UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-K

x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2015
    OR
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to ____________

       (Exact name of Registrant as specified in its charter)

 

Florida

 

0-13358

 

59-2273542

(State of Incorporation)   (Commission File Number)   (IRS Employer Identification No.)

217 North Monroe Street, Tallahassee, Florida

 

32301

(Address of principal executive offices)   (Zip Code)

 

(850) 671-0300

(Registrant’s telephone number, including area code)

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

Title of Each Class Name of Each Exchange on Which Registered
Common Stock, $0.01 par value The Nasdaq Stock Market LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The aggregate market value of the registrant’s common stock, $0.01 par value per share, held by non-affiliates of the registrant on June 30, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $159,934,867 (based on the closing sales price of the registrant’s common stock on that date). Shares of the registrant’s common stock held by each officer and director and each person known to the registrant to own 10% or more of the outstanding voting power of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not a determination for other purposes.

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

Class   Outstanding at February 29, 2016
Common Stock, $0.01 par value per share   17,221,651
     

DOCUMENTS INCORPORATED BY REFERENCE
Portions of our Proxy Statement for the Annual Meeting of Shareowners to be held on April 26, 2016, are incorporated by reference in Part III.  

 
 

CAPITAL CITY BANK GROUP, INC.

ANNUAL REPORT FOR 2015 ON FORM 10-K

 

TABLE OF CONTENTS

 

PART I PAGE
       
Item 1. Business   4
Item 1A. Risk Factors   19
Item 1B. Unresolved Staff Comments   26
Item 2. Properties   26
Item 3. Legal Proceedings   26
Item 4. Mine Safety Disclosure   26
       
PART II      
     
Item 5. Market for the Registrant’s Common Equity, Related Shareowner Matters, and Issuer Purchases of Equity Securities   27
Item 6. Selected Financial Data   29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations   30
Item 7A. Quantitative and Qualitative Disclosure About Market Risk   56
Item 8. Financial Statements and Supplementary Data   57
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   98
Item 9A. Controls and Procedures   98
Item 9B. Other Information   98
       
PART III      
       
Item 10. Directors, Executive Officers, and Corporate Governance   100
Item 11. Executive Compensation   100
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareowner Matters   100
Item 13. Certain Relationships and Related Transactions, and Director Independence   100
Item 14. Principal Accountant Fees and Services   100
       
PART IV      
       
Item 15. Exhibits and Financial Statement Schedules   101
Signatures   103

2
 

INTRODUCTORY NOTE

 

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.

 

All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements.

 

In addition to those risks discussed in this Annual Report under Item 1A Risk Factors, factors that could cause our actual results to differ materially from those in the forward-looking statements, include, without limitation:

 

§our ability to successfully manage interest rate risk, liquidity risk, and other risks inherent to our industry;
§legislative or regulatory changes, including the Dodd-Frank Act, Basel III, and the ability to repay and qualified mortgage standards;
§the effects of security breaches and computer viruses that may affect our computer systems or fraud related to credit or debit card products;
§the accuracy of our financial statement estimates and assumptions, including the estimates used for our loan loss reserve and deferred tax asset valuation allowance;
§the frequency and magnitude of foreclosure of our loans;
§the effects of our lack of a diversified loan portfolio, including the risks of geographic and industry concentrations;
§the strength of the United States economy in general and the strength of the local economies in which we conduct operations;
§our ability to declare and pay dividends, the payment of which is now subject to our compliance with additional capital requirements;
§our need and our ability to incur additional debt or equity financing;
§changes in the securities and real estate markets;
§changes in monetary and fiscal policies of the U.S. Government;
§inflation, interest rate, market and monetary fluctuations;
§the effects of harsh weather conditions, including hurricanes, and man-made disasters;
§our ability to comply with the extensive laws and regulations to which we are subject, including the laws for each jurisdiction where we operate;
§the willingness of clients to accept third-party products and services rather than our products and services and vice versa;
§increased competition and its effect on pricing;
§technological changes;
§negative publicity and the impact on our reputation;
§changes in consumer spending and saving habits;
§growth and profitability of our noninterest income;
§changes in accounting principles, policies, practices or guidelines;
§the limited trading activity of our common stock;
§the concentration of ownership of our common stock;
§anti-takeover provisions under federal and state law as well as our Articles of Incorporation and our Bylaws;
§other risks described from time to time in our filings with the Securities and Exchange Commission; and
§our ability to manage the risks involved in the foregoing.

 

However, other factors besides those listed in Item 1A Risk Factors or discussed in this Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.

3
 

PART I

 

Item 1. Business

 

About Us

 

General

 

Capital City Bank Group, Inc. (“CCBG”) is a financial holding company headquartered in Tallahassee, Florida. CCBG was incorporated under Florida law on December 13, 1982, to acquire five national banks and one state bank that all subsequently became part of CCBG’s bank subsidiary, Capital City Bank (“CCB” or the “Bank”). In this report, the terms “Company,” “we,” “us,” or “our” mean CCBG and all subsidiaries included in our consolidated financial statements.

We provide traditional deposit and credit services, asset management, trust, mortgage banking, merchant services, bank cards, data processing, and securities brokerage services through 61 banking offices in Florida, Georgia, and Alabama operated by CCB. The majority of our revenue, approximately 84%, is derived from our Florida market areas while approximately 15% and 1% of our revenue is derived from our Georgia and Alabama market areas, respectively.

Below is a summary of our financial condition and results of operations for the past three years. Our financial condition and results of operations are more fully discussed in our management discussion and analysis on page 30 and our consolidated financial statements on page 58.

Dollars in millions                
Year Ended
December 31,
  Assets   Deposits   Shareowners’
Equity
  
Revenue(1)
   Net Income 
2015  $2,797.9   $2,302.8   $274.4   $133.7   $9.1 
2014   2,627.2    2,146.8    272.5    130.8    9.3 
2013   2,611.9    2,136.2    276.4    137.3    6.0 

(1) Revenue represents interest income plus noninterest income.

Dividends and management fees received from the Bank are CCBG’s primary source of income. Dividend payments by the Bank to CCBG depend on the capitalization, earnings and projected growth of the Bank, and are limited by various regulatory restrictions, including, effective as of January 1, 2016, compliance with a minimum Common Equity Tier 1 Capital conservation buffer. See the section entitled “Regulatory Matters” in this Item 1 and Note 14 in the Notes to Consolidated Financial Statements for a discussion of the restrictions.

We had a total of 894 associates at March 1, 2016. Item 6 contains other financial and statistical information about us.

Subsidiaries of CCBG

CCBG’s principal asset is the capital stock of CCB, our wholly owned banking subsidiary, which accounted for nearly 100% of consolidated assets at December 31, 2015, and approximately 100% of consolidated net income for the year ended December 31, 2015. In addition to our banking subsidiary, CCB has three primary wholly owned subsidiaries, Capital City Trust Company, Capital City Banc Investments, Inc., and Capital City Services Company. The nature of these subsidiaries is provided below.

Operating Segment

 

We have one reportable segment with four principal services: Banking Services (CCB), Data Processing Services (Capital City Services Company), Trust and Asset Management Services (Capital City Trust Company), and Brokerage Services (Capital City Banc Investments, Inc.). Revenues from each of these principal services for the year ended 2015 totaled approximately 93.8%, 0.4%, 3.4%, and 2.4% of our total revenue, respectively. In 2014 and 2013, Banking Services (CCB) revenue was approximately 92.8% and 91.9% of our total revenue for each respective year.

 

Capital City Bank

 

CCB is a Florida-chartered full-service bank engaged in the commercial and retail banking business. Significant services offered by the Bank include:

§Business Banking – The Bank provides banking services to corporations and other business clients. Credit products are available for a wide variety of general business purposes, including financing for commercial business properties, equipment, inventories and accounts receivable, as well as commercial leasing and letters of credit. We also provide treasury management services, and, through a marketing alliance with Elavon, Inc., merchant credit card transaction processing services.
4
 

§Commercial Real Estate Lending – The Bank provides a wide range of products to meet the financing needs of commercial developers and investors, residential builders and developers, and community development. Credit products are available to purchase land and build structures for business use and for investors who are developing residential or commercial property.

 

§Residential Real Estate Lending – The Bank provides products to help meet the home financing needs of consumers, including conventional permanent and construction/ permanent (fixed, adjustable, or variable rate) financing arrangements, and FHA/VA loan products. The Bank offers both fixed-rate and adjustable rate residential mortgage (ARM) loans. A portion of our loans originated are sold into the secondary market. The Bank offers these products through its existing network of banking offices. We do not originate subprime residential real estate loans.

 

§Retail Credit – The Bank provides a full-range of loan products to meet the needs of consumers, including personal loans, automobile loans, boat/RV loans, home equity loans, and through a marketing alliance with ELAN, we offer credit card programs.

 

§Institutional Banking – The Bank provides banking services to meet the needs of state and local governments, public schools and colleges, charities, membership and not-for-profit associations including customized checking and savings accounts, cash management systems, tax-exempt loans, lines of credit, and term loans.

 

§Retail Banking – The Bank provides a full-range of consumer banking services, including checking accounts, savings programs, automated teller machines (ATMs), debit/credit cards, night deposit services, safe deposit facilities, online banking, and mobile banking. Clients can use Capital City Bank Direct which offers a “live” call center between the hours of 8 a.m. to 6 p.m. Monday through Friday and from 9 a.m. to 12 noon on Saturday. The call center can also be accessed via live chat through the internet. Bank Direct also offers an automated phone system offering 24-hour access to client deposit and loan account information and transfer of funds between linked accounts. The Bank is a member of the “Star”, “Plus” and “Presto” ATM Networks that permit banking clients to access cash at ATMs or “point-of-sale” merchants.

 

Capital City Trust Company

 

Capital City Trust Company (the “Trust Company”) is the investment management arm of CCB. The Trust Company provides asset management for individuals through agency, personal trust, IRA, and personal investment management accounts. The Trust Company also provides services for the administration of pension, profit sharing, and 401(k) plans. Associations, endowments, and other nonprofit entities hire the Trust Company to manage their investment portfolios. Additionally, a staff of well-trained professionals serves individuals requiring the services of a trustee, personal representative, or a guardian. The market value of trust assets under discretionary management exceeded $728.4 million as of December 31, 2015, with total assets under administration exceeding $819.8 million.

 

Capital City Banc Investments, Inc.

 

Capital City Banc Investments, Inc. offers access to retail investment products through INVEST Financial Corporation, a member of FINRA and SIPC. Non-deposit investment and insurance products are: (i) not FDIC insured; (ii) not deposits, obligations, or guarantees by any bank; and (iii) subject to investment risk, including the possible loss of principal amount invested. Capital City Banc Investments, Inc. offers a full line of retail securities products, including U.S. Government bonds, tax-free municipal bonds, stocks, mutual funds, unit investment trusts, annuities, life insurance and long-term health care. We are not an affiliate of INVEST Financial Corporation.

 

Capital City Services Company

 

Capital City Services Company (the “Services Company”) provides data processing services to financial institutions (including CCB), government agencies, and commercial clients located in North Florida and South Georgia. As of March 1, 2016, the Services Company is providing data processing services to three correspondent banks which have relationships with CCB.

 

Underwriting Standards

A core goal of CCB is to support the communities in which it operates. The Bank seeks loans from within its primary market area, which is defined as the counties in which the Bank’s offices are located. The Bank will originate loans within its secondary market area, defined as adjacent counties to those in which the Bank has offices. There may also be occasions when the Bank will have opportunities to make loans that are out of both the primary and secondary market areas, including participation loans. These loans will only be approved if the applicant is known to the Bank, underwriting is consistent with CCB criteria, and the applicant’s primary business is in or near our primary or secondary market area. Approval of all loans is subject to the Bank’s policies and standards described in more detail below.

5
 

The Bank has adopted comprehensive lending policies, underwriting standards and loan review procedures. Management and the Bank’s Board of Directors reviews and approves these policies and procedures on a regular basis (at least annually).

 

Management has also implemented reporting systems designed to monitor loan originations, loan quality, concentrations of credit, loan delinquencies, nonperforming loans, and potential problem loans. Bank management and the Credit Risk Oversight Committee periodically review our lines of business to monitor asset quality trends and the appropriateness of credit policies. In addition, total borrower exposure limits are established and concentration risk is monitored. As part of this process, the overall composition of the portfolio is reviewed to gauge diversification of risk, client concentrations, industry group, loan type, geographic area, or other relevant classifications of loans. Specific segments of the portfolio are monitored and reported to the Bank’s Board on a quarterly basis (i.e., commercial real estate) and the Bank has strategic plans in place to supplement Board approved credit policies governing exposure limits and underwriting standards. The Bank recognizes that exceptions to the below-listed policy guidelines may occasionally occur and has established procedures for approving exceptions to these policy guidelines.

 

Residential Real Estate Loans

 

The Bank originates 1-4 family, owner-occupied residential real estate loans in its Residential Real Estate line of business. The Bank’s policy is to underwrite these loans in accordance with secondary market guidelines in effect at the time of origination, including loan-to-value (“LTV”) and documentation requirements. The Bank originates fixed-rate, adjustable-rate and variable- rate residential real estate loans. Over the past five years, the vast majority of residential loan originations have been fixed-rate loans which are sold in the secondary market on a non-recourse basis with related servicing rights (i.e., the Bank generally does not service sold loans). Adjustable rate mortgage (“ARM”) loans with an initial fixed interest rate period greater than five years are sold in the secondary market on a non-recourse basis.

 

The Bank also originates certain residential real estate loans throughout its banking office network that are generally not eligible for sale into the secondary market due to not meeting a specific secondary market underwriting requirement. This includes our variable rate 3/1 and 5/1 ARM loans which typically have a maximum term of 30 years and maximum LTV of 80%.

 

Residential real estate loans also include home equity lines of credit and home equity loans (“HELOCs”). The Bank’s home equity portfolio includes revolving open-ended equity loans with interest-only or minimal monthly principal payments and closed-end amortizing loans. Open-ended equity loans typically have an interest only ten year draw period followed by a five year repayment period of 0.75% of principal balance monthly and balloon payment at maturity. As of December 31, 2015, approximately 63% of the Bank’s residential home equity loan portfolio consisted of first mortgages. Interest rates may be fixed or adjustable. Adjustable-rate loans are tied to the Prime Rate with a typical margin of 1.0% or more.

 

Commercial Loans

 

The Bank’s policy sets forth guidelines for debt service coverage ratios, LTV ratios and documentation standards. Commercial loans are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral and personal or other guarantees. The Bank’s policy establishes debt service coverage ratio limits that require a borrower’s cash flow to be sufficient to cover principal and interest payments on all new and existing debt. The majority of the Bank’s commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory. Many of the loans in the commercial portfolio have variable interest rates tied to the Prime Rate or U.S. Treasury indices.

 

Commercial Real Estate Loans

 

The Bank’s policy sets forth guidelines for debt service coverage ratios, LTV ratios and documentation standards. Commercial real estate loans are primarily made based on identified cash flows of the borrower with consideration given to underlying real estate collateral and personal guarantees. The Bank’s policy establishes a maximum LTV specific to property type and minimum debt service coverage ratio limits that require a borrower’s cash flow to be sufficient to cover principal and interest payments on all new and existing debt. Commercial real estate loans may be fixed or variable-rate loans with interest rates tied to the Prime Rate or U.S. Treasury indices. Bank policy requires appraisals for loans in excess of $250,000 that are secured by real property.

 

Consumer Loans

 

The Bank’s consumer loan portfolio includes personal installment loans, direct and indirect automobile financing, and overdraft lines of credit. The majority of the consumer loan portfolio consists of indirect and direct automobile loans. The majority of the Bank’s consumer loans are short-term and have fixed rates of interest that are priced based on current market interest rates and the financial strength of the borrower. The Bank’s policy establishes maximum debt-to-income ratios, minimum credit scores, and includes guidelines for verification of applicants’ income and receipt of credit reports.

6
 

Lending Limits and Extensions of Additional Credit

 

The Bank has established an internal lending limit of $10.0 million for the total aggregate amount of credit that will be extended to a client and any related entities within its Board approved policies. This compares to our legal lending limit of approximately $81 million. In practice, the Bank seeks to maintain an internal lending limit of $7.5 million which we believe helps us maintain a well-diversified loan portfolio.

 

Loan Modification and Restructuring

 

In the normal course of business, CCB receives requests from its clients to renew, extend, refinance, or otherwise modify their current loan obligations. In most cases, this may be the result of a balloon maturity that is typical in most commercial loan agreements, a request to refinance to obtain current market rates of interest, competitive reasons, or the conversion of a construction loan to a permanent financing structure at the completion or stabilization of the property. In these cases, the request is held to the normal underwriting standards and pricing strategies as any other loan request, whether new or renewal.

 

In other cases, we may modify a loan because of a reduction in debt service capacity experienced by the client (i.e., a potentially troubled loan whereby the client may be experiencing financial difficulties). To maximize the collection of loan balances, we evaluate troubled loans on a case-by-case basis to determine if a loan modification would be appropriate. We pursue loan modifications when there is a reasonable chance that an appropriate modification would allow our client to continue servicing the debt.

 

Expansion of Business

 

Our philosophy is to build long-term client relationships based on quality service, high ethical standards, and safe and sound banking practices. We maintain a locally oriented, community-based focus, which is augmented by experienced, centralized support in select specialized areas. Our local market orientation is reflected in our network of banking office locations, experienced community executives with a dedicated President for each market, and community boards which support our focus on responding to local banking needs. We strive to offer a broad array of sophisticated products and to provide quality service by empowering associates to make decisions in their local markets.

We have sought to build a franchise in small- to medium-sized markets, located on the outskirts of the larger metropolitan markets where we are positioned as a market leader. Many of our markets are on the outskirts of these larger markets in close proximity to major interstate thoroughfares such as Interstates I-10 and I-75. Our three largest markets are Tallahassee (Leon, Florida), Gainesville (Alachua, Florida), and Macon (Bibb, Georgia). The larger employers in many of our markets are state and local governments, healthcare providers, educational institutions, and small businesses. While we realize that the markets in our footprint do not provide for a level of potential growth that the larger metropolitan markets may provide, our markets do provide good growth dynamics and have historically grown in excess of the national average. We strive to provide value added services to our clients by being their banker, not just a bank. This element of our strategy distinguishes Capital City Bank from our competitors.

Our long-term vision remains to profitably expand our franchise through a combination of organic growth in existing markets and acquisitions. We have long understood that our core deposit funding base is a predominant driver of our profitability and overall franchise value, and have focused extensively on this component of our organic growth efforts in recent years. While we have not been an active acquirer of banks since 2005, this component of our strategy is still in place. When evaluating potential acquisition opportunities, we will continue to weigh the value of organic growth initiatives versus potential acquisition returns and pursue the strategies that we believe provide the best overall return to our shareowners.

 

Potential acquisition opportunities will continue to be focused on Florida, Georgia, and Alabama with a particular focus on financial institutions located on the outskirts of larger, metropolitan areas. Five markets have been identified, four in Florida and one in Georgia, in which management intends to proactively pursue expansion opportunities. These markets include Alachua, Marion, Hernando/Pasco counties in Florida, the western panhandle of Florida, and Bibb and surrounding counties in central Georgia. Our focus on some of these markets may change as we continue to evaluate our strategy and the economic conditions and demographics of any individual market. We will also continue to evaluate de novo expansion opportunities in attractive new markets in the event that acquisition opportunities are not feasible. Other expansion opportunities that will be evaluated include asset management, mortgage banking, and insurance. Embedded in our acquisition strategy is our desire to partner with institutions that are culturally similar, have experienced management and possess either established market presence or have potential for improved profitability through growth, economies of scale, or expanded services. Generally, these target institutions will range in asset size from $100 million to $400 million.

7
 

Competition

 

We operate in a highly competitive environment, especially with respect to services and pricing. In addition, the banking business is experiencing enormous changes. Since January 1, 2009, nearly 500 financial institutions have failed in the U.S., including 85 in Georgia and 70 in Florida. Nearly all of the failed banks were community banks. The assets and deposits of many of these failed community banks were acquired mostly by larger financial institutions. We expect consolidation to continue during 2016, but substantially through traditional merger and acquisition activity. We believe that the larger financial institutions acquiring banks in our market areas are less familiar with the markets in which we operate and typically target a different client base. We believe clients who bank at community banks tend to prefer the relationship style service of community banks compared to larger banks.

 

As a result, we believe a further reduction of the number of community banks could continue to enhance our competitive position and opportunities in many of our markets. Larger financial institutions, however, can benefit from economies of scale. Therefore, these larger institutions may be able to offer banking products and services at more competitive prices than us. Additionally, these larger financial institutions may offer financial products that we do not offer.

 

Our primary market area consists of 20 counties in Florida, five counties in Georgia, and one county in Alabama. In these markets, the Bank competes against a wide range of banking and nonbanking institutions including banks, savings and loan associations, credit unions, money market funds, mutual fund advisory companies, mortgage banking companies, investment banking companies, finance companies and other types of financial institutions. Most of Florida’s major banking concerns have a presence in Leon County, where the Bank has its main office. CCB’s Leon County deposits totaled $871.1 million, or 37.8% of our consolidated deposits at December 31, 2015.

 

The table below depicts our market share percentage within each county, based on commercial bank deposits within the county.

