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TABLE OF CONTENTS
Item 8. Financial Statements and Supplementary Data
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2013 |
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or |
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TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
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Commission file number: 0-24557
CARDINAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
| Virginia (State or other jurisdiction of incorporation or organization) |
54-1874630 (I.R.S. Employer Identification No.) |
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8270 Greensboro Drive, Suite 500 McLean, Virginia (Address of principal executive offices) |
22102 (Zip Code) |
Registrant's telephone number, including area code: (703) 584-3400
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Name of each exchange on which registered | |
|---|---|---|
| Common Stock, par value $1.00 per share | The Nasdaq Stock Market |
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 ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
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 ý 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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer ý | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2013: $427,113,377.
The number of shares outstanding of Common Stock, as of March 13, 2014, was 31,958,577.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2014 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.
This Annual Report on Form 10-K has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.
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Overview
Cardinal Financial Corporation, a financial holding company, was formed in late 1997 as a Virginia corporation, principally in response to opportunities resulting from the consolidation of several Virginia-based banks. These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.
We own Cardinal Bank (the "Bank"), a Virginia state-chartered community bank with 29 banking offices located in Northern Virginia, Maryland and the greater Washington, D.C. metropolitan area. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.
Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC ("George Mason") and retail securities brokerage through Cardinal Wealth Services, Inc. ("CWS"). We had a second mortgage subsidiary, Cardinal First Mortgage, LLC ("Cardinal First") that was merged into George Mason as of June 30, 2013. In addition, we reorganized our wealth management business segment and as a result the operations of the Bank's trust division, Cardinal Trust and Investment Services, merged into CWS and Wilson/Bennett Capital Management, Inc., formerly our second nonbank subsidiary, merged into CWS, all as of June 30, 2013.
On January 16, 2014, we announced the completion of our acquisition of United Financial Banking Companies, Inc. ("UFBC"), the holding company of The Business Bank ("TBB"), pursuant to a previously announced definitive merger agreement. The merger of UFBC into Cardinal was effective January 16, 2014. Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of our common stock in exchange for each share of UFBC common stock they owned immediately prior to the merger. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014 adding eight (8) banking locations in northern Virginia, one of the Company's target markets.
George Mason engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis through 20 offices located throughout the metropolitan Washington, D.C. region. George Mason is one of the largest residential mortgage originators in the greater Washington metropolitan area, generating originations of approximately $5.8 billion in 2013 and $6.6 billion in 2012, excluding advances on construction loans and including loans purchased from other mortgage banking companies owned by local home builders but managed by George Mason. George Mason sells its mortgage loans to third party investors servicing released. The profitability of George Mason is cyclical as loan production levels are sensitive to changes in the level of interest rates and changes in local home buying activity, which may be seasonal or may be caused by tightening credit conditions or a deteriorating local economy.
George Mason offers a construction-to-permanent loan program. This program provides variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market. These construction-to-permanent loans generate fee income as well as net interest income for George Mason and are classified as loans held for sale.
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CWS provides brokerage and investment services through a contract with Raymond James Financial Services, Inc. Under this contract, financial advisors can offer our customers an extensive range of financial products and services, including estate planning, qualified retirement plans, mutual funds, annuities, life insurance, fixed income and equity securities and equity research and recommendations. CWS's principal source of revenue is the net commissions it earns on the purchases and sales of investment products to its customers.
Growth Strategy
We believe that the strong demographic characteristics of our market and the relative strength of the metropolitan Washington, D.C. area, particularly Northern Virginia, provide a significant opportunity to continue building a successful community-focused banking franchise. We intend to continue to expand our business through internal growth, as well as selective geographic expansion through de novo banking offices and/or acquisition, while maintaining strong asset quality and achieving increasing profitability. The strategy for achieving these objectives includes the following:
Capitalize on the current market conditions. As the banking industry continues to restrict lending based on industry-wide asset quality limitations and capital constraints, we believe we are well positioned to take advantage of this void based on our strong balance sheet. We continue to see increased opportunities to grow our loan portfolio and benefit from demand by high quality borrowers, particularly well established business owners, including multi-generational businesses, seeking the safe and consistent reliable delivery of service that we are able to provide.
Penetrate our existing markets and further improve our branch positioning. We intend to continue to penetrate our existing markets with increased business development efforts by adding experienced bankers in communities that present attractive growth opportunities within Northern Virginia and other markets in the greater Washington, D.C. metropolitan area. We expect to continue to have opportunities to acquire or lease former branch sites from other financial institutions. As we have done in the past, we may acquire additional sites prior to planned branch openings when we believe the sites are attractive and are available on favorable terms. Because the opening of each new branch increases our operating expenses, we intend to stage future branch openings in an effort to minimize the impact of these expenses on our results of operations. We also leverage the office expansion of George Mason through entering new markets such as the Richmond and Virginia Beach areas of the Commonwealth of Virginia.
Capitalize on the continued bank consolidation in our market. We anticipate that bank mergers will result in further consolidation in our target market and we intend to capitalize on the dislocation of customers resulting from this consolidation. We believe this consolidation creates opportunities for expanding our branch network, as discussed above, as well as to increase our market share of bank deposits within our target market. We focus on building long term relationships with our clients and communities by providing personalized service from local management teams. We also will continue to explore the possibility of further growth through acquisition in Virginia, the metropolitan Washington, D.C. market, or other areas if we believe that such expansion will strengthen the Company by diversifying our customer base and sources of revenue and be accretive to earnings within a reasonable time frame.
Expand our lending activities. As of December 31, 2013, we have increased our legal lending limit to over $51.5 million as a result of retained earnings and our successful capital raise efforts during 2009. The increase in our legal lending limit allows us to further expand our commercial and real estate lending activities. It also improves our ability to seek business from larger government contractors, businesses who we believe are conservatively operated and well capitalized residential homebuilders. According to George Mason University's Center for Regional Analysis ("GMU-CRA"), federal procurement outlays in the greater Washington region declined 8.4% from 2010 to 2012. Federal
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procurement decreased from $80 billion in 2011 to $75.6 billion for 2012. Prospectively, procurement funds are expected to fall by about 2.3% to 17.4% in the greater Washington region's economy by 2015. During 2013, sequestration was not a significant event within our local economy as had been expected. In addition, the federal spending cuts that occurred during 2013 were less than those that occurred during 2012. However, further scheduled federal budget cuts could significantly impact the economy in Greater Washington Metropolitan region. Economic impact could be in the form of a possible increase in unemployment in our region and restricted business development growth as companies adjust to the decreased levels of federal spending, all of which could decrease the growth in certain segments of our loan portfolio. It may also be credit quality of a portion of our loan portfolio that is dependent upon revenues from the federal government as a source of repayment. Our goal is to aggressively grow our loan portfolio while maintaining superior asset quality through conservative underwriting practices as we operate in this challenging economic environment.
Continue to recruit experienced bankers. Historically, we have been successful in recruiting senior bankers with experience in, and knowledge of, our market. We believe current market conditions and consolidation will allow us to continue to find bankers who have been displaced or have grown dissatisfied as a result of consolidation. We intend to continue our efforts to recruit seasoned bankers, particularly experienced lenders, who we expect can immediately generate additional loan volume through their existing credit relationships.
Business Segment Operations
We operate in three business segments, commercial banking, mortgage banking and wealth management services. The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products, including demand deposit accounts, savings accounts and certificates of deposit. The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis. The wealth management services segment provides investment and financial advisory services to businesses and individuals, including financial planning, retirement/estate planning, and investment management.
For financial information about the reportable segments, see "Business Segment Operations" in Item 7 below and Note 21 of the notes to the consolidated financial statements in Item 8 below.
Market Area
We consider our primary target market to include the Virginia counties of Arlington, Fairfax, Loudoun, Prince William, and Stafford and the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park; Washington, D.C. and Montgomery County in Maryland. In addition to our primary market, we consider the Virginia counties of Spotsylvania, Culpeper and Fauquier and the Maryland county of Prince George's as secondary markets and the remaining Greater Washington Metropolitan area as a tertiary market. In addition, the metropolitan statistical areas of Richmond, Charlottesville, and Virginia Beach as well as Rappahannock, Madison, and Orange counties in Virginia plus the metropolitan statistical areas of Baltimore-Towson and California-Lexington Park in Maryland are also considered tertiary markets. We will, however, consider expansion into other areas if we believe such expansion will strengthen the Company by diversifying our customer base and sources of revenue and be accretive to earnings within a reasonable time frame.
Based on 2012 estimates released by the U.S. Census Bureau, the population of the greater Washington metropolitan area was approximately 5.86 million people, the seventh largest statistical area in the country. The median annual household income for this area in 2013 was approximately $105,900, which makes it one of the wealthiest regions in the country. For 2013, based on estimates released by
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the Bureau of Labor Statistics of the U.S. Department of Labor, the unemployment rate for the greater Washington metropolitan area was approximately 5.1%, compared to a national unemployment rate of 6.7%. As of June 30, 2013, total deposits in this area were approximately $188 billion as reported by the Federal Deposit Insurance Corporation ("FDIC").
Our headquarters are located in the center of the business district of Fairfax County, Virginia. Fairfax County, with over one million people, is the most populous county in Virginia and the most populous jurisdiction in the Washington, D.C. area. According to the latest U.S. Census Bureau estimates, Fairfax County also has the second highest median household income of any county in the United States of $109,000, surpassed only by its neighbor, Loudoun County with $116,000.
We believe the diversity of our economy, including the stability provided by businesses serving the U.S. Government, provides us with the opportunities necessary to prudently grow our business.
Competition
The greater Washington region is dominated by branches of large regional or national banks headquartered outside of the region. Our market area is a highly competitive, highly branched, banking market. We compete as a financial intermediary with other commercial banks, savings and loan associations, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, mutual fund groups and other types of financial institutions. George Mason faces significant competition from both traditional financial institutions and other national and local mortgage banking operations.
The competition to acquire deposits and to generate loans, including mortgage loans, is intense, and pricing is important. Many of our competitors are larger and have substantially greater resources and lending limits than we do. In addition, many competitors offer more extensive branch and ATM networks than we currently have. Larger institutions operating in the greater Washington market have access to funding sources at lower costs than are available to us since they have larger and more diverse fund generating capabilities. However, we believe that we have and will continue to be successful in competing in this environment due to an emphasis on a high level of personalized customer service, localized and more responsive decision making, and community involvement.
Of the $188 billion in bank deposits in the greater Washington region at June 30, 2013, approximately 84% were held by banks that are either based outside of the greater Washington region or are operating wholesale banks that generate deposits nationally. Excluding institutions based outside our region, we have grown to the fifth largest financial institution headquartered in the greater Washington region as measured by total deposits. By providing competitive products and more personalized service and being actively involved in our local communities, we believe we can continue to increase our share of this deposit market.
Customers
We believe that the recent and ongoing bank consolidation within Northern Virginia and the greater Washington, D.C. region provides a significant opportunity to build a successful, locally-oriented banking franchise. We also believe that many of the larger financial institutions in our area do not emphasize the high level of personalized service to small and medium-sized commercial businesses, professionals or individual retail customers that we emphasize.
We expect to continue serving these business and professional markets with experienced commercial relationship managers, and we have increased our retail marketing efforts through the expansion of our branch network and development of additional retail products and services. We expanded our deposit market share through aggressive marketing of our First Choice Checking,
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President's Club, Chairman's Club, Simply Savings and Monster Money Market relationship products and our Simply Checking product.
Banking Products and Services
Our principal business is to accept deposits from the public and to make loans and other investments. The principal sources of funds for the Bank's loans and investments are demand, time, savings and other deposits, repayments of existing loans, and borrowings. Our principal source of income is interest collected on loans, investment securities and other investments. Non-interest income, which includes among other things deposit and loan fees and service charges, realized and unrealized gains on mortgage banking activities, investment fee income, and management fee income, is the next largest component of our revenues. Our principal expenses are interest expense on deposits and borrowings, employee compensation and benefits, occupancy-related expenses, and other overhead expenses.
The principal business of George Mason, is to originate residential loans for sale into the secondary market on a best efforts basis. These loans are closed and serviced by George Mason on an interim basis pending their ultimate sale to a permanent investor. The mortgage subsidiary funds these loans through a line of credit from Cardinal Bank and cash available through its own operations. George Mason's income on these loans is generated from the fees it charges its customers, the gains it recognizes upon the sales of loans and the interest income it earns prior to the delivery of the loan to the investor. Costs associated with these loans are primarily comprised of salaries and commissions paid to loan originators and support personnel, interest expense incurred on funds borrowed to hold the loans pending sale and other expenses associated with the origination of the loans. In addition, George Mason generates management fee income by providing specific services to other mortgage banking companies owned by local home builders.
George Mason also offers a construction-to-permanent loan program. This program provides variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market. These construction-to-permanent loans generate fee income as well as net interest income and are classified as loans held for sale.
The mortgage banking segment's business is both cyclical and seasonal. The cyclical nature of its business is influenced by, among other things, the levels of and trends in mortgage interest rates, national and local economic conditions and consumer confidence in the economy. Historically, the mortgage banking segment has its lowest levels of quarterly loan closings during the first quarter of the year. However, due to a significant increase in interest rates during the third quarter of 2013 and subsequent increase in competition with other mortgage banking entities for loan originations, we saw a decrease in mortgage loan originations during the third and fourth quarter of 2013 as compared to prior quarters and prior years. In addition, the increase in mortgage interest rates decreased refinancing activity for George Mason as it did for other mortgage banking entities, and contributed to our decreased loan origination activity for the full 2013 year as compared to 2012.
Both Cardinal Bank and George Mason are committed to providing high quality products and services to their customers, and have made a significant investment in their core information technology systems. These systems provide the technology that fully automates the branches, processes bank transactions, mortgage originations, other loans and electronic banking, conducts database and direct response marketing, provides cash management solutions, streamlined reporting and reconciliation support.
With this investment in technology, the Bank offers internet-based delivery of products for both individuals and commercial customers. Customers can open accounts, apply for loans, check balances, check account history, transfer funds, pay bills, download account transactions into Quicken™ and
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Microsoft Money™, and correspond via e-mail with the Bank over the internet. The internet provides an inexpensive way for the Bank to expand its geographic borders and branch activities while providing services offered by larger banks.
We offer a broad array of products and services to our customers. A description of our products and services is set forth below.
Lending
We offer a full range of short to long-term commercial, real estate and consumer lending products and services, which are described in further detail below. We have established target percentage goals for each type of loan to insure adequate diversification of our loan portfolio. These goals, however, may change from time to time as a result of competition, market conditions, employee expertise, and other factors. Commercial and industrial loans, real estate-commercial loans, real estate-construction loans, real estate-residential loans, home equity loans, and consumer loans account for approximately 11%, 51%, 18%, 14%, 5% and 1%, respectively of our loan portfolio at December 31, 2013.
Commercial and Industrial Loans. We make commercial loans to qualified businesses in our market area. Our commercial lending portfolio consists primarily of commercial and industrial loans for the financing of accounts receivable, property, plant and equipment. Our government contract lending group provides secured lending to government contracting firms and businesses based primarily on receivables from the federal government. We also offer Small Business Administration (SBA) guaranteed loans and asset-based lending arrangements to our customers. We are certified as a preferred lender by the SBA, which provides us with much more flexibility in approving loans guaranteed under the SBA's various loan guaranty programs.
Historically, commercial and industrial loans generally have a higher degree of risk than residential mortgage loans. Residential mortgage loans generally are made on the basis of the borrower's ability to repay the loan from his or her salary and other income and are secured by residential real estate, the value of which generally is readily ascertainable. In contrast, commercial loans typically are made on the basis of the borrower's ability to repay the loan from the cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory, the values of which may fluctuate over time and generally cannot be appraised with as much precision as residential real estate. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent upon the commercial success of the business itself.
To manage these risks, our policy is to secure the commercial loans we make with both the assets of the business, which are subject to the risks described above, and other additional collateral and guarantees that may be available. In addition, for larger relationships, we actively monitor certain attributes of the borrower and the credit facility, including advance rate, cash flow, collateral value and other credit factors that we consider appropriate.
Commercial Mortgage Loans. We originate commercial mortgage loans. These loans are primarily secured by various types of commercial real estate, including office, retail, warehouse, industrial and other non-residential types of properties and are made to the owners and/or occupiers of such property. These loans generally have maturities ranging from one to ten years.
Historically, commercial mortgage lending entails additional risk compared with traditional residential mortgage lending. Commercial mortgage loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income-producing properties is typically dependent upon the successful operation of a business or real estate project and thus may be subject, to a greater extent than has historically been the case with residential mortgage loans, to adverse conditions in the commercial real estate market or in the general economy. Our commercial real estate loan underwriting criteria require an examination
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of debt service coverage ratios, the borrower's creditworthiness and prior credit history, and we generally require personal guarantees or endorsements with respect to these loans. In the loan underwriting process, we also carefully consider the location of the property that will be collateral for the loan.
Loan-to-value ratios for commercial mortgage loans generally do not exceed 80%. We permit loan-to-value ratios of up to 80% if the borrower has appropriate liquidity, net worth and cash flow.
Residential Mortgage Loans. Residential mortgage loans are originated by Cardinal Bank and George Mason. Our residential mortgage loans consist of residential first and second mortgage loans, residential construction loans and home equity lines of credit and term loans secured by the residences of borrowers. Second mortgage and home equity lines of credit are used for home improvements, education and other personal expenditures. We make mortgage loans with a variety of terms, including fixed, floating and variable interest rates, with maturities ranging from three months to thirty years.
Residential mortgage loans generally are made on the basis of the borrower's ability to repay the loan from his or her salary and other income and are secured by residential real estate, the value of which is generally readily ascertainable. These loans are made consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and maturities. Residential mortgage loans and home equity lines of credit secured by owner-occupied property generally are made with a loan-to-value ratio of up to 80%. Loan-to-value ratios of up to 90% may be allowed on residential owner-occupied property if the borrower exhibits unusually strong creditworthiness. We generally do not make residential loans which, at the time of inception, have loan-to-value ratios in excess of 90%.
Construction Loans. Our construction loan portfolio consists of single-family residential properties, multi-family properties and commercial projects. Construction lending entails significant additional risks compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks since funds are advanced while the property is under construction, which property has uncertain value prior to the completion of construction. Thus, it is more difficult to accurately evaluate the total loan funds required to complete a project and related loan-to-value ratios. To reduce the risks associated with construction lending, we limit loan-to-value ratios to 80% of when-completed appraised values for owner-occupied residential or commercial properties and for investor-owned residential or commercial properties. We expect that these loan-to-value ratios will provide sufficient protection against fluctuations in the real estate market to limit the risk of loss. Maturities for construction loans generally range from 12 to 24 months for non-complex residential, non-residential and multi-family properties. Construction loan agreements may include provisions which allow for the payment of contractual interest from an interest reserve. Amounts drawn from an interest reserve increase the amount of the outstanding balance of the construction loan. This is an industry standard practice.
Consumer Loans. Our consumer loans consist primarily of installment loans made to individuals for personal, family and household purposes. The specific types of consumer loans we make include home improvement loans, automobile loans, debt consolidation loans and other general consumer lending.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job
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loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. A loan may also give rise to claims and defenses by a consumer loan borrower against an assignee of such loan, such as the bank, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral.
Our policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful credit and financial analysis of the borrower. In evaluating consumer loans, we require our lending officers to review the borrower's level and stability of income, past credit history, amount of debt currently outstanding and the impact of these factors on the ability of the borrower to repay the loan in a timely manner. In addition, we require our banking officers to maintain an appropriate differential between the loan amount and collateral value.
We also issue credit cards to certain of our customers. In determining to whom we will issue credit cards, we evaluate the borrower's level and stability of income, past credit history and other factors.
Finally, we make additional loans that are not classified in one of the above categories. In making such loans, we attempt to ensure that the borrower meets our loan underwriting standards.
Loan Participations
From time to time we purchase and sell commercial loan participations to or from other banks within our market area. All loan participations purchased have been underwritten using the Bank's standard and customary underwriting criteria and are in good standing.
Deposits
We offer a broad range of interest-bearing and non-interest-bearing deposit accounts, including commercial and retail checking accounts, money market accounts, individual retirement accounts, regular interest-bearing savings accounts and certificates of deposit with a range of maturity date options. The primary sources of deposits are small and medium-sized businesses and individuals within our target market. Senior management has the authority to set rates within specified parameters in order to remain competitive with other financial institutions in our market area. All deposits are insured by the FDIC up to the maximum amount permitted by law. We have a service charge fee schedule, which is generally competitive with other financial institutions in our market, covering such matters as maintenance fees and per item processing fees on checking accounts, returned check charges and other similar fees.
Courier Services
We offer courier services to our business customers. Courier services permit us to provide the convenience and personalized service that our customers require by scheduling pick-ups of deposits and other banking transactions.
Deposit on Demand
We provide our commercial banking customers electronic deposit capability through our Deposit on Demand product. Business customers who sign up for this service can scan their deposits and send electronic batches of their deposits to the Bank. This product reduces or eliminates the need for businesses with daily deposits and high check volume to visit the Bank and provides the benefit of viewing images of deposited checks.
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Internet and Mobile Banking
We believe that there is a strong demand within our market for internet banking and to a much lesser extent telephone banking. These services allow both commercial and retail customers to access detailed account information and execute a wide variety of the banking transactions, including balance transfers and bill payment. We believe that these services are particularly attractive to our customers, as it enables them at any time to conduct their banking business and monitor their accounts. Internet banking assists us in attracting and retaining customers and encourages our existing customers to consider Cardinal for all of their banking and financial needs.
We offer Cardinal Mobile Banking to our customers. Customers who sign up for this service can access their accounts from any internet-enabled mobile device. Customers can check their balance, view account activity, make deposits to their account through Mobile Deposit, transfer funds between deposit accounts, and may pay their bill online. Cardinal Mobile Banking is encrypted using the Wireless Transport Layer Security (WTLS) protocol, which provides the highest level of security available today. Additionally, all data that passes between the wireless gateway and Cardinal Bank's web servers is encrypted using Secure Socket Layer (SSL).
Automatic Teller Machines
We have an ATM at each of our branch offices and we make other financial institutions' ATMs available to our customers.
Other Products and Services
We offer other banking-related specialized products and services to our customers, such as travelers' checks, coin counters, wire services, and safe deposit box services. We issue letters of credit for some of our commercial customers, most of which are related to real estate construction loans. We have not engaged in any securitizations of loans.
Credit Policies
Our chief credit officer and senior lending officers are primarily responsible for maintaining both a quality loan portfolio and a strong credit culture throughout the organization. The chief credit officer is responsible for developing and updating our credit policies and procedures, which are approved by the board of directors. The chief credit officer and senior lending officers may make exceptions to these credit policies and procedures as appropriate, but any such exception must be documented and made for sound business reasons.
Credit quality is controlled by the chief credit officer through compliance with our credit policies and procedures. Our risk-decision process is actively managed in a disciplined fashion to maintain an acceptable risk profile characterized by soundness, diversity, quality, prudence, balance and accountability. Our credit approval process consists of specific authorities granted to the lending officers and combinations of lending officers. Loans exceeding a particular lending officer's level of authority, or the combined limit of several officers, are reviewed and considered for approval by an officers' loan committee and, when above a specified amount, by a committee of the Bank's board of directors. Generally, loans of $1,500,000 or more require committee approval. Our policy allows exceptions for very specific conditions, such as loans secured by deposits at our Bank. The chief credit officer works closely with each lending officer at the Bank level to ensure that the business being solicited is of the quality and structure that fits our desired risk profile.
Under our credit policies, we monitor our concentration of credit risk. We have established credit concentration guideline limits for commercial and industrial loans, real estate-commercial loans, real estate-residential loans and consumer purpose loans, which include home equity loans. Furthermore, the Bank has established limits on the total amount of the Bank's outstanding loans to one borrower, all of which are set below legal lending limits.
Loans closed by George Mason are underwritten in accordance with guidelines established by the various secondary market investors to which George Mason sells its loans.
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Brokerage and Asset Management Services
CWS provides brokerage and investment services through an arrangement with Raymond James Financial Services, Inc. Under this arrangement, financial advisors can offer our customers an extensive range of investment products and services, including estate planning, qualified retirement plans, mutual funds, annuities, life insurance, fixed income and equity securities and equity research and recommendations.
Employees
At December 31, 2013, we had 809 full-time equivalent employees. None of our employees are represented by any collective bargaining unit. We believe our relations with our employees are good.
Government Supervision and Regulation
General
As a financial holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, and the examination and reporting requirements of the Board of Governors of the Federal Reserve System. Other federal and state laws govern the activities of our bank subsidiary, including the activities in which it may engage, the investments that it makes, the aggregate amount of loans that it may grant to one borrower, and the dividends it may declare and pay to us. Our bank subsidiary is also subject to various consumer and compliance laws. As a state-chartered bank, the Bank is primarily subject to regulation, supervision and examination by the Bureau of Financial Institutions of the Virginia State Corporation Commission. The Bank and its' subsidiary, George Mason, are also subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation.
The following description summarizes the more significant federal and state laws applicable to us. To the extent that statutory or regulatory provisions are described, the description is qualified in its entirety by reference to that particular statutory or regulatory provision.
The Bank Holding Company Act
Under the Bank Holding Company Act, we are subject to periodic examination by the Federal Reserve and required to file periodic reports regarding our operations and any additional information that the Federal Reserve may require. Our activities at the bank holding company level are limited to:
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- banking, managing or controlling banks;
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- furnishing services to or performing services for our subsidiaries; and
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- engaging in other activities that the Federal Reserve has determined by regulation or order to be so closely related to banking as to be a proper incident to these activities.
Some of the activities that the Federal Reserve Board has determined by regulation to be closely related to the business of a bank holding company include making or servicing loans and specific types of leases, performing specific data processing services and acting in some circumstances as a fiduciary or investment or financial adviser.
With some limited exceptions, the Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before:
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- acquiring substantially all the assets of any bank; and
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- acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it
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already owns or controls the majority of such shares), or merging or consolidating with another bank holding company.
In addition, and subject to some exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with their regulations, require Federal Reserve approval prior to any person or company acquiring 25% or more of any class of voting securities of the bank holding company. Prior notice to the Federal Reserve is required before a person acquires 10% or more, but less than 25%, of any class of voting securities and if the institution has registered securities under Section 12 of the Securities Exchange Act of 1934 or no other person owns a greater percentage of that class of voting securities immediately after the transaction.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act ("GLBA"), which made substantial revisions to the statutory restrictions separating banking activities from other financial activities. Under the GLBA, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become "financial holding companies." As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities, such as insurance underwriting and securities underwriting and distribution. In addition, financial holding companies may also acquire or engage in certain activities in which bank holding companies are not permitted to engage in, such as travel agency activities, insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary to these activities. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLBA applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. We became a financial holding company in 2004.
Payment of Dividends
Regulators have indicated that financial holding companies should generally pay dividends only if the organization's net income available to common shareholders is sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition.
We are a legal entity separate and distinct from Cardinal Bank, CWS, and Cardinal Statutory Trust I. Virtually all of our cash revenues will result from dividends paid to us by our bank subsidiary and interest earned on short term investments. Our bank subsidiary is subject to laws and regulations that limit the amount of dividends that it can pay. Under Virginia law, a bank may not declare a dividend in excess of its accumulated retained earnings. Additionally, our bank subsidiary may declare a dividend out of undivided earnings, but not if the total amount of all dividends, including the proposed dividend, declared by the bank in any calendar year exceeds the total of the bank's retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the FDIC. Our bank subsidiary may not declare or pay any dividend if, after making the dividend, the bank would be "undercapitalized," as defined in the banking regulations.
The FDIC and the state have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state and the FDIC have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsound and unsafe banking practice.
In addition, we are subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Our regulators also may restrict our ability to repurchase securities.
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Insurance of Accounts, Assessments and Regulation by the FDIC
The deposits of our bank subsidiary are insured by the FDIC up to the limits set forth under applicable law. The deposits of our bank subsidiary are subject to the deposit insurance assessments of the Deposit Insurance Fund, or "DIF", of the FDIC.
The FDIC has implemented a risk-based deposit insurance assessment system under which the assessment rate for an insured institution may vary according to regulatory capital levels of the institution and other factors, including supervisory evaluations. In addition to being influenced by the risk profile of the particular depository institution, FDIC premiums are also influenced by the size of the FDIC insurance fund in relation to total deposits in FDIC insured banks. The FDIC has authority to impose special assessments.
The FDIC is required to maintain a designated minimum ratio of the DIF to insured deposits in the United States. In July 2010, the Dodd Frank Wall Street Reform and Consumer Protection Act (the "Financial Reform Act") was signed into law. The Financial Reform Act requires the FDIC to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. The FDIC has also adopted new regulations that establish a long-term target DIF ratio of greater than two percent. As a result of the ongoing instability in the economy and the failure of other U.S. depository institutions, the DIF ratio is currently below the required targets and the FDIC has adopted a restoration plan that will result in substantially higher deposit insurance assessments primarily for depository institutions with more than $10 billion in assets over the coming years. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole.
Pursuant to the Financial Reform Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer.
The Financial Reform Act also changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. The new regulation implementing revisions to the assessment system mandated by the Financial Reform Act was effective April 1, 2011 and was reflected in the June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, our annual deposit insurance assessments are higher than before the financial crisis. While the burden on replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.
The FDIC is authorized to prohibit any insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the DIF. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution's primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. We are unaware of any existing circumstances that could result in termination of any of our bank subsidiary's deposit insurance.
Consumer Financial Protection Bureau. The Financial Reform Act created a new, independent federal agency, the Consumer Financial Protection Bureau ("CFPB") having broad rulemaking,
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supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions, including the Bank, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Financial Reform Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
In 2013, the CFPB adopted a rule, effective in January 2014, to implement certain sections of the Dodd-Frank Act requiring creditors to make a reasonable, good faith determination of a consumer's ability to repay any closed-end consumer credit transaction secured by a 1-4 family dwelling. The rule also establishes certain protections from liability under this requirement to ensure a borrower's ability to repay for loans that meet the definition of "qualified mortgage." Loans that satisfy this "qualified mortgage" safe harbor will be presumed to have complied with the new ability-to-repay standard.
Capital Requirements
Each of the FDIC and the Federal Reserve Board has issued risk-based and leverage capital guidelines applicable to banking organizations that it supervises. Under the risk-based capital requirements, we and our bank subsidiary are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must be composed of "Tier 1 Capital," which is defined as common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles. The remainder may consist of "Tier 2 Capital", which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance and pretax net unrealized holding gains on certain equity securities. In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization's overall safety and soundness. In summary, the capital measures used by the federal banking regulators are:
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- Total Risk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital (which includes common
shareholders' equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments) and Tier 2 Capital (which includes preferred stock not
qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25 percent of
risk-weighted assets and other adjustments) as a percentage of total risk-weighted assets
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- Tier 1 Risk-Based Capital ratio (Tier 1 capital divided by total risk-weighted assets), and
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- the Leverage ratio (Tier 1 capital divided by adjusted average total assets).
Under these regulations, a bank will be:
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- "well capitalized" if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier 1 Risk-Based Capital ratio of 6% or greater, a Leverage ratio of 5% or greater, and is not subject
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- •
- "adequately capitalized" if it has a Total Risk-Based Capital ratio of 8% or greater, a Tier 1 Risk-Based Capital
ratio of 4% or greater, and a Leverage ratio of 4% or greater (or 3% in certain circumstances) and is not well capitalized
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- "undercapitalized" if it has a Total Risk-Based Capital ratio of less than 8%, a Tier 1 Risk-Based Capital ratio of
less than 4% (or 3% in certain circumstances), or a Leverage ratio of less than 4% (or 3% in certain circumstances)
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- "significantly undercapitalized" if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1 Risk-Based
Capital ratio of less than 3%, or a Leverage ratio of less than 3%, or
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- "critically undercapitalized" if its tangible equity is equal to or less than 2% of tangible assets.
to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure
The risk-based capital standards of each of the FDIC and the Federal Reserve Board explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution's ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution's overall capital adequacy. The capital guidelines also provide that an institution's exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization's capital adequacy.
The FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan acceptable to the FDIC. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any financial holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers. We are considered "well-capitalized" at December 31, 2013 and, in addition, our bank subsidiary maintained sufficient capital to remain in compliance with capital requirements and is considered "well-capitalized" at December 31, 2013.
The Financial Reform Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements. Under the Collins Amendment to the Financial Reform Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, bank holding companies on a consolidated basis. These minimum requirements cannot be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions. The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets. Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013. Accordingly, our trust preferred securities will continue to qualify as Tier 1 capital.
In 2013, the Federal Reserve, the FDIC and the OCC approved a new rule that will substantially amend the regulatory risk-based capital rules applicable to us. The final rule implements the "Basel III" regulatory capital reforms and changes required by the Financial Reform Act. The final rule includes new minimum risk-based capital and leverage ratios which will be effective for us on
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January 1, 2015, and refines the definition of what constitutes "capital" for purposes of calculating these ratios. The new minimum capital requirements will be: (i) a new common equity Tier 1 ("CET1") capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%, which is increased from 4%; (iii) a total capital ratio of 8%, which is unchanged from the current rules; and (iv) a Tier 1 leverage ratio of 4%.
The final rule also establishes a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios, and when fully effective in 2019, will result in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities.
The final rule also provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing assets, deferred tax assets related to temporary differences that could not be realized through net operating loss carrybacks, and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
The final rule prescribes a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.
Other Safety and Soundness Regulations
There are significant obligations and restrictions imposed on financial holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event that the depository institution is insolvent or is in danger of becoming insolvent. These obligations and restrictions are not for the benefit of investors. Regulators may pursue an administrative action against any financial holding company or bank which violates the law, engages in an unsafe or unsound banking practice, or which is about to engage in an unsafe or unsound banking practice. The administrative action could take the form of a cease and desist proceeding, a removal action against the responsible individuals or, in the case of a violation of law or unsafe and unsound banking practice, a civil monetary penalty action. A cease and desist order, in addition to prohibiting certain action, could also require that certain actions be undertaken. Under the Financial Reform Act and longstanding policies of the Federal Reserve Board, we are required to serve as a source of financial strength to our subsidiary depository institution and to commit resources to support the Bank in circumstances where we might not do so otherwise.
The Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the United States Treasury. In addition, financial institutions are required to file Suspicious Activity Reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has
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reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The USA PATRIOT Act of 2001, enacted in response to the September 11, 2001 terrorist attacks, requires bank regulators to consider a financial institution's compliance with the BSA when reviewing applications from a financial institution. As part of its BSA program, the USA PATRIOT Act of 2001 also requires a financial institution to follow customer identification procedures when opening accounts for new customers and to review U.S. government-maintained lists of individuals and entities that are prohibited from opening accounts at financial institutions.
Monetary Policy
The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve Board. The instruments of monetary policy employed by the Federal Reserve Board include open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against deposits held by federally insured banks. The Federal Reserve Board's monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national and international economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of our bank subsidiary, its subsidiary, or any of our other subsidiaries.
Federal Reserve System
In 1980, Congress enacted legislation that imposed reserve requirements on all depository institutions that maintain transaction accounts or non-personal time deposits. NOW accounts and demand deposit accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to these reserve requirements. Effective January 1, 2014, the first $13.3 million of balances will be exempt from reserve requirements. A 3% reserve ratio will be assessed on net transaction account balances over $13.3 million to and including $89.0 million. A 10% reserve ratio will be applied to amounts in net transaction account balances in excess of $89.0 million. These percentages are subject to adjustment by the Federal Reserve Board. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at, or on behalf of, a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of our interest-earning assets. Beginning October 2008, the Federal Reserve Banks pay financial institutions interest on their required reserve balances and excess funds deposited with the Federal Reserve. The interest rate paid is the targeted federal funds rate.
Transactions with Affiliates
Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any bank or entity that controls, is controlled by or is under common control with such bank. Generally, Sections 23A and 23B (i) limit the extent to which the bank or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and maintain an aggregate limit on all such transactions with affiliates to an amount equal to 20% of such capital stock and surplus, and (ii) require that all such transactions be on terms substantially the same as, or at least as favorable to those that, the bank has provided to a non-affiliate. Certain covered transactions also must be adequately secured by eligible collateral. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. Section 23B applies to "covered transactions" as well as sales of assets and payments of money to an affiliate. These
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transactions must also be conducted on terms substantially the same as, or at least favorable to those that, the bank has provided to non-affiliates.
The Financial Reform Act also provides that banks may not "purchase an asset from, or sell an asset to" a bank insider (or their related interests) unless (i) the transaction is conducted on market terms between the parties, and (ii) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the bank, it has been approved in advance by a majority of the bank's non-interested directors.
Loans to Insiders
The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act, loans to a director, an executive officer and to a principal shareholder of a bank, and to entities controlled by any of the foregoing, may not exceed, together with all other outstanding loans to such person and entities controlled by such person, the bank's loan-to-one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed two times the bank's unimpaired capital and unimpaired surplus until the bank's total assets equal or exceed $100,000,000, at which time the aggregate is limited to the bank's unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and principal shareholders of a bank or bank holding company, and to entities controlled by such persons, unless such loan is approved in advance by a majority of the board of directors of the bank with any "interested" director not participating in the voting. The FDIC has prescribed the aggregate loan amount to such person for which prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Section 22(h) requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.
Community Reinvestment Act
Under the Community Reinvestment Act and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. The Community Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act statement for each of its market areas describing the depository institution's efforts to assist in its community's credit needs. Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are periodically assigned ratings in this regard. Banking regulators consider a depository institution's Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a financial holding company or its depository institution subsidiaries.
GLBA and federal bank regulators have made various changes to the Community Reinvestment Act. Among other changes, Community Reinvestment Act agreements with private parties must be disclosed and annual reports must be made to a bank's primary federal regulator. A financial holding company or any of its subsidiaries will not be permitted to engage in new activities authorized under the GLBA if any bank subsidiary received less than a "satisfactory" rating in its latest Community Reinvestment Act examination.
Consumer Laws Regarding Fair Lending
In addition to the Community Reinvestment Act described above, other federal and state laws regulate various lending and consumer aspects of our business. Governmental agencies, including the
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Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers may experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums of money, short of a full trial.
These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, and the Fair Housing Act, require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.
Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The following description summarizes some of its significant provisions.
The GLBA repealed sections 20 and 32 of the Glass-Steagall Act, thus permitting unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, investment, merchant banking, insurance underwriting, sales and brokerage activities. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating. We became a financial holding company in 2004.
The GLBA provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in areas identified under the law. Under the law, the federal bank regulatory agencies adopted insurance consumer protection regulations that apply to sales practices, solicitations, advertising and disclosures.
The GLBA adopts a system of functional regulation under which the Federal Reserve Board is designated as the umbrella regulator for financial holding companies, but financial holding company affiliates are principally regulated by functional regulators such as the FDIC for bank affiliates, the Securities and Exchange Commission for securities affiliates, and state insurance regulators for insurance affiliates. It repeals the broad exemption of banks from the definitions of "broker" and "dealer" for purposes of the Securities Exchange Act of 1934, as amended. It also identifies a set of specific activities, including traditional bank trust and fiduciary activities, in which a bank may engage without being deemed a "broker," and a set of activities in which a bank may engage without being
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deemed a "dealer." Additionally, GLBA makes conforming changes in the definitions of "broker" and "dealer" for purposes of the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940, as amended.
The GLBA contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution's policies and procedures regarding the handling of customers' nonpublic personal financial information. The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer credit reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLBA also provides that the states may adopt customer privacy protections that are stricter than those contained in the act.
The Financial Reform Act
On July 21, 2010, the Financial Reform Act was signed into law. The Financial Reform Act provides for sweeping financial regulatory reform and will alter the way in which we conduct certain businesses.
