    1,369 
Total  $5,125   $7,175   $75,541   $87,841 

 

- 16 -
 

 

The following table shows the PCI commercial and consumer loan portfolios, by class and their delinquency status, at December 31, 2014 (dollars in thousands):

 

  30-89 Days
Past Due
  Greater than
90 Days
  Current  Total
Commercial:                    
Commercial Construction  $-   $652   $3,130   $3,782 
Commercial Real Estate - Owner Occupied   1,138    843    29,186    31,167 
Commercial Real Estate - Non-Owner Occupied   523    1,255    27,091    28,869 
Raw Land and Lots   522    -    6,905    7,427 
Single Family Investment Real Estate   1,327    1,311    14,241    16,879 
Commercial and Industrial   144    538    3,173    3,855 
Other Commercial   107    1,133    1,016    2,256 
Consumer:                    
Mortgage   1,975    2,866    2,553    7,394 
Consumer Construction   -    516    -    516 
HELOCs   356    728    916    2,000 
Other Consumer   89    171    1,383    1,643 
Total  $6,181   $10,013   $89,594   $105,788 

 

- 17 -
 

 

The Company measures the amount of impairment by evaluating loans either in their collective homogeneous pools or individually. The following table shows the Company’s impaired loans, excluding PCI loans related to the StellarOne acquisition, by class at June 30, 2015 (dollars in thousands):

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Investment
   Interest
Income
Recognized
 
Loans without a specific allowance                         
Commercial:                         
Commercial Construction  $6,506   $6,783   $-   $5,897   $135 
Commercial Real Estate - Owner Occupied   12,917    13,182    -    12,664    258 
Commercial Real Estate - Non-Owner Occupied   12,566    12,882    -    12,880    317 
Raw Land and Lots   39,679    39,887    -    40,698    1,179 
Single Family Investment Real Estate   2,805    3,214    -    3,001    54 
Commercial and Industrial   3,361    4,070    -    3,533    67 
Other Commercial   923    928    -    954    28 
Consumer:                         
Mortgage   1,568    1,582    -    1,580    29 
Indirect Auto   -    4    -    1    - 
HELOCs   779    911    -    856    10 
Other Consumer   82    204    -    149    - 
Total impaired loans without a specific allowance  $81,186   $83,647   $-   $82,213   $2,077 
                          
Loans with a specific allowance                         
Commercial:                         
Commercial Construction  $370   $370   $10   $485   $10 
Commercial Real Estate - Owner Occupied   5,162    5,177    656    5,343    83 
Commercial Real Estate - Non-Owner Occupied   937    937    81    932    27 
Raw Land and Lots   717    717    19    760    17 
Single Family Investment Real Estate   2,742    2,766    182    2,859    68 
Commercial and Industrial   2,228    2,279    474    2,308    50 
Other Commercial   469    490    41    507    11 
Consumer:                         
Mortgage   1,395    1,448    29    1,425    6 
Consumer Construction   376    376    33    378    9 
Indirect Marine   48    149    1    54    - 
Other Consumer   226    345    84    276    1 
Total impaired loans with a specific allowance  $14,670   $15,054   $1,610   $15,327   $282 
Total impaired loans  $95,856   $98,701   $1,610   $97,540   $2,359 

 

- 18 -
 

 

The following table shows the Company’s impaired loans, by class, at December 31, 2014 (dollars in thousands):

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Investment
   Interest
Income
Recognized
 
Loans without a specific allowance                         
Commercial:                         
Commercial Construction  $5,281   $5,367   $-   $5,755   $165 
Commercial Real Estate - Owner Occupied   15,722    16,430    -    16,774    737 
Commercial Real Estate - Non-Owner Occupied   22,917    22,917    -    23,209    1,116 
Raw Land and Lots   44,790    47,662    -    47,988    2,124 
Single Family Investment Real Estate   4,197    4,881    -    6,534    170 
Commercial and Industrial   4,453    7,933    -    5,070    121 
Other Commercial   1,536    1,538    -    1,624    90 
Consumer:                         
Mortgage   1,571    1,582    -    1,583    58 
Indirect Auto   -    6    -    4    - 
Indirect Marine   201    505    -    281    - 
HELOCs   559    699    -    573    8 
Other Consumer   89    208    -    107    - 
Total impaired loans without a specific allowance  $101,316   $109,728   $-   $109,502   $4,589 
                          
Loans with a specific allowance                         
Commercial:                         
Commercial Construction  $570   $570   $51   $506   $13 
Commercial Real Estate - Owner Occupied   5,951    5,999    355    5,946    280 
Commercial Real Estate - Non-Owner Occupied   10,575    10,572    2,017    10,823    474 
Raw Land and Lots   1,343    1,373    98    1,472    59 
Single Family Investment Real Estate   4,125    4,144    562    4,293    159 
Commercial and Industrial   2,938    3,009    582    3,125    138 
Other Commercial   359    378    32    442    29 
Consumer:                         
Mortgage   3,323    3,375    481    3,381    60 
Consumer Construction   375    375    34    373    19 
Indirect Marine   192    192    5    199    15 
HELOCs   434    434    4    436    17 
Other Consumer   679    706    310    686    19 
Total impaired loans with a specific allowance  $30,864   $31,127   $4,531   $31,682   $1,282 
Total impaired loans  $132,180   $140,855   $4,531   $141,184   $5,871 

 

The Company considers TDRs to be impaired loans. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession that it would not otherwise consider to the borrower for economic or legal reasons related to the borrower’s financial difficulties. TDRs totaled $22.1 million and $26.8 million as of June 30, 2015 and December 31, 2014, respectively. All loans that are considered to be TDRs are evaluated for impairment in accordance with the Company’s allowance for loan loss methodology and are included in the preceding impaired loan tables. For the quarter ended June 30, 2015, the recorded investment in restructured loans prior to modifications was not materially impacted by the modification.

 

- 19 -
 

 

The following table provides a summary, by class, of modified loans that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing, and modified loans that have been placed on nonaccrual status, which are considered to be nonperforming, as of June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   June 30, 2015   December 31, 2014 
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
 
Performing                              
Commercial:                              
Commercial Construction   1   $296   $      -    1   $707   $     - 
Commercial Real Estate - Owner Occupied   5    1,659    -    3    682    - 
Commercial Real Estate - Non-Owner Occupied   3    2,448    -    3    3,362    - 
Raw Land and Lots   5    13,995    -    9    14,777    - 
Single Family Investment Real Estate   2    446    -    6    1,046    - 
Commercial and Industrial   2    50    -    9    722    - 
Other Commercial   2    213    -    1    191    - 
Consumer:                              
Mortgage   6    740    -    7    1,244    - 
Other Consumer   1    33    -    3    98    - 
Total performing   27   $19,880   $-    42   $22,829   $- 
                               
Nonperforming                              
Commercial:                              
Commercial Construction   1   $260   $-    1   $253   $- 
Commercial Real Estate - Owner Occupied   1    142    -    2    153    - 
Commercial Real Estate - Non-Owner Occupied   1    200    -    1    539    - 
Raw Land and Lots   1    34    -    2    1,053    - 
Single Family Investment Real Estate   2    237    -    1    433    - 
Commercial and Industrial   4    513    -    5    616    - 
Other Commercial   1    65    -    1    74    - 
Consumer:                              
Mortgage   2    756    -    2    770    - 
Other Consumer   1    37    -    1    57    - 
Total nonperforming   14   $2,244   $-    16   $3,948   $- 
                               
Total performing and nonperforming   41   $22,124   $-    58   $26,777   $- 

 

The Company considers a default of a restructured loan to occur when the borrower is 90 days past due following the restructure or a foreclosure and repossession of the applicable collateral occurs. During the three and six months ended June 30, 2015, the Company did not identify any restructured loans that went into default that had been restructured in the twelve-month period prior to default. During the three and six months ended June 30, 2014, the Company identified one loan, totaling approximately $24,000, that went into default that had been restructured in the twelve-month period prior to the time of default. This loan was a mortgage loan which had a term modification at a market rate.

