CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Forward-looking statements in filings with the Securities and Exchange Commission, including this Annual Report on Form 10-K and the accompanying Exhibits, filings incorporated by reference, reports to shareholders, and other communications that represent the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates, and intentions are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” and other similar expressions identify forward-looking statements. The following factors, among others, could cause financial performance to differ materially from that expressed in such forward-looking statements:

 

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the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;

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the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Federal Reserve System;

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inflation, interest rate, market and monetary fluctuations;

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timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

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the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa;

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the impact of changes in financial services laws and regulations, including laws about taxes, banking, securities, and insurance, and the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

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the impact of the U.S. Department of the Treasury and federal banking regulators’ continued implementation of programs to address capital and liquidity in the banking system;

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further, future, and proposed rules, including those that are part of the process outlined in the Basel Committee on Banking Supervision’s “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” which require banking institutions to increase levels of capital;

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technological changes;

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the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;

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the growth and profitability of noninterest, or fee, income being less than expected;

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unanticipated regulatory or judicial proceedings;

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changes in consumer spending and saving habits; and

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the Company’s success at managing the risks mentioned above.

 

The list of important factors is not exclusive. If one or more of the factors affecting these forward-looking statements proves incorrect, actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this Annual Report on Form 10-K and other reports we file with the Securities and Exchange Commission. Therefore, the Company cautions you not to place undue reliance on forward-looking information and statements. The Company does not intend to update any forward-looking statements, whether written or oral, to reflect changes. These cautionary statements expressly qualify all forward-looking statements that apply to the Company including the risk factors presented in Part I, Item 1A of this report.

 

 

PART I

 

Item 1.

Business.

 

General

 

First Community Bancshares, Inc. (the “Company”), a financial holding company, was founded in 1989 and incorporated under the laws of Nevada in 1997. The Company’s principal executive office is located at One Community Place, Bluefield, Virginia. The Company provides commercial banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia-chartered banking institution founded in 1874. The Bank operates as First Community Bank in Virginia, West Virginia, and North Carolina and People’s Community Bank, a Division of First Community Bank, in Tennessee. The Bank provides insurance services through its wholly owned subsidiary First Community Insurance Services and offers wealth management and investment advice through its Trust Division and wholly owned subsidiary First Community Wealth Management. Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” in this Annual Report on Form 10-K refer to First Community Bancshares, Inc. and its subsidiaries as a consolidated entity.

 

We focus on building financial partnerships and creating enduring and complete relationships with businesses and individuals through a personal and local approach to banking and financial services. We strive to be the bank of choice in the markets we serve by offering impeccable service and a complete line of competitive products that include:

 

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demand deposit accounts, savings and money market accounts, certificates of deposit, and individual retirement arrangements;

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commercial, consumer, and real estate mortgage loans and lines of credit;

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various credit card, debit card, and automated teller machine card services;

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corporate and personal trust services;

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investment management services; and

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life, health, and property and casualty insurance products.

 

Our operations are guided by a strategic plan that focuses on organic growth supplemented by strategic acquisitions of complementary financial institutions. For a summary of our financial performance, see Item 6, “Selected Financial Data,” in Part II of this report.

 

Employees

 

As of December 31, 2017, we had 562 full-time equivalent employees. Our employees are not represented by collective bargaining agreements and we consider employee relations to be excellent.

 

Market Area

 

As of December 31, 2017, we operated 44 branch locations in Virginia, West Virginia, North Carolina, and Tennessee through our sole operating segment, Community Banking. Economic indicators in our market areas show relatively stable employment and business conditions. We serve a diverse base of individuals and businesses across a variety of industries such as education, government, and health services; coal mining and gas extraction; retail trade; construction; manufacturing; tourism; and transportation.

 

Competition

 

The financial services industry is highly competitive and constantly evolving. We encounter strong competition in attracting and retaining deposit, loan, and other financial relationships in our market areas. We compete with other commercial banks, thrifts, savings and loan associations, credit unions, consumer finance companies, mortgage banking firms, commercial finance and leasing companies, securities firms, brokerage firms, and insurance companies. We have positioned ourselves as a regional community bank that provides an alternative to larger banks, which often place less emphasis on personal relationships, and smaller community banks, which lack the capital and resources to efficiently serve customer needs. Factors that influence our ability to remain competitive include the ability to develop, maintain, and build long-term customer relationships; the quality, variety, and pricing of products and services; the convenience of banking locations and office hours; technological developments; and industry and general economic conditions. We seek to mitigate these pressures with our relationship style of banking, competitive pricing, cost efficiencies, and disciplined approach to loan underwriting.

 

 

Supervision and Regulation

 

Overview

 

We are subject to extensive examination, supervision, and regulation under applicable federal and state laws and various regulatory agencies. These regulations are intended to protect consumers, depositors, borrowers, deposit insurance funds, and the stability of the financial system and are not for the protection of stockholders or creditors.

 

Applicable laws and regulations restrict our permissible activities and investments and impose conditions and requirements on the products and services we offer and the manner in which they are offered and sold. They also restrict our ability to repurchase stock or pay dividends, or to receive dividends from our banking subsidiary, and impose capital adequacy requirements on the Company and the Bank. The consequences of noncompliance with these laws and regulations can include substantial monetary and nonmonetary sanctions.

 

The following discussion summarizes significant laws and regulations applicable to the Company and the Bank. These summaries are not intended to be complete and are qualified in their entirety by reference to the applicable statute or regulation. Changes in laws and regulations may have a material effect on our business, financial condition, or results of operations.

 

First Community Bancshares, Inc.

 

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, (“BHC Act”) and a financial holding company under the Gramm-Leach-Bliley Act of 1999 (“GLB Act”). The Company elected financial holding company status in December 2006. The Company and its subsidiaries are subject to supervision, regulation, and examination by the Board of Governors of the Federal Reserve System (“Federal Reserve”). The BHC Act generally provides for umbrella regulation of financial holding companies, such as the Company, by the Federal Reserve, as well as functional regulation of financial holding company subsidiaries by applicable regulatory agencies. The Federal Reserve is granted the authority, in certain circumstances, to require reports of, examine, and adopt rules applicable to any bank holding company subsidiary.

 

The Company is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, (“Exchange Act”), as administered by the Securities and Exchange Commission (“SEC”). The Company’s common stock is listed on the NASDAQ Global Select Market under the trading symbol FCBC and is subject to NASDAQ’s rules for listed companies.

 

First Community Bank

 

The Bank is a Virginia state-chartered bank and a member of the Federal Reserve subject to supervision, regulation, and examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank (“FRB”) of Richmond. The Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”), and its deposits are insured by the FDIC to the extent provided by law. The regulations of these agencies govern most aspects of the Bank’s business, including requirements concerning the allowance for loan losses, lending and mortgage operations, interest rates received on loans and paid on deposits, the payment of dividends, loans to affiliates, mergers and acquisitions, capital, and the establishment of branches. Various consumer and compliance laws and regulations also affect the Bank’s operations.

 

As a member bank, the Bank is required to hold stock in the FRB of Richmond in an amount equal to 6% of their capital stock and surplus (half paid to acquire the stock with the remainder held as a cash reserve). Member banks do not have any control over the Federal Reserve as a result of owning the stock and the stock cannot be sold or traded.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) of 2010 significantly restructured the U.S. financial regulatory regime. The Dodd-Frank Act is extensive, complicated, and comprehensive legislation that impacts practically all aspects of a banking organization, including the following provisions:

 

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centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), responsible for implementing, examining and enforcing compliance with federal consumer financial laws;

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requires financial holding companies, such as the Company, to be well-capitalized and well managed (bank holding companies and banks must also be well-capitalized and well managed to engage in interstate bank acquisitions);

 

 

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imposes comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institutions themselves;

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implements corporate governance revisions, including executive compensation and proxy access by shareholders;

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makes permanent the $250 thousand limit for federal deposit insurance;

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repeals the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts;

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amends the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules about interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and enforces a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer; and

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increases the authority of the Federal Reserve to examine bank holding companies, such as the Company, and their non-bank subsidiaries.

 

Many of the provisions of the Dodd-Frank Act and other laws are subject to further rulemaking, guidance, and interpretation by applicable federal regulators. We continue to evaluate the impact of any new regulations.

 

Permitted Activities under the BHC Act

 

The BHC Act limits the activities of bank holding companies, such as the Company, to the business of banking, managing or controlling banks and other activities the Federal Reserve determines to be closely related to banking. A bank holding company that elects treatment as a financial holding company under the GLB Act, such as the Company, may engage in a broader range of activities that are financial in nature or complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system. These activities include securities underwriting, dealing, and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and other activities that the Federal Reserve determines to be closely related to banking.

 

In order to maintain financial holding company status, the Company and the Bank must be well-capitalized and well-managed under applicable Federal Reserve regulations and have received at least a satisfactory rating under the Community Reinvestment Act (“CRA”). See “Prompt Corrective Action” and “Community Reinvestment Act” below. If we fail to meet these requirements, the Federal Reserve may impose corrective capital and managerial requirements and place limitations or conditions on our ability to conduct activities permissible for financial holding companies. If the deficiencies persist, the Federal Reserve may require the Company to divest the Bank or divest investments in companies engaged in activities permissible only for financial holding companies.

 

The Company is required to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities, subject to certain exemptions, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation.

 

The BHC Act requires that bank holding companies obtain the Federal Reserve’s approval before acquiring direct or indirect ownership or control of more than 5% of the voting shares or all, or substantially all, of the assets of a bank. The regulatory authorities are required to consider the financial and managerial resources and future prospects of the bank holding company and the target bank, the convenience and needs of the communities to be served, and various competitive factors when approving acquisitions. The BHC Act also prohibits a bank holding company from acquiring direct or indirect control of more than 5% of the outstanding voting stock of any company engaged in a non-banking business unless the Federal Reserve determines it to be closely related to banking.

 

Capital Requirements

 

We are subject to various regulatory capital requirements administered by the Federal Reserve. The current risk-based capital requirements applicable to the Company and the Bank, parts of which are currently in the process of being phased in, are based on the December 2010 international capital standards of the Basel Committee on Banking Supervision (“Basel Committee”), known as Basel III.

 

Prior to January 1, 2015, the risk-based capital requirements that applied to the Company and the Bank were based on the 1988 capital accord of the Basel Committee, known as Basel I. Under Basel I, the Company was required to maintain a minimum Tier 1 capital ratio of 4.0%, a total capital ratio of 8.0%, and Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”) of 3.0%. Certain highly rated bank holding companies could maintain a minimum Tier 1 leverage ratio of 3.0%, but other bank holding companies were required to maintain a Tier 1 leverage ratio of 4.0% or more, depending on their condition.

 

 

On July 2, 2013, the Federal Reserve approved capital rules for U.S. banking organizations implementing Basel III (“Basel III Capital Rules”) and certain requirements of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. Basel III Capital Rules (1) introduced a new Common Equity Tier 1 (“CET1”) capital measure, (2) specified that Tier 1 capital consist of CET1 and additional Tier 1 capital instruments meeting specified requirements, (3) defined CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (4) expanded the scope of the deductions/adjustments to capital as compared to prior regulations. The following initial minimum capital ratios became effective, subject to a phase-in period, for the Company and the Bank under Basel III Capital Rules on January 1, 2015:

 

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4.5% CET1 to risk-weighted assets

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6.0% Tier 1 capital (CET1 plus additional Tier 1 capital) to risk-weighted assets

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8.0% Total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets

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4.0% Tier 1 leverage ratio

 

Basel III Capital Rules introduced a capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer was implemented on January 1, 2016, at 0.625% and will be phased in over a four-year period (increasing by an additional 0.625% each year until it reaches 2.5% on January 1, 2019). Basel III Capital Rules also provide for a countercyclical capital buffer that applies to certain covered institutions; however, the buffer does not apply to the Company or the Bank. Banking institutions with a CET1 to risk-weighted assets ratio above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, if applicable) face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

 

When fully phased in on January 1, 2019, Basel III Capital Rules will require the Company and the Bank to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in the following minimum ratios:

 

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7.0% CET1 to risk-weighted assets

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8.5% Tier 1 capital to risk-weighted assets

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10.5% Total capital to risk-weighted assets

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4.0% Tier 1 leverage ratio

 

Management believes that the Company and the Bank would meet all capital adequacy requirements under Basel III Capital Rules on a fully phased-in basis, if such requirements were in effect, as of December 31, 2017.

 

Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories, in the aggregate, exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015, at 40% and will be phased in over a four-year period (increasing an additional 20% each year until it reaches 100% on January 1, 2018).

 

Basel III Capital Rules prevent certain hybrid securities, such as trust preferred securities, as Tier 1 capital of bank holding companies, subject to phase-out. The rules do not require a phase-out of trust preferred securities issued before May 19, 2010, for holding companies of depository institutions with less than $15 billion in consolidated total assets, as of December 1, 2009.

 

Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the four Basel I categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.

 

Prompt Corrective Action

 

The federal banking regulators are required to take prompt corrective action with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at which institutions are well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if the appropriate federal regulators determine that it is engaging in an unsafe or unsound practice or is in an unsafe or unsound condition. A bank’s capital category is determined solely for applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s financial condition or prospects for other purposes.

 

 

The Bank was classified as well-capitalized under prompt corrective action regulation as of December 31, 2017. In order to be considered a well-capitalized institution under Basel III Capital Rules, an organization must not be subject to any written agreement, order, capital directive, or prompt corrective action directive and must maintain the following minimum capital ratios:

 

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6.5% CET1 to risk-weighted assets

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8.0% Tier 1 capital to risk-weighted assets

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10.0% Total capital to risk-weighted assets

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5.0% Tier 1 leverage ratio

 

Undercapitalized institutions are required to submit a capital restoration plan to federal banking regulators. Under the Federal Deposit Insurance Act, as amended (“FDIA”), in order for the capital restoration plan to be accepted by the appropriate federal banking agency, a bank holding company must provide appropriate assurances of performance and guarantee that its subsidiary bank will comply with its capital restoration plan, subject to certain limitations. Agency regulations contain broad restrictions on certain activities of undercapitalized institutions, including asset growth, acquisitions, establishing branches, and engaging in new lines of business. With certain exceptions, a depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to its parent holding company if the institution would be undercapitalized after such distribution or payment.

 

A significantly undercapitalized institution is subject to various requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and ending deposits from correspondent banks. The FDIC has limited discretion in dealing with a critically undercapitalized institution and is generally required to appoint a receiver or conservator.

 

Safety and Soundness Standards

 

Guidelines adopted by federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage risks and exposures. If an institution fails to meet safety and soundness standards, the regulatory agencies may require the institution to submit a written compliance plan describing the steps they would take to correct the situation and the time that such steps would be taken. If an institution fails to submit or implement an acceptable compliance plan, after being notified, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions, such as those applicable to undercapitalized institutions under the prompt corrective action provisions of the FDIA. An institution may be subject to judicial proceedings and civil money penalties if it fails to follow such an order.

 

Payment of Dividends

 

The Company is a legal entity that is separate and distinct from its subsidiaries. The Company’s principal source of cash flow is derived from dividends paid by the Bank. There are various restrictions by regulatory agencies related to dividends paid by the Bank to the Company and dividends paid by the Company to its shareholders. The payment of dividends by the Company and the Bank may be limited by certain factors, such as requirements to maintain capital above regulatory guideline minimums.

 

Prior FRB approval is required for the Bank to declare or pay a dividend to the Company if the total of all dividends declared in any given year exceed the total of the Bank’s net profits for that year and its retained profits for the preceding two years, less any required transfers to surplus or to fund the retirement of preferred stock. Dividends paid by the Company to shareholders are subject to oversight by the Federal Reserve. Federal Reserve policy states that bank holding companies generally should pay dividends on common stock only from income available over the past year if prospective earnings retention is consistent with the organization’s expected future needs, asset quality, and financial condition.

 

Regulatory agencies have the authority to limit or prohibit the Company and the Bank from paying dividends if the payments are deemed to constitute an unsafe or unsound practice. The appropriate regulatory authorities have stated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only from current operating earnings. In addition, the Bank may not declare or pay a dividend if, after paying the dividend, the Bank would be classified as undercapitalized. In the current financial and economic environment, the FRB has discouraged payout ratios that are at maximum allowable levels, unless both asset quality and capital are very strong, and has noted that bank holding companies should carefully review their dividend policy. Bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to their banking subsidiaries.

 

 

Source of Strength

 

Federal Reserve policy and federal law requires the Company to act as a source of financial and managerial strength to the Bank. Under this requirement, the Company is expected to commit resources to support the Bank even when it may not be in a financial position to provide such resources. Because the Company is a legal entity separate and distinct from its subsidiaries, any capital loans it makes to the Bank are subordinate in right of payment to depositors and to certain other indebtedness of the Bank. In the event of the Company’s bankruptcy, any commitment by the Company to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Transactions with Affiliates

 

The Federal Reserve Act (“FRA”) and Federal Reserve Regulation W place restrictions on “covered transactions” between the Bank and its affiliates, including the Company. The term “covered transactions” includes making loans, purchasing assets, issuing guarantees, and other similar transactions. The Dodd-Frank Act expanded the definition of “covered transactions” to include derivative activities, repurchase agreements, and securities lending or borrowing activities. These restrictions limit the amount of transactions with affiliates, require certain levels of collateral for loans to affiliates, and require that all transactions with affiliates be on terms that are consistent with safe and sound banking practices. In addition, these transactions must be on terms that are substantially the same, or at least as favorable to the Bank, as those prevailing at the time for similar transactions with non-affiliates.

 

The FRA and Federal Reserve Regulation O place restrictions on loans between the Company and the Bank and their directors, executive officers, principal shareholders, affiliates, and interests of those directors, executive officers, and principal shareholders. These restrictions limit the amount of loans to one borrower and require that loans are on terms that are substantially the same as, and follow underwriting procedures that are not less stringent than, those prevailing at the time for similar loans with non-insiders. In addition, the aggregate limit of loans to all insiders, as a group, cannot exceed the Bank’s total unimpaired capital and surplus.