The Financial Reform Act contains a broad range of significant provisions that could affect our businesses, including, without limitation, the following:
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- Mandating that the Federal Reserve limit debit card interchange fees;
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- Changing the assessment base used in calculating FDIC deposit insurance fees from assessable deposits to total assets less
tangible capital;
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- Creating a new regulatory body to set requirements around the terms and conditions of consumer financial products and
expanding the role of state regulators in enforcing consumer protection requirements over banks;
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- Increasing the minimum reserve ratio of the DIF to 1.35 percent and eliminating the maximum reserve ratio;
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- Making permanent the $250,000 limit for federal deposit insurance;
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- Allowing depository institutions to pay interest on business demand deposits effective July 21, 2011;
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- Imposing new requirements on mortgage lending, including new minimum underwriting standards, prohibitions on certain
yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage
terms and various new mandated disclosures to mortgage borrowers;
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- Establishing minimum capital levels for holding companies that are at least as stringent as those currently applicable to
banks;
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- Allowing national and state banks to establish de novo interstate branches outside of their home state, and mandating that
bank holding companies and banks be well-capitalized and well managed in order to acquire banks located outside their home state;
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- Enhancing the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of "covered transactions"
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- •
- Placing restrictions on certain asset sales to and from an insider to an institution, including requirements that such
sales be on market terms and, in certain circumstances, approved by the institution's board of directors;
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- Including a variety of corporate governance and executive compensation provisions and requirements.
and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained;
The Financial Reform Act is expected to have a negative impact on our earnings through fee reductions, higher costs and new restrictions. The Financial Reform Act may have a material adverse impact on the value of certain assets and liabilities on our balance sheet.
On December 10, 2013, the Office of the Comptroller of the Currency, the FDIC, the Board of Governors of the Federal Reserve System, the SEC, and the Commodity Futures Trading Commission (collectively, "the Agencies"), released final rules (the "Final Rules") to implement Section 619 of the Financial Reform Act, commonly known as the "Volcker Rule". The Volcker Rule, among other things, prohibits banking entities from engaging in proprietary trading and from sponsoring, having an ownership interest in or having certain relationships with hedge funds or private equity funds (referred to in the Final Rules as a covered fund), subject to certain exemptions. The Final Rules impact certain investments held by banks in collateralized debt obligations backed by trust preferred securities, which may constitute ownership interests in covered funds as those terms are defined in the Final Rules. On January 14, 2014, an interim rule was issued by the federal banking regulators to exempt certain of these trust preferred securities from the covered fund definition as issued in the Final Rules.
We own four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio. Based on the interim rule, only two of the four investments were exempt from the covered fund definition. For the two investments that were not exempt as a result of the interim rule, we will be required to divest our investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015. As a result of this new regulation, these two investments which have a par value of $3.1 million at December 31, 2013, were reclassified to the available-for-sale investment securities portfolio and an other-than-temporary impairment of $300,000 was recognized as of December 31, 2013 as we no longer have the ability to hold until recovery.
Most provisions of the Financial Reform Act require various federal banking and securities regulators to issue regulations to clarify and implement its provisions or to conduct studies on significant issues. These proposed regulations and studies are generally subject to a public notice and comment period. The timing of issuance of final regulations, their effective dates and their potential impacts to our businesses will be determined over the coming months and years. As a result, the ultimate impact of the Financial Reform Act's final rules on our businesses and results of operations will depend on regulatory interpretation and rulemaking, as well as the success of any of our actions to mitigate the negative earnings impact of certain provisions.
Future Regulatory Uncertainty
Because federal and state regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal and state regulation of financial institutions may change in the future and, as a result, impact our operations. We fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices. Congress and the federal government have continued to evaluate and develop legislation, programs, and initiatives designed to, among other things, stabilize the financial and housing markets, stimulate the economy, including the
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federal government's foreclosure prevention program, and prevent future financial crises by further regulating the financial services industry. As a result of the recent financial crisis and the ongoing challenging economic environment, we anticipate additional legislative and regulatory proposals and initiatives as well as continued legislative and regulatory scrutiny of the financial services industry. At this time, we cannot determine the final form of any proposed programs or initiatives or related legislation, the likelihood and timing of any other future proposals or legislation, and the impact they might have on us.
Additional Information
We file with or furnish to the Securities and Exchange Commission ("SEC") annual, quarterly and current reports, proxy statements, and various other documents under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The public may read and copy any materials that we file with or furnish to the SEC at the SEC's Public Reference Room, which is located at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an internet website at www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, including us, that file or furnish documents electronically with the SEC.
We also make available free of charge on or through our internet website (www.cardinalbank.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and, if applicable, amendments to those reports as filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC.
We are subject to various risks, including the risks described below. Our operations, financial condition and performance and, therefore, the market value of our Common Stock could be adversely affected by any of these risks or additional risks not presently known or that we currently deem immaterial.
Difficult conditions in the economy and the capital markets continue to adversely affect our industry.
In recent years during the financial crisis, dramatic declines in the housing market, with falling home prices and increases foreclosure rates, followed by unemployment and under-employment, negatively impacted the credit performance of real estate related loans and consumer loans and resulted in significant write-downs of asset values by financial institutions. These write-downs spread to other securities and loans and have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and reduction of business activity generally. While we have seen an improvement in economic trends, future economic pressure on consumers may adversely affect our business and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for loan losses. A worsening of these conditions would likely exacerbate the adverse effects of these current market conditions on us and others in the financial institutions industry.
The capital and credit markets have experienced volatility and disruption in recent years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers' underlying financial strength. If these levels of market disruption and volatility recur, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
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Our mortgage banking revenue is cyclical and is sensitive to the level of interest rates, changes in economic conditions, decreased economic activity, a slowdown in the housing market, any of which could adversely impact our profits.
Recently, we have significantly expanded our mortgage banking operations by adding mortgage loan officers and support staff, and this segment has become a larger portion of our consolidated business. Maintaining our revenue stream in this segment is dependent upon our ability to originate loans and sell them to investors at or near current volumes. Loan production levels are sensitive to changes in the level of interest rates and changes in economic conditions. Loan production levels may also suffer if we experience a slowdown in the local housing market or tightening credit conditions. Any sustained period of decreased activity caused by less refinancing transactions, higher interest rates, housing price pressure or loan underwriting restrictions would adversely affect our mortgage originations and, consequently, could significantly reduce our income from mortgage banking activities. As a result, these conditions would also adversely affect our net income. In addition, the effect of any such slowdown in volume on our net income could be exacerbated by accounting rules which require mortgage revenues to be realized prior to certain associated expenses. See Note 2(p) to our consolidated financial statements for a summary of this accounting policy.
Deteriorating economic conditions may also cause home buyers to default on their mortgages. In certain cases where we have originated loans and sold them to investors, we may be required to repurchase loans or provide a financial settlement to investors if it is proven that the borrower failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor. Such repurchases or settlements would also adversely affect our net income.
George Mason, as part of the service it provides to its managed companies, purchases the loans managed companies originate at the time of origination. These loans are then sold by George Mason to investors. George Mason has agreements with its managed companies requiring that, for any loans that were originated by a managed company and for which investors have requested George Mason to repurchase due to the borrowers failure to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor, the managed company be responsible for buying back the loan. In the event that the managed company's financial condition deteriorates and it is unable to fund the repurchase of such loans, George Mason may have to provide the funds to repurchase these loans from investors.
We may be adversely affected by economic conditions in our market area.
We are headquartered in Northern Virginia, and our market is the greater Washington, D.C. metropolitan area. Because our lending and deposit-gathering activities are concentrated in this market, we will be affected by the general economic conditions in the greater Washington area, which may, among other factors, be impacted by the level of federal government spending. Expected federal government cuts as a result of sequestration could severely impact negatively the unemployment rate in our region and business development activity. Changes in the economy, and government spending in particular, may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors, would impact these local economic conditions and the demand for banking products and services generally, and could negatively affect our financial condition and performance.
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Government measures to regulate the financial industry, including the Financial Reform Act, could require us to change certain of our business practices, impose significant additional costs on us, limit the products that we offer, limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the value of the assets we hold, significantly reduce our revenues or otherwise materially affect our businesses, financial condition or results of operations.
As a financial institution, we are heavily regulated at the state and federal levels. As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Financial Reform Act was signed into law. Many of the provisions of the Financial Reform Act have begun to be or will be phased in over the next several months or years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies. Although we cannot predict the full effect of the Financial Reform Act on our operations, it could, as well as the future rules implementing its reforms, impose significant additional costs on us, limit the products we offer, could limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the values of assets that we hold, significantly reduce our revenues or otherwise materially and adversely affect our businesses, financial condition, or results of operations.
The ultimate impact of the final rules on our businesses and results of operations, however, will depend on regulatory interpretation and rulemaking, as well as the success of any of our actions to mitigate the negative earnings impact of certain provisions.
We may be subject to more stringent capital requirements, which could adversely affect our results of operations and future growth.
In 2013, the Federal Reserve, the FDIC and the OCC approved a new rule that will substantially amend the regulatory risk-based capital rules applicable to us. The final rule implements the "Basel III" regulatory capital reforms and changes required by the Financial Reform Act. The final rule includes new minimum risk-based capital and leverage ratios which will be effective for us on January 1, 2015, and refines the definition of what constitutes "capital" for purposes of calculating these ratios. The new minimum capital requirements will be: (i) a new common equity Tier 1 ("CET1") capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%, which is increased from 4%; (iii) a total capital ratio of 8%, which is unchanged from the current rules; and (iv) a Tier 1 leverage ratio of 4%. The final rule also establishes a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios, and when fully effective in 2019, will result in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities. In addition, the final rule provides for a number of new deductions from and adjustments to capital and prescribes a revised approach for risk weightings that could result in higher risk weights for a variety of asset categories.
The application of these more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, adversely affect our future growth opportunities, and result in regulatory actions such as a prohibition on the payment of dividends or on the repurchase shares if we were unable to comply with such requirements.
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We may not be able to successfully manage our growth or implement our growth strategies, which may adversely affect our results of operations and financial condition.
During the last five years, we have experienced significant growth, and a key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:
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- open new branch offices or acquire existing branches or other financial institutions;
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- attract deposits to those locations and cross-sell new and existing depositors additional products and services; and
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- identify attractive loan and investment opportunities.
We may not be able to implement our growth strategy successfully if we are unable to identify attractive markets, locations or opportunities to expand. Our ability to successfully manage our growth will also depend upon our ability to maintain capital levels sufficient to support this growth, maintain effective cost controls and adequate asset quality such that earnings are not adversely impacted to a material degree.
As we implement our growth strategy by opening new branches or acquiring branches or other banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of new branches, we must absorb those higher expenses while we begin to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch aggressively could depress our earnings in the short run, even if we efficiently execute our branching strategy. In addition, failure to properly integrate or manage our expanded business could adversely effect our financial condition.
Our potential inability to integrate companies we may acquire in the future could have a negative effect on our expenses and results of operations.
On occasion, we may engage in a strategic acquisition when we believe there is an opportunity to strengthen and expand our business. To fully benefit from such acquisition, however, we must integrate the administrative, financial, lending, and retail functions of the acquired company. If we are unable to successfully integrate an acquired company, our financial condition, results of operations and capital may be negatively affected. Completed acquisitions may also lead to significant unexpected liabilities.
We have goodwill and other intangibles that may become impaired, and thus result in a charge against earnings.
At December 31, 2013, we had $10.1 million of goodwill related to the George Mason acquisition. Goodwill and other intangibles are tested for impairment on an annual basis or when facts and circumstances indicate that impairment may have occurred.
We may be forced to recognize impairment charges in the future as operating and economic conditions change.
We may be adversely impacted by changes in the condition of financial markets.
We are directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. Market risk is inherent in the financial instruments associated with our operations and activities including loans, deposits, securities, short-term borrowings, long-term debt, trading account assets and liabilities, and derivatives. Just a few of the market conditions that may shift from time to time, thereby exposing us to market risk, include fluctuations in interest and currency exchange rates, equity and futures prices, and price deterioration or changes in value due to changes in market
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perception or actual credit quality of issuers. Accordingly, depending on the instruments or activities impacted, market risks can have adverse effects on our results of operations and our overall financial condition.
The subprime mortgage market dislocation which occurred in prior years has impacted the ratings of certain monoline insurance providers which, in turn, has affected the pricing of certain municipal securities and the liquidity of the short term public finance markets. We have some exposure to monolines and, as a result, are continuing to monitor this exposure. Additionally, unfavorable economic or political conditions and changes in government policy could impact the operating budgets or credit ratings of U.S. States and U.S. municipalities and expose us to credit risk.
On December 10, 2013, the Office of the Comptroller of the Currency, the FDIC, the Board of Governors of the Federal Reserve System, the SEC, and the Commodity Futures Trading Commission (collectively, "the Agencies"), released final rules (the "Final Rules") to implement Section 619 of the Financial Reform Act, commonly known as the "Volcker Rule". The Volcker Rule, among other things, prohibits banking entities from engaging in proprietary trading and from sponsoring, having an ownership interest in or having certain relationships with hedge funds or private equity funds (referred to in the Final Rules as a covered fund), subject to certain exemptions. The Final Rules impact certain investments held by banks in collateralized debt obligations backed by trust preferred securities, which may constitute ownership interests in covered funds as those terms are defined in the Final Rules. On January 14, 2014, an interim rule was issued by the federal banking regulators to exempt certain of these trust preferred securities from the covered fund definition as issued in the Final Rules.
We own four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio. Based on the interim rule, only two of the four investments were exempt from the covered fund definition. For the two investments that were not exempt as a result of the interim rule, we will be required to divest our investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015. As a result of this new regulation, these two investments which have a par value of $3.1 million at December 31, 2013, were reclassified to the available-for-sale investment securities portfolio and an other-than-temporary impairment of $300,000 was recognized as of December 31, 2013 as we no longer have the ability to hold until recovery.
The par value of the two pooled trust preferred securities still classified as held-to-maturity totaled $4.0 million at December 31, 2013. The collateral underlying these structured securities are instruments issued by financial institutions. We own the A-3 tranches in each issuance. Each of the bonds is rated by more than one rating agency. One security has a composite rating of A- and the other security has a composite rating of BBB+. Observable trading activity remains limited for these types of securities. We have estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments recovering the amortized cost basis of each of the securities, and concluded that these securities are not other-than-temporarily impaired. However, if there are additional deferrals or defaults that impact the contractual cash flows within the tranches we own, we may be required to record an other-than-temporary impairment related to these securities, which could adversely affect our results of operations and financial condition.
Our concentration in commercial real estate and business loans may increase our future credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Approximately 87% of our loans are secured by real estate, both residential and commercial, substantially all of which are located in our
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market area. A major change in the region's real estate market, resulting in a further deterioration in real estate values, or in the local or national economy, including changes caused by raising interest rates, could adversely affect our customers' ability to pay these loans, which in turn could adversely impact us. Risk of loan defaults and foreclosures are inherent in the banking industry, and we try to limit our exposure to this risk by carefully underwriting and monitoring our extensions of credit. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.
Commercial real estate and business loans increase our exposure to credit risks.
At December 31, 2013, our portfolio of commercial and industrial and commercial real estate (including construction) totaled $1.63 billion, or 80% of total loans. We plan to continue to emphasize the origination of loans to small and medium-sized businesses as well as government contractors, professionals, such as physicians, accountants and attorneys, and commercial real estate developers and builders, which generally exposes us to a greater risk of nonpayment and loss than residential real estate loans because repayment of such loans often depends on the successful operations and cash flows of the borrowers. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate loans. Also, many of our borrowers have more than one commercial loan outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential real estate loan. In addition, these small to medium-sized businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions negatively impact these businesses, our results of operations and financial condition may be adversely affected. This concentration also exposes us more to the market risks of real estate sales leasing and other activity in the areas we serve. An adverse change in local real estate conditions and markets could materially adversely affect the values of our loans and the real estate held as collateral for such loans, and materially affect our results of operations and financial condition.
Federal bank regulatory agencies have released guidance on "Concentrations in Commercial Real Estate Lending" (the "Guidance"). The Guidance defines commercial real estate ("CRE") loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm nonresidential property where the primary or a significant source of repayment is derived from rental income associated with the property (that is, loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. The Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The Guidance is triggered when CRE loan concentrations exceed either:
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- Total reported loans for construction, land development, and other land of 100% or more of a bank's total capital; or
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- Total reported loans secured by multifamily and nonfarm nonresidential properties and loans for construction, land development, and other land of 300% or more of a bank's capital.
The Guidance applies to our CRE lending activities. Although our regulators have not required us to maintain elevated levels of capital or liquidity due to our CRE concentrations, the regulators may do so in the future, especially if there is a material downturn in our local real estate markets.
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If our allowance for loan losses is not appropriate, our results of operations may be affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and analysis of the loan portfolio, management determines the appropriateness of the allowance for loan losses by considering such factors as general and industry-specific market conditions, credit quality of the loan portfolio, the collateral supporting the loans and financial performance of our loan customers relative to their financial obligations to us. The amount of future losses is impacted by changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control. Actual losses may exceed our current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. Estimating loan loss allowances for an unseasoned portfolio is more difficult than with seasoned portfolios, and may be more susceptible to changes in estimates and to losses exceeding estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or assert that our loan loss allowance will be appropriate in the future. Future loan losses that are greater than current estimates could have a material impact on our future financial performance.
Banking regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize additional loan charge-offs, based on credit judgments different than those of our management. Any increase in the amount of our allowance or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
Our liquidity could be impaired by our inability to access the capital markets on favorable terms.
Liquidity is essential to our business. Under normal business conditions, primary sources of funding for our parent company may include dividends received from banking and nonbanking subsidiaries and proceeds from the issuance of equity capital in the capital markets. The primary sources of funding for our banking subsidiary include customer deposits and wholesale market-based funding. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption, negative views about the financial services industry generally, or an operational problem that affects third parties or us.
For further discussion or our liquidity position and other liquidity matters, including policies and procedures we use to manage our liquidity risks, see "Capital Resources" and "Liquidity" in Item 7 of this report.
Increases in FDIC insurance premiums may cause our earnings to decrease.
Since the financial crisis began several years ago, an increasing number of bank failures have imposed significant costs on the FDIC in resolving those failures, and the regulator's deposit insurance fund has been depleted. In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased, and may increase in the future, assessment rates of insured institutions, including Cardinal Bank.
Deposits are insured by the FDIC, subject to limits and conditions or applicable law and the FDIC's regulations. Pursuant to the Financial Reform Act, FDIC insurance coverage limits were permanently increased to $250,000 per customer. The FDIC administers the deposit insurance fund, and all insured depository institutions are required to pay assessments to the FDIC that fund the DIF. The Financial Reform Act changed the methodology for calculating deposit insurance assessments by changing the assessment base from the amount of an insured depository institution's domestic deposits to its total assets minus tangible equity. The new regulation implementing revisions to the assessment system mandated by the Financial Reform Act was effective April 1, 2011 and was reflected in the
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June 30, 2011 FDIC fund balance and the invoices for assessments due September 30, 2011. As a result of the new regulations, we expect higher annual deposit insurance assessments than we historically incurred before the financial crisis began several years ago. While the burden of replenishing the DIF will be placed primarily on institutions with assets of greater than $10 billion, any future increases in required deposit insurance premiums or other bank industry fees could have a significant adverse impact on our financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. There is no assurance that any such losses would not materially and adversely affect our results of operations.
We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel.
We are a customer-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our customers by our Chairman and Chief Executive Officer, Bernard H. Clineburg, and our other executive and senior lending officers. We have entered into employment agreements with Mr. Clineburg and several other executive officers. The existence of such agreements, however, does not necessarily assure us that we will be able to continue to retain their services. The unexpected loss of Mr. Clineburg or other key employees could have a significant adverse effect on our business and possibly result in reduced revenues and earnings. We maintain bank owned life insurance policies on all of our corporate executives, of which we are the beneficiary.
The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships, as well as develop new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. While we have been recently successful in acquiring what we consider to be talented banking professionals, the market for talented people is competitive and we may not continue to be successful in attracting, hiring, motivating or retaining experienced banking professionals.
We may incur losses if we are unable to successfully manage interest rate risk.
Our future profitability will substantially depend upon our ability to maintain or increase the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. Changes in interest rates will affect our operating performance and financial condition. The shape of the yield curve can also impact net interest income. Changing rates will impact how fast our mortgage loans and mortgage backed securities will have the principal repaid. Rate changes can also impact the behavior of our depositors, especially depositors in non-maturity deposits such as demand, interest checking, savings and money market accounts. While we attempt to minimize our exposure to interest rate risk, we are unable to eliminate it as it is an inherent part of our business. Our net interest spread will depend on many factors that are partly or entirely
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outside our control, including competition, federal economic, monetary and fiscal policies, and industry-specific conditions and economic conditions generally.
Our future success is dependent on our ability to compete effectively in the highly competitive banking and financial services industry.
We face vigorous competition from other commercial banks, savings and loan associations, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other types of financial institutions 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. Many of our nonbank competitors are not subject to the same extensive regulations that govern us. As a result, these nonbank 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.
Our businesses and earnings are impacted by governmental, fiscal and monetary policy.
We are affected by domestic monetary policy. For example, the Federal Reserve Board regulates the supply of money and credit in the United States and its policies determine in large part our cost of funds for lending, investing and capital raising activities and the return we earn on those loans and investments, both of which affect our net interest margin. The actions of the Federal Reserve Board also can materially affect the value of financial instruments we hold, such as loans and debt securities, and its policies also can affect our borrowers, potentially increasing the risk that they may fail to repay their loans. Our businesses and earnings also are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States. Changes in fiscal or monetary policy are beyond our control and hard to predict.
Our profitability and the value of any equity investment in us may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.
We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels. Recently enacted, proposed and future banking and other legislation and regulations have had, and will continue to have, or may have a significant impact on the financial services industry. These regulations, which are generally intended to protect depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably, and can be expected to influence our earnings and growth. Our success depends on our continued ability to maintain compliance with these regulations. Many of these regulations increase our costs and thus place other financial institutions that may not be subject to similar regulation in stronger, more favorable competitive positions.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our common stock.
Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at existing and new branch locations, as well as expanded loan and other investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain desired capital levels. Our ability to raise capital through the sale of additional equity securities or the placement of financial instruments that qualify as regulatory capital will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on
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terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
We have extended off-balance sheet commitments to borrowers which expose us to credit and interest rate risk.
We enter into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and guarantees which would impact our liquidity and capital resources to the extent customers accept or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and guarantees written is represented by the contractual or notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
We have operational risk that could impact our ability to provide services to our customers.
We have potential operational risk exposure throughout our organization. Integral to our performance is the continued effectiveness and efficiency of our technical systems, operational infrastructure, relationships with third parties and key individuals involved in our ongoing activities. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or technical failures, unlawful tampering with our information technology infrastructure, terrorist activities, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of the key individuals to perform properly.
We may be parties to certain legal proceedings that may impact our earnings.
We face significant legal risks in our businesses, and the volume of claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial institutions remain high. Substantial legal liability or significant regulatory action against us could have material adverse financial impact or cause significant reputational risk to us, which in turn could seriously harm our business prospects.
Our ability to pay dividends is limited and we may be unable to pay future dividends.
Our ability to pay dividends is limited by banking laws and regulations and the need to maintain sufficient consolidated capital in the Company and in our subsidiaries. The ability of our bank subsidiary to pay dividends to us is limited by its obligations to maintain sufficient capital, earnings and liquidity and by other general restrictions on its dividends under federal and state bank regulatory requirements. In addition, as a bank holding company, our ability to declare and pay dividends is subject to the guidelines of the Board of Governors of the Federal Reserve System, (the "Federal Reserve,") regarding capital adequacy and dividends. The Federal Reserve guidelines generally require us to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred debt) on our financial condition. These guidelines also require that we review our net income for the current and past four quarters, and the level of dividends on common stock and other Tier 1 capital instruments for those periods, as well as our projected rate or earnings retention. Under the Federal Reserve's policy, the board of directors of a bank holding company should also consider different factors to ensure that its dividend level is prudent relative to the organization's financial position and is not based on overly optimistic earnings scenarios such as any potential events that may occur before the payment date that could affect its ability to pay while still maintaining a strong financial position. As a general matter, the Federal
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Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer, or significantly reduce bank holding company's dividends if: (i) its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or (iii) it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. If we do not satisfy these regulatory requirements or the Federal Reserve's policies, we will be unable to pay dividends on our common stock.
Item 1B. Unresolved Staff Comments
None.
Cardinal Bank, excluding its George Mason subsidiary, conducts its business from 29 branch offices. Nine of these facilities are owned and 20 are leased. Leased branch banking facilities range in size from 457 square feet to 9,000 square feet. Our leases on these facilities expire at various dates through 2023, and all but three of our leases have renewal options. Sixteen of our branch banking locations have drive-up banking capabilities and all have ATMs.
Cardinal Wealth Services, Inc. conducts its business from one of Cardinal Bank's branch facilities.
George Mason conducts its business from 20 leased facilities which range in size from 1,425 square feet to 38,315 square feet. The leases have various expiration dates through 2019 and 14 of their 19 locations have renewal options.
Our headquarters facility in Tysons Corner, Virginia comprises 41,818 square feet of leased office space. This lease expires in January 2022 and has renewal options. In addition to housing various administrative functions—including accounting, data processing, compliance, treasury, marketing, deposit and loan operations—our commercial and industrial and commercial real estate lending functions and various other departments are located there.
We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs.
In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings are, to management's knowledge, threatened against us.
Item 4. Mine Safety Disclosures
None.
33
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Price for Common Stock and Dividends. Our common stock is currently listed for quotation on the Nasdaq Global Select Market under the symbol "CFNL." As of March 4, 2014, our common stock was held by 599 shareholders of record. In addition, we estimate that there were 6,954 beneficial owners of our common stock who own their shares through brokers or banks.
The high and low sale prices per share for our common stock for each quarter of 2013 and 2012 as reported on the market at the time and dividends declared during those periods were as follows:
Periods Ended
|
High | Low | Dividends | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
2012 |
||||||||||
First Quarter |
$ | 11.92 | $ | 10.28 | $ | 0.03 | ||||
Second Quarter |
12.50 | 10.98 | 0.04 | |||||||
Third Quarter |
14.79 | 12.05 | 0.04 | |||||||
Fourth Quarter |
16.66 | 13.13 | 0.09 | |||||||
2013 |
||||||||||
First Quarter |
$ | 18.40 | $ | 15.73 | $ | 0.06 | ||||
Second Quarter |
18.33 | 14.40 | 0.06 | |||||||
Third Quarter |
18.19 | 14.65 | 0.06 | |||||||
Fourth Quarter |
18.52 | 16.08 | 0.08 | |||||||
Dividend Policy. The board of directors intends to follow a policy of retaining any earnings necessary to operate our business in accordance with all regulatory policies while maximizing the long-term return for the Company's investors. Our future dividend policy is subject to the discretion of the board of directors and future dividend payments will depend upon a number of factors, including future earnings, alternative investment opportunities, financial condition, cash requirements, and general business conditions.
Our ability to distribute cash dividends will depend primarily on the ability of our subsidiaries to pay dividends to us. Cardinal Bank is subject to legal limitations on the amount of dividends it is permitted to pay. Furthermore, neither Cardinal Bank nor we may declare or pay a cash dividend on any of our capital stock if we are insolvent or if the payment of the dividend would render us insolvent or unable to pay our obligations as they become due in the ordinary course of business. For additional information on these limitations, see "Government Regulation and Supervision—Payment of Dividends" in Item 1 above.
Repurchases. On February 26, 2007, we publicly announced that the Board of Directors had adopted a program to repurchase up to 1,000,000 shares of our common stock. The timing and amount of repurchases, if any, will depend on market conditions, share price, trading volume, and other factors, and there is no assurance that we will purchase shares during any period. No termination date was set for the buyback program. Shares may be repurchased in the open market or through privately negotiated transactions.
Since the inception of the program, we have purchased 477,608 shares of our common stock at a total cost of $4.1 million. All of these shares have been cancelled and retired. No shares were repurchased during 2013.
Stock Performance Graph. The graph set forth below shows the cumulative shareholder return on the Company's Common Stock during the five-year period ended December 31, 2013, as compared with: (i) an overall stock market index, the NASDAQ Composite; and (ii) a published industry index,
34
the SNL Bank Index. The stock performance graph assumes that $100 was invested on December 31, 2008 in our common stock and each of the comparable indices and that dividends were reinvested.
| |
Period Ending | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Index
|
12/31/08 | 12/31/09 | 12/31/10 | 12/31/11 | 12/31/12 | 12/31/13 | |||||||||||||
Cardinal Financial Corporation |
100.00 | 154.42 | 207.11 | 193.38 | 297.88 | 333.46 | |||||||||||||
NASDAQ Composite |
100.00 | 145.36 | 171.74 | 170.38 | 200.63 | 281.22 | |||||||||||||
SNL Bank |
100.00 | 98.97 | 110.90 | 85.88 | 115.90 | 159.12 | |||||||||||||
35
Item 6. Selected Financial Data
Selected Financial Data
(In thousands, except per share data)
| |
Years Ended December 31, | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||
Income Statement Data: |
||||||||||||||||
Interest income |
$ | 114,115 | $ | 115,050 | $ | 102,878 | $ | 96,633 | $ | 86,742 | ||||||
Interest expense |
21,770 | 24,047 | 23,716 | 27,588 | 36,200 | |||||||||||
| | | | | | | | | | | | | | | | | |
Net interest income |
92,345 | 91,003 | 79,162 | 69,045 | 50,542 | |||||||||||
Provision for loan losses |
(32 | ) | 7,123 | 6,910 | 10,502 | 6,750 | ||||||||||
| | | | | | | | | | | | | | | | | |
Net interest income after provision for loan losses |
92,377 | 83,880 | 72,252 | 58,543 | 43,792 | |||||||||||
Non-interest income |
29,911 | 63,392 | 34,333 | 27,389 | 23,348 | |||||||||||
Non-interest expense |
84,603 | 79,317 | 64,465 | 59,469 | 52,427 | |||||||||||
| | | | | | | | | | | | | | | | | |
Net income before income taxes |
37,685 | 67,955 | 42,120 | 26,463 | 14,713 | |||||||||||
Provision for income taxes |
12,175 | 22,658 | 14,122 | 8,021 | 4,388 | |||||||||||
| | | | | | | | | | | | | | | | | |
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | $ | 18,442 | $ | 10,325 | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Balance Sheet Data: |
||||||||||||||||
Total assets |
$ | 2,894,230 | $ | 3,039,187 | $ | 2,602,716 | $ | 2,072,018 | $ | 1,976,185 | ||||||
Loans receivable, net of fees |
2,040,168 | 1,803,429 | 1,631,882 | 1,409,302 | 1,293,432 | |||||||||||
Allowance for loan losses |
27,864 | 27,400 | 26,159 | 24,210 | 18,636 | |||||||||||
Loans held for sale |
373,993 | 785,751 | 529,500 | 206,047 | 179,469 | |||||||||||
Total investment securities |
359,686 | 286,420 | 310,543 | 344,984 | 378,753 | |||||||||||
Total deposits |
2,058,859 | 2,243,758 | 1,775,260 | 1,403,725 | 1,297,005 | |||||||||||
Other borrowed funds |
475,232 | 392,275 | 510,385 | 389,586 | 427,579 | |||||||||||
Total shareholders' equity |
320,532 | 308,066 | 257,817 | 222,902 | 204,507 | |||||||||||
Common shares outstanding |
30,333 | 30,226 | 29,199 | 28,770 | 28,718 | |||||||||||
Per Common Share Data: |
||||||||||||||||
Basic net income |
$ | 0.83 | $ | 1.53 | $ | 0.95 | $ | 0.63 | $ | 0.38 | ||||||
Fully diluted net income |
0.82 | 1.51 | 0.94 | 0.62 | 0.37 | |||||||||||
Book value |
10.57 | 10.19 | 8.83 | 7.75 | 7.12 | |||||||||||
Tangible book value(1) |
10.23 | 9.85 | 8.47 | 7.38 | 6.64 | |||||||||||
Performance Ratios: |
||||||||||||||||
Return on average assets |
0.92 | % | 1.70 | % | 1.27 | % | 0.92 | % | 0.57 | % | ||||||
Return on average equity |
7.96 | 16.02 | 11.58 | 8.44 | 5.53 | |||||||||||
Dividend payout ratio |
0.27 | 0.13 | 0.12 | 0.12 | 0.10 | |||||||||||
Net interest margin(2) |
3.52 | 3.61 | 3.81 | 3.68 | 2.94 | |||||||||||
Efficiency ratio(3) |
69.20 | 51.37 | 56.80 | 61.67 | 70.95 | |||||||||||
Non-interest income to average assets |
1.07 | 2.37 | 1.56 | 1.37 | 1.29 | |||||||||||
Non-interest expense to average assets |
3.04 | 2.97 | 2.92 | 2.98 | 2.89 | |||||||||||
Loans receivable, net of fees to total deposits |
99.09 | 80.38 | 91.92 | 100.40 | 99.72 | |||||||||||
Asset Quality Ratios: |
||||||||||||||||
Net charge-offs to average loans receivable, net of fees |
(0.03 | )% | 0.35 | % | 0.34 | % | 0.37 | % | 0.22 | % | ||||||
Nonperforming loans to loans receivable, net of fees |
0.11 | 0.42 | 0.91 | 0.53 | 0.05 | |||||||||||
Nonperforming loans to total assets |
0.08 | 0.25 | 0.57 | 0.36 | 0.04 | |||||||||||
Allowance for loan losses to nonperforming loans |
1,204.15 | 359.30 | 176.45 | 320.03 | 2,677.59 | |||||||||||
Allowance for loan losses to loans receivable, net of fees |
1.37 | 1.52 | 1.60 | 1.72 | 1.44 | |||||||||||
Capital Ratios: |
||||||||||||||||
Tier 1 risk-based capital |
11.85 | % | 11.94 | % | 11.29 | % | 12.67 | % | 12.97 | % | ||||||
Total risk-based capital |
12.89 | 13.04 | 12.49 | 14.06 | 14.15 | |||||||||||
Leverage capital ratio |
11.70 | 10.49 | 10.14 | 10.82 | 11.03 | |||||||||||
Other: |
||||||||||||||||
Average shareholders' equity to average total assets |
11.52 | % | 10.59 | % | 10.95 | % | 10.93 | % | 10.31 | % | ||||||
Average loans receivable, net of fees to average total deposits |
86.91 | 83.43 | 93.27 | 96.28 | 97.57 | |||||||||||
Average common shares outstanding: |
||||||||||||||||
Basic |
30,687 | 29,654 | 29,401 | 29,123 | 27,186 | |||||||||||
Diluted |
31,077 | 29,996 | 29,784 | 29,608 | 27,674 | |||||||||||
- (1)
- Tangible book value is calculated as total shareholders' equity, less goodwill and other intangible assets, divided by common shares outstanding.
36
- (2)
- Net
interest margin is calculated as net interest income divided by total average earning assets and reported on a tax equivalent basis at a rate of 35%.
- (3)
- Efficiency ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following presents management's discussion and analysis of our consolidated financial condition at December 31, 2013 and 2012 and the results of our operations for the years ended December 31, 2013, 2012 and 2011. The discussion should be read in conjunction with the consolidated financial statements and related notes included in this report.
Caution About Forward-Looking Statements
We make certain forward-looking statements in this Form 10-K that are subject to risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
- •
- the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and
liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
- •
- changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchases of
mortgage loans sold and other estimates;
- •
- changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and
disruption of the capital and credit markets, soundness of other financial institutions we do business with;
- •
- decrease in the volume of loan originations at our mortgage banking subsidiary as a result of the cyclical nature of
mortgage banking, changes in interest rates, economic conditions, decreased economic activity, and slowdowns in the housing market which would negatively impact the income recorded on the sales of
loans held for sale.
- •
- risks inherent in making loans such as repayment risks and fluctuating collateral values;
- •
- declines in the prices of assets and market illiquidity may cause us to record an other-than-temporary impairment or other
losses, specifically in our pooled trust preferred securities portfolio resulting from increases in underlying issuers' defaulting or deferring payments;
- •
- changes in operations within the wealth management services segment, its customer base and assets under management;
- •
- changes in operations of George Mason Mortgage, LLC as a result of the activity in the residential real estate
market and any associated impact on the fair value of goodwill in the future;
- •
- legislative and regulatory changes, including the Financial Reform Act and implementation of the Volcker Rule, and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
37
- •
- exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or
related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
- •
- the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of
implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;
- •
- the ability to successfully manage our growth or implement our growth strategies as we implement new or change internal
operating systems or if we are unable to identify attractive markets, locations or opportunities to expand in the future;
- •
- the effects of future economic, business and market conditions;
- •
- governmental monetary and fiscal policies;
- •
- changes in accounting policies, rules and practices;
- •
- maintaining cost controls and asset quality as we open or acquire new branches;
- •
- maintaining capital levels adequate to support our growth;
- •
- reliance on our management team, including our ability to attract and retain key personnel;
- •
- competition with other banks and financial institutions, and companies outside of the banking industry, including those
companies that have substantially greater access to capital and other resources;
- •
- risks and uncertainties related to trust operations;
- •
- demand, development and acceptance of new products and services;
- •
- problems with technology utilized by us;
- •
- changing trends in customer profiles and behavior; and
- •
- other factors described from time to time in our reports filed with the SEC.
Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results.
In addition, this section should be read in conjunction with the description of our "Risk Factors" in Item 1A above.
Overview
We are a financial holding company formed in 1997 and headquartered in Fairfax County, Virginia. We were formed principally in response to opportunities resulting from the consolidation of several Virginia-based banks. These bank consolidations were typically accompanied by the dissolution of local boards of directors and relocation or termination of management and customer service professionals and a general deterioration of personalized customer service.
On January 16, 2014, we announced the completion of our acquisition of United Financial Banking Companies, Inc. ("UFBC"), the holding company of The Business Bank ("TBB"), pursuant to a previously announced definitive merger agreement. The merger of UFBC into Cardinal was effective January 16, 2014. Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of our common stock in exchange for each share of UFBC common stock they
38
owned immediately prior to the merger. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014 adding eight (8) banking locations in northern Virginia, one of the Company's target markets.
We own Cardinal Bank (the "Bank"), a Virginia state-chartered community bank with 29 banking offices located in Northern Virginia and the greater Washington, D.C. metropolitan area. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship managers focus on attracting small and medium sized businesses as well as government contractors, commercial real estate developers and builders and professionals, such as physicians, accountants and attorneys.
Additionally, we complement our core banking operations by offering a wide range of services through our various subsidiaries, including mortgage banking through George Mason Mortgage, LLC ("George Mason") and retail securities brokerage though Cardinal Wealth Services, Inc. ("CWS").
Prior to June 30, 2013, the Bank had a trust division, Cardinal Trust and Investment Services. This division merged its remaining operations as of June 30, 2013 into CWS. In addition, as of June 30, 2013, Wilson/Bennett Capital Management, Inc., formerly the Company's second nonbank subsidiary, merged its operations into CWS. During the second quarter of 2013, we exited the third party institutional custody and trustee component of our trust services division due to our limited opportunity to leverage this platform. As a result of our reorganization of the wealth management business segment, the remaining personal and commercial trust area of this business consolidated into CWS. In addition, the remaining Wilson/Bennett clients begin to be serviced on the CWS platform in the third quarter of 2013. Results for the year ended December 31, 2013 include six months of operations of these subsidiaries.
We had a second mortgage subsidiary, Cardinal First Mortgage, LLC ("Cardinal First") based in Fairfax, Virginia, but as of June 30, 2013, this subsidiary merged into George Mason to improve operational efficiency. Results for the year ended December 31, 2013 include six months of operations of these subsidiaries.
George Mason, based in Fairfax, Virginia, engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis through 20 offices located throughout the metropolitan Washington region. George Mason does business in eight states, primarily Virginia and Maryland, and the District of Columbia. George Mason is one of the largest residential mortgage originators in the greater Washington, D.C. metropolitan area, generating originations of approximately $5.8 billion in 2013 and $6.6 billion in 2012, excluding advances on construction loans and including loans purchased from other mortgage banking companies which are owned by local home builders but managed by George Mason (the "managed companies"). George Mason's primary sources of revenue include loan origination fees, net interest income earned on loans held for sale, gains on sales of loans and contractual management fees earned relating to services provided to other mortgage companies owned by local home builders. At the time we enter into an interest rate lock arrangement with the borrower, we enter into a loan forward sale commitment with a third party. Our mortgage loans are then sold servicing released.