 

- 20 -
 

 

The following table shows, by class and modification type, TDRs that occurred during the three and six months ended June 30, 2015 (dollars in thousands):

 

   Three months ended   Six months ended 
   June 30, 2015   June 30, 2015 
   No. of
Loans
   Recorded
Investment at
Period End
   No. of
Loans
   Recorded
Investment at
Period End
 
Term modification, at a market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   1   $120    1   $120 
Commercial and Industrial   -    -    1    18 
Total loan term extended at a market rate   1   $120    2   $138 
                     
Term modification, below market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   1   $873    1   $873 
Total loan term extended at a below market rate   1   $873    1   $873 
                     
Total   2   $993    3   $1,011 

 

The following table shows, by class and modification type, TDRs that occurred during the three and six months ended June 30, 2014 (dollars in thousands):

 

   Three months ended   Six months ended 
   June 30, 2014   June 30, 2014 
   No. of
Loans
   Recorded
Investment at
Period End
   No. of
Loans
   Recorded
Investment at
Period End
 
Term modification, at a market rate                    
Commercial:                    
Single Family Investment Real Estate   -   $-    1   $111 
Commercial and Industrial   1    35    1    35 
Other Commercial   -    -    2    287 
Total loan term extended at a market rate   1   $35    4   $433 
                     
Total   1   $35    4   $433 

 

- 21 -
 

 

The following table shows the allowance for loan loss activity, balances for allowance for loan losses, and loan balances based on impairment methodology by portfolio segment for the six months ended and as of June 30, 2015. The table below includes the provision for loan losses. In addition, a $200,000 provision was recognized during the current quarter for unfunded loan commitments for which the reserves are recorded as a component of “Other Liabilities” on the Company’s Consolidated Balance Sheets. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands):

 

   Commercial   Consumer   Total 
Allowance for loan losses:               
Balance, beginning of the year  $22,352   $10,032   $32,384 
Recoveries credited to allowance   897    799    1,696 
Loans charged off   (5,248)   (1,787)   (7,035)
Provision charged to operations   5,532    (233)   5,299 
Balance, end of period  $23,533   $8,811   $32,344 
                
Ending Balance, ALL:               
Loans individually evaluated for impairment  $1,463   $147   $1,610 
Loans collectively evaluated for impairment   22,070    8,664    30,734 
Loans acquired with deteriorated credit quality   -    -    - 
Total  $23,533   $8,811   $32,344 
                
Ending Balance, Loans:               
Loans individually evaluated for impairment  $90,917   $4,298   $95,215 
Loans collectively evaluated for impairment   3,831,592    1,495,737    5,327,329 
Loans acquired with deteriorated credit quality   77,519    10,322    87,841 
Total  $4,000,028   $1,510,357   $5,510,385 

 

The following table shows the allowance for loan loss activity, balances for allowance for loan losses, and loan balances based on impairment methodology by portfolio segment for the six months ended and as of June 30, 2014. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands):

 

   Commercial   Consumer   Total 
Allowance for loan losses:               
Balance, beginning of the year  $19,908   $10,227   $30,135 
Recoveries credited to allowance   1,599    572    2,171 
Loans charged off   (1,068)   (1,359)   (2,427)
Provision charged to operations   204    1,296    1,500 
Balance, end of period  $20,643   $10,736   $31,379 
                
Ending Balance, ALL:               
Loans individually evaluated for impairment  $2,117   $399   $2,516 
Loans collectively evaluated for impairment   18,526    10,337    28,863 
Loans acquired with deteriorated credit quality   -    -    - 
Total  $20,643   $10,736   $31,379 
                
Ending Balance, Loans:               
Loans individually evaluated for impairment  $104,620   $8,047   $112,667 
Loans collectively evaluated for impairment   3,482,781    1,506,514    4,989,295 
Loans acquired with deteriorated credit quality   114,893    16,214    131,107 
Total  $3,702,294   $1,530,775   $5,233,069 

 

- 22 -
 

 

The Company uses the past due status and delinquency trends as the primary credit quality indicator for the consumer loan portfolio segment while a risk rating system is utilized for commercial loans. Commercial loans are graded on a scale of 1 through 9. A general description of the characteristics of the risk grades follows:

 

·Risk rated 1 loans have little or no risk and are generally secured by cash or cash equivalents;
·Risk rated 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;
·Risk rated 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;
·Risk rated 4 loans are satisfactory loans with borrowers not as strong as risk rated 3 loans and may exhibit a greater degree of financial risk based on the type of business supporting the loan;
·Risk rated 5 loans are watch loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay;
·Risk rated 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position;
·Risk rated 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged; these have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;
·Risk rated 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and
·Risk rated 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.

 

The following table shows the recorded investment in all loans, excluding PCI loans, in the commercial portfolios by class with their related risk rating current as of June 30, 2015 (dollars in thousands):

 

   1-3   4   5   6   7   8   Total 
Commercial Construction  $34,756   $310,970   $17,583   $9,343   $2,631   $-   $375,283 
Commercial Real Estate - Owner Occupied   183,155    629,284    14,460    6,471    9,792    1,582    844,744 
Commercial Real Estate - Non-Owner Occupied   407,562    1,081,215    22,487    24,523    13,503    -    1,549,290 
Raw Land and Lots   11,696    132,386    9,814    16,359    26,272    -    196,527 
Single Family Investment Real Estate   66,052    333,533    8,794    6,190    4,995    -    419,564 
Commercial and Industrial   195,917    231,994    10,823    4,319    4,604    -    447,657 
Other Commercial   45,749    38,475    2,917    911    1,392    -    89,444 
Total  $944,887   $2,757,857   $86,878   $68,116   $63,189   $1,582   $3,922,509 

 

The following table shows the recorded investment in all loans, excluding PCI loans, in the commercial portfolios by class with their related risk rating current as of December 31, 2014 (dollars in thousands):

 

   1-3   4   5   6   7   8   Total 
Commercial Construction  $22,512   $289,064   $11,932   $10,906   $3,084   $-   $337,498 
Commercial Real Estate - Owner Occupied   185,789    620,587    15,003    7,688    15,209    -    844,276 
Commercial Real Estate - Non-Owner Occupied   356,263    1,041,515    22,358    28,388    31,766    -    1,480,290 
Raw Land and Lots   11,162    128,281    16,803    4,783    42,769    -    203,798 
Single Family Investment Real Estate   59,638    311,900    9,750    6,680    7,647    -    395,615 
Commercial and Industrial   138,973    230,084    9,392    4,383    7,089    -    389,921 
Other Commercial   31,571    40,913    3,818    844    1,704    -    78,850 
Total  $805,908   $2,662,344   $89,056   $63,672   $109,268   $-   $3,730,248 

 

- 23 -
 

 

The following table shows the recorded investment in only PCI loans in the commercial portfolios by class with their related risk rating and credit quality indicator information current as of June 30, 2015 (dollars in thousands):

 

   4   5   6   7   8   Total 
Commercial Construction  $-   $-   $2,311   $149   $461   $2,921 
Commercial Real Estate - Owner Occupied   5,544    581    8,856    14,857    -    29,838 
Commercial Real Estate - Non-Owner Occupied   5,070    3,801    7,648    3,497    -    20,016 
Raw Land and Lots   1,511    533    1,938    1,121    -    5,103 
Single Family Investment Real Estate   4,674    1,710    4,100    5,020    -    15,504 
Commercial and Industrial   422    12    917    1,650    24    3,025 
Other Commercial   91    -    476    545    -    1,112 
Total  $17,312   $6,637   $26,246   $26,839   $485   $77,519 