 

Deposit Insurance and Assessments

 

Substantially all of the Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to quarterly deposit insurance assessments to maintain the DIF. FDIC deposit insurance premiums are assessed using a risk-based system that places FDIC-insured institutions into one of four risk categories based on capital, supervisory ratings and other factors. The assessment rate determined by considering such information is then applied to the institution's average assets minus average tangible equity to determine the institution's insurance premium. The FDIC may change assessment rates or revise its risk-based assessment system if deemed necessary to maintain an adequate reserve ratio for the DIF. The Dodd-Frank Act required that the minimum reserve ratio for the DIF increase from 1.15% to 1.35% by September 30, 2020. Under the FDIA, the FDIC may terminate deposit insurance if it determines that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. The Bank’s FDIC deposit insurance assessments totaled $797 thousand in 2017, $1.25 million in 2016, and $1.42 million in 2015.

 

In addition, all FDIC-insured institutions must pay annual assessments to fund interest payments on bonds issued by the Financing Corporation (“FICO”). The FICO is a mixed-ownership government corporation that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. The Bank’s FICO assessments, which are set quarterly, totaled $113 thousand in 2017, $124 thousand in 2016, and $139 thousand in 2015.

 

The Volcker Rule

 

The Dodd-Frank Act amended the BHC Act to prohibit depository institutions and their affiliates from engaging in proprietary trading and from investing in, sponsoring, or having certain relationships with hedge funds or private equity funds, known as the Volcker Rule. These prohibitions are subject to a number of statutory exemptions, restrictions, and definitions. The Volcker Rule became effective on April 1, 2014, but the Federal Reserve extended the conformance period for certain requirements to July 21, 2017. Upon application of a banking entity, the Federal Reserve may provide an additional transition period of up to 5 years to conform investments in a limited class of legacy illiquid funds. The Volcker Rule has not had a material effect on the operations of the Company and subsidiaries, as the Company does not engage in the businesses prohibited by the Volcker Rule. The Company may incur costs to adopt additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material.

 

 

Community Reinvestment Act

 

The CRA of 1977, as amended, requires depository institutions to help meet the credit needs of their market areas, including low- and moderate-income individuals and communities, consistent with safe and sound banking practices. Federal banking regulators periodically examine depository institutions and assign ratings based on CRA compliance. A rating of less than satisfactory may restrict certain operating activities, delay or deny certain transactions, or result in an institution losing its financial holding company status. The Bank received a rating of satisfactory in its most recent CRA examination.

 

Incentive Compensation

 

Federal regulatory agencies have issued comprehensive guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance is based on the key principles that a banking organization’s incentive compensation arrangements should (1) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (2) be compatible with effective internal controls and risk management, and (3) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

 

Federal banking regulators periodically examine the incentive compensation arrangements of banking organizations and incorporate any deficiencies in the organization’s supervisory ratings, which can affect certain operating activities. The FRB may initiate enforcement actions if the organization’s incentive compensation arrangements or related risk management, control, or governance processes pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies. The scope and content of the U.S. banking regulators’ policies on incentive compensation are continuing to develop. It cannot be determined at this time if or when a final rule will be adopted or if compliance with such a final rule will adversely affect the ability of the Company and its subsidiaries to hire, retain and motivate their key employees.

 

Anti-Tying Restrictions

 

The Bank and its affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by the Company.

 

Consumer Protection and Privacy

 

We are subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include the Mortgage Reform and Anti-Predatory Lending Act, the Truth in Lending Act, the Truth in Savings Act, the Home Mortgage Disclosure Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Fair Housing Act, and various state law counterparts. These laws and regulations contain extensive customer privacy protection provisions that limit the ability of financial institutions to disclose non-public information about consumers to non-affiliated third parties and require financial institutions to disclose certain policies to consumers.

 

The CFPB is a federal agency with broad authority to implement, examine, and enforce compliance with federal consumer protection laws that relate to credit card, deposit, mortgage, and other consumer financial products and services. The CFPB may enforce actions to prevent and remedy unfair, deceptive, or abusive acts and practices related to consumer financial products and services. The agency has authority to impose new disclosure requirements for any consumer financial product or service. The CFPB may impose a civil penalty or injunction against an entity in violation of federal consumer financial laws.

 

Cybersecurity

 

In March 2015, federal regulators issued two related statements about cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption, and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Bank fails to observe the regulatory guidance, the Bank could be subject to various regulatory sanctions, including financial penalties.

 

 

Bank Secrecy Act and Anti-Money Laundering

 

The Bank is subject to the requirements of the Bank Secrecy Act and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (“USA PATRIOT Act”) of 2001. The USA PATRIOT Act broadened existing anti-money laundering legislation by imposing new compliance and due diligence obligations focused on detecting and reporting money laundering transactions. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of our customers. Violations can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.

 

Office of Foreign Assets Control Regulation

 

The U.S. Department of the Treasury’s (“Treasury”) Office of Foreign Assets Control (“OFAC”) administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals, and others. OFAC publishes lists of specially designated targets and countries. We are responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them, and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal, financial, and reputational consequences, including causing applicable bank regulatory authorities to not approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.

 

Sarbanes-Oxley Act

 

The Sarbanes-Oxley Act (“SOX Act”) of 2002 addresses a broad range of corporate governance, auditing and accounting, executive compensation, and disclosure requirements for public companies and their directors and officers. The SOX Act requires our Chief Executive Officer and Chief Financial Officer to certify the accuracy of certain information included in our quarterly and annual reports. The rules require these officers to certify that they are responsible for establishing, maintaining, and regularly evaluating the effectiveness of our financial reporting and disclosure controls and procedures; that they have made certain disclosures to the auditors and to the Audit Committee of the Board of Directors about our controls and procedures; and that they have included information in their quarterly and annual filings about their evaluation and whether there have been significant changes to the controls and procedures or other factors which would significantly impact these controls subsequent to their evaluation. Section 404 of the SOX Act requires management to undertake an assessment of the adequacy and effectiveness of our internal controls over financial reporting and requires our auditors to attest to and report on the effectiveness of these controls.

 

Available Information

 

We file annual, quarterly, and current reports; proxy statements; and other information with the SEC. You may read and copy any document we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information about the public reference room. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information that issuers file electronically with the SEC. We maintain a website at www.firstcommunitybank.com that makes available, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other information, including any amendments to those reports as soon as reasonably practicable after such reports are filed with, or furnished to, the SEC. You are encouraged to access these reports and other information about our business from the Investor Relations section of our website. The Investor Relations section contains information about our Board of Directors, executive officers, and corporate governance policies and principles, which include the charters of the standing committees of the Board of Directors, the Insider Trading Policy, and the Standards of Conduct governing our directors, officers, and employees. Information on our website is not incorporated by reference in this report.

 

Item 1A.

Risk Factors.

 

The risk factors described below discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our Company. Individuals should carefully consider our risk factors and information included, or incorporated by reference, in this report before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, the following risk factors are not intended to be an exhaustive list of all risks we face.

 

 

Risks Related to Our Business

 

The current economic environment poses significant challenges.

 

Our financial performance is generally highly dependent on the business environment in the markets we operate in and of the U.S. as a whole, which includes the ability of borrowers to pay interest, repay principal on outstanding loans, the value of collateral securing those loans, and demand for loans and other products and services we offer. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity, and investor or business confidence; limitations on the availability, or increases, in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.

 

In recent years, economic growth and business activity across a wide range of industries has been slow and uneven. There are continuing concerns related to the level of U.S. government debt, fiscal actions that may be taken to address that debt, oil price volatility, global economic conditions, and significant uncertainty with respect to domestic and international fiscal and monetary policy. Economic pressure on consumers and uncertainty about continuing economic improvement may result in changes in consumer and business spending, borrowing, and savings habits. There can be no assurance that these conditions will improve or that these conditions will not worsen. Such conditions could adversely affect the credit quality of the Bank’s loans and the Company’s business, financial condition, and results of operations.

 

We operate in a highly regulated industry subject to examination, supervision, enforcement, and other legal actions by various federal and state governmental authorities, laws, and judicial and administrative decisions.

 

Congress and federal regulatory agencies continually review banking laws, regulations, and policies. Changes to these statutes, regulations, and regulatory policies, including changes in the interpretation or implementation, may cause substantial and unpredictable effects, require additional costs, limit the types of financial services and products offered, or allow non-banks to offer competing financial services and products. Failure to follow laws, regulations, and policies may result in sanctions by regulatory agencies and civil money penalties, which could have material adverse effects on our reputation, business, financial condition, and results of operations. We have policies and procedures designed to prevent violations; however, there is no assurance that violations will not occur. Existing and future laws, regulations, and policies yet to be adopted may make compliance more difficult or expensive; restrict our ability to originate, broker, or sell loans; further limit or restrict commissions, interest, and other charges earned on loans we originate or sell; and adversely affect our business, financial condition, and results of operations.

 

The Bank’s ability to pay dividends is subject to regulatory limitations that may affect the Company’s ability to pay expenses and dividends to shareholders.

 

The Company is a legal entity that is separate and distinct from its subsidiaries. The Company depends on the Bank and its other subsidiaries for cash, liquidity, and the payment of dividends to the Company to pay operating expenses and dividends to stockholders. There is no assurance that the Bank will have the capacity to pay dividends to the Company in the future or that the Company will not require dividends from the Bank to satisfy obligations. The Bank’s dividend payment is governed by various statutes and regulations. For additional information, see “Payment of Dividends” in Item 1 of this report. The Company may not be able to service obligations as they become due if the Bank is unable to pay dividends sufficient to satisfy the Company’s obligations, including our common stock. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations, cash flows, and prospects.

 

We face strong competition from other financial institutions, financial service companies, and organizations that offer services similar to our offerings.

 

Our larger competitors may have substantially greater resources and lending limits, name recognition, and market presence that allow them to offer products and services that we do not offer and to price loans and deposits more aggressively than we do. The expansion of non-bank competitors, which may have fewer regulatory constraints and lower cost structures, over recent years has intensified competitive pressures on core deposit generation and retention. For additional information, see “Competition” in Item 1 of this report. Our success depends, in part, on our ability to attract and retain customers by adapting our products and services to evolving customer needs and industry and economic conditions. Failure to perform in any of these areas could weaken our competitive position, reduce deposits and loan originations, and adversely affect our financial condition, results of operations, cash flows, and prospects.

 

 

We may require additional capital in the future that may not be available when needed.

 

We may need to raise additional capital to strengthen our capital position, increase our liquidity, satisfy obligations, or pursue growth objectives. Our ability to raise additional capital depends on current conditions in capital markets, which are outside our control, and our financial performance. Certain economic conditions and declining market confidence may increase our cost of funds and limit our access to customary sources of capital, such as borrowings with other financial institutions, repurchase agreements, and availability under the FRB’s Discount Window. Events that limit access to capital markets and the inability to obtain capital may have a materially adverse effect on our business, financial condition, results of operations, and market value of common stock. We cannot provide any assurance that additional capital will be available, on acceptable terms or at all, in the future.

 

Liquidity risk could impair our ability to fund operations.

 

Liquidity is essential to our business and the inability to raise funds through deposits, borrowings, equity and debt offerings, or other sources could have a materially adverse effect on our liquidity. Company specific factors such as a decline in our credit rating, an increase in the cost of capital from financial capital markets, a decrease in business activity due to adverse regulatory action or other company specific event, or a decrease in depositor or investor confidence may impair our access to funding with acceptable terms adequate to finance our activities. General factors related to the financial services industry such as a severe disruption in financial markets, a decrease in industry expectations, or a decrease in business activity due to political or environmental events may impair our access to liquidity.

 

We are subject to interest rate risk.

 

Interest rate risk results principally when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. Our earnings and cash flows are largely dependent upon net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, particularly, the Federal Reserve. Changes in monetary policy and interest rates could influence the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings. Further, such changes could also affect our ability to originate loans and obtain deposits and the fair value of our financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income and earnings could be adversely affected. Conversely, if interest rates received on loans and other investments fall more quickly than interest rates paid on deposits and other borrowings, our net interest income and earnings could also be adversely affected.

 

Our accounting estimates and risk management processes rely on analytical and forecasting models.

 

The processes we use to estimate probable loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depend upon analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset/liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models used for determining probable loan losses are inadequate, the allowance for loan losses may not be sufficient to cover actual loan losses and an increase in the loan loss provision could materially and adversely affect our operating results. Federal regulatory agencies regularly review our loans and allowance for loan losses as an integral part of the examination process. There is no assurance that we will not, or that regulators will not require us to, increase our allowance in future periods, which could materially and adversely affect our earnings and profitability. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon the sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition, and results of operations. For additional information, see “Fair Value Measurements” and “Allowance for Loan Losses” in the “Critical Accounting Estimates” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

 

Changes in the fair value of our investment securities may reduce stockholders’ equity and net income.

 

A decline in the estimated fair value of the investment portfolio may result in a decline in stockholders’ equity, book value per common share, and tangible book value per common share. Unrealized losses are recorded even though the securities are not sold or held for sale. If a debt security is never sold and no credit impairment exists, the decrease is recovered at the security’s maturity. Equity securities have no stated maturity; therefore, declines in fair value may or may not be recovered over time. We conduct quarterly reviews of our securities portfolio to determine if unrealized losses are temporary or other than temporary. No assurance can be given that we will not need to recognize other-than-temporary impairment (“OTTI”) charges in the future. Additional OTTI charges may materially affect our financial condition and earnings. For additional information, see “Investment Securities” in the “Critical Accounting Estimates” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” and Note 3, “Investment Securities,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We are subject to credit risk associated with the financial condition of other financial institutions. 

 

Credit risk is the risk of not collecting payments pursuant to the contractual terms of loans, leases and investment securities. Financial institutions are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, investment companies, and other institutional clients. Our ability to engage in routine funding transactions could be adversely affected by the failure, actions, and commercial soundness of other financial institutions. These transactions may expose us to credit risk if our counterparty or client defaults on their contractual obligation. Our credit risk may increase if the collateral we hold cannot be realized or liquidated at prices sufficient to recover the full amount of the loan or derivative exposure due to us. In the event of default, we may be required to provide collateral to secure the obligation to the counterparties. In the event of a bankruptcy or insolvency proceeding involving one of such counterparties, we may experience delays in recovering the assets posted as collateral or may incur a loss to the extent that the counterparty was holding collateral in excess of the obligation to such counterparty. Losses from routine funding transactions could have a material adverse effect on our financial condition and results of operations.

 

Our commercial loan portfolio may expose us to increased credit risk.

 

Commercial business and real estate loans generally have a higher risk of loss because loan balances are typically larger than residential real estate and consumer loans and repayment is usually dependent on cash flows from the borrower’s business or the property securing the loan. Our commercial business loans are primarily made to small business and middle market customers. As of December 31, 2017, commercial business and real estate loans totaled $1.01 billion, or 55.52%, of our total loan portfolio. As of the same date, our largest outstanding commercial business loan was $6.15 million and largest outstanding commercial real estate loan was $11.01 million. Commercial construction loans generally have a higher risk of loss due to the assumptions used to estimate the value of property at completion and the cost of the project, including interest. If the assumptions and estimates are inaccurate, the value of completed property may fall below the related loan amount. As of December 31, 2017, commercial construction loans totaled $60.06 million, or 3.30% of our total loan portfolio. As of the same date, our largest outstanding commercial construction loan was $5.79 million. Losses from our commercial loan portfolio could have a material adverse effect on our financial condition and results of operations.

 

We are subject to environmental liability risk associated with lending activities.

 

A significant portion of our loan portfolio is secured by real property. In the ordinary course of business, we foreclose on and take title to properties that secure certain loans. Hazardous or toxic substances could be found on properties we own. If substances are present, we may be liable for remediation costs, personal injury claims, and property damage and our ability to use or sell the property would be limited. We have policies and procedures in place that require environmental reviews before initiating foreclosure actions on real property; however, these reviews may not detect all potential environmental hazards. Environmental laws that require us to incur substantial remediation costs, which could materially reduce the affected property’s value, and other liabilities associated with environmental hazards could have a material adverse effect on our financial condition and results of operations.

 

Potential acquisitions may disrupt our business and dilute stockholder value.

 

We may seek merger or acquisition partners that are culturally similar, have experienced management, and possess either significant market presence or the potential for improved profitability through financial management, economies of scale, or expanded services. Risks inherent in acquiring other banks, businesses, and banking branches may include the following:

 

●

potential exposure to unknown or contingent liabilities of the target company;

●

exposure to potential asset quality issues of the target company;

●

difficulty, expense, and delays of integrating the operations and personnel of the target company;

●

potential disruption to our business;

●

potential diversion of management’s time and attention;

 

 

●

loss of key employees and customers of the target company;

●

difficulty in estimating the value of the target company;

●

potential changes in banking or tax laws or regulations that may affect the target company;

●

unexpected costs and delays;

●

the target company’s performance does not meet our growth and profitability expectations;

●

limited experience in new markets or product areas;

●

increased time, expenses, and personnel as a result of strain on our infrastructure, staff, internal controls, and management; and

●

potential short-term decreases in profitability.

 

We regularly evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving the payment of cash or the issuance of debt or equity securities may occur at any time. Acquisitions typically involve goodwill, a purchase premium over the acquired company’s book and market values; therefore, dilution of our tangible book value and net income per common share may occur. If we are unable to realize revenue increases, cost savings, geographic or product presence growth, or other projected benefits from acquisitions, our financial condition and results of operations may be adversely affected.

 

Attractive acquisition opportunities may not be available in the future.

 

We expect banking and financial companies, which may have significantly greater resources, to compete for the acquisition of financial service businesses. This competition could increase the price of potential acquisitions that we believe are attractive. If we fail to receive proper regulatory approval, we will not be able to consummate an acquisition. Our regulators consider our capital, liquidity, profitability, regulatory compliance, level of goodwill and intangible assets, and other factors when considering acquisition and expansion proposals. Future acquisitions may be dilutive to our earnings and equity per share of our common stock.

 

We may experience future goodwill impairment.