George Mason also offers a construction-to-permanent loan program. This program provides variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market. These construction-to-permanent loans generate fee income as well as net interest income for George Mason and are classified as loans held for sale.
The mortgage banking segment's business is both cyclical and seasonal. The cyclical nature of its business is influenced by, among other factors, the levels of and trends in mortgage interest rates, national and local economic conditions and consumer confidence in the economy. Historically, the
39
mortgage banking segment has its lowest levels of quarterly loan closings during the first quarter of the year. However, due to a significant increase in interest rates during the third quarter of 2013 and subsequent increase in competition with other mortgage banking entities for loan originations, we saw a decrease in mortgage loan originations during the third and fourth quarters of 2013 as compared to prior quarters. In addition, the increase in mortgage interest rates decreased refinancing activity for George Mason as it did for other mortgage banking entities, and contributed to our decreased loan origination activity for the full 2013 year as compared to 2012.
Wilson/Bennett provided asset management services to certain of our customers. Wilson/Bennett's primary source of revenue was management fees earned on the assets it managed for its customers. These management fees were generally based upon the market value of managed and custodial assets. As part of our reorganization of the wealth management services business segment, we merged Wilson/Bennett operations into CWS as of June 30, 2013.
We formed a wholly-owned subsidiary, Cardinal Statutory Trust I, for the purpose of issuing $20.0 million of floating rate junior subordinated deferrable interest debentures ("trust preferred securities"). These trust preferred securities are due in 2034 and pay interest at a rate equal to LIBOR (London Interbank Offered Rate) plus 2.40%, which adjusts quarterly. These securities are redeemable at par. The interest rate on this debt was 2.64% at December 31, 2013. We have guaranteed payment of these securities. The $20.6 million payable by us to Cardinal Statutory Trust I is included in other borrowed funds in the consolidated statements of condition since Cardinal Statutory Trust I is an unconsolidated subsidiary as we are not the primary beneficiary of this entity. We utilized the proceeds from the issuance of the trust preferred securities to make a capital contribution into the Bank.
Net interest income is our primary source of revenue. We define revenue as net interest income plus non-interest income. As discussed further in the interest rate sensitivity section, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, non-interest income is an important source of revenue for us and includes, among other things, service charges on deposits and loans, investment fee income, gains and losses on sales of investment securities available-for-sale, gains on sales of mortgage loans, and management fee income. Realized and unrealized gains on mortgage banking activities has become a larger component of our non-interest income as we have added offices throughout the Washington metropolitan region and increased the number of loan originators in our mortgage banking segment over the past year.
Net interest income and non-interest income represented the following percentages of total revenue, which is calculated as net interest income plus non-interest income, for the three years ended December 31, 2013:
| |
Net Interest Income |
Non-Interest Income |
|||||
|---|---|---|---|---|---|---|---|
2013 |
75.5 | % | 24.5 | % | |||
2012 |
58.9 | % | 41.1 | % | |||
2011 |
69.8 | % | 30.2 | % | |||
Net interest income represented a larger portion of our total revenue for 2013 relative to 2012 as a result of steady net interest income, combined with the decrease in mortgage loan origination activity and the margin compression we experienced on mortgage loans sold, primarily due to the increase in mortgage interest rates during the latter half of 2013. Non-interest income was a larger percentage of
40
our total revenue for 2012 than in 2011 because of the increase in realized and unrealized gains from mortgage banking activities. During 2012 and 2011, we strategically increased the number of loan originators and mortgage banking offices to increase the revenues from the business line.
2013 Economic Environment
The banking environment and the markets in which we conduct our businesses will continue to be strongly influenced by developments in the U.S. and global economies, as well as the continued implementation of rulemaking from recent financial reforms. U.S. economic growth continued in 2013, the fifth consecutive year of recovery. Employment gains were generally steady as the unemployment rate fell to 6.7% by year end. However, most of the improvement in the unemployment rate was attributable to a decrease in the labor force participation rate. Nationally, home prices rose approximately 12% during 2013, and equity markets surged. Even though we experienced a federal government shutdown during October 2013, the U.S. economy saw minimal impact and by year end, Congress had agreed to a two-year budget framework which reduced fiscal uncertainty.
U.S. Treasury yields increased during 2013 as a result of market expectations that the Federal Reserve will moderate its qualitative easing ("QE") programs. This increase in interest rates impacted the results of our mortgage banking segment. Typically, during periods of increasing interest rates, mortgage originations decrease. The degree of the impact is dependent upon the duration and severity of the aforementioned conditions.
Although economic conditions remain unsettled, the metropolitan Washington, D.C. area, the region we operate in, continued to perform relatively well, compared to other regions. The unemployment rate in the Washington, D.C. metropolitan area did not increase to the same level as the national unemployment rate, and commercial and residential real estate values held up well compared to other regions. However, as the federal government continues with announced spending cuts, which is a principal economic driver in our region, we expect growth in the local economy to be slower than that of the U.S.
Our credit quality continues to remain strong despite the challenging economic environment. At December 31, 2013, we had nonaccrual loans totaling $2.3 million and no loans contractually past due 90 days or more as to principal or interest and still accruing. We recorded annualized net recoveries of 0.03% of our average loans receivable for the year ended December 31, 2013. As a result of a rapid increase in mortgage interest rates during the third quarter of 2013, refinancing originations from our mortgage banking segment decreased significantly to 33% of total originations for the full year 2013 compared to 63% of total originations for 2012. Additionally, the margin on loans sold to investors decreased from 2.07% for the second quarter of 2013 to 1.77% for the third quarter of 2013, reflecting industry overcapacity and increased competition. Margins returned to 2.24% during the fourth quarter of 2013, but originations for George Mason decreased to $886 million for the fourth quarter of 2013, the lowest level seen since 2011.
Market illiquidity and concerns over credit risk continue to impact the ratings of our pooled trust preferred securities. We hold investments of $7.1 million in par value of pooled trust preferred securities, which are significantly below book value as of December 31, 2013 due to the lack of liquidity in the market, deferrals and defaults of issuers, and continued investor apprehension for investing in these types of investments. As a result of the issuance of the Final Rules required by the Financial Reform Act which were released by federal banking agencies in late 2013, two of these investments are considered to be "covered funds" and are now required to be divested by us before July 2015. These investment have a par value of $3.1 million at December 31, 2013. We recorded an other-than-temporary-impairment of $300,000 during 2013 as a result of this new regulatory requirement as we no longer have the ability to hold until recovery.
41
We expect challenging economic and operating conditions and an evolving regulatory regime to continue for the foreseeable future. These conditions could continue to affect the markets in which we do business and could adversely impact our results for 2014. The degree of the impact is dependent upon the duration and severity of the aforementioned conditions and the nature of new banking regulations.
While our loan growth has continued to be strong, continued uncertainty and sluggish economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses. Deterioration in real estate values and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially. The systems by which we set limits and monitor the level of our credit exposure to individual entities and industries also may not function as we have anticipated.
Liquidity is essential to our business. The primary sources of funding for our Bank include customer deposits and wholesale funding. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by further disruptions in the capital markets or other events. While we believe we have a healthy liquidity position, any of the above factors could materially impact our liquidity position in the future.
The U.S. government continues to enact legislation and develop various programs and initiatives designed to stabilize the financial services industry, stabilize the housing markets and stimulate the economy. The banking industry is awaiting many of the regulations resulting from the implementation of the Financial Reform Act. We remain unsure of the full impact this legislation will have on our business, operations or our financial condition.
Critical Accounting Policies
General
U.S. generally accepted accounting principles are complex and require management to apply significant judgment to various accounting, reporting, and disclosure matters. Management must use assumptions, judgments, and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.
The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, the fair value measurements of certain assets and liabilities, accounting for economic hedging activities, accounting for impairment testing of goodwill, accounting for the impairment of amortizing intangible assets and other long-lived assets, and the valuation of deferred tax assets.
42
Allowance for Loan Losses
We maintain the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in our loan portfolio. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and term of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions, and concentrations of credit, competition, and loan review results to support our estimates.
For purposes of our analysis, we categorize our loans into one of five categories: commercial and industrial, commercial real estate (including construction), home equity lines of credit, residential mortgages, and consumer loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category and are then adjusted for portfolio trends and economical and environmental factors in determining their allowance for loan losses. Prior to 2008, we experienced minimal loss history within our loan portfolio and it has only been since the economic downturn that we have recorded a higher level of loan losses. Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.
Our peer groups are defined by selecting commercial banking institutions of similar size within Virginia, Maryland, and the District of Columbia. This is known as our custom peer group. The commercial banking institutions comprising our custom peer group can change based on certain factors including but not limited to that characteristics, size, and geographic footprint of the institution. We have identified 20 banks for our custom peer group which are within $500 million to $5 billion in total assets, the majority of whom are geographically concentrated in the Washington metropolitan area in which we operate as this area has seen less of an economic downturn than other areas of the country. We evaluate the loan quality indicators of our custom peer group to those within our national FDIC peer group, all banks in Virginia, and all banks in Maryland. These baseline peer group loss rates are then adjusted by an estimated loss emergence factor in order to determine loss coverage for pass-level credits. Finally, we make adjustments to these loss factors based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk. Our peer loss rates are updated on at least an annual basis.
In addition, we individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. In certain cases, we apply, in accordance with regulatory guidelines, a 5% loss factor to loans classified as special mention, a 15% loss factor to loans classified as substandard and a 50% loss factor to loans classified as doubtful. Loans classified as loss loans are fully reserved or charged-off. However, in most instances, we evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. For these loans, we analyze the fair value of the collateral underlying the loan and consider estimated costs to sell the collateral on a discounted basis. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan. Because of the limited number of impaired loans in our portfolio, we are able to evaluate each impaired loan individually and therefore our specific reserves for impaired loans are generally less than those recommended by the listed regulatory guidelines above.
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Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded in the commercial banking or mortgage banking segments, as appropriate, and would negatively impact earnings.
Fair Value Measurements
We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. For certain of our held-to-maturity investment securities where there is minimal observable trading activity, we use a discounted cash flow approach to estimate fair value based on internal calculations and compare our results to information provided by external pricing sources. Interest rate swap derivatives are recorded at fair value using observable inputs from a national valuation service. These inputs are applied to a third party industry-wide valuation model.
We also fair value our interest rate lock commitments and forward loan sales commitments. The fair value of our interest rate lock commitments considers the expected premium (discount) to par and we apply certain fallout rates for those rate lock commitments for which we do not close a mortgage loan. In addition, we calculate the effects of the changes in interest rates from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices. The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date. At loan closing, the fair value of the interest rate lock commitment is included in the cost basis of loans held for sale, which are carried at the lower of cost or fair value.
Accounting for Economic Hedging Activities
We record all derivative instruments on the statement of condition at their fair values. We do not enter into derivative transactions for speculative purposes. For derivatives designated as accounting hedges, we contemporaneously document the hedging relationship, including the risk management objective and strategy for undertaking the hedge, how effectiveness will be assessed at inception and at each reporting period and the method for measuring ineffectiveness. We evaluate the effectiveness of these transactions at inception and on an ongoing basis. Ineffectiveness is recorded through earnings. For derivatives designated as cash flow hedges, the fair value adjustment is recorded as a component of other comprehensive income, except for the ineffective portion which is recorded in earnings. For derivatives designated as fair value hedges, the fair value adjustments for both the hedged item and the hedging instrument are recorded through the income statement with any difference considered the ineffective portion of the hedge.
We discontinue hedge accounting prospectively when it is determined that the derivative is no longer highly effective. In situations in which cash flow hedge accounting is discontinued, we continue to carry the derivative at its fair value on the statement of condition and recognize any subsequent changes in fair value in earnings over the term of the forecasted transaction. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, we recognize immediately in earnings any gains and losses that were accumulated in other comprehensive income.
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In the normal course of business, we enter into contractual commitments, including rate lock commitments, to finance residential mortgage loans. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by us. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings.
To mitigate the effect of interest rate risk inherent in providing rate lock commitments, we economically hedge our commitments by entering into best efforts delivery forward loan sales contracts. During the rate lock commitment period, these forward loan sales contracts are marked to market through earnings and are not designated as accounting hedges. Exclusive of the fair value elements of the rate lock commitment related to servicing and the wholesale and retail rate spread, the changes in fair value related to movements in market rates of the rate lock commitments and the forward loan sales contracts generally move in opposite directions, and the net impact of changes in these valuations on net income during the loan commitment period is generally inconsequential. At the closing of the loan, the loan commitment derivative expires and we record a loan held for sale and continue to be obligated under the same forward loan sales contract. The forward sales contract is then designated as a hedge against the variability in cash to be received from the loan sale. Loans held for sale are accounted for at the lower of cost or fair value.
Accounting for Impairment Testing of Goodwill
During 2011, the Financial Accounting Standards Board, ("FASB"), issued Accounting Standards Update 2011-08 ("ASU 2011-08"), Testing Goodwill for Impairment. This ASU permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount before applying the two-step goodwill impairment test. If an entity concludes it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it need not perform the two-step impairment test. We perform our annual review of the goodwill related to our mortgage banking segment during the third quarter.
In the event we are required to perform a Step 1 fair value evaluation of the reporting unit, we make estimates of the discounted cash flows from the expected future operations of the reporting unit. This discounted cash flow analysis involves the use of unobservable inputs including: estimated future cash flows from operations; an estimate of a terminal value; a discount rate; and other inputs. Our estimated future cash flows are largely based on our historical actual cash flows. If the analysis indicates that the fair value of the reporting unit is less than its carrying value, we do an analysis to compare the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. The implied fair value of the goodwill is determined by allocating the fair value of the reporting unit to all its assets and liabilities. If the implied fair value of the goodwill is less than the carrying value, an impairment loss is recognized.
Accounting for the Impairment of Amortizing Intangible Assets and Other Long-Lived Assets
We continually review our long-lived assets for impairment whenever events or changes in circumstances indicate that the remaining estimated useful life of such assets might warrant revision or that the balances may not be recoverable. We evaluate possible impairment by comparing estimated future cash flows, before interest expense and on an undiscounted basis, with the net book value of long-term assets, including amortizable intangible assets. If undiscounted cash flows are insufficient to recover assets, further analysis is performed in order to determine the amount of the impairment.
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An impairment loss is recorded for the excess of the carrying amount of the assets over their fair values. Fair value is usually determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved.
Valuation of Deferred Tax Assets
We record a provision for income tax expense based on the amounts of current taxes payable or refundable and the change in net deferred tax assets or liabilities during the year. Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. When substantial uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset is reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.
New Financial Accounting Standards
The FASB issued ASU No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. This ASU allows an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-lived intangible assets. An organization that elects to perform a qualitative assessment is required to perform the quantitative impairment test for an indefinite-lived intangible asset if it is more likely than not that the asset is impaired. The ASU, which applies to all public, private, and not-for-profit organizations, was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this standard did not have a material impact on our consolidated financial condition or results of operations.
Financial Overview
For the year ended December 31, 2013, we reported net income of $25.5 million on a consolidated basis. The commercial banking segment recorded net income of $33.9 million and our mortgage banking segment recorded a net loss of $5.2 million. The wealth management services business segment reported a net loss of $162,000 for the year ended December 31, 2013.
For the year ended December 31, 2012, we reported net income of $45.3 million on a consolidated basis. The commercial banking segment recorded net income of $30.5 million and our mortgage banking segment recorded net income of $17.6 million. The wealth management services business segment reported a net loss of $19,000 for the year ended December 31, 2012.
2013 Compared to 2012
At December 31, 2013, total assets were $2.89 billion, a decrease of 4.8%, or $145.0 million, from $3.04 billion at December 31, 2012. Total loans receivable, net of deferred fees and costs, increased 13.1%, or $236.7 million, to $2.04 billion at December 31, 2013, from $1.80 billion at December 31, 2012. Total investment securities increased by $73.3 million, or 25.6%, to $359.7 million at December 31, 2013, from $286.4 million at December 31, 2012. Total deposits decreased 8.2%, or $184.9 million, to $2.06 billion at December 31, 2013, from $2.24 billion at December 31, 2012. Other borrowed funds, which primarily include customer repurchase agreements, federal funds sold and Federal Home Loan Bank ("FHLB") advances, increased $83.0 million to $475.2 million at December 31, 2013, from $392.3 million at December 31, 2012.
Shareholders' equity at December 31, 2013 was $320.5 million, an increase of $12.5 million from $308.1 million at December 31, 2012. The increase in shareholders' equity was primarily attributable to the recognition of net income of $25.5 million for the year ended December 31, 2013 offset by changes
46
in accumulated other comprehensive income and dividends paid to common shareholders of $7.0 million during 2013. Accumulated other comprehensive income decreased $8.2 million for the year ended December 31, 2013, primarily as a result of the decrease in market value of our available-for-sale investment securities portfolio. Total shareholders' equity to total assets at December 31, 2013 and 2012 was 11.1% and 10.1%, respectively. Book value per share at December 31, 2013 and 2012 was $10.57 and $10.19, respectively. Total risk-based capital to risk-weighted assets was 12.89% at December 31, 2013 compared to 13.04% at December 31, 2012. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2013.
We recorded net income of $25.5 million, or $0.82 per diluted common share, for the year ended December 31, 2013, compared to net income of $45.3 million, or $1.51 per diluted common share, in 2012. Net interest income increased $1.3 million to $92.3 million for the year ended December 31, 2013, compared to $91.0 million for the year ended December 31, 2012, a result of our balance sheet management and strategically decreasing the rates we pay on our deposits. Provision for loan losses decreased $7.2 million to a negative provision of $32,000 for the year ended December 31, 2013, compared to $7.1 million for 2012. Non-interest income decreased $33.5 million to $29.9 million for the year ended December 31, 2013 as compared to $63.4 million for 2012 due primarily to decreases in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking business segment. Non-interest expense was $84.6 million for the year ended December 31, 2013, an increase of $5.3 million, or 6.7%, compared to $79.3 million for the year ended December 31, 2012. The increase in non-interest expense was primarily related to increases in salaries and benefits expense, and occupancy expense.
The return on average assets for the years ended December 31, 2013 and 2012 was 0.92% and 1.70%, respectively. The return on average equity for the years ended December 31, 2013 and 2012 was 7.96% and 16.02%, respectively.
2012 Compared to 2011
At December 31, 2012, total assets were $3.04 billion, an increase of 16.8%, or $436.5 million, from $2.60 billion at December 31, 2011. Total loans receivable, net of deferred fees and costs, increased 10.5%, or $171.5 million, to $1.80 billion at December 31, 2012, from $1.63 billion at December 31, 2011. Total investment securities decreased by $24.1 million, or 7.8%, to $286.4 million at December 31, 2012, from $310.5 million at December 31, 2011. Total deposits increased 26.4%, or $468.5 million, to $2.24 billion at December 31, 2012, from $1.78 billion at December 31, 2011. Other borrowed funds, which primarily include customer repurchase agreements, federal funds sold and FHLB advances, decreased $118.1 million to $392.3 million at December 31, 2012, from $510.4 million at December 31, 2011.
Shareholders' equity at December 31, 2012 was $308.1 million, an increase of $50.3 million from $257.8 million at December 31, 2011. The increase in shareholders' equity was primarily attributable to the recognition of net income of $45.3 million for the year ended December 31, 2012. Accumulated other comprehensive income increased $1.5 million for the year ended December 31, 2012, primarily as a result of the increase in market value of our available-for-sale investment securities portfolio. Total shareholders' equity to total assets at December 31, 2012 and 2011 was 10.1% and 9.9%, respectively. Book value per share at December 31, 2012 and 2011 was $10.19 and $8.83, respectively. Total risk-based capital to risk-weighted assets was 13.04% at December 31, 2012 compared to 12.49% at December 31, 2011. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2012.
We recorded net income of $45.3 million, or $1.51 per diluted common share, for the year ended December 31, 2012, compared to net income of $28.0 million, or $0.94 per diluted common share, in 2011. Net interest income increased $11.8 million to $91.0 million for the year ended December 31,
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2012, compared to $79.2 million for the year ended December 31, 2011, a result of our balance sheet management and strategically decreasing the rates we pay on our deposits and other borrowed funds. Provision for loan losses increased $213,000 to $7.1 million for the year ended December 31, 2012, compared to $6.9 million for 2011. Non-interest income increased $29.1 million to $63.4 million for the year ended December 31, 2012 as compared to $34.3 million for 2012 due primarily to increases in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking business segment. Non-interest expense was $79.3 million for the year ended December 31, 2012, an increase of $14.8 million, or 23.0%, compared to $64.5 million for the year ended December 31, 2011. The increase in non-interest expense was primarily related to increases in salaries and benefits expense, and occupancy expense.
The return on average assets for the years ended December 31, 2012 and 2011 was 1.70% and 1.27%, respectively. The return on average equity for the years ended December 31, 2012 and 2011 was 16.02% and 11.58%, respectively.
Efficiency Ratio
The efficiency ratio measures the costs expended to generate a dollar of revenue. It represents non-interest expense as a percentage of net interest income and non-interest income. The lower the percentage, the more efficient we are operating. We believe use of the efficiency ratio, which is a non-GAAP financial measure, provides additional clarity in assessing our operating results.
See the table below for the components of our calculation of our efficiency ratio as of December 31, 2013, 2012, and 2011. Our efficiency ratio increased during 2013 as compared to 2012 and 2011 because of a decrease in non-interest income, specifically income related to our mortgage banking business segment.
Efficiency Ratio Calculation
Years Ended December 31, 2013, 2012, and 2011
(In thousands, except per share data)
Calculation of efficiency ratio(1):
|
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 92,345 | $ | 91,003 | $ | 79,162 | ||||
Non-interest income |
29,911 | 63,392 | 34,333 | |||||||
| | | | | | | | | | | |
Total net interest income and non-interest income for efficiency ratio |
122,256 | 154,395 | 113,495 | |||||||
| | | | | | | | | | | |
Non-interest expense |
84,603 | 79,317 | 64,465 | |||||||
Efficiency ratio |
69.20 | % | 51.37 | % | 56.80 | % | ||||
- (1)
- Efficiency ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income
Statements of Income
Net Interest Income/Margin
Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. Interest rates have remained at historic lows for the last several years as the Federal Reserve has had an extremely accommodative policy. We expect this low interest rate environment to continue through 2015. See "Interest Rate Sensitivity" for further information.
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Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
Average Balance |
Interest Income/ Expense |
Average Yield/ Rate |
|||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Interest-earning assets: |
||||||||||||||||||||||||||||
Loans(1)(2): |
||||||||||||||||||||||||||||
Commercial and industrial |
$ | 215,263 | $ | 8,815 | 4.09 | % | $ | 228,407 | $ | 9,528 | 4.16 | % | $ | 202,441 | $ | 8,956 | 4.40 | % | ||||||||||
Real estate—commercial |
911,493 | 43,682 | 4.71 | % | 750,979 | 40,566 | 5.40 | % | 669,841 | 39,764 | 5.92 | % | ||||||||||||||||
Real estate—construction |
349,913 | 18,367 | 5.24 | % | 341,365 | 18,070 | 5.29 | % | 250,897 | 13,977 | 5.57 | % | ||||||||||||||||
Real estate—residential |
251,980 | 11,036 | 4.37 | % | 246,622 | 11,826 | 4.79 | % | 216,065 | 10,878 | 5.03 | % | ||||||||||||||||
Home equity lines |
112,756 | 4,149 | 3.68 | % | 119,902 | 4,451 | 3.71 | % | 122,090 | 4,533 | 3.71 | % | ||||||||||||||||
Consumer |
3,333 | 181 | 5.46 | % | 3,568 | 179 | 5.01 | % | 3,120 | 167 | 5.35 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total loans(1)(2) |
1,844,738 | 86,230 | 4.67 | % | 1,690,843 | 84,620 | 5.00 | % | 1,464,454 | 78,275 | 5.35 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans held for sale |
406,673 | 16,695 | 4.11 | % | 486,134 | 19,018 | 3.91 | % | 244,542 | 10,767 | 4.40 | % | ||||||||||||||||
Investment securities available-for-sale(2) |
276,483 | 11,496 | 4.16 | % | 266,092 | 11,567 | 4.35 | % | 320,138 | 14,097 | 4.40 | % | ||||||||||||||||
Investment securities held-to-maturity |
10,407 | 189 | 1.82 | % | 12,173 | 304 | 2.50 | % | 16,124 | 440 | 2.73 | % | ||||||||||||||||
Other investments |
13,473 | 332 | 2.47 | % | 15,123 | 257 | 1.70 | % | 15,723 | 124 | 0.79 | % | ||||||||||||||||
Federal funds sold |
106,192 | 266 | 0.25 | % | 72,176 | 183 | 0.25 | % | 38,139 | 88 | 0.23 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets and interest income(2) |
2,657,966 | 115,208 | 4.33 | % | 2,542,541 | 115,949 | 4.56 | % | 2,099,120 | 103,791 | 4.94 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-earning assets: |
||||||||||||||||||||||||||||
Cash and due from banks |
17,122 | 16,273 | 14,609 | |||||||||||||||||||||||||
Premises and equipment, net |
19,701 | 18,874 | 17,943 | |||||||||||||||||||||||||
Goodwill and other intangibles, net |
10,199 | 10,394 | 10,593 | |||||||||||||||||||||||||
Accrued interest and other assets |
105,657 | 110,652 | 89,205 | |||||||||||||||||||||||||
Allowance for loan losses |
(27,397 | ) | (27,101 | ) | (24,524 | ) | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets |
$ | 2,783,248 | $ | 2,671,633 | $ | 2,206,946 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders' Equity |
||||||||||||||||||||||||||||
Interest—bearing liabilities: |
||||||||||||||||||||||||||||
Interest—bearing deposits: |
||||||||||||||||||||||||||||
Interest checking |
$ | 375,193 | $ | 2,170 | 0.58 | % | $ | 281,807 | $ | 2,457 | 0.87 | % | $ | 133,841 | $ | 255 | 0.19 | % | ||||||||||
Money markets |
294,466 | 820 | 0.27 | % | 305,058 | 1,039 | 0.34 | % | 163,856 | 673 | 0.41 | % | ||||||||||||||||
Statement savings |
213,677 | 569 | 0.27 | % | 217,797 | 650 | 0.30 | % | 238,165 | 861 | 0.36 | % | ||||||||||||||||
Certificates of deposit |
825,070 | 9,457 | 1.14 | % | 888,661 | 10,693 | 1.20 | % | 776,585 | 11,771 | 1.52 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest—bearing deposits |
1,708,406 | 13,016 | 0.76 | % | 1,693,323 | 14,839 | 0.88 | % | 1,312,447 | 13,560 | 1.03 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Other borrowed funds |
293,927 | 8,754 | 2.98 | % | 318,240 | 9,208 | 2.89 | % | 365,724 | 10,156 | 2.78 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities and interest expense |
2,002,333 | 21,770 | 1.09 | % | 2,011,563 | 24,047 | 1.20 | % | 1,678,171 | 23,716 | 1.41 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing liabilities: |
||||||||||||||||||||||||||||
Demand deposits |
414,192 | 333,496 | 257,620 | |||||||||||||||||||||||||
Other liabilities |
46,171 | 43,831 | 29,400 | |||||||||||||||||||||||||
Common shareholders' equity |
320,552 | 282,743 | 241,755 | |||||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and shareholders' equity |
$ | 2,783,248 | $ | 2,671,633 | $ | 2,206,946 | ||||||||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income and net interest margin(2) |
$ | 93,438 | 3.52 | % | $ | 91,902 | 3.61 | % | $ | 80,075 | 3.81 | % | ||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
- (1)
- Non-accrual
loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not
material for the years presented.
- (2)
- Interest income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 35%.
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Rate and Volume Analysis
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 Compared to 2012. | 2012 Compared to 2011. | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Average Volume(3) |
Average Rate |
Increase (Decrease) |
Average Volume(3) |
Average Rate |
Increase (Decrease) |
|||||||||||||
Interest income: |
|||||||||||||||||||
Loans(1)(2): |
|||||||||||||||||||
Commercial and industrial |
$ | (570 | ) | $ | (143 | ) | $ | (713 | ) | $ | 1,126 | $ | (554 | ) | $ | 572 | |||
Real estate—commercial |
9,400 | (6,284 | ) | 3,116 | 4,666 | (3,864 | ) | 802 | |||||||||||
Real estate—construction |
487 | (190 | ) | 297 | 5,040 | (947 | ) | 4,093 | |||||||||||
Real estate—residential |
257 | (1,047 | ) | (790 | ) | 1,563 | (615 | ) | 948 | ||||||||||
Home equity lines |
(265 | ) | (37 | ) | (302 | ) | (81 | ) | (1 | ) | (82 | ) | |||||||
Consumer |
(13 | ) | 15 | 2 | 24 | (12 | ) | 12 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total loans(1)(2) |
9,296 | (7,686 | ) | 1,610 | 12,338 | (5,993 | ) | 6,345 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Loans held for sale |
(3,109 | ) | 786 | (2,323 | ) | 10,637 | (2,386 | ) | 8,251 | ||||||||||
Investment securities available-for-sale(2) |
452 | (523 | ) | (71 | ) | (2,380 | ) | (150 | ) | (2,530 | ) | ||||||||
Investment securities held-to-maturity |
(44 | ) | (71 | ) | (115 | ) | (108 | ) | (28 | ) | (136 | ) | |||||||
Other investments |
(29 | ) | 104 | 75 | (5 | ) | 138 | 133 | |||||||||||
Federal funds sold |
86 | (3 | ) | 83 | 79 | 16 | 95 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest income(2) |
6,652 | (7,393 | ) | (741 | ) | 20,561 | (8,403 | ) | 12,158 | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Interest expense: |
|||||||||||||||||||
Interest—bearing deposits: |
|||||||||||||||||||
Interest checking |
814 | (1,101 | ) | (287 | ) | 282 | 1,920 | 2,202 | |||||||||||
Money markets |
(7 | ) | (212 | ) | (219 | ) | 580 | (214 | ) | 366 | |||||||||
Statement savings |
(12 | ) | (69 | ) | (81 | ) | (74 | ) | (137 | ) | (211 | ) | |||||||
Certificates of deposit |
(683 | ) | (553 | ) | (1,236 | ) | 1,699 | (2,777 | ) | (1,078 | ) | ||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest—bearing deposits |
112 | (1,935 | ) | (1,823 | ) | 2,487 | (1,208 | ) | 1,279 | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Other borrowed funds |
(703 | ) | 249 | (454 | ) | (1,319 | ) | 371 | (948 | ) | |||||||||
| | | | | | | | | | | | | | | | | | | | |
Total interest expense |
(591 | ) | (1,686 | ) | (2,277 | ) | 1,168 | (837 | ) | 331 | |||||||||
| | | | | | | | | | | | | | | | | | | | |
Net interest income(2) |
$ | 7,243 | $ | (5,707 | ) | $ | 1,536 | $ | 19,393 | $ | (7,566 | ) | $ | 11,827 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
- (1)
- Non-accrual
loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not
material for the years presented.
- (2)
- Interest
income for loans receivable and investment securities available-for-sale is reported on a fully taxable-equivalent basis at a rate of 35%
- (3)
- Changes attributable to rate/volume have been allocated to volume.
2013 Compared to 2012
Net interest income for the year ended December 31, 2013 was $92.3 million, compared to $91.0 million for the year ended December 31, 2012, an increase of $1.3 million, or 1.5%. The increase in net interest income was primarily a result of our continuing to strategically decrease rates on our deposit products as a result of the low interest rate environment and additions to interest-earning assets during 2013.
Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2013 and 2012 was 3.52% and 3.61%, respectively. The decrease in our net interest margin was primarily a result of a decrease in the yields on our interest-earnings assets offset partially by our ability to decrease interest rates on deposits in addition to balance sheet management. Net interest income, on a tax
50
equivalent basis, is a financial measure that we believe provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our federal statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.
Average yields on interest-earning assets decreased to 4.33% in 2013 from 4.56% in 2012. Total average earning assets increased by 4.4% to $2.66 billion at December 31, 2013 compared to $2.54 billion at December 31, 2012 while total interest income on a tax equivalent basis decreased $741,000 to $115.2 million for the year ended December 31, 2013 compared to $115.9 million for the same period of 2012. The increase in our earnings assets was primarily driven by an increase in average loans receivable of $153.9 million, which contributed to an additional $1.6 million in interest income on a tax equivalent basis for 2013. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2013 and 2012. Additional interest income of approximately $407,000 for 2013 and $491,000 for 2012 would have been realized had all nonperforming loans performed as originally expected. Nonperforming loans exclude those loans that are both past due 90 days or more and still accruing interest due to an assessment of collectibility.
As a result of the significant decrease in loan origination activity that occurred at George Mason during 2013, average balances for loans held for sale decreased $79.5 million to $406.7 million and resulted in a decrease in interest income of $2.3 million to $16.7 million for the year ended December 31, 2013 from $19.0 million for the year ended December 31, 2012. As a result of the decrease in our loans held for sale portfolio, we invested the excess cash (which was earning 0.25% in federal funds sold) through purchases of $134.0 million in investment securities during 2013.
As a result of several strategic customer relationship initiatives, we were able to acquire additional deposit funding to support the increase in our loans receivable portfolio in 2013. Total average interest-bearing deposits increased $15.1 million to $1.71 billion at December 31, 2013 compared to $1.69 billion at December 31, 2012. Average non-interest-bearing deposits increased $80.7 million to $414.2 million at December 31, 2013 compared to $333.5 million at December 31, 2012. The largest increase in average interest-bearing deposit balances was in our interest checking, which increased $93.4 million compared to 2012. Offsetting this increase was a decrease in average certificates of deposit of $63.6 million during 2013. The decrease in average certificates of deposits was mainly due to a decrease in wholesale funding. Average brokered certificates of deposit decreased $33.4 million during 2013. These changes in the mix of our interest-bearing liabilities assisted in us decreasing our cost of interest-bearing liabilities to 1.09% in 2013 from 1.20% in 2012. The cost of other borrowed funds, which generally are shorter term fundings and which we continued to utilize during 2013 to help fund our balance sheet growth and support our loans held for sale portfolio, increased 9 basis points to 2.98% in 2013 from 2.89% in 2012. The cost of deposit liabilities decreased 12 basis points to 0.76% in 2013 from 0.88% for 2012.
2012 Compared to 2011
Net interest income for the year ended December 31, 2012 was $91.0 million, compared to $79.2 million for the year ended December 31, 2011, an increase of $11.8 million, or 15.0%. The increase in net interest income was primarily a result of our continuing to strategically decrease rates on our deposit products and other borrowed funds during 2012 compared with 2011, in addition to increases in our interest-earning assets during 2012. In 2012, we completed a blend and extend cost reduction strategy during the second quarter on certain of our FHLB advances. We expect that this strategy will reduce our interest expense by approximately $500,000 annually. During 2011, we extinguished $55.0 million in FHLB advances which had an average cost of 2.87%, or $1.6 million
51
annually. As part of the prepayment arrangement with the FHLB, we paid a one-time penalty of $2.3 million related to these advances. We replaced these advances with lower-cost longer-term funding from the FHLB. This expense is reported in the non-interest expense section of our consolidated statements of income and no such expense occurred during 2012.
Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2012 and 2011 was 3.61% and 3.81%, respectively. The decrease in our net interest margin was primarily a result of a decrease in the yields on our interest-earnings assets offset partially by our ability to decrease interest rates on deposits and balance sheet management.
The average yield on interest-earning assets decreased to 4.56% in 2012 from 4.94% in 2011, and our cost of interest-bearing liabilities decreased to 1.20% in 2012 from 1.41% in 2011. The cost of other borrowed funds, which generally are shorter term fundings and which we continued to utilize during 2012 to help fund our balance sheet growth and support our loans held for sale portfolio, increased 11 basis points to 2.89% in 2012 from 2.78% in 2011. The cost of deposit liabilities decreased 15 basis points to 0.88% in 2012 from 1.03% for 2011.
Total average earning assets increased by 21.1% to $2.5 billion at December 31, 2012 compared to $2.1 billion at December 31, 2011. The increase in our earnings assets were primarily driven by an increase in average loans receivable of $226.4 million and an increase in our inventory of loans held for sale of $241.6 million. These increases were funded by an increase in interest-bearing deposits of $380.9 million and an increase in non-interest-bearing deposits of $75.9 million.
Average loans receivable increased $226.4 million to $1.69 billion during 2012 from $1.46 billion in 2011. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2012 and 2011. Additional interest income of approximately $491,000 for 2012 and $766,000 for 2011 would have been realized had all nonperforming loans performed as originally expected. Nonperforming loans exclude those loans that are both past due 90 days or more and still accruing interest due to an assessment of collectibility.
Average interest-bearing deposits increased $380.9 million to $1.69 billion in 2012 from $1.31 billion in 2011. The largest increase in average interest-bearing deposit balances was in our interest checking, which increased $148.0 million compared to 2011. In addition, money market deposits increased $141.2 million to $305.1 million for 2012 compared to $163.9 million for 2011. Overall, the increase in our deposits was a result of our core deposit generating First Choice Checking campaign which began in early 2012. This marketing campaign generated over $180 million in new money depositors and offered an initial rate of interest of 2.01%. During the fourth quarter of 2012, we decreased the interest rate 81 basis points to 1.20% and experienced no depositor attrition as a result of the rate decrease. Average statement savings decreased $20.4 million to $217.8 million for 2012 compared to $238.2 million for 2011. Average certificates of deposit increased $112.1 million to $888.7 million during 2012 as compared to 2011.
Interest Rate Sensitivity
We are exposed to various business risks including interest rate risk. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee ("ALCO"). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.
We employ an independent consulting firm to model our interest rate sensitivity. We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are
52
developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates. In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.
For the up 200 basis point scenario, rates are gradually moved up 200 basis points in the first year and then rates remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.
At December 31, 2013, our asset/liability position was neutral based on our interest rate sensitivity model. Our net interest income would decrease by less than 0.90% in a down 100 basis point scenario and would increase by less than 0.20% in an up 200 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would decrease by less than 2.10% in a down 100 basis point scenario and would increase by less than 0.40% in an up 200 basis point scenario.
Provision Expense and Allowance for Loan Losses
Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of known and inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.
We recorded a negative provision of $32,000 for our loan loss provisioning for the year ended December 31, 2013 compared to a provision for loan losses of $7.1 million for the year ended December 31, 2012. We recorded a negative provision during 2013 as a result of recoveries we received on previously charged-off loans in prior periods in addition to improvements in certain of our loan quality metrics. The allowance for loan losses at December 31, 2013 was $27.9 million compared to $27.4 million at December 31, 2012. Our allowance for loan loss ratio as a percent of total loans at December 31, 2013 was 1.37% compared to 1.52% at December 31, 2012. The decrease in the allowance for loan loss ratio is a direct result of a decrease in our watch-list credits, recoveries recorded during 2013, and favorable adjustments to the expected loss factors and other inputs we use to calculate our loan loss reserves as described above in "Critical Accounting Policies—Allowance for Loan Losses". While we continue to report strong credit quality in our loan portfolio, we have experienced increases in our nonperforming assets as compared to historical periods and a modest increase in net charge-offs as we work out our problem credits. During 2013, our level of nonperforming assets decreased as we sold several impaired loans that encompassed two customer relationships. These impaired loans had been on nonaccrual status for several years with limited possibility for improvement. The majority of the recoveries we recorded during 2013 were a result of these loan sales.
We recorded net loan recoveries of $496,000 for the year ended December 31, 2013 and net loan charge-offs of $5.9 million for the year ended December 31, 2012. During 2013, we charged-off $42,000 in commercial and industrial loans, residential loans of $185,000 and consumer loans of $4,000. Annualized net loan recoveries was 0.03% of average loans receivable for the year ended December 31, 2013, compared to annualized net loan charge-offs of 0.35% for the year ended December 31, 2012. Nonaccrual loans totaled $2.3 million at December 31, 2013 compared to $7.6 million at December 31, 2012.
53
A sluggish job market and declining home values could adversely affect our home equity lines of credit, credit card and other loan portfolios, including causing increases in delinquencies and default rates, which could impact our charge-offs and provision for loan losses. Deterioration in commercial and residential real estate values, employment data and household incomes may also result in higher credit losses in our commercial loan portfolio. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At December 31, 2013, our commercial real estate portfolio (including construction lending) portfolio was 69.1% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our businesses, perhaps materially, and the systems by which we set limits and monitor the level or our credit exposure to individual entities and industries, may not function as we have anticipated.