 

The following table shows the recorded investment in only PCI loans in the commercial portfolios by class with their related risk rating and credit quality indicator information current as of December 31, 2014 (dollars in thousands):

 

   4   5  6   7   8   Total 
Commercial Construction  $-   $-   $3,130   $194   $458   $3,782 
Commercial Real Estate - Owner Occupied   1,525    3,546    10,880    15,216    -    31,167 
Commercial Real Estate - Non-Owner Occupied   2,837    934    18,736    6,362    -    28,869 
Raw Land and Lots   1,564    189    3,148    2,526    -    7,427 
Single Family Investment Real Estate   2,807    1,253    6,462    6,357    -    16,879 
Commercial and Industrial   437    -    913    2,477    28    3,855 
Other Commercial   -    -    510    1,746    -    2,256 
Total  $9,170   $5,922   $43,779   $34,878   $486   $94,235 

 

Loans acquired are originally recorded at fair value, with certain loans being identified as impaired at the date of purchase. The fair values were determined based on the credit quality of the portfolio, expected future cash flows, and timing of those expected future cash flows.

 

The following shows changes in the accretable yield for loans accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality, for the periods presented (dollars in thousands):

 

  

For the Six Months ended

June 30,

 
   2015   2014 
Balance at beginning of period  $28,956   $2,980 
Additions   -    34,653 
Accretion   (3,106)   (3,677)
Reclass of nonaccretable difference due to improvement in expected cash flows   2,976    - 
Other, net (1)   (4,784)   (1,365)
Balance at end of period  $24,042   $32,591 

 

(1) This line item represents changes in the cash flows expected to be collected due to the impact of non-credit changes such as prepayment assumptions, changes in interest rates on variable rate PCI loans, and discounted payoffs that occurred in the quarter.

 

The carrying value of the Company’s PCI loan portfolio, accounted for under ASC 310-30, totaled $87.8 million at June 30, 2015 and $105.8 million at December 31, 2014. The outstanding balance of the Company’s PCI loan portfolio totaled $107.1 million at June 30, 2015 and $126.3 million at December 31, 2014. The carrying value of the Company’s acquired performing loan portfolio, accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs, totaled $1.6 billion at June 30, 2015 and $1.8 billion at December 31, 2014; the remaining discount on these loans totaled $23.0 million at June 30, 2015 and $24.3 million at December 31, 2014, respectively.

 

- 24 -
 

 

5.INTANGIBLE ASSETS

 

The Company’s intangible assets consist of core deposits and goodwill arising from previous acquisitions. The Company has determined that core deposit intangibles have a finite life and amortizes them over their estimated useful life. Core deposit intangible assets are being amortized over the period of expected benefit, which ranges from 4 to 14 years, using an accelerated method. On January 1, 2014, the Company completed the acquisition of StellarOne and acquired intangible assets of $29.6 million and recorded $234.1 million of goodwill.

 

In accordance with ASC 350, Intangibles-Goodwill and Other, the Company reviews the carrying value of indefinite lived intangible assets at least annually or more frequently if certain impairment indicators exist. The Company performed its annual impairment testing in the second quarter of 2015 and determined that there was no impairment to its goodwill or intangible assets.

 

Information concerning intangible assets with a finite life is presented in the following table (dollars in thousands):

 

   Gross Carrying
Value
   Accumulated
Amortization
   Net Carrying
Value
 
June 30, 2015               
Amortizable core deposit intangibles  $76,185   $48,791   $27,394 
                
December 31, 2014               
Amortizable core deposit intangibles  $76,185   $44,430   $31,755 
                
June 30, 2014               
Amortizable core deposit intangibles  $76,185   $39,706   $36,479 

 

Amortization expense of core deposit intangibles for the three and six months ended June 30, 2015 totaled $2.1 million and $4.4 million, respectively; for the three and six months ended June 30, 2014 totaled $2.5 million and $5.1 million, respectively; and for the year ended December 31, 2014 was $9.8 million. As of June 30, 2015, the estimated remaining amortization expense of core deposit intangibles is as follows (dollars in thousands):

 

For the remaining six months of 2015  $4,085 
For the year ending December 31, 2016   6,932 
For the year ending December 31, 2017   5,590 
For the year ending December 31, 2018   4,144 
For the year ending December 31, 2019   3,093 
For the year ending December 31, 2020   2,027 
Thereafter   1,523 
Total estimated amortization expense  $27,394 

 

6.BORROWINGS

 

Short-term Borrowings

 

The Company classifies all borrowings that will mature within a year from the date on which the Company enters into them as short-term borrowings. Total short-term borrowings consist primarily of advances from the FHLB, federal funds purchased (which are secured overnight borrowings from other financial institutions), and other lines of credit. Also included in total short-term borrowings are securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. Total short-term borrowings consist of the following as of June 30, 2015 and December 31, 2014 (dollars in thousands):

 

- 25 -
 

 

   June 30,   December 31, 
   2015   2014 
Securities sold under agreements to repurchase  $119,680   $44,393 
Other short-term borrowings   261,000    343,000 
Total short-term borrowings  $380,680   $387,393 
           
Maximum month-end outstanding balance  $445,761   $387,393 
Average outstanding balance during the period   391,424    237,896 
Average interest rate during the period   0.26%   0.24%
Average interest rate at end of period   0.25%   0.31%
           
Other short-term borrowings:          
FHLB  $255,000   $335,000 
Other lines of credit   6,000    8,000 

 

The Bank maintains federal funds lines with several correspondent banks; the remaining available balance was $175.0 million and $150.0 million at June 30, 2015 and December 31, 2014, respectively. The Company has certain restrictive covenants related to certain asset quality, capital, and profitability metrics associated with these lines and is considered to be in compliance with these covenants. Additionally, the Company had a collateral dependent line of credit with the FHLB of up to $1.5 billion and $1.4 billion at June 30, 2015 and December 31, 2014, respectively.

 

Long-term Borrowings

 

In connection with two bank acquisitions prior to 2006, the Company issued trust preferred capital notes to fund the cash portion of those acquisitions, collectively totaling $58.5 million. In connection with the acquisition of StellarOne, the Company acquired trust preferred capital notes totaling $32.0 million with a remaining fair value discount of $7.1 million at June 30, 2015. The trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

 

   Principal   Investment(1)   Spread to
3-Month LIBOR
   Rate   Maturity
Trust Preferred Capital Note - Statutory Trust I  $22,500,000   $696,000    2.75%   3.03%  6/17/2034
Trust Preferred Capital Note - Statutory Trust II   36,000,000    1,114,000    1.40%   1.68%  6/15/2036
VFG Limited Liability Trust I Indenture   20,000,000    619,000    2.73%   3.01%  3/18/2034
FNB Statutory Trust II Indenture   12,000,000    372,000    3.10%   3.38%  6/26/2033
Total  $90,500,000   $2,801,000              

 

(1) reported as “Other Assets” within the Consolidated Balance Sheets.

 

As part of a prior acquisition, the Company assumed subordinated debt with terms of LIBOR plus 1.45% and a maturity date of April 2016. At June 30, 2015, the carrying value of the subordinated debt was $17.5 million, with a remaining fair value discount of $408,000.