 

We test goodwill for impairment annually, or more often if necessary, using quantitative and qualitative factors. Impairment charges may cause an adverse effect on our earnings and financial position. For additional information, see “Intangible Assets” in the “Critical Accounting Estimates” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” and Note 9, “Goodwill and Other Intangible Assets,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We are subject to certain obligations under FDIC loss share agreements that specify how to manage, service, report, and request reimbursement for losses incurred on covered assets.

 

Our ability to receive benefits under FDIC loss share agreements is subject to compliance with certain requirements, oversight and interpretation, and contractual term limitations. Our obligations under loss share agreements are extensive, and failure to follow any obligations could result in a specific asset, or group of assets, losing loss share coverage. Reimbursement requests are subject to FDIC review and may be delayed or disallowed if we do not comply with our obligations. Losses projected to occur during the loss share term may not be realized until after the expiration of the applicable agreement; consequently, those losses may have a material adverse impact on our results of operations. Our current loss estimates only include those projected to occur during the loss share period and for which we expect reimbursement from the FDIC at the applicable reimbursement rate. We are subject to FDIC audits to ensure compliance with the loss share agreements. The loss share agreements are subject to interpretation by the FDIC and us; therefore, disagreements about the coverage of losses, expenses, and contingencies may arise. The realization of benefits to be received from the FDIC ultimately depends on the performance of the underlying covered assets, the passage of time, claims paid by the FDIC, and interpretation; therefore, the amount received could differ materially from the carrying value of expected reimbursements and have a material effect on our financial condition and results of operations. For additional information, see “FDIC Indemnification Asset” in the “Critical Accounting Estimates” section in Part II, Item 7 and Note 1, “Basis of Presentation and Accounting Policies,” and Note 7, “FDIC Indemnification Asset,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

We may be required to pay higher FDIC insurance premiums or special assessments.

 

Our deposits are insured up to applicable limits by the DIF of the FDIC and we are subject to deposit insurance assessments to maintain the DIF. For additional information, see “Deposit Insurance and Assessments” in Item 1 of this report. We are unable to predict future insurance assessment rates; however, deterioration in our risk-based capital ratios or adjustments to base assessment rates may result in higher insurance premiums or special assessments. The deterioration of banking and economic conditions and financial institution failures deplete the FDIC’s DIF and reduce the ratio of reserves to insured deposits. If the DIF is unable to meet funding requirements, increases in deposit insurance premium rates or special assessments may be required. Future assessments, increases, or required prepayments related to FDIC insurance premiums may negatively affect our financial condition and results of operations.

 

 

The repeal of the federal prohibitions on payment of interest on demand deposits could increase our interest expense.

 

All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. We do not know what interest rates other institutions may offer as market interest rates begin to increase. Our interest expense will increase and net interest margin will decrease if we offer interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on our business, financial condition, and results of operations.

 

We may lose members of our management team and have difficulty attracting skilled personnel.

 

Our success depends, in part, on our ability to attract and retain key employees. Competition for the best people can be intense. The unexpected loss of key personnel could have a material adverse impact on our business due to the loss of certain skills, market knowledge, and industry experience and the difficulty of promptly finding qualified replacement personnel. Certain existing and proposed regulatory guidance on compensation may also negatively affect our ability to retain and attract skilled personnel.

 

Our internal controls and procedures may fail or be circumvented.

 

We review our internal controls over financial reporting quarterly and enhance controls in response to these assessments, internal and external audit, and regulatory recommendations. A control system, no matter how well conceived and operated, includes certain assumptions and can only provide reasonable assurance that the objectives of the control system are met. These controls may be circumvented by individual acts, collusion, or management override. Any failure or circumvention related to our controls and procedures or failure to follow regulations related to controls and procedures could have a material adverse effect on our business, reputation, results of operations, and financial condition.

 

We continue to encounter technological change and are subject to information security risks associated with technology.

 

The financial services industry continues to experience rapid technological change with the introduction of new, and increasingly complex, technology-driven products and services. The effective use of technology increases operational efficiency that enables financial service institutions to reduce costs. Our future success depends, in part, on our ability to provide products and services that satisfactorily meet the financial needs of our customers, as well as to realize additional efficiencies in our operations. We may fail to use technology-driven products and services effectively to better serve our customers and increase operational efficiency or sufficiently invest in technology solutions and upgrades to ensure systems are operating properly. Further, many of our competitors have substantially greater resources to invest in technology, which may adversely affect our ability to compete.

 

We rely on electronic communications and information systems, including those provided by third-party vendors, to conduct our business operations. Our security risks increase as our reliance on technology increases; consequently, the expectation to safeguard information by monitoring systems for potential failures, disruptions, and breakdowns has also increased. Risks associated with technology include security breaches, operational failures and service interruptions, and reputational damages. These risks also apply to our third-party service providers. Our third-party vendors include large entities with significant market presence in their respective fields; therefore, their services could be difficult to replace quickly if there are operational failures or service interruptions.

 

We rely on our technology-driven systems to conduct daily business and accounting operations that include the collection, processing, and retention of confidential financial and client information. We may be vulnerable to security breaches, such as employee error, cyber-attacks, and viruses, beyond our control. In addition to security breaches, programming errors, vandalism, natural disasters, terrorist attacks, and third-party vendor disruptions may cause operational failures and service interruptions to our communication and information systems. Further, our systems may be temporarily disrupted during implementation or upgrade. Security breaches and service interruptions related to our information systems could damage our reputation, which may cause us to lose customers, subject us to regulatory scrutiny, or expose us to civil litigation and financial liability.

 

Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information, or to introduce viruses or other malware through "Trojan horse" programs to our information systems and/or our customers' computers. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology, and customer and employee education, such cyber-attacks against us or our merchants and our third-party service providers remain a serious issue. The pervasiveness of cybersecurity incidents in general and the risks of cyber-crime are complex and continue to evolve. More generally, publicized information about security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions.

 

 

While we have not experienced a significant compromise, significant data loss, or any material financial losses related to cybersecurity attacks, our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber-attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. A security breach or other significant disruption of our information systems or those related to our customers, merchants and our third-party vendors, including as a result of cyber-attacks, could (1) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of our customers; (2) result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers; (3) result in a violation of applicable privacy, data breach and other laws, subjecting us to additional regulatory scrutiny and expose us to civil litigation, governmental fines and possible financial liability; (4) require significant management attention and resources to remedy the damages that result; or (5) harm our reputation or cause a decrease in the number of customers who choose to do business with us. The occurrence of any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.

 

We may be subject to claims and litigation pertaining to intellectual property.

 

Banking and other financial services companies, such as the Company, rely on technology companies to provide information technology products and services necessary to support the Company’s day-to-day operations. Technology companies often enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of the Company’s vendors, or other individuals or companies, have from time to time claimed to hold intellectual property sold to the Company by its vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions often seek injunctions and substantial damages.

 

Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, the Company may have to engage in protracted litigation. Such litigation is often expensive, time consuming, disruptive to the Company’s operations, and distracting to management. If the Company is found to have infringed on one or more patents or other intellectual property rights, it may be required to pay substantial damages or royalties to a third party. In certain cases, the Company may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase the Company’s operating expenses. If legal matters related to intellectual property claims were resolved against the Company or settled, the Company could be required to make payments in amounts that could have a material adverse effect on its business, financial condition, and results of operations.

 

Risks Related to Our Common Stock

 

The market price of our common stock may be volatile.

 

Stock price volatility may make it more difficult for our stockholders to resell their common stock when desired. Our common stock price may fluctuate significantly due to a variety of factors that include the following:

 

●

actual or expected variations in quarterly results of operations;

●

recommendations by securities analysts;

●

operating and stock price performance of comparable companies, as deemed by investors;

●

news reports relating to trends, concerns, and other issues in the financial services industry;

●

perceptions in the marketplace about our Company or competitors;

●

new technology used, or services offered, by competitors;

 

 

●

significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by, or involving, our Company or competitors;

●

failure to integrate acquisitions or realize expected benefits from acquisitions;

●

changes in government regulations; and

●

geopolitical conditions, such as acts or threats of terrorism or military action.

 

General market fluctuations; industry factors; political conditions; and general economic conditions and events, such as economic slowdowns, recessions, interest rate changes, or credit loss trends, could also cause our common stock price to decrease regardless of operating results.

 

The trading volume in our common stock is less than that of other larger financial services companies.

 

Although our common stock is listed for trading on the NASDAQ, the trading volume in our common stock is less than that of other, larger financial services companies. A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock or the expectation of these sales could cause our stock price to fall.

 

We may not continue to pay dividends on our common stock in the future.

 

Our common stockholders are only entitled to receive dividends when declared by our Board of Directors from funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so, and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock. As a financial holding company, the Company’s ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve about capital adequacy and dividends. For additional information, see “Payment of Dividends” in Item 1 of this report.

 

Item 1B.

Unresolved Staff Comments.

 

None.

 

Item 2.

Properties.

 

We own our corporate headquarters located at One Community Place, Bluefield, Virginia. As of December 31, 2017, the Bank provided financial services through a network of 44 branch locations in West Virginia (18 branches), Virginia (19 branches), North Carolina (5 branches), and Tennessee (2 branches). We own 42 of these branches and lease the remaining 2 branches. We also lease a loan production office and own a wealth management office and a call center location. As of December 31, 2017, there were no mortgages or liens against any properties. We believe that our properties are suitable and adequate to serve as financial services facilities. A list of all branch and ATM locations is available on our website at www.firstcommunitybank.com. Information contained on our website is not part of this report. For additional information, see Note 8, “Premises, Equipment, and Leases,” to the Consolidated Financial Statements in Part II, Item 8 of this report.

 

Item 3.

Legal Proceedings.

 

We are currently a defendant in various legal actions and asserted claims in the normal course of business. Although we are unable to assess the ultimate outcome of each of these matters with certainty, we are of the belief that the resolution of these actions should not have a material adverse effect on our financial position, results of operations, or cash flows.

 

Item 4.

Mine Safety Disclosures.

 

None.

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information, Holders, and Dividends

 

Our common stock is traded on the NASDAQ Global Select Market under the symbol FCBC. As of February 28, 2018, there were 2,337 record holders and 16,945,756 outstanding shares of our common stock. The following table presents the high and low stock prices and cash dividends paid per share of our common stock for the periods indicated:

 

			Year Ended December 31,
			2017												2016
			Sale Price								Cash Dividends per				Sale Price								Cash Dividends per
			High				Low				Common Share				High				Low				Common Share
First quarter			$	30.86			$	23.23			$	0.16			$	19.93			$	16.67			$	0.14
Second quarter				28.80				24.06				0.16				22.74				19.03				0.14
Third quarter				29.80				24.02				0.18				25.24				21.53				0.16
Fourth quarter				32.24				26.97				0.18				31.94				20.47				0.16

 

Common stock cash dividends totaled $11.56 million in 2017, $10.40 million in 2016, and $9.99 million in 2015. Cash dividends paid per common share totaled $0.68 in 2017, $0.60 in 2016, and $0.54 in 2015. The Company’s ability to pay dividends on its common stock is dependent on the Bank’s ability to pay dividends to the Company, which is subject to various regulatory restrictions and limitations. For additional information, see “Payment of Dividends” in Part I, Item 1 of this report.

 

During the first quarter of 2015, the Company notified holders of its 6% Series A Noncumulative Convertible Preferred Stock (“Series A Preferred Stock”) of its intent to redeem all of the outstanding shares. Prior to redemption, holders converted 12,784 shares of Series A Preferred Stock with each share convertible into 69 shares of the Company’s common stock. The Company redeemed the remaining 2,367 shares for $2.37 million along with accrued and unpaid dividends of $9 thousand. As a result of the redemption, there were no shares of Series A Preferred Stock outstanding as of December 31, 2017, December 31, 2016, or December 31, 2015. Series A Preferred Stock cash dividends totaled $105 thousand in 2015.

 

Purchases of Equity Securities

 

We repurchased 50,118 shares of our common stock in 2017, 1,182,294 shares in 2016, and 1,238,299 shares in 2015. The following table provides information about purchases of our common stock made by us or on our behalf by any affiliated purchaser, as defined in Rule 10b-18(a)(3) under the Exchange Act, during the periods indicated:

 

		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares Purchased as Part of a Publicly Announced Plan				Maximum Number of Shares that May Yet be Purchased Under the Plan(1)
October 1-31, 2017			-			$	-				-				613,071
November 1-30, 2017			-				-				-				613,071
December 1-31, 2017			-				-				-				616,447
Total			-			$	-				-

                                                               

(1)

Our stock repurchase plan, as amended, authorizes the purchase and retention of up to 5,000,000 shares. The plan has no expiration date and is currently in effect. No determination has been made to terminate the plan or to cease making purchases. We held 4,383,553 shares in treasury as of December 31, 2017.

 

 

Stock Performance Graph

 

The following graph, compiled by SNL Financial LC (“SNL”), compares the cumulative total shareholder return on our common stock for the five years ended December 31, 2017, with the cumulative total return of the S&P 500 Index, the NASDAQ Composite Index, and SNL’s Asset Size & Regional Peer Group. The Asset Size & Regional Peer Group consists of 48 bank holding companies with total assets between $1 billion and $5 billion that are located in the Southeast Region of the United States and traded on NASDAQ, the OTC Bulletin Board, and pink sheets. The cumulative returns assume that $100 was originally invested on December 31, 2012, and that all dividends are reinvested.

 

 

		Year Ended December 31,
		2012				2013				2014				2015				2016				2017
First Community Bancshares, Inc.			100.00				107.80				109.87				128.17				213.40				208.43
S&P 500 Index			100.00				132.39				150.51				152.59				170.84				208.14
NASDAQ Composite Index			100.00				140.12				160.78				171.97				187.22				242.71
SNL Asset & Regional Peer Group(1)			100.00				119.35				130.28				146.71				196.01				220.52

                                                                    

(1) Includes the following institutions: Access National Corporation; American National Bankshares Inc.; Atlantic Capital Bancshares, Inc.; Bear State Financial, Inc.; Burke & Herbert Bank & Trust Company; C&F Financial Corporation; Capital City Bank Group, Inc.; CapStar Financial; Holdings, Inc.; Carolina Financial Corporation; Carter Bank & Trust; Charter Financial Corporation; Citizens Holding Company; City Holding Company; CNB Corporation; Colony Bankcorp, Inc.; Community Bankers Trust Corporation; Entegra Financial Corp.; Fidelity Southern Corporation; First Bancorp; First Bancorp, Inc.; First Bancshares, Inc.; First Citizens Bancshares, Inc.; First Community Bancshares, Inc.; First Farmers and Merchants Corporation; Hamilton State Bancshares, Inc.; HomeTrust Bancshares, Inc.; Live Oak Bancshares, Inc.; MetroCity Bankshares, Inc.; MVB Financial Corp.; National Bankshares, Inc.; National Commerce Corporation; Paragon Commercial Corporation; Peoples Bancorp of North Carolina, Inc.; Premier Financial Bancorp, Inc.; Reliant Bancorp, Inc.; SmartFinancial, Inc.; Southern BancShares (N.C.), Inc.; Southern First Bancshares, Inc.; Southern National Bancorp of Virginia, Inc.; Summit Financial Group, Inc.; TGR Financial, Inc.; and Wilson Bank Holding Co.

 

 

Item 6.

Selected Financial Data.

 

The following table presents selected consolidated financial data, derived from the audited financial statements, as of and for the five years ended December 31, 2017. This information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data,” of this report.

 

		Year Ended December 31,
(Amounts in thousands, except share and per share data)		2017				2016				2015				2014				2013
Selected Balance Sheet Data
Investment securities		$	190,729			$	212,712			$	438,714			$	384,065			$	520,388
Loans			1,817,184				1,852,948				1,706,541				1,691,208				1,711,604
Allowance for loan losses			19,276				17,948				20,233				20,227				24,077
Total assets			2,388,460				2,386,398				2,462,276				2,607,936				2,602,514
Average assets			2,370,321				2,455,458				2,520,934				2,608,570				2,661,602
Deposits			1,929,891				1,841,338				1,873,259				2,000,759				1,950,742
Borrowings			80,086				178,713				219,370				229,741				300,396
Total liabilities			2,037,746				2,047,341				2,119,259				2,256,562				2,273,908
Preferred stock			-				-				-				15,151				15,251
Total stockholders' equity			350,714				339,057				343,017				351,374				328,606
Average stockholders' equity			349,701				338,475				348,199				342,619				355,611
Summary of Operations
Interest income		$	95,308			$	94,724			$	96,102			$	106,108			$	109,476
Interest expense			8,090				9,844				11,349				15,290				17,834
Net interest income			87,218				84,880				84,753				90,818				91,642
Provision for loan losses			2,771				1,255				2,191				145				8,208
Noninterest income			26,248				27,066				29,530				30,003				29,771
Noninterest expense			68,582				72,746				76,171				82,862				78,985
Income tax expense			20,628				12,819				11,381				12,324				10,908
Net income			21,485				25,126				24,540				25,490				23,312
Dividends on preferred stock			-				-				105				910				1,024
Net income available to common shareholders			21,485				25,126				24,435				24,580				22,288
Selected Share and Per Share Data
Basic earnings per common share		$	1.26			$	1.45			$	1.32			$	1.34			$	1.13
Diluted earnings per common share			1.26				1.45				1.31				1.31				1.11
Cash dividends per common share			0.68				0.60				0.54				0.50				0.48
Book value per common share at year-end(1)			20.63				19.95				18.95				18.06				16.79
Weighted average basic shares outstanding			17,002,116				17,319,689				18,531,039				18,406,363				19,792,099
Weighted average diluted shares outstanding			17,077,842				17,365,524				18,727,464				19,483,054				20,961,800
Selected Ratios
Return on average assets			0.91	%			1.02	%			0.97	%			0.94	%			0.84	%
Return on average common equity			6.14	%			7.42	%			7.08	%			7.51	%			6.57	%
Average equity to average assets			14.75	%			13.78	%			13.81	%			13.13	%			13.36	%
Dividend payout			53.81	%			41.36	%			40.95	%			37.44	%			42.62	%
Common equity Tier 1 ratio(2)			13.98	%			13.88	%			14.54	%		NA				NA
Total risk-based capital ratio			15.06	%			15.79	%			15.95	%			17.68	%			16.44	%
Tier 1 risk-based capital ratio			13.98	%			14.74	%			14.73	%			16.43	%			15.19	%
Tier 1 leverage ratio			11.06	%			11.07	%			10.62	%			10.12	%			9.95	%

                                                                                                     

(1) Book value per common share is defined as stockholders' equity divided by as-converted common shares outstanding.