 

   Market Share as of June 30,(1) 
County  2015   2014   2013 
Florida               
Alachua   4.7%   4.8%   4.5%
Bradford   49.9%   51.5%   51.8%
Citrus   3.5%   3.6%   3.6%
Clay   1.9%   2.0%   1.8%
Dixie   15.8%   9.9%   15.1%
Gadsden   77.4%   77.4%   70.2%
Gilchrist   45.5%   42.2%   40.8%
Gulf   13.9%   14.0%   14.0%
Hernando   1.9%   1.8%   1.9%
Jefferson   21.9%   22.1%   19.8%
Leon   13.2%   15.3%   15.3%
Levy   27.1%   28.0%   27.8%
Madison   13.2%   10.3%   9.0%
Pasco   0.1%   0.1%   0.1%
Putnam   19.6%   19.5%   18.9%
St. Johns   0.8%   0.9%   0.9%
Suwannee   8.2%   6.8%   6.8%
Taylor   19.0%   22.0%   21.8%
Wakulla   14.8%   13.6%   13.6%
Washington   12.9%   13.6%   13.8%
Georgia               
Bibb   3.4%   3.6%   3.8%
Burke   6.2%   6.8%   12.7%
Grady   14.1%   14.3%   14.6%
Laurens   9.6%   9.1%   9.0%
Troup   6.1%   5.3%   5.1%
Alabama               
Chambers   8.6%   7.6%   8.1%

 

(1)Obtained from the FDIC Summary of Deposits Report for the year indicated.
8
 

The following table sets forth the number of commercial banks and offices, including our offices and our competitors’ offices, within each of the respective counties.

County  Number of
Commercial
Banks
   Number of
Commercial Bank
Offices
 
Florida          
Alachua    17    64 
Bradford    3    3 
Citrus    12    42 
Clay    13    32 
Dixie    4    5 
Gadsden    2    3 
Gilchrist    4    6 
Gulf    3    5 
Hernando    13    39 
Jefferson    2    2 
Leon    18    78 
Levy    2    11 
Madison    4    4 
Pasco    21    102 
Putnam    6    12 
St. Johns    21    62 
Suwannee    5    8 
Taylor    3    4 
Wakulla    3    4 
Washington    6    6 
Georgia          
Bibb    11    51 
Burke    5    10 
Grady    5    8 
Laurens    10    20 
Troup    10    23 
Alabama          
Chambers    6    9 

 

Data obtained from the June 30, 2015 FDIC Summary of Deposits Report.

Seasonality

 

We believe our commercial banking operations are not generally seasonal in nature; however, public deposits tend to increase with tax collections in the fourth and first quarters of each year and decline with spending thereafter.

9
 

Regulatory Considerations

We must comply with state and federal banking laws and regulations that control virtually all aspects of our operations. These laws and regulations generally aim to protect our depositors, not necessarily our shareowners or our creditors. Any changes in applicable laws or regulations may materially affect our business and prospects. Proposed legislative or regulatory changes may also affect our operations. The following description summarizes some of the laws and regulations to which we are subject. References to applicable statutes and regulations are brief summaries, do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations.

The Company

 

We are registered with the Board of Governors of the Federal Reserve as a financial holding company under the Bank Holding Company Act of 1956. As a result, we are subject to supervisory regulation and examination by the Federal Reserve. The Gramm-Leach-Bliley Act, the Bank Holding Company Act, and other federal laws subject financial holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

Permitted Activities

 

The Gramm-Leach-Bliley Act modernized the U.S. banking system by: (i) allowing bank holding companies that qualify as “financial holding companies” such as CCBG to engage in a broad range of financial and related activities; (ii) allowing insurers and other financial service companies to acquire banks; (iii) removing restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and (iv) establishing the overall regulatory scheme applicable to bank holding companies that also engage in insurance and securities operations. The general effect of the law was to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers. Activities that are financial in nature are broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities, or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.

 

In contrast to financial holding companies, bank holding companies are limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

Changes in Control

Subject to certain exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered securities under Section 12 of the Securities Exchange Act of 1934, which we will refer to as the Exchange Act, or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. Our common stock is registered under Section 12 of the Exchange Act.

 

 10 
 

The Federal Reserve Board maintains a policy statement on minority equity investments in banks and bank holding companies, that generally permits investors to (i) acquire up to 33% of the total equity of a target bank or bank holding company, subject to certain conditions, including (but not limited to) that the investing firm does not acquire 15% or more of any class of voting securities, and (ii) designate at least one director, without triggering the various regulatory requirements associated with control.

 

As a financial holding company, we are required to obtain prior approval from the Federal Reserve before (i) acquiring all or substantially all of the assets of a bank or bank holding company, (ii) acquiring direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless we own a majority of such bank’s voting shares), or (iii) merging or consolidating with any other bank or bank holding company. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the Community Reinvestment Act of 1977.

 

Under Florida law, a person or entity proposing to directly or indirectly acquire control of a Florida bank must also obtain permission from the Florida Office of Financial Regulation. Florida statutes define “control” as either (i) indirectly or directly owning, controlling or having power to vote 25% or more of the voting securities of a bank; (ii) controlling the election of a majority of directors of a bank; (iii) owning, controlling, or having power to vote 10% or more of the voting securities as well as directly or indirectly exercising a controlling influence over management or policies of a bank; or (iv) as determined by the Florida Office of Financial Regulation. These requirements will affect us because CCB is chartered under Florida law and changes in control of CCBG are indirect changes in control of CCB.

 

Tying

Financial holding companies and their affiliates are prohibited from tying the provision of certain services, such as extending credit, to other services or products offered by the holding company or its affiliates, such as deposit products.

Capital; Dividends; Source of Strength

The Federal Reserve imposes certain capital requirements on financial holding companies under the Bank Holding Company Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “Capital Regulations.” Subject to its capital requirements and certain other restrictions, we are generally able to borrow money to make a capital contribution to CCB, and such loans may be repaid from dividends paid from CCB to us. We are also able to raise capital for contributions to CCB by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

 

In accordance with Federal Reserve policy, which has been codified by the Dodd-Frank Act, we are expected to act as a source of financial strength to CCB and to commit resources to support CCB in circumstances in which we might not otherwise do so. In furtherance of this policy, the Federal Reserve may require a financial holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the financial holding company. Further, federal bank regulatory authorities have additional discretion to require a financial holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.

 

Capital City Bank

CCB is a banking institution that is chartered by and headquartered in the State of Florida, and it is subject to supervision and regulation by the Florida Office of Financial Regulation. The Florida Office of Financial Regulation supervises and regulates all areas of CCB’s operations including, without limitation, the making of loans, the issuance of securities, the conduct of CCB’s corporate affairs, the satisfaction of capital adequacy requirements, the payment of dividends, and the establishment or closing of banking centers. CCB is also a member bank of the Federal Reserve System, which makes CCB’s operations subject to broad federal regulation and oversight by the Federal Reserve. In addition, CCB’s deposit accounts are insured by the FDIC to the maximum extent permitted by law, and the FDIC has certain enforcement powers over CCB.

 11 
 

As a state-chartered banking institution in the State of Florida, CCB is empowered by statute, subject to the limitations contained in those statutes, to take and pay interest on, savings and time deposits, to accept demand deposits, to make loans on residential and other real estate, to make consumer and commercial loans, to invest, with certain limitations, in equity securities and in debt obligations of banks and corporations and to provide various other banking services for the benefit of CCB’s clients. Various consumer laws and regulations also affect the operations of CCB, including state usury laws, laws relating to fiduciaries, consumer credit and equal credit opportunity laws, and fair credit reporting. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) prohibits insured state chartered institutions from conducting activities as principal that are not permitted for national banks. A bank, however, may engage in an otherwise prohibited activity if it meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the Deposit Insurance Fund.

Reserves

 

The Federal Reserve requires all depository institutions to maintain reserves against transaction accounts (noninterest bearing and NOW checking accounts). The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements. An institution may borrow from the Federal Reserve Bank “discount window” as a secondary source of funds, provided that the institution meets the Federal Reserve Bank’s credit standards.

 

Dividends

 

CCB is subject to legal limitations on the frequency and amount of dividends that can be paid to us. The Federal Reserve may restrict the ability of CCB to pay dividends if such payments would constitute an unsafe or unsound banking practice. Additionally, effective as of January 1, 2016, financial institutions are be required to maintain a capital conservation buffer of at least 0.625% of risk-weighted assets in order to avoid restrictions on capital distributions and other payments. If a financial institution’s capital conservation buffer falls below the minimum requirement, its maximum payout amount for capital distributions and discretionary payments declines to a set percentage of eligible retained income based on the size of the buffer. See “Capital Regulations,” below for additional details on this new capital requirement.

 

In addition, Florida law and Federal regulation also places restrictions on the declaration of dividends from state chartered banks to their holding companies. Pursuant to the Florida Financial Institutions Code, the board of directors of state-chartered banks, after charging off bad debts, depreciation and other worthless assets, if any, and making provisions for reasonably anticipated future losses on loans and other assets, may quarterly, semi-annually or annually declare a dividend of up to the aggregate net profits of that period combined with the bank’s retained net profits for the preceding two years and, with the approval of the Florida Office of Financial Regulation and Federal Reserve, declare a dividend from retained net profits which accrued prior to the preceding two years. Before declaring such dividends, 20% of the net profits for the preceding period as is covered by the dividend must be transferred to the surplus fund of the bank until this fund becomes equal to the amount of the bank’s common stock then issued and outstanding. A state-chartered bank may not declare any dividend if (i) its net income (loss) from the current year combined with the retained net income (loss) for the preceding two years aggregates a loss or (ii) the payment of such dividend would cause the capital account of the bank to fall below the minimum amount required by law, regulation, order or any written agreement with the Florida Office of Financial Regulation or a federal regulatory agency.

 

Insurance of Accounts and Other Assessments

 

CCB pays its deposit insurance assessments to the Deposit Insurance Fund, which is determined through a risk-based assessment system. Our deposit accounts are currently insured by the Deposit Insurance Fund generally up to a maximum of $250,000 per separately insured depositor.

 

Under the current assessment system, the FDIC assigns an institution to one of four risk categories, designed to measure risk, with the first category having two sub-categories based on the institution’s most recent supervisory and capital evaluations. Total base assessment rates currently range from 0.025% of deposits for an institution in the highest sub-category of the highest category to 0.45% of deposits for an institution in the lowest category.

 

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately six tenths of a basis point of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019.

 

 12 
 

Under the Federal Deposit Insurance Act, or FDIA, the FDIC may terminate deposit insurance upon a finding 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.

 

Transactions With Affiliates

 

Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of CCB to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an “affiliate” generally must be collateralized and certain transactions between CCB and its “affiliates”, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to CCB, as those prevailing for comparable nonaffiliated transactions. In addition, CCB generally may not purchase securities issued or underwritten by affiliates.

 

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank, which we refer to as “10% Shareowners”, or to any political or campaign committee the funds or services of which will benefit those executive officers, directors, or 10% Shareowners or which is controlled by those executive officers, directors or 10% Shareowners, are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed CCB’s unimpaired capital and unimpaired surplus. Section 22(g) identifies limited circumstances in which CCB is permitted to extend credit to executive officers.

 

Community Reinvestment Act

 

The Community Reinvestment Act and its corresponding regulations are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations provide for regulatory assessment of a bank’s record in meeting the credit needs of its service area. Federal banking agencies are required to make public a rating of a bank’s performance under the Community Reinvestment Act. The Federal Reserve considers a bank’s Community Reinvestment Act rating when the bank submits an application to establish bank branches, merge, or acquire the assets and assume the liabilities of another bank. In the case of a financial holding company, the Community Reinvestment Act performance record of all banks involved in the merger or acquisition are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank or financial holding company. An unsatisfactory record can substantially delay or block the transaction. CCB received a satisfactory rating on its most recent Community Reinvestment Act assessment.

 

Capital Regulations

 

The federal banking regulators have adopted risk-based, capital adequacy guidelines for financial holding companies and their subsidiary state-chartered banks. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and financial holding companies, to account for off-balance sheet exposure, to minimize disincentives for holding liquid assets and to achieve greater consistency in evaluating the capital adequacy of major banks throughout the world. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories each with designated weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

 

 13 
 

The federal banking regulators adopted risk-based capital adequacy guidelines for U.S. banks. As described above, the federal banking regulators have adopted final rules that became effective January 1, 2015 for community banks. These final rules represent major changes to the prior general risk-based capital rule and are designed to substantially conform to the Basel III international standards. The new risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure, to minimize disincentives for holding liquid assets, and to achieve greater consistency in evaluating the capital adequacy of major banks throughout the world. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories each with designated weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

 

Under the final rule, minimum requirements increased for both the quality and quantity of capital held by banking organizations. In this respect, the final rule implements strict eligibility criteria for regulatory capital instruments and improves the methodology for calculating risk-weighted assets to enhance risk sensitivity. Consistent with the international Basel framework, the rule includes a new minimum ratio of Common Equity Tier 1 Capital to Risk-Weighted Assets of 4.5% and a Common Equity Tier 1 Capital conservation buffer of 2.5% of risk-weighted assets. The rule also, among other things, raises the minimum ratio of Tier 1 Capital to Risk-Weighted Assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a three-year period (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019). If a financial institution’s capital conservation buffer falls below the minimum required amount, its maximum payout amount for capital distributions and discretionary payments will be limited or prohibited based on the size of the institution’s buffer. The types of payments subject to this limitation include dividends, share buybacks, discretionary payments on Tier 1 instruments, and discretionary bonus payments.

 

In computing total risk-weighted assets, bank and bank holding company assets are given risk-weights of 0%, 20%, 50% and 100%. In addition, certain off-balance sheet items are given similar credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. Most loans will be assigned to the 100% risk category, except for performing first mortgage loans fully secured by 1- to 4-family and certain multi-family residential property, which carry a 50% risk rating. Most investment securities (including, primarily, general obligation claims on states or other political subdivisions of the United States) will be assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% risk-weight, and direct obligations of the U.S. Treasury or obligations backed by the full faith and credit of the U.S. Government, which have a 0% risk-weight. In covering off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing financial obligations, are given a 100% conversion factor. Transaction-related contingencies such as bid bonds, standby letters of credit backing nonfinancial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50% conversion factor. Short-term commercial letters of credit are converted at 20% and certain short-term unconditionally cancelable commitments have a 0% factor.

 

The new capital regulations may also impact the treatment of accumulated other comprehensive income (“AOCI”) for regulatory capital purposes. Under the new rules, AOCI would generally flow through to regulatory capital, however, community banks and their holding companies may make a one-time irrevocable opt-out election to continue to treat AOCI the same as under the old regulations for regulatory capital purposes. This election was required to be made on the first call report or bank holding company annual report (on form FR Y-9C) filed after January 1, 2015. The Company chose the opt-out election. Additionally, the new rules also permit community banks with less than $15 billion in total assets to continue to count certain non-qualifying capital instruments issued prior to May 19, 2010, including trust preferred securities and cumulative perpetual preferred stock, as Tier 1 capital (subject to a limit of 25% of tier 1 capital). However, non-qualifying capital instruments issued on or after May 19, 2010 will not qualify for Tier 1 capital treatment.

 

Federal law and regulations establish a capital-based regulatory scheme designed to promote early intervention for troubled banks and require the FDIC to choose the least expensive resolution of bank failures. The capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” To qualify as a “well-capitalized” institution under the new rules in effect as of January 1, 2015, a bank must have a leverage ratio of not less than 5%, a Tier 1 Common Equity ratio of not less than 6.5%, a Tier 1 Capital ratio of not less than 8%, and a total risk-based capital ratio of not less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level.

 

 14 
 

Under the regulations, the applicable agency can treat an institution as if it were in the next lower category if the agency determines (after notice and an opportunity for hearing) that the institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of a financial institution will increase, and the permissible activities of the institution will decrease, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to (i) submit a capital restoration plan; (ii) raise additional capital; (iii) restrict their growth, deposit interest rates, and other activities; (iv) improve their management; (v) eliminate management fees; or (vi) divest themselves of all or a part of their operations. It should be noted that the minimum ratios referred to above are merely guidelines and the bank regulators possess the discretionary authority to require higher capital ratios.

 

As of December 31, 2015, we exceeded the requirements contained in the applicable regulations, policies and directives pertaining to capital adequacy to be classified as “well capitalized” and are unaware of any material violation or alleged violation of these regulations, policies or directives (see table below). Rapid growth, poor loan portfolio performance, or poor earnings performance, or a combination of these factors, could change our capital position in a relatively short period of time, making additional capital infusions necessary.

 

   Actual   Required
For Capital
Adequacy
Purposes
   To Be Well-
Capitalized
Under
Prompt
Corrective
Action
Provisions
 
(Dollars in thousands)  Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of December 31, 2015:                              
Common Equity Tier 1 Capital:                              
CCBG  $215,075    12.84%  $75,385    4.50%   *    * 
CCB   266,138    15.93%   75,162    4.50%   108,567    6.50%
                               
Tier 1 Capital:                              
CCBG   275,075    16.42%   100,513    6.00%   *    * 
CCB   266,138    15.93%   100,216    6.00%   133,621    8.00%
                               
Total Capital:                              
CCBG   289,028    17.25%   134,018    8.00%   *    * 
CCB   280,091    16.77%   133,621    8.00%   167,026    10.00%
                               
Tier 1 Leverage:                              
CCBG   275,075    10.65%   103,342    4.00%   *    * 
CCB   266,138    10.33%   103,095    4.00%   128,869    5.00%

 

*Not applicable to bank holding companies.

Prompt Corrective Action

Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the Federal Deposit Insurance Act, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.

15
 

Interstate Banking and Branching

 

The Bank Holding Company Act, amended by the Interstate Banking Act, provides that adequately capitalized and managed financial and bank holding companies are permitted to acquire banks in any state.

 

State laws prohibiting interstate banking or discriminating against out-of-state banks are preempted. States are not permitted to enact laws opting out of this provision; however, states are allowed to adopt a minimum age restriction requiring that target banks located within the state be in existence for a period of time, up to a maximum of five years, before a bank may be subject to the Interstate Banking Act. Also, the Dodd-Frank Act, added deposit caps which prohibit acquisitions that result in the acquiring company controlling 30% or more of the deposits of insured banks and thrift institutions held in the state in which the target maintains a branch or 10% or more of the deposits nationwide. States have the authority to waive the 30% deposit cap. State-level deposit caps are not preempted as long as they do not discriminate against out-of-state companies, and the federal deposit caps apply only to initial entry acquisitions.

 

Under the Dodd-Frank Act, national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state. Florida law permits a state bank to establish a branch of the bank anywhere in the state. Accordingly, under the Dodd-Frank Act, a bank with its headquarters outside the State of Florida may establish branches anywhere within the state.

 

Anti-money Laundering

 

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”), provides the federal government with additional powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act (“BSA”), the USA PATRIOT Act puts in place measures intended to encourage information sharing among bank regulatory and law enforcement agencies. In addition, certain provisions of the USA PATRIOT Act impose affirmative obligations on a broad range of financial institutions.

Among other requirements, the USA PATRIOT Act and the related Federal Reserve regulations require banks to establish anti-money laundering programs that include, at a minimum:

§internal policies, procedures and controls designed to implement and maintain the savings association’s compliance with all of the requirements of the USA PATRIOT Act, the BSA and related laws and regulations;
§systems and procedures for monitoring and reporting of suspicious transactions and activities;
§a designated compliance officer;
§employee training;
§an independent audit function to test the anti-money laundering program;
§procedures to verify the identity of each client upon the opening of accounts; and
§heightened due diligence policies, procedures and controls applicable to certain foreign accounts and relationships.

 

Additionally, the USA PATRIOT Act requires each financial institution to develop a customer identification program (“CIP”) as part of its anti-money laundering program. The key components of the CIP are identification, verification, government list comparison, notice and record retention. The purpose of the CIP is to enable the financial institution to determine the true identity and anticipated account activity of each customer. To make this determination, among other things, the financial institution must collect certain information from customers at the time they enter into the customer relationship with the financial institution. This information must be verified within a reasonable time through documentary and non-documentary methods. Furthermore, all customers must be screened against any CIP-related government lists of known or suspected terrorists. We and our affiliates have adopted policies, procedures and controls designed to comply with the BSA and the USA PATRIOT Act.

Regulatory Enforcement Authority

Federal and state banking laws grant substantial enforcement powers to federal and state banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

16
 

Federal Home Loan Bank System

 

CCB is a member of the Federal Home Loan Bank of Atlanta, which is one of 12 regional Federal Home Loan Banks. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the FHLB system. It makes loans to members (i.e. advances) in accordance with policies and procedures established by the board of trustees of the FHLB.

 

As a member of the FHLB of Atlanta, CCB is required to own capital stock in the FHLB in an amount at least equal to 0.09% (or 9 basis points), which is subject to annual adjustments, of the CCB’s total assets at the end of each calendar year (with a dollar cap of $15 million), plus 4.25% of its outstanding advances (borrowings) from the FHLB of Atlanta under the activity-based stock ownership requirement. As of December 31, 2015, CCB was in compliance with this requirement.

 

Privacy

 

Under the Gramm-Leach-Bliley Act, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties.

 

Overdraft Fee Regulation

 

The Electronic Fund Transfer Act prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machines (“ATM”) and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those type of transactions. If a consumer does not opt in, any ATM transaction or debit that overdraws the consumer’s account will be denied. Overdrafts on the payment of checks and regular electronic bill payments are not covered by this new rule. Before opting in, the consumer must be provided a notice that explains the financial institution’s overdraft services, including the fees associated with the service, and the consumer’s choices. Financial institutions must provide consumers who do not opt in with the same account terms, conditions and features (including pricing) that they provide to consumers who do opt in.