 

On August 23, 2012, the Company modified its fixed rate FHLB advances to floating rate advances, which resulted in reducing the Company’s FHLB borrowing costs. In connection with this modification, the Company incurred a prepayment penalty of $19.6 million on the original advances, which is included as a component of long-term borrowings in the Company’s Consolidated Balance Sheets. In accordance with ASC 470-50, Modifications and Extinguishments, the Company will amortize this prepayment penalty over the term of the modified advances using the effective rate method. The amortization expense is included as a component of interest expense on long-term borrowings in the Company’s Consolidated Statements of Income. Amortization expense for the three and six months ended June 30, 2015 and 2014 was $455,000 and $902,000 and $444,000 and $881,000, respectively.

 

In connection with the StellarOne acquisition, the Company assumed $70.0 million in long-term borrowings with the FHLB that had a remaining fair value premium of $1.6 million at June 30, 2015.

 

- 26 -
 

 

As of June 30, 2015, the Company had advances from the FHLB consisting of the following (dollars in thousands):

 

Long-term Type  Spread to
3-Month LIBOR
   Interest Rate   Maturity Date  Advance Amount 
                   
Adjustable Rate Credit   0.44%   0.72%   8/23/2022  $55,000 
Adjustable Rate Credit   0.45%   0.74%   11/23/2022   65,000 
Adjustable Rate Credit   0.45%   0.74%   11/23/2022   10,000 
Adjustable Rate Credit   0.45%   0.74%   11/23/2022   10,000 
Fixed Rate   -    3.62%   11/28/2017   10,000 
Fixed Rate   -    3.44%   7/28/2015   10,000 
Fixed Rate   -    3.75%   7/30/2018   5,000 
Fixed Rate   -    3.97%   7/30/2018   5,000 
Fixed Rate Hybrid   -    2.11%   10/5/2016   25,000 
Fixed Rate Hybrid   -    0.91%   7/25/2016   15,000 
                $210,000 

 

As of December 31, 2014, the Company had advances from the FHLB consisting of the following (dollars in thousands):

 

Long-term Type  Spread to
3-Month LIBOR
   Interest Rate   Maturity Date  Advance Amount 
                
Adjustable Rate Credit   0.44%    0.70%   8/23/2022  $55,000 
Adjustable Rate Credit   0.45%    0.71%   11/23/2022   65,000 
Adjustable Rate Credit   0.45%    0.71%   11/23/2022   10,000 
Adjustable Rate Credit   0.45%    0.71%   11/23/2022   10,000 
Fixed Rate   -    3.62%   11/28/2017   10,000 
Fixed Rate   -    3.44%   7/28/2015   10,000 
Fixed Rate   -    3.75%   7/30/2018   5,000 
Fixed Rate   -    3.97%   7/30/2018   5,000 
Fixed Rate Hybrid   -    2.11%   10/5/2016   25,000 
Fixed Rate Hybrid   -    0.91%   7/25/2016   15,000 
                $210,000 

 

The carrying value of the loans and securities pledged as collateral for FHLB advances totaled $1.8 billion and $1.2 billion as of June 30, 2015 and December 31, 2014, respectively.

 

As of June 30, 2015, the contractual maturities of long-term debt are as follows for the years ending (dollars in thousands):

 

   Trust
Preferred
Capital Notes
   Subordinated
Debt
   FHLB
Advances
   Fair Value
Premium
(Discount)
   Prepayment
Penalty
   Total Long-term
Borrowings
 
Remaining six months in 2015  $-   $-   $10,000   $25   $(929)  $9,096 
2016   -    17,500    40,000    271    (1,882)   55,889 
2017   -    -    10,000    170    (1,922)   8,248 
2018   -    -    10,000    (143)   (1,970)   7,887 
2019   -    -    -    (286)   (2,018)   (2,304)
2020   -    -    -    (301)   (2,074)   (2,375)
Thereafter   93,301    -    140,000    (5,622)   (3,826)   223,853 
Total Long-term borrowings  $93,301   $17,500   $210,000   $(5,886)  $(14,621)  $300,294 

 

- 27 -
 

 

7.COMMITMENTS AND CONTINGENCIES

 

Litigation Matters

In the ordinary course of its operations, the Company and its subsidiaries are parties to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

 

Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Company’s Consolidated Balance Sheets. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk. The Company considers credit losses related to off-balance sheet commitments by undergoing a similar process in evaluating losses for loans that are carried on balance sheet. The Company considers historical loss rates, current economic conditions, risk ratings, and past due status among other factors in the consideration of whether credit losses are inherent in the Company’s off-balance sheet commitments to extend credit. The Company does not expect credit losses arising from off-balance sheet commitments to have a material adverse impact on the Company’s consolidated financial statements.

 

Commitments to extend credit are agreements to lend to customers as long as there are no violations of any conditions established in the contracts. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

Letters of credit are conditional commitments issued by the Company to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

UMG, a wholly owned subsidiary of the Bank, uses rate lock commitments and best efforts contracts during the origination process and for loans held for sale. These best efforts contracts are designed to mitigate UMG’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale. The Company held approximately $2.7 million and $2.6 million in loans available for sale in which the related rate lock commitment had expired as of June 30, 2015 and December 31, 2014, respectively. At June 30, 2015 and December 31, 2014, the reserves associated with these loans held for sale were $102,000 and $104,000, respectively, and are reflected on the balance sheet of the mortgage segment.

 

- 28 -
 

 

The following table presents the balances of commitments and contingencies (dollars in thousands):

 

   June 30,   December 31, 
   2015   2014 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $1,498,272   $1,601,287 
Standby letters of credit   119,611    117,988 
Mortgage loan rate lock commitments   74,848    49,552 
Total commitments with off-balance sheet risk  $1,692,731   $1,768,827 
Commitments with balance sheet risk:          
Loans held for sale  $39,450   $42,519 
Total other commitments  $1,732,181   $1,811,346 

 

(1) Includes unfunded overdraft protection.

 

The Company must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final weekly reporting period in the periods ended June 30, 2015 and December 31, 2014, the aggregate amount of daily average required reserves was approximately $47.9 million and $48.7 million, respectively.

 

The Company has approximately $25.4 million in deposits in other financial institutions, of which $9.5 million and $3.5 million serve as collateral for the cash flow hedges and loan swaps, respectively, as discussed in Note 8 “Derivatives”. The Company had approximately $11.3 million in deposits in other financial institutions that were uninsured at June 30, 2015. On an annual basis, the Company’s management evaluates the loss risk of its uninsured deposits in financial counterparties.

 

For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify the interest rate characteristics of various balance sheet accounts. See Note 8 “Derivatives” for additional information.

 

In the ordinary course of business, the Company records an indemnification reserve relating to mortgage loans previously sold based on historical statistics and loss rates; as of June 30, 2015 and December 31, 2014, the Company’s indemnification reserve for such mortgage loans was $447,000 and $662,000, respectively.

 

8.DERIVATIVES

 

The Company is exposed to economic risks arising from its business operations and uses derivatives primarily to manage risk associated with changing interest rates, and to assist customers with their risk management objectives. The Company designates its derivatives either as hedging instruments in a qualifying hedge accounting relationship (cash flow or fair value hedge) or as a free standing derivative such as interest rate lock commitments that do not qualify for hedge accounting. The Company uses interest rate derivatives to manage its exposure to interest rate movements and add stability to interest income and expense. The Company also enters into back-to-back loan swaps to assist customers in managing the risks due to changing interest rates.

 

Cash Flow Hedges

As part of its cash flow hedging strategy, the Company uses interest rate swap agreements to limit the variability of expected future cash flows (primarily associated with the Company’s variable rate borrowings) by exchanging a notional amount, equal to the principal amount of the borrowings, for fixed-rate interest based on benchmarked interest rates. As of June 30, 2015, the Company had 11 interest rate swaps designated as cash flow hedges with an aggregate notional amount of $263.0 million.

