10-Q 1 d701437d10q.htm 10-Q 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended: March 31, 2014

OR

 

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

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number 000-49966

 

 

COMMUNITY FIRST, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Tennessee   04-3687717

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

501 South James M. Campbell Blvd.

Columbia, Tennessee

  38401
(Address of Principal Executive Offices)   (Zip Code)

(931) 380-2265

(Registrant’s Telephone Number, Including Area Code)

None

(Former Name, Address and Fiscal Year, if Changed Since Last Report)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    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  x    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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. Common stock outstanding (no par value): 3,274,830 shares of common stock, no par value per share, as of May 9, 2014.

 

 

 


Table of Contents

COMMUNITY FIRST, INC.

TABLE OF CONTENTS

 

PART I.

  FINANCIAL INFORMATION   

Item 1.

  Financial Statements (Unaudited)   
 

Consolidated Balance Sheets March 31, 2014 (Unaudited) and December 31, 2013

     3   
 

Consolidated Statements of Operations and Comprehensive Income Three months ended March 31, 2014 and 2013 (Unaudited)

     5   
 

Consolidated Statement of Changes in Shareholders’ Equity Three months ended March 31, 2014 (Unaudited)

     7   
 

Consolidated Statements of Cash Flows Three months ended March 31, 2014 and 2013 (Unaudited)

     8   
 

Notes to Consolidated Financial Statements (Unaudited)

     10   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     71   

Item 4.

  Controls and Procedures      72   

PART II.

  OTHER INFORMATION   

Item 1.

  Legal Proceedings      73   

Item 1A.

  Risk Factors      73   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      73   

Item 3.

  Defaults Upon Senior Securities      73   

Item 4.

  Mine Safety Disclosures      73   

Item 5.

  Other Information      73   

Item 6.

  Exhibits      74   

SIGNATURES

     74   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Community First, Inc.

Consolidated Balance Sheets

March 31, 2014 (Unaudited) and December 31, 2013

 

(amounts in thousands, except share and per share data)    March 31,
2014
    December 31,
2013
 

Assets

    

Cash and due from financial institutions

   $ 37,657      $ 49,036   

Time deposits in other financial institutions

     20,209        6,500   

Securities available for sale, at fair value

     90,442        81,926   

Loans held for sale, at fair value

     340        —     

Loans

     263,132        273,707   

Allowance for loan losses

     (6,613     (8,039
  

 

 

   

 

 

 

Net loans

     256,519        265,668   
  

 

 

   

 

 

 

Restricted equity securities, at cost

     1,727        1,727   

Premises and equipment, net

     11,637        10,215   

Accrued interest receivable

     1,110        1,225   

Core deposit and customer relationship intangibles, net

     1,180        1,215   

Other real estate owned, net

     17,628        18,314   

Bank owned life insurance

     9,666        9,603   

Other assets

     2,962        3,014   
  

 

 

   

 

 

 

Total Assets

   $ 451,077      $ 448,443   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Deposits:

    

Noninterest-bearing

   $ 55,656      $ 53,980   

Interest-bearing

     353,272        353,552   
  

 

 

   

 

 

 

Total Deposits

     408,928        407,532   
  

 

 

   

 

 

 

Subordinated debentures

     23,000        23,000   

Accrued interest payable

     4,362        4,287   

Other liabilities

     5,282        5,008   
  

 

 

   

 

 

 

Total Liabilities

     441,572        439,827   
  

 

 

   

 

 

 

 

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Table of Contents

Community First, Inc.

Consolidated Balance Sheets

March 31, 2014 (Unaudited) and December 31, 2013

(Continued)

 

(amounts in thousands, except share and per share data)    March 31,
2014
    December 31,
2013
 

Shareholders’ Equity

    

Senior Preferred shares, no par value; 5% cumulative. Authorized 2,500,000 shares; 17,806 issued and outstanding with liquidation value of $20,646 at March 31, 2014 and $20,368 at December 31, 2013.

     17,806        17,806   

Warrant Preferred shares, no par value; 9% cumulative. 890 issued and outstanding with liquidation value of $1,146 at March 31, 2014 and $1,120 at December 31, 2013.

     890        890   

Net discount on Preferred shares

     —          (33
  

 

 

   

 

 

 

Total Preferred shares

     18,696        18,663   

Common stock, no par value. Authorized 10,000,000 shares; 3,274,830 shares issued and outstanding at March 31, 2014 and 3,274,777 shares issued and outstanding at December 31, 2013

     28,591        28,590   

Accumulated deficit

     (35,303     (35,760

Accumulated other comprehensive loss, net

     (2,479     (2,877
  

 

 

   

 

 

 

Total Shareholders’ Equity

     9,505        8,616   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 451,077      $ 448,443   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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Community First, Inc.

Consolidated Statements of Operations and Comprehensive Income

Three Months Ended March 31, 2014 and 2013

(Unaudited)

 

(amounts in thousands, except share and per share data)   

Three Months

Ended

March 31,

 
     2014     2013  

Interest income

    

Loans, including fees

   $ 3,458      $ 4,189   

Taxable securities

     436        298   

Tax-exempt securities

     25        44   

Federal funds sold and other

     71        77   
  

 

 

   

 

 

 

Total interest income

     3,990        4,608   

Interest expense

    

Deposits

     589        911   

FHLB advances and federal funds purchased

     —          78   

Subordinated debentures and other

     193        251   
  

 

 

   

 

 

 

Total interest expense

     782        1,240   
  

 

 

   

 

 

 

Net interest income

     3,208        3,368   

Provision for loan losses

     (500     300   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     3,708        3,068   

Noninterest income

    

Service charges on deposit accounts

     407        384   

Gain on sale of loans

     10        30   

Other

     150        183   
  

 

 

   

 

 

 

Total noninterest income

     567        597   

Noninterest expense

    

Salaries and employee benefits

     1,647        1,652   

Regulatory and compliance

     264        294   

Occupancy

     146        266   

Furniture and equipment

     77        101   

Data processing fees

     275        263   

Advertising and public relations

     55        42   

Operational expense

     100        100   

Other real estate owned expense

     239        (26

Other

     678        770   
  

 

 

   

 

 

 

Total noninterest expenses

     3,481        3,462   
  

 

 

   

 

 

 

Income before income tax expense

     794        203   

 

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Community First, Inc.

Consolidated Statements of Operations and Comprehensive Income

Three Months Ended March 31, 2014 and 2013

(Unaudited, Continued)

 

(amounts in thousands, except share and per share data)   

Three Months

Ended

March 31,

 
     2014     2013  

Income tax expense

     —          —     
  

 

 

   

 

 

 

Net income

     794        203   

Preferred stock dividends declared

     (304     (239

Accretion of preferred stock discount

     (33     (48
  

 

 

   

 

 

 

Net income (loss) available (allocated) to common shareholders

   $ 457      $ (84
  

 

 

   

 

 

 

Income (loss) per share available (allocated) to common shareholders

    

Basic

   $ 0.14      $ (0.03

Diluted

     0.14        (0.03

Weighted average common shares outstanding

    

Basic

     3,274,827        3,274,394   

Diluted

     3,274,827        3,274,394   

Comprehensive Income

    

Net income

   $ 794      $ 203   

Unrealized gains (losses) on securities, net of income taxes of $0 in 2014 and 2013

     398        (189
  

 

 

   

 

 

 

Comprehensive income

   $ 1,192      $ 14   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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Community First, Inc.

Consolidated Statement of Changes in Shareholders’ Equity

Three Months Ended March 31, 2014

(Unaudited)

 

(amounts in thousands, except share and per share data)    Common
Shares
     Preferred
Stock
     Common
Stock
     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss, Net
    Total
Shareholders’
Equity
 

Balance at January 1, 2014

     3,274,777       $ 18,663       $ 28,590       $ (35,760   $ (2,877   $ 8,616   

Accretion of discount on preferred stock

     —           33         —           (33     —          —     

Sale of shares of common stock

     53         —           1         —          —          1   

Cash dividends declared on preferred stock

     —           —           —           (304     —          (304

Net income

     —           —           —           794        —          794   

Change in unrealized loss on securities available for sale, net of $0 income tax

                398        398   
             

 

 

   

 

 

 

Balance at March 31, 2014

     3,274,830       $ 18,696       $ 28,591       $ (35,303   $ (2,479   $ 9,505   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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Community First, Inc.

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2014 and 2013

(Unaudited)

 

(amounts in thousands, except share and per share data )    Three Months Ended
March 31,
 
     2014     2013  

Cash flows from operating activities

    

Net income

   $ 794      $ 203   

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation

     135        158   

Amortization on securities, net

     91        107   

Core deposit intangible amortization

     35        34   

Provision for loan losses

     (500     300   

Loans originated for sale

     (779     (1,678

Proceeds from sale of loans

     457        2,029   

Gain on sale of loans

     (10     (30

Decrease in accrued interest receivable

     115        83   

Increase in accrued interest payable

     75        213   

Increase in surrender value of bank owned life insurance

     (63     (68

Net write down (gain on sale) of other real estate owned

     265        (54

Other, net

     51        425   
  

 

 

   

 

 

 

Net cash from operating activities

     666        1,722   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Available for sale securities

    

Purchases:

    

Mortgage-backed securities

     (7,612     —     

Other

     (2,732     (13,852

Maturities, prepayments, and calls:

    

Mortgage-backed securities

     1,636        2,480   

Other

     500        9,000   

Net decrease in loans

     9,507        12,844   

Proceeds from sales of other real estate owned

     563        1,594   

(Increase) decrease in time deposits in other financial institutions

     (13,709     250   

Additions to premises and equipment

     (1,595     (73
  

 

 

   

 

 

 

Net cash (used in) from investing activities

     (13,442     12,243   
  

 

 

   

 

 

 

 

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Community First, Inc.

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2014 and 2013

(Unaudited, Continued)

 

(amounts in thousands, except share and per share data )    Three Months Ended
March 31,
 
     2014     2013  

Cash flows from financing activities

    

Net increase (decrease) in deposits

     1,396        (9,613

Proceeds from issuance of common stock

     1        1   
  

 

 

   

 

 

 

Net cash used in financing activities

     1,397        (9,612
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (11,379     4,353   

Cash and cash equivalents at beginning of period

     49,036        94,877   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 37,657      $ 99,230   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Cash paid during year for:

    

Interest

   $ 707      $ 1,027   

Income taxes paid

     —          —     

Supplemental noncash disclosures

    

Transfers from loans to repossessed assets

     142        1,020   

Preferred stock dividends declared but not paid

     304        239   

Transfer to loans from loans held for sale

     —          —     

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

(amounts in thousands, except share and per share data)

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION

The consolidated financial statements include Community First, Inc. and its wholly-owned subsidiary, Community First Bank & Trust. Community First, Inc., together with the Bank, is referred to herein as the “Company.” The sole subsidiary of Community First Bank & Trust is Community First Properties, Inc., which was originally established as a Real Estate Investment Trust (“REIT”) but which terminated its REIT election in the first quarter of 2012. Community First Bank & Trust together with its subsidiary is referred to herein as the “Bank.” Intercompany transactions and balances are eliminated in consolidation.

The Bank conducts substantially all of its banking activities in Maury, Williamson and Hickman Counties, in Tennessee. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flows from operations of businesses. The significant loan concentrations that exceed 10% of total loans are as follows: commercial real estate loans, 1-4 family residential loans, and construction loans. The customers’ ability to repay their loans is dependent, on the real estate and general economic conditions in the Company’s market areas. Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

The unaudited consolidated financial statements as of March 31, 2014 and for the three-month periods ended March 31, 2014 and 2013 have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (the “SEC”) and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the information. They do not include all the information and footnotes required by GAAP for complete financial statements. Operating results for interim periods are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the 2013 consolidated audited financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014 (File No. 000-49966) (the “2013 Form 10-K”).

 

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

 

Critical Accounting Policies:

The consolidated financial statements in this report are prepared in conformity with GAAP and with general practices in the banking industry. As such, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. A summary of our significant accounting policies is described in our 2013 Form 10-K. The significant accounting policies and estimates which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Allowance for Loan Losses: Credit risk is inherent in the business of extending loans to borrowers. This credit risk is addressed through a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

A loan is identified as impaired when, based on current information and events, it is probable that the scheduled payments of principal or interest will not be collected when due according to the contractual terms of the loan agreement. However, some loans are termed impaired because of doubt regarding collectability of interest and principal according to the contractual terms, even though such loans are both fully secured by collateral and current in their interest and principal payments. Additionally, loans are considered troubled debt restructurings and classified as impaired if their terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans over $150 are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

 

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

 

Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component of the allowance covers loans collectively evaluated for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following loan portfolio segments have been identified with a discussion of the risk characteristics of these portfolio segments:

Real Estate Construction loans consist of loans made for both residential and commercial construction and land development. Residential real estate construction loans are loans secured by real estate to build 1-4 family dwellings. These are loans made to borrowers obtaining loans in their personal name for the personal construction of their own dwellings or loans to builders for the purpose of constructing homes for resale. These loans to builders can be for speculative homes for which there is no specific homeowner for which the home is being built, as well as loans to builders that have a pre-sale contract to another individual.