The provision for loan losses was $6.9 million for 2011. Net charge-offs for the year ended December 31, 2011 was $5.0 million.
See "Critical Accounting Policies" above for more information on our allowance for loan losses methodology.
The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio.
Allowance for Loan Losses
Years Ended December 31, 2013, 2012, 2011, 2010, and 2009
(In thousands)
| |
2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Beginning balance, January 1 |
$ | 27,400 | $ | 26,159 | $ | 24,210 | $ | 18,636 | $ | 14,518 | ||||||
Provision for loan losses |
(32 | ) | 7,123 | 6,910 | 10,502 | 6,750 | ||||||||||
Loans charged off: |
||||||||||||||||
Commercial and industrial |
(42 | ) | (6,153 | ) | (5,057 | ) | (3,187 | ) | (876 | ) | ||||||
Residential |
(185 | ) | (751 | ) | (577 | ) | (2,064 | ) | (1,756 | ) | ||||||
Consumer |
(4 | ) | (15 | ) | (20 | ) | (50 | ) | (6 | ) | ||||||
| | | | | | | | | | | | | | | | | |
Total loans charged off |
(231 | ) | (6,919 | ) | (5,654 | ) | (5,301 | ) | (2,638 | ) | ||||||
Recoveries: |
||||||||||||||||
Commercial and industrial |
621 | 756 | 340 | 3 | 5 | |||||||||||
Residential |
104 | 277 | 338 | 219 | — | |||||||||||
Consumer |
2 | 4 | 15 | 151 | 1 | |||||||||||
| | | | | | | | | | | | | | | | | |
Total recoveries |
727 | 1,037 | 693 | 373 | 6 | |||||||||||
Net (charge offs) recoveries |
496 | (5,882 | ) | (4,961 | ) | (4,928 | ) | (2,632 | ) | |||||||
Ending balance, December 31, |
$ | 27,864 | $ | 27,400 | $ | 26,159 | $ | 24,210 | $ | 18,636 | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| |
2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Loans: |
||||||||||||||||
Balance at year end |
$ | 2,040,168 | $ | 1,803,429 | $ | 1,631,882 | $ | 1,409,302 | $ | 1,293,432 | ||||||
Allowance for loan losses to loans receivable, net of fees |
1.37 | % | 1.52 | % | 1.60 | % | 1.72 | % | 1.44 | % | ||||||
Net charge-offs (recoveries) to average loans receivable |
-0.03 | % | 0.35 | % | 0.34 | % | 0.37 | % | 0.22 | % | ||||||
54
Allocation of the Allowance for Loan Losses
At December 31, 2013, 2012, 2011, 2010, and 2009
(In thousands)
| |
2013 | 2012 | 2011 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Allocation | % of Total* |
Allocation | % of Total* |
Allocation | % of Total* |
|||||||||||||
Commercial and industrial |
$ | 3,329 | 10.72 | % | $ | 525 | 12.35 | % | $ | 3,390 | 14.98 | % | |||||||
Real estate—commercial |
16,076 | 51.30 | % | 17,990 | 45.80 | % | 13,377 | 45.59 | % | ||||||||||
Real estate—construction |
5,336 | 17.77 | % | 7,675 | 20.69 | % | 6,495 | 18.06 | % | ||||||||||
Real estate—residential |
2,421 | 14.65 | % | 857 | 14.42 | % | 1,709 | 13.71 | % | ||||||||||
Home equity lines |
609 | 5.36 | % | 266 | 6.51 | % | 1,119 | 7.47 | % | ||||||||||
Consumer |
93 | 0.20 | % | 87 | 0.23 | % | 69 | 0.19 | % | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total allowance for loan losses |
$ | 27,864 | 100.00 | % | $ | 27,400 | 100.00 | % | $ | 26,159 | 100.00 | % | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| |
2010 | 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Allocation | % of Total* |
Allocation | % of Total* |
|||||||||
Commercial and industrial |
$ | 2,941 | 14.20 | % | $ | 2,797 | 12.45 | % | |||||
Real estate—commercial |
10,558 | 44.73 | % | 9,666 | 45.80 | % | |||||||
Real estate—construction |
7,593 | 17.01 | % | 2,829 | 14.80 | % | |||||||
Real estate—residential |
1,875 | 15.39 | % | 2,096 | 17.67 | % | |||||||
Home equity lines |
1,175 | 8.46 | % | 1,182 | 9.07 | % | |||||||
Consumer |
68 | 0.21 | % | 66 | 0.21 | % | |||||||
| | | | | | | | | | | | | | |
Total allowance for loan losses |
$ | 24,210 | 100.00 | % | $ | 18,636 | 100.00 | % | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
- *
- Percentage of loan type to the total loan portfolio.
Non-Interest Income
The following table provides detail for non-interest income for the years ended December 31, 2013, 2012, and 2011.
55
Non-Interest Income
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Insufficient funds fee income |
$ | 342 | $ | 369 | $ | 371 | ||||
Service charges on deposit accounts |
640 | 558 | 572 | |||||||
Other fee income on deposit accounts |
259 | 251 | 159 | |||||||
ATM transaction fees |
751 | 736 | 665 | |||||||
Credit card fees |
119 | 127 | 116 | |||||||
Loan service charges |
1,328 | 1,472 | 1,210 | |||||||
Title Insurance & other income |
987 | 2,489 | 1,408 | |||||||
Investment fee income |
1,337 | 2,623 | 2,546 | |||||||
Realized and unrealized gains on mortgage banking activities |
21,615 | 47,794 | 20,529 | |||||||
Net realized gains on investment securities available-for-sale |
— | — | 2,397 | |||||||
Net realized gains on investment securities—trading |
68 | 158 | 144 | |||||||
Management fee income |
1,981 | 4,082 | 3,406 | |||||||
Bank-owned life insurance income |
411 | 3,072 | 796 | |||||||
Gain (loss) on sale of real estate |
30 | (333 | ) | — | ||||||
Other income (loss) |
43 | (6 | ) | 14 | ||||||
| | | | | | | | | | | |
Total non-interest income |
$ | 29,911 | $ | 63,392 | $ | 34,333 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Non-interest income includes service charges on deposits and loans, realized and unrealized gains on mortgage banking activities, investment fee income, management fee income, and gains on sales of investment securities available-for-sale, and continues to be an important factor in our operating results. Non-interest income for the years ended December 31, 2013 and 2012 was $29.9 million and $63.4 million, respectively.
The decrease in non-interest income for the year ended December 31, 2013, compared to the same period of 2012, is primarily the result of a decrease in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking segment. Realized and unrealized gains on mortgage banking activities decreased $26.2 million to $21.6 million for the year ended December 31, 2013, compared to $47.8 million for 2012. For the year ended December 31, 2013, gains on sales of mortgage loans totaled $21.6 million, comprised of $36.7 million in realized gains and a $15.1 million decrease in the fair value of rate lock commitments. For the year ended December 31, 2012, gains on sales of mortgage loans totaled $47.8 million, which included realized gains of $32.1 million and a $15.7 million fair value increase. For the year ended December 31, 2013, we closed $5.8 billion in mortgage originations compared to $6.6 billion in 2012. Refinance activity represented approximately 33% of the originations during 2013, a decrease from 63% experienced during 2012.
The decrease in realized and unrealized gains on mortgage banking activities is directly related to the significant decrease in loan origination and sales volume occurring in the mortgage banking segment during 2013 as compared to 2012, as mortgage rates rapidly increased during the third quarter of 2013 as a result of market concerns over the ending of qualitative easing by the Federal Reserve, which had kept interest rates at historic lows. As interest rates increase, the unrealized gains associated with the fair market value of our rate lock commitments and closed loans held for sale decreased significantly. In accordance with GAAP, if a lender enters into a mortgage loan commitment with a customer and intends to sell the mortgage loan after it is funded, the written loan commitment is to be accounted for as a derivative instrument and is to be recorded at fair value through earnings. George
56
Mason enters into commitments where individual loans are "locked in" at a specified interest rate for a fixed period. At the time of commitment, George Mason also enters into a "best efforts" forward contract with an investor to sell the loan at an agreed upon price if, and after, the loan is closed. This price represents the fair value of the "interest rate lock commitment" (IRLC) and is an unrealized gain that is included in earnings during the period of the IRLC. This gain is also recognized earlier in earnings than the expenses associated with originating, underwriting and closing the loan, which, under GAAP, are recognized and deferred by the Company at the time of loan sale to the investor. When the loan actually closes, the unrealized gain is added to the basis of the ensuing loan held for sale (LHFS). At any point in time (e.g. quarter end) the fair value of the existing IRLCs (not yet closed) and the premium to the basis of existing LHFS (loans closed but not yet purchased by investors) represent unrealized gains that have been recognized in income, either in the current period or prior periods. At the time the loan is sold to investors, the "investor buy price" is equal to the basis of the loan held for sale, and there is no gain or loss recognized. This accounting creates a mismatch between the income recognition on loan production and the expense recognition for those same loans. Direct costs associated with the loan origination, such as commissions and salaries, are recorded as a reduction to realized and unrealized gains on mortgage banking activities.
Maintaining our revenue stream in the mortgage banking segment is dependent upon our ability to originate loans and sell them to investors at or near current volumes. Over the last two years, we have increased our mortgage banking presence to 20 offices, which as of the third quarter of 2013 includes the Richmond and Virginia Beach areas of the Commonwealth of Virginia. We have also added 50 loan origination officers and support staff during the last 18 months to help increase our market share. However, loan production levels are sensitive to changes in the level of interest rates and changes in economic conditions. During 2012, revenues from mortgage banking increased due to our expansion; however, a significant portion of this increase was also due to a lowering interest rate environment that resulted in high mortgage loan refinancing activity, which did not continue at 2012 levels during 2013. Loan production levels may also suffer if we experience a slowdown in the local housing market or tightening credit conditions. Any sustained period of decreased activity caused by less refinancing transactions, higher interest rates, housing price pressure or loan underwriting restrictions would adversely affect our mortgage originations and, consequently, could significantly reduce our income from mortgage banking activities. As a result, these conditions would also adversely affect our net income.
Management fee income, which represents the income earned for services George Mason provides to other mortgage companies owned by local home builders and generally fluctuates based on the volume of loan sales, decreased $2.1 million to $2.0 million during 2013 as compared to $4.1 million in 2012. The decrease in management fee income is a result of the discontinuation of two managed company relationships within the last year in addition to the decrease in loan origination volume experienced during 2013. During the first quarter of 2014, the remaining two managed company relationships we currently provide services to will cease as will the associated revenue stream we have earned from this type of service.
Investment fee income decreased $1.3 million to $1.3 million for the year ended December 31, 2013, compared to $2.6 million for 2012. Investment fee income includes net commissions earned at CWS and income earned at Wilson/Bennett and from our trust division prior to the completion of the aforementioned wealth management reorganization as of June 30, 2013.
Service charges on deposit accounts increased $78,000 to $2.0 million for the year ended December 31, 2013, compared to $1.9 million for the year ended December 31, 2012. Service charges on deposit accounts include insufficient funds fee income, service charges on deposit accounts, other fee income on deposit accounts and ATM transaction fees as shown in the table above. Loan fees totaled $1.4 million for the year ended December 31, 2013, a decrease of $152,000, compared to $1.6 million for the year ended December 31, 2012. Title insurance and other income totaled $987,000
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for the year ended December 31, 2013, a decrease of $1.5 million, compared to $2.5 million for the year ended December 31, 2012. The decrease in title insurance and other income is primarily a result of the decrease in mortgage loan origination activity, specifically refinance activity, at George Mason 2013. As a result of new regulations that become effective during 2014, we have decided to close George Mason's title company as these new regulations impair our ability to maintain a level of profitability within this subsidiary.
For the year ended December 31, 2013, income from bank-owned life insurance was $411,000, a decrease of $2.7 million when compared to the same period of 2012. During 2012, we received a death benefit payment of $6.6 million which resulted in an increase in non-interest income of $2.4 million for the year ended December 31, 2012.
We recorded trading gains of $68,000 for the year ended December 31, 2013, compared to trading gains of $158,000 for the year ended December 31, 2012. We have purchased investments to economically hedge against fair value changes of our nonqualified deferred compensation plan liability. These investments are designated as trading securities, and as such, the changes in fair value are reflected in earnings. These trading gains were primarily the result of increased stock prices and were mostly offset by a compensation expense associated with this benefit plan.
For the year ended December 31, 2013, we recorded a gain on the sales of other real estate owned of $30,000 compared to a loss of $333,000 for the year ended December 31, 2012.
Non-interest income for the years ended December 31, 2012 and 2011 was $63.4 million and $34.3 million, respectively. The increase in non-interest income for the year ended December 31, 2012, compared to the same period of 2011, is primarily the result of an increase in realized and unrealized gains on mortgage banking activities and management fee income from our mortgage banking segment. Realized and unrealized gains on mortgage banking activities increased $27.3 million to $47.8 million for the year ended December 31, 2012, compared to $20.5 million for 2011. For the year ended December 31, 2012, gains on sales of mortgage loans totaled $47.8 million, comprised of $32.1 million in realized gains and a $15.7 million fair value increase. For the year ended December 31, 2011, gains on sales of mortgage loans totaled $20.5 million, which included realized gains of $14.4 million and a $6.1 million fair value increase. For the year ended December 31, 2012, we closed $6.6 billion in mortgage originations compared to $3.9 billion in 2011. Refinance activity represented approximately 63% of the originations during 2012, an increase from 51% experienced during 2011. The increase in realized and unrealized gains on mortgage banking activities is directly related to the substantial increase in loan origination and sales volume occurring in the mortgage banking segment during 2012 as compared to 2011, as mortgage rates declined to historic lows.
Management fee income increased $676,000 to $4.1 million during 2012 as compared to $3.4 million in 2011. The increase in management fee income is a result of the aforementioned historically low interest rate environment and the refinance boom that occur in our market during 2012.
Investment fee income increased $77,000 to $2.6 million for the year ended December 31, 2012, compared to $2.5 million for 2011. Service charges on deposit accounts increased $147,000 to $1.9 million for the year ended December 31, 2012, compared to $1.8 million for the year ended December 31, 2011. Loan fees totaled $1.6 million for the year ended December 31, 2012, an increase of $273,000, compared to $1.3 million for the year ended December 31, 2011. Title insurance and other income totaled $2.5 million for the year ended December 31, 2012, an increase of $1.1 million, compared to $1.4 million for the year ended December 31, 2011. The increase in title insurance and other income is primarily a result of an increase in fee income earned by George Mason's title company during 2012.
For the year ended December 31, 2012, the increase in the cash surrender value of our bank-owned life insurance was $3.1 million, an increase of $2.3 million when compared to the same
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period of 2011. We received a death benefit payment of $6.6 million which resulted in an increase in non-interest income of $2.4 million. The remaining increase is a result of the increase in the earnings of the underlying investment assets of our bank-owned life insurance.
For the year ended December 31, 2012, we recorded no gains on sales of investment securities available-for-sale compared to net gains of $2.4 million for the same period of 2011. During 2011, we had mortgage-backed investment securities available-for-sale that were paying off rapidly due to mortgage refinancing activity. We elected to sell these bonds and realize the current market pricing premium rather than to hold the investment and recover par. In addition, we recorded trading gains of $158,000 for the year ended December 31, 2012, compared to trading losses of $144,000 for the year ended December 31, 2011.
For the year ended December 31, 2012, we recorded a net loss on the sales of other real estate owned of $333,000. No such loss was reported in the comparable period of 2011.
Non-Interest Expense
The following table reflects the components of non-interest expense for the years ended December 31, 2013, 2012 and 2011.
Non-Interest Expense
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Salary and benefits |
$ | 41,523 | $ | 39,370 | $ | 28,707 | ||||
Occupancy |
8,389 | 7,186 | 6,032 | |||||||
Professional fees |
3,765 | 4,209 | 3,955 | |||||||
Depreciation |
3,196 | 2,669 | 2,517 | |||||||
Data processing and communications |
4,720 | 4,427 | 4,117 | |||||||
Advertising and marketing |
4,688 | 5,197 | 3,199 | |||||||
FDIC insurance assessments |
1,391 | 1,336 | 1,387 | |||||||
Mortgage loan repurchases and settlements |
(49 | ) | 962 | 670 | ||||||
Bank franchise taxes |
2,836 | 2,388 | 2,089 | |||||||
Amortization of intangibles |
148 | 198 | 198 | |||||||
Impairment of pooled trust preferred securities |
300 | — | — | |||||||
Impairment of other real estate owned |
— | — | 911 | |||||||
Loss on extinguishment of debt |
— | — | 2,271 | |||||||
Merger and acquisition expense |
464 | — | — | |||||||
Premises and equipment |
4,164 | 3,524 | 2,669 | |||||||
Stationary and supplies |
1,808 | 1,693 | 1,183 | |||||||
Loan expenses |
589 | 454 | 463 | |||||||
Other taxes |
624 | 467 | 284 | |||||||
Travel and entertainment |
764 | 763 | 632 | |||||||
Miscellaneous |
5,283 | 4,474 | 3,181 | |||||||
| | | | | | | | | | | |
Total non-interest expense |
$ | 84,603 | $ | 79,317 | $ | 64,465 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Non-interest expense includes, among other things, salaries and benefits, occupancy costs, professional fees, depreciation, data processing, telecommunications and miscellaneous expenses. Non-interest expense was $84.6 million and $79.3 million for the years ended December 31, 2013 and 2012, respectively, an increase of $5.3 million, or 6.7%. The increase in non-interest expense for the
59
year ended December 31, 2013, compared to 2012, was primarily the result of increases in salary and benefits costs, occupancy expense, and other expenses that are primarily related to market expansion.
Salaries and benefits expense increased $2.2 million to $41.5 million for the year ended December 31, 2013 compared to $39.4 million for 2012. The increase in salaries and benefits expense is primarily related to increases in our business development personnel in our commercial banking and mortgage banking segments. We added commercial lenders at the Bank and opened two de novo banking offices during 2013. Additionally, we added 32 mortgage loan officers at George Mason. The increase in expenses attributable to staffing were partially offset by a decrease in the variable component of our compensation expense, which decreased as a result of our 2013 performance.
Occupancy expense increased $1.2 million to $8.4 million for the year ended December 31, 2013 compared to $7.2 million for 2012. The increase in occupancy expense during 2013 as compared to 2012 is primarily attributable to an increase in mortgage origination offices and de novo banking offices as we strategically increase our market share. Because of our increase in locations, we have added fixed assets to support these new offices which resulted in an increase in depreciation expense of $527,000 to $3.2 million for the year ended December 31, 2013 compared to $2.7 million for the same period of 2012. Data processing and communications expense increased $293,000 to $4.7 million for the year ended December 31, 2013 compared to $4.4 million, a result of the aforementioned increase in locations.
Professional fees decreased $444,000 to $3.8 million for 2013 compared to $4.2 million for 2012. The decrease in professional fees during 2013 as compared to 2012 is primarily attributable to a decrease in legal expenses of approximately $180,000 and a decrease in temporary staffing of $328,000 that was allocated to George Mason to handle the increase in loan origination volume during the 2012 refinance boom. The level of temporary staffing was maintained at George Mason until the beginning of the third quarter of 2013 when loan origination volume dropped significantly due to the current mortgage market conditions. Marketing and advertising expense decreased $509,000 to $4.7 million for the year ended December 31, 2013 as compared to $5.2 million for the same period of 2012. The decrease in marketing and advertising expense was a result of additional expenses incurred during 2012 for our core deposit marketing campaign and support for new office openings at our mortgage banking segment.
Mortgage loan repurchases and settlements for 2013 decreased $1.0 million from $962,000 for the year ended December 31, 2012. Over the last few years, we have taken steps to limit our exposure to loan repurchases through agreements entered into with various investors. Given the steps that have been taken to limit our exposure coupled with the passage of time and the expiration of the statute of limitations for loans originated in certain prior years, our current expectation is that future putback claims will be limited in number. We evaluate the individual merits of each claim, and recognize an expense when settlement is deemed probable and the amount of such a settlement is estimable.
We recorded an other-than-temporary-impairment of $300,000 for the year ended December 31, 2013 as a result of the issuance of the Final Rules required by the Financial Reform Act which were released by federal banking agencies in late 2013. Two of our pooled trust preferred securities are considered to be "covered funds" and are now required to be divested by us before July 2015. The impairment recorded brings the book value of these investments in line with their fair value as of December 31, 2013.
Merger and acquisition expense was $464,000 for the year ended December 31, 2013 as a result of our acquisition of United Financial Banking Companies, Inc. We recorded no such expense during 2012.
Non-interest expense was $79.3 million and $64.5 million for the years ended December 31, 2012 and 2011, respectively, an increase of $14.8 million, or 23.0%. The increase in non-interest expense for
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the year ended December 31, 2012, compared to 2011, was primarily the result of increases in salary and benefits costs, occupancy expense, and marketing and advertising expense.
Salaries and benefits expense increased $10.7 million to $39.4 million for the year ended December 31, 2012 compared to $28.7 million for 2011. The increase in salaries and benefits expense is primarily related to increases in our business development personnel in our commercial banking and mortgage banking segments in addition to increases in the variable component of our compensation expense as a result of better than expected financial results for 2012.
Occupancy expense increased $1.2 million to $7.2 million for the year ended December 31, 2012 compared to $6.0 million for 2011. The increase in occupancy expense during 2012 as compared to 2011 is primarily attributable to an increase in mortgage banking offices as we strategically increase our market share in this line of business.
Professional fees increased $254,000 to $4.2 million for 2012 compared to $4.0 million for 2011. The increase in professional fees during 2012 as compared to 2011 is primarily attributable to increased legal expenses related to our response to the inquiry from the Department of Justice which we have resolved satisfactorily. Marketing and advertising expense increased $2.0 million to $5.2 million for the year ended December 31, 2012 as compared to $3.2 million for the same period of 2011. The increase in marketing and advertising expense was a result of our core deposit marketing campaign and marketing expenses which helped support new office openings at our mortgage banking segment.
FDIC insurance premiums decreased $51,000 to $1.3 million for the year ended December 31, 2012 compared to $1.4 million for the same period of 2011. Effective June 30, 2011, the FDIC changed the premium assessment calculation from a measure based on deposits to a measure based on net tangible assets. This change resulted in a lower premium expense amount for us.
We recorded an expense of $962,000 related to our mortgage loan repurchases and settlements for 2012 compared to $670,000 for 2011.
Income Taxes
We recorded a provision for income tax expense of $12.2 million for the year ended December 31, 2013, compared to $22.7 million for the year ended December 31, 2012. Our effective tax rate for December 31, 2013 was 32.3%, compared to 33.3% for 2012. Our effective tax rate is less than the statutory rate because of income we receive on tax-exempt investments.
We recorded a provision for income tax expense of $14.1 million for the year ended December 31, 2011. Our effective tax rate for December 31, 2011 was 33.5%. See also "Critical Accounting Policies—Valuation of Deferred Tax Assets".
Statements of Condition
Loans Receivable, Net
Total loans receivable, net of deferred fees and costs, were $2.04 billion at December 31, 2013, an increase of $236.7 million, or 13.1%, compared to $1.80 billion at December 31, 2012. Loans held for sale decreased $411.8 million to $374.0 million at December 31, 2013 compared to $785.8 million at December 31, 2012. The decrease in our inventory of loans held for sale during 2013 compared to 2012 is primarily due to the significant decrease in loan origination and sales volume, as mortgage rates rapidly increased during the third quarter of 2013 as a result of market concerns over the ending of qualitative easing by the Federal Reserve, which had kept interest rate at historic lows.
At December 31, 2013, we had loans accounted for on a nonaccrual basis totaling $2.3 million. Nonaccrual loans at December 31, 2012 totaled $7.6 million. We had no accruing loans contractually past due 90 days or more as to principal or interest payments at December 31, 2013 and December 31,
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2012. The decrease in nonaccrual loans from December 31, 2012 is primarily a result of having sold several impaired loans that encompassed two customer relationships. These impaired loans had been on nonaccrual status for several years with limited possibility for improvement. Loans that are classified as "troubled debt restructurings" at December 31, 2013 totaled $2.3 million compared to $7.3 million at December 31, 2012.
Interest income on nonaccrual loans, if recognized, is recorded when cash is received. When a loan is placed on nonaccrual, unpaid interest is reversed against interest income if it was accrued in the current year and is charged to the allowance for loan losses if it was accrued in prior years. While on nonaccrual, the collection of interest is recorded as interest income only after all past-due principal has been collected. When all past contractual obligations are collected and, in our opinion, the borrower has demonstrated the ability to remain current, the loan is returned to an accruing status. At December 31, 2013, the loans on nonaccrual status did not have a valuation allowance. Gross interest income that would have been recorded if our nonaccrual loans had been current with their original terms and had been outstanding throughout the period or since origination if held for part of the period for the years ended December 31, 2013 and 2012 was $626,000 and $491,000, respectively. The interest income realized prior to loans being placed on nonaccrual status for the year ended December 31, 2013 and 2012 was $5,000 and $111,000, respectively.
Total loans receivable, net of deferred fees and costs, were $1.80 billion at December 31, 2012, an increase of $171.5 million, or 10.5%, compared to $1.63 billion at December 31, 2011. Loans held for sale increased $256.3 million to $785.8 million at December 31, 2012 compared to $529.5 million at December 31, 2011. The increase in our inventory of loans held for sale during 2012 compared to 2011 is primarily the result of our continued focus to strategically increase the market share of our mortgage banking operations by opening additional offices and retaining loan origination officers for our defined market area.
At December 31, 2012, we had loans accounted for on a nonaccrual basis totaling $7.6 million. Nonaccrual loans at December 31, 2011 totaled $14.6 million. Accruing loans, which are contractually past due 90 days or more as to principal or interest payments, at December 31, 2012 and December 31, 2011 were $0 and $208,000, respectively, all of which were determined to be well secured and in the process of collection. The decrease in nonaccrual loans from December 31, 2011 is primarily a result of our aggressively managing nonperforming loans and our ability to limit exposure to certain adverse credit risk as a result of our sound credit underwriting policies. Loans that are classified as troubled debt restructurings at December 31, 2012 totaled $7.3 million compared to $15.3 million at December 31, 2011.
At December 31, 2012, the loans on nonaccrual status did not have a valuation allowance. We charged-off $3.4 million during 2012 related to the outstanding principal balances of those impaired loans which were unsecured based on the estimated values of the underlying collateral. Gross interest income that would have been recorded if our nonaccrual loans had been current with their original terms and had been outstanding throughout the period or since origination if held for part of the period for the years ended December 31, 2012 and 2011 was $491,000 and $766,000, respectively. The interest income realized prior to the loans being placed on nonaccrual status for the year ended December 31, 2012 and 2011 was $111,000 and $341,000, respectively.
The ratio of nonperforming loans to total loans was 0.11%, 0.42%, and 0.54% at December 31, 2013, 2012 and 2011, respectively.
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The following tables present the composition of our loans receivable portfolio at the end of each of the five years ended December 31, 2013 and additional information on nonperforming loans receivable.
Loans Receivable
At December 31, 2013, 2012, 2011, 2010, and 2009
(In thousands)
| |
2013 | 2012 | 2011 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 219,156 | 10.72 | % | $ | 222,961 | 12.35 | % | $ | 244,874 | 14.98 | % | |||||||
Real estate—commercial |
1,048,579 | 51.30 | % | 827,243 | 45.80 | % | 745,317 | 45.59 | % | ||||||||||
Real estate—construction |
363,063 | 17.77 | % | 373,717 | 20.69 | % | 295,189 | 18.06 | % | ||||||||||
Real estate—residential |
299,484 | 14.65 | % | 260,352 | 14.42 | % | 224,171 | 13.71 | % | ||||||||||
Home equity lines |
109,481 | 5.36 | % | 117,647 | 6.51 | % | 122,130 | 7.47 | % | ||||||||||
Consumer |
4,159 | 0.20 | % | 4,204 | 0.23 | % | 3,148 | 0.19 | % | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Gross loans |
2,043,922 | 100.00 | % | 1,806,124 | 100.00 | % | 1,634,829 | 100.00 | % | ||||||||||
Net deferred (fees) costs |
(3,754 | ) | (2,695 | ) | (2,947 | ) | |||||||||||||
Less: allowance for loan losses |
(27,864 | ) | (27,400 | ) | (26,159 | ) | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Loans receivable, net |
$ | 2,012,304 | $ | 1,776,029 | $ | 1,605,723 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| |
2010 | 2009 | |
|
|||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 200,384 | 14.20 | % | $ | 161,156 | 12.45 | % | |||||||||||
Real estate—commercial |
631,292 | 44.73 | % | 592,780 | 45.80 | % | |||||||||||||
Real estate—construction |
240,007 | 17.01 | % | 191,523 | 14.80 | % | |||||||||||||
Real estate—residential |
217,130 | 15.39 | % | 228,693 | 17.67 | % | |||||||||||||
Home equity lines |
119,403 | 8.46 | % | 117,392 | 9.07 | % | |||||||||||||
Consumer |
3,042 | 0.21 | % | 2,859 | 0.21 | % | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Gross loans |
1,411,258 | 100.00 | % | 1,294,403 | 100.00 | % | |||||||||||||
Net deferred (fees) costs |
(1,956 | ) | (971 | ) | |||||||||||||||
Less: allowance for loan losses |
(24,210 | ) | (18,636 | ) | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Loans receivable, net |
$ | 1,385,092 | $ | 1,274,796 | |||||||||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Nonperforming Loans
At December 31, 2013, 2012, 2011, 2010, and 2009
(In thousands)
| |
2013 | 2012 | 2011 | 2010 | 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Nonaccruing loans |
$ | 2,314 | $ | 7,626 | $ | 14,614 | $ | 7,516 | $ | 696 | ||||||
Loans contractually past-due 90 days or more |
— | — | 208 | 49 | 151 | |||||||||||
| | | | | | | | | | | | | | | | | |
Total nonperforming loans |
$ | 2,314 | $ | 7,626 | $ | 14,822 | $ | 7,565 | $ | 847 | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
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The following table presents information on loan maturities and interest rate sensitivity.
Loan Maturities and Interest Rate Sensitivity
At December 31, 2013
(Dollars in thousands)
| |
One Year or Less |
Between One and Five Years |
After Five Years |
Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 98,062 | $ | 99,323 | $ | 21,771 | $ | 219,156 | |||||
Real estate—commercial |
300,596 | 485,440 | 262,543 | 1,048,579 | |||||||||
Real estate—construction |
239,006 | 77,894 | 46,163 | 363,063 | |||||||||
Real estate—residential |
87,667 | 133,650 | 78,167 | 299,484 | |||||||||
Home equity lines |
106,826 | 2,359 | 296 | 109,481 | |||||||||
Consumer |
988 | 1,894 | 1,277 | 4,159 | |||||||||
| | | | | | | | | | | | | | |
Total loans receivable |
$ | 833,145 | $ | 800,560 | $ | 410,217 | $ | 2,043,922 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Fixed-rate loans |
$ | 416,215 | $ | 308,732 | $ | 724,947 | |||||||
Floating-rate loans |
384,345 | 101,485 | 485,830 | ||||||||||
| | | | | | | | | | | | | | |
Total loans receivable |
$ | 800,560 | $ | 410,217 | $ | 1,210,777 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
- *
- Payments due by period are based on the repricing characteristics and not contractual maturities.
Investment Securities
Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and trading securities. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. Investment securities-trading are securities we purchase to economically hedge against fair value changes of our nonqualified deferred compensation plan liability. These securities include cash equivalents, equities and mutual funds. Investment securities were $359.7 million at December 31, 2013, an increase of $73.3 million or 25.6%, from $286.4 million at December 31, 2012. We purchased $134.2 million in investment securities during 2013 as a result of an excess cash position we had at the Bank due to the decrease in our loans held for sale portfolio.
At December 31, 2013, the yield on the available-for-sale investment portfolio was 3.63% and the yield on the held-to-maturity portfolio was 1.79%.
We complete reviews for other-than-temporary impairment at least quarterly. As of December 31, 2013, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. At December 31, 2013, 98% of our mortgage-backed securities are guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).
We have $2.4 million in non-government non-agency mortgage-backed securities held-to-maturity. These securities are rated from AAA to AA. The various protective elements on the non agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.
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At December 31, 2013, certain of our investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.
On December 10, 2013, the Office of the Comptroller of the Currency, the FDIC, the Board of Governors of the Federal Reserve System, the SEC, and the Commodity Futures Trading Commission (collectively, "the Agencies"), released final rules (the "Final Rules") to implement Section 619 of the Financial Reform Act, commonly known as the "Volcker Rule". The Volcker Rule, among other things, prohibits banking entities from engaging in proprietary trading and from sponsoring, having an ownership interest in or having certain relationships with hedge funds or private equity funds (referred to in the Final Rules as a covered fund), subject to certain exemptions. The Final Rules impact certain investments held by banks in collateralized debt obligations backed by trust preferred securities, which may constitute ownership interests in covered funds as those terms are defined in the Final Rules. On January 14, 2014, an interim rule was issued by the federal banking regulators to exempt certain of these trust preferred securities from the covered fund definition as issued in the Final Rules.
We own four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio. Based on the interim rule, only two of the four investments were exempt from the covered fund definition. For the two investments that were not exempt as a result of the interim rule, we will be required to divest our investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015. As a result of this new regulation, these two investments which have a par value of $3.1 million at December 31, 2013, were reclassified to the available-for-sale investment securities portfolio and an other-than-temporary impairment of $300,000 was recognized as of December 31, 2013 as we no longer have the ability to hold until recovery.
The par value of the two pooled trust preferred securities still classified as held-to-maturity totaled $4.0 million at December 31, 2013. The collateral underlying these structured securities are instruments issued by financial institutions. We own the A-3 tranches in each issuance. Each of the bonds is rated by more than one rating agency. One security has a composite rating of A- and the other security has a composite rating of BBB+. Observable trading activity remains limited for these types of securities. We have estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, we expect to receive all contractual interest and principal payments recovering the amortized cost basis of each of the securities, and concluded that these securities are not other-than-temporarily impaired. We continuously monitor the financial condition of the underlying issues and the level of subordination below the A-3 tranches. We also utilize a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches. In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.
In one of the pooled trust preferred securities issues, 60% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $169 million of the remaining $233 million, or 73% of the performing collateral defaulted or deferred payment. In the other pooled trust preferred security, 56% of the principal balance is subordinate to our class of ownership, and it is estimated that a break in contractual cash flow would occur if $155 million of the remaining $243 million, or 64% of the performing collateral defaulted to deferred payment. Significant judgment is involved in the evaluation of other-than-temporary impairment. We do
65
not intend to sell nor do we believe it is probable that we will be required to sell these pooled trust preferred securities prior to the recovery of our investment.
With the exception of the aforementioned impairment recorded on certain of our pooled trust preferred securities, no other-than-temporary impairment has been recognized for the remaining securities in our investment portfolio as of December 31, 2013 and 2012.
We hold $17.8 million in FHLB stock at December 31, 2013 which is included in other investments on the statement of condition.
Investment securities were $286.4 million at December 31, 2012, a decrease of $24.1 million or 7.8%, from $310.5 million in investment securities at December 31, 2011.
Of the $286.4 million in the investment portfolio at December 31, 2012, $11.4 million were classified as held-to-maturity, $271.9 million were classified as available-for-sale, and $3.2 million were classified as trading securities. At December 31, 2012, the yield on the available-for-sale investment portfolio was 3.84% and the yield on the held-to-maturity portfolio was 2.27%.
The following table reflects the composition of the investment portfolio at December 31, 2013, 2012, and 2011.
Investment Securities
At December 31, 2013, 2012, and 2011
(In thousands)
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Available-for-sale at December 31, 2013 |
||||||||||
U.S. government-sponsored agencies |
||||||||||
One to five years |
$ | 25,591 | $ | 26,863 | 3.07 | % | ||||
Five to ten years |
20,000 | 21,404 | 3.82 | % | ||||||
After ten years |
29,971 | 28,661 | 3.59 | % | ||||||
| | | | | | | | | | | |
Total U.S. government-sponsored agencies |
75,562 | 76,928 | 3.47 | % | ||||||
| | | | | | | | | | | |
Mortgage-backed securities(1) |
||||||||||
One to five years |
99 | 101 | 4.66 | % | ||||||
Five to ten years |
25,883 | 26,134 | 3.57 | % | ||||||
After ten years |
118,627 | 121,594 | 3.78 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
144,609 | 147,829 | 3.74 | % | ||||||
| | | | | | | | | | | |
Tax exempt municipal securities(2) |
||||||||||
Within one year |
3,557 | 3,661 | 4.44 | % | ||||||
One to five years |
4,529 | 4,809 | 3.83 | % | ||||||
Five to ten years |
37,392 | 38,870 | 3.55 | % | ||||||
After ten years |
62,970 | 63,744 | 3.61 | % | ||||||
Taxable municipal securities |
||||||||||
Five to ten years |
4,273 | 4,602 | 4.99 | % | ||||||
After ten years |
995 | 1,052 | 5.33 | % | ||||||
| | | | | | | | | | | |
Total municipal securities |
113,716 | 116,738 | 3.69 | % | ||||||
| | | | | | | | | | | |
U. S. treasury securities |
||||||||||
Within one year |
4,992 | 5,029 | 2.36 | % | ||||||
| | | | | | | | | | | |
Total U.S. treasury securities |
4,992 | 5,029 | 2.36 | % | ||||||
| | | | | | | | | | | |
Pooled trust preferred securities |
||||||||||
After ten years |
2,795 | 2,795 | 1.49 | % | ||||||
| | | | | | | | | | | |
Total pooled trust preferred securities |
2,795 | 2,795 | 1.49 | % | ||||||
| | | | | | | | | | | |
Total investment securities available-for-sale |
$ | 341,674 | $ | 349,319 | 3.63 | % | ||||
| | | | | | | | | | | |
66
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Held-to-maturity at December 31, 2013 |
||||||||||
Mortgage-backed securities(1) |
||||||||||
One to five years |
$ | 663 | $ | 703 | 4.63 | % | ||||
Five to ten years |
131 | 137 | 5.44 | % | ||||||
After ten years |
1,678 | 1,777 | 2.02 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
2,472 | 2,617 | 2.90 | % | ||||||
| | | | | | | | | | | |
Pooled trust preferred securities |
||||||||||
After ten years |
4,005 | 2,910 | 1.11 | % | ||||||
| | | | | | | | | | | |
Total pooled trust preferred securities |
4,005 | 2,910 | 1.11 | % | ||||||
| | | | | | | | | | | |
Total investment securities held-to-maturity |
6,477 | 5,527 | 1.79 | % | ||||||
| | | | | | | | | | | |
Total investment securities |
$ | 348,151 | $ | 354,846 | 3.58 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Available-for-sale at December 31, 2012 |
||||||||||
U.S. government-sponsored agencies |
||||||||||
One to five years |
$ | 25,596 | $ | 27,757 | 3.01 | % | ||||
Five to ten years |
30,160 | 33,776 | 3.01 | % | ||||||
| | | | | | | | | | | |
Total U.S. government-sponsored agencies |
55,756 | 61,533 | 3.01 | % | ||||||
| | | | | | | | | | | |
Mortgage-backed securities(1) |
||||||||||
Five to ten years |
4,956 | 5,261 | 4.18 | % | ||||||
After ten years |
105,258 | 113,652 | 4.26 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
110,214 | 118,913 | 4.26 | % | ||||||
| | | | | | | | | | | |
Tax exempt municipal securities(2) |
||||||||||
One to five years |
5,137 | 5,428 | 4.13 | % | ||||||
Five to ten years |
26,191 | 28,738 | 3.51 | % | ||||||
After ten years |
42,445 | 46,163 | 4.03 | % | ||||||
Taxable municipal securities |
||||||||||
Five to ten years |
3,789 | 4,345 | 4.97 | % | ||||||
After ten years |
1,493 | 1,673 | 5.27 | % | ||||||
| | | | | | | | | | | |
Total municipal securities |
79,055 | 86,347 | 3.93 | % | ||||||
| | | | | | | | | | | |
U. S. treasury securities |
||||||||||
One to five years |
4,968 | 5,110 | 2.36 | % | ||||||
| | | | | | | | | | | |
Total U.S. treasury securities |
4,968 | 5,110 | 2.36 | % | ||||||
| | | | | | | | | | | |
Total investment securities available-for-sale |
$ | 249,993 | $ | 271,903 | 3.84 | % | ||||
| | | | | | | | | | | |
67
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Held-to-maturity at December 31, 2012 |
||||||||||
Mortgage-backed securities(1) |
||||||||||
One to five years |
$ | 186 | $ | 201 | 4.48 | % | ||||
Five to ten years |
928 | 991 | 4.77 | % | ||||||
After ten years |
2,591 | 2,755 | 3.86 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
3,705 | 3,947 | 4.12 | % | ||||||
| | | | | | | | | | | |
Pooled trust preferred securities |
||||||||||
After ten years |
7,661 | 5,072 | 1.38 | % | ||||||
| | | | | | | | | | | |
Total pooled trust preferred securities |
7,661 | 5,072 | 1.38 | % | ||||||
| | | | | | | | | | | |
Total investment securities held-to-maturity |
11,366 | 9,019 | 2.27 | % | ||||||
| | | | | | | | | | | |
Total investment securities |
$ | 261,359 | $ | 280,922 | 3.77 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Available-for-sale at December 31, 2011 |
||||||||||
U.S. government-sponsored agencies |
||||||||||
One to five years |
$ | 5,254 | $ | 5,908 | 3.92 | % | ||||
Five to ten years |
30,481 | 34,192 | 3.98 | % | ||||||
| | | | | | | | | | | |
Total U.S. government-sponsored agencies |
35,735 | 40,100 | 3.97 | % | ||||||
| | | | | | | | | | | |
Mortgage-backed securities(1) |
||||||||||
Five to ten years |
7,477 | 7,867 | 4.08 | % | ||||||
After ten years |
150,073 | 159,227 | 4.29 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
157,550 | 167,094 | 4.28 | % | ||||||
| | | | | | | | | | | |
Tax exempt municipal securities(2) |
||||||||||
One to five years |
240 | 258 | 4.30 | % | ||||||
Five to ten years |
17,185 | 18,794 | 3.50 | % | ||||||
After ten years |
53,825 | 58,364 | 4.03 | % | ||||||
Taxable municipal securities |
||||||||||
Five to ten years |
3,305 | 3,656 | 4.96 | % | ||||||
After ten years |
1,991 | 2,113 | 5.21 | % | ||||||
| | | | | | | | | | | |
Total municipal securities |
76,546 | 83,185 | 3.98 | % | ||||||
| | | | | | | | | | | |
U. S. treasury securities |
||||||||||
One to five years |
4,945 | 5,181 | 2.36 | % | ||||||
| | | | | | | | | | | |
Total U.S. treasury securities |
4,945 | 5,181 | 2.36 | % | ||||||
| | | | | | | | | | | |
Total investment securities available-for-sale |
$ | 274,776 | $ | 295,560 | 4.12 | % | ||||
| | | | | | | | | | | |
68
| |
Amortized Cost |
Fair Value |
Average Yield |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Held-to-maturity at December 31, 2011 |
||||||||||
Mortgage-backed securities(1) |
||||||||||
Five to ten years |
$ | 1,671 | $ | 1,783 | 4.71 | % | ||||
After ten years |
3,444 | 3,651 | 4.22 | % | ||||||
| | | | | | | | | | | |
Total mortgage-backed securities |
5,115 | 5,434 | 4.38 | % | ||||||
| | | | | | | | | | | |
Pooled trust preferred securities |
||||||||||
After ten years |
7,803 | 4,532 | 1.47 | % | ||||||
| | | | | | | | | | | |
Total pooled trust preferred securities |
7,803 | 4,532 | 1.47 | % | ||||||
| | | | | | | | | | | |
Total investment securities held-to-maturity |
12,918 | 9,966 | 2.63 | % | ||||||
| | | | | | | | | | | |
Total investment securities |
$ | 287,694 | $ | 305,526 | 4.05 | % | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
- (1)
- Based
on contractual maturities.