 

Consumer Laws and Regulations

 

CCB is also subject to other federal and state consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth below is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Check Clearing for the 21st Century Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair and Accurate Credit Transactions Act, the Mortgage Disclosure Improvement Act, and the Real Estate Settlement Procedures Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. CCB must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

 

In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards, which generally require creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establishes certain protections from liability under this requirement for loans that meet the requirements of the “qualified mortgage” safe harbor. In addition, on October 3, 2015, the new TILA-RESPA Integrated Disclosure (TRID) rules for mortgage closings took effect for new loan applications. These new loan forms may have the effect of lengthening the time it takes to approve mortgage loans in the short-term following implementation of the rule.

 

The Volcker Rule

 

Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, prohibits us from owning, sponsoring, or having certain relationships with any hedge funds or private equity funds, subject to certain exemptions. The Volcker Rule directed the federal banking, securities and commodities and futures regulatory agencies to undertake a coordinated rulemaking effort to create rules implementing the Volcker Rule. The final interagency rules implementing the Volcker Rule, which were issued in December 2013 and became effective on April 1, 2014, afford financial institutions a two-year conformance period during which they can wind-down, sell, or otherwise conform their respective activities, investments and relationships to the requirements of the Volcker Rule and its implementing regulations. We do not believe that the Volcker Rule or the final interagency rules implementing the Volcker Rule will have a material impact on our investment activities since we do not engage in transactions covered by the regulation.

17
 

Future Legislative Developments

 

Various legislative acts are from time to time introduced in Congress and the Florida legislature. This legislation may change banking statutes and the environment in which our banking subsidiary and we operate in substantial and unpredictable ways. We cannot determine the ultimate effect that potential legislation, if enacted, or implementing regulations with respect thereto, would have upon our financial condition or results of operations or that of our banking subsidiary.

 

Effect of Governmental Monetary Policies

 

The commercial banking business in which CCB engages is affected not only by general economic conditions, but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowing, availability of borrowing at the “discount window,” open market operations, the imposition of changes in reserve requirements against member banks’ deposits and assets of foreign banking centers and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the instruments of monetary policy available to the Federal Reserve. These monetary policies are used in varying combinations to influence overall growth and distributions of bank loans, investments and deposits, and this use may affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve have had a significant effect on the operating results of commercial banks and are expected to continue to do so in the future. The monetary policies of the Federal Reserve are influenced by various factors, including inflation, unemployment, and short-term and long-term changes in the international trade balance and in the fiscal policies of the U.S. Government. Future monetary policies and the effect of such policies on the future business and earnings of CCB cannot be predicted.

 

Income Taxes

 

We are subject to income taxes at the federal level and subject to state taxation based on the laws of each state in which we operate. We file a consolidated federal tax return with a fiscal year ending on December 31.

 

Website Access to Company’s Reports

 

Our Internet website is www.ccbg.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, including any amendments to those reports filed or furnished pursuant to section 13(a) or 15(d), and reports filed pursuant to Section 16, 13(d), and 13(g) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. The information on our website is not incorporated by reference into this report.

18
 

Item 1A. Risk Factors

 

An investment in our common stock contains a high degree of risk. You should consider carefully the following risk factors before deciding whether to invest in our common stock. Our business, including our operating results and financial condition, could be harmed by any of these risks. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to the other information contained in our filings with the SEC, including our financial statements and related notes.

Risks Related to Our Business

 

We may incur losses if we are unable to successfully manage interest rate risk.

 

Our profitability depends to a large extent on Capital City Bank’s net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and expense on interest-bearing liabilities such as deposits and borrowings. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, recession, unemployment, federal funds target rate, money supply, domestic and international events and changes in the United States and other financial markets. Our net interest income may be reduced if: (i) more interest-earning assets than interest-bearing liabilities reprice or mature during a time when interest rates are declining or (ii) more interest-bearing liabilities than interest-earning assets reprice or mature during a time when interest rates are rising.

 

Changes in the difference between short-term and long-term interest rates may also harm our business. We generally use short-term deposits to fund longer-term assets. When interest rates change, assets and liabilities with shorter terms reprice more quickly than those with longer terms, which could have a material adverse effect on our net interest margin. If market interest rates rise rapidly, interest rate adjustment caps may also limit increases in the interest rates on adjustable rate loans, which could further reduce our net interest income. Additionally, we believe that due to the recent historical low interest rate environment, the effects of the repeal of Regulation Q, which previously had prohibited the payment of interest on demand deposits by member banks of the Federal Reserve System, has not been realized. The increased price competition for deposits that may result upon the return to a historically normal interest rate environment could adversely affect net interest margins of community banks.

 

Although we continually monitor interest rates and have a number of tools to manage our interest rate risk exposure, changes in market assumptions regarding future interest rates could significantly impact our interest rate risk strategy, our financial position and results of operations. If our interest rate risk management strategies are not appropriately monitored or executed, these activities may not effectively mitigate our interest rate sensitivity or have the desired impact on our results of operations or financial condition.

 

Our loan portfolio includes loans with a higher risk of loss which could lead to higher loan losses and nonperforming assets.

 

We originate commercial real estate loans, commercial loans, construction loans, vacant land loans, consumer loans, and residential mortgage loans primarily within our market area. Commercial real estate, commercial, construction, vacant land, and consumer loans may expose a lender to greater credit risk than traditional fixed rate fully amortizing loans secured by single-family residential real estate because the collateral securing these loans may not be sold as easily as single-family residential real estate. In addition, these loan types tend to involve larger loan balances to a single borrower or groups of related borrowers and are more susceptible to a risk of loss during a downturn in the business cycle. These loans also have historically had greater credit risk than other loans for the following reasons:

 

§Commercial Real Estate Loans. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on the borrower’s ability to either refinance the loan or timely sell the underlying property. As of December 31, 2015, commercial mortgage loans comprised approximately 33.2% of our total loan portfolio.

 

§Commercial Loans. Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of December 31, 2015, commercial loans comprised approximately 12.0% of our total loan portfolio.

 

§Construction Loans. The risk of loss is largely dependent on our initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If our estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2015, construction loans comprised approximately 3.2% of our total loan portfolio.
19
 
§Vacant Land Loans. Because vacant or unimproved land is generally held by the borrower for investment purposes or future use, payments on loans secured by vacant or unimproved land will typically rank lower in priority to the borrower than a loan the borrower may have on their primary residence or business. These loans are susceptible to adverse conditions in the real estate market and local economy. As of December 31, 2015, vacant land loans comprised approximately 4.4% of our total loan portfolio.

 

§HELOCs. Our open-ended home equity loans have an interest-only draw period followed by a five-year repayment period of 0.75% of the principal balance monthly and a balloon payment at maturity. Upon the commencement of the repayment period, the monthly payment can increase significantly, thus, there is a heightened risk that the borrower will be unable to pay the increased payment. Further, these loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment may depend on the borrower’s ability to either refinance the loan or timely sell the underlying property. As of December 31, 2015, HELOCs comprised approximately 15.6% of our total loan portfolio.

 

§Consumer Loans. Consumer loans (such as automobile loans and personal lines of credit) are collateralized, if at all, with assets that may not provide an adequate source of payment of the loan due to depreciation, damage, or loss. As of December 31, 2015, consumer loans comprised approximately 16.1% of our total loan portfolio, with indirect auto loans making up a majority of this portfolio at approximately 84% of the total balance.

 

The increased risks associated with these types of loans result in a correspondingly higher probability of default on such loans (as compared to fixed rated fully amortizing single-family real estate loans). Loan defaults would likely increase our loan losses and nonperforming assets and could adversely affect our allowance for loan losses.

 

We process, maintain, and transmit confidential client information through our information technology systems, such as our online banking service. Cybersecurity issues, such as security breaches and computer viruses, affecting our information technology systems or fraud related to our credit or debit card products could disrupt our business, result in the unintended disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.

 

We collect and store sensitive data, including our proprietary business information and that of our clients, and personally identifiable information of our clients and employees, in our information technology systems. We also provide our clients the ability to bank online. The secure processing, maintenance, and transmission of this information is critical to our operations. Our network, or those of our clients, could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems. Financial institutions and companies engaged in data processing have increasingly reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disrupt or degrade service, sabotage systems or cause other damage.

 

We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. Security breaches and viruses could expose us to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in our systems and could adversely affect our reputation and our ability to generate deposits.

 

Additionally, fraud losses related to credit and debit cards have risen in recent years due in large part to growing and evolving schemes to illegally use cards or steal consumer credit card information despite risk management practices employed by the credit and debit card industry. Many issuers of debit and credit cards have suffered significant losses in recent years due to the theft of cardholder data that has been illegally exploited for personal gain.

 

 20 
 

The potential for credit and debit card fraud against us or our clients and our third party service providers is a serious issue. Credit card fraud is pervasive and the risks of cybercrime are complex and continue to evolve. In view of the recent high-profile retail data breaches involving client personal and financial information, the potential impact on us and any exposure to consumer losses and the cost of technology investments to improve security could cause losses to us or our clients, damage to our brand, and an increase in our costs.

 

An inadequate allowance for loan losses would reduce our earnings.

 

We are exposed to the risk that our clients may be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure full repayment. This could result in credit losses that are inherent in the lending business. We evaluate the collectability of our loan portfolio and provide an allowance for loan losses that we believe is adequate based upon such factors as:

 

§the risk characteristics of various classifications of loans;
§previous loan loss experience;
§specific loans that have loss potential;
§delinquency trends;
§estimated fair market value of the collateral;
§current economic conditions; and
§geographic and industry loan concentrations.

 

As of December 31, 2015, the Bank’s allowance for loan losses was $14.0 million, which represented approximately 0.93% of its total amount of loans. The Bank had $10.3 million in nonaccruing loans as of December 31, 2015. The allowance is based on management’s reasonable estimate and may not prove sufficient to cover future loan losses. Although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to the Bank’s nonperforming or performing loans. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require us to recognize additional losses based on their judgments about information available to them at the time of their examination. Accordingly, the allowance for loan losses may not be adequate to cover loan losses or significant increases to the allowance may be required in the future if economic conditions should worsen. Material additions to the Bank’s allowance for loan losses would adversely impact our net income and capital in future periods, while having the effect of overstating our current period earnings.

 

Since we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs associated with the ownership of real property, which could result in reduced net income.

 

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate.

 

The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to:

 

§general or local economic conditions;
§environmental cleanup liability;
§neighborhood values;
§interest rates;
§real estate tax rates;
§operating expenses of the mortgaged properties;
§supply of and demand for rental units or properties;
§ability to obtain and maintain adequate occupancy of the properties;
§zoning laws;
§governmental rules, regulations and fiscal policies; and
§acts of God.

 

Certain expenditures associated with the ownership of real estate, principally real estate taxes, insurance and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the rental income earned from such property, and we may have to advance funds in order to protect our investment or we may be required to dispose of the real property at a loss.

 

 21 
 

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

 

Effective liquidity management is essential for the operation of our business. We require sufficient liquidity to meet client loan requests, client deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances causing industry or general financial market stress. An inability to raise funds through deposits, borrowings, earnings and other sources, could have a substantial negative effect on our liquidity.  In particular, a majority of our liabilities during 2015 were checking accounts and other liquid deposits, which are generally payable on demand or upon short notice, while by comparison, a substantial majority of our assets were loans, which cannot generally be called or sold in the same time frame. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could negatively impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, adverse regulatory action against us, or our inability to attract and retain deposits. Our ability to borrow could be impaired by factors that are not specific to us, such a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry. Our failure to maintain adequate liquidity could materially and adversely affect our business, results of operations or financial condition.

 

Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.

 

We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable financing than we can. Many of our non-bank competitors are not subject to the same extensive regulations that govern our activities. As a result, these non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.

 

Risks Related to Regulation and Legislation

We are subject to extensive regulation, including an unprecedented increase in new regulation, which could restrict our activities and impose financial requirements or limitations on the conduct of our business.

 

Both CCBG and the Bank are subject to extensive regulation, supervision and examination by our regulators, including the Florida Office of Financial Regulation, the Federal Reserve, and the FDIC. Our compliance with these industry regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, access to capital and brokered deposits and locations of banking offices. If we are unable to meet these regulatory requirements, our financial condition, liquidity and results of operations would be materially and adversely affected.

 

We are experiencing an unprecedented increase in regulations and supervision. Significant new legislation and regulations affecting the financial services industry have been adopted or proposed in recent years, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Dodd-Frank Act, into law. Congress and our regulators continue to develop, propose and adopt rules and propose new regulatory initiatives, so the cumulative effect of all of the new legislation and regulations on our business and operations remains uncertain.

 

We must also meet regulatory capital requirements imposed by our regulators. These capital requirements have increased as a result of the implementation of the Basel III framework under Dodd-Frank and have required us to hold more capital and reduce our leverage. An inability to meet these capital requirements would result in numerous mandatory supervisory actions and additional regulatory restrictions, and could have a negative impact on our financial condition, liquidity and results of operations.

 

In addition to the regulations of the Florida Office of Financial Regulation, the Federal Reserve, and the FDIC, as a member of the Federal Home Loan Bank, the Bank must also comply with applicable regulations of the Federal Housing Finance Agency and the Federal Home Loan Bank.

 

 22 
 

The Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit and other activities. Many of these regulations are intended primarily for the protection of our depositors and the Deposit Insurance Fund and not for the benefit of our shareowners. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines and other penalties, any of which could adversely affect our results of operations, capital base and the price of our securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect our business and financial condition. Please refer to the Section entitled “Business – Regulatory Considerations” in this Report.

 

The new Basel III Capital Standards may have an adverse effect on us.

 

In 2013, the Federal Reserve Board released its final rules which implement in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. Under the final rule, minimum requirements increased for both the quality and quantity of capital held by banking organizations. Consistent with the international Basel framework, the rule includes a new minimum ratio of Common Equity Tier 1 Capital (“CET1”) to Risk-Weighted Assets (“RWA”) of 4.5% and a CET1 conservation buffer of 2.5% of RWA (which will be phased in from 2016 through 2019) that apply to all supervised financial institutions. As of January 1, 2016, the CET1conservation buffer requirement was 0.625%, which requires us to hold additional CET1 capital in excess of the minimum required to meet the CET1 to RWA ratio requirement. The rule also, among other things, raised the minimum ratio of Tier 1 Capital to RWA from 4% to 6% and included a minimum leverage ratio of 4% for all banking organizations. The impact of the new capital rules requires us to maintain higher levels of capital, which we expect will lower our return on equity. Additionally, if our CET1 to RWA ratio does not exceed the minimum required plus the additional CET1 conservation buffer, we may be restricted in our ability to pay dividends or make other distributions of capital to our shareowners.

 

Compliance with the Consumer Financial Protection Bureau’s ability-to-repay rule safe-harbor could adversely impact our growth or profitability.

 

The Consumer Financial Protection Bureau issued a rule, effective as of January 14, 2014, designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which holds lenders accountable for ensuring a borrower’s ability to repay a mortgage at the time the loan is originated. Loans that satisfy the “qualified mortgage” safe-harbor will be presumed to have complied with the new ability-to-repay standard. Under the Consumer Financial Protection Bureau’s rule, a “qualified mortgage” loan must not contain certain specified features, including but not limited to:

 

§excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);
§interest-only payments;
§negative-amortization; and
§terms longer than 30 years.

 

Also, to qualify as a “qualified mortgage,” a borrower’s total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The Consumer Financial Protection Bureau’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact our growth or profitability.

 

Florida financial institutions, such as the Bank, face a higher risk of noncompliance and enforcement actions with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

 

Since September 11, 2001, banking regulators have intensified their focus on anti-money laundering and Bank Secrecy Act compliance requirements, particularly the anti-money laundering provisions of the USA PATRIOT Act. There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control (“OFAC”). Since 2004, federal banking regulators and examiners have been extremely aggressive in their supervision and examination of financial institutions located in the State of Florida with respect to the institution’s Bank Secrecy Act/anti-money laundering compliance. Consequently, numerous formal enforcement actions have been instituted against financial institutions.

 

 23 
 

In order to comply with regulations, guidelines and examination procedures in this area, the Bank has been required to adopt new policies and procedures and to install new systems. If the Bank’s policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that it has already acquired or may acquire in the future are deficient, the Bank would be subject to liability, including fines and regulatory actions such as restrictions on its ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of its business plan, including its acquisition plans.

 

Risks Related to Market Events

 

Our loan portfolio is heavily concentrated in mortgage loans secured by properties in Florida and Georgia which causes our risk of loss to be higher than if we had a more geographically diversified portfolio.

 

Our interest-earning assets are heavily concentrated in mortgage loans secured by real estate, particularly real estate located in Florida and Georgia. As of December 31, 2015, approximately 72% of our loans had real estate as a primary, secondary, or tertiary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower; however, the value of the collateral may decline during the time the credit is extended. If we are required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.

 

Additionally, as of December 31, 2015, substantially all of our loans secured by real estate are secured by commercial and residential properties located in Northern Florida and Middle Georgia. The concentration of our loans in these areas subjects us to risk that a downturn in the economy or recession in these areas could result in a decrease in loan originations and increases in delinquencies and foreclosures, which would more greatly affect us than if our lending were more geographically diversified. In addition, since a large portion of our portfolio is secured by properties located in Florida and Georgia, the occurrence of a natural disaster, such as a hurricane, or a man-made disaster could result in a decline in loan originations, a decline in the value or destruction of mortgaged properties and an increase in the risk of delinquencies, foreclosures or loss on loans originated by us. We may suffer further losses due to the decline in the value of the properties underlying our mortgage loans, which would have an adverse impact on our results of operations and financial condition.

 

Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.

 

Due to the lack of diversified industry within the markets served by the Bank and the relatively close proximity of our geographic markets, we have both geographic concentrations as well as concentrations in the types of loans funded. Specifically, due to the nature of our markets, a significant portion of the portfolio has historically been secured with real estate. As of December 31, 2015, approximately 33.2% and 35.6% of our $1.504 billion loan portfolio was secured by commercial real estate and residential real estate, respectively. As of this same date, approximately 3.2% was secured by property under construction.

 

In the event we are required to foreclose on a property securing one of our mortgage loans or otherwise pursue our remedies in order to protect our investment, we may be unable to recover funds in an amount equal to our projected return on our investment or in an amount sufficient to prevent a loss to us due to prevailing economic conditions, real estate values and other factors associated with the ownership of real property. As a result, the market value of the real estate or other collateral underlying our loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans, and consequently, we would sustain loan losses.

 

The fair value of our investments could decline which would cause a reduction in shareowners’ equity.

 

A large portion of our investment securities portfolio as of December 31, 2015 has been designated as available-for-sale pursuant to U.S. generally accepted accounting principles relating to accounting for investments. Such principles require that unrealized gains and losses in the estimated value of the available-for-sale portfolio be “marked to market” and reflected as a separate item in shareowners’ equity (net of tax) as accumulated other comprehensive income/loss. Shareowners’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. The fair value of our investment portfolio may decline, causing a corresponding decline in shareowners’ equity.

 

Management believes that several factors will affect the fair values of our investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes in interest rates, the degree of volatility in the securities markets, inflation rates or expectations of inflation and the slope of the interest rate yield curve (the yield curve refers to the differences between short-term and long-term interest rates; a positively sloped yield curve means short-term rates are lower than long-term rates). These and other factors may impact specific categories of the portfolio differently, and we cannot predict the effect these factors may have on any specific category.

 

 24 
 

Risks Related to an Investment in Our Common Stock

 

We may be unable to pay dividends in the future.

 

In 2015, our Board of Directors declared four quarterly cash dividends. Declarations of any future dividends will be contingent on our ability to earn sufficient profits and to remain well capitalized, including our ability to hold and generate sufficient capital to comply with the new CET1 conservation buffer requirement. In addition, due to our contractual obligations with the holders of our trust preferred securities, if we defer the payment of accrued interest owed to the holders of our trust preferred securities, we may not make dividend payments to our shareowners.

 

Further, under applicable statutes and regulations, the Bank’s board of directors, after charging-off bad debts, depreciation and other worthless assets, if any, and making provisions for reasonably anticipated future losses on loans and other assets, may quarterly, semi-annually, or annually declare and pay dividends to CCBG of up to the aggregate net income of that period combined with the Bank’s retained net income for the preceding two years and, with the approval of the Florida Office of Financial Regulation and Federal Reserve, declare a dividend from retained net income which accrued prior to the preceding two years.  Additional state laws generally applicable to Florida corporations may also limit our ability to declare and pay dividends. Thus, our ability to fund future dividends may be restricted by state and federal laws and regulations. 

 

Limited trading activity for shares of our common stock may contribute to price volatility.

 

While our common stock is listed and traded on the Nasdaq Global Select Market, there has historically been limited trading activity in our common stock. The average daily trading volume of our common stock over the 12-month period ending December 31, 2015 was approximately 21,073 shares. Due to the limited trading activity of our common stock, relativity small trades may have a significant impact on the price of our common stock.

 

Securities analysts may not initiate coverage or continue to cover our common stock, and this may have a negative impact on its market price.

 

The trading market for our common stock will depend in part on the research and reports that securities analysts publish about us and our business. We do not have any control over securities analysts and they may not initiate coverage or continue to cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are covered by securities analysts, and our common stock is the subject of an unfavorable report, our stock price would likely decline. If one or more of these analysts ceases to cover our Company or fails to publish regular reports on us, we could lose visibility in the financial markets, which may cause our stock price or trading volume to decline.