(2) The common equity Tier 1 ratio became effective on January 1, 2015.

 

 

Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report. Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bancshares, Inc. and its subsidiaries as a consolidated entity.

 

Executive Overview

 

First Community Bancshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of December 31, 2017, the Bank operated 44 branches as First Community Bank in Virginia, West Virginia, and North Carolina and as People’s Community Bank, a Division of First Community Bank, in Tennessee. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network and, to a lesser extent, retail and wholesale repurchase agreements and Federal Home Loan Bank (“FHLB”) borrowings. We invest our funds primarily in loans to retail and commercial customers and various investment securities.

 

The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of commissions on assets under management and investment advisory fees. As of December 31, 2017, the Trust Division and FCWM managed $957 million in combined assets under various fee-based arrangements as fiduciary or agent.

 

The Bank offers insurance products and services through its wholly owned subsidiary First Community Insurance Services (“FCIS”). FCIS provides in-branch commercial and insurance services in Virginia and West Virginia. Revenues are primarily derived from commissions paid by issuing companies on the sale of policies.

 

Our acquisition and divestiture activity during the three years ended December 31, 2017, includes the sale of Greenpoint Insurance Group, Inc. (“Greenpoint”) to Ascension Insurance Agency, Inc. on October 31, 2016, and the simultaneous sale of six branches to and purchase of seven branches from First Bank on July 15, 2016. For additional information, see Note 2, “Acquisitions and Divestitures,” to the Consolidated Financial Statements in Item 8 of this report.

 

Critical Accounting Estimates

 

Our consolidated financial statements are prepared in conformity with generally accepted accounting principles (“GAAP”) in the U.S. and prevailing practices in the banking industry. Our accounting policies, as presented in Note 1, “Basis of Presentation and Accounting Policies,” to the Consolidated Financial Statements in Item 8 of this report are fundamental in understanding MD&A and the disclosures presented in Item 8, “Financial Statements and Supplementary Data,” of this report. Management may be required to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates used, we have identified fair value measurements, investment securities, the allowance for loan losses, goodwill and other intangible assets, and income taxes as the accounting areas that require the most subjective or complex judgments or are the most susceptible to change.

 

Fair Value Measurements

 

We use the fair value hierarchy to determine the fair value of certain assets and liabilities. The hierarchy consists of three levels that include valuations based on observable quoted prices in active markets; quoted prices in inactive markets or other observable inputs, such as third-party sources; and unobservable inputs. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates. The assumptions and estimates used to determine fair value may be highly subjective in nature, such as cash flow estimates, risk characteristics, credit quality measurements, and interest rates; therefore, valuations may not be precise. The amounts realized or paid on the settlement or maturity of fair value instruments may be significantly different from estimates. While management believes our valuation methodologies are appropriate and consistent with other market participants, different methodologies or assumptions used to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. For additional information, see Note 17, “Fair Value,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

Investment Securities

 

We review our investment portfolio quarterly for indications of other-than-temporary impairment (“OTTI”). We use inputs from independent third parties to determine the fair value of investment securities, which are reviewed and corroborated by management. Unrealized losses are evaluated to determine whether the impairment is temporary or other-than-temporary in nature. For debt securities, we consider our intent to sell the securities, the evidence available to determine if it is more likely than not that we will have to sell the securities before recovery of amortized cost, and the probable credit losses. Probable credit losses are evaluated using the present value of expected future cash flows; the severity and duration of the impairment; the issuer’s financial condition and near-term prospects to service the debt; the cause of the decline, such as adverse conditions related to the issuer, the industry, or economic environment; the payment structure of the debt; the issuer’s failure to make scheduled interest or principal payments; and any change in the issuer’s credit rating by rating agencies. If the present value of expected future cash flows discounted at the security's effective yield is less than the net book value, the difference is recognized as a credit-related OTTI in noninterest income. If we do not intend to sell and if we are not likely to be required to sell the security, the OTTI is separated into an amount representing the credit loss, which is recognized as a charge to noninterest income, and the amount representing all other factors, which is recognized in other comprehensive income (“OCI”). For equity securities, we consider our intent and ability to hold the security to recovery; the severity and duration of the impairment; the issuer’s financial condition, capital strength, and near-term prospects; and any change in the issuer’s credit rating by rating agencies. If the fair value of the security is less than the net book value, the OTTI is recognized as a charge to noninterest income. For additional information, see Note 3, “Investment Securities,” to the Consolidated Financial Statements in Item 8 of this report.

 

Allowance for Loan Losses

 

We review our allowance for loan losses quarterly to determine if it is sufficient to absorb probable loan losses in the portfolio. This determination requires management to make significant estimates and assumptions. While management uses its best judgment and available information, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of regulatory authorities towards loan classifications. These uncertainties may result in material changes to the allowance for loan losses in the near term; however, the amount of the change cannot reasonably be estimated.

 

Our allowance for loan losses consists of reserves assigned to specific loans and credit relationships and general reserves assigned to loans not separately identified that have been segmented into groups with similar risk characteristics using our internal risk grades. General reserve allocations are based on management’s judgments of qualitative and quantitative factors about macro and micro economic conditions reflected within the loan portfolio and the economy. Factors considered in this evaluation include, but are not limited to, probable losses from loan and other credit arrangements, general economic conditions, changes in credit concentrations or pledged collateral, historical loan loss experience, and trends in portfolio volume, maturities, composition, delinquencies, and nonaccruals. Historical loss rates for each risk grade of commercial loans are adjusted by environmental factors to estimate the amount of reserve needed by segment. Individually significant loans require additional analysis that may include the borrower’s underlying cash flow and capacity for debt repayment, specific business conditions, and value of secondary sources of repayment; consequently, this analysis may result in the identification of weakness and a corresponding need for a specific reserve. No allowance for loan losses is carried over or established at acquisition for purchased loans acquired in business combinations. A provision for loan losses is recorded for any credit deterioration in purchased performing loans after the acquisition date. Loans acquired in business combinations that are deemed impaired at acquisition, purchased credit impaired (“PCI”) loans, are grouped into pools and evaluated separately from the non-PCI portfolio. The estimated cash flows to be collected on PCI loans are discounted at a market rate of interest. Management believed the allowance was adequate to absorb probable loan losses inherent in the loan portfolio as of December 31, 2017. For additional information, see Note 6, “Allowance for Loan Losses,” to the Consolidated Financial Statements in Item 8 of this report.

 

Third-party collateral valuations are regularly obtained and evaluated to help management determine changes in cash flows on purchased loans acquired in business combinations, potential credit impairment, and the amount of impairment to record. Internal collateral valuations are generally performed within two to four weeks of identifying the initial potential impairment. The internal evaluation compares the original appraisal to current local real estate market conditions and considers experience and expected liquidation costs. When a third-party evaluation is received, it is reviewed for reasonableness. Once the evaluation is reviewed and accepted, discounts are applied to fair market value, based on, but not limited to, our historical liquidation experience for like collateral, resulting in an estimated net realizable value. The estimated net realizable value is compared to the outstanding loan balance to determine the appropriate amount of specific impairment reserve. Specific reserves are generally recorded for impaired loans while third-party evaluations are in process and for impaired loans that continue to make some form of payment. While waiting for receipt of the third-party appraisal, we regularly review the relationship to identify any potential adverse developments and begin the tasks necessary to gain control of the collateral and prepare it for liquidation, including, but not limited to, engagement of counsel, inspection of collateral, and continued communication with the borrower. Generally, the only difference between current appraised value, adjusted for liquidation costs, and the carrying amount of the loan, less the specific reserve, is any downward adjustment to appraised value that we determine appropriate, such as the costs to sell the property. Impaired loans that do not meet certain criteria and do not have a specific reserve have typically been written down through partial charge-offs to net realizable value. Based on prior experience, the Company rarely returns loans to performing status after they have been partially charged off. Impaired credits move quickly through the process towards ultimate resolution except in cases involving bankruptcy and various state judicial processes, which may extend the time for ultimate resolution.

 

 

Goodwill and Other Intangible Assets

 

We test goodwill annually, or more frequently if necessary, using a qualitative assessment to determine if it is more likely than not that the fair value of a reporting unit is less than its carrying amount. We have one reporting unit for goodwill impairment testing purposes -- Community Banking. Prior to October 2016, we maintained two reporting units -- Community Banking and Insurance Services. The Insurance Services reporting unit consisted of the Company’s wholly owned subsidiary Greenpoint, which was sold in October 2016. We performed our annual assessment of goodwill as of October 31, 2017, and concluded that our carrying value of goodwill was not impaired. Qualitative factors considered in the analysis included macroeconomic conditions, industry and market considerations, overall financial performance, changes in stock price, and our progress towards stated objectives as compared to prior years. An impairment charge to goodwill and other intangible assets may be required in the future if the Company’s future earnings and cash flows decline or discount rates used in determining fair value increase. For additional information, see Note 9, “Goodwill and Other Intangible Assets,” to the Consolidated Financial Statements in Item 8 of this report.

 

Income Taxes

 

The establishment of provisions for federal and state income taxes is a complex area of accounting that involves judgments and estimates in applying relevant tax statutes. We operate in many state tax jurisdictions, which requires the appropriate allocation of income and expense to each state based on a variety of apportionment or allocation bases. Audits by federal and state tax authorities may reveal liabilities that differ from our estimates and provisions. We continually evaluate our exposure to possible tax assessments arising from audits and record an estimate of possible exposure based on current facts and circumstances.

 

We measure deferred tax assets and liabilities using the enacted tax rates applicable in the periods we expect temporary differences to be realized or settled. As changes in tax laws and rates are enacted, we adjust deferred tax assets and liabilities through the provision for income taxes. When evidence indicates that it is more likely than not that some, or all, of the deferred tax asset is not recoverable, we may record a valuation allowance to reduce the carrying value of the asset. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.

 

The Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted on December 22, 2017. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21%; eliminates the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable year; limits the deduction for net interest expense incurred by U.S. corporations; allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets for tax purposes; eliminates or reduces certain deductions related to meals and entertainment expenses; modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee; and limits the deductibility of deposit insurance premiums. The Tax Reform Act also significantly changes U.S. tax law related to foreign operations, however, such changes do not currently impact us. As a result of the Tax Reform Act, we recognized income tax expense totaling $6.55 million related to the revaluation of our deferred tax balances, which includes provisional estimates primarily related to certain purchase accounting, indemnification asset, intangible, and depreciation items. We are still analyzing certain aspects of the Tax Reform Act and refining calculations, which could potentially affect the measurement of these balances. Based on current projections, we expect that our effective tax rate for 2018 will be approximately 22% to 23% under the new tax law; however, there can be no assurance to the actual amount as it is dependent upon the nature and amount of future income and expenses and transactions with discrete tax effects. For additional information, see Note 15, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report.

 

Performance Overview

 

Highlights of our results of operations in 2017, and financial condition as of December 31, 2017, include the following:

 

●

Pre-tax income increased $4.17 million, or 10.98%, to $42.11 million compared to the prior year.

 

 

●

Net income decreased $3.64 million, or 14.49%, and diluted earnings per share decreased $0.19 to $1.26 compared to the prior year. Excluding the impact of the $6.55 million tax expense related to the Tax Reform Act, net income increased $2.91 million, or 11.59% to $28.04 million compared to the prior year.

●

The GAAP efficiency ratio improved to 60.44%, from 64.98%, and the non-GAAP efficiency ratio improved to 58.07%, from 61.75%, compared to the prior year.

●

Net interest margin increased 22 basis points to 4.23% and normalized net interest margin increased 18 basis points to 3.97% compared to the prior year.

●

Net charge-offs decreased $2.10 million, or 59.23%, to $1.44 million compared to the prior year.

●

Tangible book value per common share increased $0.75 to $14.64 compared to the prior year. The Company and the Bank both significantly exceed regulatory “well capitalized” targets as of December 31, 2017.

 

Results of Operations

 

Net Income

 

The following table presents the changes in net income and related information for the periods indicated:

                           

														2017 Compared to 2016								2016 Compared to 2015
		Year Ended December 31,												Increase				%				Increase				%
		2017				2016				2015				(Decrease)				Change				(Decrease)				Change
(Amounts in thousands, except per share data)
Net income		$	21,485			$	25,126			$	24,540			$	(3,641	)			-14.49	%		$	586				2.39	%
Net income available to common shareholders			21,485				25,126				24,435				(3,641	)			-14.49	%			691				2.83	%
Basic earnings per common share			1.26				1.45				1.32				(0.19	)			-13.10	%			0.13				9.85	%
Diluted earnings per common share			1.26				1.45				1.31				(0.19	)			-13.10	%			0.14				10.69	%
Return on average assets			0.91	%			1.02	%			0.97	%			-0.11	%			-10.93	%			0.05	%			5.57	%
Return on average common equity			6.14	%			7.42	%			7.08	%			-1.28	%			-17.24	%			0.34	%			4.80	%

 

2017 Compared to 2016. Net income decreased in 2017 due to increases in income tax expense, driven by tax expense related to the Tax Reform Act, and the provision for loan losses and decrease in noninterest income. These changes were offset by an increase in net interest income and a decrease in noninterest expense.

 

2016 Compared to 2015. Net income increased in 2016 due to decreases in noninterest expense and in the provision for loan losses and an increase in net interest income. These changes were offset by a decrease in noninterest income and increase in income tax expense.

 

 

Net Interest Income

 

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” below. The following table presents the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

 

		Year Ended December 31,
		2017												2016												2015
(Amounts in thousands)		Average Balance				Interest(1)				Average Yield/ Rate(1)				Average Balance				Interest(1)				Average Yield/ Rate(1)				Average Balance				Interest(1)				Average Yield/ Rate(1)
Assets
Earning assets
Loans(2)		$	1,837,092			$	90,032				4.90	%		$	1,793,618			$	87,848				4.90	%		$	1,680,021			$	87,768				5.22	%
Securities available for sale			164,489				5,695				3.46	%			287,332				8,047				2.80	%			363,359				9,575				2.64	%
Securities held to maturity			32,954				487				1.48	%			71,069				757				1.07	%			70,987				770				1.08	%
Interest-bearing deposits			73,405				1,008				1.37	%			18,864				153				0.81	%			98,639				267				0.27	%
Total earning assets			2,107,940			$	97,222				4.61	%			2,170,883			$	96,805				4.46	%			2,213,006			$	98,380				4.44	%
Other assets			262,381												284,575												307,928
Total assets		$	2,370,321											$	2,455,458											$	2,520,934
Liabilities
Interest-bearing deposits
Demand deposits		$	401,092			$	412				0.10	%		$	342,169			$	250				0.07	%		$	343,036			$	203				0.06	%
Savings deposits			520,430				148				0.03	%			531,050				248				0.05	%			532,221				367				0.07	%
Time deposits			510,411				4,427				0.87	%			525,162				3,981				0.76	%			631,654				5,308				0.84	%
Total interest-bearing deposits			1,431,933				4,987				0.35	%			1,398,381				4,479				0.32	%			1,506,911				5,878				0.39	%
Borrowings
Federal funds purchased			1				-				0.00	%			4,058				26				0.64	%			535				2				0.37	%
Retail repurchase agreements			47,716				32				0.07	%			68,701				49				0.07	%			71,262				68				0.10	%
Wholesale repurchase agreements			25,000				806				3.22	%			49,727				1,874				3.77	%			50,000				1,878				3.76	%
FHLB advances and other borrowings			55,502				2,265				4.08	%			116,602				3,416				2.93	%			89,400				3,523				3.94	%
Total borrowings			128,219				3,103				2.42	%			239,088				5,365				2.24	%			211,197				5,471				2.59	%
Total interest-bearing liabilities			1,560,152				8,090				0.52	%			1,637,469				9,844				0.60	%			1,718,108				11,349				0.66	%
Noninterest-bearing demand deposits			438,513												456,474												433,936
Other liabilities			21,955												23,040												20,691
Total liabilities			2,020,620												2,116,983												2,172,735
Stockholders' equity			349,701												338,475												348,199
Total liabilities and equity		$	2,370,321											$	2,455,458											$	2,520,934
Net interest income, FTE						$	89,132											$	86,961											$	87,031
Net interest rate spread, FTE											4.09	%											3.86	%											3.78	%
Net interest margin, FTE											4.23	%											4.01	%											3.93	%

                                                                                           

(1)	Fully taxable equivalent ("FTE") basis based on the federal statutory rate of 35%
(2)	Nonaccrual loans are included in average balances; however, no related interest income is recognized during the period of nonaccrual.

 

 

The following table presents the impact to net interest income on a FTE basis due to changes in volume (average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

 

		Year Ended																Year Ended
		December 31, 2017 Compared to 2016																December 31, 2016 Compared to 2015
		Dollar Increase (Decrease) due to																Dollar Increase (Decrease) due to
										Rate/																Rate/
(Amounts in thousands)		Volume				Rate				Volume				Total				Volume				Rate				Volume				Total
Interest earned on(1):
Loans(2)		$	2,130			$	-			$	54			$	2,184			$	5,930			$	(5,376	)		$	(474	)		$	80
Securities available for sale			(3,440	)			1,896				(808	)			(2,352	)			(2,007	)			581				(102	)			(1,528	)
Securities held to maturity			(408	)			291				(153	)			(270	)			1				(7	)			(7	)			(13	)
Interest-bearing deposits with other banks			442				106				307				855				(215	)			533				(432	)			(114	)
Total interest-earning assets			(1,276	)			2,293				(600	)			417				3,709				(4,269	)			(1,015	)			(1,575	)
Interest paid on(1):
Demand deposits			41				103				18				162				(1	)			34				14				47
Savings deposits			(5	)			(106	)			11				(100	)			(1	)			(106	)			(12	)			(119	)
Time deposits			(112	)			578				(20	)			446				(895	)			(505	)			73				(1,327	)
Federal funds purchased			(26	)			(26	)			26				(26	)			13				1				10				24
Retail repurchase agreements			(15	)			-				(2	)			(17	)			(3	)			(21	)			5				(19	)
Wholesale repurchase agreements			(932	)			(273	)			137				(1,068	)			(10	)			5				1				(4	)
FHLB advances and other Borrowings			(1,790	)			1,341				(702	)			(1,151	)			1,072				(903	)			(276	)			(107	)
Total interest-bearing liabilities			(2,839	)			1,617				(532	)			(1,754	)			175				(1,495	)			(185	)			(1,505	)
Change in net interest income,
FTE		$	1,563			$	676			$	(68	)		$	2,171			$	3,534			$	(2,774	)		$	(830	)		$	(70	)

                                                                           

(1)	FTE basis based on the federal statutory rate of 35%
(2)	Nonaccrual loans are included in average balances; however, no related interest income is recognized during the period of nonaccrual.