Commercial Construction loans are loans extended to borrowers secured by and to build commercial structures such as churches, retail strip centers, industrial warehouses or office buildings. Land development loans are granted to commercial borrowers to finance the improvement of real estate by adding infrastructure so that ensuing construction can take place. Construction and land development loans are generally short term in maturity to match the expected completion of a particular project. These loan types are generally more vulnerable to changes in economic conditions in that they project there will be a demand for the product. They require monitoring to ensure the project is progressing in a timely manner within the expected budgeted amount. This monitoring is accomplished via periodic physical inspections by an outside third party.

1-4 Family Residential loans consist of both open end and closed end loans secured by first or junior liens on 1-4 family improved residential dwellings. Open end loans are Home Equity Lines of Credit that allow the borrower to use equity in the real estate to borrow and repay as the need arises. First and junior lien residential real estate loans are closed end loans with a specific maturity that generally does not exceed 7 years. Economic conditions can affect the borrower’s ability to repay the loans, and the value of the real estate securing the loans can change over the life of the loan.

Commercial Real Estate loans consist of loans secured by farmland or by improved commercial property. Farmland includes all land known to be used or usable for agricultural purposes, such as crop and livestock production, grazing, or pasture land. Improved commercial property can be owner occupied or non-owner occupied property secured by commercial structures such as churches, retail strip centers, hotels, industrial warehouses or office buildings. The repayment of these loans tends to depend upon the operation and management of a business or lease income from a business, and therefore adverse economic conditions can affect the ability to repay.

 

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 1 – ORGANIZATION AND BASIS OF PRESENTATION (Continued)

 

Other Real Estate Secured loans consist of loans secured by five or more multi-family dwelling units. These loans are typically exemplified by apartment buildings or complexes. The ability to manage and rent units affects the income that usually provides repayment for this type of loan.

Commercial, Financial, and Agricultural loans consist of loans extended for the operation of a business or a farm. They are not secured by real estate. Commercial loans are used to provide working capital, acquire inventory, finance the carrying of receivables, purchase equipment or vehicles, or purchase other capital assets. Agricultural loans are typically for purposes such as planting crops, acquiring livestock, or purchasing farm equipment. The repayment of these loans comes from the cash flow of a business or farm and is generated by sales of inventory or providing of services. The collateral tends to depreciate over time and is difficult to monitor. Frequent statements are required from the borrower pertaining to inventory levels or receivables aging.

Consumer loans consist largely of loans extended to individuals for purposes such as to purchase a vehicle or other consumer goods. These loans are not secured by real estate but are frequently collateralized by the consumer items being acquired with the loan proceeds. This type of collateral tends to depreciate, and therefore the term of the loan is tailored to fit the expected value of the collateral as it depreciates, along with specific underwriting policies and guidelines.

Tax Exempt loans consist of loans that are extended to entities such as municipalities. These loans tend to be dependent on the ability of the borrowing entity to continue to collect taxes to repay the indebtedness.

Other loans consist of those loans which are not elsewhere classified in these categories and are not secured by real estate.

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS

Although the Company reported net income in 2013, 2012 and the first three months of 2014, the Company reported losses for each year from 2008 to 2011. The losses incurred by the Company were primarily the result of the economic recession that began in 2008 and the continued impacts of that recession and the resulting sluggish economic conditions. The Bank is a community bank that focuses heavily on commercial and residential development lending. As a result of the collapse of the housing market, many developments stalled, resulting in developers no longer being able to meet their payment obligations to the Bank. Also, during this time, market values for existing real estate properties decreased, which jeopardized the collateral securing the loans made by the Bank. The losses incurred by the Bank and the Company have contributed to both the Bank and the Company being subject to additional regulatory scrutiny and increased supervisory actions by regulators.

Banks and bank holding companies with total consolidated assets in excess of $500,000 are subject to regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet minimum capital requirements can initiate regulatory actions that could have a direct material effect on the financial statements.

 

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COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

Prompt corrective action regulations classify banks into one of five capital categories depending on how well they meet their minimum capital requirements. Although these terms are not used to represent the overall financial condition of a bank, the classifications are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. If adequately capitalized or worse, or subject to a written agreement, consent order, or cease and desist order requiring higher minimum capital levels as the Bank is, regulatory approval is required for the Bank to accept, renew or rollover brokered deposits. If a bank is classified as undercapitalized or worse, its capital distributions are restricted, as is asset growth and expansion, and capital restoration plans are required. At March 31, 2014, the Bank’s capital ratios were above those levels necessary to be considered “well capitalized” under the regulatory framework for prompt corrective action and all ratios were above those levels required by the Consent Order (as defined below) and the written agreement that the Bank has entered into with the Tennessee Department of Financial Institutions (the “Department”). The Company’s capital ratios are below what is required to be considered “adequately capitalized” under the regulatory framework. Two of the three capital ratios were considered “adequate”; however, the Tier 1 to Average Assets ratio was below the requirements to be considered “adequate”, which prohibits the Company from being “adequately capitalized”.

On April 19, 2012, the Company entered into a written agreement (the “Written Agreement”) with the Federal Reserve Bank of Atlanta (the “FRB”). Under the terms of the Written Agreement, the Company agreed to, among other things, take the following actions:

 

    Take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with the Consent Order (as defined below);

 

    Submit within 60 days of April 19, 2012 a written plan to maintain sufficient capital at the Company on a consolidated basis, and within 10 days of approval of the plan by the FRB, adopt the approved capital plan;

 

    Submit within 60 days of April 19, 2012 a written statement of the Company’s planned sources and uses of cash for debt service, operating expenses, and other purposes for 2012;

 

    Provide notice in compliance with applicable federal law and regulations, of any changes in directors or senior executive officer of the Company;

 

    Comply with applicable federal law and regulations restricting indemnification and severance payments; and

 

    Provide within 45 days after the end of each calendar quarter, a written progress report detailing the form and manner of all actions taken to secure compliance with the provisions of the Written Agreement.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

In addition, under the terms of the Written Agreement, the Company has agreed to, among other things:

 

    Refrain from declaring or paying any dividends without prior approval of the FRB;

 

    Not directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without prior approval;

 

    Not (along with the Company’s non-bank subsidiary) make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior approval;

 

    Not (along with the Company’s non-bank subsidiaries) directly or indirectly incur, increase, or guarantee any debt without prior approval; and

 

    Not directly or indirectly purchase or redeem any shares of its stock without prior approval.

As of March 31, 2014, all of the plans required to be submitted to the FRB have been submitted and approved. Management believes that the Company is in compliance with the requirements of the Written Agreement as of March 31, 2014.

At the request of the FRB, the board of directors of the Company, on January 18, 2011, adopted a board resolution agreeing that the Company would not incur additional debt, pay common or preferred dividends, or redeem treasury stock without approval from the FRB. The terms of the Written Agreement, which replaced the board resolution, among other things, similarly prohibit the Company from incurring debt, paying dividends or interest or redeeming shares of its capital stock. The Company requested permission to make dividend payments on its outstanding preferred stock (the “Preferred Stock”) and interest payments on its subordinated debt that were scheduled for the first quarter of 2011. The FRB granted permission to pay the Preferred Stock dividends that were due on February 15, 2011, but denied permission to make interest payments on the Company’s subordinated debt. As a result of the FRB’s decision, the Company was required to begin the deferral of interest payments on each of its three issuances of subordinated debentures during the first quarter of 2011.

The Company has the right to defer the payment of interest on its subordinated debentures at any time, for a period not to exceed 20 consecutive quarters. During the period in which it is deferring the payment of interest on its subordinated debentures, the Company may not pay any dividends on its common or preferred stock, and the Company’s subsidiaries may not pay dividends on the subsidiaries’ common or preferred stock owned by entities other than the Company and its subsidiaries. Accordingly, the Company was required to suspend dividend payments on the Preferred Stock beginning in the second quarter of 2011.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

Consequently, at March 31, 2014, the Company had $3,915 of interest accrued on its subordinated debentures for which payment is being deferred. In addition, the Company had accumulated $3,096 in deferred dividends on the shares of Preferred Stock it had sold to the United States Department of the Treasury (the “U.S. Treasury”) under the TARP Capital Purchase Program (the “CPP”). Under the terms of the CPP, failure to pay dividends for six dividend periods triggers the right of the holders of the Preferred Stock to elect two directors to an institution’s board. Since the Company has deferred payment of dividends on its Preferred Stock for more than six quarters, the holders of the Preferred Stock voting together as a single class now have the right to elect up to two directors to the Company’s board of directors. On April 14, 2014, the U.S. Treasury sold all of the shares of Preferred Stock it owned in a modified Dutch auction to multiple qualified investors, including certain members of the Company’s board of directors and senior officers.

The sale of the Preferred Stock had no effect on the terms of the outstanding securities, including the Company’s obligation to satisfy accrued and unpaid dividends or the holders’ right to elect up to two directors to the Company’s board of directors. However, the Company is no longer subject to various executive compensation and corporate governance requirements to which participants in the CPP were subject while the U.S. Treasury held the Preferred Stock.

Similarly, the sole subsidiary of the Bank, Community First Properties, Inc., also suspended the payment of dividends on its preferred stock beginning with the dividend payment due on December 31, 2011. At March 31, 2014, Community First Properties, Inc. had $39 of preferred stock dividends accrued for which payment is being deferred.

On September 20, 2011, the Bank consented to the issuance of a consent order (the “Consent Order”) by the Federal Deposit Insurance Corporation (the “FDIC”). The Consent Order requires the Bank to attain and achieve regulatory capital ratios higher than those required by regulatory standards, improve, among other things, its processes for identifying and classifying problem loans, and improve its overall profitability. The Consent Order required the Bank to formulate written plans detailing how the Bank would achieve such requirements. The Bank has prepared and submitted all of the required plans to the FDIC and the FDIC has approved those plans as written. In addition, the terms of the Consent Order require the Bank to provide quarterly progress reports to the FDIC. For more information regarding the Consent Order, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” On March 14, 2013, the Bank entered into a written agreement with the Tennessee Department of Financial Institutions (the “Department”), the terms of which are substantially the same as those of the Consent Order, including required minimum levels of capital that the Bank must maintain.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

As a result of entering into the Consent Order, the Bank also is subject to additional limitations on its operations including a prohibition on accepting, rolling over, or renewing brokered deposits, which could adversely affect the Bank’s liquidity and/or operating results. The existence of the Consent Order also limits the Bank from paying deposit rates above national rate caps published weekly by the FDIC unless the Bank is determined to be operating in a high-rate market area. On December 1, 2011, the Bank received notification from the FDIC that it is operating in a high-rate environment, which allows the Bank to pay rates higher than the national rate caps, but continues to limit the Bank to rates that do not exceed the prevailing rate in the Bank’s market by more than 75 basis points. The Bank is also limited, as a result of its condition, in its ability to pay more than de minimis severance payments to its employees and must receive the consent of the FDIC and the Department to appoint new officers or directors.

The Consent Order includes time frames to implement the foregoing and on-going compliance requirements for the Bank, such as quarterly progress reports that the Bank must submit to its regulators. In accordance with the terms of the Consent Order, management prepared and submitted a capital plan with the objective of attaining the capital ratios required by the Consent Order. At March 31, 2014, each of the Bank’s regulatory capital ratios exceeded the regulatory capital ratios proscribed by the Consent Order and the written agreement with the Department. Management has submitted a written plan to the FDIC to bring the Bank into compliance with the loan concentration component of the Consent Order, and that plan was approved by the FDIC.