- (2)
- Yields for our tax-exempt municipal securities are not reported on a tax-equivalent basis.
Deposits and Other Borrowed Funds
Total deposits were $2.06 billion at December 31, 2013, a decrease of $184.9 million, or 8.2%, from $2.24 billion at December 31, 2012. The decrease in total deposits during 2013 as compared to 2012 was primarily due to a decrease in wholesale funding in the form of brokered certificates of deposit. Brokered certificates of deposit decreased $340.4 million to $301.2 million at December 31, 2013 compared to $641.6 million at December 31, 2012. We have had success in attracting deposit balances from customers seeking to deposit their money with smaller, local banks and depositors are increasing balances held with financial institutions as a result of the increased protection of their money by the FDIC.
We use short term brokered CDs to assist us in funding our loans held for sale portfolio. During 2012 as a result of our expansion in the mortgage banking segment, we saw a significant increase in our loans held for sale inventory, which has caused a corresponding increase in our brokered CD balances. During 2013, we used the funds available from the decrease in loans held for sale to return brokered CDs funds as they matured. At December 31, 2013, we had brokered certificates of deposit of $301.2 million, of which $72.7 million were placed in the CDARS program. We are a member of the Certificates of Deposit Account Registry Service ("CDARS"). CDARS allows banking customers to access FDIC insurance protection on multi-million dollar certificates of deposit. When a customer places a large deposit through CDARS, funds are placed into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection. Our CDARs deposits are primarily a result of our participation in the network's one-way buy program. This program allows us to post a bid rate for CDARS network banking customers to simply place deposits with us. We entered into $50.4 million in one-way buys in order to lock-in short-term funding at December 31, 2013. Brokered certificates of deposit at December 31, 2012 were $641.6 million, of which $293.6 million were in the CDARS program.
Other borrowed funds, which primarily include federal funds purchased, customer repurchase agreements, FHLB advances and our payable to Cardinal Statutory Trust I, were $475.2 million at December 31, 2013, an increase of $83.0 million, from $392.3 million at December 31, 2012. The primary reason for the increase in other borrowed funds at December 31, 2013 was due to an increase in advances from the Federal Home Loan Bank of Atlanta of $100 million to $315.0 million at December 31, 2013 compared to $215.0 million at December 31, 2012. These advances were primarily used to assist in funding loans receivable originations at the Bank during 2013.
69
Other borrowed funds at each of December 31, 2013 and 2012, included $20.6 million payable to Cardinal Statutory Trust I, the issuer of our trust preferred securities. This debt had an interest rate of 2.64% and 2.71% at December 31, 2013 and 2012, respectively. Cardinal Statutory Trust I is an unconsolidated entity as we are not the primary beneficiary of the trust.
At December 31, 2013, other borrowed funds also included $94.6 million in customer repurchase agreements, and $45.0 million in federal funds purchased.
The following table reflects the short-term borrowings and other borrowed funds outstanding at December 31, 2013.
Short-Term Borrowings and Other Borrowed Funds
At December 31, 2013
(In thousands)
Advance Date
|
Term of Advance | Maturity or Call Date |
Interest Rate | Amount Outstanding |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Dec-13 |
1 month | Jan-14 | 0.17 | % | $ | 100,000 | |||||
| | | | | | | | | | | | |
Total short-term FHLB advances and weighted average rate |
0.17 | % | $ | 100,000 | |||||||
| | | | | | | | | | | | |
|
|||||||||||
Customer repurchase agreements |
0.16 | % | $ | 94,613 | |||||||
Federal Funds Purchased |
0.43 | % | 45,000 | ||||||||
| | | | | | | | | | | | |
Total other short-term borrowed funds and weighted average rate |
0.25 | % | $ | 139,613 | |||||||
| | | | | | | | | | | | |
Other borrowed funds: |
|||||||||||
Trust preferred |
3.36 | % | $ | 20,619 | |||||||
FHLB advances—long term |
4.45 | % | 215,000 | ||||||||
| | | | | | | | | | | | |
Other borrowed funds and weighted average rate |
4.35 | % | $ | 235,619 | |||||||
| | | | | | | | | | | | |
Total other borrowed funds and weighted average rate |
2.27 | % | $ | 475,232 | |||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Total deposits were $2.24 billion at December 31, 2012, an increase of $468.5 million, or 26.4%, from $1.78 billion at December 31, 2011. At December 31, 2012, we had brokered certificates of deposit of $641.6 million, of which $293.6 million were placed in the CDARS program, and primarily generated from the one-way buy program. We entered into $277.0 million in one-way buys in order to lock-in short-term funding as a result of the increase in our loans held for sale portfolio in the latter half of 2012. Brokered certificates of deposit at December 31, 2011 were $452.0 million, of which $303.2 million were in the CDARS program.
Other borrowed funds were $392.3 million at December 31, 2012, a decrease of $118.1 million, from $510.4 million at December 31, 2011. The primary reason for the decrease in other borrowed funds at December 31, 2012 was due to a decrease in FHLB advances of $80 million to $215.0 million at December 31, 2012 compared to $295.0 million at December 31, 2011.
Other borrowed funds at each of December 31, 2012 and 2011, included $20.6 million payable to Cardinal Statutory Trust I, the issuer of our trust preferred securities. This debt had an interest rate of 2.71% and 2.95% at December 31, 2012 and 2011, respectively.
At December 31, 2012, other borrowed funds also included $106.7 million in customer repurchase agreements and $50.0 million in federal funds purchased.
70
The following table reflects the maturities of the certificates of deposit of $100,000 or more as of December 31, 2013, 2012 and 2011.
Certificates of Deposit of $100,000 or More
At December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Maturities:
|
Fixed Term | No-Penalty* | Total | |||||||
Three months or less |
$ | 116,690 | $ | 7,196 | $ | 123,886 | ||||
Over three months through six months |
43,466 | 2,455 | 45,921 | |||||||
Over six months through twelve months |
46,909 | 2,105 | 49,014 | |||||||
Over twelve months |
90,186 | 40,970 | 131,156 | |||||||
| | | | | | | | | | | |
|
$ | 297,251 | $ | 52,726 | $ | 349,977 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| |
2012 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Maturities:
|
Fixed Term | No-Penalty* | Total | |||||||
Three months or less |
$ | 281,426 | $ | 15,024 | $ | 296,450 | ||||
Over three months through six months |
59,679 | 2,445 | 62,124 | |||||||
Over six months through twelve months |
54,783 | 3,369 | 58,152 | |||||||
Over twelve months |
115,776 | 32,582 | 148,358 | |||||||
| | | | | | | | | | | |
|
$ | 511,664 | $ | 53,420 | $ | 565,084 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
| |
2011 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
Maturities:
|
Fixed Term | No-Penalty* | Total | |||||||
Three months or less |
$ | 338,083 | $ | 8,632 | $ | 346,715 | ||||
Over three months through six months |
47,584 | 2,813 | 50,397 | |||||||
Over six months through twelve months |
49,171 | 13,071 | 62,242 | |||||||
Over twelve months |
113,905 | 20,052 | 133,957 | |||||||
| | | | | | | | | | | |
|
$ | 548,743 | $ | 44,568 | $ | 593,311 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
- *
- No-Penalty certificates of deposit can be redeemed at anytime at the request of the depositor.
Business Segment Operations
We provide banking and non-banking financial services and products through our subsidiaries. We operate in three business segments, commercial banking, mortgage banking and wealth management services. As of June 30, 2013, we merged operations of our trust division and Wilson/Bennett into CWS, both of which had been included in the wealth management services segment. In addition, as of June 30, 2013, we merged operations of Cardinal First Mortgage, LLC, and merged this subsidiary into George Mason. Results for the year ended December 31, 2013 include six months of operations of these subsidiaries prior to their closure.
The commercial banking segment includes both commercial and consumer lending and provides customers such products as commercial loans, real estate loans, and other business financing and consumer loans. In addition, this segment also provides customers with various deposit products including demand deposit accounts, savings accounts and certificates of deposit.
71
The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis.
The wealth management services segment provides investment and financial services to businesses and individuals, including financial planning, retirement/estate planning, investment management.
Information about the reportable segments, and reconciliation of this information to the consolidated financial statements at December 31, 2013, 2012 and 2011 follows.
Segment Reporting
December 31, 2013, 2012, and 2011
(In thousands)
At and for the Year Ended December 31, 2013:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 90,563 | $ | 2,474 | $ | — | $ | (692 | ) | $ | — | $ | 92,345 | ||||||
Provision for loan losses |
(117 | ) | 85 | — | — | — | (32 | ) | |||||||||||
Non-interest income |
3,767 | 24,760 | 1,337 | 85 | (38 | ) | 29,911 | ||||||||||||
Non-interest expense |
43,832 | 35,185 | 1,580 | 4,044 | (38 | ) | 84,603 | ||||||||||||
Provision (benefit) for income taxes |
16,734 | (2,821 | ) | (81 | ) | (1,657 | ) | — | 12,175 | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 33,881 | $ | (5,215 | ) | $ | (162 | ) | $ | (2,994 | ) | $ | — | $ | 25,510 | ||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,862,039 | $ | 380,124 | $ | 2,266 | $ | 323,538 | $ | (673,737 | ) | $ | 2,894,230 | ||||||
At and for the Year Ended December 31, 2012:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 89,472 | $ | 2,365 | $ | — | $ | (834 | ) | $ | — | $ | 91,003 | ||||||
Provision for loan losses |
6,865 | 258 | — | — | — | 7,123 | |||||||||||||
Non-interest income |
5,868 | 54,794 | 2,623 | 176 | (69 | ) | 63,392 | ||||||||||||
Non-interest expense |
43,495 | 29,529 | 2,656 | 3,706 | (69 | ) | 79,317 | ||||||||||||
Provision (benefit) for income taxes |
14,436 | 9,764 | (14 | ) | (1,528 | ) | — | 22,658 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 30,544 | $ | 17,608 | $ | (19 | ) | $ | (2,836 | ) | $ | — | $ | 45,297 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,954,412 | $ | 815,820 | $ | 2,693 | $ | 329,328 | $ | (1,063,066 | ) | $ | 3,039,187 | ||||||
72
At and for the Year Ended December 31, 2011:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 77,456 | $ | 2,522 | $ | — | $ | (816 | ) | $ | — | $ | 79,162 | ||||||
Provision for loan losses |
6,910 | — | — | — | — | 6,910 | |||||||||||||
Non-interest income |
6,116 | 25,592 | 2,552 | 161 | (88 | ) | 34,333 | ||||||||||||
Non-interest expense |
42,202 | 16,032 | 2,610 | 3,709 | (88 | ) | 64,465 | ||||||||||||
Provision (benefit) for income taxes |
11,397 | 4,291 | (29 | ) | (1,537 | ) | — | 14,122 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 23,063 | $ | 7,791 | $ | (29 | ) | $ | (2,827 | ) | $ | — | $ | 27,998 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,549,326 | $ | 531,403 | $ | 590 | $ | 278,820 | $ | (757,423 | ) | $ | 2,602,716 | ||||||
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of a financial institution. The guidelines define capital as both Tier 1 (which includes common shareholders' equity, defined to include certain debt obligations) and Tier 2 (to include certain other debt obligations and a portion of the allowance for loan losses and 45% of unrealized gains in equity securities).
Shareholders' equity at December 31, 2013 was $320.5 million, an increase of $12.5 million, compared to $308.1 million at December 31, 2012. For the year ended December 31, 2013, we recorded net income of $25.5 million, which contributed to the increase in shareholders' equity during 2013. Accumulated other comprehensive income decreased $8.2 million for the year ended December 31, 2013. Total shareholders' equity to total assets at December 31, 2013 and 2012 was 11.1% and 10.1%, respectively. Book value per share at December 31, 2013 and 2012 was $10.57 and $10.19, respectively. Total risk-based capital to risk-weighted assets was 12.89% at December 31, 2013 compared to 13.04% at December 31, 2012. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2013.
Shareholders' equity at December 31, 2012 was $308.1 million, an increase of $50.3 million, compared to $257.8 million at December 31, 2011. For the year ended December 31, 2012, we recorded net income of $45.3 million, which contributed to the increase in shareholders' equity during 2012. Accumulated other comprehensive income increased $1.5 million for the year ended December 31, 2012. Total shareholders' equity to total assets at December 31, 2012 and 2011 was 10.1% and 9.9%, respectively. Book value per share at December 31, 2012 and 2011 was $10.19 and $8.83, respectively. Total risk-based capital to risk-weighted assets was 13.04% at December 31, 2012 compared to 12.49% at December 31, 2011. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2012.
As noted above, regulatory capital levels for the bank and bank holding company meet those established for "well-capitalized" institutions. While we are currently considered "well-capitalized," we may from time-to-time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.
The following table shows the minimum capital requirement and our capital position at December 31, 2013, 2012, and 2011 for the Company and for the Bank.
73
Capital Components
At December 31, 2013, 2012, and 2011
(In thousands)
Cardinal Financial Corporation (Consolidated):
| |
Actual | For Capital Adequacy Purposes |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||||
At December 31, 2013 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 349,894 | 12.89 | % | $ | 217,111 | ³ | 8.00 | % | $ | 271,389 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
321,513 | 11.85 | % | 108,555 | ³ | 4.00 | % | 162,833 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
321,513 | 11.70 | % | 109,928 | ³ | 4.00 | % | 137,410 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2012 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 328,547 | 13.04 | % | $ | 201,530 | ³ | 8.00 | % | $ | 251,913 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
300,732 | 11.94 | % | 100,765 | ³ | 4.00 | % | 151,148 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
300,732 | 10.49 | % | 114,693 | ³ | 4.00 | % | 143,366 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2011 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 278,385 | 12.49 | % | $ | 178,364 | ³ | 8.00 | % | $ | 222,955 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
251,811 | 11.29 | % | 89,182 | ³ | 4.00 | % | 133,773 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
251,811 | 10.14 | % | 99,319 | ³ | 4.00 | % | 124,149 | ³ | 5.00 | % | ||||||||||||||
Cardinal Bank:
| |
Actual | For Capital Adequacy Purposes |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||||
At December 31, 2013 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 343,392 | 12.73 | % | $ | 215,733 | ³ | 8.00 | % | $ | 269,666 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
315,011 | 11.68 | % | 107,867 | ³ | 4.00 | % | 161,800 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
315,011 | 11.54 | % | 109,212 | ³ | 4.00 | % | 136,515 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2012 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 315,511 | 12.59 | % | $ | 200,440 | ³ | 8.00 | % | $ | 250,550 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
287,695 | 11.48 | % | 100,220 | ³ | 4.00 | % | 150,330 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
287,695 | 10.08 | % | 114,196 | ³ | 4.00 | % | 142,745 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2011 |
|||||||||||||||||||||||||
Total risk-based capital |
$ | 265,668 | 11.98 | % | $ | 177,479 | ³ | 8.00 | % | $ | 221,849 | ³ | 10.00 | % | |||||||||||
Tier I risk-based capital |
239,093 | 10.78 | % | 88,740 | ³ | 4.00 | % | 133,110 | ³ | 6.00 | % | ||||||||||||||
Leverage capital ratio |
239,093 | 9.68 | % | 98,783 | ³ | 4.00 | % | 123,479 | ³ | 5.00 | % | ||||||||||||||
74
Liquidity
Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service and pricing.
In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered CD market, the repurchase agreement market and the federal funds market. We are a member of the Certificates of Deposit Account Registry Services ("CDARS"). CDARS allows banking customers to access FDIC insurance protection on multi-million dollar certificates of deposit through our Bank. When a customer places a large deposit through CDARS, we place their funds into certificates of deposit with other banks in the CDARS network in increments of less than $250,000 so that principal and interest are eligible for FDIC insurance protection. We also maintain secured lines of credit with the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.
Cash flow from amortizing assets or maturing assets can also provide funding to meet the needs of depositors and borrowers.
We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.
Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $378.5 million at December 31, 2013, or 13.1% of total assets. We held investments that are classified as held-to-maturity in the amount of $6.5 million at December 31, 2013. To maintain ready access to the Bank's secured lines of credit, the Bank has pledged roughly half of its investment securities and a portion of its commercial real estate and residential real estate loan portfolios to the Federal Home Loan Bank of Atlanta with additional investment securities and certain loans in its commercial & industrial loan portfolios pledged to the Federal Reserve Bank of Richmond. Additional borrowing capacity at the Federal Home Loan Bank of Atlanta at December 31, 2013 was approximately $439.8 million. Borrowing capacity with the Federal Reserve Bank of Richmond was approximately $94.5 million at December 31, 2013. These facilities are subject to the FHLB and the Federal Reserve approving disbursement to us. In addition, we have unsecured federal funds purchased lines of $315 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.
Contractual Obligations
We have entered into a number of long-term contractual obligations to support our ongoing activities. These contractual obligations will be funded through operating revenues and liquidity sources held or available to us and exclude contractual interest costs, where applicable.
75
The required payments under such obligations excluding interest were as follows:
Contractual Obligations
At December 31, 2013
(In thousands)
| |
Payments Due by Period | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Total | Less than 1 Year |
1 - 3 Years | 3 - 5 Years | More than 5 Years |
|||||||||||
Long-Term Debt Obligations: |
||||||||||||||||
Certificates of deposit |
$ | 450,031 | $ | 246,997 | $ | 169,781 | $ | 30,186 | $ | 3,067 | ||||||
Brokered certificates of deposit |
301,236 | 181,640 | 85,348 | 34,248 | — | |||||||||||
Advances from the Federal Home Loan Bank of Atlanta |
315,000 | 100,000 | 75,000 | 110,000 | 30,000 | |||||||||||
Trust preferred securities |
20,619 | — | — | — | 20,619 | |||||||||||
Operating lease obligations |
36,880 | 8,408 | 12,305 | 7,267 | 8,900 | |||||||||||
| | | | | | | | | | | | | | | | | |
Total |
$ | 1,123,766 | $ | 537,045 | $ | 342,434 | $ | 181,701 | $ | 62,586 | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Financial Instruments with Off-Balance-Sheet Risk and Credit Risk
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
The Bank's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer's credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.
Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan
76
facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.
A summary of the contract amount of the Bank's exposure to off-balance-sheet risk as of December 31, 2013 and 2012, is as follows:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Financial instruments whose contract amounts represent potential credit risk: |
|||||||
Commitments to extend credit |
$ | 1,486,572 | $ | 1,248,766 | |||
Standby letters of credit |
28,008 | 36,466 | |||||
Commitments to extend credit of $210.9 million as of December 31, 2013 were related to George Mason's mortgage loan funding commitments and were of a short-term nature. Commitments to extend credit of $1.3 billion primarily have floating rates as of December 31, 2013. It is uncertain as to the amount that we will be required to fund on these commitments as many such arrangements expire with no amount drawn.
We have counter-party risk which may arise from the possible inability of George Mason's third-party investors to meet the terms of their forward sales contracts. George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk. We do not expect any third-party investor to fail to meet its obligation. In addition, we have derivative counterparty risk relating to three interest rate swaps we have with third parties. This risk may arise from the inability of the third party to meet the terms of the contract. We continuously monitor the financial condition of these third parties. We do not expect these third parties to fail to meet their obligations.
George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities. We evaluate the merits of each claim and estimate the reserve based on actual and expected claims received and consider the historical amounts paid to settle such claims. We have taken steps to limit our exposure to such loan repurchases through agreements entered into with various investors. As a result, we received a limited number of additional claims.
During 2013 and 2012, George Mason either repurchased from or settled with investors on such loans for a total of $302,000 and $375,000, respectively. This reserve had a balance of $261,000 and $628,000 at December 31, 2013 and 2012, respectively. The expense (benefit) related to this reserve for the years ended December 2013, 2012, and 2011 was ($49,000), $962,000, and $670,000, respectively.
Quarterly Data
The following table provides quarterly data for the years ended December 31, 2013 and 2012. Quarterly per share results may not calculate to the year-end per share results due to rounding.
77
Quarterly Data
Years ended December 31, 2013 and 2012
(In thousands, except per share data)
| |
2013 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Fourth Quarter |
Third Quarter |
Second Quarter |
First Quarter |
|||||||||
Interest income |
$ | 29,078 | $ | 29,052 | $ | 27,779 | $ | 28,206 | |||||
Interest expense |
5,279 | 5,360 | 5,526 | 5,605 | |||||||||
| | | | | | | | | | | | | | |
Net interest income |
23,799 | 23,692 | 22,253 | 22,601 | |||||||||
Provision for loan losses |
(400 | ) | (157 | ) | 132 | 457 | |||||||
| | | | | | | | | | | | | | |
Net interest income after provision for loan losses |
23,399 | 23,535 | 22,385 | 23,058 | |||||||||
Non-interest income |
6,152 | 1,658 | 13,627 | 8,474 | |||||||||
Non-interest expense |
21,626 | 21,044 | 21,251 | 20,682 | |||||||||
| | | | | | | | | | | | | | |
Net income before income taxes |
7,925 | 4,149 | 14,761 | 10,850 | |||||||||
Provision for income taxes |
2,379 | 1,168 | 4,958 | 3,670 | |||||||||
| | | | | | | | | | | | | | |
Net income |
$ | 5,546 | $ | 2,981 | $ | 9,803 | $ | 7,180 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Earnings per share—basic |
$ | 0.18 | $ | 0.10 | $ | 0.32 | $ | 0.23 | |||||
| | | | | | | | | | | | | | |
Earnings per share—diluted |
$ | 0.18 | $ | 0.10 | $ | 0.32 | $ | 0.23 | |||||
| | | | | | | | | | | | | | |
| |
2012 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Fourth Quarter |
Third Quarter |
Second Quarter |
First Quarter |
|||||||||
Interest income |
$ | 29,960 | $ | 29,838 | $ | 27,582 | $ | 27,670 | |||||
Interest expense |
5,794 | 6,180 | 6,141 | 5,932 | |||||||||
| | | | | | | | | | | | | | |
Net interest income |
24,166 | 23,658 | 21,441 | 21,738 | |||||||||
Provision for loan losses |
(1,500 | ) | (1,500 | ) | (2,225 | ) | (1,898 | ) | |||||
| | | | | | | | | | | | | | |
Net interest income after provision for loan losses |
22,666 | 22,158 | 19,216 | 19,840 | |||||||||
Non-interest income |
14,975 | 22,172 | 16,563 | 9,682 | |||||||||
Non-interest expense |
18,578 | 22,287 | 20,371 | 18,081 | |||||||||
| | | | | | | | | | | | | | |
Net income before income taxes |
19,063 | 22,043 | 15,408 | 11,441 | |||||||||
Provision for income taxes |
6,022 | 7,591 | 5,257 | 3,788 | |||||||||
| | | | | | | | | | | | | | |
Net income |
$ | 13,041 | $ | 14,452 | $ | 10,151 | $ | 7,653 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Earnings per share—basic |
$ | 0.43 | $ | 0.49 | $ | 0.34 | $ | 0.26 | |||||
| | | | | | | | | | | | | | |
Earnings per share—diluted |
$ | 0.43 | $ | 0.48 | $ | 0.34 | $ | 0.26 | |||||
| | | | | | | | | | | | | | |
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our Asset/Liability Committee is responsible for reviewing our liquidity requirements and maximizing our net interest income consistent with capital requirements, liquidity, interest rate and economic outlooks, competitive factors and customer needs. Interest rate risk arises because the assets of the Bank and the liabilities of the Bank have different maturities and characteristics. In order to measure this interest rate risk, we use a simulation process that measures the impact of changing interest rates on net interest income. This model is run for the Bank by an independent consulting firm. The simulations incorporate assumptions related to expected activity in the balance sheet. For
78
maturing assets, assumptions are developed for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the most recent period end balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that interest rates remain unchanged. This becomes the base case. Next, the model determines the impact on net interest income given specified changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points and up 200 basis points. The down 200 basis point scenario was discontinued given the current level of interest rates. In the ramped down rate change, the model moves rates gradually down 100 basis points over the first year and then rates remain flat in the second year.
For the up 200 basis point scenario, rates are gradually moved up 200 basis points in the first year and remain flat in the second year. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.
At December 31, 2013, our asset/liability position was neutral based on our interest rate sensitivity model. Our net interest income would decrease by less than 0.90% in a down 100 basis point scenario and would increase by less than 0.20% in an up 200 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would decrease by less than 2.10% in a down 100 basis point scenario and would increase by less than 0.40% in an up 200 basis point scenario.
See also "Interest Rate Sensitivity" in Item 2 above for a discussion of our interest rate risk.
We have counter-party risk which may arise from the possible inability of George Mason's third-party investors to meet the terms of their forward sales contracts. George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk. We do not expect any third-party investor to fail to meet its obligation. In addition, we have derivative counterparty risk relating to certain interest rate swaps we have with third parties. This risk may arise from the inability of the third party to meet the terms of the contract. We monitor the financial condition of these third parties on an annual basis. We do not expect these third parties to fail to meet their obligations.
79
Item 8. Financial Statements and Supplementary Data
80
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Cardinal Financial Corporation:
We have audited the accompanying consolidated statements of condition of Cardinal Financial Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2013. We also have audited the Company's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and subsidiaries as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
| /s/ KPMG LLP |
McLean,
Virginia
March 14, 2014
81
PART II
Item 8. Financial Statements and Supplementary Data.
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
December 31, 2013 and 2012
(In thousands,
except share data)
| |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Assets |
|||||||
Cash and due from banks |
$ |
18,285 |
$ |
17,552 |
|||
Federal funds sold |
10,924 | 49,588 | |||||
| | | | | | | | |
Total cash and cash equivalents |
29,209 | 67,140 | |||||
Investment securities available-for-sale |
349,319 | 271,903 | |||||
Investment securities held-to-maturity (market value of $5,527 and $9,019 at December 31, 2013 and December 31, 2012, respectively) |
6,477 | 11,366 | |||||
Investment securities—trading |
3,890 | 3,151 | |||||
| | | | | | | | |
Total investment securities |
359,686 | 286,420 | |||||
Other investments |
19,068 |
14,302 |
|||||
Loans held for sale |
373,993 | 785,751 | |||||
Loans receivable, net of deferred fees and costs |
2,040,168 |
1,803,429 |
|||||
Allowance for loan losses |
(27,864 | ) | (27,400 | ) | |||
| | | | | | | | |
Loans receivable, net |
2,012,304 | 1,776,029 | |||||
Premises and equipment, net |
20,389 |
19,192 |
|||||
Deferred tax asset, net |
5,395 | — | |||||
Goodwill and intangibles, net |
10,144 | 10,292 | |||||
Bank-owned life insurance |
32,063 | 31,652 | |||||
Prepaid FDIC insurance premiums |
— | 2,165 | |||||
Accrued interest receivable and other assets |
31,979 | 46,244 | |||||
| | | | | | | | |
Total assets |
$ | 2,894,230 | $ | 3,039,187 | |||
| | | | | | | | |
| | | | | | | | |
Liabilities and Shareholders' Equity |
|||||||
Non-interest bearing deposits |
$ |
433,749 |
$ |
351,815 |
|||
Interest bearing deposits |
1,625,110 | 1,891,943 | |||||
| | | | | | | | |
Total deposits |
2,058,859 | 2,243,758 | |||||
Other borrowed funds |
475,232 |
392,275 |
|||||
Mortgage funding checks |
6,528 | 51,679 | |||||
Deferred tax liability, net |
— | 1,946 | |||||
Escrow liabilities |
1,572 | 4,629 | |||||
Accrued interest payable and other liabilities |
31,507 | 36,834 | |||||
| | | | | | | | |
Total liabilities |
2,573,698 | 2,731,121 | |||||
| |
2013 | 2012 | |
|
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Common stock, $1 par value |
|||||||||||||
Shares authorized |
50,000,000 | 50,000,000 | |||||||||||
Shares issued and outstanding |
30,332,685 | 30,226,330 | 30,333 | 30,226 | |||||||||
Additional paid-in capital |
174,001 | 172,021 | |||||||||||
Retained earnings |
111,323 | 92,777 | |||||||||||
Accumulated other comprehensive income, net |
4,875 | 13,042 | |||||||||||
| | | | | | | | | | | | | | |
Total shareholders' equity |
320,532 | 308,066 | |||||||||||
| | | | | | | | | | | | | | |
Total liabilities and shareholders' equity |
$ | 2,894,230 | $ | 3,039,187 | |||||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
82
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2013, 2012, and 2011
(In thousands, except per share data)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Interest income: |
||||||||||
Loans receivable |
$ | 86,152 | $ | 84,615 | $ | 78,237 | ||||
Loans held for sale |
16,695 | 19,017 | 10,767 | |||||||
Federal funds sold |
266 | 173 | 88 | |||||||
Investment securities available-for-sale |
10,481 | 10,673 | 13,222 | |||||||
Investment securities held-to-maturity |
189 | 305 | 440 | |||||||
Other investments |
332 | 267 | 124 | |||||||
| | | | | | | | | | | |
Total interest income |
114,115 | 115,050 | 102,878 | |||||||
Interest expense: |
||||||||||
Deposits |
13,016 | 14,839 | 13,560 | |||||||
Other borrowed funds |
8,754 | 9,208 | 10,156 | |||||||
| | | | | | | | | | | |
Total interest expense |
21,770 | 24,047 | 23,716 | |||||||
| | | | | | | | | | | |
Net interest income |
92,345 | 91,003 | 79,162 | |||||||
Provision for loan losses |
(32 | ) | 7,123 | 6,910 | ||||||
| | | | | | | | | | | |
Net interest income after provision for loan losses |
92,377 | 83,880 | 72,252 | |||||||
Non-interest income: |
||||||||||
Service charges on deposit accounts |
1,992 | 1,914 | 1,767 | |||||||
Loan fees |
1,447 | 1,599 | 1,326 | |||||||
Title insurance & other income |
987 | 2,489 | 1,408 | |||||||
Investment fee income |
1,337 | 2,623 | 2,546 | |||||||
Realized and unrealized gains on mortgage banking activities |
21,615 | 47,794 | 20,529 | |||||||
Net realized gains on investment securities available-for-sale |
— | — | 2,397 | |||||||
Net realized gains on investment securities-trading |
68 | 158 | 144 | |||||||
Management fee income |
1,981 | 4,082 | 3,406 | |||||||
Income from bank-owned life insurance |
411 | 3,072 | 796 | |||||||
Gain (loss) on sale of real estate |
30 | (333 | ) | — | ||||||
Other income (loss) |
43 | (6 | ) | 14 | ||||||
| | | | | | | | | | | |
Total non-interest income |
29,911 | 63,392 | 34,333 | |||||||
Non-interest expense: |
||||||||||
Salary and benefits |
41,523 | 39,370 | 28,707 | |||||||
Occupancy |
8,389 | 7,186 | 6,032 | |||||||
Professional fees |
3,765 | 4,209 | 3,955 | |||||||
Depreciation |
3,196 | 2,669 | 2,517 | |||||||
Data processing and communications |
4,720 | 4,427 | 4,117 | |||||||
Advertising and marketing |
4,688 | 5,197 | 3,199 | |||||||
FDIC insurance assessment |
1,391 | 1,336 | 1,387 | |||||||
Mortgage loan repurchases and settlements |
(49 | ) | 962 | 670 | ||||||
Bank franchise taxes |
2,836 | 2,388 | 2,089 | |||||||
Amortization of intangibles |
148 | 198 | 198 | |||||||
Loss on extinguishment of debt |
— | — | 2,271 | |||||||
Impairment of pooled trust preferred securities |
300 | — | — | |||||||
Impairment of other real estate owned |
— | — | 911 | |||||||
Merger and acquisition expense |
464 | — | — | |||||||
Other operating expenses |
13,232 | 11,375 | 8,412 | |||||||
| | | | | | | | | | | |
Total non-interest expense |
84,603 | 79,317 | 64,465 | |||||||
| | | | | | | | | | | |
Income before income taxes |
37,685 | 67,955 | 42,120 | |||||||
Provision for income taxes |
12,175 | 22,658 | 14,122 | |||||||
| | | | | | | | | | | |
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Earnings per common share—basic |
$ | 0.83 | $ | 1.53 | $ | 0.95 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Earnings per common share—diluted |
$ | 0.82 | $ | 1.51 | $ | 0.94 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Weighted-average common shares outstanding—basic |
30,687 | 29,654 | 29,401 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Weighted-average common shares outstanding—diluted |
31,077 | 29,996 | 29,784 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
83
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2013, 2012 and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
Other comprehensive income: |
||||||||||
Unrealized gain on available-for-sale investment securities: |
||||||||||
Unrealized holding gain (loss) arising during the year, net of tax benefit of $5.1 million in 2013, net of tax expense of $391 thousand in 2012, and net of tax expense of $4.5 million in 2011 |
(9,276 | ) | 741 | 9,644 | ||||||
Less: reclassification adjustment for net gains included in net income, net of tax expense of $0 in 2013, $0 in 2012, and $804 thousand in 2011 |
— | — | (1,593 | ) | ||||||
| | | | | | | | | | | |
|
(9,276 | ) | 741 | 8,051 | ||||||
| | | | | | | | | | | |
Unrealized gain (loss) on derivative instruments designated as cash flow hedges, net of tax expense of $589 thousand in 2013, net of tax expense of $470 thousand in 2012, and net of tax benefit of $572 thousand in 2011 |
1,109 | 785 | (960 | ) | ||||||
| | | | | | | | | | | |
Comprehensive income |
$ | 17,343 | $ | 46,823 | $ | 35,089 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
84
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years Ended December 31, 2013, 2012, and
2011
(In thousands)
| |
Common Shares |
Common Stock |
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income |
Total | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 2010 |
28,770 | $ | 28,770 | $ | 160,859 | $ | 28,848 | $ | 4,425 | $ | 222,902 | ||||||||
Stock options exercised |
429 | 429 | 2,198 | — | — | 2,627 | |||||||||||||
Stock compensation expense, net of tax benefit |
— | — | 673 | — | — | 673 | |||||||||||||
Dividends on common stock of $0.12 per share |
— | — | — | (3,474 | ) | — | (3,474 | ) | |||||||||||
Change in accumulated other comprehensive income |
— | — | — | — | 7,091 | 7,091 | |||||||||||||
Net income |
— | — | — | 27,998 | — | 27,998 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2011 |
29,199 | $ | 29,199 | $ | 163,730 | $ | 53,372 | $ | 11,516 | $ | 257,817 | ||||||||
Stock options exercised |
1,027 | 1,027 | 8,063 | — | — | 9,090 | |||||||||||||
Stock compensation expense, net of tax benefit |
— | — | 228 | — | — | 228 | |||||||||||||
Dividends on common stock of $0.20 per share |
— | — | — | (5,892 | ) | — | (5,892 | ) | |||||||||||
Change in accumulated other comprehensive income |
— | — | — | — | 1,526 | 1,526 | |||||||||||||
Net income |
— | — | — | 45,297 | — | 45,297 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2012 |
30,226 | $ | 30,226 | $ | 172,021 | $ | 92,777 | $ | 13,042 | $ | 308,066 | ||||||||
Stock options exercised |
107 | 107 | 977 | — | — | 1,084 | |||||||||||||
Stock compensation expense, net of tax benefit |
— | — | 1,003 | — | — | 1,003 | |||||||||||||
Dividends on common stock of $0.23 per share |
— | — | — | (6,964 | ) | — | (6,964 | ) | |||||||||||
Change in accumulated other comprehensive income |
— | — | — | — | (8,167 | ) | (8,167 | ) | |||||||||||
Net income |
— | — | — | 25,510 | — | 25,510 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2013 |
30,333 | $ | 30,333 | $ | 174,001 | $ | 111,323 | $ | 4,875 | $ | 320,532 | ||||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
See accompanying notes to consolidated financial statements.