 

The following table presents the net interest analysis on a FTE basis excluding the impact of non-cash purchase accounting accretion from acquired loan portfolios for the periods indicated:

 

		Year Ended December 31,
		2017								2016								2015
(Amounts in thousands)		Interest(1)				Average Yield/ Rate(1)				Interest(1)				Average Yield/ Rate(1)				Interest(1)				Average Yield/ Rate(1)
Earning assets
Loans(2)		$	90,032				4.90	%		$	87,848				4.90	%		$	87,768				5.22	%
Accretion income			7,863								7,690								11,258
Less: cash accretion income			2,446								2,924								4,149
Non-cash accretion income			5,417								4,766								7,109
Loans, normalized(3)			84,615				4.61	%			83,082				4.63	%			80,659				4.80	%
Other earning assets			7,190				2.65	%			8,957				2.37	%			10,612				1.99	%
Total earning assets			91,805				4.36	%			92,039				4.24	%			91,271				4.12	%
Total interest-bearing liabilities			8,090				0.52	%			9,844				0.60	%			11,349				0.66	%
Net interest income, normalized(3)		$	83,715							$	82,195							$	79,922
Net interest rate spread, normalized(3)							3.84	%							3.64	%							3.46	%
Net interest margin, normalized(3)							3.97	%							3.79	%							3.61	%

                                                                                                                      

(1)	FTE basis based on the federal statutory rate of 35%
(2)	Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.
(3)	Normalized totals are non-GAAP financial measures that exclude non-cash loan interest accretion related to PCI loans.

 

 

2017 Compared to 2016. Net interest income comprised 76.87% of total net interest and noninterest income in 2017 compared to 75.82% in 2016. Net interest income on a GAAP basis increased $2.34 million, or 2.75%, and net interest income on a FTE basis increased $2.17 million, or 2.50%. Normalized net interest income on a FTE basis is a non-GAAP measure that excludes non-cash loan accretion income related to PCI loans. For additional information, see “Non-GAAP Financial Measures” below. Normalized net interest margin increased 18 basis points compared to an increase of 22 basis points on a FTE basis. Normalized net interest spread increased 20 basis points compared to an increase of 23 basis points on a FTE basis.

 

Average earning assets decreased $62.94 million, or 2.90%, primarily due to decreases in investment securities offset by an increase in interest-bearing deposits and loan growth. The normalized yield on earning assets increased 12 basis points compared to an increase of 15 basis points on a GAAP basis. Average loans increased $43.47 million, or 2.42%, and the average loan to deposit ratio increased to 98.22% from 96.70%. The normalized yield on loans decreased 2 basis points while remaining constant on a GAAP basis. Non-cash accretion income increased $651 thousand, or 13.66%.

 

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $77.32 million, or 4.72%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 8 basis points, largely driven by a decrease in the average balance of borrowings. Average borrowings decreased $110.87 million, or 46.37%, largely due to a $61.10 million, or 52.40%, decrease in average FHLB advances and other borrowings, a $24.73 million, or 49.73%, decrease in average wholesale repurchase agreements, a $20.99 million, or 30.55%, decrease in average retail repurchase agreements, and a $4.06 million, or 99.98%, decrease in average federal funds purchased. Average interest-bearing deposits increased $33.55 million, or 2.40%, which was driven by a $58.92 million, or 17.22%, increase in average interest-bearing demand deposits offset by a $14.75 million, or 2.81%, decrease in average time deposits, and a $10.62 million, or 2.00%, decrease in average savings deposits, which include money market and savings accounts.

 

2016 Compared to 2015. Net interest income comprised 75.82% of total net interest and noninterest income in 2016 compared to 74.16% in 2015. Net interest income on a GAAP basis increased $127 thousand, or 0.15%, and net interest income on a FTE basis decreased $70 thousand, or 0.08%. Normalized net interest income on a FTE basis is a non-GAAP measure that excludes non-cash loan accretion income related to PCI loans. For additional information, see “Non-GAAP Financial Measures” below. Normalized net interest margin increased 18 basis points compared to an increase of 8 basis points on a FTE basis. The normalized and FTE net interest spread increased 18 basis points.

 

Average earning assets decreased $42.12 million, or 1.90%, primarily due to decreases in securities available for sale and interest-bearing deposits offset by loan growth. The normalized yield on earning assets increased 12 basis points compared to an increase of 2 basis points on a GAAP basis. Average loans increased $113.60 million, or 6.76%, and the average loan to deposit ratio increased to 96.70% from 86.56%. The normalized yield on loans decreased 17 basis points compared to a decrease of 32 basis points on a GAAP basis. Non-cash accretion income decreased $2.34 million, or 32.96%, as the effect of accretion income continued to decline from acquired portfolio attrition.

 

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $80.64 million, or 4.69%, primarily due to a decline in average interest-bearing time deposit balances. The yield on interest-bearing liabilities decreased 6 basis points, which was comprised of a 7 basis point decrease in the rate on interest-bearing deposits and a 1 basis point increase in the rate on borrowings. Average interest-bearing deposits decreased $108.53 million, or 7.20%, which was driven by a $106.49 million, or 16.86%, decrease in average time deposits, a $1.17 million, or 0.22%, decrease in savings deposits, which include money market and savings accounts, and an $867 thousand, or 0.25%, decrease in interest-bearing demand deposits. Average borrowings increased $27.89 million, or 13.21%, largely due to a $27.20 million, or 30.43%, increase in average FHLB advances and other borrowings.

 

Provision for Loan Losses

 

2017 Compared to 2016. The provision charged to operations increased $1.52 million to $2.77 million, which included a $1.49 million increase in the non-PCI provision to $2.78 million and a $30 thousand increase in the PCI provision to a recovery of $12 thousand.

 

2016 Compared to 2015. The provision charged to operations decreased $936 thousand to $1.26 million, which included an $870 thousand decrease in the non-PCI provision to $1.30 million and a $66 thousand decrease in the PCI provision to a recovery of $41 thousand. The provision charged to operations included a $1 thousand benefit attributed to the FDIC indemnification asset to reflect the indemnified portion of the post-acquisition exposure. The reduction in the non-PCI provision was partially due to the reversal of loan loss reserves totaling $1.35 million attributed to loans divested in the First Bank transaction.

 

 

Noninterest Income

 

The following table presents the components of, and changes in, noninterest income for the periods indicated:

 

														2017 Compared to 2016								2016 Compared to 2015
		Year Ended December 31,												Increase				%				Increase				%
		2017				2016				2015				(Decrease)				Change				(Decrease)				Change
(Amounts in thousands)
Wealth management		$	3,150			$	2,828			$	2,975			$	322				11.39	%		$	(147	)			-4.94	%
Service charges on deposits			13,803				13,588				13,717				215				1.58	%			(129	)			-0.94	%
Other service charges and fees			8,624				8,102				8,045				522				6.44	%			57				0.71	%
Insurance commissions			1,347				5,442				6,899				(4,095	)			-75.25	%			(1,457	)			-21.12	%
Net impairment loss			-				(4,646	)			-				4,646				-100.00	%			(4,646	)			-
Net (loss) gain on sale of securities			(661	)			335				144				(996	)			-297.31	%			191				132.64	%
Net FDIC indemnification asset amortization			(3,517	)			(5,474	)			(6,379	)			1,957				-35.75	%			905				-14.19	%
Net gain on divestitures			-				3,682				-				(3,682	)			-100.00	%			3,682				-
Other operating income			3,502				3,209				4,129				293				9.13	%			(920	)			-22.28	%
Total noninterest income		$	26,248			$	27,066			$	29,530			$	(818	)			-3.02	%		$	(2,464	)			-8.34	%

 

2017 Compared to 2016. Noninterest income comprised 23.13% of total net interest and noninterest income in 2017 compared to 24.18% in 2016. Noninterest income decreased $818 thousand, or 3.02%, primarily due to a decrease in insurance commissions and the associated net gain related to the Greenpoint divestiture in the fourth quarter of 2016 and divestiture of six bank branches to First Bank in the third quarter of 2016. The decrease was largely offset by the absence of net impairment losses and the decrease in net negative amortization related to the FDIC indemnification asset as loss share coverage on commercial loans expired on June 30, 2017. We recognized a net loss of $661 thousand on the sale of securities related primarily to certain single issue trust preferred securities. See Note 3, “Investment Securities,” to the Consolidated Financial Statements in Item 1 of this report. Excluding the impact from impairment losses, sales of securities and branches, net FDIC indemnification asset amortization, the net gain on divestitures, and bank owned life insurance proceeds, noninterest income decreased $2.76 million, or 8.44%, to $29.97 million in 2017, from $32.73 million in 2016. The decrease was primarily due to the $4.10 million decrease in insurance commissions resulting from the Greenpoint divestiture offset by increases in wealth management income, service charges and fees, and other operating income.

 

2016 Compared to 2015. Noninterest income comprised 24.18% of total net interest and noninterest income in 2016 compared to 25.84% in 2015. Noninterest income decreased $2.46 million, or 8.34%, in 2016 primarily due to net impairment losses offset by a net gain on divestitures and a decrease in insurance commissions. We realized net impairment losses of $4.64 million on certain debt securities and $11 thousand on certain equity securities. We realized a net gain of $3.68 million on the divestiture of Greenpoint and six bank branches. Insurance commissions decreased largely due to the Greenpoint divestiture. Other operating income decreased primarily due to the absence of a $1.14 million net death benefit from the maturity of a life insurance policy recognized in 2015 offset by a $381 thousand gain on the sale of closed branches and $474 thousand in legal settlements. Net negative amortization related to the FDIC indemnification asset decreased as the expiration of the loss share agreement for commercial loans approaches. We recognized a net gain of $335 thousand on the sale of securities related primarily to certain Agency mortgage-backed securities. Excluding the impact from impairment losses, sales of securities and branches, net FDIC indemnification asset amortization, the net gain on divestitures, and net death benefits, noninterest income decreased $1.89 million, or 5.47%, to $32.73 million in 2016 from $34.62 million in 2015.

 

 

Noninterest Expense

 

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

 

														2017 Compared to 2016								2016 Compared to 2015
		Year Ended December 31,												Increase				%				Increase				%
		2017				2016				2015				(Decrease)				Change				(Decrease)				Change
(Amounts in thousands)
Salaries and employee benefits		$	36,317			$	39,912			$	39,625			$	(3,595	)			-9.01	%		$	287				0.72	%
Occupancy expense			4,775				5,297				5,817				(522	)			-9.85	%			(520	)			-8.94	%
Furniture and equipment expense			4,425				4,341				5,199				84				1.94	%			(858	)			-16.50	%
Amortization of intangibles			1,056				1,136				1,118				(80	)			-7.04	%			18				1.61	%
FDIC premiums and assessments			910				1,383				1,513				(473	)			-34.20	%			(130	)			-8.59	%
FHLB debt prepayment fees			-				-				1,702				-				-				(1,702	)			-100.00	%
Merger, acquisition, and divestiture expense			-				730				86				(730	)			-100.00	%			644				748.84	%
Other operating expense			21,099				19,947				21,111				1,152				5.78	%			(1,164	)			-5.51	%
Total noninterest expense		$	68,582			$	72,746			$	76,171			$	(4,164	)			-5.72	%		$	(3,425	)			-4.50	%

 

2017 Compared to 2016. Noninterest expense decreased $4.16 million, or 5.72%, in 2017 compared to 2016, which was largely due to a decrease in salaries and employee benefits coupled with the absence of merger, acquisition, and divestiture expense and decreases in occupancy, furniture, and equipment expense, FDIC premiums and assessments, and intangible amortization. Salaries and employee benefits decreased as full-time equivalent employees, calculated using the number of hours worked, decreased to 562 as of December 31, 2017, from 580 as of December 31, 2016. The increase in other operating expense included a $759 thousand increase in legal fees and write-downs on certain long-term investments in land and buildings totaling $552 thousand, which were offset by a $218 thousand decrease in the net loss on sales and expenses related to other real estate owned (“OREO”) to $1.20 million from $1.42 million in 2016.

 

2016 Compared to 2015. Noninterest expense decreased $3.43 million, or 4.50%, in 2016 compared to 2015, which was largely due to the absence of FHLB prepayment penalties and a decrease in operating expenses. The decrease in other operating expense was primarily due to a $1.02 million decrease in the net loss on sales and expenses related to OREO to $1.42 million from $2.44 million in 2015. The decrease was offset by a $535 thousand increase in consulting fees and a $425 thousand increase in legal fees. We incurred expenses totaling $730 thousand related to the First Bank branch exchange and divestiture of Greenpoint. Occupancy, furniture, and equipment expense decreased $1.38 million, or 12.51%, due to branch closures and divestitures. Full-time equivalent employees decreased to 580 as of December 31, 2016, from 673 as of December 31, 2015, primarily due to personnel restructuring as a result of the First Bank and Greenpoint transactions.

 

Income Tax Expense

 

2017 Compared to 2016. Income tax expense increased $7.81 million, or 60.92%, and the effective tax rate increased to 48.98% compared to 33.78% in the prior year. The increase was largely attributed to tax expense of $6.55 million related to the revaluation of our net deferred tax asset in accordance with the Tax Reform Act. Excluding the impact of the revaluation, income tax expense increased $1.26 million, or 9.81%, and the effective rate decreased 36 basis points to 33.42% largely from a decrease in taxable revenues as a percent of operating earnings. For additional information, see Note 15, “Income Taxes,” to the Consolidated Financial Statements in Item 8 of this report.

 

2016 Compared to 2015. Income tax expense increased $1.44 million, or 12.64%, and the effective tax rate increased 210 basis points to 33.78%. The increase in the effective tax rate was largely due to an increase in taxable revenues as a percent of operating earnings and non-deductible goodwill related to the Greenpoint divestiture.

 

Non-GAAP Financial Measures

 

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that management believes provide investors with important information useful in understanding our operational performance and comparing our financial measures with other financial institutions. The non-GAAP financial measures presented in this report include net interest income on a FTE basis and normalized net interest income on a FTE basis. While we believe these non-GAAP financial measures enhance understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared on a GAAP basis. Our non-GAAP financial measures may not be comparable to those reported by other financial institutions. The reconciliations of these measures to GAAP measures are presented below.

 

 

We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. The FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory rate of 35%. Normalized net interest income on a FTE basis is a non-GAAP measure that excludes non-cash loan accretion income related to PCI loans.

 

The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

 

		Year Ended December 31,
		2017				2016				2015
(Amounts in thousands)
Net interest income, GAAP		$	87,218			$	84,880			$	84,753
FTE adjustment(1)			1,914				2,081				2,278
Net interest income, FTE			89,132				86,961				87,031
Less: non-cash accretion income(2)			5,417				4,766				7,109
Net interest income, normalized		$	83,715			$	82,195			$	79,922
Net interest margin, GAAP			4.14	%			3.91	%			3.83	%
FTE adjustment(1)			0.09	%			0.10	%			0.10	%
Net interest margin, FTE			4.23	%			4.01	%			3.93	%
Less: non-cash accretion income(2)			0.26	%			0.22	%			0.32	%
Net interest margin, normalized			3.97	%			3.79	%			3.61	%

                                                                                                                          

(1)	FTE basis based on the federal statutory rate of 35%
(2)	Includes non-cash purchase accounting accretion income from acquired loan portfolios

 

 

We believe the efficiency ratio provides investors with important information about our operating expense control and efficiency of operations. Management also believes this non-GAAP measure focuses attention on our core operating performance over time. The following table reconciles the GAAP-based efficiency ratio to the non-GAAP efficiency ratio for the periods indicated:

 

		Year Ended December 31,
(Amounts in thousands)		2017				2016				2015
GAAP efficiency ratio
Noninterest expense		$	68,582			$	72,746			$	76,171
Net interest income			87,218				84,880				84,753
Noninterest income			26,248				27,066				29,530
Net interest income plus noninterest income			113,466				111,946				114,283
GAAP efficiency ratio			60.44	%			64.98	%			66.65	%
Non-GAAP efficiency ratio
Noninterest expense, GAAP		$	68,582			$	72,746			$	76,171
Non-GAAP adjustments
Merger, acquisition, and divestiture expense			-				(730	)			(86	)
FHLB debt prepayment fees			-				-				(1,702	)
OREO expense and net loss			(1,202	)			(1,420	)			(2,438	)
Other non-core items			(391	)			(364	)			(259	)
Total non-GAAP adjustments			(1,593	)			(2,514	)			(4,485	)
Adjusted noninterest expense			66,989				70,232				71,686
Net interest income plus noninterest income, GAAP			113,466				111,946				114,283
Non-GAAP adjustments
Tax equivalency adjustment			1,914				2,081				2,950
Net impairment losses			-				4,646				-
Net loss (gain) on sale of securities			661				(335	)			(144	)
Net gain on divestitures			-				(3,682	)			-
Other non-core items			(689	)			(918	)			(1,263	)
Total non-GAAP adjustments			1,886				1,792				1,543
Adjusted net interest income plus noninterest income			115,352				113,738				115,826
Non-GAAP efficiency ratio(1)			58.07	%			61.75	%			61.89	%

                                                                                                                                                   

(1)	A non-GAAP financial measure computed by dividing adjusted noninterest expense by the sum of tax equivalent net interest income and adjusted noninterest income

 

Financial Condition

 

Total assets as of December 31, 2017, increased $2.06 million, or 0.09%, to $2.39 billion from $2.39 billion as of December 31, 2016. Total liabilities as of December 31, 2017, decreased $9.60 million, or 0.47%, to $2.04 billion from $2.05 billion as of December 31, 2016.