The Company’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid by the Bank in any calendar year is limited to the current year’s net income, combined with the retained net income of the preceding two years, subject to the capital requirements described above. Although the Bank was profitable in each of 2012 and 2013, and the first three months of 2014, the Bank is prohibited under the terms of the Consent Order with the FDIC and the written agreement with the Department from paying dividends to the Company without prior approval from the FDIC and the Department. The Company is also restricted in the types and amounts of dividends it can pay pursuant to the terms of the Preferred Stock and by the terms of the Written Agreement, which prohibits the Company from paying interest or dividends (including interest on the Company’s subordinated debentures and dividends on the Company’s Preferred Stock) without the FRB’s prior approval.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

Bank holding companies and banks are subject to various regulatory capital requirements administered by state and federal banking agencies. The Company’s and the Bank’s capital amounts and ratios at March 31, 2014 and December 31, 2013, were as follows:

 

     Actual     For Capital
Adequacy
Purposes
    To Be Well
Capitalized Under
Applicable
Regulatory
Provisions(1)
    Required by
terms of
Consent Order
with FDIC
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  

March 31, 2014

                    

Total Capital to risk weighted assets

                    

Community First Bank & Trust

   $ 42,213         15.11   $ 22,344         8.00   $ 27,930         10.00   $ 33,516         12.00

Consolidated

     25,908         9.26     22,381         8.00     27,977         10.00     N/A         N/A   

Tier 1 Capital to risk weighted assets

                    

Community First Bank & Trust

   $ 38,683         13.85   $ 11,172         4.00   $ 16,758         6.00   $ 27,930         10.00

Consolidated

     14,915         5.33     11,191         4.00     16,786         6.00     N/A         N/A   

Tier 1 Capital to average assets

                    

Community First Bank & Trust

   $ 38,683         8.64   $ 17,919         4.00   $ 22,399         5.00   $ 38,077         8.50

Consolidated

     14,915         3.31     18,013         4.00     N/A         N/A        N/A         N/A   

December 31, 2013

                    

Total Capital to risk weighted assets

                    

Community First Bank & Trust

   $ 41,250         14.70   $ 22,445         8.00   $ 28,056         10.00   $ 33,667         12.00

Consolidated

     24,905         8.87     22,474         8.00     28,092         10.00     N/A         N/A   

Tier 1 Capital to risk weighted assets

                    

Community First Bank & Trust

   $ 37,687         13.43   $ 11,222         4.00   $ 16,833         6.00   $ 28,056         10.00

Consolidated

     14,225         5.06     11,237         4.00     16,855         6.00     N/A         N/A   

Tier 1 Capital to average assets

                    

Community First Bank & Trust

   $ 37,687         8.41   $ 17,917         4.00   $ 22,396         5.00   $ 38,073         8.50

Consolidated

     14,225         3.16     18,008         4.00     N/A         N/A        N/A         N/A   

 

(1) Because the Company’s total assets were less than $500,000 at March 31, 2014 and December 31, 2013, the Company was not at those dates subject to capital level requirements at the Company level.

The Bank’s capital ratios at March 31, 2014 were above those levels necessary to be considered “well capitalized” under the regulatory framework for prompt corrective action, but the existence of the Consent Order requires regulators to continue to classify the Bank as “adequately capitalized” even though the capital levels would qualify as “well capitalized” if the Consent Order were not in place.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 2 – REGULATORY MATTERS AND MANAGEMENT PLANS (Continued)

 

Because the Company’s total assets were less than $500,000 at March 31, 2014, the Company is not required to meet consolidated capital level requirements. Had the Company’s total assets exceeded $500,000 at that date, the Company’s capital levels at March 31, 2014 would have been considered below those required to be considered “adequately capitalized” under applicable regulations because only two of the three capital ratios were above the levels necessary to be considered “adequate”. The Company’s Tier 1 to Average Assets ratio was below the requirements to be considered “adequate”, which prohibits the Company from being considered “adequately capitalized”.

Management’s Plans

The Company is currently considering various options to increase capital levels at the Company and the Bank, including the sale of common or preferred stock of the Company or other assets, or alternatively the sale of the Company. Any sale of the Company’s common stock would likely be at a price that would result in substantial dilution in ownership for the Company’s existing common shareholders and could result in a change in control of the Company. If a change in control was deemed to have occurred, certain IRS regulations related to the preservation of net operating loss carryforwards could subject the Company to risk of forfeiture of these tax benefits. The loss of these tax benefits would not cause the Company to recognize a direct reduction in cash, but rather would eliminate the tax benefits that the Company would otherwise be able to utilize to offset future year’s profits, if any, to reduce the Company’s tax liabilities. Failure by the Bank or the Company to comply with the terms of the Consent Order, the Written Agreement or the written agreement that the Bank has entered into with the Department, as applicable, may result in additional adverse regulatory action.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE

The following table summarizes the amortized cost and fair value of the available for sale securities portfolio at March 31, 2014 and December 31, 2013 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss), net of applicable income taxes:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

March 31, 2014

          

U.S. Government sponsored entities

   $ 34,105       $ 3       $ (1,076   $ 33,032   

Mortgage-backed (residential)

     48,186         492         (353     48,325   

State and municipal

     8,953         136         (4     9,085   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 91,244       $ 631       $ (1,433   $ 90,442   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2013

          

U.S. Government sponsored entities

   $ 34,604       $ —         $ (1,247   $ 33,357   

Mortgage-backed (residential)

     42,294         488         (501     42,281   

State and municipal

     6,228         78         (18     6,288   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 83,126       $ 566       $ (1,766   $ 81,926   
  

 

 

    

 

 

    

 

 

   

 

 

 

There were no sales of securities during the three month periods ended March 31, 2014 and 2013.

The amortized cost and fair value of the securities portfolio are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage backed securities are presented separately due to varying maturity dates as a result of prepayments.

 

     March 31, 2014  
     Amortized Cost      Fair Value  

Due in one year or less

   $ 126       $ 126   

Due after one through five years

     17,053         16,753   

Due after five through ten years

     15,719         15,184   

Due after ten years

     10,160         10,054   

Mortgage backed (residential)

     48,186         48,325   
  

 

 

    

 

 

 

Total

   $ 91,244       $ 90,442   
  

 

 

    

 

 

 

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

 

At March 31, 2014 and December 31, 2013, respectively, securities totaling $36,669 and $37,182 were pledged to secure public deposits.

At March 31, 2014, the Company held two securities for which the aggregate face amount of investments is greater than 10% of the Company’s shareholders’ equity as of March 31, 2014.

 

Type

   Issuer    Face
Value
     Fair
Value
     % of
Capital
 

State and municipals

   State of Texas    $ 1,245       $ 1,274         13.10

State and municipals

   Minneapolis, MN    $ 1,000       $ 1,006         10.52

At December 31, 2013, the Company held one security for which the aggregate face amount of investments is greater than 10% of shareholders’ equity as of December 31, 2013.

 

Type

   Issuer    Face
Value
     Fair
Value
     % of
Capital
 

State and municipals

   State of Texas    $ 1,245       $ 1,248         14.45

Other than the above investments, the Company did not hold securities of any one issuer, other than U.S. Government sponsored entities, with a face amount greater than 10% of shareholders’ equity as of March 31, 2014 or December 31, 2013.

The following table summarizes securities with unrealized losses at March 31, 2014 and December 31, 2013 aggregated by major security type and length of time in a continuous unrealized loss position:

 

     Less than 12 Months     12 Months or More     Total  

March 31, 2014

                                       
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  

Description of Securities

   Value      Loss     Value      Loss     Value      Loss  

U.S. Government sponsored entities

   $ 29,184       $ (921   $ 2,845       $ (155   $ 32,029       $ (1,076

Mortgage-backed (residential)

     30,783         (353     —           —          30,783         (353

State and municipals

     514         (4     —           —          514         (4
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 60,481       $ (1,278   $ 2,845       $ (155   $ 63,326       $ (1,433
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     Less than 12 Months     12 Months or More     Total  

December 31, 2013

                  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  

Description of Securities

   Value      Loss     Value      Loss     Value      Loss  

U.S. Government sponsored entities

   $ 32,376       $ (1,228   $ 481       $ (19   $ 32,857       $ (1,247

Mortgage-backed (residential)

     27,902         (501     —           —          27,902         (501

State and municipals

     3,003         (18     —           —          3,003         (18
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 63,281       $ (1,747   $ 481       $ (19   $ 63,762       $ (1,766
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

 

Other-Than-Temporary Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Securities classified as available for sale are generally evaluated for OTTI under the provisions of ASC 320-10, Investments - Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in accumulated other comprehensive income becomes the new amortized cost basis of the investment.

As of March 31, 2014, the Company’s securities portfolio consisted of 129 securities, 70 of which were in an unrealized loss position. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company did not have at March 31, 2014 the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company did not consider these securities to be other-than-temporarily impaired at March 31, 2014.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 3 – SECURITIES AVAILABLE FOR SALE (Continued)

 

The table below presents a rollforward for the three month periods ended March 31, 2014 and 2013 of the credit losses recognized in earnings:

 

     Three months ended
March 31,
 
     2014      2013  

Beginning Balance

   $ —         $ 6,338   

Additions for credit losses on securities for which no previous other-than-temporary impairment was recognized

     —           —     

Reduction for credit losses on securities for which no recovery has been received and for which no recovery is expected

     —           —     
  

 

 

    

 

 

 

Ending Balance

   $ —         $ 6,338   
  

 

 

    

 

 

 

During the second quarter of 2013, the Company wrote off two securities for which previous other than temporary losses had been recognized. Both of the securities written off were trust preferred securities issued by affiliated trusts of financial institutions that have failed and are no longer in existence. Management does not anticipate that the Company will recover any of the charged off balances in the future.

NOTE 4 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on matrix pricing which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using estimates of current market rates for each type of security.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

During times when trading is more liquid, broker quotes are used (if available) to validate the model agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Loans Held for Sale: Generally, the fair value of loans held for sale is based on what secondary markets are currently offering for loans with similar characteristics or based on an agreed upon sales price with third party investors and typically result in a Level 2 classification of the inputs for determining fair value.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Real estate acquired through foreclosure on a loan or by surrender of the real estate in lieu of foreclosure is called “OREO”. OREO is initially recorded at the fair value of the property less estimated costs to sell, which establishes a new cost basis. OREO is subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Valuation adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Valuation adjustments are also required when the listing price to sell an OREO property has had to be reduced below the current carrying value. If there is a decrease in the fair value of the property from the last valuation, the decrease in value is charged to noninterest expense. All income produced from, changes in fair values in, and gains and losses on OREOs is also included in noninterest expense. During the time the property is held, all related operating and maintenance costs are expensed as incurred.

Appraisals for both collateral dependent impaired loans and OREO are performed by certified general appraisers, certified residential appraisers or state licensed appraisers whose qualifications and licenses are annually reviewed and verified by the Bank. Once received, either Bank personnel or an independent review appraiser reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value, and determines whether the appraisal is reasonable. Appraisals for collateral dependent impaired loans and OREO are updated annually. On an annual basis, the Company compares the actual selling costs of collateral that has been liquidated to the selling price to determine what additional adjustment should be made to the appraisal value to arrive at fair value. Beginning in the third quarter of 2010, the Company’s analysis indicated that an additional discount of 15% should be applied to properties with appraisals performed within 12 months.

Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on the anticipated gain from the sale of the underlying loan. Changes in the fair values of these derivatives are included in noninterest income as gain on sale of loans.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

Assets and Liabilities Measured on a Recurring Basis

 

            Fair Value Measurements at
March 31, 2014 using
 
     Carrying Value     

Significant Other
Observable
Inputs

(Level 2)

     Significant
Unobservable
Inputs (Level 3)
 

Assets:

        

Available for sale securities:

        

U.S. government sponsored entities

   $ 33,032       $ 33,032       $ —     

Mortgage-backed (residential)

     48,325         48,325         —     

State and municipals

     9,085         8,979         106   
  

 

 

    

 

 

    

 

 

 

Total available for sale securities

     90,442         90,336         106   

Loans held for sale

     340         340         —     

 

            Fair Value Measurements at
December 31, 2013 using
 
     Carrying Value     

Significant Other
Observable
Inputs

(Level 2)

     Significant
Unobservable
Inputs (Level 3)
 

Assets:

        

Available for sale securities:

        

U.S. government sponsored entities

   $ 33,357       $ 33,357       $ —     

Mortgage-backed (residential)

     42,281         42,281         —     

State and municipals

     6,288         6,183         105   
  

 

 

    

 

 

    

 

 

 

Total available for sale securities

     81,926         81,821         105   

Loans held for sale

     —           —           —     

There were no transfers among fair value pricing levels during the three months ended March 31, 2014 and 2013.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three month periods ended March 31, 2014 and 2013:

Fair Value Measurements Using Significant Unobservable Inputs

(Level 3)

Corporate Securities

 

    

Three months ended

March 31,

 
         2014              2013      

Beginning balance

   $ —         $ 987   

Change in fair value

     —           2   
  

 

 

    

 

 

 

Ending balance

   $ —         $ 989   
  

 

 

    

 

 

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level 3)

State and County Municipal Securities

 

    

Three months ended

March 31,

 
         2014              2013      

Beginning balance

   $ 105       $ 108   

Change in fair value

     1         —     
  

 

 

    

 

 

 

Ending balance

   $ 106       $ 108   
  

 

 

    

 

 

 

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

The following methods and assumptions were used by the Company in generating its fair value disclosures:

U.S. Government Sponsored Entities and Mortgage-Backed Securities:

The Company uses an independent third party to value its U.S. government sponsored entities and mortgage-backed securities, which are obligations that are not backed by the full faith and credit of the United States government and consist of Government Sponsored Entities that either issue the securities or guarantee the collection of principal and interest payments thereon. The third party’s valuation approach uses relevant information generated by recently executed transactions that have occurred in the market place that involve similar assets, as well as using cash flow information when necessary. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing; however, when the securities are added to the portfolio after the third party’s system-wide market value monthly update, the valuations are considered Level 3 pricing.