 

The Company has entered into three interest rate swap agreements (the “trust swaps”) to mitigate the variable interest rate risk related to the trust preferred capital notes further described in Note 6 “Borrowings.” The Company receives interest of LIBOR from a counterparty and pays a weighted average fixed rate of 2.77% to the same counterparty calculated on a notional amount of $68.0 million. The original terms of the trust swaps range from three to six years.

 

The Company has entered into four interest rate swap agreements (the “prime loan swaps”) to mitigate the variable interest rate risks of certain prime commercial loans. The Company receives a fixed interest rate ranging from 4.71% to 5.20% from the counterparty and pays interest based on the Wall Street Journal prime index, with a spread of up to 0.49%, to the same counterparty calculated on a notional amount of $55.0 million. One of the four prime loan swaps contains a floor rate of 4.00%. The original terms of the four prime loan swaps is six years with a fixed rate that started September 17, 2013.

 

- 29 -
 

 

The Company has entered into four interest rate swap agreements (“FHLB advance swaps”) to mitigate variable interest rate risk on certain designated variable rate FHLB borrowings. The Company receives an interest rate based on the three month LIBOR from the counterparty and pays an interest rate ranging from 3.16% to 3.46% to the same counterparty calculated on a notional amount of $140.0 million. The FHLB advance swaps are deferred starting swaps with terms of six years and five years and effective dates of February 23, 2017 and February 23, 2018, respectively.

 

All swaps were entered into with counterparties that met the Company’s credit standards and the agreements contain collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant. As of June 30, 2015, the Company had $9.5 million of cash pledged as collateral for the cash flow hedges and securities with a market value of $4.5 million pledged as collateral for the prime loan swaps and FHLB advance swaps.

 

Amounts receivable or payable are recognized as accrued under the terms of the agreements. In accordance with ASC 815, Derivatives and Hedging, the Company has designated the trust swaps, prime loan swaps, and FHLB advance swaps as cash flow hedges, with the effective portions of the derivatives’ unrealized gains or losses recorded as a component of other comprehensive income. The ineffective portions of the unrealized gains or losses, if any, would be recorded in interest income and interest expense in the Company’s Consolidated Statements of Income. The Company has assessed the effectiveness of each hedging relationship by comparing the changes in cash flows of the hedging instrument. Based on the Company’s assessment, its cash flow hedges are highly effective. At June 30, 2015, the fair value of the Company’s cash flow hedges was a net unrealized loss of $7.0 million, the amount the Company would have expected to pay if the contracts were terminated.

 

Shown below is a summary of the derivatives designated as cash flow hedges at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of June 30, 2015                                   
Pay fixed - receive floating interest rate swaps   7   $208,000   $-   $7,810    0.28%(1)   2.77%(1)   1.63(1)
                                    
Receive fixed - pay floating interest rate swaps   4   $55,000   $859   $-    4.93%   3.55%   4.22 

 

(1) Due to their deferred nature, the rates and the life exclude the four FHLB advance swaps.

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2014                                   
Pay fixed - receive floating interest rate swaps   7   $208,000   $-   $8,433    0.26%(1)   2.77%(1)   2.12(1)
                                    
Receive fixed - pay floating interest rate swaps   4   $55,000   $580   $-    4.93%   3.55%   4.72 

 

(1) Due to their deferred nature, the rates and the life exclude the four FHLB advance swaps.

 

- 30 -
 

 

Fair Value Hedge

During the normal course of business, the Company enters into interest rate swaps to convert certain long-term fixed-rate loans to floating rates to hedge the Company’s exposure to interest rate risk. The Company applies hedge accounting in accordance with ASC 815, and the fair value hedge and the underlying hedged item, attributable to the risk being hedged, are recorded at fair value with unrealized gains and losses being recorded in the Company’s Consolidated Statements of Income. The ineffective portions of the unrealized gains or losses, if any, would be recorded in interest income and interest expense in the Company’s Consolidated Statements of Income. The Company uses statistical regression analysis to assess hedge effectiveness, both at inception of the hedging relationship and on an ongoing basis. The regression analysis involves regressing the periodic change in fair value of the hedging instrument against the periodic changes in fair value of the asset being hedged due to changes in the hedged risk.

 

As of June 30, 2015, the Company had three swaps constituting fair value hedges, whereby the Company pays a fixed interest rate ranging from 3.23% to 3.53% to the counterparty and receives interest of one month LIBOR plus a spread of up to 2.13% from the same counterparty calculated on an aggregate notional amount of $53.6 million with terms ranging from 15 to 17 years. At December 31, 2014, the Company had one fair value hedge with an aggregate notional amount of $38.3 million. At June 30, 2015, the fair value of the Company’s fair value hedges was an unrealized gain of $542,000, the amount the Company would have expected to receive if the contract was terminated; the asset is reported in “Other Assets” in the Company’s Consolidated Balance Sheets. At June 30, 2015, the aggregate notional amount of the hedged items was $53.6 million with a fair value of ($483,000). At December 31, 2014, the Company had one hedged item with an aggregate notional amount of $38.3 million. The Company’s fair value hedges continue to be highly effective and had no material impact on the Company’s Consolidated Statements of Income.

 

Loan Swaps

During the normal course of business, the Company enters into interest rate swap loan relationships (“loan swaps”) with borrowers to meet their financing needs. Upon entering into the loan swaps, the Company enters into offsetting positions with counterparties in order to minimize interest rate risk. These back-to-back loan swaps qualify as financial derivatives with fair values as reported in “Other Assets” and “Other Liabilities” in the Company’s Consolidated Balance Sheets. As of June 30, 2015, the Company had cash and securities with a market value of $6.5 million pledged as collateral for the loan swaps.

 

Shown below is a summary regarding loan swap derivative activities at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of June 30, 2015                                   
Receive fixed - pay floating interest rate swaps   35   $141,548   $2,830   $-    4.25%   2.48%   7.06 
Pay fixed - receive floating interest rate swaps   35   $141,548   $-   $2,830    2.48%   4.25%   7.06 

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2014                                   
Receive fixed - pay floating interest rate swaps   30   $122,793   $2,681   $-    4.29%   2.50%   7.14 
Pay fixed - receive floating interest rate swaps   30   $122,793   $-   $2,681    2.50%   4.29%   7.14 

 

Interest Rate Lock Commitments

During the normal course of business, the Company enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (“rate lock commitments”).  Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives.  The period of time between issuance of a loan commitment, closing, and sale of the loan generally ranges from 30 to 120 days.  The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan.  The correlation between the rate lock commitments and the best efforts contracts is high due to their similarity.

 

- 31 -
 

 

The market values of rate lock commitments and best efforts forward delivery commitments is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets.  The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset while taking into consideration the probability that the rate lock commitments will close.  The fair value of the rate lock commitments as of June 30, 2015 was $344,000 and is reported as a component of “Other Assets” in the Company’s Consolidated Balance Sheets; the fair value of the Company’s best efforts forward delivery commitments was ($570,000) and is recorded as a component of “Other Liabilities” in the Company’s Consolidated Balance Sheets. Any impact to income is recorded in current period earnings as a component of “Gain on sale of mortgage loans, net of commissions” in the Company’s Consolidated Statements of Income. The aggregate notional amount of these derivatives was $74.8 million and $49.6 million at June 30, 2015 and December 31, 2014, respectively.