 

Investment Securities

 

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

 

Available-for-sale securities as of December 31, 2017, remained relatively constant compared to December 31, 2016, with a change in composition resulting from the purchase of U.S. Treasury securities offset by the maturity and sale of municipal, single-issue trust preferred, and mortgage-backed Agency securities. Held-to-maturity securities as of December 31, 2017, decreased $21.98 million, or 46.64%, compared to December 31, 2016, primarily due to the maturity of U.S. Agency securities.

 

 

The following table presents the amortized cost and fair value of investment securities as of the dates indicated:

 

		December 31,
		2017								2016								2015
		Amortized				Fair				Amortized				Fair				Amortized				Fair
(Amounts in thousands)		Cost				Value				Cost				Value				Cost				Value
Available for Sale
U.S. Agency securities		$	11,289			$	11,296			$	1,342			$	1,345			$	31,414			$	30,702
U.S. Treasury securities			19,987				19,971				-				-				-				-
Municipal securities			101,552				103,648				111,659				113,331				124,880				128,678
Single issue trust preferred securites			9,367				8,884				22,104				19,939				55,882				47,832
Corporate securities			-				-				-				-				70,571				70,333
Certificates of deposit			-				-				-				-				5,000				5,000
Mortgage-backed Agency securities			22,095				21,726				31,290				30,891				84,576				83,556
Equity securities			55				55				55				73				66				72
Total securities available for sale		$	164,345			$	165,580			$	166,450			$	165,579			$	372,389			$	366,173
Fair value to amortized cost							100.75	%							99.48	%							98.33	%
Held to Maturity
U.S. Agency securities		$	17,937			$	17,888			$	36,741			$	36,865			$	61,863			$	61,832
Municipal securities			-				-				-				-				190				193
Corporate securities			7,212				7,196				10,392				10,401				10,488				10,465
Total securities held to maturity		$	25,149			$	25,084			$	47,133			$	47,266			$	72,541			$	72,490
Fair value to amortized cost							99.74	%							100.28	%							99.93	%

 

The following table provides information about our investment portfolio as of the dates indicated:

 

		December 31,
		2017												2016
		Available for Sale				Held to Maturity				Total				Available for Sale				Held to Maturity				Total
(Amounts in years)
Average life			5.44				1.11				4.87				7.75				1.30				6.32
Average duration			4.74				1.09				4.26				6.66				1.26				5.47

 

There were no holdings of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of our total consolidated shareholders’ equity as of December 31, 2017 or 2016.

 

 

The following tables present the amortized cost, fair value, and weighted-average yield of available-for-sale and held-to-maturity securities, by contractual maturity, as of December 31, 2017. Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.

 

		Available-for-Sale Securities
(Amounts in thousands)		U.S. Agency Securities				U.S. Treasury Securities				Municipal Securities				Corporate Notes				Total				Tax Equivalent Purchase Yield(1)
Amortized cost maturity:
One year or less		$	10,065			$	19,987			$	-			$	-			$	30,052				1.17	%
After one year through five years			-				-				7,193				-				7,193				4.57	%
After five years through ten years			1,224				-				90,062				9,367				100,653				4.15	%
After ten years			-				-				4,297				-				4,297				4.43	%
Amortized cost		$	11,289			$	19,987			$	101,552			$	9,367				142,195
Mortgage-backed securities																			22,095				2.18	%
Equity securities																			55				0.00	%
Total amortized cost																		$	164,345
Tax equivalent purchase yield(1)			1.46	%			1.13	%			4.39	%			2.08	%			3.55	%
Average contractual maturity (in years)			1.37				0.25				7.48				9.08				6.09
Fair value maturity:
One year or less		$	10,055			$	19,971			$	-			$	-			$	30,026
After one year through five years			-				-				7,308				-				7,308
After five years through ten years			1,241				-				91,886				8,884				102,011
After ten years			-				-				4,454				-				4,454
Fair value		$	11,296			$	19,971			$	103,648			$	8,884				143,799
Mortgage-backed securities																			21,726
Equity securities																			55
Total fair value																		$	165,580

                                                                                        

(1)	FTE basis based on the federal statutory rate of 35%

 

		Held-to-Maturity Securities
(Amounts in thousands)		U.S. Agency Securities				Corporate Notes				Total				Tax Equivalent Purchase Yield(1)
Amortized cost maturity:
One year or less		$	-			$	-			$	-				0.00	%
After one year through five years			17,937				7,212				25,149				1.67	%
After five years through ten years			-				-				-				0.00	%
After ten years			-				-				-				0.00	%
Total amortized cost		$	17,937			$	7,212			$	25,149
Tax equivalent purchase yield(1)			1.59	%			1.84	%			1.67	%
Average contractual maturity (in years)			1.14				1.06				1.11
Fair value maturity:
One year or less		$	-			$	-			$	-
After one year through five years			17,888				7,196				25,084
After five years through ten years			-				-				-
After ten years			-				-				-
Total fair value		$	17,888			$	7,196			$	25,084

                                                                                                                

(1)	FTE basis based on the federal statutory rate of 35%

 

Investment securities are reviewed quarterly for possible other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt securities in 2017 or 2015. We recognized OTTI charges in earnings associated with debt securities of $4.64 million in 2016 due to our change in intent to hold certain trust preferred securities in our portfolio to recovery. These specific securities were sold to reduce credit concentrations with two issuers, which increased cash reserves and reduced exposure to the financial industry. We recognized no OTTI charges in earnings associated with equity securities in 2017 or 2015. We recognized OTTI charges in earnings associated with certain equity securities of $11 thousand in 2016. For additional information, see “Investment Securities” in the “Critical Accounting Estimates” section above and Note 3, “Investment Securities,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

Loans Held for Investment

 

Loans held for investment, our largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose. Certain loans acquired in FDIC-assisted transactions are covered under loss share agreements (“covered loans”). The general characteristics of each loan segment are as follows:

 

●

Commercial loans – This segment consists of loans to small and mid-size industrial, commercial, and service companies that include, but are not limited to, natural gas producers, retail merchants, and wholesale merchants. Commercial real estate projects represent a variety of sectors of the commercial real estate market, including single family and apartment lessors, commercial real estate lessors, and hotel/motel operators. Commercial loan underwriting guidelines require that comprehensive reviews and independent evaluations be performed on credits exceeding predefined size limits. Updates to these loan reviews are done periodically or annually depending on the size of the loan relationship.

●

Consumer real estate loans – This segment consists of loans to individuals within our market footprint for home equity loans and lines of credit and for the purchase or construction of owner occupied homes. Residential real estate loan underwriting guidelines require that borrowers meet certain credit, income, and collateral standards at origination.

●

Consumer and other loans – This segment consists of loans to individuals within our market footprint that include, but are not limited to, personal lines of credit, credit cards, and the purchase of automobiles, boats, mobile homes, and other consumer goods. Consumer loan underwriting guidelines require that borrowers meet certain credit, income, and collateral standards at origination.

 

Total loans held for investment, net of unearned income, as of December 31, 2017, decreased $35.76 million, or 1.93%, compared to December 31, 2016, primarily due to a $29.05 million, or 50.96%, decrease in covered loans due to the expiration of the commercial loss share agreement on June 30, 2017, and continued loan runoff in the remaining portfolio. Non-covered loans decreased $6.72 million, or 0.37%, which was driven by declines in residential real estate. We had no foreign loans or loan concentrations to any single borrower or industry, which are not otherwise disclosed as a category of loans, that represented 10% or more of outstanding loans, as of December 31, 2017 or 2016. For additional information, see Note 4, “Loans,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

The following table presents loans, net of unearned income and by loan class, as of the dates indicated:

 

		December 31,
(Amounts in thousands)		2017				2016				2015				2014				2013
Non-covered loans held for investment
Commercial loans
Construction, development, and other land		$	60,017			$	56,948			$	48,896			$	41,271			$	35,255
Commercial and industrial			92,188				92,204				88,903				83,099				95,455
Multi-family residential			125,202				134,228				95,026				97,480				70,197
Single family non-owner occupied			141,670				142,965				149,351				135,171				135,559
Non-farm, non-residential			616,633				598,674				485,460				473,906				475,911
Agricultural			7,035				6,003				2,911				1,599				2,324
Farmland			25,649				31,729				27,540				29,517				32,614
Total commercial loans			1,068,394				1,062,751				898,087				862,043				847,315
Consumer real estate loans
Home equity lines			103,205				106,361				107,367				110,957				111,770
Single family owner occupied			502,686				500,891				495,209				485,475				496,012
Owner occupied construction			39,178				44,535				43,505				32,799				28,703
Total consumer real estate loans			645,069				651,787				646,081				629,231				636,485
Consumer and other loans
Consumer loans			70,772				77,445				72,000				69,347				71,313
Other			5,001				3,971				7,338				6,555				3,926
Total consumer and other loans			75,773				81,416				79,338				75,902				75,239
Total non-covered loans			1,789,236				1,795,954				1,623,506				1,567,176				1,559,039
Total covered loans			27,948				56,994				83,035				122,240				151,682
Total loans held for investment, net of unearned income			1,817,184				1,852,948				1,706,541				1,689,416				1,710,721
Less: allowance for loan losses			19,276				17,948				20,233				20,227				24,077
Total loans held for investment, net of unearned income and allowance		$	1,797,908			$	1,835,000			$	1,686,308			$	1,669,189			$	1,686,644
Loans held for sale		$	-			$	-			$	-			$	1,792			$	883

 

The following table presents covered loans, by loan class, as of the dates indicated:

 

		December 31,
(Amounts in thousands)		2017				2016				2015				2014				2013
Commercial loans
Construction, development, and other land		$	39			$	4,570			$	6,303			$	13,100			$	15,865
Commercial and industrial			-				895				1,170				2,662				3,325
Multi-family residential			-				8				640				1,584				1,933
Single family non-owner occupied			284				962				2,674				5,918				7,449
Non-farm, non-residential			9				7,512				14,065				25,317				34,646
Agricultural			-				25				34				43				164
Farmland			-				397				643				716				873
Total commercial loans			332				14,369				25,529				49,340				64,255
Consumer real estate loans
Home equity lines			23,720				35,817				48,565				60,391				69,206
Single family owner occupied			3,896				6,729				8,595				11,968				16,919
Owner occupied construction			-				-				262				453				1,184
Total consumer real estate loans			27,616				42,546				57,422				72,812				87,309
Consumer and other loans
Consumer loans			-				79				84				88				118
Total covered loans		$	27,948			$	56,994			$	83,035			$	122,240			$	151,682

 

 

The following table presents the percentage of loans to total loans in the non-covered portfolio, by loan class, as of the dates indicated:

 

		December 31,
		2017				2016				2015				2014				2013
Commercial loans
Construction, development, and other land			3.36	%			3.17	%			3.01	%			2.64	%			2.26	%
Commercial and industrial			5.15	%			5.13	%			5.48	%			5.30	%			6.12	%
Multi-family residential			7.00	%			7.47	%			5.85	%			6.22	%			4.50	%
Single family non-owner occupied			7.92	%			7.96	%			9.20	%			8.63	%			8.70	%
Non-farm, non-residential			34.46	%			33.34	%			29.90	%			30.24	%			30.53	%
Agricultural			0.39	%			0.34	%			0.18	%			0.10	%			0.15	%
Farmland			1.43	%			1.77	%			1.70	%			1.88	%			2.09	%
Total commercial loans			59.71	%			59.18	%			55.32	%			55.01	%			54.35	%
Consumer real estate loans
Home equity lines			5.77	%			5.92	%			6.62	%			7.08	%			7.17	%
Single family owner occupied			28.09	%			27.89	%			30.50	%			30.98	%			31.82	%
Owner occupied construction			2.19	%			2.48	%			2.68	%			2.09	%			1.84	%
Total consumer real estate loans			36.05	%			36.29	%			39.80	%			40.15	%			40.83	%
Consumer and other loans
Consumer loans			3.96	%			4.31	%			4.43	%			4.42	%			4.57	%
Other			0.28	%			0.22	%			0.45	%			0.42	%			0.25	%
Total consumer and other loans			4.24	%			4.53	%			4.88	%			4.84	%			4.82	%
Total non-covered loans			100.00	%			100.00	%			100.00	%			100.00	%			100.00	%

 

The following table presents the percentage of loans to total loans in the covered portfolio, by loan class, as of the dates indicated:

 

		December 31,
		2017				2016				2015				2014				2013
Commercial loans
Construction, development, and other land			0.14	%			8.02	%			7.59	%			10.72	%			10.46	%
Commercial and industrial			0.00	%			1.57	%			1.41	%			2.18	%			2.19	%
Multi-family residential			0.00	%			0.01	%			0.77	%			1.30	%			1.27	%
Single family non-owner occupied			1.02	%			1.69	%			3.22	%			4.84	%			4.91	%
Non-farm, non-residential			0.03	%			13.18	%			16.94	%			20.71	%			22.84	%
Agricultural			0.00	%			0.04	%			0.04	%			0.03	%			0.11	%
Farmland			0.00	%			0.70	%			0.77	%			0.59	%			0.58	%
Total commercial loans			1.19	%			25.21	%			30.74	%			40.37	%			42.36	%
Consumer real estate loans
Home equity lines			84.87	%			62.84	%			58.49	%			49.40	%			45.63	%
Single family owner occupied			13.94	%			11.81	%			10.35	%			9.79	%			11.15	%
Owner occupied construction			0.00	%			0.00	%			0.32	%			0.37	%			0.78	%
Total consumer real estate loans			98.81	%			74.65	%			69.16	%			59.56	%			57.56	%
Consumer and other loans
Consumer loans			0.00	%			0.14	%			0.10	%			0.07	%			0.08	%
Total covered loans			100.00	%			100.00	%			100.00	%			100.00	%			100.00	%

 

 

The following table presents the maturities and rate sensitivities of the non-covered loan portfolio as of December 31, 2017:

 

		Due in One Year or Less				Due After One Year Through Five Years				Due After Five Years				Total
(Amounts in thousands)
Commercial loans
Construction, development, and other land(1)		$	17,946			$	15,243			$	26,828			$	60,017
Commercial and industrial			27,305				52,747				12,136				92,188
Multi-family residential			14,606				27,819				82,777				125,202
Single family non-owner occupied			15,515				28,653				97,502				141,670
Non-farm, non-residential			41,040				197,139				378,454				616,633
Agricultural			741				5,534				760				7,035
Farmland			5,227				9,193				11,229				25,649
Total commercial loans			122,380				336,328				609,686				1,068,394
Consumer real estate loans
Home equity lines			6,164				15,754				81,287				103,205
Single family owner occupied			3,701				33,301				465,684				502,686
Owner occupied construction			2,547				1,275				35,356				39,178
Total consumer real estate loans			12,412				50,330				582,327				645,069
Consumer and other loans
Consumer loans			13,046				55,820				1,906				70,772
Other			1,827				1,369				1,805				5,001
Total consumer and other loans			14,873				57,189				3,711				75,773
Total non-covered loans		$	149,665			$	443,847			$	1,195,724			$	1,789,236
Rate sensitivities
Predetermined interest rate		$	92,442			$	395,966			$	391,264			$	879,672
Floating or adjustable interest rate			57,223				47,881				804,460				909,564
Total non-covered loans		$	149,665			$	443,847			$	1,195,724			$	1,789,236

                                                                                          

(1)	Construction loans with maturities due after five years include construction to permanent loans that have not converted to principal and interest payments.

 

 

The following table presents the maturities and rate sensitivities of the covered loan portfolio as of December 31, 2017:

 

(Amounts in thousands)		Due in One Year or Less				Due After One Year Through Five Years				Due After Five Years				Total
Commercial loans
Construction, development, and other land		$	1			$	38			$	-			$	39
Single family non-owner occupied			-				258				26				284
Non-farm, non-residential			-				9				-				9
Total commercial loans			1				305				26				332
Consumer real estate loans
Home equity lines			395				11,774				11,551				23,720
Single family owner occupied			18				754				3,124				3,896
Total consumer real estate loans			413				12,528				14,675				27,616
Total covered loans		$	414			$	12,833			$	14,701			$	27,948
Rate sensitivities
Predetermined interest rate		$	6			$	989			$	3,033			$	4,028
Floating or adjustable interest rate			408				11,844				11,668				23,920
Total covered loans		$	414			$	12,833			$	14,701			$	27,948

 

Risk Elements

 

We seek to mitigate credit risk by following specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company’s loan review function generally analyzes all commercial loan relationships greater than $4.0 million annually and at various times during the year. Smaller commercial and retail loans are sampled for review during the year.

 

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. For additional information, see Note 5, “Credit Quality,” to the Consolidated Financial Statements in Item 8 of this report.