 

Our directors, executive officers, and principal shareowners, if acting together, have substantial control over all matters requiring shareowner approval, including changes of control. Because Mr. William G. Smith, Jr. is a principal shareowner and our Chairman, President, and Chief Executive Officer and Chairman of the Bank, he has substantial control over all matters on a day to day basis.

 

Our directors, executive officers, and principal shareowners beneficially owned approximately 37% of the outstanding shares of our common stock as of December 31, 2015. Our principal shareowners include the Estate of Robert H. Smith, who was the brother of William G. Smith, Jr., our Chairman, President and Chief Executive Officer, which beneficially owns 17.8% of our shares. William G. Smith, Jr. beneficially owns 21.9% of our shares. In addition, 2S Partnership beneficially owns 6.1% of our shares, however, its shares were historically deemed to be beneficially owned by Messrs. Smith and Smith. Together, Mr. Smith and the Estate of Robert H. Smith beneficially own approximately 34% of our shares.

 

Accordingly, these directors, executive officers, and principal shareowners, if acting together, may be able to influence or control matters requiring approval by our shareowners, including the election of directors and the approval of mergers, acquisitions or other extraordinary transactions. In addition, because William G. Smith, Jr. is the Chairman, President, and Chief Executive Officer of CCBG and Chairman of the Bank, he has substantial control over all matters on a day-to-day basis, including the nomination and election of directors.

 

These directors, executive officers, and principal shareowners may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. The concentration of ownership may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our shareowners of an opportunity to receive a premium for their common stock as part of a sale of our Company and might ultimately affect the market price of our common stock. You may also have difficulty changing management, the composition of the Board of Directors, or the general direction of our Company.

 

 25 
 

Our Articles of Incorporation, Bylaws, and certain laws and regulations may prevent or delay transactions you might favor, including a sale or merger of CCBG.

 

CCBG is registered with the Federal Reserve as a financial holding company under the Bank Holding Company Act (“BHCA”). As a result, we are subject to supervisory regulation and examination by the Federal Reserve. The Gramm-Leach-Bliley Act, the BHCA, and other federal laws subject financial holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

Provisions of our Articles of Incorporation, Bylaws, certain laws and regulations and various other factors may make it more difficult and expensive for companies or persons to acquire control of us without the consent of our Board of Directors. It is possible, however, that you would want a takeover attempt to succeed because, for example, a potential buyer could offer a premium over the then prevailing price of our common stock.

 

For example, our Articles of Incorporation permit our Board of Directors to issue preferred stock without shareowner action. The ability to issue preferred stock could discourage a company from attempting to obtain control of us by means of a tender offer, merger, proxy contest or otherwise. Additionally, our Articles of Incorporation and Bylaws divide our Board of Directors into three classes, as nearly equal in size as possible, with staggered three-year terms. One class is elected each year. The classification of our Board of Directors could make it more difficult for a company to acquire control of us. We are also subject to certain provisions of the Florida Business Corporation Act and our Articles of Incorporation that relate to business combinations with interested shareowners. Other provisions in our Articles of Incorporation or Bylaws that may discourage takeover attempts or make them more difficult include:

 

§Supermajority voting requirements to remove a director from office;
§Provisions regarding the timing and content of shareowner proposals and nominations;
§Supermajority voting requirements to amend Articles of Incorporation unless approval is received by a majority of “disinterested directors”;
§Absence of cumulative voting; and
§Inability for shareowners to take action by written consent.

 

Shares of our common stock are not an insured deposit and may lose value.

 

The shares of our common stock are not a bank deposit and will not be insured or guaranteed by the FDIC or any other government agency. Your investment will be subject to investment risk, and you must be capable of affording the loss of your entire investment.

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

We are headquartered in Tallahassee, Florida. Our executive office is in the Capital City Bank building located on the corner of Tennessee and Monroe Streets in downtown Tallahassee. The building is owned by the Bank, but is located on land leased under a long-term agreement.

 

As of February 29, 2016, the Bank had 61 banking offices. Of the 61 locations, the Bank leases the land, buildings, or both at seven locations and owns the land and buildings at the remaining 54.

 

Item 3. Legal Proceedings

 

We are party to lawsuits and claims arising out of the normal course of business. In management’s opinion, there are no known pending claims or litigation, the outcome of which would, individually or in the aggregate, have a material effect on our consolidated results of operations, financial position, or cash flows.

 

Item 4. Mine Safety Disclosure.

 

Not applicable.

 

 26 
 

PART II

 

Item 5. Market for the Registrant’s Common Equity, Related Shareowner Matters, and Issuer Purchases of Equity Securities

 

Common Stock Market Prices and Dividends

 

Our common stock trades on the Nasdaq Global Select Market under the symbol “CCBG.” We had a total of 1,559 shareowners of record as of February 29, 2016.

 

The following table presents the range of high and low closing sales prices reported on the Nasdaq Global Select Market and cash dividends declared for each quarter during the past two years.

 

   2015   2014 
   Fourth
Quarter
   Third
Quarter
   Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter
   First
Quarter
 
Common stock price:                                        
High  $16.05   $15.75   $16.32   $16.33   $16.00   $14.98   $14.71   $14.59 
Low   13.56    14.39    13.94    13.16    13.00    13.26    12.60    11.56 
Close   15.35    14.92    15.27    16.25    15.54    13.54    14.53    13.28 
Cash dividends per share   0.04    0.03    0.03    0.03    0.03    0.02    0.02    0.02 

 

Florida law and Federal regulations impose restrictions on our ability to pay dividends and limitations on the amount of dividends that the Bank can pay annually to us. See Item 1. “Capital; Dividends; Sources of Strength” and “Dividends” in the Business section on page 11 and 12 and the section entitled “Liquidity and Capital Resources – Dividends” -- in Management’s Discussion and Analysis of Financial Condition and Operating Results on page 51 and Note 14 in the Notes to Consolidated Financial Statements.

27
 

Performance Graph

 

This performance graph compares the cumulative total shareholder return on our common stock with the cumulative total shareholder return of the Nasdaq Composite Index and the SNL Financial LC $1B-$5B Bank Index for the past five years.  The graph assumes that $100 was invested on December 31, 2010 in our common stock and each of the above indices, and that all dividends were reinvested.  The shareholder return shown below represents past performance and should not be considered indicative of future performance.

 

 (Line Graph)

 

   Period Ending 
Index  12/31/10   12/31/11   12/31/12   12/31/13   12/31/14   12/31/15 
Capital City Bank Group, Inc.   $100.00   $77.90   $92.75   $96.01   $127.56   $127.09 
Nasdaq Composite    100.00    99.21    116.82    163.75    188.03    201.40 
SNL $1B-$5B Bank Index    100.00    91.20    112.45    163.52    170.98    191.39 

28
 

Item 6. Selected Financial Data

 

(Dollars in Thousands, Except Per Share Data)  2015   2014   2013   2012   2011 
Interest Income  $79,658   $78,221   $82,152   $89,680   $99,459 
Net Interest Income   76,351    74,641    77,736    84,312    91,922 
Provision for Loan Losses   1,594    1,905    3,472    16,166    18,996 
Noninterest Income   54,091    52,536    55,111    54,569    57,244 
Noninterest Expense   115,273    114,358    121,405    123,943    124,643 
Net Income   9,116    9,260    6,045    108    4,897 
                          
Per Common Share:                         
Basic Net Income  $0.53   $0.53   $0.35   $0.01   $0.29 
Diluted Net Income   0.53    0.53    0.35    0.01    0.29 
Cash Dividends Declared   0.13    0.09            0.30 
Diluted Book Value   15.93    15.53    15.85    14.31    14.68 
                          
Performance Ratios:                         
Return on Average Assets   0.34%   0.36%   0.24%   0.00%   0.19%
Return on Average Equity   3.31    3.27    2.40    0.04    1.86 
Net Interest Margin (FTE)   3.31    3.36    3.54    3.81    4.18 
Noninterest Income as % of Operating Revenues   41.47    41.30    41.48    39.29    38.38 
Efficiency Ratio   87.94    89.68    91.09    88.72    83.24 
                          
Asset Quality:                         
Allowance for Loan Losses  $13,953   $17,539   $23,095   $29,167   $31,035 
Allowance for Loan Losses to Loans   0.93%   1.22%   1.65%   1.93%   1.91%
Nonperforming Assets   29,595    52,449    85,035    117,648    137,623 
Nonperforming Assets to Assets   1.06    2.00    3.26    4.47    5.21 
Nonperforming Assets to Loans + OREO   1.94    3.55    5.87    7.47    8.14 
Allowance to Nonperforming Loans   135.40    104.60    62.48    45.42    41.37 
Net Charge-Offs to Average Loans   0.35    0.53    0.66    1.16    1.39 
                          
Capital Ratios:                         
Tier 1 Capital   16.42%   16.67%   16.56%   14.35%   13.96%
Total Capital   17.25    17.76    17.94    15.72    15.32 
Common Equity Tier 1 Capital(1)   12.84    NA    NA    NA    NA 
Tangible Capital   6.99    7.38    7.58    6.35    6.51 
Leverage   10.65    10.99    10.46    9.90    10.26 
Equity to Assets   9.81    10.37    10.58    9.37    9.54 
Dividend Pay-Out   24.53    16.98    NM    NM    103.45 
                          
Averages for the Year:                         
Loans, Net of Unearned Income  $1,474,833   $1,414,000   $1,450,806   $1,556,565   $1,686,995 
Earning Assets   2,324,854    2,237,623    2,213,686    2,229,621    2,221,317 
Total Assets   2,659,317    2,564,176    2,568,662    2,590,173    2,583,197 
Deposits   2,163,441    2,093,477    2,070,073    2,105,672    2,081,583 
Shareowners’ Equity   275,144    283,079    251,427    252,960    263,048 
                          
Year-End Balances:                         
Loans, Net of Unearned Income  $1,503,907   $1,442,062   $1,399,669   $1,521,302   $1,628,683 
Earning Assets   2,470,444    2,276,781    2,274,019    2,261,781    2,266,193 
Total Assets   2,797,860    2,627,169    2,611,903    2,633,984    2,641,312 
Deposits   2,302,849    2,146,794    2,136,248    2,144,996    2,172,519 
Shareowners’ Equity   274,352    272,540    276,400    246,889    251,942 
                          
Other Data:                         
Basic Average Shares Outstanding   17,273,406    17,424,788    17,324,759    17,204,559    17,139,558 
Diluted Average Shares Outstanding   17,318,184    17,488,020    17,399,355    17,219,765    17,140,390 
Shareowners of Record(2)   1,559    1,589    1,651    1,691    1,701 
Banking Locations(2)   61    63    63    66    70 
Full-Time Equivalent Associates(2)   858    895    891    913    959 

 

(1)Not applicable prior to January 1, 2015
(2)As of record date. The record date is on or about March 1st of the following year.
 NM – Not Meaningful
29
 

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

 

Management’s discussion and analysis (“MD&A”) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes included in the Annual Report on Form 10-K.  The MD&A is divided into subsections entitled “Business Overview,” “Executive Overview,” “Results of Operations,” “Financial Condition,” “Liquidity and Capital Resources,” “Off-Balance Sheet Arrangements,” “Fourth Quarter, 2015 Financial Results,” and “Accounting Policies.”  The following information should provide a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2015 compares with prior years.  Throughout this section, Capital City Bank Group, Inc., and its subsidiaries, collectively, are referred to as “CCBG,” “Company,” “we,” “us,” or “our.”

 

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K, including this MD&A section, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “target,” “goal,” and similar expressions are intended to identify forward-looking statements.

 

All forward-looking statements, by their nature, are subject to risks and uncertainties.  Our actual future results may differ materially from those set forth in our forward-looking statements.  Please see the Introductory Note and Item 1A Risk Factors of this Annual Report for a discussion of factors that could cause our actual results to differ materially from those in the forward-looking statements.

 

However, other factors besides those listed in Item 1A Risk Factors or discussed in this Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties.  Any forward-looking statements made by us or on our behalf speak only as of the date they are made.  We do not undertake to update any forward-looking statement, except as required by applicable law.

 

BUSINESS OVERVIEW

 

Our Business

 

We are a financial holding company headquartered in Tallahassee, Florida, and we are the parent of our wholly owned subsidiary, Capital City Bank (the “Bank” or “CCB”). The Bank offers a broad array of products and services through a total of 63 banking offices located in Florida, Georgia, and Alabama. The Bank offers commercial and retail banking services, as well as trust and asset management, retail securities brokerage and data processing services. Please see the section captioned “About Us” beginning on page 4 for more detailed information about our business.

 

Our profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest and fees received on interest earning assets, such as loans and securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by the provision for loan losses, operating expenses such as salaries and employee benefits, occupancy and other operating expenses including income taxes, and noninterest income such as deposit fees, wealth management fees, mortgage banking fees, bank card fees, and data processing fees.

 

Strategic Review

 

Our philosophy is to build long-term client relationships based on quality service, high ethical standards, and safe and sound banking practices. We maintain a locally oriented, community-based focus, which is augmented by experienced, centralized support in select specialized areas. Our local market orientation is reflected in our network of banking office locations, experienced community executives with a dedicated President for each market, and community boards which support our focus on responding to local banking needs. We strive to offer a broad array of sophisticated products and to provide quality service by empowering associates to make decisions in their local markets.

 

 30 
 

We have sought to build a franchise in small-to medium-sized, less competitive markets, located on the outskirts of the larger metropolitan markets where we are positioned as a market leader. Many of our markets are on the outskirts of these larger markets in close proximity to major interstate thoroughfares such as Interstates I-10 and I-75. Our three largest markets are Tallahassee (Leon-Florida), Gainesville (Alachua-Florida), and Macon (Bibb-Georgia). In 13 of 20 markets in Florida and three of five markets in Georgia, we rank within the top four banks in terms of market share. Furthermore, in the counties in which we operate, we maintain an average 8.55% market share in the Florida counties and 5.75% in the Georgia counties, suggesting that there is significant opportunity to grow market share within these geographic areas. The larger employers in many of our markets are state and local governments, healthcare providers, educational institutions, and small businesses. While we realize that the markets in our footprint do not provide for a level of potential growth that the larger metropolitan markets may provide, our markets do provide good growth dynamics and have historically grown in excess of the national average The value of these markets stems from the fact they are less competitive, secondary markets. We strive to provide value added services to our clients by being not just their bank, but their banker. This element of our strategy distinguishes Capital City Bank from our competitors.

 

Our long-term vision remains to profitably expand our franchise through a combination of organic growth in existing markets and acquisitions. We have long understood that our core deposit funding base is a predominant driver of our profitability and overall franchise value, and have focused extensively on this component of our organic growth efforts in recent years. While we have not been an active acquirer of banks since 2005, this component of our strategy is still in place. When evaluating potential acquisition opportunities, we will continue to weigh the value of organic growth initiatives versus potential acquisition returns and pursue the strategies that provide the best overall return to our shareowners.

 

Potential acquisition opportunities will continue to be focused on Florida, Georgia, and Alabama with a particular focus on financial institutions located on the outskirts of larger, metropolitan areas. Five markets have been identified, four in Florida and one in Georgia, in which management intends to proactively pursue expansion opportunities. These markets include Alachua, Marion, Hernando/Pasco counties in Florida, the western panhandle of Florida, and Bibb and surrounding counties in central Georgia. Our focus on some of these markets may change as we continue to evaluate our strategy and the economic conditions and demographics of any individual market. We will also continue to evaluate de novo expansion opportunities in attractive new markets in the event that acquisition opportunities are not feasible. Other expansion opportunities that will be evaluated include asset management, mortgage banking, and insurance. Embedded in our acquisition strategy is our desire to partner with institutions that are culturally similar, have experienced management and possess either established market presence or have potential for improved profitability through growth, economies of scale, or expanded services. Generally, these target institutions will range in asset size from $100 million to $400 million.

 

EXECUTIVE OVERVIEW

 

In 2015, we continued to see improvement in our fundamentals and again made meaningful progress across all aspects of our business positioning us very well moving into 2016. Economic activity in our markets continued to improve as did our operating revenues, driven by strong growth in our investment and loan portfolios. Prudent expense management and significant progress made toward reducing our nonperforming assets also contributed to our success.

 

For 2015, we realized net income of $9.1 million, or $0.53 per diluted share compared to $9.3 million, or $0.53 per diluted share, in 2014. The slight decrease in earnings for 2015 was attributable to higher noninterest expense of $0.9 million and higher income taxes of $2.8 million, partially offset by a $1.7 million increase in net interest income, higher noninterest income of $1.5 million, and a lower loan loss provision of $0.3 million.

 

Below are summary highlights that impacted our performance for the year:

 

§Strong broad based loan growth of $62 million, or 4.3% (period-end)
§Growth in tax-equivalent net interest income of $1.9 million, or 2.5%
§Strong and diversified fee income -- residential mortgage loan sales up 47%
§44% reduction in nonperforming assets and 25% decline in total credit costs
§A return of $8.2 million of capital through share repurchases and dividends

 

During 2015, we realized meaningful re-composition in our earning asset mix as strong loan growth and increased deployment of liquidity into our investment portfolio drove a 2.5% increase in tax-equivalent net interest income. Loan growth in 2015 was broad based as we realized growth in commercial, tax-free, construction, home equity, and consumer loans. Increased commercial and residential real estate loan production also helped to stabilize those portfolios.

 

 31 
 

We believe our noninterest income is well diversified. In 2015, mortgage banking fees, bank owned life insurance income and bank card fees contributed to the overall increase in noninterest income compared to 2014. During 2015, we made significant progress toward the development of new fee income opportunities aimed at adding value to our client relationships and better leveraging our strong core deposit base franchise.

 

Core operating costs (excluding OREO) grew in 2015 largely due to higher pension plan expense, but continued prudent expense management resulted in reductions in many other expense categories. Significant progress was made during 2015 in the execution of strategies aimed at optimizing our delivery systems to improve our operating efficiency.

 

Our total credit costs (loan loss provision plus OREO costs) declined by 25% in 2015 driven by lower OREO costs attributable to strong OREO sales. Our loan loss provision declined slightly in 2015 reflective of continued favorable problem loan migration.

 

In 2015, many of our strategic initiatives gained traction that we expect will improve our profitability. We believe prudent management of both our credit and interest rate risk profiles during an historic period of low interest rates has placed us in a very good position to drive operating leverage when interest rates increase further.

 

Key components of our 2015 financial performance are summarized below:

 

Results of Operations

 

§For 2015, taxable equivalent net interest income increased $1.9 million, or 2.5%, to $77.0 million driven by a positive shift in earning asset mix due to growth in the loan and investment portfolios, partially offset by unfavorable loan repricing. Our net interest margin of 3.31% in 2015 was five basis points lower than the 3.36% recorded in 2014 reflective of a seven basis point decrease in the earning asset yield that was partially offset by a two basis point reduction in the cost of funds.

 

§Total credit costs (loan loss provision plus other real estate owned (“OREO”) expenses) were $6.6 million in 2015 compared to $8.7 million for 2014. Continued favorable problem loan migration and improvement in key credit metrics resulted in a $0.3 million decrease in our loan loss provision and lower valuation adjustments drove a $1.8 million reduction in OREO costs.

 

§For 2015, noninterest income totaled $54.1 million, a $1.5 million, or 3.0%, increase over 2014 primarily attributable to higher other income of $1.7 million (reflecting the receipt of BOLI proceeds) and mortgage banking fees of $1.5 million, partially offset by lower deposit fees of $1.7 million.

 

§For 2015, noninterest expense totaled $115.3 million, a $0.9 million, or 0.8%, increase over 2014 primarily attributable to higher compensation expense of $3.2 million, partially offset by lower OREO expense of $1.8 million and other expense (excluding OREO expenses) of $0.4 million.

 

Financial Condition

 

§Average assets totaled approximately $2.659 billion for 2015, an increase of $95.1 million, or 3.71%, over 2014.  Average earning assets were approximately $2.325 billion, representing an increase of $87.2 million, or 3.9%, over 2014.  Year-over-year, our average net overnight funds (deposits with banks plus fed funds sold less fed funds purchased) sold decreased $131.9 million, while investment securities increased $158.3 million and average gross loans were higher by $60.8 million.

 

§Average gross loans totaled $1.475 billion, a $60.8 million, or 4.3%, increase over 2014. Loan growth in 2015 was broad-based including commercial, tax-free, construction, home equity, and continued growth in auto finance.

 

§Average total deposits for 2015 were $2.163 billion, an increase of $70.0 million, or 3.3%, over 2014. We experienced growth in all deposit types except for money market accounts and time deposits.

 

§At year-end 2015, our nonperforming assets totaled $29.6 million, a decrease of $22.9 million from year-end 2014. Nonaccrual loans totaled $10.3 million at year-end 2015, a decrease of $6.5 million from year-end 2014, reflective of loan resolutions which outpaced gross additions. Nonaccrual loan additions slowed again for the fourth consecutive year, by $6.8 million, or 30%. The balance of OREO totaled $19.3 million at year-end 2015, a decrease of $16.4 million from year-end 2014. We continued to experience progress during 2015 in our efforts to dispose of OREO selling properties totaling $20.2 million compared to $23.8 million in 2014. Nonperforming assets represented 1.06% of total assets at December 31, 2015 compared to 2.00% at December 31, 2014.