 

9.ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The change in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2015 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized
Gains (Losses)
on AFS
Securities
   Unrealized
Gain for AFS
Securities
Transferred
to HTM
   Change in Fair
Value of Cash
Flow Hedge
   Total 
Balance - March 31, 2015  $21,097   $-   $(6,402)  $14,695 
                     
Unrealized gain transferred from AFS to HTM   (5,251)   5,251    -    - 
                     
Other comprehensive income (loss)   (6,845)   (208)   1,809    (5,244)
Amounts reclassified from accumulated other comprehensive income   (263)   -    41    (222)
Net current period other comprehensive income (loss)   (7,108)   (208)   1,850    (5,466)
                     
Balance - June 30, 2015  $8,738   $5,043   $(4,552)  $9,229 

 

   Unrealized
Gains (Losses)
on AFS
Securities
   Unrealized
Gain for AFS
Securities
Transferred
to HTM
   Change in Fair
Value of Cash
Flow Hedges
   Total 
Balance - December 31, 2014  $17,439   $-   $(5,184)  $12,255 
                     
Unrealized gain transferred from AFS to HTM   (5,251)   5,251    -    - 
                     
Other comprehensive income (loss)   (3,062)   (208)   319    (2,951)
Amounts reclassified from accumulated other comprehensive income   (388)   -    313    (75)
Net current period other comprehensive income (loss)   (3,450)   (208)   632    (3,026)
                     
Balance - June 30, 2015  $8,738   $5,043   $(4,552)  $9,229 

 

- 32 -
 

 

The change in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2014 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized Gains
(Losses) on AFS
Securities
   Change in Fair
Value of Cash
Flow Hedge
   Total 
Balance - March 31, 2014  $7,486   $(2,760)  $4,726 
                
Other comprehensive income (loss)   6,733    (778)   5,955 
Amounts reclassified from accumulated other comprehensive income   (17)   217    200 
Net current period other comprehensive income (loss)   6,716    (561)   6,155 
                
Balance - June 30, 2014  $14,202   $(3,321)  $10,881 

 

   Unrealized Gains
(Losses) on AFS
Securities
   Change in Fair
Value of Cash
Flow Hedges
   Total 
Balance - December 31, 2013  $1,192   $(3,382)  $(2,190)
                
Other comprehensive income (loss)   13,046    (203)   12,843 
Amounts reclassified from accumulated other comprehensive income   (36)   264    228 
Net current period other comprehensive income (loss)   13,010    61    13,071 
                
Balance - June 30, 2014  $14,202   $(3,321)  $10,881 

 

Reclassifications of unrealized gains (losses) on available for sale securities are reported in the Company’s Consolidated Statements of Income as “Gains on securities transactions, net” with the corresponding income tax effect being reflected as a component of income tax expense. The Company reported net gains of $404,000 and $597,000 for the three and six months ended June 30, 2015, respectively, related to the sale of securities. Excluding OTTI recovery of $400,000 in the second quarter of 2014, the Company reported net gains of $26,000 and $55,000 for the three and six months ended June 30, 2014, respectively, related to the sale of securities. The tax effect of these transactions during the three and six months ended June 30, 2015 and 2014 were $142,000 and $209,000 and $9,000 and $19,000, respectively, which amounts were included as a component of income tax expense.

 

Reclassifications of the change in fair value of cash flow hedges are reported in interest income and interest expense in the Company’s Consolidated Statements of Income with the corresponding income tax effect being reflected as a component of income tax expense. The Company reported net interest expense of $63,000 and $482,000 and $334,000 and $406,000 for the three and six months ended June 30, 2015 and 2014, respectively. The tax effect of these transactions during the three and six months ended June 30, 2015 and 2014 were $22,000 and $169,000 and $117,000 and $142,000, respectively, which amounts were included as a component of income tax expense.

 

- 33 -
 

  

10.FAIR VALUE MEASUREMENTS

 

The Company follows ASC 820, Fair Value Measurements and Disclosures, to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants.

 

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

 

  Level 1   Valuation is based on quoted prices in active markets for identical assets and liabilities.
       
  Level 2   Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the markets.
       
  Level 3   Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.  These unobservable inputs reflect the Company’s assumptions about what market participants would use and information that is reasonably available under the circumstances without undue cost and effort.

 

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

 

Derivative instruments

As discussed in Note 8 “Derivatives”, the Company records derivative instruments at fair value on a recurring basis. The Company utilizes derivative instruments as part of the management of interest rate risk to modify the re-pricing characteristics of certain portions of the Company’s interest-bearing assets and liabilities. The Company has contracted with a third party vendor to provide valuations for derivatives using standard valuation techniques and therefore classifies such valuations as Level 2. Third party valuations are validated by the Company using Bloomberg Valuation Service’s derivative pricing functions. The Company has considered counterparty credit risk in the valuation of its derivative assets and has considered its own credit risk in the valuation of its derivative liabilities.

 

During the ordinary course of business, the Company enters into interest rate lock commitments related to the origination of mortgage loans held for sale as well as best effort forward delivery commitments to mitigate interest rate risk; these instruments are recorded at estimated fair value based on the value of the underlying loan, which in turn is based on quoted prices for similar loans in the secondary market. However, this value is adjusted by a pull-through rate which considers the likelihood that the loan in a lock position will ultimately close. The pull-through rate is derived from the Company’s internal data and is adjusted using significant management judgment. The pull-through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. As such, interest rate lock commitments are classified as Level 3. An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitment derivative will result in positive fair value adjustments while a decrease in the pull-through rate will result in a negative fair value adjustment. The Company’s weighted average pull-through rate was approximately 80% as of June 30, 2015 and approximately 90% as of December 31, 2014. As of June 30, 2015, the interest rate lock commitments are recorded as a component of “Other Assets” and the best effort forward delivery commitments are recorded as a component of “Other Liabilities” on the Company’s Consolidated Balance Sheets.

 

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity, then the security would fall to the lowest level of the hierarchy (Level 3).

 

- 34 -
 

 

The Company’s investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio. The vendor’s primary source for security valuation is Interactive Data Corporation (“IDC”), which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

 

The vendor utilizes proprietary valuation matrices for valuing all municipals securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance, and rating to incorporate additional spreads to the industry benchmark curves.

 

The Company uses Bloomberg Valuation Service, an independent information source that draws on quantitative models and market data contributed from over 4,000 market participants, to validate third party valuations. Any material differences between valuation sources are researched by further analyzing the various inputs that are utilized by each pricing source. No material differences were identified during the validation as of June 30, 2015 and December 31, 2014.

 

The carrying value of restricted Federal Reserve Bank and FHLB stock approximates fair value based on the redemption provisions of each entity and is therefore excluded from the following table.

 

- 35 -
 

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   Fair Value Measurements at June 30, 2015 using 
   Quoted Prices in
Active Markets for
Identical Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Securities available for sale:                    
U.S. government and agency securities  $-   $8,380   $-   $8,380 
Obligations of states and political subdivisions   -    247,641    -    247,641 
Corporate and other bonds   -    75,154    -    75,154 
Mortgage-backed securities   -    546,994    -    546,994 
Other securities   -    10,193    -    10,193 
Derivatives:                    
Interest rate swap   -    2,830    -    2,830 
Cash flow hedges   -    859    -    859 
Interest rate lock commitments   -    -    344    344 
Best effort forward delivery commitments   -    -    570    570 
                     
LIABILITIES                    
Derivatives:                    
Interest rate swap  $-   $2,830   $-   $2,830 
Cash flow hedges   -    7,810    -    7,810 

 

   Fair Value Measurements at December 31, 2014 using 
   Quoted Prices in
Active Markets for
Identical Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Securities available for sale:                    
U.S. government and agency securities  $-   $8,454   $-   $8,454 
Obligations of states and political subdivisions   -    445,647    -    445,647 
Corporate bonds   -    78,680    -    78,680 
Mortgage-backed securities   -    559,329    -    559,329 
Other securities   -    10,004    -    10,004 
Derivatives:                    
Interest rate swap   -    2,681    -    2,681 
Cash flow hedges   -    580    -    580 
Interest rate lock commitments   -    -    513    513 
                     
LIABILITIES                    
Derivatives:                    
Interest rate swap  $-   $2,681   $-   $2,681 
Cash flow hedges   -    8,433    -    8,433 

 

- 36 -
 

 

Certain assets are measured at fair value on a nonrecurring basis in accordance with U.S. GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

 

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

 

Loans held for sale

Loans held for sale are carried at the lower of cost or market value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. Nonrecurring fair value adjustments recorded on loans held for sale for the three and six months ended June 30, 2015 totaled $77,000 and $60,000, respectively, and for the three and six months ended June 30, 2014 totaled $42,000 and $86,000, respectively. Gains and losses on the sale of loans are recorded within the mortgage segment and are reported on a separate line item in the Company’s Consolidated Statements of Income.