 

 

The following table presents the components of nonperforming assets and related information as of the periods indicated:

 

		December 31,
(Amounts in thousands)		2017				2016				2015				2014				2013
Non-covered nonperforming
Nonaccrual loans		$	18,997			$	15,854			$	17,847			$	10,556			$	19,161
Accruing loans past due 90 days or more			1				-				-				-				-
TDRs(1)			120				114				73				2,726				1,311
Total non-covered nonperforming loans			19,118				15,968				17,920				13,282				20,472
Non-covered OREO			2,409				5,109				4,873				6,638				7,318
Total non-covered nonperforming assets		$	21,527			$	21,077			$	22,793			$	19,920			$	27,790
Covered nonperforming
Nonaccrual loans		$	342			$	608			$	647			$	2,438			$	3,353
Accruing loans past due 90 days or more			-				-				-				-				86
Total covered nonperforming loans			342				608				647				2,438				3,439
Covered OREO			105				276				4,034				6,324				7,541
Total covered nonperforming assets		$	447			$	884			$	4,681			$	8,762			$	10,980
Total nonperforming
Nonaccrual loans		$	19,339			$	16,462			$	18,494			$	12,994			$	22,514
Accruing loans past due 90 days or more			1				-				-				-				86
TDRs(1)			120				114				73				2,726				1,311
Total nonperforming loans			19,460				16,576				18,567				15,720				23,911
OREO			2,514				5,385				8,907				12,962				14,859
Total nonperforming assets		$	21,974			$	21,961			$	27,474			$	28,682			$	38,770
Additional Information
Performing TDRs(2)		$	7,614			$	12,838			$	13,889			$	11,808			$	10,900
Total TDRs(3)			7,734				12,952				13,962				14,534				12,211
Gross interest income that would have been recorded under the original terms of restructured and nonperforming loans			1,217				1,414				1,645				1,171				1,548
Actual interest income recorded on restructured and nonperforming loans			222				424				608				597				511
Non-covered ratios
Nonperforming loans to total loans			1.07	%			0.89	%			1.10	%			0.85	%			1.31	%
Nonperforming assets to total assets			0.91	%			0.90	%			0.96	%			0.80	%			1.14	%
Non-PCI allowance to nonperforming loans			100.83	%			112.32	%			112.61	%			151.85	%			113.92	%
Non-PCI allowance to total loans			1.08	%			1.00	%			1.24	%			1.29	%			1.50	%
Total ratios
Nonperforming loans to total loans			1.07	%			0.89	%			1.09	%			0.93	%			1.40	%
Nonperforming assets to total assets			0.92	%			0.92	%			1.12	%			1.10	%			1.49	%
Allowance for loan losses to nonperforming loans			99.05	%			108.28	%			108.97	%			128.67	%			100.69	%
Allowance for loan losses to total loans			1.06	%			0.97	%			1.19	%			1.20	%			1.41	%

                                                                                                       

(1)	TDRs restructured within the past six months and nonperforming exclude nonaccrual TDRs of $169 thousand, $224 thousand, $923 thousand, $306 thousand, and $734 thousand for the five years ended December 31, 2017.
(2)	TDRs with six months or more of satisfactory payment performance exclude TDRs of $1.76 million, $1.06 million, $416 thousand, $248 thousand, and $1.47 million for the five years ended December 31, 2017.
(3)	Total TDRs exclude nonaccrual TDRs of $1.93 million, $1.28 million, $1.34 million, $554 thousand, and $2.20 million for the five years ended December 31, 2017.

 

Non-covered nonperforming assets as of December 31, 2017, increased $450 thousand, or 2.14%, from December 31, 2016, primarily due to an increase in non-covered nonaccrual loans. Non-covered nonaccrual loans as of December 31, 2017, increased $3.14 million, or 19.82%, from December 31, 2016. As of December 31, 2017, non-covered nonaccrual loans were largely attributed to single family owner occupied (69.00%) and non-farm, non-residential (12.89%) loans. As of December 31, 2017, approximately $673 thousand, or 3.54%, of non-covered nonaccrual loans were attributed to performing loans acquired in business combinations. Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

 

 

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $30.71 million as of December 31, 2017, an increase of $5.70 million, or 22.77%, compared to $25.02 million as of December 31, 2016. Non-covered delinquent loans as a percent of total non-covered loans totaled 1.71% as of December 31, 2017, which includes past due loans (0.65%) and nonaccrual loans (1.06%).

 

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms. Certain TDRs are classified as nonperforming when modified and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Accruing TDRs as of December 31, 2017, decreased $5.22 million, or 40.29%, to $7.73 million from December 31, 2016. Nonperforming accruing TDRs as of December 31, 2017, increased $6 thousand, or 5.26%, to $120 thousand from December 31, 2016. Nonperforming accruing TDRs as a percent of total accruing TDRs totaled 1.55% as of December 31, 2017, compared to 0.88% as of December 31, 2016. Specific reserves on TDRs totaled $642 thousand as of December 31, 2017, compared to $670 thousand as of December 31, 2016.

 

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, decreased $2.70 million, or 52.85%, as of December 31, 2017, compared to December 31, 2016. Non-covered OREO consisted of 16 properties with an average holding period of 12 months as of December 31, 2017. The net loss on the sale of OREO totaled $937 thousand in 2017, $1.15 million in 2016, and $1.85 million in 2015. The following table presents the changes in OREO during the periods indicated:

 

		Year Ended December 31,
		2017												2016
		Non-covered				Covered				Total				Non-covered				Covered				Total
(Amounts in thousands)
Beginning balance		$	5,109			$	276			$	5,385			$	4,873			$	4,034			$	8,907
Additions			2,204				79				2,283				3,962				1,200				5,162
Disposals			(4,165	)			(218	)			(4,383	)			(2,887	)			(4,405	)			(7,292	)
Valuation adjustments			(739	)			(32	)			(771	)			(839	)			(553	)			(1,392	)
Ending balance		$	2,409			$	105			$	2,514			$	5,109			$	276			$	5,385

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates. As of December 31, 2017, our qualitative risk factors reflect a stable risk of loan losses due to consistent asset quality metrics and relatively stable business and economic conditions in our primary market areas. The loan portfolio is continually monitored for deterioration in credit, which may result in the need to increase the allowance for loan losses in future periods. Management considered the allowance adequate as of December 31, 2017; however, no assurance can be made that additions to the allowance will not be required in future periods. For additional information, see “Allowance for Loan Losses” in the “Critical Accounting Estimates” section above and Note 6, “Allowance for Loan Losses,” to the Consolidated Financial Statements in Item 8 of this report.

 

The allowance for loan losses as of December 31, 2017, increased $1.33 million, or 7.40%, from December 31, 2016. The increase was largely attributed to a $1.74 million increase in specific reserves on impaired loans combined with a $700 thousand increase in unallocated reserves. The non-PCI allowance as a percent of non-covered loans totaled 1.08% as of December 31, 2017, compared to 1.00% as of December 31, 2016. PCI loans were aggregated into five loan pools as of December 31, 2017 and 2016; Waccamaw commercial, Waccamaw serviced home equity lines, Waccamaw residential, Peoples Bank of Virginia (“Peoples”) commercial, and Peoples residential. The cash flow analysis identified no impaired PCI loan pools as of December 31, 2017, compared to one impaired PCI loan pool with a cumulative impairment of $12 thousand as of December 31, 2016. Net charge-offs decreased $2.10 million, or 59.23%, in 2017 compared to 2016, largely due to an overall reduction in charge-offs for commercial real estate loans.

 

 

The following table presents the changes in the allowance for loan losses, by loan class, during the periods indicated:

 

		Year Ended December 31,
		2017				2016				2015				2014				2013
(Amounts in thousands)
Beginning balance		$	17,948			$	20,233			$	20,227			$	24,077			$	25,770
Removal of loans transferred(1)			-				-				-				(682	)			-
Provision for loan losses charged to operations, non-PCI loans			2,783				1,296				2,166				420				7,912
(Recovery of) provision for loan losses charged to operations, PCI loans			(12	)			(41	)			25				(275	)			296
(Recovery of) provision for loan losses recorded through the FDIC indemnification asset			-				(1	)			(29	)			(422	)			451
Charge-offs
Commercial loans
Construction, development, and other land			427				254				256				1,238				2,738
Commercial and industrial			224				144				93				459				720
Multi-family residential			9				64				-				35				17
Single family non-owner occupied			52				237				87				488				2,618
Non-farm, non-residential			142				1,684				773				832				1,613
Agricultural			-				-				-				-				17
Farmland			68				9				73				-				20
Consumer real estate loans
Home equity lines			13				1,073				92				451				1,873
Single family owner occupied			675				508				812				988				947
Owner occupied construction			11				31				2				305				295
Consumer and other loans
Consumer loans			658				457				461				659				491
Other			664				715				1,096				1,026				1,178
Total charge-offs			2,943				5,176				3,745				6,481				12,527
Recoveries
Commercial loans
Construction, development, and other land			306				282				135				84				510
Commercial and industrial(2)			160				484				173				1,736				98
Multi-family residential			9				15				-				10				16
Single family non-owner occupied			180				79				92				331				158
Non-farm, non-residential			146				59				74				239				119
Agricultural			-				-				-				-				22
Farmland			-				-				-				-				8
Consumer real estate loans
Home equity lines			201				137				402				514				273
Single family owner occupied			108				182				258				76				169
Owner occupied construction			105				39				18				-				-
Consumer and other
Consumer loans			137				123				101				121				107
Other			148				237				336				479				695
Total recoveries			1,500				1,637				1,589				3,590				2,175
Net charge-offs			1,443				3,539				2,156				2,891				10,352
Ending balance		$	19,276			$	17,948			$	20,233			$	20,227			$	24,077
Net charge-offs to average non-covered loans			0.08	%			0.21	%			0.14	%			0.18	%			0.68	%
Net charge-offs to average total loans			0.08	%			0.20	%			0.13	%			0.17	%			0.61	%

                                                                                                                

(1)	Includes a $682 thousand removal in 2014 due to loans transferred in branch divestitures
(2)	Includes a $1.60 million recovery in 2014 related to the positive resolution of a sizable problem credit

 

 

The following table presents the allowance for loan losses, excluding PCI loans, by loan class, as of the dates indicated:

 

		December 31,
(Amounts in thousands)		2017				2016				2015				2014				2013
Commercial loans
Construction, development, and other land		$	830			$	889			$	1,119			$	1,151			$	1,141
Commercial and industrial			762				495				504				689				5,215
Multi-family residential			1,094				1,157				1,535				1,917				1,211
Single family non-owner occupied			1,976				2,752				3,369				3,228				3,549
Non-farm, non-residential			6,597				6,185				6,393				5,805				4,650
Agricultural			51				43				22				13				23
Farmland			362				169				190				206				301
Consumer real estate loans
Home equity lines			803				895				1,091				1,330				1,361
Single family owner occupied			5,710				4,364				4,969				4,935				5,030
Owner occupied construction			297				228				297				225				206
Consumer and other loans
Consumer loans			794				759				690				670				635
Total allowance, excluding PCI loans		$	19,276			$	17,936			$	20,179			$	20,169			$	23,322

 

The following table presents the PCI allowance for loan losses, by loan pool, as of the dates indicated:

 

		December 31,
(Amounts in thousands)		2017				2016				2015				2014				2013
Commercial loans
Waccamaw commercial		$	-			$	-			$	-			$	37			$	-
Peoples commercial			-				-				-				-				69
Other			-				-				-				-				8
Consumer real estate loans
Waccamaw serviced home equity lines			-				-				-				-				277
Waccamaw residential			-				-				1				-				217
Peoples residential			-				12				53				21				184
Total PCI allowance		$	-			$	12			$	54			$	58			$	755

 

Deposits

 

Total deposits as of December 31, 2017, increased $88.55 million, or 4.81%, compared to December 31, 2016. Noninterest-bearing deposits increased $26.44 million and interest-bearing deposits increased $87.07 million while savings deposits, which include money market accounts and savings accounts, decreased $10.47 million; and time deposits, which include certificates of deposit and individual retirement accounts, decreased $14.49 as of December 31, 2017, compared to December 31, 2016. We had no material deposit concentrations to any single customer or industry that represented 10% or more of outstanding deposits as of December 31, 2017 or 2016.

 

The following schedule presents the contractual maturities of time deposits of $100 thousand or more as of December 31, 2017:

 

(Amounts in thousands)
Three months or less		$	15,401
Over three through six months			13,188
Over six through twelve months			22,441
Over twelve months			147,090
		$	198,120

 

 

Borrowings

 

Total borrowings as of December 31, 2017, decreased $98.63 million, or 55.19%, compared to December 31, 2016, primarily due to moving certain cash management accounts into interest-bearing deposit products. Short-term borrowings consisted of retail repurchase agreements, which decreased $67.92 million, or 93.03%, as of December 31, 2017, compared to December 31, 2016. The following table presents the balances and weighted average rates paid on short-term borrowings for the periods indicated:

 

		Year Ended December 31,
		2017								2016								2015
		Amount				Rate				Amount				Rate				Amount				Rate
(Amounts in thousands)
Year-end balance		$	5,086				0.11	%		$	73,005				0.07	%		$	88,614				0.19	%
Average annual balance(1)			47,717				0.07	%			108,620				0.21	%			72,691				0.10	%
Maximum month-end balance(1)			90,968								182,554								122,693

                                                                            

(1)	Average annual and month-end balances include federal funds purchased and short-term FHLB advances that were repaid prior to year end.

 

Long-term borrowings consisted of a wholesale repurchase agreement and a convertible FHLB advance as of December 31, 2017. The wholesale repurchase agreement totaled $25.00 million with a weighted average rate of 3.18% as of December 31, 2017 and 2016. Long-term FHLB borrowings decreased $15.00 million, or 23.08%, to $50.00 million and the weighted average rate decreased 4 basis points to 4.00% as of December 31, 2017, compared to December 31, 2016. The decrease was due to a $15.00 million convertible advance with a 4.15% rate that matured on May 4, 2017. The Company redeemed all of its trust preferred securities on January 9, 2017, resulting in a decrease of $15.46 million in subordinated debt.

 

Liquidity and Capital Resources

 

Liquidity

 

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) of the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

 

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of December 31, 2017, the Company’s cash reserves totaled $19.22 million and availability on an unsecured, committed line of credit with an unrelated financial institution totaled $15.00 million. There was no outstanding balance on the line of credit as of December 31, 2017. The Company’s cash reserves and investments provide adequate working capital to meet obligations, projected dividends to shareholders, and anticipated debt repayments for the next twelve months.

 

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of December 31, 2017, our unencumbered cash totaled $157.95 million, unused borrowing capacity from the FHLB totaled $411.20 million, available credit from the FRB Discount Window totaled $6.15 million, available lines from correspondent banks totaled $90.00 million, and unpledged available-for-sale securities totaled $114.24 million.

 

 

Cash Flows

 

The following table summarizes the components of cash flow for the periods indicated:

 

		Year Ended December 31,
		2017				2016				2015
(Amounts in thousands)
Net cash provided by operating activities		$	39,009			$	43,088			$	58,519
Net cash provided by (used in) investing activities			65,157				110,210				(70,785	)
Net cash used in financing activities			(22,522	)			(128,778	)			(173,607	)
Net increase (decrease) in cash and cash equivalents			81,644				24,520				(185,873	)
Cash and cash equivalents, beginning balance			76,307				51,787				237,660
Cash and cash equivalents, ending balance		$	157,951			$	76,307			$	51,787

 

2017 Compared to 2016. Cash and cash equivalents increased $81.64 million compared to an increase of $24.52 million in the prior year. The increase was primarily due to a $106.26 million reduction in net cash used in financing activities as we increased deposit accounts and significantly reduced FHLB and other borrowings. Net cash provided by investing activities decreased $45.05 million largely due to a decrease in proceeds from sales and maturities of investment securities, which were partially offset by less loan origination activity. Net cash provided by operating activities experienced a slight decrease of $4.08 million.

 

2016 Compared to 2015. Cash and cash equivalents increased $24.52 million compared to a decrease of $185.87 million in the prior year primarily due to a $181.00 million increase in net cash provided by investing activities. The increase was largely the result of an increase in proceeds from sales and maturities of investment securities, an increase in proceeds from acquisition and divestiture activities, and a reduction in the purchase of investment securities offset by an increase in loan originations. Net cash used in financing activities decreased $44.83 million primarily due to a decrease in interest-bearing deposits offset by an increase in the repayment of long-term debt. Net cash provided by operating activities decreased $15.43 million.

 

Capital Resources

 

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of December 31, 2017, increased $11.66 million, or 3.44%, to $350.71 million from $339.06 million as of December 31, 2016. The change in stockholders’ equity was largely due to net income of $21.49 million offset by dividends declared on our common stock of $11.56 million. In accordance with current regulatory guidelines, accumulated other comprehensive income/(loss) is largely excluded from stockholders' equity in the calculation of our capital ratios. Accumulated other comprehensive loss was reduced by $1.42 million, or 70.36%, to $596 thousand as of December 31, 2017, compared to December 31, 2016, primarily due to net unrealized gains on securities. We repurchased 50,118 shares of our common stock in 2017 totaling $1.26 million. Our book value per common share increased $0.68, or 3.41%, to $20.63 as of December 31, 2017, from $19.95 as of December 31, 2016.

 

Capital Adequacy Requirements

 

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements, based on the international capital standards known as Basel III, became effective on January 1, 2015, subject to a four-year phase-in period. Basel III’s capital conservation buffer became effective on January 1, 2016, at 0.625%, and will be phased in over a four-year period (increasing by an additional 0.625% each year until it reaches 2.5% on January 1, 2019). A description of the Basel III capital rules is included in Part I, Item 1 of the 2016 Form 10-K. Our current required capital ratios are as follows:

 

●

4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 5.75% including the capital conservation buffer)

●

6.0% Tier 1 capital to risk-weighted assets (effectively 7.25% including the capital conservation buffer)

●

8.0% Total capital to risk-weighted assets (effectively 9.25% including the capital conservation buffer)

●

4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

 

 

The following table presents our capital ratios as of the dates indicated:

 

		December 31,
		2017				2016				2015
The Company
Common equity Tier 1 ratio			13.98%				13.88%				14.54%
Tier 1 risk-based capital ratio			13.98%				14.74%				14.73%
Total risk-based capital ratio			15.06%				15.79%				15.95%
Tier 1 leverage ratio			11.06%				11.07%				10.62%
The Bank
Common equity Tier 1 ratio			12.47%				12.93%				13.60%
Tier 1 risk-based capital ratio			12.47%				12.93%				13.60%
Total risk-based capital ratio			13.55%				13.98%				14.82%
Tier 1 leverage ratio			9.84%				9.71%				9.77%

 

As of December 31, 2017, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events since those notifications that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules on a fully phased-in basis, if such requirements were in effect, as of December 31, 2017. Our risk-based capital ratios as of December 31, 2017, decreased from December 31, 2016, due to an increase in risk-weighted assets. For additional information, see “Capital Requirements” in Part I, Item 1 and Note 21, “Regulatory Requirements and Restrictions,” to the Consolidated Financial Statements in Item 8 of this report.