85
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities: |
||||||||||
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
||||||||||
Depreciation |
3,196 | 2,669 | 2,517 | |||||||
Amortization of premiums, discounts and intangibles |
137 | 34 | 292 | |||||||
Impairment of pooled trust preferred securities |
300 | — | — | |||||||
Provision for loan losses |
(32 | ) | 7,123 | 6,910 | ||||||
Loans held for sale originated |
(5,782,912 | ) | (6,577,775 | ) | (3,893,935 | ) | ||||
Proceeds from the sale of loans held for sale |
6,216,285 | 6,369,318 | 3,591,011 | |||||||
Realized and unrealized gains on mortgage banking activities |
(21,615 | ) | (47,794 | ) | (20,529 | ) | ||||
Proceeds from sale, maturity and call of investment securities-trading |
— | — | 743 | |||||||
Purchase of investment securities-trading |
(1,707 | ) | (1,174 | ) | (1,182 | ) | ||||
Unrealized (gain) loss on sale of investments securities-trading |
(68 | ) | (158 | ) | (144 | ) | ||||
Gain on sale of investment securities available-for-sale |
— | — | (2,397 | ) | ||||||
(Gain) loss on sale of other assets |
— | 49 | — | |||||||
Decrease in fair value of other real estate owned |
— | — | 911 | |||||||
(Gain) Loss on sales of other real estate owned |
(30 | ) | 333 | — | ||||||
Stock compensation expense, net of tax benefits |
1,003 | 228 | 673 | |||||||
Provision for deferred income taxes |
(2,866 | ) | 5,817 | 1,086 | ||||||
Increase in cash surrender value of bank-owned life insurance |
(411 | ) | (3,072 | ) | (796 | ) | ||||
(Increase) decrease in accrued interest receivable, other assets and deferred tax asset |
15,391 | (19,125 | ) | (12,952 | ) | |||||
Increase (decrease) in accrued interest payable, escrow liabilities and other liabilities |
(6,901 | ) | 10,390 | 11,339 | ||||||
| | | | | | | | | | | |
Net cash provided by (used in) operating activities |
445,280 | (207,840 | ) | (288,455 | ) | |||||
| | | | | | | | | | | |
Cash flows from investing activities: |
||||||||||
Net purchases of premises and equipment |
(4,393 | ) | (3,712 | ) | (5,102 | ) | ||||
Proceeds from the sale of fixed assets |
— | 1,104 | — | |||||||
Proceeds from maturity and call of investment securities available-for-sale |
11,484 | — | 970 | |||||||
Proceeds from sale of mortgage-backed securities available-for-sale |
— | — | 40,384 | |||||||
Proceeds from maturity and call of investment securities held-to-maturity |
— | — | 5,618 | |||||||
Proceeds from sale of other investments |
255 | 3,608 | 24 | |||||||
Proceeds from bank-owned life insurance |
— | 6,574 | — | |||||||
Purchase of investment securities available-for-sale |
(66,372 | ) | (22,810 | ) | (18,266 | ) | ||||
Purchase of mortgage-backed securities available-for-sale |
(67,834 | ) | — | (62,538 | ) | |||||
Purchase of other investments |
(5,021 | ) | (790 | ) | (675 | ) | ||||
Redemptions of investment securities available-for-sale |
35,902 | 47,761 | 49,265 | |||||||
Redemptions of investment securities held-to-maturity |
1,790 | 1,546 | 3,325 | |||||||
Proceeds from the sale of other real estate owned |
— | 5,839 | 531 | |||||||
Net increase in loans receivable, net of deferred fees and costs |
(236,213 | ) | (180,555 | ) | (230,779 | ) | ||||
| | | | | | | | | | | |
Net cash used in investing activities |
(330,402 | ) | (141,435 | ) | (217,243 | ) | ||||
| | | | | | | | | | | |
Cash flows from financing activities: |
||||||||||
Net increase (decrease) in deposits |
(184,899 | ) | 468,498 | 371,535 | ||||||
Net increase (decrease) in other borrowed funds |
(17,043 | ) | (38,110 | ) | 108,070 | |||||
Net increase (decrease) in mortgage funding checks |
(45,151 | ) | 25,690 | 25,327 | ||||||
Proceeds from FHLB advances |
100,000 | 55,000 | 110,000 | |||||||
Repayments of FHLB advances |
— | (135,000 | ) | (97,271 | ) | |||||
Stock options exercised |
1,084 | 9,090 | 2,627 | |||||||
Excess tax benefit from stock option exercises |
164 | — | 155 | |||||||
Dividends on common stock |
(6,964 | ) | (5,892 | ) | (3,474 | ) | ||||
| | | | | | | | | | | |
Net cash provided by (used in) financing activities |
(152,809 | ) | 379,276 | 516,969 | ||||||
| | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents |
(37,931 | ) | 30,001 | 11,271 | ||||||
Cash and cash equivalents at beginning of year |
67,140 | 37,139 | 25,868 | |||||||
| | | | | | | | | | | |
Cash and cash equivalents at end of year |
$ | 29,209 | $ | 67,140 | $ | 37,139 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Supplemental disclosure of cash flow information: |
||||||||||
Cash paid during the year for interest |
$ | 21,823 | $ | 24,549 | $ | 24,189 | ||||
Cash paid for income taxes |
14,964 | 18,262 | 13,618 | |||||||
Supplemental schedule of noncash investing and financing activities: |
||||||||||
Unsettled purchases of investment securities available-for-sale |
$ | 2,050 | $ | — | $ | — | ||||
Transfer of investment securities from held-to-maturity to available-for-sale |
2,795 | — | — | |||||||
Transfer of loans to other real estate owned |
— | 3,126 | 3,238 | |||||||
See accompanying notes to consolidated financial statements.
86
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Organization
Cardinal Financial Corporation (the "Company" or "Cardinal") is incorporated under the laws of the Commonwealth of Virginia as a financial holding company whose activities consist of investment in its wholly-owned subsidiaries. The principal operating subsidiary of the Company is Cardinal Bank (the "Bank"), a state-chartered institution and its subsidiary, George Mason Mortgage, LLC ("George Mason"), a mortgage banking company based in Fairfax, Virginia. The Company had a second mortgage subsidiary, Cardinal First Mortgage, LLC ("Cardinal First") also based in Fairfax, Virginia, but as of June 30, 2013, this subsidiary merged into George Mason. In addition to the Bank, the Company has one nonbank subsidiary, Cardinal Wealth Services, Inc. ("CWS"), an investment services subsidiary. As of June 30, 2013, the remaining operations of the Bank's trust division, Cardinal Trust and Investment Services, merged into CWS. Also as of June 30, 2013, Wilson/Bennett Capital Management, Inc., formerly the Company's second nonbank subsidiary, merged into CWS.
On January 16, 2014, the Company announced the completion of its acquisition of United Financial Banking Companies, Inc. ("UFBC"), the holding company of The Business Bank ("TBB"), pursuant to a previously announced definitive merger agreement. The merger of UFBC into Cardinal was effective January 16, 2014. Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of the Company's common stock in exchange for each share of UFBC common stock they owned immediately prior to the merger. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014 adding eight (8) banking locations in northern Virginia, one of the Company's target markets.
(2) Summary of Significant Accounting Policies
- (a)
- Use of Estimates
U.S. generally accepted accounting principles are complex and require management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and contingent liabilities, at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates affecting the Company's financial statements relate to accounting for business combinations and impairment testing of goodwill, the allowance for loan losses, accounting for impairment of identifiable intangible assets, the valuation of the deferred tax assets, other-than-temporary impairment assessments for investment securities, fair value measurements of certain assets and liabilities, fair values of derivatives and investment securities and reserves for repurchase of mortgage loans previously sold to investors. Actual results could differ from these estimates.
- (b)
- Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
- (c)
- Accounting for Business Combinations
Business combinations are accounted for under the purchase method. The purchase method requires that the cost of an acquired entity be allocated to the assets acquired and liabilities assumed, based on their estimated fair values at the date of acquisition. The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed, including identifiable intangibles, is recorded as goodwill.
87
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
- (d)
- Cash and Cash Equivalents
For the consolidated statements of cash flows, the Company has defined cash and cash equivalents as cash and due from banks and federal funds sold.
- (e)
- Investment Securities
The Company classifies its investment securities into one of three categories: available-for-sale, held-to-maturity or trading. Held-to-maturity securities are those securities for which the Company has the ability and intent to hold until maturity. Trading securities are those securities for which the Company has purchased and holds for the purpose of selling in the near future. All other securities are classified as available-for-sale.
Held-to-maturity securities are carried at amortized cost. Available-for-sale and trading securities are carried at estimated fair value. Unrealized gains and losses, net of applicable tax, on available-for-sale securities are reported in other comprehensive income (loss). Unrealized market value adjustments, fees and realized gains and losses, on trading securities are reported in non-interest income.
At December 31, 2013 and 2012, the Company had investment securities classified as trading. These investments were purchased to economically hedge against fair value changes of the Company's nonqualified deferred compensation plan liability. Those investments were designated as trading securities, and as such, the changes in fair value are reflected in earnings.
Gains and losses on the sale of securities are determined using the specific identification method.
The Company regularly evaluates its securities whose values have declined below their amortized cost to assess whether the decline in fair value is other-than-temporary. The Company considers various factors in determining whether a decline in fair value is other-than-temporary including the issuer's financial condition and/or future prospects, the effects of changes in interest rates or credit spreads, the expected recovery period and other quantitative and qualitative information. The valuation of securities for impairment is a process subject to estimation, judgment and uncertainty and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions and future changes in assessments of the aforementioned factors. It is expected that such factors will change in the future, which may result in future other-than-temporary impairments. For impairments of debt securities that are deemed to be other-than-temporary, the credit portion of an other-than-temporary impairment loss is recognized in earnings and the non-credit portion is recognized in accumulated other comprehensive income in those situations where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security prior to recovery.
On December 10, 2013, the Office of the Comptroller of the Currency, the FDIC, the Board of Governors of the Federal Reserve System, the SEC, and the Commodity Futures Trading Commission (collectively, "the Agencies"), released final rules (the "Final Rules") to implement Section 619 of the Financial Reform Act, commonly known as the "Volcker Rule". The Volcker Rule, among other things, prohibits banking entities from engaging in proprietary trading and from sponsoring, having an ownership interest in or having certain relationships with hedge funds or private equity funds (referred to in the Final Rules as a covered fund), subject to certain exemptions. The Final Rules impact certain investments held by banks in collateralized debt obligations backed by trust preferred securities, which
88
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
may constitute ownership interests in covered funds as those terms are defined in the Final Rules. On January 14, 2014, an interim rule was issued by the federal banking regulators to exempt certain of these trust preferred securities from the covered fund definition as issued in the Final Rules.
The Company owns four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio. Based on the interim rule, only two of the four investments were exempt from the covered fund definition. For the two investments that were not exempt as a result of the interim rule, the Company will be required to divest its investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule in July 2015. As a result of this new regulation, these two investments were reclassified to the available-for-sale investment securities portfolio and an other-than-temporary impairment of $300,000 was recognized as of December 31, 2013 as we no longer have the ability to hold until recovery.
Interest income and dividends on securities are recognized in interest income on an accrual basis. Premiums and discounts are recognized in interest income using the effective interest method. Prepayments of the mortgages securing mortgage-backed securities may affect the yield to maturity. The Company uses actual principal prepayment experience and estimates of future principal prepayments in calculating the yield necessary to apply the effective interest method.
- (f)
- Loans Held for Sale
Mortgage loans originated and intended for sale into the secondary market are carried at the lower of cost or estimated fair value, determined on an aggregate loan basis. The Company sells its mortgage loans forward to investors and the estimated fair value is largely dependent upon the terms of these outstanding loan purchase commitments as well as movement in market interest rates. Net unrealized losses, if any, are recognized through a valuation allowance by charges to operations. The carrying amount of loans held for sale includes principal balances, valuation allowances, origination premiums or discounts and fees and direct costs that are deferred at the time of origination.
The Company sells its originated mortgage loans to third party investors servicing released. Upon sale and delivery, the loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third-party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third-party investors to put the mortgage loans back to the Company.
- (g)
- Loans Receivable and Allowance for Loan Losses
Loans receivable that management has the intent and ability to hold for the foreseeable future or until loan maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs, and net of the allowance for loan losses and deferred fees and costs. Loan origination fees and certain direct origination costs are deferred and amortized as an adjustment of the yield using the payment terms required by the loan contract.
Loans are generally placed into nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of principal and/or interest is in doubt. A loan remains in nonaccrual status until the loan is current as to payment of both principal and interest or past-due less than 90 days and the borrower demonstrates the ability to pay and remain current. Loans are charged-off when a loan or a portion thereof is considered uncollectible.
89
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
When cash payments are received, they are applied to principal first, then to accrued interest. It is the Company's policy not to record interest income on nonaccrual loans until principal has become current. In certain instances, accruing loans that are past due 90 days or more as to principal or interest may not go on nonaccrual status if the Chief Credit Officer determines that the loans are well secured and are in the process of collection.
The Company determines and recognizes impairment of certain loans when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the loan agreement. A loan is not considered impaired during a period of delay in payment if the Company expects to collect all amounts due, including past-due interest. An impaired loan is measured at the present value of its expected future cash flows discounted at the loan's coupon rate, or at the loan's observable market price or fair value of the collateral if the loan is collateral dependent. Because substantially all of the Company's loans are collateral dependent, the Company generally measures impairment based on the estimated fair value of the collateral. The Company measures the collateral value on impaired loans by obtaining an updated appraisal of the underlying collateral and may discount further the appraised value, if necessary, to an amount equal to the expected cash proceeds in the event the loan is foreclosed upon and the collateral is sold. In addition, an estimate of costs to sell the collateral is assumed.
Nonperforming assets include nonaccrual loans, loans past due 90 days or more and other real estate owned.
The allowance for loan losses is increased by provisions for loan losses and recoveries of previously charged-off loans, and decreased by loan charge-offs.
The Company maintains the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in the loan portfolio. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of the individual borrowers including the value of the underlying collateral. Unusual and infrequently occurring events, such as weather-related disasters, may impact the assessment of possible credit losses. As a part of its analysis, the Company uses comparative peer group data and qualitative factors, such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions and concentrations of credit, competition, and loan review results to support estimates.
For purposes of this analysis, the Company categorizes loans into one of five categories: commercial and industrial, commercial real estate (including construction), home equity lines of credit, residential mortgages, and consumer loans. Typically, financial institutions use their historical loss experience and trends in losses for each category which are then adjusted for portfolio trends and economical and environmental factors in determining their allowance for loan losses. Prior to 2008, the Company experienced minimal loss history within its loan portfolio and it has only been since the economic downturn that the Company has recorded a higher level of loan losses. Because of this, the Company's allowance model uses the average loss rates of similar institutions (the custom peer group) as a baseline which is then adjusted based on its particular loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied to each of the five categories of loans.
90
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
The Company's peer groups are defined by selecting commercial banking institutions of similar size within Virginia, Maryland and the District of Columbia. This is known as the custom peer group. The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. The Company has identified 20 banks for the custom peer group which are within $500 million to $5 billion in total assets, the majority of whom are geographically concentrated in the Washington metropolitan area in which the Company operates as this area has seen less of an economic downturn than other areas of the country. The Company evaluates the loan quality indicators of the custom peer group to those within its national FDIC peer group, all banks in Virginia, and all banks in Maryland. These baseline peer group loss rates are then adjusted by an estimated loss emergence factor in order to determine loss coverage for pass-level credits. Finally, the Company makes adjustments to these loss factors based on an analysis of its loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing the Company's credit risk. Peer loss rates are updated on at least an annual basis.
In addition, the Company individually assigns loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. In certain cases, the Company applies, in accordance with regulatory guidelines, a 5% loss factor to all loans classified as special mention, a 15% loss factor to all loans classified as substandard and a 50% loss factor to all loans classified as doubtful. Loans classified as loss loans are fully reserved or charged-off. However, in most instances, the Company evaluates the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. For these loans, the Company analyzes the fair value of the collateral underlying the loan and considers estimated costs to sell the collateral on a discounted basis. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) the Company recognizes an impairment and establishes a specific reserve for the impaired loan. Because of the limited number of impaired loans within the its portfolio, the Company is able to evaluate each impaired loan individually and therefore specific reserves for impaired loans are generally less than those recommended by the listed regulatory guidelines above.
In addition, various regulatory agencies, as part of their examination process, periodically review the Company's allowance for loan losses. These agencies may require the Company to recognize additions to the allowance based on their risk evaluation and credit judgment. Management believes that the allowance for loan losses at December 31, 2013 and 2012 is a reasonable estimate of known and inherent losses in the loan portfolio at those dates.
Loans considered to be troubled debt restructuring ("TDRs") are loans that have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty. All restructured loans are considered impaired loans and may either be in accruing status or nonaccruing status. Nonaccruing restructured loans may return to accruing status provided doubt has been removed concerning the collectability of principal and interest as evidenced by a sufficient period of payment performance in accordance with the restructured terms. Loans may be removed from the restructured category in the year subsequent to the restructuring if their revised loan terms are considered to be consistent with terms that can be obtained in the credit market for loans with comparable risk and if they meet certain performance criteria.
91
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
- (h)
- Premises and Equipment
Land is carried at cost. Premises, furniture, equipment, and leasehold improvements are carried at cost, less accumulated depreciation and amortization. Depreciation of premises, furniture and equipment is computed using the straight-line method over estimated useful lives from three to 25 years. Amortization of leasehold improvements is computed using the straight-line method over the useful lives of the improvements or the lease term, whichever is shorter. Purchased computer software which is capitalized is amortized over estimated useful lives of one to three years. Rent expense on operating leases is recorded using the straight-line method over the appropriate lease term.
- (i)
- Goodwill and Other Intangibles
Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is not amortized but is evaluated at least annually for impairment by comparing its fair value with its carrying amount. Impairment is indicated when the carrying amount of a reporting unit exceeds its estimated fair value.
ASU 2011-08 simplifies testing for goodwill impairment by permitting entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is greater than its carrying value. If an entity can qualitatively demonstrate that a reporting unit's fair value is more likely than not greater than its carrying value, then it would not be required to perform the quantitative two-step goodwill impairment test.
A two-step valuation process is applied, as required by ASU 2011-08. In Step 1, each reporting unit's fair value is determined based on three metrics: (1) a primary market approach, which measures fair value based on trading multiples of independent publicly traded financial institutions of comparable size and character to the reporting units, (2) a secondary market approach, which measures fair value based on acquisition multiples of publicly traded financial institutions of comparable size and character which were recently acquired, and (3) an income approach, which estimates fair value based on discounted cash flows. If the fair value of any reporting unit exceeds its adjusted net book value, no write-down of goodwill is necessary. If the fair value of any reporting unit is less than its adjusted net book value, a Step 2 valuation procedure is required to assess the proper carrying value of the goodwill allocated to that reporting unit. The valuation procedures applied in a Step 2 valuation are similar to those that would be performed upon an acquisition, with the Step 1 fair value representing a hypothetical reporting unit purchase price.
No impairment was recorded for 2013, 2012, and 2011.
- (j)
- Bank-Owned Life Insurance
Under the Company's bank-owned life insurance policy, executives or other key individuals are the insureds and the Company is the owner and beneficiary of the policy. As such, the insured has no claim to the insurance policy, the policy's cash value, or a portion of the policy's death proceeds. The increase in the cash surrender value over time is recorded as other non-interest income. The Company monitors the financial strength and condition of the counterparty.
During 2012, the Company received a death benefit payment of $6.6 million which resulted in an increase in non-interest income of $2.4 million.
92
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
- (k)
- Realized and Unrealized Gains on Mortgage Banking Activities
Realized and unrealized gains on mortgage banking activities include income earned by George Mason from the origination and sale of mortgage loans to third party investors, and other activities incidental to mortgage banking activities. The Company enters into interest rate lock commitments to sell and deliver the mortgage loans, servicing released, to third party investors on a best efforts basis. Unrealized gains include the recognition of the fair value of the rate lock commitment derivative, which approximates the differential between the par value of the loan and the amount that will be received upon the delivery of the loan to the third party investor.
- (l)
- Management Fee Income
Management fee income represents income earned for the management and operational support provided by George Mason to other mortgage banking companies (the "managed companies") owned by local homebuilders. The relationship of George Mason to these managed companies is solely as service provider and there is no fiduciary relationship or equity investment involved. Fees earned by George Mason are accrued based on contractual arrangements with each of the managed companies and are generally determined as a percentage of the managed company's net income before income taxes. During the fourth quarter of 2013, the Company amended its agreement with the managed companies to record fee income on a per loan basis. As of the effective date of the amendment, George Mason charges $700 per loan originated by each of the managed companies.
- (m)
- Investment Fee Income
Investment fee income represents commissions paid by customers of CWS and asset management fees paid by the customers of Wilson/Bennett for investment services. Revenue from Trust Services is also a component of investment fee income and is recognized in the period earned in accordance with contractual percentage of assets under management or custody. Trust Services revenue is generally determined based upon the fair value of assets under management or custody at the end of the period. Fees are recognized in income as they are earned. As of June 30, 2013, the Company merged the remaining operations of its trust division and Wilson/Bennett, both of which had been included in the wealth management services segment, into CWS. Results for the year ended December 31, 2013 include six months of operations of these subsidiaries.
- (n)
- Income Taxes
Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
When uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset may be reduced by a valuation allowance. The amount of any valuation allowance established is based upon an estimate of the deferred tax asset that is more likely than not to be recovered. Increases or decreases in the valuation allowance result in increases or decreases to the provision for income taxes.
93
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
Uncertain tax positions, if any, are accounted for by applying a recognition threshold and measurement attribute for tax positions taken or expected to be taken on a tax return. Recognition and measurement of tax positions is based on management's evaluations of relevant tax code and appropriate industry information about audit proceedings for comparable positions at other organizations. Increases to unrecognized tax benefits will occur as a result of accruing for the nonrecognition of the position for the current year. Decreases will occur as a result of the lapsing of the statute of limitations for the oldest outstanding year which includes the position.
- (o)
- Earnings Per Common Share
Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of shares of common stock outstanding during the periods, including shares which will be issued to settle liabilities of the deferred compensation plans. Diluted earnings per share reflects the impact of dilutive potential common shares that would have been outstanding if common stock equivalents had been issued, as well as any adjustment to income that would result from the assumed issuance. Common stock equivalents that may be issued by the Company relate primarily to outstanding stock options, and the dilutive potential common shares resulting from outstanding stock options are determined using the treasury stock method. Common stock equivalents for diluted earnings per share purposes also includes common shares which may be issued, but are not required to be issued, to settle the Company's obligations under its deferred compensation plans. The effects of anti-dilutive common stock equivalents are excluded from the calculation of diluted earnings per share.
- (p)
- Derivative Instruments and Hedging Activities
The Company records its derivatives at their fair values in other assets and other liabilities on the statement of condition. The Company does not enter into derivative transactions for speculative purposes. For derivatives designated as accounting hedges, the Company contemporaneously documents the hedging relationship, including the risk management objective and strategy for undertaking the hedge, how effectiveness will be assessed at inception and at each reporting period and the method for measuring ineffectiveness. The Company evaluates the effectiveness of these transactions at inception and on an ongoing basis. Ineffectiveness is recorded through earnings. For derivatives designated as cash flow hedges, the fair value adjustment is recorded as a component of other comprehensive income, net of tax, except for the ineffective portion. For derivatives designated as fair value hedges, the fair value adjustments for both the hedged item and the hedging instrument are recorded through the income statement with any difference considered the ineffective portion of the hedge. The Company discontinues hedge accounting when i) the hedge is no longer considered highly effective or ii) the derivative matures or is sold or terminates.
In the normal course of business, the Company enters into rate lock commitments, to finance residential mortgage loans. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company. Interest rate risk arises on these commitments and subsequently closed loans if interest rates change between the time of the interest rate lock and the delivery of the loan to the investor. Loan commitments related to residential mortgage loans intended to be sold are considered derivatives and are marked to market through earnings. In addition to the effects of the change in market interest rate, the fair value measurement of the derivative also
94
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
contemplates the expected cash flows to be received from the counterparty to the future sale of the loan. For purposes of calculating the aggregate fair value of the rate lock derivatives at year end, the Company assumes an estimated loan closing and investor delivery rate based on historical experience. The measurement of the estimated fair value of the rate lock derivatives is presented as realized and unrealized gains from mortgage banking activities.
To mitigate the effect of interest rate risk inherent in providing rate lock commitments, the Company economically hedges its commitments by entering into best efforts forward delivery loan sales contracts. During the rate lock commitment period, these forward loan sales contract derivatives are marked to fair value. The fair values of loan commitments and the fair values of forward sales contracts generally move in opposite directions, and the net impact of the changes in these valuations on net income during the loan commitment period is generally inconsequential, excluding the effect of the fair value component associated with the projected cash flows from the loan delivery to the investor. At the closing of the loan, the rate lock commitment derivative matures and the Company records a loan held for sale and continues to be obligated under the same forward loan sales contract. The loans held for sale are then designated as the hedged item in a cash flow hedge. The derivative in this relationship is the forward loan sale commitment.
When hedge accounting is discontinued because it is probable an anticipated loan sale will not occur, the Company recognizes immediately in earnings any gains and losses that were accumulated in other comprehensive income.
- (q)
- Stock-Based Compensation
The Company recognizes in the income statement the grant-date fair value of stock options and other equity-based compensation. The Company classifies stock awards as either an equity award or a liability award. Equity classified awards are valued as of the grant date using either an observable market price or a valuation methodology. Liability classified awards are valued at fair value at each reporting date. For the periods presented, all of the Company's stock options are classified as equity awards.
The Company awards stock options with a graded-vesting period and as such has elected to recognize compensation costs over the requisite service period for the entire award. Total compensation costs charged against income for the years ended December 31, 2013, 2012, and 2011, was $687,000, $228,000, and $604,000, respectively. The total income tax benefit related to stock options exercised and recognized in the income statement for share-based compensation arrangements was $287,000, $600,000, and $361,000, for the years ended December 31, 2013, 2012, and 2011, respectively.
At December 31, 2013, the Company had two stock-based employee compensation plans, which are described more fully in Note 20.
Stock options are granted with an exercise price equal to the common stock's fair market value on the date of grant. Director stock options have ten year terms and vest and become fully exercisable on the grant date. Certain employee stock options have ten year terms and vest and become fully exercisable in 25% increments beginning as of the grant date. In addition, the Company has granted stock options to employees of the Company that have ten year terms and vest and become fully exercisable in 20% increments beginning after their first year of service.
95
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(2) Summary of Significant Accounting Policies (Continued)
The weighted average per share fair values of stock option grants made in 2013, 2012, and 2011, were $5.83, $4.65, and $4.84, respectively. The fair values of the options granted were estimated on the grant date using the Black-Scholes option-pricing model based on the following weighted average assumptions:
| |
2013 | 2012 | 2011 | |||
|---|---|---|---|---|---|---|
Estimated option life |
6.5 years | 6.5 years | 6.5 years | |||
Risk free interest rate |
1.14 - 2.21% | 0.97 - 1.69% | 1.45 - 2.81% | |||
Expected volatility |
39.50% | 42.10% | 44.70% | |||
Expected dividend yield |
1.23% | 1.10% | 1.02% |
Expected volatility is based upon the average annual historical volatility of the Company's common stock. The estimated option life is derived from the "simplified method" formula as described in Staff Accounting Bulletin No. 110. The risk free interest rate is based upon the seven-year U.S. Treasury note rate in effect at the time of grant. The expected dividend yield is based upon implied and historical dividend declarations.
(3) Investment Securities and Other Investments
The approximate fair value and amortized cost of investment securities at December 31, 2013 and 2012 are shown below.
| |
2013 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) |
Gross Amortized cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair value | |||||||||
Investment Securities Available-for-Sale |
|||||||||||||
U.S. government-sponsored agencies |
$ | 75,562 | $ | 2,914 | $ | (1,548 | ) | $ | 76,928 | ||||
Mortgage-backed securities |
144,609 | 3,566 | (346 | ) | 147,829 | ||||||||
Municipal securities |
113,716 | 3,426 | (404 | ) | 116,738 | ||||||||
U.S. treasury securities |
4,992 | 37 | — | 5,029 | |||||||||
Pooled trust preferred securities |
2,795 | — | — | 2,795 | |||||||||
| | | | | | | | | | | | | | |
Total |
$ | 341,674 | $ | 9,943 | $ | (2,298 | ) | $ | 349,319 | ||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Investment Securities Held-to-Maturity |
|||||||||||||
Mortgage-backed securities |
2,472 | 145 | — | 2,617 | |||||||||
Pooled trust preferred securities |
4,005 | — | (1,095 | ) | 2,910 | ||||||||
| | | | | | | | | | | | | | |
Total |
$ | 6,477 | $ | 145 | $ | (1,095 | ) | $ | 5,527 | ||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
96
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities and Other Investments (Continued)
| |
2012 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) |
Gross Amortized cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair value | |||||||||
Investment Securities Available-for-Sale |
|||||||||||||
U.S. government-sponsored agencies |
$ | 55,756 | $ | 5,777 | $ | — | $ | 61,533 | |||||
Mortgage-backed securities |
110,214 | 8,704 | (5 | ) | 118,913 | ||||||||
Municipal securities |
79,055 | 7,292 | — | 86,347 | |||||||||
U.S. treasury securities |
4,968 | 142 | — | 5,110 | |||||||||
| | | | | | | | | | | | | | |
Total |
$ | 249,993 | $ | 21,915 | $ | (5 | ) | $ | 271,903 | ||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Investment Securities Held-to-Maturity |
|||||||||||||
Mortgage-backed securities |
3,705 | 242 | — | 3,947 | |||||||||
Pooled trust preferred securities |
7,661 | — | (2,589 | ) | 5,072 | ||||||||
| | | | | | | | | | | | | | |
Total |
$ | 11,366 | $ | 242 | $ | (2,589 | ) | $ | 9,019 | ||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
The fair value and amortized cost of investment securities by contractual maturity at December 31, 2013 are shown below. Expected maturities may differ from contractual maturities because many issuers have the right to call or prepay obligations with or without call or prepayment penalties.
| |
2013 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Available-for-Sale | Held-to-Maturity | |||||||||||
| (In thousands) |
Amortized cost |
Fair Value |
Amortized cost |
Fair Value |
|||||||||
Within One Year |
$ | 8,549 | $ | 8,690 | $ | — | $ | — | |||||
After 1 year but within 5 years |
$ | 30,120 | $ | 31,672 | $ | — | $ | — | |||||
After 5 years but within 10 years |
61,665 | 64,876 | — | — | |||||||||
After 10 years |
96,731 | 96,252 | 4,005 | 2,910 | |||||||||
Mortgage-backed securities |
144,609 | 147,829 | 2,472 | 2,617 | |||||||||
| | | | | | | | | | | | | | |
Total |
$ | 341,674 | $ | 349,319 | $ | 6,477 | $ | 5,527 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
For the years ended December 31, 2013, 2012, and 2011, proceeds from sales of investment securities available-for-sale amounted to $0, $0, and $40.4 million, respectively. Gross realized gains in 2013, 2012, and 2011, amounted to $0, $0, and $2.4 million, respectively. There were no gross realized losses for each of the years ended December 31, 2013, 2012, and 2011.
The table below shows the Company's investment securities' gross unrealized losses and their fair value, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at December 31, 2013 and 2012.
97
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities and Other Investments (Continued)
| |
At December 31, 2013 | |
|
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Less than 12 months | 12 months or more | Total | ||||||||||||||||
| Investment Securities Available-for-Sale (In thousands) |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
|||||||||||||
U.S. government sponsored agencies |
$ | 38,554 | $ | (1,548 | ) | $ | — | $ | — | $ | 38,554 | $ | (1,548 | ) | |||||
Mortgage-backed securities |
46,563 | (335 | ) | 318 | (11 | ) | 46,881 | (346 | ) | ||||||||||
Municipal securities |
30,452 | (404 | ) | — | — | 30,452 | (404 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities |
$ | 115,569 | $ | (2,287 | ) | $ | 318 | $ | (11 | ) | $ | 115,887 | $ | (2,298 | ) | ||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| |
Less than 12 months |
12 months or more | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Investment Securities Held-to-Maturity (In thousands) |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
|||||||||||||
Pooled trust preferred securities |
$ | — | $ | — | $ | 2,910 | $ | (1,095 | ) | $ | 2,910 | $ | (1,095 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities |
$ | — | $ | — | $ | 2,910 | $ | (1,095 | ) | $ | 2,910 | $ | (1,095 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| |
At December 31, 2012 | |
|
||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Less than 12 months |
12 months or more | Total | ||||||||||||||||
| Investment Securities Available-for-Sale (In thousands) |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
|||||||||||||
Mortgage-backed securities |
$ | — | $ | — | $ | 362 | $ | (5 | ) | $ | 362 | $ | (5 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities |
$ | — | $ | — | $ | 362 | $ | (5 | ) | $ | 362 | $ | (5 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| |
Less than 12 months |
12 months or more | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Investment Securities Held-to-Maturity (In thousands) |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
Fair Value |
Unrealized loss |
|||||||||||||
Pooled trust preferred securities |
$ | — | $ | — | $ | 5,072 | $ | (2,589 | ) | $ | 5,072 | $ | (2,589 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities |
$ | — | $ | — | $ | 5,072 | $ | (2,589 | ) | $ | 5,072 | $ | (2,589 | ) | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
The Company estimates the fair value of its pooled trust preferred securities portfolio by using third party projected cash flows for each of the issuances in the portfolio, and a discount rate that is commensurate with the risk inherent in the expected cash flows is applied to arrive at the estimated fair value.
The Company completes reviews for other-than-temporary impairment at least quarterly. As of December 31, 2013, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. At December 31, 2013, 98% of the Company's mortgage-backed securities are guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Association (GNMA).
98
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities and Other Investments (Continued)
The Company has $2.4 million in non-government non-agency mortgage-backed securities in its held-to-maturity portfolio. These securities are rated from AAA to AA. The various protective elements on the non agency securities may change in the future if market conditions or the financial stability of credit insurers changes, which could impact the ratings of these securities.
At December 31, 2013, certain of the Company's investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Other mortgage-backed securities and municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. The Company does not intend to sell nor does the Company believe it will be required to sell any of its temporarily impaired securities prior to the recovery of the amortized cost.
The Company owns four pooled trust preferred securities which were all previously classified as held-to-maturity within the investment securities portfolio. Based on the interim rule, only two of the four investments were exempt from the covered fund definition. For the two investments that were not exempt as a result of the interim rule, the Company will be required to divest its investment in these particular pooled trust preferred securities prior to the effectiveness of the Final Rule on July 21, 2015. As a result of this new regulation, these two investments which had a par value of $3.1 million and a carrying value of $2.8 million at December 31, 2013, were reclassified to the available-for-sale investment securities portfolio and an other-than-temporary impairment of $300,000 was recognized as of December 31, 2013 as the Company no longer has the ability to hold until recovery. The impairment recorded was determined based on the market bid price of these investments.
The par value of the two pooled trust preferred securities still classified as held-to-maturity totaled $4.0 million at December 31, 2013. The collateral underlying these structured securities are instruments issued by financial institutions. The Company owns the A-3 tranches in each issuance. Each of the bonds is rated by more than one rating agency. One security has a composite rating of A- and the other security has a composite rating of BBB+. Observable trading activity remains limited for these types of securities. The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the securities, and concluded that these securities are not other-than-temporarily impaired. The Company continuously monitors the financial condition of the underlying issues and the level of subordination below the A-3 tranches. The Company also utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches. In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.
In one of the pooled trust preferred securities, 60% of the principal balance is subordinate to the Company's class of ownership, and it is estimated that a break in contractual cash flow would occur if $169 million of the remaining $233 million, or 73% of the performing collateral defaulted or deferred payment. In the other pooled trust preferred security, 56% of the principal balance is subordinate to the Company's class of ownership, and it is estimated that a break in contractual cash flow would occur if $155 million of the remaining $243 million, or 64% of the performing collateral defaulted or deferred payment. Significant judgment is involved in the evaluation of other-than-temporary impairment. The
99
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities and Other Investments (Continued)
Company does not intend to sell nor does the Company believe it is probable that it will be required to sell these pooled trust preferred securities prior to the recovery of its investment.
With the exception of the aforementioned impairment recorded on the Company's pooled trust preferred securities, no other-than-temporary impairment has been recognized for the remaining securities in the Company's investment portfolio as of December 31, 2013, 2012, and 2011.
Investment securities that were pledged to secure borrowed funds and other balances as required at December 31, 2013 and 2012 had carrying values of $188.1 million and $235.9 million, respectively. The market values of these pledged securities at December 31, 2013 and 2012 were $197.1 million and $256.1 million, respectively. They were pledged as follows:
| |
2013 | ||||||
|---|---|---|---|---|---|---|---|
| (In thousands) |
Carrying Value | Market Value | |||||
FHLB advances |
$ | 6,510 | $ | 7,225 | |||
Customer repurchase agreements |
119,883 | 125,703 | |||||
Debtor in possession, public deposits, trust services division deposits and interest rate swap |
61,695 | 64,144 | |||||
| | | | | | | | |
|
$ | 188,088 | $ | 197,072 | |||
| | | | | | | | |
| | | | | | | | |
| |
2012 | ||||||
|---|---|---|---|---|---|---|---|
| (In thousands) |
Carrying Value | Market Value | |||||
FHLB advances |
$ | 8,497 | $ | 9,731 | |||
Customer repurchase agreements |
164,258 | 177,708 | |||||
Debtor in possession, public deposits, trust services division deposits and interest rate swap |
63,180 | 68,699 | |||||
| | | | | | | | |
|
$ | 235,935 | $ | 256,138 | |||
| | | | | | | | |
| | | | | | | | |
Investment securities are pledged against certain customer deposit accounts (referred to as customer repurchase agreements). See Note 11 to the notes to consolidated financial statements for additional information.
Other investments include Federal Home Loan Bank stock of $17.8 million and $13.6 million at December 31, 2013 and 2012, respectively, and $63,000 of Community Bankers' Bank stock at December 31, 2013 and 2012. As a member of the Federal Home Loan Bank of Atlanta ("FHLB"), the Company's banking subsidiary is required to hold stock in this entity. Stock membership in Community Bankers' Bank allows the Company to participate in loan purchases and sales. In addition, included in other investments at December 31, 2013 and 2012 is the Company's $619,000 investment in Cardinal Statutory Trust I. At December 31, 2013 and 2012, the Company has an equity investment in a local bank holding company of $50,000. These investments are carried at cost since no active trading markets exist. At December 31, 2013, the Company had low income housing fund investments of $524,000 compared to $2,000 at December 31, 2012.
The Company's policy is to review for impairment of FHLB stock at each reporting period. At December 31, 2013, FHLB was in compliance with all of its regulatory capital requirements. The Company believes its holdings in the stock are ultimately recoverable at par value as of December 31, 2013. In addition, the Company has ample liquidity and does not require redemption of its FHLB stock
100
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Investment Securities and Other Investments (Continued)
in the foreseeable future. Based on the Company's analysis of positive and negative factors, it believes that as of December 31, 2013 and 2012, its FHLB stock was not impaired.
(4) Investment Securities—Trading
The Company acquired investment assets and designated them as trading to economically hedge against fair value changes of the Company's nonqualified deferred compensation plan liability. Those investments were designated as trading securities, and as such, the changes in fair value are reflected in earnings. Trading securities at December 31, 2013 and 2012 are as follows:
| (in thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Cash equivalents |
$ | 506 | $ | 464 | |||
Equities |
— | 419 | |||||
Mutual funds |
3,384 | 2,268 | |||||
| | | | | | | | |
|
$ | 3,890 | $ | 3,151 | |||
| | | | | | | | |
| | | | | | | | |
The net realized gain on trading securities for the years ended December 31, 2013, 2012, and 2011 and was $68,000, $158,000, and $144,000, respectively.
(5) Loans Receivable and Allowance for Loan Losses
The loan portfolio at December 31, 2013 and 2012 consists of the following:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 219,156 | $ | 222,961 | |||
Real estate—commercial |
1,048,579 | 827,243 | |||||
Real estate—construction |
363,063 | 373,717 | |||||
Real estate—residential |
299,484 | 260,352 | |||||
Home equity lines |
109,481 | 117,647 | |||||
Consumer |
4,159 | 4,204 | |||||
| | | | | | | | |
|
2,043,922 | 1,806,124 | |||||
Net deferred fees |
(3,754 | ) | (2,695 | ) | |||
| | | | | | | | |
Loans receivable, net of fees |
2,040,168 | 1,803,429 | |||||
Allowance for loan losses |
(27,864 | ) | (27,400 | ) | |||
| | | | | | | | |
Loans receivable, net |
$ | 2,012,304 | $ | 1,776,029 | |||
| | | | | | | | |
| | | | | | | | |
Loans totaling $1.1 billion serve as collateral for the Company's Federal Home Loan Bank advance capacity at December 31, 2013. Loans held as collateral at the Federal Reserve for use of the Company's discount window line of credit total $109.8 million at December 31, 2013.