 

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral dependent loans are reported at the fair value of the underlying collateral if repayment is solely from the underlying value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data. When evaluating the fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (Level 3). The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Collateral dependent impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Company’s Consolidated Statements of Income.

 

Other real estate owned

OREO is evaluated for impairment at least quarterly by the Bank’s Special Asset Loan Committee and any necessary write downs to fair values are recorded as impairment and included as a component of noninterest expense. Fair values of OREO are carried at fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as Level 3 valuation.

 

Total valuation expenses related to OREO properties for the three and six months ended June 30, 2015 totaled $710,000 and $1.3 million, respectively, and for the three and six months ended June 30, 2014 totaled $817,000 and $1.1 million, respectively.

 

- 37 -
 

 

The following tables summarize the Company’s financial assets that were measured at fair value on a nonrecurring basis at June 30, 2015 and December 31, 2014 (dollars in thousands):

 

   Fair Value Measurements at June 30, 2015 using 
   Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Loans held for sale  $-   $39,450   $-   $39,450 
Impaired loans   -    -    3,931    3,931 
Other real estate owned   -    -    22,222    22,222 

 

   Fair Value Measurements at December 31, 2014 using 
   Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Loans held for sale  $-   $42,519   $-   $42,519 
Impaired loans   -    -    15,797    15,797 
Other real estate owned   -    -    28,118    28,118 

 

The following table displays quantitative information about Level 3 Fair Value Measurements at June 30, 2015 (dollars in thousands):

 

   Fair Value Measurements at June 30, 2015 
   Fair Value   Valuation Technique(s)  Unobservable Inputs  Weighted
Average
 
ASSETS                
Commercial Real Estate - Owner Occupied  $2,315   Market comparables  Discount applied to market comparables (1)   28%
Single Family Investment Real Estate   1,044   Market comparables  Discount applied to market comparables (1)   0%
Other (2)   572   Market comparables  Discount applied to market comparables (1)   14%
Total Impaired Loans   3,931            
                 
Other real estate owned   22,222   Market comparables  Discount applied to market comparables (1)   29%
Total  $26,153            

 

(1) A discount percentage (in addition to expected selling costs) is applied based on the age of independent appraisals, current market conditions, and experience within the local market.

(2) The “Other” category of the impaired loans section consists of Other Commercial, Mortgage, Consumer Construction, Indirect Marine, and Other Consumer.

 

- 38 -
 

 

The following table displays quantitative information about Level 3 Fair Value Measurements at December 31, 2014 (dollars in thousands):

 

   Fair Value Measurements at December 31, 2014 
   Fair Value   Valuation Technique(s)  Unobservable Inputs  Weighted
Average
 
ASSETS                
Commercial Real Estate - Owner Occupied  $3,304   Market comparables  Discount applied to market comparables (1)   34%
Commercial Real Estate - Non-Owner Occupied   7,828   Market comparables  Discount applied to market comparables (1)   1%
Raw Land and Lots   431   Market comparables  Discount applied to market comparables (1)   16%
Single Family Investment Real Estate   1,366   Market comparables  Discount applied to market comparables (1)   14%
Commercial and Industrial   339   Market comparables  Discount applied to market comparables (1)   45%
Other (2)   2,529   Market comparables  Discount applied to market comparables (1)   6%
Total Impaired Loans   15,797            
                 
Other real estate owned   28,118   Market comparables  Discount applied to market comparables (1)   32%
Total   $43,915            

 

(1) A discount percentage (in addition to expected selling costs) is applied based on the age of independent appraisals, current market conditions, and experience within the local market.

(2) The “Other” category of the impaired loans section consists of Other Commercial, Mortgage, Consumer Construction, Indirect Marine, HELOCs, and Other Consumer.

 

ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

 

Cash and cash equivalents

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Held to Maturity Securities

The Company’s investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio. The vendor’s primary source for security valuation is IDC, which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

 

The vendor utilizes proprietary valuation matrices for valuing all municipals securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance, and rating to incorporate additional spreads to the industry benchmark curves.

 

The Company uses Bloomberg Valuation Service, an independent information source that draws on quantitative models and market data contributed from over 4,000 market participants, to validate third party valuations. Any material differences between valuation sources are researched by further analyzing the various inputs that are utilized by each pricing source. No material differences were identified during the validation as of June 30, 2015 and December 31, 2014.

 

- 39 -
 

 

Loans

The fair value of performing loans is estimated by discounting expected future cash flows using a yield curve that is constructed by adding a loan spread to a market yield curve. Loan spreads are based on spreads currently observed in the market for loans of similar type and structure. Fair value for impaired loans and their respective level within the fair value hierarchy, are described in the previous disclosure related to fair value measurements of assets that are measured on a nonrecurring basis.

 

Bank owned life insurance

The carrying value of bank owned life insurance approximates fair value. The Company records these policies at their cash surrender value, which is estimated using information provided by insurance carriers.

 

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

 

Borrowings

The carrying value of the Company’s repurchase agreements is a reasonable estimate of fair value. Other borrowings are discounted using the current yield curve for the same type of borrowing. For borrowings with embedded optionality, a third party source is used to value the instrument. The Company validates all third party valuations for borrowings with optionality using Bloomberg’s derivative pricing functions.

 

Accrued interest

The carrying amounts of accrued interest approximate fair value.

 

Commitments to extend credit and standby letters of credit

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2015 and December 31, 2014, the fair value of loan commitments and standby letters of credit was immaterial.

 

- 40 -
 

 

The carrying values and estimated fair values of the Company’s financial instruments at June 30, 2015 and December 31, 2014 are as follows (dollars in thousands):

 

       Fair Value Measurements at June 30, 2015 using 
       Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
   Total Fair
Value
 
   Carrying Value   Level 1   Level 2   Level 3   Balance  
ASSETS                         
Cash and cash equivalents  $136,833   $136,833   $-   $-   $136,833 
Securities available for sale   888,362    -    888,362    -    888,362 
Held to maturity securities   201,072    -    199,475    -    199,475 
Restricted stock   50,171    -    50,171    -    50,171 
Loans held for sale   39,450    -    39,450    -    39,450 
Net loans   5,478,041    -    -    5,497,910    5,497,910 
Derivatives:                         
Interest rate lock commitments   344    -    -    344    344 
Interest rate swap   2,830    -    2,830    -    2,830 
Cash flow hedges   859    -    859    -    859 
Best effort forward delivery commitments   570    -    -    570    570 
Accrued interest receivable   21,840    -    21,840    -    21,840 
Bank owned life insurance   141,284    -    141,284    -    141,284 
                          
LIABILITIES                         
Deposits  $5,784,474   $-   $5,781,540   $-   $5,781,540 
Borrowings   680,974    -    660,729    -    660,729 
Accrued interest payable   1,749    -    1,749    -    1,749 
Derivatives:                         
Interest rate swap   2,830    -    2,830    -    2,830 
Cash flow hedges   7,810    -    7,810    -    7,810 

 

- 41 -
 

 

       Fair Value Measurements at December 31, 2014 using 
       Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
   Total Fair
Value
 