 

Commitments, Contingencies, and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

We enter into certain contractual obligations that require future cash payments. Management believes we have adequate resources to fund our outstanding commitments and the ability to adjust rates on certificates of deposit, in a changing interest rate environment; attract new deposits; and replace deposits with FHLB advances or other fund providers, if cost effective. The following table presents our contractual cash obligations, by payment date, as of December 31, 2017:

 

		Less Than				One to				Three to				More than
		One Year				Three Years				Five Years				Five Years				Total
(Amounts in thousands)
Deposits without a stated maturity(1)		$	1,453,281			$	-			$	-			$	-			$	1,453,281
Certificates of deposit(2)(3)			222,058				191,284				93,637				1,794				508,773
Securities sold under agreements to repurchase			5,881				25,122				-				-				31,003
Long-term borrowings(2)(3)			2,000				4,000				50,033				-				56,033
Operating leases			237				208				194				694				1,333
Total contractual cash obligations		$	1,683,457			$	220,614			$	143,864			$	2,488			$	2,050,423

                                                                                                 

(1)	Excludes interest
(2)	Includes interest on fixed and variable rate obligations (changes in market interest rates may materially affect the variable rate obligation to be paid, which is reflected using the rates in effect as of December 31, 2017)
(3)	Excludes unamortized premiums and discounts

 

Off-Balance Sheet Arrangements

 

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument.

 

 

The following table presents our off-balance sheet arrangements, by commitment expiration, as of December 31, 2017:

 

		Less than				One to				Three to				More than
		One Year(1)				Three Years				Five Years				Five Years				Total
(Amounts in thousands)
Commitments to extend credit		$	93,513			$	32,507			$	22,142			$	94,985			$	243,147
Financial letters of credit			240				-				-				10				250
Performance letters of credit(2)			34,360				96,927				50				-				131,337
Total off-balance sheet risk		$	128,113			$	129,434			$	22,192			$	94,995			$	374,734

                                                                                                                         

(1)	Lines of credit with no stated maturity date are included in the less than one year expiration category.
(2)	Includes FHLB letters of credit

 

The reserve for the risk inherent in unfunded lending commitments totaled $66 thousand as of December 31, 2017, and $326 thousand as of December 31, 2016. For additional information, see Note 20, “Litigation, Commitments, and Contingencies,” to the Consolidated Financial Statements in Item 8 of this report.

 

Market Risk and Interest Rate Sensitivity

 

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

 

In order to manage our exposure to interest rate risk, we periodically review third-party and internal simulation models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

 

On December 13, 2017, the Federal Open Market Committee raised the benchmark federal funds rate to a range of 125 to 150 basis points. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated. Due to the current target rate, we do not reflect a decrease of more than 100 basis points from current rates in our analysis.

 

			Year Ended December 31,
			2017								2016
			Change in				Percent				Change in				Percent
Increase (Decrease) in Basis Points			Net Interest Income				Change				Net Interest Income				Change
(Dollars in thousands)
300			$	3,759				4.3	%		$	526				0.6	%
200				2,756				3.2	%			438				0.5	%
100				1,535				1.8	%			183				0.2	%
(100)				(4,405	)			-5.1	%			(2,616	)			-3.1	%

 

We have established policy limits for tolerance of interest rate risk in various interest rate scenarios and exposure limits to changes in the economic value of equity. As of December 31, 2017, exposure to interest rate risk was within our defined policy limits.

 

 

The Company primarily uses derivative instruments to manage exposure to market risk and meet customer financing needs. As of December 31, 2017, we maintained interest rate swap agreements with notional amounts totaling $5.81 million to modify our exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The fair value of the swap agreements, which are accounted for as fair value hedges and recorded as derivative liabilities, totaled $90 thousand as of December 31, 2017, and $167 thousand as of December 31, 2016. For additional information, see Note 12, “Derivative Instruments and Hedging Activities,” to the Consolidated Financial Statements in Item 8 of this report.

 

Inflation and Changing Prices

 

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not be material to our financial performance.

 

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk.

 

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 7 of this report.

 

 

Item 8.     Financial Statements and Supplementary Data.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX
		Page
Consolidated Balance Sheets as of December 31, 2017 and 2016		50
Consolidated Statements of Income for the years ended December 31, 2017, 2016, and 2015		51
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2017, 2016, and 2015		52
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2017, 2016, and 2015		53
Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016, and 2015		54
Notes to Consolidated Financial Statements		55
Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements		104
Management’s Assessment of Internal Control Over Financial Reporting		105
Report of Independent Registered Public Accounting Firm on Management’s Assessment of Internal Control Over Financial Reporting		106

 

 

FIRST COMMUNITY BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS

 

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

 

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANCSHARES, INC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See Notes to Consolidated Financial Statements.

 

 

FIRST COMMUNITY BANCSHARES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

- Report of Independent Registered Public Accounting Firm -

 

Board of Directors and the Stockholders

First Community Bancshares, Inc. and Subsidiary

 

Opinion on the Consolidated Financial Statements 

We have audited the accompanying consolidated balance sheets of First Community Bancshares, Inc. and Subsidiary (the “Company) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017 and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 5, 2018, expressed an unqualified opinion thereon.

 

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error fraud.

 

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

We have served as the Company’s auditor since 2006.

 

 

/s/ Dixon Hughes Goodman LLP

 

Asheville, North Carolina

March 5, 2018

 

 

- Management’s Assessment of Internal Control over Financial Reporting -

 

First Community Bancshares, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements and notes included in this Annual Report on Form 10-K have been prepared in conformity with U.S. generally accepted accounting principles and necessarily include some amounts that are based on management’s best estimates and judgments.

 

We, as management of the Company, are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with U.S. generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

 

Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that its system of internal control over financial reporting was effective as of December 31, 2017.

 

Dixon Hughes Goodman LLP, independent registered public accounting firm, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017. The Report of Independent Registered Public Accounting Firm, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017, appears hereafter in Item 8 of this Annual Report on Form 10-K.

 

 

Dated this 5^th day of March, 2018.

 

 

/s/ William P. Stafford, II		/s/ David D. Brown
William P. Stafford, II		David D. Brown
Chief Executive Officer		Chief Financial Officer

 

 

- Report of Independent Registered Public Accounting Firm -

 

Board of Directors and the Stockholders

First Community Bancshares, Inc. and Subsidiary

 

Opinion on Internal Control Over Financial Reporting

We have audited First Community Bancshares, Inc. and Subsidiary (the “Company”) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, First Community Bancshares, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of First Community Bancshares, Inc. and Subsidiary as of December 31, 2017 and 2016, and our report, dated March 5, 2018 expressed an unqualified opinion on those consolidated financial statements.

 

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

Definition and Limitations of Internal Control Over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/ Dixon Hughes Goodman LLP

 

Asheville, North Carolina

March 5, 2018

 

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.

Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of December 31, 2017, our disclosure controls and procedures were effective.

 

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

 

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

 

Changes in Internal Control over Financial Reporting

 

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended December 31, 2017, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Management's Report on Internal Controls over Financial Reporting

 

For additional information about the Company’s internal controls, see “Management's Assessment of Internal Control over Financial Reporting,” and “Report of Independent Registered Public Accounting Firm,” in Item 8 of this report.

 

Item 9B.

Other Information.

 

None.

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance.

 

Board of Directors, First Community Bancshares, Inc.

 

W. C. Blankenship, Jr. Retired Agent, State Farm Insurance   C. William Davis Attorney at Law, Richardson & Davis, PLLC

Samuel L. Elmore Retired Chief Credit Officer and Senior Vice President, First Community Bank; Past Executive Vice President, Citizens Southern Bank, Inc.; Past President and Chief Executive Officer, Bank One; Past Vice President, Key Centurion Bancshares; Past President and Chief Operations Officer, Beckley National Bank; Director, Raleigh County Commission on Aging

  

 

Richard S. Johnson Chairman, President, and Chief Executive Officer, The Wilton Companies; Director and Past Chairman, City of Richmond Economic Development Authority; Trustee Emeritus, University of Richmond   I. Norris Kantor Of Counsel, Katz, Kantor, Stonestreet & Buckner, PLLC; Board of Governors, Bluefield State College   Gary R. Mills President, First Community Bancshares, Inc.; Chief Executive Officer and President, First Community Bank		M. Adam Sarver Member/Co-Manager, Main Street Builders, LLC, Eastern Door & Glass, LLC, and Clover Leaf Properties, LLC   William P. Stafford, II Chief Executive Officer, First Community Bancshares, Inc.; Attorney at Law, Brewster, Morhous, Cameron, Caruth, Moore, Kersey & Stafford, PLLC
Executive Officers, First Community Bancshares, Inc.
William P. Stafford, II Chief Executive Officer   Gary R. Mills President		David D. Brown Chief Financial Officer and Secretary   E. Stephen Lilly Chief Operating Officer and Executive Vice President
Board of Directors, First Community Bank
James H. Atkinson, Jr. Retired Chief Executive Officer, Peoples Bank of Virginia   W. C. Blankenship, Jr. See above   Robert L. Buzzo Retired Vice President and Secretary, First Community Bancshares, Inc.; Retired President Emeritus, First Community Bank   Samuel D. Campbell Attorney at Law   C. William Davis See above    Samuel L. Elmore See above   S. Michael Feola Retired Senior Vice President – Regional President, First Community Bank   T. Vernon Foster President of J. La’Verne Print Communications; Past Director, TriStone Community Bank; Executive Director: MBA Programs, Career Management & Public Relations, University of Louisville, College of Business		Richard H. Jarrell Chick-fil-A Franchise Owner; Director, Raleigh General Hospital Board of Trustees; Director, Beckley-Raleigh County Chamber of Commerce; Director, United Way of Southwest Virginia; Director, Raleigh County Board of Education   Richard S. Johnson See above    I. Norris Kantor See above    Gary R. Mills See above    M. Adam Sarver See above    William P. Stafford, II See above    Frank C. Tinder President, Tinder Enterprises, Inc. and Tinco Leasing Corporation; Realtor, Premier Realty

 

 

Additional Information

 

The following information required in this item is incorporated by reference to our Proxy Statement for the Annual Meeting of Stockholders to be held on April 24, 2018 (“2018 Annual Meeting”):

 

●

Information about directors and executive officers is included under the headings “Proposal 1: Election of Directors,” “Nominees for the Class of 2021,” “Incumbent Directors,” “Non-Director Executive Officers,” and “Corporate Governance.”

●

Information about compliance with Section 16(a) of the Exchange Act is included under the heading “Section 16(a) Beneficial Ownership Reporting Compliance.”

●

Information about the Audit Committee and the Audit Committee Financial Expert is included under the heading “Board Committees.”

 

Our Standards of Conduct apply to all directors and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Standards of Conduct is available on the Investor Relations section of our website at www.firstcommunitybank.com. There have been no waivers of the Standards of Conduct for any officer.

 

There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since the disclosure in our Proxy Statement filed with the SEC on March 14, 2017.

 

Item 11.

Executive Compensation.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2018 Annual Meeting under the headings “Board Committees,” “Compensation Discussion and Analysis,” “Director Compensation,” and “Pay Ratio Disclosure.”

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The following table provides information about compensation plans under which our equity securities are authorized for issuance as of December 31, 2017:

 

Number of securities

Number of securities

remaining available

to be issued upon

Weighted-average

for future issuance

exercise of

exercise price of

under equity

outstanding

outstanding

compensation plans

options, warrants

options, warrants

(excluding securities

Plan category

and rights

and rights

reflected in column (a))

(a)

(b)

(c)

Equity compensation plans approved by security holders(1)

80,903

$

18.89

386,621

(3)

Equity compensation plans not approved by security holders(2)

119,801

20.98

-

Total

200,704

386,621

 

---

(1)	Includes the 2012 Omnibus Equity Compensation Plan and 2004 Omnibus Stock Option Plan
(2)	Includes the 2001 Directors' Option Plan, 1999 Stock Option Plan, and other plans related to past business combinations, which are expired or not available to issue new options, warrants, or rights
(3)	Shares available for future issuance are under the 2012 Omnibus Equity Compensation Plan.

 

Additional information required in this item is incorporated by reference to our Proxy Statement for the 2018 Annual Meeting under the heading “Information on Stock Ownership.”

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2018 Annual Meeting under the headings “Corporate Governance” and “Related Person/Party Transactions.”

 

 

Item 14.

Principal Accounting Fees and Services.

 

The information required in this item is incorporated by reference to our Proxy Statement for the 2018 Annual Meeting under the heading “Independent Registered Public Accounting Firm.”

 

PART IV

 

Item 15.

Exhibits, Financial Statement Schedules.

 

(a)	Documents Filed as Part of this Report

 

(1)

Financial Statements

 

The financial statements required in this item are incorporated by reference to Item 8, “Financial Statements and Supplementary Data,” in Part II of this report.

 

(2)

Financial Statement Schedules

 

The schedules required in this item are omitted because they are not applicable or the required information is included in the consolidated financial statements or related notes.

 

(3)

Exhibits

 

Exhibit No.

Exhibit

3.1	Articles of Incorporation of First Community Bancshares, Inc., as amended, incorporated by reference to Exhibit 3(i) of the Quarterly Report on Form 10-Q for the period ended June 30, 2010, filed on August 16, 2010

3.2	Amended and Restated Bylaws of First Community Bancshares, Inc., incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K dated February 23, 2016, filed on February 25, 2016

4.1	Specimen stock certificate of First Community Bancshares, Inc., incorporated by reference to Exhibit 4.1 of the Annual Report on Form 10-K for the period ended December 31, 2002, filed on March 25, 2003

4.2	Indenture between First Community Bancshares, Inc. and Wilmington Trust Company, incorporated by reference to Exhibit 4.2 of the Quarterly Report on Form 10-Q for the period ended September 30, 2003, filed on November 10, 2003

4.3	Amended and Restated Declaration of Trust of FCBI Capital Trust, incorporated by reference to Exhibit 4.3 of the Quarterly Report on Form 10-Q for the period ended September 30, 2003, filed on November 10, 2003

4.4	Preferred Securities Guarantee Agreement, incorporated by reference to Exhibit 4.4 of the Quarterly Report on Form 10-Q for the period ended September 30, 2003, filed on November 10, 2003

10.1.1**

First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000

10.1.2**

Amendment One to the First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1.1 of the Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed on May 7, 2004

10.2**

First Community Bancshares, Inc. 1999 Stock Option Agreement, incorporated by reference to Exhibit 10.5 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002

10.3**

First Community Bancshares, Inc. 2001 Nonqualified Director Stock Option Agreement, incorporated by reference to Exhibit 10.4 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002

10.4**

First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan, incorporated by reference to Annex B of the Definitive Proxy Statement on Form DEF 14A dated April 27, 2004, filed on March 15, 2004

10.5**

First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan Stock Award Agreement, incorporated by reference to Exhibit 10.13 of the Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on August 6, 2004

10.6**

First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan, incorporated by reference to Appendix B of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2012, filed on March 7, 2012

10.7**

First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan Restricted Stock Grant Agreement, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated and filed May 28, 2013

10.8**

First Community Bancshares, Inc. Life Insurance Endorsement Method Split Dollar Plan and Agreement, incorporated by reference to Exhibit 10.5 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000

10.9.1**

First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 30, 2008, filed on January 5, 2009; Amendment #1, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010; Amendment #2, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated February 21, 2013, filed on February 25, 2013; Amendment #3, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated May 24, 2016, filed on May 27, 2016; and Amendment #4, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on February 28, 2017

 

 

10.9.2**	Amendment #1 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010
10.9.3**	Amendment #2 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated February 21, 2013, filed on February 25, 2013

10.9.4**

Amendment #3 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.9.5**

Amendment #4 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.10**

Amended and Restated Deferred Compensation Plan for Directors of First Community Bancshares, Inc. and Affiliates, incorporated by reference to Exhibit 99.2 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006

10.11.1**

First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006, and Amendment #2, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.11.2**

Amendment #2 to the First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on February 28, 2017

10.12.1**

First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010, and Amendment #2, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.12.2**

Amendment #2 to the First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016

10.13**

Employment Agreement between First Community Bancshares, Inc. and David D. Brown, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.14**

Employment Agreement between First Community Bancshares, Inc. and E. Stephen Lilly, incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.15**

Employment Agreement between First Community Bancshares, Inc. and Gary R. Mills, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.16**

Employment Agreement between First Community Bancshares, Inc. and William P. Stafford, II, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on April 16, 2015

10.17**

Employment Agreement between First Community Bank and Mark R. Evans, incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K dated April 2, 2009, filed on April 3, 2009

11	Statement Regarding Computation of Earnings per Share, incorporated by reference to Note 18 of the Notes to Condensed Consolidated Financial Statements in Part II, Item 8 of this report

12*	Statement Regarding Computation of Ratios

21*	Subsidiaries of the Registrant

23*	Consent of Independent Public Accounting Firm

31.1*

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101***

Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of December 31, 2017 and 2016; (ii) Consolidated Statements of Income for the years ended December 31, 2017, 2016, and 2015; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016, and 2015; (iv) Consolidated Statements of Stockholders' Equity for the years ended December 31, 2017, 2016, and 2015; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016, and 2015; and (vi) Notes to Consolidated Financial Statements

 

*	Filed herewith

**	Indicates a management contract or compensation plan or agreement

***	Submitted electronically herewith

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 5^th day of March, 2018.

 

First Community Bancshares, Inc.

(Registrant)

 

By:	/s/ William P. Stafford, II		By:	/s/ David D. Brown
	William P. Stafford, II			David D. Brown
	Chief Executive Officer (Principal Executive Officer)			Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature		Title		Date
/s/ William P. Stafford, II		Chairman and Chief Executive Officer		March 5, 2018
William P. Stafford, II
/s/ David D. Brown		Chief Financial Officer		March 5, 2018
David D. Brown
/s/ W. C. Blankenship, Jr.		Director		March 5, 2018
W. C. Blankenship, Jr.
/s/ Samuel L. Elmore		Director		March 5, 2018
Samuel L. Elmore
/s/ Richard S. Johnson		Director		March 5, 2018
Richard S. Johnson
/s/ Gary R. Mills		President and Director		March 5, 2018
Gary R. Mills
/s/ M. Adam Sarver		Director		March 5, 2018
M. Adam Sarver

 

112