For purposes of monitoring the performance of the loan portfolio and estimating the allowance for loan losses, the Company's loans receivable portfolio is segmented as follows: commercial and industrial, real estate-commercial, real estate-construction, real estate-residential, home equity lines and consumer loans.
101
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Commercial and Industrial Loans. The Company makes commercial loans to qualified businesses within its market area. The commercial lending portfolio consists primarily of commercial and industrial loans for the financing of accounts receivable, property, plant and equipment. The Company has a government contract lending group which provides secured lending to government contracting firms and businesses based primarily on receivables from the federal government. In addition, the Company, which is certified as a preferred lender by the Small Business Administration (SBA), offers SBA guaranteed loans and asset-based lending arrangements to its customers.
Commercial and industrial loans generally have a higher degree of risk than other certain types of loans. Commercial loans typically are made on the basis of the borrower's ability to repay the loan from the cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory, the values of which may fluctuate over time and generally cannot be appraised with as much precision as residential real estate. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent upon the commercial success of the business itself. To manage these risks, the Company's policy is to secure commercial loans originated with both the assets of the business, which are subject to the risks described above, and other additional collateral and guarantees that may be available.
Real Estate-Commercial Loans. Real estate-commercial loans are primarily secured by various types of commercial real estate, including office, retail, warehouse, industrial and other non-residential types of properties and are made to the owners and/or occupiers of such property.
These loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income-producing properties is typically dependent upon the successful operation of a business or real estate project and thus may be subject to adverse conditions in the commercial real estate market or in the general economy. The Company generally requires personal guarantees or endorsements with respect to these loans and loan-to-value ratios for real estate-commercial loans generally do not exceed 80%.
Real Estate-Construction Loans. The Company's real estate-construction loan portfolio consists of single-family residential properties, multi-family properties and commercial projects. Construction lending entails significant additional risks as they often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks since funds are advanced while the property is under construction, which property has uncertain value prior to the completion of construction. Thus, it is more difficult to accurately evaluate the total loan funds required to complete a project and related loan-to-value ratios. To reduce the risks associated with construction lending, the Company generally limits loan-to-value ratios to 80% of when-completed appraised values for owner-occupied residential or commercial properties and for investor-owned residential or commercial properties. Construction loan agreements may include provisions which allow for the payment of contractual interest from an interest reserve. Amounts drawn from an interest reserve increase the amount of the outstanding balance of the construction loan. This is an industry standard practice.
Real Estate-Residential and Home Equity Loans. Real estate-residential loans are originated by Cardinal Bank and George Mason. This portfolio consists of residential first and second mortgage loans, residential construction loans and home equity lines of credit and term loans secured primarily by the residences of borrowers.
102
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Residential mortgage loans and home equity lines of credit secured by owner-occupied property generally are made with a loan-to-value ratio of up to 80%. Loan-to-value ratios of up to 90% may be allowed on residential owner-occupied property if the borrower exhibits unusually strong creditworthiness.
Consumer Loans. The Company's consumer loans consist primarily of installment loans made to individuals for personal, family and household purposes. The specific types of consumer loans originated include home improvement loans, automobile loans, debt consolidation loans and other general consumer lending.
Consumer loans may entail greater risk than certain other types of loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets, such as automobiles.
The Company's policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful credit and financial analysis of the borrower. In evaluating consumer loans, the Company requires its lending officers to review the borrower's collateral and stability of income, past credit history, amount of debt currently outstanding and the impact of these factors on the ability of the borrower to repay the loan in a timely manner.
The Company also issues credit cards to certain of its customers. In determining to whom the Company will issue credit cards, the Company evaluates the borrower's level and stability of income, past credit history and other factors. Credit card receivables are included in the consumer loan portfolio.
Substantially all of the Company's loans, commitments and standby letters of credit have been granted to customers located in the Washington, D.C. metropolitan area. As a matter of regulatory restriction, the Company's banking subsidiary limits the amount of credit extended to any single borrower or group of related borrowers. At December 31, 2013, the amount of credit extended to any single borrower or group of related borrowers was limited to $51.5 million. Loans in process at December 31, 2013 and 2012 were $0 and $573,000, respectively.
The Company's allowance for loan losses is based first, on a segmentation of its loan portfolio by general loan type, or portfolio segments, as presented in the preceding table. Certain portfolio segments are further disaggregated and evaluated collectively for impairment based on class segments, which are largely based on the type of collateral underlying each loan.
An analysis of the change in the allowance for loan losses follows:
| (In thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Balance, beginning of year |
$ | 27,400 | $ | 26,159 | $ | 24,210 | ||||
Provision for loan losses |
(32 | ) | 7,123 | 6,910 | ||||||
Loans charged-off |
(231 | ) | (6,919 | ) | (5,654 | ) | ||||
Recoveries |
727 | 1,037 | 693 | |||||||
| | | | | | | | | | | |
Balance, end of year |
$ | 27,864 | $ | 27,400 | $ | 26,159 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
103
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
An analysis of the allowance for loan losses based on loan type, or segment, and the Company's loan portfolio, which identifies certain loans that are evaluated for individual or collective impairment, is below:
Allowance for Loan Losses
For the Year Ended December 31, 2013
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Allowance for loan losses: |
||||||||||||||||||||||
Beginning Balance, January 1 |
$ | 525 | $ | 17,990 | $ | 7,675 | $ | 857 | $ | 266 | $ | 87 | 27,400 | |||||||||
Charge-offs |
(42 | ) | — | — | (185 | ) | — | (4 | ) | (231 | ) | |||||||||||
Recoveries |
311 | 289 | 21 | 104 | — | 2 | 727 | |||||||||||||||
Provision for loan losses |
2,535 | (2,203 | ) | (2,360 | ) | 1,645 | 343 | 8 | (32 | ) | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2013 |
$ | 3,329 | $ | 16,076 | $ | 5,336 | $ | 2,421 | $ | 609 | $ | 93 | $ | 27,864 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2013: |
||||||||||||||||||||||
Individually evaluated for impairment |
$ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||
Collectively evaluated for impairment |
3,329 | 16,076 | 5,336 | 2,421 | 609 | 93 | 27,864 | |||||||||||||||
104
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Loans Receivable
At December 31, 2013
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Loans Receivable: |
||||||||||||||||||||||
Ending Balance, December 31, 2013 |
$ | 219,156 | $ | 1,048,579 | $ | 363,063 | $ | 299,484 | $ | 109,481 | $ | 4,159 | $ | 2,043,922 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2013: |
||||||||||||||||||||||
Individually evaluated for impairment |
$ | 814 | $ | 1,738 | $ | 775 | $ | — | $ | 51 | $ | — | $ | 3,378 | ||||||||
Collectively evaluated for impairment |
218,342 | 1,046,841 | 362,288 | 299,484 | 109,430 | 4,159 | 2,040,544 | |||||||||||||||
Allowance for Loan Losses
For the Year Ended December 31, 2012
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Allowance for loan losses: |
||||||||||||||||||||||
Beginning Balance, January 1 |
$ | 3,390 | $ | 13,377 | $ | 6,495 | $ | 1,709 | $ | 1,119 | $ | 69 | 26,159 | |||||||||
Charge-offs |
(1,194 | ) | (4,959 | ) | — | (291 | ) | (460 | ) | (15 | ) | (6,919 | ) | |||||||||
Recoveries |
24 | 105 | 627 | 241 | 36 | 4 | 1,037 | |||||||||||||||
Provision for loan losses |
(1,695 | ) | 9,467 | 553 | (802 | ) | (429 | ) | 29 | 7,123 | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2012 |
$ | 525 | $ | 17,990 | $ | 7,675 | $ | 857 | $ | 266 | $ | 87 | $ | 27,400 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2012: |
||||||||||||||||||||||
Individually evaluated for impairment |
$ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||
Collectively evaluated for impairment |
525 | 17,990 | 7,675 | 857 | 266 | 87 | 27,400 | |||||||||||||||
105
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Loans Receivable
At December 31, 2012
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Loans Receivable: |
||||||||||||||||||||||
Ending Balance, December 31, 2012 |
$ | 222,961 | $ | 827,243 | $ | 373,717 | $ | 260,352 | $ | 117,647 | $ | 4,204 | $ | 1,806,124 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2012: |
||||||||||||||||||||||
Individually evaluated for impairment |
$ | 2,064 | $ | 1,657 | $ | 4,725 | $ | — | $ | — | $ | — | $ | 8,446 | ||||||||
Collectively evaluated for impairment |
220,897 | 825,586 | 368,992 | 260,352 | 117,647 | 4,204 | 1,797,678 | |||||||||||||||
The accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment and uncertainty in evaluating the levels of the allowance required for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment and uncertainty can have on the consolidated financial results.
The Company's ongoing credit quality management process relies on a system of activities to assess and evaluate various factors that impact the estimation of the allowance for loan losses. These factors include, but are not limited to: current economic conditions; loan concentrations, collateral adequacy and value; past loss experience for particular types of loans, size, composition and nature of loans; migration of loans through the Company's loan rating methodology; trends in charge-offs and recoveries. This process also contemplates a disciplined approach to managing and monitoring credit exposures to ensure that the structure and pricing of credit is always consistent with the Company's assessment of the risk. The loan officer has frequent contact with the borrower and is a key player in the credit management process and must develop and diligently practice sound credit management skills and habits to ensure effectiveness. Under the direction of the Company's loan committee and the chief credit officer, the credit risk management function works with the loans officers and other groups within the Company to monitor the loan portfolio, maintain the watch list, and compile the analysis necessary to determine the allowance for loan losses.
106
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Loans are added to the watch list when circumstances appear to warrant the inclusion of the relationship. As a general rule, loans are added to the watch list when they are deemed to be problem assets. Problem assets are defined as those that have been risk rated substandard or lower. Successful problem asset management requires early recognition of deteriorating credits and timely corrective or risk management actions. Generally, risk ratings are either approved or amended by the loan committee accordingly. Problem loans are maintained on the watch list until the loan is either paid off or circumstances around the borrower's situation improve to the point that the risk rating on the loan is adjusted upward.
In addition to internal activities, the Company also engages an external consultant on a quarterly basis to review the Company's loan portfolio. This external loan review function helps to evaluate the soundness of the loan portfolio through a third party review of existing exposures in the portfolio, supporting the commercial loan officers in the execution of its credit management responsibilities, and monitoring the adherence to the Company's credit risk management standards.
The following tables report the Company's nonaccrual and past due loans at December 31, 2013 and 2012. In addition, the credit quality of the loan portfolio is provided as of December 31, 2013 and 2012.
Nonaccrual and Past Due Loans
At December 31, 2013
(In thousands)
| |
30 - 59 Days Past Due |
60 - 89 Days Past Due |
90 Days or More Past Due (includes nonaccrual) |
Total Past Due |
Current | Total Loans | 90 Days Past Due and Still Accruing |
Nonaccrual Loans |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 101 | $ | 316 | $ | — | $ | 417 | $ | 218,739 | 219,156 | $ | — | $ | — | ||||||||||
Real estate—commercial |
|||||||||||||||||||||||||
Owner occupied |
— | — | — | — | 279,631 | 279,631 | — | — | |||||||||||||||||
Non-owner occupied |
82 | — | 1,738 | 1,820 | 767,128 | 768,948 | — | 1,738 | |||||||||||||||||
Real estate—construction |
|||||||||||||||||||||||||
Residential |
— | — | — | — | 120,144 | 120,144 | — | — | |||||||||||||||||
Commercial |
— | — | 525 | 525 | 242,394 | 242,919 | — | 525 | |||||||||||||||||
Real estate—residential |
|||||||||||||||||||||||||
Single family |
8 | — | — | 8 | 213,537 | 213,545 | — | — | |||||||||||||||||
Multi-family |
— | — | — | — | 85,939 | 85,939 | — | — | |||||||||||||||||
Home equity lines |
— |
— |
51 |
51 |
109,430 |
109,481 |
— |
51 |
|||||||||||||||||
Consumer |
|||||||||||||||||||||||||
Installment |
— | — | — | — | 3,912 | 3,912 | — | — | |||||||||||||||||
Credit cards |
— | — | — | — | 247 | 247 | — | — | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
|
$ | 191 | $ | 316 | $ | 2,314 | $ | 2,821 | $ | 2,041,101 | $ | 2,043,922 | $ | — | $ | 2,314 | |||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
107
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Nonaccrual and Past Due Loans
At December 31, 2012
(In thousands)
| |
30 - 59 Days Past Due |
60 - 89 Days Past Due |
90 Days or More Past Due (includes nonaccrual) |
Total Past Due |
Current | Total Loans | 90 Days Past Due and Still Accruing |
Nonaccrual Loans |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | — | $ | — | $ | 2,064 | $ | 2,064 | $ | 220,897 | 222,961 | $ | — | $ | 2,064 | ||||||||||
Real estate—commercial |
|||||||||||||||||||||||||
Owner occupied |
— | — | — | — | 255,343 | 255,343 | — | — | |||||||||||||||||
Non-owner occupied |
— | — | 3,800 | 3,800 | 568,100 | 571,900 | — | 3,800 | |||||||||||||||||
Real estate—construction |
|||||||||||||||||||||||||
Residential |
— | — | — | — | 84,551 | 84,551 | — | — | |||||||||||||||||
Commercial |
— | — | 1,762 | 1,762 | 287,404 | 289,166 | — | 1,762 | |||||||||||||||||
Real estate—residential |
|||||||||||||||||||||||||
Single family |
— | — | — | — | 209,740 | 209,740 | — | — | |||||||||||||||||
Multi-family |
— | — | — | — | 50,612 | 50,612 | — | — | |||||||||||||||||
Home equity lines |
— |
— |
— |
— |
117,647 |
117,647 |
— |
— |
|||||||||||||||||
Consumer |
|||||||||||||||||||||||||
Installment |
— | — | — | — | 3,916 | 3,916 | — | — | |||||||||||||||||
Credit cards |
— | — | — | — | 288 | 288 | — | — | |||||||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
|
$ | — | $ | — | $ | 7,626 | $ | 7,626 | $ | 1,798,498 | $ | 1,806,124 | $ | — | $ | 7,626 | |||||||||
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
At December 31, 2013, 2012, and 2011, the Company had impaired loans on nonaccrual status of $2.3 million, $7.6 million, and $14.6 million, respectively. The valuation allowance for impaired loans for each of the years ended December 31, 2013 and 2012 was $0. For the years ended December 31, 2013, 2012, and 2011, the Company charged-off $0, $4.8 million, and $5.1 million, respectively, related to impaired loans for the portion of the outstanding principal balance which was unsecured based on the estimated fair value of the underlying collateral.
The average balance of impaired loans was $4.2 million, $11.3 million, and $10.3 million, for 2013, 2012, and 2011, respectively. Interest income that would have been recorded had these loans been performing for the years ended December 31, 2013, 2012, and 2011, would have been $626,000, $491,000, and $766,000, respectively. The interest income realized prior to these loans being placed on nonaccrual status for December 31, 2013, 2012, and 2011, was $5,000, $111,000, and $341,000, respectively. For each of the years ended December 31, 2013 and 2012, the Company did not have any accruing loans past due 90 days or more as to principal or interest payments.
108
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Additional information on the Company's impaired loans that were evaluated for specific reserves as of December 31, 2013 and 2012, including the recorded investment on the statement of condition and the unpaid principal balance, is shown below:
Impaired Loans
At December 31, 2013
(In thousands)
| |
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Interest Income Recognized |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
With no related allowance: |
|||||||||||||
Commercial and industrial |
$ | 814 | $ | 814 | $ | — | $ | 23 | |||||
Real estate—commercial |
|||||||||||||
Owner occupied |
— | — | — | — | |||||||||
Non-owner occupied |
1,738 | 3,872 | — | — | |||||||||
Real estate—construction |
|||||||||||||
Residential |
— | — | — | — | |||||||||
Commercial |
775 | 2,928 | — | — | |||||||||
Real estate—residential |
|||||||||||||
Single family |
— | — | — | — | |||||||||
Multi-family |
— | — | — | — | |||||||||
Home equity lines |
51 | 51 | — | — | |||||||||
With related allowance: |
|||||||||||||
Commercial and industrial |
$ | — | $ | — | $ | — | $ | — | |||||
Real estate—commercial |
— | ||||||||||||
Owner occupied |
— | — | — | — | |||||||||
Non-owner occupied |
— | — | — | — | |||||||||
Real estate—construction |
— | ||||||||||||
Residential |
— | — | — | — | |||||||||
Commercial |
— | — | — | — | |||||||||
Real estate—residential |
— | ||||||||||||
Single family |
— | — | — | — | |||||||||
Multi-family |
— | — | — | — | |||||||||
Home equity lines |
— | — | — | — | |||||||||
By segment total: |
|||||||||||||
Commercial and industrial |
$ | 814 | $ | 814 | $ | — | $ | 23 | |||||
Real estate—commercial |
1,738 | 3,872 | — | — | |||||||||
Real estate—construction |
775 | 2,928 | — | — | |||||||||
Real estate—residential |
— | — | — | — | |||||||||
Home equity lines |
51 | 51 | — | — | |||||||||
| | | | | | | | | | | | | | |
Total |
$ | 3,378 | $ | 7,665 | $ | — | $ | 23 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
The difference between the recorded investment and the unpaid principal balance in the above table is a result of partial loan charge-offs that the Company has recorded on these impaired loans.
109
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Impaired Loans
At December 31, 2012
(In thousands)
| |
Recorded Investment |
Unpaid Principal Balance |
Related Allowance |
Interest Income Recognized |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
With no related allowance: |
|||||||||||||
Commercial and industrial |
$ | 2,064 | $ | 2,985 | $ | — | $ | 269 | |||||
Real estate—commercial |
|||||||||||||
Owner occupied |
— | — | — | — | |||||||||
Non-owner occupied |
4,370 | 6,943 | — | 35 | |||||||||
Real estate—construction |
|||||||||||||
Residential |
— | — | — | — | |||||||||
Commercial |
2,012 | 5,449 | — | 469 | |||||||||
Real estate—residential |
|||||||||||||
Single family |
— | — | — | — | |||||||||
Multi-family |
— | — | — | — | |||||||||
Home equity lines |
— | — | — | — | |||||||||
With related allowance: |
|||||||||||||
Commercial and industrial |
$ | — | $ | — | $ | — | $ | — | |||||
Real estate—commercial |
— | ||||||||||||
Owner occupied |
— | — | — | — | |||||||||
Non-owner occupied |
— | — | — | — | |||||||||
Real estate—construction |
— | ||||||||||||
Residential |
— | — | — | — | |||||||||
Commercial |
— | — | — | — | |||||||||
Real estate—residential |
— | ||||||||||||
Single family |
— | — | — | — | |||||||||
Multi-family |
— | — | — | — | |||||||||
Home equity lines |
— | — | — | — | |||||||||
By segment total: |
|||||||||||||
Commercial and industrial |
$ | 2,064 | $ | 2,985 | $ | — | $ | 269 | |||||
Real estate—commercial |
4,370 | 6,943 | — | 35 | |||||||||
Real estate—construction |
2,012 | 5,449 | — | 469 | |||||||||
Real estate—residential |
— | — | — | — | |||||||||
Home equity lines |
— | — | — | — | |||||||||
| | | | | | | | | | | | | | |
Total |
$ | 8,446 | $ | 15,377 | $ | — | $ | 773 | |||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
In order to maximize the collection of certain loans, the Company will attempt to work with borrowers when necessary to extend or modify loan terms to better align with the borrower's ability to repay. Extensions and modifications to loans are made in accordance with the Company's policy and conform to regulatory guidance. Each occurrence is unique to the borrower and is evaluated separately. The Company considers regulatory guidelines when restructuring a loan to ensure that prudent lending practices are followed. As such, qualification criteria and payment terms consider the borrower's current and prospective ability to comply with the modified terms of the loan.
110
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
A modification is classified as a troubled debt restructuring ("TDR") if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Company has granted a concession to the borrower. The Company determines that a borrower may be experiencing financial difficulty if the borrower is currently in default on any of its debt, or if the Company is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future. Many aspects of the borrower's financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk, and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. When evaluating whether a concession has been granted, the Company also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Company for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management's judgment is required when determining whether a modification is a TDR.
Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reductions in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.
Nonaccruing loans that are modified can be placed back on accrual status when both the principal and interest are current and it is probable that the Company will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement. The Company modified one
111
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
loan as a TDR during the year ended December 31, 2013. The following table reconciles the beginning and ending balances on TDRs for the year ended December 31, 2013 and 2012, respectively:
Troubled Debt Restructurings
At December 31, 2013
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Allowance for loan losses: |
||||||||||||||||||||||
Beginning Balance, January 1, 2013 |
$ | 1,776 | $ | 3,800 | $ | 1,762 | $ | — | $ | — | $ | — | $ | 7,338 | ||||||||
New TDRs |
— | 570 | — | — | — | — | 570 | |||||||||||||||
Increases to existing TDRs |
— | — | — | — | — | — | — | |||||||||||||||
Charge-Offs Post Modification |
— | — | — | — | — | — | — | |||||||||||||||
Sales, paydowns, or other decreases |
(1,776 | ) | (2,632 | ) | (1,237 | ) | — | — | — | (5,645 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2012 |
$ | — | $ | 1,738 | $ | 525 | $ | — | $ | — | $ | — | $ | 2,263 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
Troubled Debt Restructurings
At December 31, 2012
(In thousands)
| |
Commercial and Industrial |
Real Estate— Commercial |
Real Estate— Construction |
Real Estate— Residential |
Home Equity Lines |
Consumer | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Allowance for loan losses: |
||||||||||||||||||||||
Beginning Balance, January 1, 2012 |
$ | 3,497 | $ | 9,098 | $ | 2,750 | $ | — | $ | — | $ | — | $ | 15,345 | ||||||||
New TDRs |
— | — | — | — | — | — | — | |||||||||||||||
Increases to existing TDRs |
— | — | — | — | — | — | — | |||||||||||||||
Charge-Offs Post Modification |
(1,068 | ) | (3,749 | ) | — | — | — | — | (4,817 | ) | ||||||||||||
Sales, paydowns, or other decreases |
(653 | ) | (1,549 | ) | (988 | ) | — | — | — | (3,190 | ) | |||||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
Ending Balance, December 31, 2012 |
$ | 1,776 | $ | 3,800 | $ | 1,762 | $ | — | $ | — | $ | — | $ | 7,338 | ||||||||
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
All of these TDRs are on nonaccrual as of December 31, 2013 and 2012, respectively, per the Company's policy for placing a loan on nonaccrual and are included in the impaired loans table above.
112
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Nonaccrual TDRs that are reasonably assured of repayment according to their modified terms may be returned to accrual status by the Company upon a detailed credit evaluation of the borrower's financial condition and prospects for repayment under the revised terms. Consistent with regulatory guidance, upon sustained performance and classification as a TDR over the Company's year-end, the loan will be removed from TDR status as long as the modified terms were market-based at the time of the modification.
As of December 31, 2013, the TDRs make up one relationship with the Bank. These loans are performing as expected post-modification. As of December 31, 2012, the TDRs make up three relationships with the Bank and were performing as expected post-modification. For restructured loans in the portfolio, the Company had no loan loss reserves for each of the years ended December 31, 2013 and 2012, respectively. There were no outstanding commitments to advance additional funds to customer relationships whose loans had been restructured for each of the years ended December 31, 2013 and 2012.
Loans modified as TDRs within the previous 12 months and for which there was a payment default during the period are calculated by first identifying TDRs that defaulted during the period and then determining whether they were modified within the 12 months prior to the default. For the year ended December 31, 2013, one loan identified as a TDR had a payment default within the last twelve months. For the year ended December 31, 2012, no loans identified as TDRs had a payment default within the last twelve months.
One of the most significant factors in assessing the credit quality of the Company's loan portfolio is the risk rating. The Company uses the following risk ratings to manage the credit quality of its loan portfolio: pass, substandard, doubtful and loss. During 2011, the Company added an additional risk rating, other loans especially mentioned ("OLEM"), for the monitoring of credit quality. Other loans especially mentioned are those loans in which the borrower exhibits potential weakness that may, if not corrected or reversed, weaken the bank's credit position at some future date. These loans may not show problems as yet due to the borrower's apparent ability to service the debt, but special circumstances surround the loans of which the Bank's management should be aware. Substandard risk rated loans are those loans whose full final collectability may not appear to be a matter for serious doubt, but which nevertheless have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and require close supervision by management. Loans that have a risk rating of doubtful have all the weakness inherent in one graded substandard with the added provision that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and value, highly questionable. A loss loan is one that is considered uncollectible and will be charged-off immediately. All other loans not rated OLEM, substandard, doubtful or loss are considered to have a pass risk rating. Substandard and doubtful risk rated loans are evaluated for impairment. The following table presents a summary of the risk ratings by portfolio segment and class segment at December 31, 2013 and 2012, respectively.
113
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Internal Risk Rating Grades
At December 31, 2013
(In thousands)
| |
Pass | OLEM | Substandard | Doubtful | Loss | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 217,755 | $ | 587 | $ | 814 | $ | — | $ | — | ||||||
Real estate—commercial |
||||||||||||||||
Owner occupied |
279,631 | — | — | — | — | |||||||||||
Non-owner occupied |
753,872 | 13,338 | 1,738 | — | — | |||||||||||
Real estate—construction |
||||||||||||||||
Residential |
120,144 | — | — | — | — | |||||||||||
Commercial |
242,144 | — | 775 | — | — | |||||||||||
Real estate—residential |
||||||||||||||||
Single family |
213,537 | 8 | — | — | — | |||||||||||
Multi-family |
85,939 | — | — | — | — | |||||||||||
Home equity lines |
109,430 |
— |
51 |
— |
— |
|||||||||||
Consumer |
||||||||||||||||
Installment |
3,912 | — | — | — | — | |||||||||||
Credit cards |
247 | — | — | — | — | |||||||||||
| | | | | | | | | | | | | | | | | |
|
$ | 2,026,611 | $ | 13,933 | $ | 3,378 | $ | — | $ | — | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
114
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Loans Receivable and Allowance for Loan Losses (Continued)
Internal Risk Rating Grades
At December 31, 2012
(In thousands)
| |
Pass | OLEM | Substandard | Doubtful | Loss | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Commercial and industrial |
$ | 220,266 | $ | 631 | $ | 2,064 | $ | — | $ | — | ||||||
Real estate—commercial |
||||||||||||||||
Owner occupied |
255,343 | — | — | — | — | |||||||||||
Non-owner occupied |
542,983 | 27,260 | 1,657 | — | — | |||||||||||
Real estate—construction |
||||||||||||||||
Residential |
84,551 | — | — | — | — | |||||||||||
Commercial |
281,163 | 3,278 | 4,725 | — | — | |||||||||||
Real estate—residential |
||||||||||||||||
Single family |
209,740 | — | — | — | — | |||||||||||
Multi-family |
50,612 | — | — | — | — | |||||||||||
Home equity lines |
117,647 |
— |
— |
— |
— |
|||||||||||
Consumer |
||||||||||||||||
Installment |
3,916 | — | — | — | — | |||||||||||
Credit cards |
288 | — | — | — | — | |||||||||||
| | | | | | | | | | | | | | | | | |
|
$ | 1,766,509 | $ | 31,169 | $ | 8,446 | $ | — | $ | — | ||||||
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Loans rated substandard and doubtful totaling $3.4 million and $8.4 million were evaluated for impairment at December 31, 2013 and 2012, respectively. For each of the years ended December 31, 2013 and 2012, there was no related allowance for impaired loans. Loans receivable—evaluated for impairment and measured at fair value on a non-recurring basis, net of the related allowance is $3.4 million and $8.4 million for the years ended December 31, 2013 and 2012, respectively (see Note 23 to the notes to consolidated financial statements for additional information).
(6) Other Real Estate Owned
The Company had no other real estate owned as of December 31, 2013 and 2012. The balances in other real estate owned are at lower of carrying value or fair value less any costs to sell on the statement of condition. The fair value is determined by obtaining an updated appraisal of the foreclosed property which is then discounted for estimated selling costs.
The Company recorded impairment charges of $911,000 during 2011 related to the decrease in fair values of the properties held in other real estate owned. No such expense was recorded during 2013 and 2012. The Company recorded a net gain on the sales of real estate of $30,000 for the year ended December 31, 2013. For the years ended December 31, 2012 and 2011, the Company recorded net losses on the sales of real estate of $333,000 and $0, respectively.
115
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(7) Loans Held for Sale
The loans held for sale portfolio at December 31, 2013 and 2012, consisted of the following:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Residential |
$ | 311,493 | $ | 728,973 | |||
Construction-to-permanent |
60,168 | 44,399 | |||||
| | | | | | | | |
|
371,661 | 773,372 | |||||
Net deferred costs |
2,332 | 12,379 | |||||
| | | | | | | | |
Loans held for sale, net |
$ | 373,993 | $ | 785,751 | |||
| | | | | | | | |
| | | | | | | | |
Loans that are classified as construction-to-permanent are those loans that provide variable rate financing for customers to construct their residences. Once the home has been completed, the loan converts to fixed rate financing and is sold into the secondary market.
(8) Goodwill and Other Intangible Assets
The Company performs its annual recoverability assessment during the third calendar quarter for its mortgage banking reporting unit. The Company adopted the provisions of ASU No. 2011-08, Testing Goodwill for Impairment ("ASU No. 2011-08"). For purposes of performing the recoverability assessment, ASU No. 2011-08 requires an entity to assess all relevant events and circumstances in evaluating whether it is more likely than not that the fair value of the mortgage banking reporting unit is less than its carrying value. After evaluating all relevant facts and circumstances, the Company determined that it is more likely than not that the fair value of the mortgage banking reporting unit exceeds its carrying value and no goodwill impairment was indicated for the year ended December 31, 2013.
Information concerning amortizable intangibles follows:
| |
Mortgage Banking | Wealth Management and Trust Services |
Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (In thousands) |
Gross Carrying Amount |
Accumulated Amortization |
Gross Carrying Amount |
Accumulated Amortization |
Gross Carrying Amount |
Accumulated Amortization |
|||||||||||||
Balance at December 31, 2011 |
$ | 1,781 | $ | 1,435 | $ | 616 | $ | 616 | $ | 2,397 | $ | 2,051 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
2012 activity: |
|||||||||||||||||||
Customer relationship intangibles |
— | 198 | — | — | — | 198 | |||||||||||||
Trade name |
— | — | — | — | — | — | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2012 |
$ | 1,781 | $ | 1,633 | $ | 616 | $ | 616 | $ | 2,397 | $ | 2,249 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
2013 activity: |
|||||||||||||||||||
Customer relationship intangibles |
— | 148 | — | — | — | 148 | |||||||||||||
Trade name |
— | — | — | — | — | — | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2013 |
$ | 1,781 | $ | 1,781 | $ | 616 | $ | 616 | $ | 2,397 | $ | 2,397 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
116
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(8) Goodwill and Other Intangible Assets (Continued)
The aggregate amortization expense for 2013, 2012, and 2011, was $148,000, $198,000, and $198,000, respectively. There is no additional amortization expense as the Company's other identified intangibles are fully amortized.
The carrying amount of goodwill for the years ended December 31, 2013 and 2012 were as follows:
| (In thousands) |
Commercial Banking |
Mortgage Banking |
Total | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Balance at December 31, 2013 and 2012 |
$ | 24 | $ | 10,120 | $ | 10,144 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
(9) Premises and Equipment
The components of premises and equipment at December 31, 2013 and 2012 were as follows:
| (in thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Land |
$ | 4,350 | $ | 4,350 | |||
Buildings |
6,680 | 6,680 | |||||
Furniture and equipment |
25,478 | 22,509 | |||||
Leasehold improvements |
10,807 | 9,206 | |||||
| | | | | | | | |
Total cost |
47,315 | 42,745 | |||||
Less accumulated depreciation and amortization |
(26,926 | ) | (23,553 | ) | |||
| | | | | | | | |
Premises and equipment, net |
$ | 20,389 | $ | 19,192 | |||
| | | | | | | | |
| | | | | | | | |
Depreciation expense for the years ended December 31, 2013, 2012, and 2011, was $3.2 million, $2.7 million, and $2.5 million, respectively.
The Company has entered into operating leases for office space over various terms. The leases generally have options to renew and are subject to annual increases as well as allocations of real estate taxes and certain operating expenses.
Minimum future rental payments under the no cancelable operating leases, as of December 31, 2013 were as follows:
| Year ending December 31, |
Amount | |||
|---|---|---|---|---|
| |
(In thousands) |
|||
2014 |
$ | 8,408 | ||
2015 |
6,933 | |||
2016 |
5,372 | |||
2017 |
3,830 | |||
2018 |
3,437 | |||
Thereafter |
8,900 | |||
| | | | | |
|
$ | 36,880 | ||
| | | | | |
| | | | | |
The total rent expense was $7.9 million, $6.6 million, and $5.5 million for the years ended December 31, 2013, 2012, and 2011, respectively, and is recorded in occupancy expense on the consolidated statements of income.
117
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(9) Premises and Equipment (Continued)
The Company subleased excess office space to third parties. Future minimum lease payments under noncancelable subleasing arrangements as of December 31, 2013 were as follows:
| Year ending December 31, |
Amount | |||
|---|---|---|---|---|
| |
(In thousands) |
|||
2014 |
$ | 47 | ||
2015 |
49 | |||
2016 |
50 | |||
2017 |
52 | |||
2018 |
31 | |||
Thereafter |
— | |||
| | | | | |
|
$ | 229 | ||
| | | | | |
| | | | | |
The total rent income was $158,000, $166,000, and $187,000, in 2013, 2012, and 2011, respectively, and is recorded as a reduction of occupancy expense in the consolidated statements of income.
(10) Deposits
Deposits consist of the following at December 31, 2013 and 2012:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Non-interest bearing demand deposits |
$ | 433,749 | $ | 351,815 | |||
Interest bearing deposits: |
|||||||
Interest checking |
398,136 | 347,697 | |||||
Money market and statement savings |
475,707 | 430,391 | |||||
Certificates of deposit |
751,267 | 1,113,855 | |||||
| | | | | | | | |
Total interest-bearing deposits |
1,625,110 | 1,891,943 | |||||
| | | | | | | | |
Total deposits |
$ | 2,058,859 | $ | 2,243,758 | |||
| | | | | | | | |
| | | | | | | | |
Interest expense by deposit categories is as follows:
| (In thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Interest checking |
$ | 2,170 | $ | 2,457 | $ | 255 | ||||
Money market and statement savings |
1,389 | 1,689 | 1,534 | |||||||
Certificates of deposit |
9,457 | 10,693 | 11,771 | |||||||
| | | | | | | | | | | |
Total interest expense |
$ | 13,016 | $ | 14,839 | $ | 13,560 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
The aggregate amount of certificates of deposit, each with a minimum denomination of $100,000 was $350.0 million and $565.1 million at December 31, 2013 and 2012, respectively.
118
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(10) Deposits (Continued)
At December 31, 2013, the scheduled maturities of certificates of deposit with a minimum denomination of $100,000 were as follows:
Maturities:
| (In thousands) |
Fixed Term | No-Penalty | Total | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Three months or less |
$ | 116,690 | $ | 7,196 | $ | 123,886 | ||||
Over three months through six months |
43,466 | 2,455 | 45,921 | |||||||
Over six months through twelve months |
46,909 | 2,105 | 49,014 | |||||||
Over twelve months |
90,186 | 40,970 | 131,156 | |||||||
| | | | | | | | | | | |
|
$ | 297,251 | $ | 52,726 | $ | 349,977 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
No-penalty certificates of deposit can be redeemed at anytime at the request of the depositor.
Brokered certificates of deposits at December 31, 2013 and 2012 were $301.2 and $616.6 million, respectively.
At December 31, 2013, the scheduled maturities of certificates of deposit were as follows:
| (In thousands) |
|
|||
|---|---|---|---|---|
2014 |
$ | 428,637 | ||
2015 |
157,204 | |||
2016 |
97,926 | |||
2017 |
45,997 | |||
2018 |
18,437 | |||
2019 |
3,066 | |||
| | | | | |
|
$ | 751,267 | ||
| | | | | |
| | | | | |
(11) Other Borrowed Funds
At December 31, 2013 and 2012, other borrowed funds consisted of the following:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Fixed rate FHLB advances |
$ | 315,000 | $ | 215,000 | |||
Federal funds purchased |
45,000 | 50,000 | |||||
Customer repurchase agreements |
94,613 | 106,656 | |||||
Payable to Statutory Trust I |
20,619 | 20,619 | |||||
| | | | | | | | |
|
$ | 475,232 | $ | 392,275 | |||
| | | | | | | | |
| | | | | | | | |
The Company had fixed rate advances from the FHLB totaling $315.0 million and $215.0 million at December 31, 2013 and 2012, respectively. These advances mature through 2022 and have interest rates ranging from 0.17% to 4.85%.
119
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(11) Other Borrowed Funds (Continued)
The contractual maturities of the fixed rate advances for each of December 31, 2013 and 2012 were as follows:
(In thousands)
| At December 31, 2013 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Type of Advance
|
Interest Rate | Advance Term | Maturity Date | Balance | |||||||
Fixed Rate Credit |
0.17% | 1 month | 2014 | $ | 100,000 | ||||||
Fixed Rate Hybrid |
3.37 - 3.50% | 48 months | 2015 | 10,000 | |||||||
Fixed Rate Hybrid |
2.03% | 48 months | 2016 | 10,000 | |||||||
Fixed Rate Hybrid |
3.45% | 60 months | 2016 | 5,000 | |||||||
Convertible |
3.93 - 4.55% | 120 months | 2016 | 50,000 | |||||||
Fixed Rate Hybrid |
2.46 - 2.65% | 60 months | 2017 | 30,000 | |||||||
Convertible |
3.10 - 4.85% | 120 months | 2017 | 60,000 | |||||||
Convertible |
2.81 - 4.00% | 120 months | 2018 | 20,000 | |||||||
Fixed Rate Hybrid |
2.98% | 84 months | 2019 | 10,000 | |||||||
Fixed Rate Hybrid |
3.80 - 4.01% | 120 months | 2022 | 20,000 | |||||||
| | | | | | | | | | | | |
Total FHLB Advances |
3.09% | $ | 315,000 | ||||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
(In thousands)
| At December 31, 2012 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Type of Advance
|
Interest Rate | Advance Term | Maturity Date | Balance | |||||||
Fixed Rate Hybrid |
3.37 - 3.50% | 48 months | 2015 | $ | 10,000 | ||||||
Fixed Rate Hybrid |
2.03% | 48 months | 2016 | 10,000 | |||||||
Fixed Rate Hybrid |
3.45% | 60 months | 2016 | 5,000 | |||||||
Convertible |
3.93 - 4.55% | 120 months | 2016 | 50,000 | |||||||
Fixed Rate Hybrid |
2.46 - 2.65% | 60 months | 2017 | 30,000 | |||||||
Convertible |
3.10 - 4.85% | 120 months | 2017 | 60,000 | |||||||
Convertible |
2.81 - 4.00% | 120 months | 2018 | 20,000 | |||||||
Fixed Rate Hybrid |
2.98% | 84 months | 2019 | 10,000 | |||||||
Fixed Rate Hybrid |
3.80 - 4.01% | 120 months | 2022 | 20,000 | |||||||
| | | | | | | | | | | | |
Total FHLB Advances |
3.61% | $ | 215,000 | ||||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
The average balances of FHLB advances for the years ended December 31, 2013 and 2012 were $217.3 million and $230.5 million, respectively. The maximum amount outstanding at any month-end for the years ended December 31, 2013 and 2012 was $315.0 million and $295.0 million, respectively. Total interest expense on FHLB advances for the years ended December 31, 2013, 2012, and 2011 was $7.9 million, $8.2 million, and $9.6 million, respectively.