State and Municipal Securities:

The valuation of the Company’s state and municipal securities is supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. For these securities that are rated by the rating agencies and have recent trades, the Company considers these valuations to be Level 2 pricing. For these securities that are not rated by the rating agencies and for which trading volumes are thin, the valuations are considered Level 3 pricing.

Corporate Securities:

For corporate securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3) as determined by an independent third party. The significant unobservable inputs used in the valuation model include discount rates and yields or current spreads to U.S. Treasury rates.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

     March 31, 2014  
     Carrying Value      Fair Value
Measurements
using other
significant
unobservable
inputs (Level 3)
 

Assets:

     

Impaired loans:

     

Real estate construction

   $ 597       $ 597   

1-4 Family residential

     1,530         1,530   

Commercial real estate

     2,262         2,262   

Other loans

     463         463   
  

 

 

    

 

 

 

Total impaired loans

     4,852         4,852   

Other real estate owned:

     

Construction and development

     6,492         6,492   

1-4 Family residential

     96         96   

Non-farm, non-residential

     4,495         4,495   
  

 

 

    

 

 

 

Total other real estate owned

     11,083         11,083   

 

- 28 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

     December 31, 2013  
     Carrying Value      Fair Value
Measurements
using other
significant
unobservable
inputs (Level 3)
 

Assets:

     

Impaired loans:

     

Real estate construction

   $ 4,321       $ 4,321   

1-4 Family residential

     6,173         6,173   

Commercial real estate

     3,382         3,382   

Commercial, financial and agricultural

     1         1   

Other loans

     926         926   
  

 

 

    

 

 

 

Total impaired loans

     14,803         14,803   

Other real estate owned:

     

Construction and development

     6,079         6,079   

1-4 Family residential

     228         228   

Non-farm, non-residential

     4,707         4,707   
  

 

 

    

 

 

 

Total other real estate owned

     11,014         11,014   

Impaired loans, with specific allocations or partial charge offs based on the fair value of the underlying collateral for collateral dependent loans, had a recorded investment of $6,000, with a valuation allowance of $1,148, resulting in no additional provision for loan losses for the three-month period ended March 31, 2014, compared to an additional provision of $262 in the first three months of 2013. Impaired loans, with specific allocations or partial charge offs based on the fair value of the underlying collateral for collateral dependent loans, had a recorded investment of $17,223, with a valuation allowance of $2,420, resulting in an additional provision for loan losses of $45 for the year ended December 31, 2013.

Other real estate owned, measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $11,083, which is made up of the outstanding balance of $13,415, net of a valuation allowance of $2,332 at March 31, 2014, resulting in a write-down of $218 charged to expense in the three months ended March 31, 2014, compared to a write-down of $16 charged to expense in the first three months of 2013. Net carrying amount was $11,014 at December 31, 2013, which was made up of the outstanding balance of $13,163, net of a valuation allowance of $2,149.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

The following table presents quantitative information about Level 3 fair value measurements for financial instruments at fair value on a non-recurring basis at March 31, 2014:

 

     Fair
Value
    

Valuation
Technique(s)

  

Unobservable

Input(s)

  

Range (Weighted
Average) (1)

Impaired Loans:

           

Real estate construction

   $ 597       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (21.0%)

(6.98%)

1-4 Family residential

     1,530       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (0.0%)

(0.0%)

Commercial real estate

     2,262       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (20.0%)

(4.09%)

Other loans

     463       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (15.0%)

(15.0%)

Other real estate owned:

           

Construction and development

     6,492       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (22.0%)

(7.17%)

1-4 Family residential

     96       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (0.0%)

(0.0%)

Non-farm, non-residential

     4,495       Sales comparison approach    Adjustment for differences between the comparable sales   

(0.0%) – (11.0%)

(8.15%)

 

(1) The range presented in the table reflects the discounts applied by the independent appraiser in arriving at their conclusion of market value. Management applies an additional 15% discount to the appraiser’s conclusion of market value to arrive at fair value.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

Carrying amount and estimated fair values of significant financial instruments at March 31, 2014 and December 31, 2013 were as follows:

 

     March 31, 2014  
     Carrying
Amount
     Total      Level 1      Level 2      Level 3  

Financial assets

              

Cash and cash equivalents

   $ 37,657       $ 37,657       $ 37,657       $ —         $ —     

Time deposits in other financial institutions

     20,209         20,182         —           20,182         —     

Securities available for sale

     90,442         90,442         —           90,336         106   

Loans held for sale, at fair value

     340         340         —           340         —     

Loans, net of allowance

     256,519         253,609         —           —           253,609   

Restricted equity securities

     1,727         NA         NA         NA         NA   

Accrued interest receivable

     1,110         1,110         12         333         765   

Financial liabilities

              

Deposits with stated maturities

     224,873         225,964         —           225,964         —     

Deposits without stated maturity

     184,055         184,055         184,055         —           —     

Accrued interest payable

     4,362         4,362         2         445         3,915   

Subordinated debentures

     23,000         12,500         —           —           12,500   

 

     December 31, 2013  
     Carrying
Amount
     Total      Level 1      Level 2      Level 3  

Financial assets

              

Cash and cash equivalents

   $ 49,036       $ 49,036       $ 49,036       $ —         $ —     

Time deposits in other financial institutions

     6,500         6,524         —           6,524         —     

Securities available for sale

     81,926         81,926         —           81,821         105   

Loans, net of allowance

     265,668         264,613         —           —           264,613   

Restricted equity securities

     1,727         NA         NA         NA         NA   

Accrued interest receivable

     1,225         1,225         5         311         909   

Financial liabilities

              

Deposits with stated maturities

     233,777         234,984         —           234,984         —     

Deposits without stated maturity

     173,755         173,755         173,755         —           —     

Accrued interest payable

     4,287         4,287         1         564         3,722   

Subordinated debentures

     23,000         12,500         —           —           12,500   

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 4 – FAIR VALUE (Continued)

 

Carrying amount is the estimated fair value for cash and cash equivalents, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully resulting in a Level 1 classification. Fair value for accrued interest receivable and payable is based on the contractual terms of the facility, resulting in a Level 1, Level 2 or Level 3 classification based on the classification of the respective facility. The method for determining fair values of securities is discussed above. Restricted equity securities do not have readily determinable fair values due to their restrictions on transferability, therefore no fair value is presented. For fixed rate loans and variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk resulting in a Level 3 classification. For fixed and variable rate deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk resulting in a Level 2 classification. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values resulting in a Level 3 classification. Fair value of loans held for sale is based on market quotes resulting in a Level 2 classification. Fair value of subordinated debentures is based on discounted cash flows using current rates for similar financing resulting in a Level 3 classification. The fair value of off-balance-sheet items is not considered material.

NOTE 5 – LOANS

Loans outstanding by category at March 31, 2014 and December 31, 2013 were as follows:

 

     March 31,
2014
     December 31,
2013
 

Real estate construction:

     

Residential construction

   $ 7,629       $ 8,454   

Other construction

     23,092         21,684   

1-4 Family residential:

     

Revolving, open ended

     20,020         22,513   

First liens

     84,681         86,318   

Junior liens

     1,985         1,991   

Commercial real estate:

     

Farmland

     8,483         7,667   

Owner occupied

     41,849         41,286   

Non-owner occupied

     46,858         48,137   

Other real estate secured loans

     3,090         4,800   

Commercial, financial and agricultural:

     

Agricultural

     776         839   

Commercial and industrial

     18,279         22,346   

Consumer

     5,164         5,474   

Tax exempt

     51         51   

Other

     1,175         2,147   
  

 

 

    

 

 

 
   $ 263,132       $ 273,707   
  

 

 

    

 

 

 

 

- 32 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

The following tables present activity in allowance for loan losses and the outstanding loan balance by portfolio segment and are based on impairment methods as of March 31, 2014 and 2013. The balances for “recorded investment” in the following tables related to credit quality do not include approximately $765, $1,011 and $909 in accrued interest receivable at March 31, 2014, March 31, 2013 and December 31, 2013, respectively. Accrued interest receivable is a component of the Company’s recorded investment in loans.

 

    Real Estate
Construction
    1-4 Family
Residential
    Commercial
Real Estate
    Other
Real
Estate
Secured
Loans
    Commercial,
Financial
and
Agricultural
    Consumer     Tax
Exempt
    Other
Loans
    Unallocated     Total  

Three months ended March 31, 2014

                   

Activity in the allowance for loan losses:

                   

Beginning Balance

  $ 1,249      $ 3,235      $ 1,273      $ 33      $ 704      $ 24      $ —        $ 929      $ 592      $ 8,039   

Charge-offs

    —          (21     —          —          —          —          —          (940     —          (961

Recoveries

    5        4        8        —          6        1        —          11        —          35   

Provision

    (173     (632     (85     (18     (47     1        —          466        (12     (500
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 1,081      $ 2,586      $ 1,196      $ 15      $ 663      $ 26      $ —        $ 466      $ 580      $ 6,613   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended March 31, 2013

                   

Activity in the allowance for loan losses:

                   

Beginning Balance

  $ 1,938      $ 4,133      $ 1,514      $ 226      $ 994      $ 14      $ —        $ 368      $ 580      $ 9,767   

Charge-offs

    —          (55     —          —          (96     (3     —          (9     —          (163

Recoveries

    3        56        8        —          51        5        —          6        —          129   

Provision

    (136     283        (64     (26     9        (2     —          238        (2     300   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 1,805      $ 4,417      $ 1,458      $ 200      $ 958      $ 14      $ —        $ 603      $ 578      $ 10,033   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

- 33 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

    Real Estate
Construction
    1-4 Family
Residential
    Commercial
Real Estate
    Other
Real
Estate
Secured
Loans
    Commercial,
Financial
and
Agricultural
    Consumer     Tax
Exempt
    Other
Loans
    Unallocated     Total  

Ending allowance balance attributable to loans at March 31, 2014:

                   

Individually evaluated for impairment

  $ 302      $ 176      $ 117      $ —        $ 176      $ —        $ —        $ 463      $ —        $ 1,234   

Collectively evaluated for Impairment

    779        2,410        1,079        15        487        26        —          3        580        5,379   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 1,081      $ 2,586      $ 1,196      $ 15      $ 663      $ 26      $ —        $ 466      $ 580      $ 6,613   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending allowance balance attributable to loans at December 31, 2013:

                   

Individually evaluated for impairment

  $ 476      $ 592      $ 276      $ —        $ 176      $ —        $ —        $ 926      $ —        $ 2,446   

Collectively evaluated for Impairment

    773        2,643        997        33        528        24        —          3        592        5,593   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 1,249      $ 3,235      $ 1,273      $ 33      $ 704      $ 24      $ —        $ 929      $ 592      $ 8,039   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans at March 31, 2014:

               

Individually evaluated for impairment

  $ 11,169      $ 2,570      $ 4,015      $ 117      $ 176      $ 10      $ —        $ 926        $ 18,983   

Collectively evaluated for impairment

    19,552        104,116        93,175        2,973        18,879        5,154        51        249          244,149   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

Total loans balance

  $ 30,721      $ 106,686      $ 97,190      $ 3,090      $ 19,055      $ 5,164      $ 51      $ 1,175        $ 263,132   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

Loans at December 31, 2013:

               

Individually evaluated for impairment

  $ 11,370      $ 7,658      $ 4,883      $ 119      $ 176      $ 12      $ —        $ 1,853        $ 26,071   

Collectively evaluated for impairment

    18,768        103,164        92,207        4,681        23,009        5,462        51        294          247,636   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