 

 32 
 

 

§Our allowance for loan losses at year-end 2015 was $14.0 million (0.93% of loans) and provided coverage of 135% of nonperforming loans compared to $17.5 million (1.22% of loans) and 105% of nonperforming loans at year-end 2014. Net charge-offs for 2015 totaled $5.2 million, or 0.35% of average loans compared to $7.5 million, or 0.53% in 2014, primarily reflective of lower commercial real estate loan charge-offs.

 

§Shareowners’ equity increased by $1.8 million from $272.5 million at December 31, 2014 to $274.3 million at December 31, 2015. We continue to maintain a strong capital base as evidenced by a risk-based capital ratio of 17.25% and tangible common equity ratio of 6.99% at December 31, 2015 compared to 17.76% and 7.38%, respectively, at December 31, 2014. All of our regulatory capital ratios significantly exceed the threshold to be well-capitalized under the Basel III capital standards.

 

RESULTS OF OPERATIONS

 

For 2015, we realized net income of $9.1 million, or $0.53 per diluted share compared to $9.3 million, or $0.53 per diluted share, in 2014, and $6.0 million, or $0.35 per diluted share in 2013.

 

The decrease in earnings for 2015 was attributable to higher noninterest expense of $0.9 million and higher income taxes of $2.8 million, partially offset by a $1.7 million increase in net interest income, higher noninterest income of $1.5 million, and a lower loan loss provision of $0.3 million.

 

The increase in earnings for 2014 as compared to 2013 reflects lower noninterest expense of $7.0 million, a lower loan loss provision of $1.6 million, and lower income taxes of $0.4 million, partially offset by lower net interest income of $3.1 million and noninterest income of $2.6 million.

 

A condensed earnings summary for the last three years is presented in Table 1 below:

 

Table 1

CONDENSED SUMMARY OF EARNINGS

     
(Dollars in Thousands, Except Per Share Data)  2015   2014   2013 
Interest Income  $79,658   $78,221   $82,152 
Taxable Equivalent Adjustments   638    494    583 
Total Interest Income (FTE)   80,296    78,715    82,735 
Interest Expense   3,307    3,580    4,416 
Net Interest Income (FTE)   76,989    75,135    78,319 
Provision for Loan Losses   1,594    1,905    3,472 
Taxable Equivalent Adjustments   638    494    583 
Net Interest Income After Provision for Loan Losses   74,757    72,736    74,264 
Noninterest Income   54,091    52,536    55,111 
Noninterest Expense   115,273    114,358    121,405 
Income Before Income Taxes   13,575    10,914    7,970 
Income Tax Expense   4,459    1,654    1,925 
Net Income  $9,116   $9,260   $6,045 
                
Basic Net Income Per Share  $0.53   $0.53   $0.35 
Diluted Net Income Per Share  $0.53   $0.53   $0.35 

 

 33 
 

Net Interest Income

 

Net interest income represents our single largest source of earnings and is equal to interest income and fees generated by earning assets, less interest expense paid on interest bearing liabilities.  We provide an analysis of our net interest income, including average yields and rates in Tables 2 and 3 below.  We provide this information on a “taxable equivalent” basis to reflect the tax-exempt status of income earned on certain loans and investments, the majority of which are state and local government debt obligations.

 

In 2015, our taxable equivalent net interest income increased $1.9 million, or 2.5%.  This follows a decrease of $3.2 million, or 4.1%, in 2014, and a decrease of $6.6 million, or 7.8%, in 2013.  The increase in tax equivalent net interest income for 2015 as compared 2014 reflects a positive shift in earning asset mix due to growth in the loan and investment portfolios, partially offset by unfavorable loan repricing. The decrease in our taxable equivalent net interest income in 2014 as compared to 2013 was primarily driven by declines in loan income attributable to lower average portfolio balances and unfavorable asset repricing, which was partially offset by reductions in interest expense. The lower interest expense is primarily attributable to declines in certificates of deposit balances and reflects favorable repricing in all interest-bearing deposit categories.

 

For 2015, taxable equivalent interest income increased $1.6 million, or 2.0%, over 2014. In 2014, taxable equivalent interest income declined $4.0 million, or 4.9%, from 2013. In 2015, the increase was primarily due to higher balances in the loan and investment portfolios, partially offset by lower yields on new loan production and loan portfolio repricing. The decrease in 2014 was specifically attributable to both the shift in earning asset mix and lower yields. The declining loan portfolio resulted in the higher yielding interest earning assets being replaced with lower yielding federal funds or investment securities.

 

These factors produced a seven basis point decline in the yield on interest earning assets, which decreased from 3.52% in 2014 to 3.45% in 2015. This compares to a 22 basis point decline from 2014 to 2013.

 

Interest expense decreased $273,000, or 7.6%, from 2014 to 2015, and $836,000, or 18.9%, from 2013 to 2014.  The lower cost of funds for both years was a result of both certificates of deposit repricing to lower rates and rate reductions on deposit products.  The rate reductions on deposits reflect our response to a historically low interest rate environment and desire to continue our focus on core banking relationships. The average rate paid on interest-bearing liabilities decreased two basis points from 2014 to 2015, and declined five basis points from 2013 to 2014, reflecting the factors mentioned above.

 

Our interest rate spread (defined as the taxable equivalent yield on average earning assets less the average rate paid on interest bearing liabilities) decreased four basis points in 2015 compared to 2014 and declined 17 basis points in 2014 compared to 2013.  The decrease in both years was primarily attributable to the adverse impact of lower rates and a change in the mix of interest earning assets, which more than offset the repricing of our deposit base.

 

Our net interest margin (defined as taxable equivalent interest income less interest expense divided by average earning assets) of 3.31% in 2015 was five basis points lower than the 3.36% recorded in 2014. The net interest margin in 2014 was 18 basis points lower than the 3.54% reported in 2013. In 2015, the yield on earning assets declined seven basis points compared to 2014, and was partially offset by a decline in the cost of funds of two basis points. In 2014, compared to 2013, the yield on earning assets declined 22 basis points and was partially offset by a decline in the cost of funds of four basis points.

 

The net interest margin for the fourth quarter of 2015 was 3.37%, an increase of six basis points over the third quarter of 2015, and a decrease of six basis points from the fourth quarter of 2014. The increase in the margin compared to the third quarter was primarily attributable to the recognition of deferred interest on a loan that paid off during the quarter, and to a lesser degree, an increase in the rate received on overnight funds which occurred later in the fourth quarter.

 

Net interest income increased for the third straight quarter and was higher than the fourth quarter of 2014. Historically low interest rates and increased competition for loans continue to put pressure on loan yields, partially offsetting the favorable impact attributable to growth in the loan and investment portfolios.

 

Our current strategy, which is consistent with our historical strategy, is to not accept greater interest rate risk by reaching further out the curve for yield, particularly given the fact that short term rates are at historical lows.  We continue to maintain short duration portfolios on both sides of the balance sheet and believe we are well positioned to respond to changing market conditions.  Over time, this strategy has historically produced fairly consistent outcomes and a net interest margin that is significantly above peer comparisons. 

34
 

Table 2

AVERAGE BALANCES AND INTEREST RATES

 

   2015   2014   2013 
(Taxable Equivalent Basis - Dollars in Thousands)  Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
   Average
Balance
   Interest   Average
Rate
 
ASSETS                                             
Loans, Net of Unearned Income(1)(2)  $1,474,833   $73,436    4.98%  $1,414,000   $73,637    5.21%  $1,450,806   $78,484    5.41%
Taxable Investment Securities   530,297    5,223    0.98    362,393    3,423    0.91    232,173    2,344    0.94 
Tax-Exempt Investment Securities(2)   81,748    1,005    1.23    91,324    722    0.79    108,042    830    0.76 
Funds Sold   237,976    632    0.27    369,906    933    0.25    422,665    1,077    0.25 
Total Earning Assets   2,324,854    80,296    3.45%   2,237,623    78,715    3.52%   2,213,686    82,735    3.74%
Cash & Due From Banks   48,195              45,367              49,978           
Allowance for Loan Losses   (15,876)             (21,234)             (28,167)          
Other Assets   302,144              302,420              333,165           
TOTAL ASSETS  $2,659,317             $2,564,176             $2,568,662           
                                              
LIABILITIES                                             
NOW Accounts  $747,297   $254    0.03%  $715,846   $318    0.04%  $719,493   $482    0.07%
Money Market Accounts   257,920    134    0.05    273,092    190    0.07    284,245    211    0.07 
Savings Accounts   255,397    126    0.05    227,215    112    0.05    203,864    101    0.05 
Other Time Deposits   186,944    430    0.23    206,136    479    0.23    231,354    637    0.28 
Total Interest Bearing Deposits   1,447,558    944    0.07%   1,422,289    1,099    0.08%   1,438,956    1,431    0.10%
Short-Term Borrowings   58,481    59    0.10    44,403    78    0.18    53,922    235    0.44 
Subordinated Notes Payable   62,887    1,368    2.14    62,887    1,328    2.08    62,887    1,420    2.23 
Other Long-Term Borrowings   29,698    936    3.15    33,727    1,075    3.19    41,077    1,330    3.24 
Total Interest Bearing Liabilities   1,598,624    3,307    0.21%   1,563,306    3,580    0.23%   1,596,842    4,416    0.28%
Noninterest Bearing Deposits   715,883              671,188              631,117           
Other Liabilities   69,666              46,603              89,276           
TOTAL LIABILITIES   2,384,173              2,281,097              2,317,235           
                                              
SHAREOWNERS’ EQUITY                                             
TOTAL SHAREOWNERS’ EQUITY   275,144              283,079              251,427           
                                              
TOTAL LIABILITIES & EQUITY  $2,659,317             $2,564,176             $2,568,662           
                                              
Interest Rate Spread             3.25%             3.29%             3.46%
Net Interest Income       $76,989             $75,135             $78,319      
Net Interest Margin(3)             3.31%             3.36%             3.54%

 

(1)Average balances include nonaccrual loans.  Interest income includes loan fees of $1.4 million for 2015, $1.6 million for 2014 and 2013.
(2)Interest income includes the effects of taxable equivalent adjustments using a 35% tax rate.
(3)Taxable equivalent net interest income divided by average earning assets.
35
 

Table 3

RATE/VOLUME ANALYSIS (1)

 

   2015 vs. 2014   2014 vs. 2013 
   Increase (Decrease) Due to Change In   Increase (Decrease) Due to Change In 
(Taxable Equivalent Basis - Dollars in Thousands)  Total   Volume   Rate   Total   Volume   Rate 
Earnings Assets:                              
Loans, Net of Unearned Interest(2)  $(201)  $3,168   $(3,369)  $(4,847)  $(1,991)  $(2,856)
Investment Securities:                              
Taxable   1,800    1,586    214    1,079    1,315    (236)
Tax-Exempt(2)   283    (76)   359    (108)   (128)   20 
Funds Sold   (301)   (333)   32    (144)   (134)   (10)
Total   1,581    4,345    (2,764)   (4,020)   (938)   (3,082)
                               
Interest Bearing Liabilities:                              
NOW Accounts   (64)   14    (78)   (164)   (2)   (162)
Money Market Accounts   (56)   (11)   (45)   (21)   (8)   (13)
Savings Accounts   14    14        11    12    (1)
Time Deposits   (49)   (45)   (4)   (158)   (69)   (89)
Short-Term Borrowings   (19)   25    (44)   (157)   (41)   (116)
Subordinated Notes Payable   40        40    (92)       (92)
Other Long-Term Borrowings   (139)   (128)   (11)   (255)   (238)   (17)
Total   (273)   (131)   (142)   (836)   (346)   (490)
                               
Changes in Net Interest Income  $1,854   $4,476   $(2,622)  $(3,184)  $(592)  $(2,592)

 

(1)This table shows the change in taxable equivalent net interest income for comparative periods based on either changes in average volume or changes in average rates for interest earning assets and interest-bearing liabilities. Changes which are not solely due to volume changes or solely due to rate changes have been attributed to rate changes.

 

(2)Interest income includes the effects of taxable equivalent adjustments using a 35% tax rate to adjust interest on tax-exempt loans and securities to a taxable equivalent basis.

 

Provision for Loan Losses

 

The provision for loan losses was $1.6 million in 2015 compared to $1.9 million in 2014 and $3.5 million in 2013. The decline in the provision for all periods reflects favorable problem loan migration, lower loan losses, and overall improvement in key credit metrics, partially offset by growth in the loan portfolio. We discuss these trends in further detail below under Risk Element Assets and Allowance for Loan Losses.

 

Noninterest Income

 

Noninterest income totaled $54.1 million in 2015, $52.5 million in 2014, and $55.1 million in 2013. For 2015, the $1.5 million, or 3.0%, increase over 2014 reflects higher other income of $1.7 million, mortgage banking fees $1.5 million, and bank card fees of $0.4 million, partially offset by lower deposit fees of $1.7 million, wealth management fees of $0.3 million and data processing fees of $0.1 million. Stronger new home purchase originations drove the increase in mortgage banking fees. The receipt of bank owned life insurance (“BOLI”) proceeds drove the increase in other income. Lower overdraft fees drove the reduction in deposit fees.

 

For 2014, the $2.6 million, or 4.7%, decrease from 2013 reflects lower deposit fees of $0.9 million, data processing fees of $1.1 million, wealth management fees of $0.4 million and mortgage banking fees of $0.5 million, partially offset by higher bank card fees of $0.1 million and other income of $0.2 million. Lower overdraft fees drove the reduction in deposit fees. The termination of a large government processing contract drove the decline in data processing fees. Wealth management declined due to a lower level of client trading activity as well as strong new retail investment product sales in 2013. Lower refinancing activity drove the reduction in mortgage banking fees.

 

Noninterest income as a percent of total operating revenues (net interest income plus noninterest income) was 41.47% in 2015, 41.30% in 2014, and 41.48% in 2013.

 

 36 
 

The table below reflects the major components of noninterest income.

 

(Dollars in Thousands)  2015   2014   2013 
Deposit Fees  $22,608   $24,320   $25,254 
Bank Card Fees   11,278    10,892    10,786 
Wealth Management Fees   7,533    7,808    8,179 
Mortgage Banking Fees   4,539    3,082    3,534 
Data Processing Fees   1,472    1,543    2,674 
Other   6,661    4,891    4,684 
Total Noninterest Income  $54,091   $52,536   $55,111 

 

Various significant components of noninterest income are discussed in more detail below.

 

Deposit Fees. For 2015, deposit service charge fees totaled $22.6 million compared to $24.3 million in 2014 and $25.3 million in 2013. The $1.7 million, or 7.01%, decrease in 2015 and the $0.9 million, or 3.7% decrease in 2014, were due to a lower level of overdraft fees primarily reflecting improved financial management by our clients and to a lesser extent a reduction in the number of accounts utilizing our overdraft service.

 

Bank Card Fees. Bank card fees totaled $11.3 million in 2015 compared to $10.9 million in 2014 and $10.8 million in 2013. The $0.4 million, or 3.5% increase in 2015 and the slight increase in 2014 reflects higher card activity and average ticket amount by our clients.

 

Wealth Management Fees. Wealth management fees including both trust fees (i.e., managed accounts, trusts/estates, and retirement plans) and retail brokerage fees (i.e., investment and insurance products) totaled $7.5 million in 2015 compared to $7.8 million in 2014 and $8.2 million in 2013. The $0.3 million, or 3.5%, decrease in 2015 was primarily attributable to lower fees from our retail brokerage business generally reflective of a lower level of assets under management. The $0.4 million, or 4.5%, decrease in 2014 was primarily attributable to lower fees from our retail brokerage business reflective of very strong new retail investment product sales in 2013. At December 31, 2015, total assets under management were approximately $1.139 billion compared to $1.278 billion at December 31, 2014 and $1.259 billion at December 31, 2013.

 

Mortgage Banking Fees. Mortgage banking fees totaled $4.5 million in 2015 compared to $3.1 million in 2014 and $3.5 million in 2013. The $1.4 million, or 47.3%, increase in 2015 was primarily due to strong new home purchase originations. The $0.4 million, or 12.8%, decrease in 2014 was driven by a slowdown in refinance activity, but was partially offset by a higher margin realized for sold loans. Refinancing activity represented 18% of our loan production in 2015 compared to 14% and 32% for 2014 and 2013, respectively. Market conditions, housing activity, the level of interest rates and the percent of our fixed-rate production have significant impacts on our mortgage banking fees.

 

Data Processing Fees. For 2015 and 2014, data processing fees totaled $1.5 million. For 2013, data processing fees totaled $2.7 million. The decrease in 2014 was attributable to the termination of a large government processing contract that began migrating to another processor in mid-2013, completing the transition in mid-2014. We currently maintain processing arrangements with three banks and two government agencies.

 

Other. Other noninterest income totaled $6.7 million in 2015 compared to $4.9 million in 2014 and $4.7 million in 2013. The increase in 2015 reflects the receipt of BOLI proceeds. The increase in 2014 was due to higher bank owned life insurance income and working capital financing fees.

 

Noninterest Expense

 

Noninterest expense totaled $115.3 million in 2015 compared to $114.4 million in 2014 and $121.4 million in 2013. For 2015, the $0.9 million, or 0.8%, increase was attributable to higher compensation expense of $3.2 million, partially offset by lower OREO expense of $1.8 million, other expense (excluding OREO expenses) of $0.4 million and occupancy expense of $0.1 million. The increase in compensation expense was primarily due to an increase in associate benefit expense (primarily pension expense) partially offset by lower salary expense (primarily deferred loan costs and incentive plan expense). The reduction in OREO expense was primarily attributable to lower property valuation adjustments and to a lesser extent lower property carrying costs. The decrease in other expense was primarily attributable to lower legal fees, postage costs, and FDIC insurance fees, partially offset by higher processing costs. Lower technology equipment costs and maintenance costs for premises/FF&E drove the decrease in occupancy expense.

 

 37 
 

For 2014, the $7.0 million, or 5.8%, decrease was attributable to lower compensation expense of $3.9 million, OREO expense of $1.4 million, and other expense (excluding OREO expenses) of $2.2 million, partially offset by higher occupancy expense of $0.5 million. The reduction in compensation expense was primarily due to a decrease in pension plan expense partially offset by higher incentive expense for both cash and stock plans. Lower property carrying costs as well as a reduction in property valuation adjustments were the primary reasons for the reduction in OREO expense. The reduction in other expense was primarily attributable to lower FDIC insurance fees reflective of a favorable premium adjustment and reductions in both legal and professional fees. The increase in occupancy expense was due to higher maintenance contract costs reflective of security and technology upgrades and to a lesser extent higher building maintenance costs attributable to non-recurring expenditures.

 

Our operating efficiency ratio (expressed as noninterest expense as a percent of taxable equivalent net interest income plus noninterest income) was 87.94%, 89.68% and 91.09% in 2015, 2014 and 2013, respectively. Higher operating revenues (primarily net interest income and BOLI proceeds) drove the improvement in the ratio for 2015 and lower noninterest expense (primarily lower pension and OREO expense) drove the improvement in the ratio for 2014.

 

Expense management is an important part of our culture and strategic focus and we will continue to review and evaluate opportunities to optimize our operations, reduce operating costs and manage our discretionary expenses.

 

The table below reflects the major components of noninterest expense.

 

(Dollars in Thousands)  2015   2014   2013 
Salaries  $48,263   $48,896   $48,584 
Associate Benefits   17,151    13,319    17,543 
Total Compensation   65,414    62,215    66,127 
                
Premises   9,015    9,126    8,863 
Equipment   8,723    8,692    8,468 
Total Occupancy   17,738    17,818    17,331 
                
Legal Fees   2,506    3,187    3,663 
Professional Fees   3,788    3,732    4,304 
Processing Services   6,540    6,062    5,396 
Advertising   1,391    1,461    1,719 
Travel and Entertainment   901    900    870 
Printing and Supplies   825    865    994 
Telephone   1,976    1,903    1,891 
Postage   996    1,147    1,309 
Insurance – Other   2,737    2,934    4,144 
Other Real Estate   4,971    6,811    8,234 
Miscellaneous   5,490    5,323    5,423 
Total Other Expense   32,121    34,325    37,947 
                
Total Noninterest Expense  $115,273   $114,358   $121,405 

 

Various significant components of noninterest expense are discussed in more detail below.

 

Compensation. Compensation expense totaled $65.4 million in 2015, $62.2 million in 2014, and $66.1 million in 2013. For 2015, the $3.2 million, or 5.1%, increase from 2014 was attributable to higher associate benefit expense of $3.8 million partially offset by lower salary expense of $0.6 million. The increase in associate benefit expense reflects higher pension plan expense of $4.0 million and associate insurance expense of $0.2 million, partially offset by lower stock compensation expense of $0.4 million. The higher level of pension plan expense was attributable to the utilization of a lower discount rate (attributable to lower long-term rates at the end of 2014) for determining pension plan liabilities. Revision to the mortality tables used to calculate pension plan liabilities also contributed to the increase, but to a lesser extent. Pension plan expense is determined by an external actuarial valuation based on assumptions that are evaluated annually, taking into consideration both current market conditions and anticipated long-term market conditions. A discussion of the sensitivity to these assumptions is detailed in the Critical Accounting Policy section of this report. Rising health care costs contributed to the increase in associate insurance expense. A lower level of goal achievement for both our executive and company-wide stock incentive plans drove the reduction in stock compensation expense. The decrease in salary expense was attributable to higher deferred loan cost amortization (which is accounted for as a credit offset to salary expense), partially offset by higher associate salary expense reflective of merit raises given during the year.