   Carrying Value   Level 1   Level 2   Level 3   Balance  
ASSETS                         
Cash and cash equivalents  $133,260   $133,260   $-   $-   $133,260 
Securities available for sale   1,102,114    -    1,102,114    -    1,102,114 
Restricted stock   54,854    -    54,854    -    54,854 
Loans held for sale   42,519    -    42,519    -    42,519 
Net loans   5,313,612    -    -    5,340,759    5,340,759 
Derivatives:                         
Interest rate lock commitments   513    -    -    513    513 
Interest rate swap   2,681    -    2,681    -    2,681 
Cash flow hedges   580    -    580    -    580 
Accrued interest receivable   21,775    -    21,775    -    21,775 
Bank owned life insurance   139,005    -    139,005    -    139,005 
                          
LIABILITIES                         
Deposits  $5,638,770   $-   $5,637,929   $-   $5,637,929 
Borrowings   686,935    -    666,224    -    666,224 
Accrued interest payable   1,899    -    1,899    -    1,899 
Derivatives:                         
Interest rate swap   2,681    -    2,681    -    2,681 
Cash flow hedges   8,433    -    8,433    -    8,433 

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

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11.STOCK-BASED COMPENSATION

 

The Company’s stock incentive plan provides for the granting of stock-based awards to key employees of the Company and its subsidiaries in the form of: (i) incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code of 1986 (“incentive stock options”); (ii) non-qualified stock options; (iii) restricted stock; and (iv) other stock-based awards. The Company issues new shares to satisfy stock-based awards. A stock option’s maximum term is ten years from the date of grant and the option price cannot be less than the fair market value of the stock on the grant date. No stock options have been granted since February 2012. Restricted stock and other stock-based awards typically vest in varying annual installments over a three- to five-year vesting schedule.

 

On January 29, 2015, the Company’s Board of Directors adopted, and shareholders approved, the Union Bankshares Corporation Stock and Incentive Plan (the “Amended and Restated SIP”), which amends and restates the former plan (the “2011 Plan”). The Amended and Restated SIP became effective on April 21, 2015 and the Company may grant awards under the amended plan until April 20, 2025. The Amended and Restated SIP amends the 2011 Plan to, among other things, increase the maximum number of shares of the Company’s common stock issuable under the plan from 1,000,000 to 2,500,000 and add non-employee directors of the Company and certain subsidiaries, as well as regional advisory boards, as potential participants in the plan. The increase in shares in the Amended and Restated SIP includes shares that had been granted previously under the 2011 Plan. As of June 30, 2015, there were 1,960,531 shares available in the Amended and Restated SIP.

 

For the three months ended June 30, 2015 and 2014, the Company recognized stock-based compensation expense (included in salaries and benefits expense) of approximately $13,000 and $180,000 ($27,000 and $144,000 net of tax), respectively. For the six months ended June 30, 2015 and 2014, the Company recognized stock-based compensation expense of approximately $403,000 and $554,000 ($308,000 and $414,000 net of tax), respectively. Stock-based compensation expense represents approximately $0.01 per common share for both the six months ended June 30, 2015 and 2014.

 

Stock Options

 

The following table summarizes the stock option activity for the six months ended June 30, 2015:

 

   Number of
Stock Options
   Weighted
Average
Exercise Price
 
Options outstanding, December 31, 2014   389,269   $16.69 
Exercised   (25,873)   15.46 
Expired, forfeited, or cancelled   (24,267)   19.86 
Options outstanding, June 30, 2015   339,129    16.55 
Options exercisable, June 30, 2015   280,799    17.18 

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model. The model uses variables which include the historical dividend yield of the Company’s common stock, the average contractual life and vesting schedule of the option, the historic volatility of the Company’s common stock price, and the risk-free interest rate at the time the option was granted. Other than options that were assumed and converted upon completion of the StellarOne merger, the Company has not granted incentive compensation in the form of options since February 2012.

 

The following table summarizes information concerning stock options issued to the Company’s employees that are vested or are expected to vest and stock options exercisable as of June 30, 2015:

 

   Stock Options
Vested or
Expected to Vest
   Exercisable 
Stock options (number of shares)   339,151    280,799 
Weighted average remaining contractual life in years   4.82    4.50 
Weighted average exercise price on shares above water  $14.30   $14.48 
Aggregate intrinsic value  $2,550,311   $1,989,870 

 

- 43 -
 

 

Restricted Stock

 

The Amended and Restated SIP permits the granting of restricted stock awards. This equity component of compensation can be in the form of restricted stock awards or restricted stock units with time-based vesting. Performance share units can also be granted with vesting based on achieving certain performance metrics or other market-based conditions such as total shareholder return relative to a peer group. Generally, restricted stock awards vest 50% on each of the third and fourth anniversaries from the date of the grant; performance and market-based awards typically vest on the third anniversary from the date of grant subject to meeting the specified performance criteria. All grants of restricted stock are subject to approval by the Company’s Compensation Committee at its sole discretion. The value of a restricted stock award is calculated by multiplying the fair market value of the Company’s common stock on the grant date by the number of shares awarded. Market-based awards are valued at the grant date using the Monte Carlo simulation method. Recipients of time-based restricted stock awards have the right to vote their non-vested shares and to receive, if declared and paid by the Company, any cash or stock dividends. Recipients of performance share units do not have the right to vote their non-vested units, and do not receive cash or stock dividends. Non-vested shares of restricted stock are included in the computation of basic earnings per share. The following table summarizes the restricted stock activity for the six months ended June 30, 2015:

 

   Number of Shares of
Restricted Stock
   Weighted Average Grant-
Date Fair Value
 
Balance, December 31, 2014   287,120   $20.07 
Granted   122,995    22.01 
Net settle for taxes   (10,352)   21.61 
Vested   (30,401)   16.08 
Forfeited   (12,396)   19.82 
Balance, June 30, 2015   356,966    21.21 

 

The estimated unamortized compensation expense, net of estimated forfeitures, related to nonvested stock and stock options issued and outstanding as of June 30, 2015 that will be recognized in future periods is as follows (dollars in thousands):

 

   Stock Options   Restricted Stock   Total 
For the remaining six months of 2015  $97   $1,662   $1,759 
For year ending December 31, 2016   120    1,845    1,965 
For year ending December 31, 2017   14    1,110    1,124 
For year ending December 31, 2018   -    496    496 
For year ending December 31, 2019   -    71    71 
Total  $231   $5,184   $5,415 

 

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12.EARNINGS PER SHARE

 

Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares outstanding attributable to stock awards.

 

There were approximately 53,625 and 160,768 shares underlying anti-dilutive awards for the three months ended June 30, 2015 and 2014, respectively, and there were approximately 56,151 and 134,785 shares underlying anti-dilutive awards for the six months ended June 30, 2015 and 2014, respectively. Anti-dilutive awards were excluded from the calculation of diluted EPS.

 

The following is a reconciliation of the denominators of the basic and diluted EPS computations for the three and six months ended June 30, 2015 and 2014 (in thousands except per share data):

 

   Net Income Available to
Common Shareholders
(Numerator)
   Weighted
Average
Common Shares
(Denominator)
   Per Share
Amount
 
For the three months ended June 30, 2015               
Net income, basic  $15,348    45,129   $0.34 
Add: potentially dilutive common shares - stock awards   -    81    - 
Diluted  $15,348    45,210   $0.34 
                
For the three months ended June 30, 2014               
Net income, basic  $14,673    46,195   $0.32 
Add: potentially dilutive common shares - stock awards   -    102    - 
Diluted  $14,673    46,297   $0.32 
                
For the six months ended June 30, 2015               
Net income, basic  $31,049    45,117   $0.69