Total loans balance

  $ 30,138      $ 110,822      $ 97,090      $ 4,800      $ 23,185      $ 5,474      $ 51      $ 2,147        $ 273,707   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

 

- 34 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Loans individually evaluated for impairment by class of loans as of and for the three months ended March 31, 2014:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
for Loan
Losses
Allocated
     Average
Recorded
Investment
     Income
Recognized
    Cash Basis
Income
Recognized
 

With no related allowance recorded:

                

Real estate construction:

                

Residential construction

   $ 2,326       $ 2,326       $ —         $ 1,163       $ —        $ —     

Other construction

     6,563         6,563         —           6,564         —          —     

1-4 Family residential:

                

Revolving, open ended

     —           —           —           55         —          —     

First liens

     1,085         1,085         —           1,124         6        6   

Junior liens

     83         83         —           83         (1     —     

Commercial real estate:

                

Owner occupied

     —           —           —           706         —          —     

Non-owner occupied

     3,592         1,636         —           1,632         1        —     

Other real estate loans

     117         117         —           118         —          —     

Commercial, financial and agricultural:

                

Agricultural

     —           —           —           —           —          —     

Commercial and industrial

     —           —           —           —           —          —     

Consumer

     —           —           —           1         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with no related allowance recorded

     13,766         11,810         —           11,446         6        6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

With an allowance recorded:

                

Real estate construction:

                

Residential construction

     —           —           —           1,258         —          —     

Other construction

     2,280         2,280         302         2,286         —          —     

1-4 Family residential:

                

Revolving, open ended

     93         93         88         136         1        2   

First Liens

     1,309         1,309         88         3,716         16        23   

Junior Liens

     —           —           —           —           —          —     

Commercial real estate:

                

Owner occupied

     —           —           —           —           —          —     

Non-owner occupied

     2,379         2,379         117         2,112         33        36   

Other real estate loans

     —           —           —           —           —          —     

Commercial, financial and agricultural:

                

Agricultural

     —           —           —           —           —          —     

Commercial and industrial

     176         176         176         176         —          —     

Consumer

     10         10         —           11         —          —     

Other loans

     5,301         926         463         1,390         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with an allocated allowance recorded

     11,548         7,173         1,234         11,085         50        61   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 25,314       $ 18,983       $ 1,234       $ 22,531       $ 56      $ 67   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Loans individually evaluated for impairment by class of loans as of and for the three months ended March 31, 2013:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
for Loan
Losses
Allocated
     Average
Recorded
Investment
     Income
Recognized
    Cash Basis
Income
Recognized
 

With no related allowance recorded:

                

Real estate construction:

                

Residential construction

   $ 714       $ 714       $ —         $ 1,265       $ 8      $ 8   

Other construction

     6,551         6,551         —           8,101         —          —     

1-4 Family residential:

                

Revolving, open ended

     40         40         —           20         —          —     

First liens

     2,059         2,059         —           2,252         12        11   

Junior liens

     67         67         —           71         1        1   

Commercial real estate:

                

Owner occupied

     1,096         1,096         —           1,097         12        14   

Non-owner occupied

     2,121         2,121         —           2,057         32        32   

Other real estate secured loans

     125         125         —           126         —          —     

Commercial, financial and agricultural:

                

Commercial and industrial

     6         6         —           176         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with no related allowance recorded

     12,779         12,779         —           15,165         65        66   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

With an allowance recorded:

                

Real estate construction:

                

Residential construction

     3,124         3,124         397         3,003         11        11   

Other construction

     6,044         4,089         554         2,550         13        13   

1-4 Family residential:

                

Revolving, open ended

     575         575         575         575         1        1   

First Liens

     6,010         6,010         392         4,672         37        27   

Junior Liens

     84         84         2         174         1        1   

Commercial real estate:

                

Owner occupied

     2,015         2,015         283         1,869         35        38   

Non-owner occupied

     148         149         55         1,141         3        3   

Other real estate secured loans

     2,194         2,194         69         2,199         35        36   

Commercial, financial and agricultural:

                

Commercial and industrial

     831         831         348         434         (25     —     

Other loans

     6,227         1,853         600         1,854         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with an allocated allowance recorded

     27,252         20,924         3,275         18,471         111        130   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 40,031       $ 33,703       $ 3,275       $ 33,636       $ 176      $ 196   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

- 36 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Loans individually evaluated for impairment by class of loans as of and for the year ended December 31, 2013:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
for Loan
Losses
Allocated
     Average
Recorded
Investment
     Income
Recognized
    Cash Basis
Income
Recognized
 

With no related allowance recorded:

                

Real estate construction:

                

Residential construction

   $ —         $ —         $ —         $ 633       $ —        $ —     

Other construction

     6,564         6,564         —           7,507         1        1   

1-4 Family residential:

                

Revolving, open ended

     110         110         —           184         4        5   

First liens

     1,163         1,163         —           1,751         29        33   

Junior liens

     83         83         —           70         4        3   

Commercial real estate:

                

Farmland

     —           —           —           —           —          —     

Owner occupied

     1,411         1,411         —           1,159         58        64   

Non-owner occupied

     3,582         1,627         —           1,354         —          —     

Other real estate loans

     119         119         —           123         —          —     

Commercial, financial and agricultural:

                

Agricultural

     1         1         —           93         —          —     

Commercial and industrial

     —           —           —           1         —          —     

Consumer

     1         1         —           —           —          —     

Other Loans

     —           —           —           —           —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with no related allowance recorded

     13,034         11,079         —           12,875         96        106   

With an allowance recorded:

                

Real estate construction:

                

Residential construction

     2,515         2,515         62         2,868         —          —     

Other construction

     2,291         2,291         414         2,866         15        15   

1-4 Family residential:

                

Revolving, open ended

     179         179         132         377         3        5   

First Liens

     6,122         6,122         460         5,167         272        255   

Junior Liens

     —           —           —           87         —          —     

Commercial real estate:

                

Farmland

     —           —           —           —           —          —     

Owner occupied

     1,845         1,845         276         1,862         129        126   

Non-owner occupied

     —           —           —           1,224         —          —     

Other real estate loans

     —           —           —           1,100         —          —     

Commercial, financial and agricultural:

                

Commercial and industrial

     176         176         176         374         (35     —     

Consumer

     11         11         —           7         1        1   

Other loans

     6,227         1,853         926         1,853         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total with an allocated allowance recorded

     19,366         14,992         2,446         17,785         385        402   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 32,400       $ 26,071       $ 2,446       $ 30,660       $ 481      $ 508   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

- 37 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Troubled Debt Restructurings

The Company has $18,225 of loans with allocated specific reserves of $970 to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2014 compared to $24,667 with allocated specific reserves of $2,122 at December 31, 2013. The Company lost $10 and $47 of interest income in the three months ended March 31, 2014 and 2013, respectively, that would have been recorded in interest income if the specific loans had not been restructured. The Bank had no commitments to lend additional funds to loans classified as troubled debt restructurings at March 31, 2014 or December 31, 2013.

During the first three months of 2014, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or granting of amortization terms for balloon notes that are longer than the Bank’s typical practice.

Modifications involving a reduction of the stated interest rate and extension of the maturity date of the loan were for periods ranging from six months to two years.

Loans classified as troubled debt restructurings are included in impaired loans.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the first three months of 2014 and 2013:

 

March 31, 2014    Number of
Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 

1-4 Family residential:

        

First liens

     1       $ 263       $ 263   

Commercial real estate:

        

Owner occupied

     2         545         545   
  

 

 

    

 

 

    

 

 

 

Total

             3       $ 808       $ 808   
  

 

 

    

 

 

    

 

 

 

March 31, 2013

        

1-4 Family residential:

        

First liens

     3       $ 5,501       $ 5,501   

Commercial real estate:

        

Owner occupied

     1         162         162   
  

 

 

    

 

 

    

 

 

 

Total

     4       $ 5,663       $ 5,663   
  

 

 

    

 

 

    

 

 

 

Troubled debt restructurings described above had an outstanding balance of $808 at March 31, 2014. There was no increase for the allowance for loan losses during the first three months of 2014. Troubled debt restructurings still accruing interest totaled $1,727 and $9,014 at March 31, 2014 and December 31, 2013, respectively.

A loan is considered to be in payment default once it is more than 90 days contractually past due under the modified terms. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the first three months of 2014 or 2013.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. This evaluation is performed in accordance with the Company’s internal loan policy. Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still accruing by class of loans as of March 31, 2014 and December 31, 2013:

 

     March 31, 2014      December 31, 2013  
     Nonaccrual      Loans past due
over 90 days still
accruing
     Nonaccrual      Loans past due
over 90 days still
accruing
 

Real estate construction:

           

Residential construction

   $ 2,326       $ —         $ 2,514       $ —     

Other construction

     8,834         —           8,833         —     

1-4 Family residential:

           

Revolving, open ended

     110         —           230         —     

First Liens

     778         —           868         —     

Junior Liens

     83         —           —           —     

Commercial real estate:

           

Farmland

     —           —           —           —     

Owner occupied

     324         —           324         —     

Non-owner occupied

     1,602         —           1,627         —     

Other real estate loans

     117         —           119         —     

Commercial, financial and agricultural:

           

Agricultural

     —           —           —           —     

Commercial and industrial

     1,789         —           1,784         —     

Consumer

     —           —           —           —     

Other loans

     927         —           1,853         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 16,890       $ —         $ 18,152       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

- 40 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

The following table presents the aging of the recorded investment in past due loans, including nonaccrual loans as of March 31, 2014 and December 31, 2013 by class of loans:

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     Greater than
90 Days Past
Due
     Total Past
Due
     Loans
Not Past
Due
     Total  

March 31, 2014

                 

Real estate construction:

                 

Residential construction

   $ —         $ —         $ —         $ —         $ 7,629       $ 7,629   

Other construction

     9         55         11         75         23,017         23,092   

1-4 Family residential:

                 

Revolving, open ended

     19         —           110         129         19,891         20,020   

First Liens

     752         —           73         825         83,856         84,681   

Junior Liens

     20         —           83         103         1,882         1,985   

Commercial real estate:

                 

Farmland

     —           —           —           —           8,483         8,483   

Owner occupied

     —           —           —           —           41,849         41,849   

Non-owner occupied

     35         —           —           35         46,823         46,858   

Other real estate secured loans

     —           —           117         117         2,973         3,090   

Commercial, financial and agricultural:

                 

Agricultural

     —           —           —           —           776         776   

Commercial and industrial

     —           77         1,790         1,867         16,412         18,279   

Consumer

     48         —           —           48         5,116         5,164   

Tax exempt

     —           —           —           —           51         51   

Other loans

     —           —           926         926         249         1,175   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 883       $ 132       $ 3,110       $ 4,125       $ 259,007       $ 263,132   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     30 – 59
Days
Past Due
     60 – 89
Days
Past Due
     Greater than
90 Days Past
Due
     Total Past
Due
     Loans
Not Past
Due
     Total  

December 31, 2013

                 

Real estate construction:

                 

Residential construction

   $ —         $ —         $ —         $ —         $ 8,454       $ 8,454   

Other construction

     110         13         —           123         21,561         21,684   

1-4 Family residential:

                 

Revolving, open ended

     48         33         230         311         22,202         22,513   

First Liens

     295         358         162         815         85,503         86,318   

Junior Liens

     83         —           —           83         1,908         1,991   

Commercial real estate:

                 

Farmland

     216         —           —           216         7,451         7,667   

Owner occupied

     747         221         324         1,292         39,994         41,286   

Non-owner occupied

     —           —           —           —           48,137         48,137   

Other real estate secured loans

     —           119         —           119         4,681         4,800   

Commercial, financial and agricultural:

                 

Agricultural

     —           —           —           —           839         839   

Commercial and industrial

     1,058         —           1,784         2,842         19,504         22,346   

Consumer

     22         26         —           48         5,426         5,474   

Tax exempt

     —           —           —           —           51         51   

Other loans

     —           —           1,853         1,853         294         2,147   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,579       $ 770       $ 4,353       $ 7,702       $ 266,005       $ 273,707   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

- 41 -


Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. The Company assigns an initial credit risk rating on every loan. All loan relationships with aggregate debt greater than $250 are reviewed at least annually or more frequently if performance of the loan or other factors warrants review. Smaller balance loans are reviewed and evaluated based on changes in loan performance, such as becoming past due or upon notifying the Bank of a change in the borrower’s financial status. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch are considered to be of acceptable credit quality, but contain greater credit risk than pass rated loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance.