 

 38 
 

For 2014, the $3.9 million, or 5.9%, decrease from 2013 was attributable to lower associate benefit expense of $4.2 million partially offset by higher salary expense of $0.3 million. The decrease in associate benefit expense reflects lower pension plan expense of $5.0 million partially offset by higher stock compensation expense of $0.5 million and associate insurance expense of $0.3 million. The lower level of pension plan expense was attributable to the utilization of a higher discount rate (attributable to higher long-term rates at the end of 2013) for determining pension plan liabilities. Improved company performance drove the increase in stock compensation expense and rising health care costs contributed to the increase in associate insurance expense. The increase in salary expense was attributable to higher expense for our cash incentive plans reflective of improved individual and company performance. Lower associate salary expense reflective of reduced headcount partially offset the increase in cash incentives.

 

Occupancy. Occupancy expense (including premises and equipment) totaled $17.7 million for 2015, $17.8 million for 2014, and $17.3 million for 2013. For 2015, the $0.1 million, or 0.5%, decrease from 2014 reflects lower premises expense, primarily lower building maintenance and repair costs. For 2014, the $0.5 million, or 2.8%, increase over 2013 reflects higher premises expense of $0.3 million and equipment expense of $0.2 million. Higher building maintenance costs, partially attributable to non-recurring expenditures, drove the increase in premises expense. Higher maintenance contract costs reflective of security and technology upgrades drove the majority of the increase in equipment expense.

 

Other. Other noninterest expense totaled $32.1 million in 2015, $34.3 million in 2014, and $37.9 million in 2013. For 2015, the $2.2 million, or 6.4%, decrease from 2014 was primarily attributable to lower OREO expense of $1.8 million, FDIC insurance fees of $0.2 million and legal fees of $0.7 million, partially offset by an increase in processing services of $0.5 million. Lower property valuation adjustments, and to a lesser extent lower property carrying costs, drove the decrease in OREO expense. The decrease in FDIC insurance fees was attributable to a favorable premium adjustment due to our improved financial performance. Legal fees declined due to a lower level of legal support needed for problem loan resolutions. Higher costs related to our new online banking platform put in place early in 2015 drove the increase in processing services.

 

For 2014, the $3.6 million, or 9.5%, decrease from 2013 was primarily attributable to lower OREO expense of $1.4 million, FDIC insurance fees of $1.2 million, legal fees of $0.5 million, and professional fees of $0.6 million. Lower property carrying costs driven by strong property sales during the year as well as a reduction in property valuation adjustments reflective of improving property values were the primary reasons for the reduction in OREO expense. The decrease in FDIC insurance fees was attributable to a favorable premium adjustment due to our improved financial performance. Legal fees declined due to a lower level of legal support needed for problem loan resolutions. Lower audit and consulting costs drove the reduction in professional fees.

 

Income Taxes

 

For 2015, we realized income tax expense of $4.5 million (effective tax rate of 32.8%) compared to income tax expense of $1.7 million (effective tax rate of 15.2%) in 2014 and income tax expense of $1.9 million (effective tax rate of 24.2%) in 2013. Receipt of the aforementioned BOLI proceeds in 2015 was tax-exempt; therefore our effective tax rate was favorably impacted. Income taxes for 2014 were favorably impacted by a $2.2 million state tax benefit attributable to an adjustment in our reserve for uncertain tax positions associated with the full resolution of prior year matters. The tax provision for 2013 was favorably affected by the resolution of state tax contingencies totaling approximately $0.8 million. Absent future discrete events, we anticipate our effective income tax rate to be within a range of 34%-35%.

 

FINANCIAL CONDITION

 

Average assets totaled approximately $2.659 billion for the year 2015, an increase of $95.1 million, or 3.7%, over 2014.  Average interest earning assets were approximately $2.325 billion, representing an increase of $87.2 million, or 3.9%, over 2014.   Year-over-year, average overnight funds decreased $131.9 million, while investment securities increased $158.3 million and average gross loans were higher by $60.8 million.  We discuss these variances in more detail below.

 

Table 2 provides information on average balances and rates, Table 3 provides an analysis of rate and volume variances and Table 4 highlights the changing mix of our interest earning assets over the last three years.

 

 39 
 

Loans

 

In 2015, average loans increased $60.8 million, or 4.3%, compared to a decrease of $36.8 million, or 2.5%, in 2014. Loans as a percentage of average earning assets improved to 63.4% in 2015, an increase over 2014 levels of 63.2%, and a decline from 2013 at 65.5%. Year-over-year average balances in the loan portfolio experienced increases in all loan types except commercial and residential mortgages. Earlier in the year, growth in loans was driven primarily by auto loans, whereas in recent quarters the growth has been broader based, including commercial, tax-free, construction, home equity as well as consumer.

 

Without compromising our credit standards or taking on inordinate interest rate risk, we continue to make minor modifications on some of our lending programs to try to mitigate the significant impact that consumer and business deleveraging is having on our portfolio. These programs, coupled with economic improvements in our anchor markets, have helped to increase overall production.

 

We originate mortgage loans secured by 1-4 family residential properties through our Residential Real Estate line of business, a majority of which are fixed-rate loans that are sold into the secondary market to third party purchasers on a best efforts delivery basis with servicing released. A majority of our adjustable rate loan product is retained in our loan portfolio.

 

Table 4

SOURCES OF EARNING ASSET GROWTH

 

   2014 to   Percentage   Components of 
   2015   Total   Average Earning Assets 
(Average Balances – Dollars In Thousands)  Change   Change   2015   2014   2013 
Loans:                         
Commercial, Financial, and Agricultural  $24,929    29.0%   6.8%   5.9%   5.8%
Real Estate – Construction   4,841    6.0    2.0    1.8    1.9 
Real Estate – Commercial Mortgage   (11,137)   (13.0)   21.7    23.1    26.2 
Real Estate – Residential   (12,322)   (14.0)   13.0    14.1    14.5 
Real Estate – Home Equity   2,782    3.0    9.9    10.1    10.5 
Consumer   51,740    59.0    10.1    8.2    6.8 
Total Loans  $60,833    70.0%   63.5%   63.2%   65.7%
                          
Investment Securities:                         
Taxable  $167,903    192.0%   22.8%   16.2%   10.5%
Tax-Exempt   (9,575)   (11.0)   3.5    4.1    4.9 
Total Securities   158,328    181.0    26.3    20.3    15.4 
                          
Funds Sold   (131,930)   (151.0)   10.2    16.5    18.9 
                          
Total Earning Assets  $87,231    100.0%   100.0%   100.0%   100.0%

 

Our average loan-to-deposit ratio increased to 68.2% in 2015 from 67.5% in 2014. The higher loan-to-deposit ratio reflects an increase in average loan balances relative to the growth in average deposits.

 

The composition of our loan portfolio at December 31st for each of the past five years is shown in Table 5. Table 6 arrays our total loan portfolio as of December 31, 2015, by maturity period. As a percentage of the total portfolio, loans with fixed interest rates represented 34.3% as of December 31, 2015, compared to 32.2% on December 31, 2014. The higher ratio was primarily due to increases in consumer indirect and tax-free loans, which while having a fixed rate, typically have a shorter duration.

40
 

Table 5

LOANS BY CATEGORY

 

(Dollars in Thousands)  2015   2014   2013   2012   2011 
Commercial, Financial and Agricultural  $179,816   $136,925   $126,607   $139,850   $130,879 
Real Estate – Construction(1)   47,402    43,472    36,187    43,740    26,367 
Real Estate – Commercial Mortgage   499,813    510,120    533,871    613,625    639,140 
Real Estate – Residential(1)   301,299    304,781    315,582    329,947    399,371 
Real Estate – Home Equity   233,901    229,572    227,922    236,263    244,263 
Consumer   241,676    217,192    159,500    157,877    188,663 
Total Loans, Net of Unearned Income  $1,503,907   $1,442,062   $1,399,669   $1,521,302   $1,628,683 

 

(1)Includes loans held for sale.

 

Table 6

LOAN MATURITIES

   Maturity Periods 
(Dollars in Thousands)  One Year
or Less
   Over One
Through
Five Years
   Over
Five
Years
   Total 
Commercial, Financial and Agricultural  $50,251   $99,508   $30,057   $179,816 
Real Estate – Construction   36,599    8,520    2,283    47,402 
Real Estate – Commercial Mortgage   54,745    92,905    352,163    499,813 
Real Estate – Residential   24,029    39,246    238,024    301,299 
Real Estate – Home Equity   1,670    50,801    181,430    233,901 
Consumer(1)   12,496    222,930    6,250    241,676 
Total  $179,790   $513,910   $810,207   $1,503,907 
                     
Loans with Fixed Rates  $79,075   $371,217   $65,566   $515,858 
Loans with Floating or Adjustable Rates   100,715    142,693    744,641    988,049 
Total  $179,790   $513,910   $810,207   $1,503,907 

 

(1)Demand loans and overdrafts are reported in the category of one year or less.

 

Risk Element Assets

 

Risk element assets consist of nonaccrual loans, OREO, TDRs, past due loans, potential problem loans, and loan concentrations. Table 7 depicts certain categories of our risk element assets as of December 31st for each of the last five years. Activity within our nonperforming asset portfolio is provided below in Table 8.

 

Nonperforming assets (nonaccrual loans and OREO) totaled $29.6 million at December 31, 2015 compared to $52.4 million at December 31, 2014. Nonaccrual loans totaled $10.3 million at December 31, 2015, a decrease of $6.5 million from December 31, 2014, reflective of loan resolutions (charge-offs, transfer of loans to OREO, and payments) and loans restored to an accrual status, which outpaced gross additions. Gross additions declined by approximately $7 million and $22 million in 2015 and 2014, respectively. The balance of OREO totaled $19.3 million at December 31, 2015, a decrease of $16.4 million from December 31, 2014. We again realized good progress in 2015 disposing of OREO properties totaling $20.2 million compared to $23.8 million in 2014. Nonperforming assets represented 1.06% of total assets at December 31, 2015 compared to 2.00% at December 31, 2014.

 

We continue to allocate significant resources to reduce our level of nonperforming assets, while mitigating losses and 2015 was another productive year in this respect as total nonperforming assets declined by $22.8 million, or 44%.

41
 

Table 7

RISK ELEMENT ASSETS

 

(Dollars in Thousands)  2015   2014   2013   2012   2011 
Nonaccruing Loans:                         
Commercial, Financial and Agricultural  $96   $507   $188   $1,069   $755 
Real Estate – Construction   97    424    426    4,071    334 
Real Estate – Commercial Mortgage   4,191    5,806    25,227    41,045    42,820 
Real Estate – Residential   4,739    6,737    6,440    13,429    25,671 
Real Estate – Home Equity   1,017    2,544    4,084    4,034    4,283 
Consumer   165    751    599    574    1,160 
Total Nonperforming Loans (“NPLs”)(1)  $10,305   $16,769   $36,964   $64,222   $75,023 
Other Real Estate Owned   19,290    35,680    48,071    53,426    62,600 
Total Nonperforming Assets (“NPAs”)  $29,595   $52,449   $85,035   $117,648   $137,623 
Past Due Loans 30 – 89 Days  $5,775   $6,792   $7,746   $9,934   $19,425 
Past Due Loans 90 Days or More (accruing)                   224 
Performing Troubled Debt Restructurings  $35,634   $44,409   $44,764   $47,474   $37,675 
                          
Nonperforming Loans/Loans   0.69%   1.16%   2.64%   4.22%   4.61%
Nonperforming Assets/Total Assets   1.06    2.00    3.26    4.47    5.21 
Nonperforming Assets/Loans Plus OREO   1.94    3.55    5.87    7.47    8.14 
Allowance/Nonperforming Loans   135.40%   104.60%   62.48%   45.42%   41.37%

 

(1)Nonaccrual TDRs totaling $2.7 million, $2.2 million and $11.0 million are included in nonaccrual/NPL totals for December 31, 2015, December 31, 2014 and December 31, 2013, respectively.

 

Table 8

NONPERFORMING ASSET ACTIVITY

 

(Dollars in Thousands)  2015   2014 
NPA Beginning Balance:  $52,449   $85,035 
Change in Nonaccrual Loans:          
Beginning Balance   16,769    36,964 
Additions   15,715    22,466 
Charge-Offs   (4,726)   (8,857)
Transferred to OREO   (4,627)   (13,888)
Paid Off/Payments   (6,293)   (9,639)
Restored to Accrual   (6,533)   (10,277)
Ending Balance   10,305    16,769 
           
Change in OREO:          
Beginning Balance   35,680    48,071 
Additions(1)   5,752    15,271 
Valuation Write-downs   (1,713)   (3,142)
Sales   (20,155)   (23,791)
Other   (274)   (729)
Ending Balance   19,290    35,680 
           
NPA Net Change   (22,854)   (32,586)
NPA Ending Balance  $29,595   $52,449 

 

(1)The difference in OREO additions and nonaccrual loans transferred to OREO represents loans migrating to OREO status that were not in a nonaccrual status in a prior period.

 

Nonaccrual Loans. Nonaccrual loans totaled $10.3 million at December 31, 2015, a decrease of $6.5 million from December 31, 2014. Gross additions to nonaccrual status during 2015 totaled $15.7 million compared to $22.5 million in 2014. All loan categories had a year-over-year decrease in nonaccrual loans with residential real estate seeing the largest decline.

 

Generally, loans are placed on nonaccrual status if principal or interest payments become 90 days past due or management deems the collectability of the principal and interest to be doubtful. Once a loan is placed in nonaccrual status, all previously accrued and uncollected interest is reversed against interest income. Interest income on nonaccrual loans is recognized when the ultimate collectability is no longer considered doubtful. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current or when future payments are reasonably assured. If interest on our loans classified as nonaccrual during 2015 had been recognized on a fully accruing basis, we would have recorded an additional $0.9 million of interest income for the year ended December 31, 2015.

42
 

Other Real Estate Owned. OREO represents property acquired as the result of borrower defaults on loans or by receiving a deed in lieu of foreclosure. OREO is recorded at the lower of cost or estimated fair value, less estimated selling costs, at the time of foreclosure. Write-downs occurring at foreclosure are charged against the allowance for loan losses. On an ongoing basis, properties are either revalued internally or by a third party appraiser as required by applicable regulations. Subsequent declines in value are reflected as other noninterest expense. Carrying costs related to maintaining the OREO properties are expensed as incurred and are also reflected as other noninterest expense.

 

OREO totaled $19.3 million at December 31, 2015 versus $35.7 million at December 31, 2014. During 2015, we added properties totaling $5.8 million and partially or completely liquidated properties totaling $20.2 million. Revaluation adjustments for OREO properties during 2015 totaled $1.7 million and were charged to noninterest expense when realized. For 2014, we added properties totaling $15.3 million and partially or completely liquidated properties totaling $23.8 million. Revaluation adjustments for OREO properties during 2014 totaled $3.1 million and were charged to noninterest expense when realized.

 

The composition of our OREO portfolio as of December 31 is provided in the table below.

 

(Dollars in Thousands)  2015   2014 
Lots/Land  $11,718   $19,405 
Residential 1-4   2,221    4,430 
Commercial Building   4,137    10,197 
Other   1,214    1,648 
Total OREO  $19,290   $35,680 

 

Troubled Debt Restructurings. TDRs are loans on which, due to the deterioration in the borrower’s financial condition, the original terms have been modified and deemed a concession to the borrower. From time to time we will modify a loan as a workout alternative. Most of these instances involve a principal moratorium, extension of the loan term, or interest rate reduction.

 

Loans classified as TDRs at December 31, 2015 totaled $38.3 million compared to $49.2 million at December 31, 2014. Accruing TDRs made up approximately $35.6 million, or 93%, of our TDR portfolio at December 31, 2015 of which $1.1 million was over 30 days past due. The weighted average rate for the loans within the accruing TDR portfolio is 5.3%. During 2015, we modified 43 loan contracts totaling approximately $3.3 million. Our TDR default rate (default balance as a percentage of average TDRs) during 2015 and 2014 was 4% and 16%, respectively.

 

The composition of our TDR portfolio as of December 31 is provided in the table below.

 

   2015   2014 
(Dollars in Thousands)  Accruing   Nonaccruing(1)   Accruing   Nonaccruing(1) 
Commercial, Financial and Agricultural  $897   $   $838   $266 
Real Estate – Construction                
Real Estate – Commercial Mortgage   16,621    1,070    26,565    1,591 
Real Estate – Residential   14,979    1,582    14,940    2,531 
Real Estate – Home Equity   2,914        1,856    356 
Consumer   223    35    211     
Total TDRs  $35,634   $2,687   $44,410   $4,744 

 

(1)Nonaccruing TDRs are included in nonaccrual/NPL totals and NPA/NPL ratio calculations.

 

Activity within our TDR portfolio is provided in the table below.

 

(Dollars in Thousands)  2015   2014 
TDR Beginning Balance:  $49,154   $58,543 
Additions   3,317    4,978 
Charge-Offs   (1,580)   (2,410)
Paid Off/Payments   (6,084)   (6,689)
Removal Due to Change in TDR Status   (4,906)   (73)
Defaults   (1,580)   (5,195)
TDR Ending Balance  $38,321   $49,154 

 

Past Due Loans. A loan is defined as a past due loan when one full payment is past due or a contractual maturity is over 30 days past due. Past due loans at December 31, 2015 totaled $5.8 million compared to $6.8 million at December 31, 2014.

43
 

Potential Problem Loans. Potential problem loans are defined as those loans which are now current but where management has doubt as to the borrower’s ability to comply with present loan repayment terms. At December 31, 2015, we had $3.6 million in loans of this type which are not included in either of the nonaccrual, TDR or 90 day past due loan categories compared to $6.4 million at December 31, 2014. Management monitors these loans closely and reviews their performance on a regular basis.

 

Loan Concentrations. Loan concentrations exist when there are amounts loaned to multiple borrowers engaged in similar activities which cause them to be similarly impacted by economic or other conditions and such amount exceeds 10% of total loans. Due to the lack of diversified industry within the markets served by the Bank and the relatively close proximity of the markets, we have both geographic concentrations as well as concentrations in the types of loans funded. Specifically, due to the nature of our markets, a significant portion of the loan portfolio has historically been secured with real estate, approximately 72% at December 31, 2015 and 75% at December 31, 2014. The primary types of real estate collateral are commercial properties and 1-4 family residential properties. At December 31, 2015, commercial real estate and residential real estate mortgage loans (including home equity loans) accounted for 33.2% and 35.6%, respectively, of the total loan portfolio.

 

The following table summarizes our real estate loan portfolio as segregated by the type of property. Property type concentrations are stated as a percentage of December 31st total real estate loans.

 

   2015   2014 
   Investor
Real Estate
   Owner
Occupied
Real Estate
   Investor
Real Estate
   Owner
Occupied
Real Estate
 
Vacant Land, Construction, and Land Development   10.5%       10.0%    
Improved Property   22.2    67.3%   22.0    68.0%
Total Real Estate Loans   32.7%   67.3%   32.0%   68.0%

 

A major portion of our real estate loan portfolio is centered in the owner occupied category which carries a lower risk of non-collection than certain segments of the investor category. Approximately 68% of the land/construction category was secured by residential real estate at December 31, 2015.

 

Allowance for Loan Losses

 

Management believes it maintains the allowance for loan losses at a level sufficient to provide for probable credit losses inherent in the loan portfolio as of the balance sheet date. Credit losses arise from the borrowers’ inability or unwillingness to repay, and from other risks inherent in the lending process including collateral risk, operations risk, concentration risk, and economic risk. As such, all related risks of lending are considered when assessing the adequacy of the allowance. The allowance for loan losses is established through a provision charged to expense. Loans are charged-off against the allowance when losses are probable and reasonably quantifiable. The allowance for loan losses is based on management’s judgment of overall credit quality. This is a significant estimate based on a detailed analysis of the loan portfolio. The balance can and will change based on revisions to our assessment of the loan portfolio’s overall credit quality and other risk factors both internal and external to us.

 

Management evaluates the adequacy of the allowance for loan losses on a quarterly basis. The allowance consists of two components. The first component consists of amounts reserved for impaired loans. A loan is deemed impaired when, based on current information and events, it is probable that the company will not be able to collect all amounts due (principal and interest payments), according to the contractual terms of the loan agreement. Loans are monitored for potential impairment through our ongoing loan review procedures and portfolio analysis. Classified loans and past due loans over a specific dollar amount, and all troubled debt restructurings are individually evaluated for impairment.

 

The approach for assigning reserves for the impaired loans is determined by the dollar amount of the loan and loan type. Impairment measurement for loans over a specific dollar are assigned on an individual loan basis with the amount reserved dependent on whether repayment of the loan is dependent on the liquidation of collateral or from some other source of repayment. If repayment is dependent on the sale of collateral, the reserve is equivalent to the recorded investment in the loan less the fair value of the collateral after estimated sales expenses. If repayment is not dependent on the sale of collateral, the reserve is equivalent to the recorded investment in the loan less the estimated cash flows discounted using the loan’s effective interest rate. The discounted value of the cash flows is based on the anticipated timing of the receipt of cash payments from the borrower. The reserve allocations for individually measured impaired loans are sensitive to the extent market conditions or the actual timing of cash receipts change. Impairment reserves for smaller-balance loans under a specific dollar amount are assigned on a pooled basis utilizing loss factors for impaired loans of a similar nature.

 

 44 
 

The second component is a general reserve on all loans other than those identified as impaired. General reserves are assigned to various homogenous loan pools, including commercial, commercial real estate, construction, residential 1-4 family, home equity, and consumer. General reserves are assigned based on historical loan loss ratios determined by loan pool and internal risk rating that are adjusted for various internal and external risk factors unique to each loan pool.