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Impaired loans are evaluated separately from other loans in the Bank’s portfolio. Credit quality information related to impaired loans was presented above and is excluded from the tables below.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 5 – LOANS (Continued)

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk categories of loans by class of loans are as follows:

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful  

March 31, 2014

              

Real estate construction:

              

Residential construction

   $ 4,829       $ 474       $ —         $ —         $ —     

Other construction

     6,885         6,507         —           857         —     

1-4 Family residential:

              

Revolving, open ended

     19,503         79         —           345         —     

First Liens

     65,910         10,601         68         5,708         —     

Junior Liens

     1,882         20         —           —           —     

Commercial real estate:

              

Farmland

     5,756         915         —           1,812         —     

Owner occupied

     35,212         2,759         —           1,499         —     

Non-owner occupied

     38,510         3,813         —           2,899         —     

Other real estate loans

     2,973         —           —           —           —     

Commercial, financial and agricultural:

              

Agricultural

     720         —           —           56         —     

Commercial and industrial

     15,912         1,999         —           192         —     

Consumer

     4,985         8         —           161         —     

Tax exempt

     51         —           —           —           —     

Other loans

     249         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 203,377       $ 27,175       $ 68       $ 13,529       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Pass      Watch      Special
Mention
     Substandard      Doubtful  

December 31, 2013

              

Real estate construction:

              

Residential construction

   $ 5,241       $ 698       $ —         $ —         $ —     

Other construction

     5,525         6,447         —           857         —     

1-4 Family residential:

              

Revolving, open ended

     20,837         194         —           1,193         —     

First Liens

     69,877         3,807         —           5,349         —     

Junior Liens

     1,660         248         —           —           —     

Commercial real estate:

              

Farmland

     4,934         1,141         —           1,592         —     

Owner occupied

     34,594         1,580         —           1,856         —     

Non-owner occupied

     39,463         4,107         —           2,940         —     

Other real estate loans

     2,993         1,688         —           —           —     

Commercial, financial and agricultural:

              

Agricultural

     782         56         —           —           —     

Commercial and industrial

     19,761         2,098         —           311         —     

Consumer

     5,292         4         1         165         —     

Tax exempt

     51         —           —           —           —     

Other loans

     294         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 211,304       $ 22,068       $ 1       $ 14,263       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 6 – INCOME PER SHARE

In accordance with ASC 260-10, Earnings Per Share, basic income per share available to common shareholders is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted income per share available to common shareholders reflects the potential dilution that could occur if securities, stock options or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company. The factors used in the income per share computation follow:

 

     Three months ended
March 31,
 
     2014     2013  

Basic

    

Net income

   $ 794      $ 203   

Less: Earnings allocated to preferred stock

     (304     (239

Less: Accretion of preferred stock discount

     (33     (48
  

 

 

   

 

 

 

Net Income (loss) available (allocated) to common stock

   $ 457      $ (84
  

 

 

   

 

 

 

Weighted average common shares

     3,274,827        3,274,394   
  

 

 

   

 

 

 

Basic net income (loss) per share

   $ 0.14      $ (0.03
  

 

 

   

 

 

 

Diluted

    

Net income (loss) available (allocated) to common stock

   $ 457      $ (84
  

 

 

   

 

 

 

Weighted average common shares

     3,274,827        3,274,394   

Add: Dilutive effects of assumed exercises of stock options

     —          —     
  

 

 

   

 

 

 

Average common shares and dilutive potential common shares outstanding

     3,274,827        3,274,394   
  

 

 

   

 

 

 

Diluted net income (loss) per share

   $ 0.14      $ (0.03
  

 

 

   

 

 

 

At March 31, 2014 and 2013, respectively, stock options for 59,600 and 64,700 shares of common stock were not considered in computing diluted net income per share for the three month periods ended March 31, 2014 and 2013 because they were antidilutive.

 

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Table of Contents

COMMUNITY FIRST, INC.

Notes to Consolidated Financial Statements

March 31, 2014

(Unaudited)

 

NOTE 7 – INCOME TAXES

The Company recorded no tax expense during the first three months of 2014. During 2010, the Company established a valuation allowance against all of its deferred tax assets and has maintained that valuation allowance through the first three months of 2014. The Company intends to maintain this valuation allowance until it determines it is more likely than not that the asset can be realized through current and future taxable income. Because the Company has recorded a valuation allowance against its deferred tax assets, any deferred tax benefit or expense will be offset by a corresponding increase or decrease, respectively, to the valuation allowance. Until the reversal of the deferred tax valuation allowance, tax benefit or expense from current year operations is expected to be minimal.

 

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Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

(amounts in thousands, except share and per share data)

The following discussion compares the financial condition of the Company at March 31, 2014 to December 31, 2013, and the results of operations for the three months ended March 31, 2014 and 2013. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

Certain of the statements made herein, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning and subject to the protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target,” and other similar words and expressions of the future.

These forward-looking statements may not be realized due to a variety of factors, including, without limitation those described under Item 1A, “Risk Factors”, in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 27, 2014 (File No. 000-49966) (the “2013 Form 10-K”) and in other reports we file with the SEC from time to time, and the following:

 

    deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses;

 

    greater than anticipated deterioration or lack of sustained growth in the national or local economies including the Nashville-Davidson-Murfreesboro-Franklin MSA;

 

    changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions or regulatory development;

 

    the inability to meet the requirements of our regulatory orders and agreements, which we and our Bank subsidiary are subject to;

 

    failure to maintain capital levels above levels required by banking regulations or commitments or agreements we make with our regulators;

 

    the inability to comply with regulatory capital requirements, including those resulting from recently adopted changes to capital calculation methodologies and required capital maintenance levels, and to secure any required regulatory approvals for capital actions;

 

    the continued reduction of our loan balances and, conversely, the inability to ultimately grow our loan portfolio;

 

    governmental monetary and fiscal policies, as well as legislative and regulatory changes, including changes in banking, securities and tax laws and regulations;

 

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Table of Contents

OVERVIEW (Continued)

 

    the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities;

 

    continuation of the historically low short-term interest rate environment;

 

    the ability to retain large, uninsured deposits;

 

    rapid fluctuations or unanticipated changes in interest rates;

 

    any activity that would cause us to conclude that there was impairment of any asset, including goodwill or any other intangible asset;

 

    our recording a further valuation allowance related to our deferred tax asset;

 

    the effects of competition from a wide variety of local, regional, national and other providers of financial, investment, and insurance services;

 

    changes in state and federal legislation, regulations or policies applicable to banks and other financial service providers, including regulatory or legislative developments arising out of current unsettled conditions in the economy, including implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

 

    the failure of assumptions underlying the establishment of reserves for possible loan losses and other estimates;

 

    further deterioration in the valuation of other real estate owned;

 

    changes in accounting policies, rules and practices;

 

    the actions of the owners of the preferred securities sold through our participation in the United States Department of the Treasury’s (the “U.S. Treasury”) Capital Purchase Program (the “CPP”);

 

    changes in technology or products that may be more difficult, or costly, or less effective, than anticipated;

 

    the effects of war or other conflict, acts of terrorism or other catastrophic events that may affect general economic conditions; and

 

    other circumstances, many of which may be beyond our control.

All written or oral forward-looking statements that are made by or are attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

FINANCIAL CONDITION

At March 31, 2014, total assets were $451,077 and total liabilities were $441,572. Total assets increased $2,634 or 0.6% compared to $448,443 at December 31, 2013. Total liabilities increased $1,745, or 0.4%, compared to $439,827 at December 31, 2013. The increase in assets was caused by increases in time deposits in other financial institutions, securities available for sale and premises and equipment offset by decreases in cash and cash equivalents and net loans. The increase in liabilities was caused by an increase in noninterest-bearing deposits. Total equity increased 10.3%, or $889, to $9,505 at March 31, 2014 compared to $8,616 at December 31, 2013. The increase in equity is primarily due to net income and gains in other comprehensive income during the first three months of 2014 caused by market fluctuations in securities available for sale.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

Cash and Cash Equivalents

Cash and cash equivalents were $37,657 at March 31, 2014 compared to $49,036 at December 31, 2013. This decrease is primarily due to the use of cash to invest in time deposits in other financial institutions and securities available for sale. The Bank has continued to maintain high levels of liquid resources during 2014 due to the availability of excess liquidity in the Bank’s market area coupled with reduced loan demand as a result of weak economic conditions.

Time Deposits in Other Financial Institutions

Time deposits in other financial institutions totaled $20,209 at March 31, 2014 compared to $6,500 at December 31, 2013. Management has begun utilizing time deposits in other financial institutions in conjunction with the Bank’s securities portfolio in order to maximize yield and maintain a reasonable total duration for the Bank’s assets outside of the loan portfolio. Original maturities of time deposits in other financial institutions range from three months to 5 years. Most of the CDs with maturities beyond three years are callable with minimal early withdrawal penalties. All of the deposits are in FDIC insured institutions and the amount on deposit with each individual institution does not exceed the FDIC insurance limit of $250, with the exception of one deposit totaling $449. As of March 31, 2014, time deposits in other financial institutions had a weighted average rate of 0.747% and a weighted average remaining life of 1.21 years.

Loans

Total loans (excluding loans held for sale) at March 31, 2014 were $263,132, compared to $273,707 at December 31, 2013, a decrease of $10,575 or 3.9%. The decrease in loans during the first three months of 2014 is due to regular loan payments outpacing demand for new loans and additional foreclosure activity.

Loans in the portfolio at March 31, 2014 of approximately $52,895, or 20.1%, are at a variable rate of interest, $193,347, or 73.5%, are at a fixed rate, and $16,890, or 6.4%, are nonaccrual. $102,259, or 38.9%, of total loans reprice within one year of March 31, 2014. As market rates dropped during the economic recession, management implemented rate floors for many variable rate loans in an effort to protect the Bank’s net interest margin. As a result, when market rates begin to rise, loans at their floor will not reprice at higher rates until market rates rise above their contractual floor rates. Only the loans noted above that have variable rates not at a floor rate will reprice with the first increase in market rates. The existence of these rate floors may negatively impact our net interest margin when rates begin to rise, at least until rates rise above these floors.

On March 31, 2014, the Company’s loan to deposit ratio (including loans held for sale) was 64.3%, compared to 67.2% at December 31, 2013. Management expects loan demand to modestly improve through the remainder of 2014, which should slow or stop the decline in gross loans, though foreclosure activity could result in some additional decreases in loan balances. Management anticipates that there will not be significant growth in loans until there are indicators of significant improvements in both the local and national economy, leading customers to begin spending more and resulting in increased demand. If the Company’s deposit growth among core deposit customers continues to outpace its loan demand, the Company’s net interest margin may be adversely affected as the funds from these deposits may be invested in securities and other interest earning assets, like time deposits in other financial institutions, that offer lower yields than loans.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

Securities Available for Sale

Set forth below is a table showing the carrying amount and breakdown of the Company’s securities available for sale at March 31, 2014 and December 31, 2013:

 

     March 31, 2014     December 31, 2012  
     Amount      % of Total     Amount      % of Total  

U.S. government sponsored entities

   $ 33,032         36.5   $ 33,357         40.7

Mortgage-backed (residential)

     48,325         53.4     42,281         51.6

State and municipal

     9,085         10.0     6,288         7.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 90,442         100.0   $ 81,926         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The Company’s securities portfolio is used to, among other things, provide yield and for pledging purposes to secure public fund deposits. As of March 31, 2014, the carrying value of securities increased $8,516 to $90,442, compared to $81,926 at December 31, 2013. Securities available for sale as a percentage of total assets was 20.1% at March 31, 2014, compared to 18.3% at December 31, 2013. Net unrealized loss on securities available for sale was $802 at March 31, 2014, compared to a net unrealized loss of $1,200 at December 31, 2013. Changes in interest rates in the securities market caused this fluctuation in the net unrealized loss. Management is continually monitoring the credit quality of the Bank’s investments and believes that the unrealized losses that existed in the Bank’s portfolio at March 31, 2014 are temporary based on the bond ratings and anticipated recovery of bonds held. At March 31, 2014, the Company did not have the intent to sell these securities and it is more likely than not that it will not be required to sell the securities before their anticipated recovery.