 

Table 9 analyzes the activity in the allowance over the past five years.

 

For 2015, our net charge-offs totaled $5.2 million, or 0.35%, of average loans, compared to $7.5 million, or 0.53%, for 2014, and $9.5 million, or 0.66%, for 2013. The decrease in 2015 was primarily attributable to a $2.5 million decline in commercial real estate loan charge-offs. Lower residential and construction loan charge-offs of $1.6 million and $1.1 million, respectively, drove the decrease in net charge-offs in 2014. At December 31, 2015, the allowance for loan losses of $14.0 million was 0.93% of outstanding loans (net of overdrafts) and provided coverage of 135% of nonperforming loans compared to 1.22% and 105%, respectively, at December 31, 2014, and 1.65% and 62%, respectively, at December 31, 2013.

 

Table 10 provides an allocation of the allowance for loan losses to specific loan types for each of the past five years.

 

The reduction in the allowance for loan losses from both periods December 31, 2014 to December 31, 2015 and December 31, 2013 to December 31, 2014, was primarily attributable to a decline in general reserves reflective of slower problem loan migration and continued improvement in credit quality metrics. A decrease in our impaired loan balance and related reserves contributed to a lesser extent and reflects slower inflow and successful resolutions, as well as lower loss content. During 2015, growth in the loan portfolio and related general reserves partially offset the aforementioned reductions due to favorable problem loan migration. It is management’s opinion that the allowance at December 31, 2015 is adequate to absorb probable losses inherent in the loan portfolio.

 

Table 9

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

 

(Dollars in Thousands)  2015   2014   2013   2012   2011 
Balance at Beginning of Year  $17,539   $23,095   $29,167   $31,035   $35,436 
Charge-Offs:                         
Commercial, Financial and Agricultural   1,029    871    748    822    1,843 
Real Estate – Construction       28    1,070    629    114 
Real Estate – Commercial   1,250    3,788    3,651    6,031    6,713 
Real Estate – Residential   1,852    2,160    3,835    9,719    11,870 
Real Estate – Home Equity   1,403    1,379    1,159    2,896    2,727 
Consumer   1,901    1,820    1,751    2,125    2,924 
Total Charge-Offs   7,435    10,046    12,214    22,222    26,191 
                          
Recoveries:                         
Commercial, Financial and Agricultural   239    214    209    290    387 
Real Estate – Construction       9    1    43    14 
Real Estate – Commercial   183    468    363    682    251 
Real Estate – Residential   705    752    838    1,291    478 
Real Estate – Home Equity   136    141    294    399    214 
Consumer   992    1,001    965    1,483    1,450 
Total Recoveries   2,255    2,585    2,670    4,188    2,794 
                          
Net Charge-Offs   5,180    7,461    9,544    18,034    23,397 
                          
Provision for Loan Losses   1,594    1,905    3,472    16,166    18,996 
                          
Balance at End of Year  $13,953   $17,539   $23,095   $29,167   $31,035 
                          
Ratio of Net Charge-Offs to Average Loans Outstanding   0.35%   0.53%   0.66%   1.16%   1.39%
                          
Allowance for Loan Losses as a Percent of Loans at End of Year   0.93%   1.22%   1.65%   1.93%   1.91%
                          
Allowance for Loan Losses as a Multiple of Net Charge-Offs   2.69x   2.35x   2.42x   1.62x   1.33x
45
 

Table 10

ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

 

   2015   2014   2013   2012   2011 
(Dollars in Thousands)  Allowance
Amount
   Percent
of Loans
in Each
Category
To Total
Loans
   Allowance
Amount
   Percent
of Loans
in Each
Category
To Total
Loans
   Allowance
Amount
   Percent
of Loans
in Each
Category
To Total
Loans
   Allowance
Amount
   Percent
of Loans
in Each
Category
To Total
Loans
   Allowance
Amount
   Percent
of Loans
in Each
Category
To Total
Loans
 
Commercial, Financial and
Agricultural
   $905      12.0%    $784      9.5%    $699      9.0%    $1,253      9.2%    $1,534      8.0%
Real Estate:                                                  
Construction   101    3.1    843    3.0    1,580    2.6    2,856    2.9    1,133    1.6 
Commercial   4,498    33.2    5,287    35.4    7,710    38.1    11,081    40.3    10,660    39.2 
Residential   4,409    20.0    6,520    21.1    9,073    22.6    8,678    21.7    12,518    24.5 
Home Equity   2,473    15.6    2,882    15.9    3,051    16.3    2,945    15.5    2,392    15.0 
Consumer   1,567    16.1    1,223    15.1    982    11.4    1,327    10.4    1,887    11.7 
Not Allocated                           1,027        911     
                                                   
Total  $13,953    100.0%  $17,539    100.0%  $23,095    100.0%  $29,167    100.0%  $31,035    100.0%

 

Investment Securities

 

In 2015, our average investment portfolio increased $158.3 million, or 34.9%, from 2014 and increased $113.5 million, or 33.4%, from 2013 to 2014.  As a percentage of average earning assets, the investment portfolio represented 26.3% in 2015, compared to 20.3% in 2014.  In both 2014 and 2015, we strategically grew the portfolio to better deploy our liquidity. In 2016, we will continue to closely monitor liquidity levels and pledging requirements to assess the need to purchase additional investments, as well as look for new investment products that are prudent relative to our risk profile and overall investment strategy.


The investment portfolio is a significant component of our operations and, as such, it functions as a key element of liquidity and asset/liability management. Two types of classifications are approved for investment securities which are Available-for-Sale (“AFS”) and Held-for-Maturity (“HTM”). In 2014 and 2015, securities were purchased under both the AFS and HTM designations. As of December 31, 2015, $451.0 million, or 70.6% of the investment portfolio was classified as AFS, with the remaining $187.9 million, or 29.4%, classified as HTM.

 

In 2015, average taxable investments increased $114.9 million, or 26.8%, while tax-exempt investments increased $24.7 million, or 35.3%.  Both taxable and tax-exempt investments increased as part of our overall investment strategy in 2015. Short-term, high quality tax-exempt and taxable bonds offered attractive yields during the year, resulting in favorable repricing in the investment portfolio. Management will continue to purchase municipal issues as they become available and when it considers the yield to be attractive.

 

At acquisition, the classification of the security will be determined based on how the purchase will affect the company’s asset/liability strategy and future business plans and opportunities. Such decisions will be weighed against multiple factors, including regulatory capital requirements, volatility in earnings or other comprehensive income, and liquidity needs. Securities in the AFS portfolio are recorded at fair value with unrealized gains and losses associated with these securities recorded net of tax, in the accumulated other comprehensive income (loss) component of shareowners’ equity. Securities that are HTM will be acquired or owned with the intent of holding them to maturity (final payment date). HTM investments are measured at amortized cost. It is neither management’s current intent nor practice to participate in the trading of investment securities for the purpose of recognizing gains and therefore we do not maintain a trading portfolio.

 

At December 31, 2015, there were 295 positions (combined AFS and HTM) with unrealized losses totaling $1.2 million. Of the 295 positions, 134 were Ginnie Mae mortgage-backed securities (GNMA), U.S. Treasuries, or SBA securities, all of which carry the full faith and credit guarantee of the U.S. Government. SBA securities float monthly or quarterly to the prime rate and are uncapped. Of these 134 positions, there were 22 GNMA positions and 22 SBA positions in an unrealized loss position for longer than 12 months, and have unrealized losses of $222,000 and $63,000, respectively. There were 141 municipal bonds in an unrealized loss position that were pre-refunded, or rated “AA-“or better. 14 of these positions were in an unrealized loss position for longer than 12 months, and had unrealized loss of $13,000. The remaining 20 securities were government agency bonds, which have been in an unrealized loss position for less than 12 months, with an unrealized loss of $116,000. None of the positions with unrealized losses are considered impaired, and all are expected to mature at par.

46
 

The average maturity of the total portfolio at December 31, 2015 and 2014 was 1.85 and 2.17 years, respectively. Balances increased primarily in U.S. Treasury and municipal bonds, with the remaining asset classes being unchanged or lower compared to the prior year. The decline in average life of the investment portfolio occurred primarily in U.S. Treasuries, as the natural aging of these investments shortened the overall portfolio. We continue to invest in short-duration, high quality bonds. See Table 11 for a breakdown of maturities by investment type.

 

The weighted average taxable equivalent yield of the investment portfolio at December 31, 2015 was 1.08% versus 1.00% in 2014. This higher yield reflects the reinvestment of proceeds at slightly higher market rates during 2015.  The Company’s bond portfolio contained no investments in obligations, other than U.S. Governments, of any state, municipality, political subdivision or any other issuer that exceed 10% of our shareowners’ equity at December 31, 2015.

 

Table 11 and Note 2 in the Notes to Consolidated Financial Statements present a detailed analysis of our investment securities as to type, maturity and yield at December 31.

 

Table 11

INVESTMENT SECURITIES BY CATEGORY

 

   2015   2014   2013 
(Dollars in Thousands)  Carrying Amount   Percent   Carrying Amount   Percent   Carrying Amount   Percent 
Available for Sale                              
U.S. Government Treasury  $250,346    39.2%  $186,031    36.8%  $71,833    18.0%
U.S. Government Agency   101,824    15.9    96,097    19.0    75,146    18.8 
States and Political Subdivisions   88,362    13.8    48,388    9.6    91,753    23.0 
Mortgage-Backed Securities   1,901    0.3    2,287    0.5    2,795    0.7 
Equity Securities   8,595    1.3    8,745    1.7    9,893    2.4 
Total   451,028    70.6    341,548    67.6    251,420    62.9 
                               
Held to Maturity                              
U.S. Government Treasury   134,554    21.1    76,179    3.9    43,533    4.0 
U.S. Government Agency   10,043    1.6    19,807    15.1    15,794    10.9 
States and Political Subdivisions   15,693    2.5    26,716    5.3    33,216    13.9 
Mortgage-Backed Securities   27,602    4.3    40,879    8.1    55,668    8.3 
Total   187,892    29.4    163,581    32.4    148,211    37.1 
                               
Total Investment Securities  $638,920    100%  $505,129    100%  $399,631    100%
47
 

Table 12

MATURITY DISTRIBUTION OF INVESTMENT SECURITIES

                                         
   Within 1 year   1 - 5 years   5 - 10 years   After 10 years   Total 
(Dollars in Thousands)  Amount   WAY(3)   Amount   WAY(3)   Amount   WAY(3)   Amount   WAY(3)   Amount   WAY(3) 
Available for Sale                                                  
U.S. Government Treasury  $64,342    0.59%  $186,004    1.02%  $    %  $    %  $250,346    0.89%
U.S. Government Agency   9,161    0.94    92,663    0.90                    101,824    0.90 
States and Political Subdivisions   16,878    0.81    71,484    1.46                    88,362    1.34 
Mortgage-Backed Securities(1)   215    3.47    1,545    4.94    141    5.92            1,901    4.84 
Other Securities(2)                           8,595    5.26    8,595    5.26 
Total  $90,596    0.62%  $351,696    1.10%  $141    5.92%  $8,595    5.26%  $451,028    1.08%
                                                   
Held to Maturity                                                  
U.S. Government Treasury  $30,025    0.74%  $104,529    1.02%  $    %  $    %  $134,554    0.96%
U.S. Government Agency   6,950    0.85    3,093    0.88                    10,043    0.86 
States and Political Subdivisions   7,293    0.85    8,400    1.82                    15,693    1.37 
Mortgage-Backed Securities(1)   3,583    1.20    24,019    1.72                    27,602    1.65 
Total  $47,851    0.81%  $140,041    1.19%  $    %  $    %  $187,892    1.09%
                                                   
Total Investment Securities  $138,447    0.68%  $491,737    1.12%  $141    5.92%  $8,595    5.26%  $638,920    1.08%

 

(1)Based on weighted-average life.
(2)Federal Home Loan Bank Stock and Federal Reserve Bank Stock are included in this category for weighted average yield, but do not have stated maturities.
(3)Weighted average yield calculated based on current amortized cost balances – not presented on a tax equivalent basis.
48
 

Deposits and Funds Purchased

 

Average total deposits for 2015 were $2.163 billion; an increase of $70.0 million, or 3.3%, over 2014. Average deposits increased $23.4 million, or 1.1%, from 2013 to 2014. Increases in 2015 occurred in all deposit types except money market accounts and certificates of deposit. The increase from 2013 to 2014 occurred in noninterest bearing deposits and savings accounts, which were partially offset by declines in the remaining product types.

 

The seasonal inflow of public funds started in the fourth quarter of 2015 and is expected to continue through the first quarter of 2016. Deposit levels remain strong and our mix of deposits continues to improve slightly as higher cost certificates of deposit are replaced with lower rate non-maturity deposits and noninterest bearing demand accounts.  

 

Notwithstanding the interest rate increase by the Federal Reserve in December 2015, our strategy is to lag deposit rates, while closely monitoring liquidity and competitor rates. This strategy is consistent with previous rate cycles, and allows us to manage the mix of our deposits rather than compete on rate. We believe this enables us to maintain a low cost of funds – 14 basis points for the year 2015 and 16 basis points for the year 2014.

 

Table 2 provides an analysis of our average deposits, by category, and average rates paid thereon for each of the last three years. Table 13 reflects the shift in our deposit mix over the last year and Table 14 provides a maturity distribution of time deposits in denominations of $100,000 and over at December 31, 2015.

 

Average short-term borrowings, which include federal funds purchased, securities sold under agreements to repurchase, FHLB advances (maturing in less than one year), and other borrowings, increased $14.1 million, or 31.7% in 2015.  The higher balance was primarily attributable to increases in repurchase agreements, partially offset by a decrease in other borrowed funds. See Note 8 in the Notes to Consolidated Financial Statements for further information on short-term borrowings.

 

We continue to focus on the value of our deposit franchise, which produces a strong base of core deposits with minimal reliance on wholesale funding.

 

Table 13

SOURCES OF DEPOSIT GROWTH

 

   2014 to   Percentage   Components of 
   2015   of Total   Total Deposits 
(Average Balances - Dollars in Thousands)  Change   Change   2015   2014   2013 
Noninterest Bearing Deposits  $44,695    63.8%   33.1%   32.1%   30.5%
NOW Accounts   31,451    45.0    34.5    34.2    34.8 
Money Market Accounts   (15,172)   (21.7)   11.9    13.0    13.7 
Savings   28,182    40.3    11.8    10.9    9.8 
Time Deposits   (19,192)   (27.4)   8.7    9.8    11.2 
Total Deposits  $69,964    100.0%   100.0%   100.0%   100.0%

 

Table 14

MATURITY DISTRIBUTION OF CERTIFICATES OF DEPOSIT $100,000 OR OVER

 

   2015 
(Dollars in Thousands)  Time
Certificates
of Deposit
   Percent 
Three months or less  $16,383    33.2%
Over three through six months   11,618    23.6 
Over six through twelve months   17,025    34.6 
Over twelve months   4,243    8.6 
Total  $49,269    100.0%
49
 

Market Risk and Interest Rate Sensitivity

 

Overview.  Market risk arises from changes in interest rates, exchange rates, commodity prices, and equity prices.  We have risk management policies designed to monitor and limit exposure to market risk and we do not participate in activities that give rise to significant market risk involving exchange rates, commodity prices, or equity prices.  In asset and liability management activities, our policies are designed to minimize structural interest rate risk.

 

Interest Rate Risk Management.  Our net income is largely dependent on net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than interest-earning assets.  When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income.  Net interest income is also affected by changes in the portion of interest-earning assets that are funded by interest-bearing liabilities rather than by other sources of funds, such as noninterest-bearing deposits and shareowners’ equity.

 

We have established what we believe to be a comprehensive interest rate risk management policy, which is administered by management’s Asset Liability Management Committee (“ALCO”).  The policy establishes limits of risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity (“EVE”) at risk) resulting from a hypothetical change in interest rates for maturities from one day to 30 years.  We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling.  The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts.  As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology used by us.  When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model.  Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan clients’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.

 

The balance sheet is subject to testing for interest rate shock possibilities to indicate the inherent interest rate risk. We prepare a current base case and several alternative interest rate simulations (-100,+100, +200, +300, and +400 basis points (bp)), at least once per quarter, and report the analysis to ALCO, our Market Risk Oversight Committee (“MROC”), our Enterprise Risk Oversight Committee (“EROC”) and the Board of Directors.  We augment our interest rate shock analysis with alternative interest rate scenarios on a quarterly basis that may include ramps, parallel shifts, and a flattening or steepening of the yield curve (non-parallel shift). In addition, more frequent forecasts may be produced when interest rates are particularly uncertain or when other business conditions so dictate.

 

It is management’s goal to structure the balance sheet so that net interest earnings at risk over a 12-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels. Management attempts to achieve this goal by balancing, within policy limits, the volume of floating-rate liabilities with a similar volume of floating-rate assets, by keeping the average maturity of fixed-rate asset and liability contracts reasonably matched, by managing the mix of our core deposits, and by adjusting our rates to market conditions on a continuing basis.

 

Analysis.  Measures of net interest income at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments.  These measures are typically based upon a relatively brief period, usually one year.  They do not necessarily indicate the long-term prospects or economic value of the institution.

 

ESTIMATED CHANGES IN NET INTEREST INCOME(1)

 

During the year, the bank implemented the results of a comprehensive deposit study and made some revisions to interest rate risk modeling methodologies as a result.  The more significant results of the exercise included the removal of time lags built in to deposit pricing if market rates move, which resulted in more linear changes in margin as market rates change. 

 

Changes in Interest Rates  +400 bp   +300 bp   +200 bp   +100 bp   -100 bp 
Policy Limit   -15.0%   -12.5%   -10.0%   -7.5%   -7.5%
December 31, 2015   8.17%   5.2%   2.6%   1.1%   -6.7%
December 31, 2014   NA    2.7%   4.0%   -1.1%   -2.9%
50
 

The Net Interest Income (“NII”) at Risk position improved for the period ending December 2015 in the rates +300 bp and +100 bp scenarios when compared to the same period in 2014. The NII at risk position declined in the +200 bp scenario, but remained positive. The model suggests the largest exposure is when rates fall 100 bp, which is attributable to the historically low interest rate environment. Compared to last year, a rate shock scenario of +400 bp was added. In addition, revised policy limits were reviewed and approved by the Board after analysis was performed on peer bank limits. All measures of net interest income at risk are within our prescribed policy limits.

 

The measures of equity value at risk indicate our ongoing economic value by considering the effects of changes in interest rates on all of our cash flows, and discounting the cash flows to estimate the present value of assets and liabilities. The difference between these discounted values of the assets and liabilities is the economic value of equity, which in theory approximates the fair value of our net assets.

 

ESTIMATED CHANGES IN ECONOMIC VALUE OF EQUITY(1)

 

Changes in Interest Rates  +400 bp   +300 bp   +200 bp   +100 bp   -100 bp 
Policy Limit   -30.0%   -25.0%   -20.0%   -15.0%   -15.0%
December 31, 2015   31.1%   24.7%   17.3%   9.4%   -26.2%
December 31, 2014   NA    -2.1%   1.0%   -3.3%   -8.3%

 

As of December 2015, the improvement in the economic value of equity in all rate scenarios was more favorable than it was as of December 2014, with the exception of the down 100 bp scenario, as exposure to falling rates is more extreme due to the low level of current deposit costs and limited capacity to reduce those costs relative to the reduction in discount rates used to value them. To bring this metric into compliance with our policy limits in the down 100 bp scenario would require the bank to extend its asset duration which we do not believe is prudent given the current historically low interest rate environment.

 

Much of the improvement in EVE in the rates up scenarios was attributable to the extension of our average life assumptions on core deposits.as a result of the core deposit study, as longer average lives on non-maturity deposits produce a more asset sensitive posture for EVE.

 

Compared to last year, an EVE rate scenario of +400 bp was added. In addition, revised policy limits were reviewed and approved by the Board after analysis was performed on peer bank limits.

 

 (1) Down 200, 300, and 400 bp rate scenarios have been excluded due to the current historically low interest rate environment.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity

 

In general terms, liquidity is a measurement of our ability to meet our cash needs.  Our objective in managing our liquidity is to maintain our ability to fund loan commitments, purchase securities, accommodate deposit withdrawals or repay other liabilities in accordance with their terms, without an adverse impact on our current or future earnings.  Our liquidity strategy is guided by policies that are formulated and monitored by our ALCO and senior management, and which take into account the marketability of assets, the sources and stability of funding and the level of unfunded commitments.  We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness.  For the years ended December 31, 2015 and 2014, our principal source of funding has been our clients’ deposits, supplemented by our short-term and long-term borrowings, primarily from securities sold under repurchase agreements, federal funds purchased and FHLB borrowings.  We believe that the cash generated from operations, our borrowing capacity and our access to capital resources are sufficient to meet our future operating capital and funding requirements.

 

As of December 31, 2015, we had the ability to generate approximately $1.038 billion in additional liquidity through all of our available resources beyond our overnight funds sold position.  In addition to the primary borrowing outlets mentioned above, we also have the ability to generate liquidity by borrowing from the Federal Reserve Discount Window and through brokered deposits.  Management recognizes the importance of maintaining liquidity and has developed a Contingent Liquidity Plan, which addresses various liquidity stress levels and our response and action based on the level of severity.  We periodically test our credit facilities for access to the funds, but also understand that as the severity of the liquidity level increases certain credit facilities may no longer be available.  A liquidity stress test is completed quarterly based on events that could potentially occur at the Bank with the results reported to ALCO, MROC, EROC and the Board of Directors.  We believe the liquidity available to us is sufficient to meet our ongoing needs.

 

We view our investment portfolio as a liquidity source and have the option to pledge the portfolio as collateral for borrowings or deposits, and/or sell selected securities.  The portfolio consists of debt issued by the U.S. Treasury, U.S. governmental agencies, and municipal governments.  The weighted-average life of the portfolio is 1.83 years and as of December 31, 2015 had a net unrealized pre-tax gain of $0.1 million in the available-for sale portfolio.

51
 

Our average net overnight funds (defined as funds sold plus interest-bearing deposits with other banks less funds purchased) sold position was $238.0 million during 2015 compared to an average net overnight funds sold position of $369.9 million in 2014. The decrease in this positon compared to the prior year reflects higher growth in both the investment and loan portfolios, partially offset by an increase in average deposits.

 

Capital expenditures are expected to approximate $5.0 million over the next 12 months, which consist primarily of ATM replacements, furniture and fixtures, and other technology purchases.  Management believes that these capital expenditures will be funded with existing resources without impairing our ability to meet our ongoing obligations.

 

Borrowings

 

At December 31, 2015, advances from the FHLB consisted of $28.3 million in outstanding debt consisting of 29 notes.  In 2015, the Bank made FHLB advance payments totaling $4.8 million, which included four advances that matured or were paid off. No new FHLB advances were obtained in 2015.  The FHLB notes are collateralized by a blanket floating lien on all of our 1-4 family residential mortgage loans, commercial real estate mortgage loans, and home equity mortgage loans. 

 

We have issued two junior subordinated deferrable interest notes to wholly owned Delaware statutory trusts.  The first note for $30.9 million was issued to CCBG Capital Trust I in November 2004.  The second note for $32.0 million was issued to CCBG Capital Trust II in May 2005.  See Note 8 in the Notes to Consolidated Financial Statements for additional information on these borrowings.  The interest payment for the CCBG Capital Trust I borrowing is due quarterly and adjusts quarterly to a variable rate of LIBOR plus a margin of 1.90%.  This note matures on December 31, 2034.  The interest payment for the CCBG Capital Trust II borrowing is due quarterly and will adjust annually to a variable rate of LIBOR plus a margin of 1.80%.  This note matures on June 15, 2035.  The proceeds of these borrowings were used to partially fund acquisitions.

 

Table 15

CONTRACTUAL CASH OBLIGATIONS

 

Table 14 sets forth certain information about contractual cash obligations at December 31, 2015.

 

   Payments Due By Period 
(Dollars in Thousands)  < 1 Yr   > 1 – 3 Yrs   > 3 – 5 Yrs   > 5 Yrs   Total 
Federal Home Loan Bank Advances  $2,829   $18,882   $3,122   $3,513   $28,346 
Subordinated Notes Payable               62,887    62,887 
Operating Lease Obligations   480    1,273    826    1,981    4,560 
Time Deposit Maturities   153,328    21,893    1,906    1,580    178,707 
Total Contractual Cash Obligations  $156,637   $42,048   $5,854   $69,961   $274,500 

 

Capital

 

Shareowners’ equity totaled $274.4 million at December 31, 2015 compared to $272.5 million at December 31, 2014. During 2015, shareowners’ equity increased $1.9 million, or 0.7%. During the year, shareowners’ equity was positively impacted by net income of $9.1 million, stock compensation accretion of $1.1 million, and net adjustments totaling $0.6 million related to transactions under our stock compensation plans. Shareowners’ equity was reduced by common stock dividends of $2.2 million, share repurchases totaling $6.0 million, a $0.7 million increase in the accumulated other comprehensive loss for our pension plan, and a net increase of $0.2 million in the unrealized loss on investment securities.

 

Shareowners’ equity as of December 31, for each of the last three years is presented below:

 

(Dollars in Thousands)  2015   2014   2013 
Common Stock  $172   $174   $174 
Additional Paid-in Capital   38,256    42,569    41,152 
Retained Earnings   258,181    251,306    243,614 
Subtotal   296,609    294,049    284,940 
Accumulated Other Comprehensive Loss, Net of Tax   (22,257)   (21,509)   (8,540)
Total Shareowners’ Equity  $274,352   $272,540   $276,400 

 

We continue to maintain a strong capital position. The ratio of shareowners’ equity to total assets at year-end was 9.81%, 10.37%, and 10.58%, in 2015, 2014, and 2013, respectively. Management believes our strong capital base offered protection during the course of the last economic downturn and provides sufficient capacity to meet our strategic objectives.

52
 

We are subject to risk-based capital guidelines that measure capital relative to risk-weighted assets and off-balance sheet financial instruments. Capital guidelines issued by the Federal Reserve require bank holding companies to have a minimum total risk-based capital ratio of 8.00%, with at least half of the total capital in the form of Tier 1 Capital. As of December 31, 2015, we exceeded these capital guidelines with a total risk-based capital ratio of 17.25% and a Tier 1 capital ratio of 16.42%, compared to 17.76% and 16.67%, respectively, in 2014. As allowed by Federal Reserve capital guidelines, the trust preferred securities issued by CCBG Capital Trust I and CCBG Capital Trust II are included as Tier 1 Capital in our capital calculations previously noted. See Note 9 in the Notes to Consolidated Financial Statements for additional information on our two trust preferred security offerings. See Note 14 in the Notes to Consolidated Financial Statements for additional information as to our capital adequacy.

 

The federal banking regulators issued new capital rules establishing a new comprehensive capital framework for U.S. banking organizations which became effective January 1, 2015 (subject to a phase-in period) (the “Basel III Capital Rules”). Refer to the Regulatory Considerations – Capital Regulations section on page 13 for a detailed discussion of the new Basel III capital requirements. The reduction in our regulatory capital ratios in 2015 reflects the implementation of Basel III and the repurchase of our common stock. The common equity tier 1 ratio is a new required ratio that was created out of the Basel III capital requirements. The ratio measures core equity components relative to risk-weighted assets. Capital guidelines require a minimum common equity tier 1 ratio of 4.5% plus a capital conservation buffer of 2.5% that will be phased in between 2016 and 2019 (currently 0.625%). As of December 31, 2015, our common equity tier 1 ratio was 12.84%.

 

A leverage ratio is also used in connection with the risk-based capital standards and is defined as Tier 1 Capital divided by average assets. The minimum leverage ratio under this standard is 4% for the highest-rated bank holding companies which are not undertaking significant expansion programs. A higher standard may be required for other companies, depending upon their regulatory ratings and expansion plans. On December 31, 2015, we had a leverage ratio of 10.65% compared to 10.99% in 2014.

 

At December 31, 2015, our common stock had a book value of $15.93 per diluted share compared to $15.53 at December 31, 2014. Book value is impacted by the net unrealized gains and losses on investment securities available-for-sale. At December 31, 2015, the net unrealized loss was $127,000 compared to a $59,000 net unrealized gain at December 31, 2014. The aforementioned net unrealized loss of $127,000 reflects a $91,000 net gain on available for sale securities and $218,000 in unamortized loss related to the transfer of securities to held-to-maturity in 2013. Book value is also impacted by the recording of our unfunded pension liability through other comprehensive income in accordance with Accounting Standards Codification Topic 715. At December 31, 2015, the net pension liability reflected in other comprehensive loss was $22.1 million compared to $21.6 million at December 31, 2014.

 

In February 2014, our Board of Directors authorized the repurchase of up to 1,500,000 shares of our outstanding common stock over a five year period. Repurchases may be made in the open market or in privately negotiated transactions; however, we are not obligated to repurchase any specified number of shares. A total of 424,828 shares of our outstanding common stock have been purchased at an average price of $14.68 under the plan. During 2015, we repurchased 405,228 shares at an average price of $14.73 per share.

 

We offer an Associate Incentive Plan under which certain associates are eligible to earn equity-based awards based upon achieving established performance goals. In 2015, 61,118 shares were earned under this plan of which 7,931 shares were issued in 2015 and 53,187 were issued in January 2016. In 2014, 76,547 shares were earned under this plan of which 3,200 shares were issued in 2014 and 73,347 were issued in January 2015.

 

We also offer stock purchase plans, which permit our associates and directors to purchase shares at a 10% discount. In 2015, 33,582 shares, valued at approximately $0.5 million (before 10% discount), were issued under these plans. In 2014, 39,562 shares, valued at approximately $0.6 million (before 10% discount), were issued under these plans.

 

Dividends

 

Adequate capital and financial strength is paramount to our stability and the stability of our subsidiary bank. Cash dividends declared and paid should not place unnecessary strain on our capital levels. When determining the level of dividends the following factors are considered:

 

·Compliance with state and federal laws and regulations;
·Our capital position and our ability to meet our financial obligations;
·Projected earnings and asset levels; and
·The ability of the Bank and us to fund dividends.
53
 

Inflation

 

The impact of inflation on the banking industry differs significantly from that of other industries in which a large portion of total resources are invested in fixed assets such as property, plant and equipment.

 

Assets and liabilities of financial institutions are virtually all monetary in nature, and therefore are primarily impacted by interest rates rather than changing prices. While the general level of inflation underlies most interest rates, interest rates react more to changes in the expected rate of inflation and to changes in monetary and fiscal policy.  Net interest income and the interest rate spread are good measures of our ability to react to changing interest rates and are discussed in further detail in the section entitled “Results of Operations.”

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We do not currently engage in the use of derivative instruments to hedge interest rate risks. However, we are a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of our clients.

 

At December 31, 2015, we had $364.2 million in commitments to extend credit and $6.1 million in standby letters of credit. Commitments to extend credit are agreements to lend to a client so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by us to guarantee the performance of a client to a third party. We use the same credit policies in establishing commitments and issuing letters of credit as we do for on-balance sheet instruments.

 

If commitments arising from these financial instruments continue to require funding at historical levels, management does not anticipate that such funding will adversely impact our ability to meet on-going obligations. In the event these commitments require funding in excess of historical levels, management believes current liquidity, investment security maturities, available advances from the FHLB and Federal Reserve Bank provide a sufficient source of funds to meet these commitments.

 

FOURTH QUARTER 2015 – FINANCIAL RESULTS

 

Results of Operations

 

We realized net income of $2.6 million, or $0.16 per diluted share for the fourth quarter of 2015, compared to net income of $1.7 million, or $0.09 per diluted share for the third quarter of 2015. The growth in earnings reflects a $0.7 million increase in net interest income and a decrease in noninterest expense of $0.9 million, partially offset by higher income taxes $0.6 million and a higher provision for loan losses of $0.1 million.

 

Tax equivalent net interest income for the fourth quarter of 2015 was $20.0 million compared to $19.3 million for the third quarter of 2015. The increase reflects recognition of deferred interest on a loan that was paid off during the quarter, partially offset by unfavorable loan repricing. The net interest margin for the fourth quarter of 2015 was 3.37% (annualized), an increase of six basis points over the third quarter of 2015 attributable to the aforementioned recognition of deferred interest and to a lesser degree, an increase in the rate received on overnight funds which occurred late in the fourth quarter.

 

The provision for loan losses for the fourth quarter of 2015 was $0.5 million compared to $0.4 million for the third quarter of 2015 and reflects continued favorable problem loan migration. Net charge-offs for the fourth quarter of 2015 totaled $1.3 million, or 0.34% (annualized) of average loans, compared to $0.9 million, or 0.24% (annualized), for the third quarter of 2015.

 

Noninterest income for the fourth quarter of 2015 totaled $13.2 million, comparable to the third quarter of 2015 as higher wealth management fees of $0.1 million and other income of $0.3 million were offset by lower mortgage banking fees of $0.3 million and deposit fees of $0.1 million. Higher estate management fees drove the increase in wealth management fees. The increase in other income was attributable to higher income from an equity investment. The decrease in mortgage banking fees reflects lower loan production which was very strong in the third quarter as well as a lower margin on loans sold in the fourth quarter. The decrease in deposit fees reflects lower overdraft fees attributable to decreased utilization of our overdraft service.

 

Noninterest expense for the fourth quarter of 2015 totaled $28.3 million, a decrease of $0.9 million, or 3.0%, from the third quarter of 2015. The decrease was primarily attributable to lower compensation expense of $0.8 million reflective of a $0.5 million decrease in pension expense due to a higher level of required 2015 pension expense in the third quarter upon finalization of actuarial work. Lower commission expense of $0.2 million and payroll taxes of $0.1 million also contributed to the decrease.

54
 

Discussion of Financial Condition

 

Average earning assets were $2.353 billion for the fourth quarter of 2015, an increase of $42.9 million, or 1.9%, over the third quarter of 2015, attributable to a higher level of total deposits, primarily public funds deposits. Average loans were $1.492 billion for the fourth quarter of 2015, an $8.9 million, or 0.6%, increase over the third quarter of 2015, primarily in the tax-free loan category.

 

Nonperforming assets (nonaccrual loans and OREO) totaled $29.6 million at December 31, 2015, a decrease of $8.8 million from September 30, 2015. Nonaccrual loans totaled $10.3 million at December 31, 2015, a decrease of $2.9 million from September 30, 2015. Nonaccrual loan additions totaled $3.6 million in the fourth quarter of 2014 compared to $1.9 million for the third quarter of 2015. The balance of OREO totaled $19.3 million at December 31, 2015, a decrease of $5.9 million from September 30, 2015. For the fourth quarter of 2015, we added properties totaling $1.8 million, sold properties totaling $7.5 million and recorded valuation adjustments totaling $0.2 million. Nonperforming assets represented 1.06% of total assets at December 31, 2015 compared to 1.47% at September 30, 2015.

 

Average total deposits were $2.174 billion for the fourth quarter of 2015, an increase of $37.3 million, or 1.7%, over the third quarter of 2015 reflective of higher noninterest bearing deposits and savings accounts, partially offset by declines in money markets and certificates of deposit. The seasonal inflow of public funds started in the fourth quarter of 2015 and will continue through the first quarter of 2016. Deposit levels remain strong and our mix of deposits continues to improve as higher cost certificates of deposit are replaced with lower rate non-maturity deposits and noninterest bearing demand accounts.  Average borrowings increased by $5.8 million attributable to higher repurchase agreement balances.

 

Equity capital was $274.4 million as of December 31, 2015, compared to $273.7 million as of September 30, 2015. Our leverage ratio was 10.65% and 10.71% for these periods. Further, our risk-adjusted capital ratio was 17.25% at December 31, 2015 compared to 17.24% at September 30, 2015, significantly exceeding the 10.0% threshold to be designated as “well-capitalized” under the risk-based regulatory guidelines. At December 31, 2015, our tangible common equity ratio was 6.99%, compared to 7.46% at September 30, 2015. Our common equity tier 1 ratio was 12.84% as of December 31, 2015 compared to 12.76% as of September 30, 2015. All of our capital ratios significantly exceed the threshold to be designated as “well-capitalized” under the Basel III capital standards as of December 31, 2015.

 

ACCOUNTING POLICIES

 

Critical Accounting Policies

 

The consolidated financial statements and accompanying Notes to Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make various estimates and assumptions (see Note 1 in the Notes to Consolidated Financial Statements).  We believe that, of our significant accounting policies, the following may involve a higher degree of judgment and complexity.

 

Allowance for Loan Losses.  The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses within the existing portfolio of loans.  The allowance is the amount considered adequate to absorb losses inherent in the loan portfolio based on management’s evaluation of credit risk as of the balance sheet date.

 

The allowance for loan losses includes allowance allocations calculated in accordance with U.S. GAAP.  The level of the allowance reflects management’s continuing evaluation of specific credit risks, loss experience, loan portfolio quality, economic conditions and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing.  This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as information becomes available.

 

The Company’s allowance for loan losses consists of two components: (i) specific reserves established for probable losses on impaired loans; and (ii) general reserves for non-homogenous loans not deemed impaired and homogenous loan pools based on, but not limited to, historical loan loss experience, current economic and market conditions, levels of past due loans, and levels of problem loans.

 

Our financial results are affected by the changes in and the absolute level of the allowance for loan losses. This estimation process is judgmental and requires an estimate of the loss severity rates that we apply to our unimpaired loan portfolio.

 

Goodwill. Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets.  We perform an impairment review on an annual basis or more frequently if events or changes in circumstances indicate that the carrying value may not be recoverable.  Adverse changes in the economic environment, declining operations, or other factors could result in a decline in the estimated implied fair value of goodwill. If the estimated implied fair value of goodwill is less than the carrying amount, a loss would be recognized to reduce the carrying amount to the estimated implied fair value.

55
 

We evaluate goodwill for impairment on an annual basis, using a two-step process. Step One compares the estimated fair value of the reporting unit to its carrying amount. We have determined that we have one reporting unit which consists of the Company as a whole, thus the carrying amount of the reporting unit is the net book value of the Company, including goodwill. If the carrying amount of the reporting unit exceeds its estimated fair value, Step Two is performed by comparing the fair value of the reporting unit’s implied goodwill to the carrying value of goodwill. If the carrying value of the reporting unit’s goodwill exceeds the estimated fair value, an impairment charge is recorded equal to the excess.

 

During the fourth quarter, we performed our annual impairment testing. We proceeded with Step One by first estimating the fair value of the reporting unit utilizing a market approach that was supplemented with a reconciliation of the resulting equity value of the Company with our market capitalization. The market approach utilized the guideline company valuation (“GLC”) method to determine the overall equity valuation. A book and tangible book multiple was developed to determine a market value of equity on a controlling basis. A control premium was then applied to the minority value to calculate a Step One value indication for the Company. The multiples that resulted from the GLC method were validated by comparing to peer companies. Based on the valuation developed as part of Step One, the estimated fair value of our reporting unit exceeded the carrying value of goodwill and therefore, no Step Two was required. For Step One of the impairment testing, change in economic conditions and observable bank purchase transactions can impact the outcome of the market valuation approach.

 

Pension Assumptions.  We have a defined benefit pension plan for the benefit of substantially all of our associates.  Our funding policy with respect to the pension plan is to contribute amounts to the plan sufficient to meet minimum funding requirements as set by law.  Pension expense, which is included in the Consolidated Statements of Operations in noninterest expense as “Compensation,” is determined by an external actuarial valuation based on assumptions that are evaluated annually as of December 31, the measurement date for the pension obligation.  The Consolidated Statements of Financial Condition reflect an accrued pension benefit cost due to funding levels and unrecognized actuarial amounts.  The most significant assumptions used in calculating the pension obligation are the weighted-average discount rate used to determine the present value of the pension obligation, the weighted-average expected long-term rate of return on plan assets, and the assumed rate of annual compensation increases.  These assumptions are re-evaluated annually with the external actuaries, taking into consideration both current market conditions and anticipated long-term market conditions.

 

The weighted-average discount rate is determined by matching the anticipated defined pension plan cash flows to a long-term corporate Aa-rated bond index and solving for the underlying rate of return, which investing in such securities would generate.  This methodology is applied consistently from year-to-year.  The discount rate utilized in 2015 was 4.15%.  The estimated impact to 2015 pension expense of a 25 basis point increase or decrease in the discount rate would have been a decrease and increase of approximately $785,000 and $816,000, respectively.  We anticipate using a 4.52% discount rate in 2016.

 

The weighted-average expected long-term rate of return on plan assets is determined based on the current and anticipated future mix of assets in the plan.  The assets currently consist of equity securities, U.S. Government and Government agency debt securities, and other securities (typically temporary liquid funds awaiting investment).  The weighted-average expected long-term rate of return on plan assets utilized for 2015 was 7.5%.  The estimated impact to 2015 pension expense of a 25 basis point increase or decrease in the rate of return would have been an approximate $261,000 increase or decrease, respectively.  We anticipate using a rate of return on plan assets for 2015 of 7.5%.

 

The assumed rate of annual compensation increases of 3.25% in 2015 reflected expected trends in salaries and the employee base.  We anticipate using a compensation increase of 3.25% for 2016 reflecting current market trends.

 

Effective December 31, 2015, we changed the method used to estimate the service and interest components of net periodic benefit cost for the defined benefit plan. Detailed information on the pension plan, the actuarially determined disclosures, and the assumptions used are provided in Note 12 of the Notes to Consolidated Financial Statements.

 

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board, the SEC, and other regulatory bodies have enacted new accounting pronouncements and standards that either have impacted our results in prior years presented, or will likely impact our results in 2016. Please refer to Note 1 of the Notes to our Consolidated Financial Statements.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

See “Financial Condition - Market Risk and Interest Rate Sensitivity” in Management’s Discussion and Analysis of Financial Condition and Results of Operations, above, which is incorporated herein by reference. 

56
 

Item 8. Financial Statements and Supplementary Data

 

Table 16

QUARTERLY FINANCIAL DATA (Unaudited) 

 

   2015   2014 
(Dollars in Thousands, Except Per Share Data)  Fourth   Third   Second   First   Fourth   Third   Second   First 
Summary of Operations:                                        
Interest Income  $20,602   $19,877   $19,833   $19,346   $19,871   $19,766   $19,348   $19,236 
Interest Expense   808    811    849    839    852    868    910    950 
Net Interest Income   19,794    19,066    18,984    18,507    19,019    18,898    18,438    18,286 
Provision for Loan Losses   513    413    375    293    623    424    499    359 
Net Interest Income After
Provision for Loan Losses
   19,281    18,653    18,609    18,214    18,396    18,474    17,939    17,927 
Noninterest Income   13,221    13,228    14,794    12,848    13,053    13,351    13,347    12,785 
Noninterest Expense   28,280    29,164    28,439