Other Real Estate Owned

At March 31, 2014, other real estate owned (“ORE”) totaled $17,628, a decrease of $686 from $18,314 at December 31, 2013. This decrease is primarily due to the sale of properties during the first quarter of 2014. The balance of ORE is comprised of properties acquired through or in lieu of foreclosure on real estate loans, property acquired by the Company for future Bank branch locations that is no longer intended for that purpose and is currently held for sale, and loans made to facilitate the sale of ORE properties that are required to be reported as ORE (“FAS 66 Loans”). The balances recorded for each individual property are based on appraisals that are not more than twelve months old, discounted by an additional 15%. The additional 15% discount was adopted by the Company beginning in the third quarter of 2010 based on an analysis of actual recoveries of ORE balances, including selling costs. Based on that analysis, the Company recorded a valuation allowance of $346 (recognized through ORE expense) in the third quarter of 2010. In addition, the Company began applying the additional 15% discount in its determination of specific reserves for impaired loans that are collateral dependent. As a result, the majority of the financial loss incurred by the Company as a result of the 15% discount has been recognized through loan charge-offs and the provision for loan losses at the time the property is transferred to ORE, with the foreclosed property being transferred into ORE at the discounted value. The Company annually updates its analysis regarding the additional 15% discount. Should such updates indicate that a change in the 15% discount is warranted, the Company would implement the change accordingly and that change would be applied to all properties that are subsequently moved into ORE. Additional write-downs of individual properties typically occur when the results of updated appraisals and further application of the 15% discount on the value reflected in the updated appraisal indicates that the value of the respective property has declined. The Company obtains updated appraisals for ORE properties at least annually. These write-downs are recognized in the quarterly period in which the appraisal is accepted by the Company.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

The Company actively markets the properties within its ORE portfolio utilizing both Bank personnel and third parties (brokers, agents, etc.). All ORE properties are classified into one of four categories: rental properties, non-rental properties, auction properties, and land. Rental properties consist of any property that can be leased or rented in order to produce income for the Company while the Company is pursuing the sale of the property. Non-rental properties consist of improved real estate that the Company’s management has concluded would not be attractive to a renter or that management believes will be most efficiently sold unoccupied. Auction properties are typically properties of lower value that the Company is willing to accept the risk of an auction in order to sell. These properties are typically auctioned off within six to twelve months of the property being transferred into ORE; however, circumstances related to a particular property may warrant holding the property for a longer period. Auction properties are typically auctioned off in absolute auctions with no minimum reserves. Land generally consists of unimproved raw land, though some properties may have some infrastructure work completed for housing development. Properties within the land category of ORE are typically held for longer periods of time than other ORE properties as the marketing of these properties, particularly large parcels, often extends for over six months.

The following table shows a breakdown of the ORE portfolio by category as of the end of the periods indicated:

 

     March 31, 2014     December 31, 2013     September 30, 2013     June 30, 2013  

Bank Premises

   $ 484         2.8   $ 484         2.6   $ 484         2.2   $ 484         2.6

Rental

     7,614         43.2     7,616         41.6     11,382         51.5     7,675         41.5

Non-rental

     1,083         6.1     1,126         6.2     1,083         4.9     493         2.7

Auction

     15         0.1     21         0.1     21         0.1     235         1.3

Land

     8,432         47.8     9,067         49.5     9,147         41.3     9,589         51.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 17,628         100.0   $ 18,314         100.0   $ 22,117         100.0   $ 18,476         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company makes every effort to sell ORE as quickly as feasible while still recovering as much of the original investment as possible. Management also considers the cost associated with holding individual properties in determining how aggressively it markets an individual property. The Company’s ORE that is classified as rental properties generally consists of 1-4 family properties, though some are commercial real estate. Rental income generated by this group has typically exceeded the holding costs of the respective properties. The majority of the rental properties are listed for sale with real estate agents; however, properties in this group are not the primary focus of management’s marketing efforts given the income producing nature of the property. The Company’s ORE that is classified as auction properties are marketed aggressively with dates set for auctions and most auction properties being allowed to sell without a reserve price. The Company’s other ORE properties are being marketed, though there is no definite date as to when they may be expected to be sold.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

The following table provides activity within the ORE portfolio in terms of individual parcels for the three-month periods ended on the dates indicated:

 

     Rental      Non-rental      Auction      Land  

Three Months Ended March 31, 2014

           

Foreclosures

     1         —           —           —     

Sales

     5         1         —           3   

Weighted average age of properties held at period end (months)

     22.2         11.1         34.1         27.8   

Three Months Ended March 31, 2013

           

Foreclosures

     3         —           —           3   

Sales

     5         2         2         3   

Weighted average age of properties held at period end (months)

     11.9         4.8         37.5         15.5   

The following table sets forth information related to the largest five ORE properties held by the Company as of March 31, 2014:

 

Property Description

  

Original loan classification

   Original
Loan
Amount
     Charge-off
prior to
transfer into
ORE
     Write-down
after transfer
into ORE
     Carrying
Balance
 

Unimproved land

   Real estate construction    $ 5,000       $ 905       $ 536       $ 2,949   

Unimproved land

   Real estate construction      3,103         1,896         204         961   

Unimproved land

   Real estate construction      2,546         196         85         927   

Mixed use commercial property

   Commercial real estate      3,684         1,536         196         850   

Unimproved land

   Real estate construction      1,134         402         —           799   

The following table sets forth information related to the largest five ORE properties held by the Company as of December 31, 2013:

 

Property Description

  

Original loan classification

   Original
Loan
Amount
     Charge-off
prior to
transfer into
ORE
     Write-down
after transfer
into ORE
     Carrying
Balance
 

Unimproved land

   Real estate construction    $ 5,000       $ 905       $ 374       $ 3,111   

Unimproved land

   Real estate construction      3,103         1,896         204         961   

Unimproved land

   Real estate construction      2,546         196         85         927   

Mixed use commercial property

   Commercial real estate      3,684         1,536         196         850   

Unimproved land

   Real estate construction      1,134         402         —           799   

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

Each of the ORE properties identified in the March 31, 2014 table above is listed with a real estate agent and is also listed as available for sale on the Bank’s website. The four properties classified as unimproved land were, at the time the loans were made, intended to be developed. The property carried at $2,949 is commercial property located in an area that remains significantly and negatively impacted by the downturn in the real estate market. Although the Company continues to actively market the property, management anticipates that it could take a significant amount of time to sell the property. The properties carried at $961, $927 and $799 are located in residential areas that were also negatively impacted by the downturn in the economy. Although there are some positive indicators of improvements in the local markets where the properties are located, management believes it will likely require a significant amount of time to sell the properties. The commercial real estate property is income producing rental property that is being managed by a third party property manager on behalf of the Company. The Company continues to market this rental property, but because of the income producing nature of the property, it is likely that management will resist selling the property for less than the current carrying value of the property.

Deposits

The Company relies on the Bank’s deposit growth, as well as alternative funding sources such as other borrowed money, FHLB advances, and federal funds purchased from correspondent banks, to fund its operations.

The following table sets forth the composition of the deposits at March 31, 2014 and December 31, 2013.

 

     March 31, 2014     December 31, 2013  
     Amount      % of Total     Amount      % of Total  

Noninterest-bearing demand accounts

   $ 55,656         13.6   $ 53,980         13.2

Interest-bearing demand accounts

     128,614         31.5     120,259         29.5

Savings accounts

     26,498         6.5     24,770         6.1

Time deposits greater than $100

     90,941         22.2     97,294         23.9

Other time deposits

     107,219         26.2     111,229         27.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 408,928         100.0   $ 407,532         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The following table sets forth all time deposits broken down by remaining maturity at March 31, 2014:

 

Less than three months

   $ 42,771   

Three months through twelve months

     106,243   

One year through three years

     34,170   

More than three years

     14,976   
  

 

 

 

Total

   $ 198,160   

Total deposits were $408,928 at March 31, 2014, compared to $407,532 at December 31, 2013, an increase of $1,396. The increase was primarily due to increases in noninterest-bearing demand deposits.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

During 2012 and 2013 and through March 31, 2014, the Bank has maintained higher levels of liquid assets due to the availability of excess liquidity in the Bank’s market area coupled with reduced loan demand as a result of weak economic conditions. Management has been utilizing the available cash to pay off national market and broker deposits as they have matured, resulting in significant reductions in cost of funds. Management has been seeking additional core customer deposits during 2014 and anticipates that it will continue to do so in order to improve the Bank’s overall liquidity position as well as net interest income and to continue to reduce the Bank’s reliance on national market and broker deposits.

Shareholders’ Equity

At March 31, 2014, shareholders’ equity totaled $9,505, an increase of $899 from $8,616 at December 31, 2013. The increase was primarily due to net income combined with a decrease in the unrealized loss on securities available for sale.

The 17,806, Series A shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Senior Preferred Shares”) have a $21,792 liquidation value and had a cumulative dividend rate of 5% per year, until May 15, 2014, and a dividend rate of 9% thereafter. In addition, under the terms of the CPP, the Company issued warrants to U.S. Treasury to purchase additional preferred shares equal to 5% of the investment in Senior Preferred Shares at a discounted exercise price. The U.S. Treasury exercised the warrants immediately upon investment in the Senior Preferred shares, which resulted in issuance of 890 shares of Fixed Rate Perpetual Preferred Shares, Series B (the “Warrant Preferred Shares” and together with the Senior Preferred Shares, the “Preferred Shares”) . The U.S. Treasury’s exercise of the warrants resulted in a net discount on the issuance of the preferred shares of $890. The discount was amortized over a five year period, which ended on February 27, 2014. The $890 liquidation value Warrant Preferred Shares have a cumulative dividend rate of 9% per year until redeemed. Dividends on both Senior Preferred Shares and Warrant Preferred Shares are required to be paid quarterly. Total required annual dividends for both Senior Preferred Shares and Warrant Preferred Shares are expected to be as follows: 2014: $1,564; 2015 and thereafter: $1,683 per year. The Company is permitted to redeem all or a portion of the Preferred Shares at any time after consultation with its primary federal regulator, but may not redeem the Warrant Preferred Shares until all of the Senior Preferred Shares have been redeemed. Dividend payments on both Senior Preferred and Warrant Preferred shares would be reduced for any redemption.

On April 14, 2014, the U.S. Treasury, the holder of all the Senior Preferred and Warrant Preferred shares issued by the Company, closed on the sale of the securities in a modified Dutch auction. The clearing price for the Senior Preferred shares was $300.50 per share and the clearing price for the Warrant Preferred shares was $521.75 per share. The sale was to unaffiliated third party investors as well as certain directors and executive officers of the Company.

The Company received none of the proceeds from the sale of the Senior Preferred or Warrant Preferred shares by the U.S. Treasury. The sale of the securities had no effect on the terms of the outstanding securities, including the Company’s obligation to satisfy accrued and unpaid dividends or the holder’s right to elect two members to the board of directors of the Company. Further, the sale of the securities has no effect on the Company’s capital, regulatory capital, financial condition or results of operations. Upon the closing of the sale of the securities, the Company is no longer subject to various executive compensation and corporate governance requirements to which participants in the CPP were subject while the U.S. Treasury held the securities.

 

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Table of Contents

FINANCIAL CONDITION (Continued)

 

At the request of the FRB, the board of directors of the Company, on January 18, 2011, adopted a board resolution agreeing that the Company would not incur additional debt, pay common or preferred dividends, or redeem treasury stock without approval from the FRB. The board resolution was replaced by the Written Agreement that the Company entered into with the FRB on April 19, 2012, the terms of which similarly prohibit the Company from incurring debt, paying dividends or interest or redeeming shares of its capital stock. The Company requested permission to make dividend payments on its Preferred Shares and interest payments on its subordinated debt that were scheduled for the first quarter of 2011. The FRB granted permission to pay the preferred dividends that were due on February 15, 2011, but denied permission to make interest payments on the Company’s subordinated debt. As a result of the FRB’s decision, the Company was required to begin the deferral of interest payments on each of its three issues of subordinated debentures during the first quarter of 2011. The Company has the right to defer the payment of interest on the subordinated debentures at any time, for a period not to exceed 20 consecutive quarters. During the period in which it is deferring the payment of interest on its subordinated debentures, the Company may not pay any dividends on its common or preferred stock, including the Preferred Shares, and the Company’s subsidiaries may not pay dividends on the subsidiaries’ common or preferred stock owned by entities other than the Company and its subsidiaries. Accordingly, the Company was required to suspend dividend payments on the Preferred Shares beginning in the second quarter of 2011. At March 31, 2014, the Company has $3,915 of interest on its subordinated debentures accrued for which payment is being deferred. In addition, the Company has accumulated $3,096 in deferred dividends on the Preferred Shares. The Bank’s subsidiary Community First Properties, Inc. suspended the payment of dividends on its preferred stock beginning with the dividend payment due on December 31, 2011. At March 31, 2014, Community First Properties, Inc. has $39 of preferred stock dividends accrued for which payment is being deferred.

RESULTS OF OPERATIONS

Net Income

The Company had net income of $794 for the three months ended March 31, 2014 compared to net income of $203 for the same period in 2013, an increase in net income of $591. Net income available to common shareholders was $457 for the first three months of 2014 compared to a net loss allocated to common shareholders of $84 for the same period in 2013.

 

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Table of Contents

RESULTS OF OPERATIONS (Continued)

 

Average Balance Sheets, Net Interest Income

Changes in Interest Income and Interest Expense

The following table shows the average daily balances of each principal category of our assets, liabilities and shareholders’ equity and an analysis of net interest income for the three month periods ended March 31, 2014 and 2013. The table reflects how changes in the volume of interest earning assets and interest-bearing liabilities and changes in interest rates have affected our interest income, interest expense, and net interest income for the periods indicated. Information is provided in each category with respect to changes attributable to (1) changes in volume (changes in volume multiplied by prior rate); (2) changes in rate (changes in rate multiplied by prior volume); and (3) changes in rate/volume (changes in rate multiplied by change in volume). The changes attributable to the combined impact of volume and rate have all been allocated to the changes due to rate.

 

                   Change  
     March 31, 2014      March 31, 2013      Due to     Due to        
    

Average

Balance

   

Interest

Rate

   

Revenue/

Expense

    

Average

Balance

   

Interest

Rate

   

Revenue/

Expense

     Volume
(1)
    Rate
(2) (3)
    Total  

Gross loans (a and b)

   $ 269,056        5.21   $ 3,458       $ 302,573        5.61   $ 4,189       $ (464   $ (267   $ (731

Taxable securities available for sale

     82,729        2.14     436         66,372        1.82     298         73        650        138   

Tax exempt securities available for sale

     3,071        3.30     25         5,353        3.33     44         (19     —          (19

Federal funds sold and other

     56,873        0.51     71         89,838        0.35     77         (28     220        (6
  

 

 

   

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

   

 

 

 

Total interest earning assets

     411,729        3.93     3,990         464,136        4.03     4,608         (438     (180     (618

Cash and due from banks

     3,617             3,645              

Other nonearning assets

     43,435             45,147              

Allowance for loan losses

     (8,028          (9,858           
  

 

 

        

 

 

            

Total assets

   $ 450,753           $ 503,070              
  

 

 

        

 

 

            

Deposits:

                    

NOW & money market investments

   $ 124,989        0.43   $ 134       $ 113,256        0.60   $ 167       $ 17      $ (50   $ (33

Savings

     25,525        0.10     6         21,075        0.13     7         1        (2     (1

Time deposits $100 and over

     93,362        0.96     222         120,581        1.17     347         (78     (47     (125

Other time deposits

     109,766        0.84     227         138,014        1.15     390         (80     (83     (163
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     353,642        0.68     589         392,926        0.94     911         (140     (182     (322

Federal Home Loan Bank advances

     —          0.00     —           13,000        2.43     78         (78     —          (78

Subordinated debentures

     23,000        3.40     193         23,000        3.42     194         —          (1     (1

Repurchase agreement

     —          0.00     —           7,000        3.30     57         (57     —          (57

Federal funds purchased and other

     —          0.00     —           7        0.00     —           —          —          —     
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total other borrowings

     23,000        3.40     193         43,007        3.10     329         (135     (1     (136

Total interest-bearing liabilities

     376,642        0.84     782         435,933        1.15     1,240         (275     (183     (458

Noninterest-bearing liabilities

     65,250             56,880              
  

 

 

        

 

 

            

Total liabilities

     441,892             492,813              

Shareholders’ equity

     8,861             10,257              
  

 

 

        

 

 

            

Total liabilities and shareholders’ equity

   $ 450,753           $ 503,070              
  

 

 

        

 

 

            

Net interest income

       $ 3 208           $ 3,368       $ (163   $ 3      $ (160
      

 

 

        

 

 

    

 

 

   

 

 

   

 

 

 

Net interest margin

       3.16          2.94         
    

 

 

        

 

 

          

 

(a) Interest income includes fees on loans of $116 and $124 in 2014 and 2013, respectively.
(b) Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest income.
(1) Changes in volume multiplied by prior rate
(2) Changes in rate multiplied by prior volume
(3) Changes in rate multiplied by change in volume

 

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Table of Contents

RESULTS OF OPERATIONS (Continued)

 

Net Interest Income

Net interest income for the first three months of 2014 was $3,208, a decrease of $160, or 4.8% compared to $3,368 for the same period in 2013. The decrease in net interest income is primarily due to decreases in the average balance of earning assets offset by decreases in the average balance of time deposits, FHLB advances and the repurchase agreement.

Net interest margin began to be compressed during the last half of 2011 and that trend continued through the first three months of 2014 due to historically low market rates for loans driven by intense competition and securities driving down the yield on earning assets as new money must be invested at lower rates. In addition, loan demand is extremely low in the Bank’s market area, leading to larger than anticipated reductions in loan balances as loan repayments continue to outpace loan demand. The reduction in loans contributes to the excess liquidity, some of which the Bank invested in securities available for sale and time deposits in other financial institutions. Current market rates for new investments in securities are very low, which also contributes to compressed net interest margin as the Bank is forced to reinvest funds received from loan payoffs and higher rate securities when they mature or are called. Management anticipates that this trend will continue until there is a significant economic change in the Bank’s market that results in increased loan demand.

Total interest income for the first three months of 2014 was $3,990 a decrease of $618 from $4,608 for the same period in 2013. The decrease is primarily due to a decline in loan interest income as a result of the decrease in loan balances. The average balance of loans during the first three months of 2014 was $269,056, a decrease of $33,517 from $302,573 during the same period in 2013. The decrease in the average balance of loans is due to continued weak loan demand. The decrease in net interest income is further due to a decrease in the average rate earned on loans in the first three months of 2014 compared to the same period in 2013.

The average balance of federal funds sold and other during the first three months of 2014 was $56,873, a decrease of $32,965 from $89,838 during the same period in 2012. This decrease is due to the use of cash to pay the maturity of FHLB advances and a repurchase agreement and to invest in available for sale securities. The average rate earned on federal funds sold and other in the first three months of 2014 was 0.51% compared to 0.35% for the same period in 2012. The increase in rate is due to the Company’s utilization of excess cash by investing in time deposits in financial institutions.

Interest income on taxable securities increased $138 to $436 in the first three months of 2014 compared to $298 in the first three months of 2013. The increase is primarily due to an increase in the average balance of taxable securities combined with an increase in the average rate earned on taxable securities.

Total interest expense was $782 in the first three months of 2014, a decrease of $458 from $1,240 in the first three months of 2013. The decrease in interest expense is largely due to a reduction in the average rate paid on deposits and the average balance of deposits in the first three months of 2014 compared to the same period in 2013. The decrease is further due to the maturity of FHLB advances and the above described repurchase agreement.

Total interest expense on deposits was $589 in the first three months of 2014, a reduction of $322 from $911 in the first three months of 2013. The average rate paid on deposits was 0.68% in the first three months of 2014 compared to 0.94% for the same period in 2013. The most significant decreases in average rates were on time deposits. The reduction in average rate paid on deposits was the result of continued decreases in market rates in the Bank’s market area.

 

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Table of Contents

RESULTS OF OPERATIONS (Continued)

 

Provisions for Loan Losses

In the first three months of 2014, the Bank reversed $500 of the allowance for loan loss as a result of improvements in asset quality and reductions in gross loans. In the first three months of 2013, the Bank recorded provision for loan loss of $300. The ratio of allowance for loan losses to gross loans was 2.51% at March 31, 2014 compared to 2.94% at December 31, 2013.

Management’s determination of the appropriate level of the provision for loan losses and the adequacy of the allowance for loan losses is based, in part, on an evaluation of specific loans, as well as the consideration of historical loss, which management believes is representative of probable incurred loan losses. Other factors considered by management include the composition of the loan portfolio, economic conditions, results of regulatory examinations, reviews of updated real estate appraisals, and the creditworthiness of the Bank’s borrowers and other qualitative factors.

Nonperforming loans decreased from $27,166 at December 31, 2013 to $18,617 at March 31, 2014. The decrease in nonperforming loans is due to improved credit standing for problem loan relationships, foreclosure activity and some decreases in troubled debt restructurings (“TDRs”). Management has been focused on reducing the Bank’s overall level of problem assets. Elimination of those problem assets often requires foreclosure of problem loans, resulting in charge-offs and the balance of the loan moving to ORE. Once the Bank has control of the collateral, it is then able to undertake efforts to liquidate the assets. The ratio of the allowance to nonperforming loans was 35.5% at March 31, 2014, compared to 29.59% at December 31, 2013. The portion of the allowance attributable to impaired loans was $1,234 at March 31, 2014, a decrease from $2,446 at December 31, 2013. Total impaired loans totaled $18,983 at March 31, 2014 compared to $26,071 at December 31, 2013.

The portion of the allowance attributable to historical and environmental factors has decreased since December 31, 2013. Management’s evaluation of the allowance for loan losses, in addition to specific loan allocations, is based on volume of non-impaired loans and changes in credit quality and environmental factors. The balance of non-impaired loans decreased during the first three months of 2014 due to the reduction in gross loans.

 

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Table of Contents

RESULTS OF OPERATIONS (Continued)

 

Problem loans that are not impaired are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch are considered to be of acceptable credit quality, but contain greater credit risk than pass rated loans due to weak balance sheets, marginal earnings or cash flow, or other uncertainties. These loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance.

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Impaired loans are evaluated separately from other loans in the Bank’s portfolio. Credit quality information related to impaired loans was presented above and is excluded from the tables below.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2014 and December 31, 2013, based on the most recent analysis performed, the risk category of loans by segment of loans is as follows:

 

March 31, 2014    Pass      Watch      Special
Mention
     Substandard      Doubtful  

Real estate construction

   $ 11,714       $ 6,981       $ —         $ 857       $ —     

1-4 Family residential

     87,295         10,700         68         6,053         —     

Commercial real estate

     79,478         7,487         —           6,210         —     

Other real estate loans

     2,973         —           —           —           —     

Commercial, financial and agricultural

     16,632         1,999         —           248         —     

Consumer

     4,985         8         —           161         —     

Tax exempt

     51         —           —           —           —     

Other loans

     249         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 203,377       $ 27,175       $ 68       $ 13,529       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2013    Pass      Watch      Special
Mention
     Substandard      Doubtful  

Real estate construction

   $ 10,766       $ 7,145       $ —         $ 857       $ —     

1-4 Family residential

     92,374         4,249         —           6,542         —     

Commercial real estate

     78,991         6,828         —           6,388         —     

Other real estate loans

     2,993         1,688         —           0         —     

Commercial, financial and agricultural

     20,543         2,154         —           311         —     

Consumer

     5,292         4         1         165         —     

Tax exempt

     51         0         —           0         —     

Other loans

     294         0         —           0         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 211,304       $ 22,068       $ 1       $ 14,263       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

RESULTS OF OPERATIONS (Continued)

 

The table below illustrates changes in the AFLL ratio (the ratio, expressed as a percentage, of the allowance for loan losses to total gross loans) over the past five quarters and the changes in related risk metrics over the same periods:

 

Quarter Ended    March 31,
2014
    December 31,
2013
    September 30,
2013
    June 30,
2013
    March 31,
2013
 

AFLL Ratio

     2.51     2.94     2.94     3.07     3.42

ASC 450 allowance ratio (1)

     2.20     2.26     2.22     2.25     2.61

Specifically impaired loans (ASC 310 component)

   $ 1,234      $ 2,446      $ 2,609      $ 3,069      $ 3,275   

Historical and environmental (ASC 450-10 component)

     5,379        5,593        5,754        5,985        6,758   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan loss

   $ 6,613      $ 8,039      $ 8,363      $ 9,054      $ 10,033   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming loans to gross loans (2)

     7.55     9.93     9.85     12.29     13.06

Impaired loans to gross loans

     7.21     9.53     9.14     9.94     11.50

Allowance to nonperforming loans ratio

     33.27     29.59     29.83     24.97     26.31

Quarter-to-date net charge offs to average gross loans (3)

     0.33     0.02     0.23     0.33     0.05

 

(1) Historical and environmental component as a percentage of non-impaired loans.
(2) Nonaccrual loans and loans past due 90 or more days still accruing interest, and troubled debt restructurings still accruing interest as a percentage of gross loans.
(3) Annualized.

Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following table presents information regarding loans included as nonaccrual and troubled debt restructurings and the gross income that would have been recorded in the three-month periods ended March 31, 2014 and 2013 if the loans had been current:

 

     Three months ended  
     March 31,
2014