Customer repurchase agreements generally mature within one to four days and are reflected in the consolidated statements of financial condition at the amount of cash received. The Company's deposit customers are the counterparties to these types of funding arrangements. The Company pledges investment securities to collateralize these borrowings. At December 31, 2013 and 2012, the Company
120
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(11) Other Borrowed Funds (Continued)
had repurchase agreements of $94.6 million and $106.7 million, respectively. The weighted-average interest rate of these customer repurchase agreements was 0.16%, 0.21%, and 0.24%, at December 31, 2013, 2012, and 2011, respectively. The average balances of customer repurchase agreements during 2013, 2012, and 2011 were $104.8 million, $117.3 million, and $87.0 million, respectively, and the maximum amount outstanding at any month-end during 2013, 2012, and 2011, was $148.1 million, $160.1 million, and $106.7 million, respectively. Interest expense on customer repurchase agreements for 2013, 2012, and 2011, was $165,000, $249,000, and $210,000, respectively.
At December 31, 2013 and 2012, the Company had federal funds purchased of $45.0 million and $50.0 million, respectively, outstanding with a weighted average interest rate of 0.43% and 0.38%, respectively. Interest expense on federal funds purchased in 2013, 2012, and 2011, was $24,000, $35,000, and $33,000, respectively.
The Company has a line of credit at the Federal Reserve discount window in the amount of $94.5 million at December 31, 2013, none of which was drawn as of that date. There was no interest expense related to the discount window in 2013, 2012, and 2011.
In July 2004, the Company formed a wholly-owned subsidiary, Cardinal Statutory Trust I (the "Trust"), for the purpose of issuing $20.0 million of floating rate junior subordinated deferrable interest debentures ("trust preferred securities"). These trust preferred securities are due in 2034 and have an interest rate of LIBOR (London Interbank Offered Rate) plus 2.40%, which adjusts quarterly. At December 31, 2013, the interest rate on trust preferred securities was 2.64%. These securities are redeemable at par beginning September 2009. The Company has guaranteed payment of these securities. The $20.6 million payable by the Company to the Trust is included in other borrowed funds. The Trust is an unconsolidated subsidiary since the Company is not the primary beneficiary of this entity. The additional $619,000 that is payable by the Company to the Trust represents the Company's unfunded capital investment in the Trust. The Company utilized the proceeds from the issuance of the trust preferred securities to make a capital contribution into the Bank. Interest expense on the trust preferred securities in 2013, 2012, and 2011, was $693,000, $834,000, and $816,000, respectively.
During 2011, the Company extinguished $55.0 million in FHLB advances which had an average cost of 2.87%, or $1.6 million annually. As part of the prepayment arrangement with the FHLB, the Company paid a one-time penalty of $2.3 million related to these advances. The Company replaced these advances with lower-cost longer-term funding from the FHLB. This expense is reported in the non-interest expense section of the Company's consolidated statements of income and no such expense occurred during 2013 or 2012.
The scheduled maturities of other borrowed funds at December 31, 2013 were as follows:
| (In thousands) |
2014 | 2015 | 2016 | 2017 | 2018 | 2019 and Thereafter |
|||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
FHLB advances |
$ | 100,000 | $ | 10,000 | $ | 65,000 | $ | 90,000 | $ | 20,000 | $ | 30,000 | |||||||
Customer repurchase agreements |
94,613 | — | — | — | — | — | |||||||||||||
Federal funds sold |
45,000 | — | — | — | — | — | |||||||||||||
Payable to Statutory Trust I |
— | — | — | — | — | 20,619 | |||||||||||||
| | | | | | | | | | | | | | | | | | | | |
|
$ | 239,613 | $ | 10,000 | $ | 65,000 | $ | 90,000 | $ | 20,000 | $ | 50,619 | |||||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
121
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(12) Income Taxes
The Company and its subsidiaries file consolidated federal tax returns on a calendar-year basis. For the years ended December 31, 2013, 2012, and 2011, the Company recorded income tax expense of $12.2 million, $22.7 million, and $14.1 million, respectively.
The provision for income tax expense is reconciled to the amount computed by applying the federal corporate tax rate to income before taxes as follows:
| (In thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Income tax at federal corporate rate of 35% |
$ | 13,189 | $ | 23,784 | $ | 14,742 | ||||
Change in valuation allowance |
245 | 671 | — | |||||||
Change in the carrying rate of deferred tax assets and liabilities |
— | — | 1 | |||||||
Expected state tax benefit of losses of nonbank entities |
— | — | — | |||||||
State tax expense, net of federal tax benefit |
77 | 226 | 263 | |||||||
Nontaxable income |
(1,466 | ) | (2,152 | ) | (1,152 | ) | ||||
Nondeductible expenses |
184 | 400 | 27 | |||||||
Other |
(54 | ) | (271 | ) | 241 | |||||
| | | | | | | | | | | |
|
$ | 12,175 | $ | 22,658 | $ | 14,122 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
The components of income tax expense are as follows:
| (In thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Included in net income |
||||||||||
Current |
||||||||||
Federal |
$ | 14,432 | $ | 16,355 | $ | 12,675 | ||||
State |
609 | 486 | 361 | |||||||
| | | | | | | | | | | |
Total current |
15,041 | 16,841 | 13,036 | |||||||
| | | | | | | | | | | |
Deferred |
||||||||||
Federal |
(2,799 | ) | 5,695 | 1,057 | ||||||
State |
(67 | ) | 122 | 29 | ||||||
| | | | | | | | | | | |
Total deferred |
(2,866 | ) | 5,817 | 1,086 | ||||||
| | | | | | | | | | | |
Total included in net income |
$ | 12,175 | $ | 22,658 | $ | 14,122 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Included in shareholders' equity: |
||||||||||
Deferred tax expense related to the change in the net unrealized gain on investment securities available for sale |
$ | (5,064 | ) | $ | 391 | $ | 4,468 | |||
Deferred tax expense (benefit) related to the change in the net unrealized gain (loss) on derivative instruments designated as cash flow hedges |
589 | 470 | (572 | ) | ||||||
| | | | | | | | | | | |
Total included in shareholders' equity |
$ | (4,475 | ) | $ | 861 | $ | 3,896 | |||
| | | | | | | | | | | |
| | | | | | | | | | | |
122
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(12) Income Taxes (Continued)
The tax effects of temporary differences between the financial reporting basis and income tax basis of assets and liabilities relate to the following:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Deferred tax assets: |
|||||||
Allowance for loan losses |
$ | 9,988 | $ | 9,761 | |||
Net operating state loss carryforwards |
2,490 | 2,258 | |||||
Unrealized losses on derivative instruments designated as cash flow hedges |
22 | 611 | |||||
Deferred compensation |
5,424 | 3,965 | |||||
Other |
991 | 1,999 | |||||
| | | | | | | | |
Total gross deferred tax assets |
18,915 | 18,594 | |||||
Less valuation allowance |
(2,490 | ) | (2,258 | ) | |||
| | | | | | | | |
Net deferred tax assets |
16,425 | 16,336 | |||||
| | | | | | | | |
Deferred tax liabilities: |
|||||||
Unrealized gains on investment securities available-for-sale |
(2,740 | ) | (7,805 | ) | |||
Goodwill and intangibles, net |
(601 | ) | (149 | ) | |||
Fair value adjustments |
(5,910 | ) | (8,751 | ) | |||
Depreciation |
(926 | ) | (865 | ) | |||
Prepaid expenses |
(190 | ) | (15 | ) | |||
Loan origination costs |
(663 | ) | (697 | ) | |||
| | | | | | | | |
Total gross deferred tax liabilities |
(11,030 | ) | (18,282 | ) | |||
| | | | | | | | |
Net deferred tax asset (liability) |
$ | 5,395 | $ | (1,946 | ) | ||
| | | | | | | | |
| | | | | | | | |
Deferred tax assets and liabilities are recognized for the tax effects of differing carrying values of assets and liabilities for tax and financial statement purposes that will reverse in future periods. When uncertainty exists concerning the recoverability of a deferred tax asset, the carrying value of the asset may be reduced by a valuation allowance. Valuation allowances of $2.5 million and $2.3 million for December 31, 2013 and 2012, respectively, have been established for deferred tax assets. This valuation allowance relates primarily to the state net operating losses of the parent company, CWS and Wilson/Bennett as realization is dependent upon generating future taxable income within those entities and in the specific jurisdiction. There is uncertainty concerning the recoverability of these state net operating losses as the entities which own these losses have never operated profitably and future profitability is uncertain. Management believes that future operations of the Company will generate sufficient taxable income to realize the net deferred tax assets at each of December 31, 2013 and 2012. The Company has state net operating loss carryforwards of $41.5 million that begin to expire in 2017.
As of December 31, 2013 and 2012, the Company had no unrecognized tax benefits. The Company had no interest expense or tax penalties related to uncertain tax positions during the years ended December 31, 2013 and 2012. If the Company had such expenses, they would be classified in the consolidated statements of income as part of the provision for income tax expense.
123
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Derivative Instruments and Hedging Activities
Forward Mortgage Loan Sales Commitments and Interest Rate Lock Commitments
The Company enters into rate lock commitments with its mortgage customers. The Company is also a party to forward mortgage loan sales contracts to sell loans servicing released. The rate lock commitment and forward sale agreement are undesignated derivatives and marked to fair value through earnings. The fair value of the rate lock derivative includes the servicing premium and the interest spread for the difference between retail and wholesale mortgage rates. Realized and unrealized gains on mortgage banking activities presents the gain recognized for the period presented and associated with these elements of fair value. On the date the mortgage loan closes, the loan held for sale is designated as the hedged item in a cash flow hedge relationship and the forward loan sale commitment is designated as the hedging instrument.
At December 31, 2013, accumulated other comprehensive income included an unrealized gain, net of tax, of $1.1 million related to forward loan sale contracts designated as the hedging instrument in the cash flow hedge. At December 31, 2012, accumulated other comprehensive income included an unrealized gain, net of tax, of $785,000 related to forward loan sale contracts designated as the hedging instrument in the cash flow hedge. Loans held for sale are generally sold within sixty days of closing and, therefore, substantially all of the amount recorded in accumulated other comprehensive income at December 31, 2013 which is related to the Company's cash flow hedges will be recognized in earnings during the first quarter of 2014. During 2013, 2012, and 2011, the Company recognized minimal amounts due to hedge ineffectiveness.
At December 31, 2013, the Company had $210.9 million in residential mortgage rate lock commitments and associated forward sales and $293.2 million in forward loan sales associated with $374.0 million of loans that had closed and were presented as held for sale. At December 31, 2013, the derivative asset was $16.5 million and the derivative liability was $5.7 million.
At December 31, 2012, the Company had $481.7 million in residential mortgage rate lock commitments and associated forward sales and $723.8 million in forward loan sales associated with $785.8 million of loans that had closed and were presented as held for sale. At December 31, 2012, the derivative asset was $27.2 million and the derivative liability was $4.2 million.
Interest Rate Risk Management—Cash Flow Hedging Instruments
The Company uses long-term variable rate debt as a source of funds for use in the Company's lending and investment activities and other general business purposes. These debt obligations expose the Company to variability in interest payments due to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. The Company believes it is prudent to limit the variability of a portion of its interest payments and, therefore, generally hedges a portion of its variable-rate interest payments. To meet this objective, the Company entered into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.
124
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Derivative Instruments and Hedging Activities (Continued)
At December 31, 2012, information pertaining to outstanding interest rate swap agreements used to hedge variable rate debt (trust preferred securities which is included in other borrowed funds on the statement of condition) is shown below. These interest rate swap agreements matured during 2013.
| (Dollars in thousands) |
2012 | |||
|---|---|---|---|---|
Notional amount |
$ | 10,000 | ||
Weighted average pay rate |
3.97 | % | ||
Weighted average receive rate |
1.54 | % | ||
Weighted average maturity in years |
1 years | |||
Unrealized gain (loss) relating to interest rate swaps |
$ | 119 | ||
These agreements provided for the Company to receive payments at a variable rate determined by a specific index (three month LIBOR) in exchange for making payments at a fixed rate. At December 31, 2012, the unrealized loss relating to interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income. These amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the long-term debt affects earnings. The cash flow hedging relationships were highly effective during 2012 and the amount of ineffectiveness was de minimus.
Interest Rate Risk Management—Fair Value Hedging Instruments
The Company originates fixed and variable rate loans. Fixed rate loans expose the Company to variability in their fair value due to changes in the level of interest rates. The Company believes it is prudent to limit the variability in the fair value of a portion of its fixed rate loan portfolio. The Company also believes it is economically prudent to keep hedge coverage ratios at acceptable risk levels, which may vary depending on current and expected interest rate movement. It is the Company's objective to hedge the change in fair value of fixed rate loans at coverage levels that are appropriate, given anticipated or existing interest rate levels and other market considerations, as well as the relationship of change in this asset to other assets of the Company. To meet this objective, the Company utilizes interest rate swaps as an asset/liability management strategy to hedge the change in value of the loans due to changes in expected interest rate assumptions. The Company entered into an interest rate swap to hedge the change in fair value of one loan receivable. This interest rate swap agreement requires a series of floating rate payments in exchange for receiving a series of fixed rate payments.
At December 31, 2012, the information pertaining to the single outstanding interest rate swap agreement used to hedge fixed-rate loans is shown below. This interest rate swap agreement matured during 2013.
| (Dollars in thousands) |
2012 | |||
|---|---|---|---|---|
Notional amount |
$ | 11,174 | ||
Weighted average pay rate |
5.42 | % | ||
Weighted average receive rate |
0.25 | % | ||
Weighted average maturity in years |
1 year | |||
Unrealized loss relating to interest rate swaps |
$ | 478 | ||
125
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(13) Derivative Instruments and Hedging Activities (Continued)
The agreement provided for the Company to make payments at a variable rate determined by a specified index (one month LIBOR) in exchange for receiving payments at a fixed rate.
At December 31, 2012, the unrealized loss relating to use of interest rate swap was recorded in net income with an offsetting gain for the fair value of the loan. The fair value of the loan is included in loans receivable on the statement of condition. The hedge relationship has been effective since inception and is forecasted to remain effective. Ineffectiveness reflected in earnings is immaterial for the periods presented.
(14) Fair Value of Derivative Instruments and Hedging Activities
The following tables disclose the derivative instruments' location on the Company's statement of condition and the fair value of those instruments at December 31, 2013 and 2012. In addition, the gains and losses related to these derivative instruments is provided for the years ended December 31, 2013 and 2012.
Derivative Instruments and Hedging Activities
At December 31, 2013
(in thousands)
| |
Asset Derivatives | Liability Derivatives | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Balance Sheet Location |
Fair Value | Balance Sheet Location |
Fair Value | |||||||
Derivatives Designated as Hedging Instruments |
|||||||||||
Forward Loan Sales Commitments |
Accrued Interest |
5,489 |
Accrued Interest |
4,043 |
|||||||
| | | | | | | | | | | | |
Total Derivatives Designated as Hedging Instruments |
5,489 | 4,043 | |||||||||
| | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments |
|||||||||||
Rate Lock and Forward Loan Sales Commitments |
Accrued Interest |
10,989 |
Accrued Interest |
9 |
|||||||
Rate Lock Commitments |
Accrued Interest |
9 |
Accrued Interest |
1,554 |
|||||||
| | | | | | | | | | | | |
Total Derivatives Not Designated as Hedging Instruments |
10,998 | 1,563 | |||||||||
| | | | | | | | | | | | |
Total Derivatives |
$ |
16,487 |
$ |
5,606 |
|||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
126
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Fair Value of Derivative Instruments and Hedging Activities (Continued)
Derivative Instruments and Hedging Activities
At December 31, 2012
(in thousands)
| |
Asset Derivatives | Liability Derivatives | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Balance Sheet Location |
Fair Value | Balance Sheet Location |
Fair Value | |||||||
Derivatives Designated as Hedging Instruments |
|||||||||||
Interest Rate Swaps |
Accrued Interest |
$ |
— |
Accrued Interest |
$ |
616 |
|||||
Forward Loan Sales Commitments |
Accrued Interest |
2,136 |
Accrued Interest |
3,623 |
|||||||
| | | | | | | | | | | | |
Total Derivatives Designated as Hedging Instruments |
2,136 | 4,239 | |||||||||
| | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments |
|||||||||||
Rate Lock and Forward Loan Sales Commitments |
Accrued Interest |
24,657 |
Accrued Interest |
449 |
|||||||
Rate Lock Commitments |
Accrued Interest Receivable and Other Assets |
449 |
Accrued Interest Payable and Other Liabilities |
91 |
|||||||
| | | | | | | | | | | | |
Total Derivatives Not Designated as Hedging Instruments |
25,106 | 540 | |||||||||
| | | | | | | | | | | | |
Total Derivatives |
$ |
27,242 |
$ |
4,779 |
|||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
127
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Fair Value of Derivative Instruments and Hedging Activities (Continued)
Impact of Derivative Instruments on the Statement of Income
For the Year Ended December 31, 2013
(in thousands)
Derivatives in Fair Value Hedging Relationships |
Locations of Gain (Loss) Recognized in Income on Derivative |
Amount of Gain (Loss) Recognized in Income on Derivative |
Location of Gain (Loss) Recognized in Income on Hedged Item |
Amount of Gain (Loss) Recognized in Income on Hedged Item |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Interest Rate Swaps |
Other Income | $ | 478 | Other Income | $ | (478 | ) | ||||
| | | | | | | | | | | | |
Total |
$ | 478 | $ | (478 | ) | ||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Derivatives in Cash Flow Hedging Relationships |
Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion) |
Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion) |
Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion) |
Location of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest Rate Swaps |
$ | 89 | Other Income | $ | — | Other Income | $ | — | ||||||
Forward Loan Sales Commitments |
1,020 | Other Income | 3,774 | Other Income | — | |||||||||
| | | | | | | | | | | | | | | |
Total |
$ | 1,109 | $ | 3,774 | $ | — | ||||||||
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Derivatives Not Designated as Hedging Instruments
|
Amount of Gain (Loss) Recognized in Income on Derivative |
Location of Gain (Loss) Recognized in Income on Derivative |
|||
|---|---|---|---|---|---|
Interest Rate Lock Commitment |
$ | 59,566 | Realized and unrealized gains on mortgage banking activities | ||
Forward Loan Sales Commitments |
6,421 | Other Income | |||
Rate Lock Commitments |
(6,421 | ) | Other Income | ||
| | | | | | |
Total |
$ | 59,566 | |||
| | | | | | |
| | | | | | |
128
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(14) Fair Value of Derivative Instruments and Hedging Activities (Continued)
Impact of Derivative Instruments on the Statement of Income
For the Year Ended December 31, 2012
(in thousands)
Derivatives in Fair Value Hedging Relationships |
Locations of Gain (Loss) Recognized in Income on Derivative |
Amount of Gain (Loss) Recognized in Income on Derivative |
Location of Gain (Loss) Recognized in Income on Hedged Item |
Amount of Gain (Loss) Recognized in Income on Hedged Item |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
Interest Rate Swaps |
Other Income | $ | 522 | Other Income | $ | (522 | ) | ||||
| | | | | | | | | | | | |
Total |
$ | 522 | $ | (522 | ) | ||||||
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Derivatives in Cash Flow Hedging Relationships |
Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion) |
Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion) |
Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion) |
Location of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing) |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Interest Rate Swaps |
$ | 119 | Other Income | $ | — | Other Income | $ | — | ||||||
Forward Loan Sales Commitments |
666 | Other Income | (756 | ) | Other Income | — | ||||||||
| | | | | | | | | | | | | | | |
Total |
$ | 785 | $ | (756 | ) | $ | — | |||||||
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| Derivatives Not Designated as Hedging Instruments | Amount of Gain (Loss) Recognized in Income on Derivative |
Location of Gain (Loss) Recognized in Income on Derivative |
|||
|---|---|---|---|---|---|
Interest Rate Lock Commitment |
$ | 79,397 | Realized and unrealized gains on mortgage banking activities | ||
Forward Loan Sales Commitments |
(2,875 | ) | Other Income | ||
Rate Lock Commitments |
2,875 | Other Income | |||
| | | | | | |
Total |
$ | 79,397 | |||
| | | | | | |
| | | | | | |
(15) Regulatory Matters
The Bank, as a state-chartered bank, is subject to the dividend restrictions established by the State Corporation Commission of the Commonwealth of Virginia. Under such restrictions, the Bank may not, without the prior approval of the Bank's primary regulator, declare dividends in excess of the sum of the current year's earnings (as defined) plus the retained earnings (as defined) from the prior two years. At December 31, 2013, there were approximately $173.8 million of accumulated earnings at the Bank which could be paid as dividends to the Company.
The Bank is required to maintain a minimum non-interest earning clearing balance with the Federal Reserve Bank. The average amount of the clearing balance was $1.0 million for 2013.
129
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(15) Regulatory Matters (Continued)
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires banking regulators to stratify banks into five quality tiers based upon their relative capital strengths and increase the regulation of the weaker institutions. The key measures of capital are: (1) total capital (Tier I capital plus the allowance for loan losses up to certain limitations) as a percent of total risk-weighted assets, (2) Tier I capital (as defined) as a percent of total risk-weighted assets (as defined), and (3) Tier I capital (as defined) as a percent of total average assets (as defined).
The regulatory capital of the Company at December 31, 2013 and 2012 is as follows:
| |
Actual | For Capital Adequacy Purposes |
To Be Well Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||||
At December 31, 2013 |
|||||||||||||||||||||||||
(In thousands) |
|||||||||||||||||||||||||
Total capital to risk weighted assets |
$ |
349,894 |
12.89 |
% |
$ |
217,111 |
³ |
8.00 |
% |
$ |
271,389 |
³ |
10.00 |
% |
|||||||||||
Tier I capital to risk weighted assets |
321,513 | 11.85 | % | 108,555 | ³ | 4.00 | % | 162,833 | ³ | 6.00 | % | ||||||||||||||
Tier I capital to average assets |
321,513 | 11.70 | % | 109,928 | ³ | 4.00 | % | 137,410 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2012 |
|||||||||||||||||||||||||
(In thousands) |
|||||||||||||||||||||||||
Total capital to risk weighted assets |
$ |
328,547 |
13.04 |
% |
$ |
201,530 |
³ |
8.00 |
% |
$ |
251,913 |
³ |
10.00 |
% |
|||||||||||
Tier I capital to risk weighted assets |
300,732 | 11.94 | % | 100,765 | ³ | 4.00 | % | 151,148 | ³ | 6.00 | % | ||||||||||||||
Tier I capital to average assets |
300,732 | 10.49 | % | 114,693 | ³ | 4.00 | % | 143,366 | ³ | 5.00 | % | ||||||||||||||
The regulatory capital of the Bank at December 31, 2013 and 2012 is as follows:
| |
Actual | For Capital Adequacy Purposes |
Capitalized Under Prompt Corrective Action Provisions |
||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Amount | Ratio | Amount | |
Ratio | Amount | |
Ratio | |||||||||||||||||
At December 31, 2013 |
|||||||||||||||||||||||||
(In thousands) |
|||||||||||||||||||||||||
Total capital to risk-weighted assets |
$ | 343,392 | 12.73 | % | $ | 215,733 | ³ | 8.00 | % | $ | 269,666 | ³ | 10.00 | % | |||||||||||
Tier I capital to risk-weighted assets |
315,011 | 11.68 | % | 107,867 | ³ | 4.00 | % | 161,800 | ³ | 6.00 | % | ||||||||||||||
Tier I capital to average assets |
315,011 | 11.54 | % | 109,212 | ³ | 4.00 | % | 136,515 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2012 |
|||||||||||||||||||||||||
(In thousands) |
|||||||||||||||||||||||||
Total capital to risk-weighted assets |
$ | 315,511 | 12.59 | % | $ | 200,440 | ³ | 8.00 | % | $ | 250,550 | ³ | 10.00 | % | |||||||||||
Tier I capital to risk-weighted assets |
287,695 | 11.48 | % | 100,220 | ³ | 4.00 | % | 150,330 | ³ | 6.00 | % | ||||||||||||||
Tier I capital to average assets |
287,695 | 10.08 | % | 114,196 | ³ | 4.00 | % | 142,745 | ³ | 5.00 | % | ||||||||||||||
At December 31, 2013 and 2012, the Company and the Bank met all regulatory capital requirements and are considered "well-capitalized" from a regulatory perspective.
130
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(15) Regulatory Matters (Continued)
George Mason is also required to maintain defined capital levels under Department of Housing and Urban Development guidelines. At December 31, 2013 and 2012, George Mason maintained capital in excess of these required guidelines.
(16) Related-Party Transactions
Certain directors, officers and employees and/or their related business interests are at present, as in the past, banking customers in the ordinary course of business of the Company. As such, the Company has had, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders and their associates, on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with non-related parties and do not involve more than normal risk of collectability or present other unfavorable features.
Analysis of activity for loans to related parties follows:
| (In thousands) |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Balance, beginning of year |
$ | 32,604 | $ | 34,988 | |||
New loans |
292 | 1,236 | |||||
Loans paid off or paid down |
(4,599 | ) | (3,620 | ) | |||
| | | | | | | | |
Balance, end of year |
$ | 28,297 | $ | 32,604 | |||
| | | | | | | | |
| | | | | | | | |
George Mason leases its headquarters office space from a director of the Company who is the manager and a 3.1% owner of the limited liability company that owns the building in which the space is leased. The lease was extended during 2013 so that it now expires June 30, 2019. The rent that George Mason pays for the use of this space under the existing lease ranges from $1.0 to $1.2 million annually over the next six years. Rent payments totaled $789,000 in 2013, $912,000 in 2012, and $738,000 in 2011. The Company also leases branch office space from a director who has an indirect ownership in the building. Certain of his immediate family members own a minority interest in the limited liability company that owns the building. The rent the Bank pays for the use of this space under the existing lease is $31,000 to $32,000 annually for the next three years. Rent payments totaled $30,000 in 2013 and $34,000 in 2012.
(17) Earnings Per Common Share
The following is the calculation of basic and diluted earnings per common share.
| (In thousands, except per share data) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
Weighted average shares for basic |
30,687 | 29,654 | 29,401 | |||||||
Weighted average shares for diluted |
31,077 | 29,996 | 29,784 | |||||||
Basic earnings per common share |
$ | 0.83 | $ | 1.53 | $ | 0.95 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Diluted earnings per common share |
$ | 0.82 | $ | 1.51 | $ | 0.94 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
131
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(17) Earnings Per Common Share (Continued)
The following shows the composition of basic outstanding shares for the years ended December 31, 2013, 2012, and 2011:
| (in thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Weighted average shares outstanding—basic |
30,271 | 29,244 | 28,938 | |||||||
Weighted average shares attributable to deferred compensation plans |
416 | 410 | 463 | |||||||
| | | | | | | | | | | |
Total weighted average shares—basic |
30,687 | 29,654 | 29,401 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Weighted average shares for the basic earnings per share calculation is increased by the number of shares required to be issued under the Company's various deferred compensation plans. These plans provide for a Company match. The Company match must be in common stock of the Company.
The following shows the composition of diluted outstanding shares for the years ended December 31, 2013, 2012, and 2011:
| (in thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Weighted average shares outstanding—basic |
30,271 | 29,244 | 28,938 | |||||||
Weighted average shares attributable to deferred compensation plans |
628 | 664 | 694 | |||||||
Weighted average shares attributable to vested stock options |
151 | 88 | 152 | |||||||
Incremental shares from unvested stock options |
27 | — | — | |||||||
| | | | | | | | | | | |
Total weighted average shares—diluted |
31,077 | 29,996 | 29,784 | |||||||
| | | | | | | | | | | |
| | | | | | | | | | | |
Employees and directors who participate in the Company's deferred compensation plans can allocate, at their discretion, their contributions to various investment options, including an option to invest in Company Common Stock. The incremental weighted average shares attributable to the deferred compensation plans included in diluted outstanding shares assumes the participants opt to invest all of their contributions into the Company's Common Stock investment option.
Antidilutive outstanding stock options excluded from the weighted average shares outstanding for the diluted earnings per share calculation for the years ended December 31, 2013 and 2011 were 157 and 19,412, respectively. There were no antidilutive outstanding stock options for the year ended December 31, 2012. These stock options have exercise prices that were greater than the average market price of the Company's common stock for the years presented. In addition, for the years ended December 31, 2013 and 2012, there were 26,995 and 14,739, respectively, incremental shares related to unvested stock options added to the diluted weighted average share calculation. No unvested incremental stock option shares were added to the earnings per share calculation for 2011 as the addition of these shares to the diluted weighted average share calculation would have been antidilutive.
(18) 401(k) Plan
Employees who work twenty (20) hours or more a week and have been employed by the Company for a month can elect to participate in and make contributions into a 401(k) Plan. The Company contributes $0.50 for $1.00 of employee contributions up to a maximum of 3% of the employee's
132
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(18) 401(k) Plan (Continued)
contribution. Expense related to the Company's match in 2013, 2012, and 2011, was $ 1.3 million, $1.1 million, and $682,000, respectively. Employees are immediately vested in the Company's matching contribution.
(19) Deferred Compensation Plans
The Company has deferred compensation plans for its directors and certain employees. Under the directors' plan, a director may elect to defer all or a portion of any director-related fees including fees for serving on board committees. Under the employees' plan, certain employees may defer all or a portion of their compensation including any bonus or commission compensation. Director and employee deferrals, other than employees of George Mason, are matched 50% by the Company. Deferrals made by employees of George Mason are not eligible for the Company match. The amount of the Company match is deemed invested in Company common stock which vests immediately for the directors and over three years for employees. The maximum Company match per employee is $50,000 per year. There is no annual ceiling to the Company match for directors. Expense relating to the deferred compensation plans for the years ended December 31, 2013, 2012, and 2011, was $286,000, $215,000, and $253,000, respectively, the employee portion of which is included in salary and benefits expense and the directors portion of the expense is included in other operating expense in the consolidated statements of income.
The deferred compensation plan liability at December 31, 2013 and 2012 was $8.3 million and $7.2 million, respectively. The trust established for the deferred compensation plan is funded.
The Company has a supplemental executive retirement plan (SERP) that covers certain executive officers. Under the plan, the Company pays each participant, or their beneficiary, the amount of compensation deferred plus accrued interest beginning with the individual's retirement. A liability is accrued for the obligation under these plans. The expense incurred for the SERP in 2013, 2012, and 2011 was $210,000, $2.4 million, and $434,000, respectively. The SERP liability was $7.1 million and $6.9 million as of December 31, 2013 and 2012, respectively.
(20) Director and Employee Stock-Based Compensation Plans
At December 31, 2013, the Company had two stock-based employee compensation plans, the 1999 Stock Option Plan (the "Option Plan") and the 2002 Equity Compensation Plan (the "Equity Plan").
In 1998, the Company adopted the Option Plan pursuant to which the Company may grant stock options for up to 625,000 shares of the Company's common stock to employees and members of the Company's and its subsidiaries' boards of directors. As of November 23, 2008, the Option Plan expired, and therefore, there are no shares of common stock available to grant under this plan.
In 2002, the Company adopted the Equity Plan. The Equity Plan authorizes the granting of options, which may be incentive stock options or non-qualified stock options, stock appreciation rights, restricted stock awards, phantom stock awards or performance share awards to directors, eligible officers and key employees of the Company. In 2011, the shareholders approved an amendment to the Equity Plan to increase the number of shares of common stock reserved for issuance under it from 2,420,000 to 3,170,000, an increase of 750,000 shares. In addition, the amendment extended the term of
133
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(20) Director and Employee Stock-Based Compensation Plans (Continued)
the Equity Plan to February 21, 2021. There are 701,818 shares of the Company's common stock available for future grants and awards in the Equity Plan as of December 31, 2013.
The following tables present a summary of the Company's stock option activity for the years ended December 31, 2013, 2012, and 2011:
| |
Number of Shares |
Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term (Years) |
Aggregate Intrinsic Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding at December 31, 2012 |
851,358 | $ | 10.21 | ||||||||||
Granted |
278,250 | 16.23 | |||||||||||
Exercised |
(106,355 | ) | 8.64 | ||||||||||
Forfeited |
(11,700 | ) | 10.18 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2013 |
1,011,553 | $ | 12.03 | 5.44 | $ | 6,025,243 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Options exercisable at December 31, 2013 |
722,403 | $ | 11.15 | 4.25 | $ | 4,943,418 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| |
Number of Shares |
Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term (Years) |
Aggregate Intrinsic Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding at December 31, 2011 |
1,832,860 | $ | 9.38 | ||||||||||
Granted |
63,750 | 12.11 | |||||||||||
Exercised |
(1,027,702 | ) | 8.84 | ||||||||||
Forfeited |
(17,550 | ) | 10.20 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2012 |
851,358 | $ | 10.21 | 4.67 | $ | 5,182,708 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Options exercisable at December 31, 2012 |
682,458 | $ | 10.19 | 3.84 | $ | 4,166,600 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| |
Number of Shares |
Weighted Average Exercise Price |
Weighted Average Remaining Contractual Term (Years) |
Aggregate Intrinsic Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Outstanding at December 31, 2010 |
2,197,289 | $ | 8.67 | ||||||||||
Granted |
153,100 | 11.20 | |||||||||||
Exercised |
(428,779 | ) | 6.13 | ||||||||||
Forfeited |
(88,750 | ) | 10.77 | ||||||||||
| | | | | | | | | | | | | | |
Outstanding at December 31, 2011 |
1,832,860 | $ | 9.38 | 4.19 | $ | 2,493,627 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
Options exercisable at December 31, 2011 |
1,659,160 | $ | 9.38 | 3.74 | $ | 2,250,771 | |||||||
| | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
134
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(20) Director and Employee Stock-Based Compensation Plans (Continued)
Information pertaining to stock options outstanding at December 31, 2013 is as follows:
At December 31, 2013
| |
Options Outstanding | Options Exercisable | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
Weighed Average | |
|
|||||||||||
Range of Exercise Prices |
Number Outstanding |
Remaining Contractual Life |
Exercise Price |
Number Exercisable |
Weighted Average Exercise Price |
||||||||||
$5.95 - $8.28 |
88,510 | 5.1 years | $ | 6.45 | 72,560 | $ | 6.52 | ||||||||
$8.39 - $9.59 |
62,500 | 1.9 years | 8.89 | 60,700 | 8.90 | ||||||||||
$9.78 - $10.91 |
201,224 | 3.1 years | 10.34 | 175,224 | 10.38 | ||||||||||
$11.03 - $12.65 |
368,069 | 4.5 years | 11.60 | 311,469 | 11.58 | ||||||||||
$13.00 - $15.02 |
68,500 | 9.2 years | 14.76 | 52,350 | 14.95 | ||||||||||
$15.32 - $17.82 |
222,750 | 9.2 years | 16.54 | 50,100 | 16.57 | ||||||||||
| | | | | | | | | | | | | | | | |
Outstanding at year end |
1,011,553 | 5.44 | 12.03 | 722,403 | 11.15 | ||||||||||
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total intrinsic value of options exercised during the years ended December 31, 2013, 2012, and 2011, was $875,000, $7.7 million, and $2.0 million, respectively.
A summary of the status of the Company's non-vested stock options and changes during the year ended December 31, 2013 is as follows:
| |
Number of Shares |
Weighted Average Grant Date Fair Value |
|||||
|---|---|---|---|---|---|---|---|
Balance at December 31, 2010 |
211,500 | $ | 3.93 | ||||
Granted |
153,100 | 4.84 | |||||
Vested |
(144,750 | ) | 4.71 | ||||
Forfeited |
(46,150 | ) | 4.47 | ||||
| | | | | | | | |
Balance at December 31, 2011 |
173,700 | $ | 3.94 | ||||
| | | | | | | | |
Granted |
63,750 | 4.65 | |||||
Vested |
(54,220 | ) | 3.99 | ||||
Forfeited |
(14,330 | ) | 4.21 | ||||
| | | | | | | | |
Balance at December 31, 2012 |
168,900 | $ | 4.17 | ||||
| | | | | | | | |
Granted |
278,250 | 5.83 | |||||
Vested |
(150,250 | ) | 5.09 | ||||
Forfeited |
(7,750 | ) | 4.21 | ||||
| | | | | | | | |
Balance at December 31, 2013 |
289,150 | $ | 5.29 | ||||
| | | | | | | | |
| | | | | | | | |
At December 31, 2013, there was $1.1 million of total unrecognized compensation expense related to non-vested share-based compensation arrangements granted under the plans. The expense is expected to be recognized over a weighted average period of 2.5 years. The total fair value of shares that vested during the years ended December 31, 2013, 2012, and 2011, was $765,000, $216,000, and $681,000, respectively.
135
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(21) Segment Reporting
The Company operates in three business segments: commercial banking, mortgage banking, and wealth management services. As of June 30, 2013, the Company merged the remaining operations of its trust division and Wilson/Bennett Capital Management, Inc., both of which had been included in the wealth management services segment, into CWS. In addition, as of June 30, 2013, the Company merged the operations of Cardinal First Mortgage, LLC into George Mason. Results for the year ended December 31, 2013 include six months of operations of these subsidiaries.
The commercial banking segment includes both commercial and consumer lending and provides customers with such products as commercial loans, real estate loans, business financing and consumer loans. In addition, this segment provides customers with several choices of deposit products including demand deposit accounts, savings accounts and certificates of deposit. The mortgage banking segment engages primarily in the origination and acquisition of residential mortgages for sale into the secondary market on a best efforts basis. The wealth management services segment provides investment and financial advisory services to businesses and individuals, including financial planning, retirement/estate planning, and investment management.
Information about the reportable segments and reconciliation of this information to the consolidated financial statements at and for the years ended December 31, 2013, 2012, and 2011 follows:
(In thousands)
At and for the Year Ended December 31, 2013:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 90,563 | $ | 2,474 | $ | — | $ | (692 | ) | $ | — | $ | 92,345 | ||||||
Provision for loan losses |
(117 | ) | 85 | — | — | — | (32 | ) | |||||||||||
Non-interest income |
3,767 | 24,760 | 1,337 | 85 | (38 | ) | 29,911 | ||||||||||||
Non-interest expense |
43,832 | 35,185 | 1,580 | 4,044 | (38 | ) | 84,603 | ||||||||||||
Provision (benefit) for income taxes |
16,734 | (2,821 | ) | (81 | ) | (1,657 | ) | — | 12,175 | ||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 33,881 | $ | (5,215 | ) | $ | (162 | ) | $ | (2,994 | ) | $ | — | $ | 25,510 | ||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,862,039 | $ | 380,124 | $ | 2,266 | $ | 347,288 | $ | (697,487 | ) | $ | 2,894,230 | ||||||
136
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(21) Segment Reporting (Continued)
At and for the Year Ended December 31, 2012:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 89,472 | $ | 2,365 | $ | — | $ | (834 | ) | $ | — | $ | 91,003 | ||||||
Provision for loan losses |
6,865 | 258 | — | — | — | 7,123 | |||||||||||||
Non-interest income |
5,868 | 54,794 | 2,623 | 176 | (69 | ) | 63,392 | ||||||||||||
Non-interest expense |
43,495 | 29,529 | 2,656 | 3,706 | (69 | ) | 79,317 | ||||||||||||
Provision (benefit) for income taxes |
14,436 | 9,764 | (14 | ) | (1,528 | ) | — | 22,658 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 30,544 | $ | 17,608 | $ | (19 | ) | $ | (2,836 | ) | $ | — | $ | 45,297 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,954,412 | $ | 815,820 | $ | 2,693 | $ | 329,328 | $ | (1,063,066 | ) | $ | 3,039,187 | ||||||
At and for the Year Ended December 31, 2011:
| |
Commercial Banking |
Mortgage Banking |
Wealth Management Services |
Other | Intersegment Elimination |
Consolidated | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net interest income |
$ | 77,456 | $ | 2,522 | $ | — | $ | (816 | ) | $ | — | $ | 79,162 | ||||||
Provision for loan losses |
6,910 | — | — | — | — | 6,910 | |||||||||||||
Non-interest income |
6,116 | 25,592 | 2,552 | 161 | (88 | ) | 34,333 | ||||||||||||
Non-interest expense |
42,202 | 16,032 | 2,610 | 3,709 | (88 | ) | 64,465 | ||||||||||||
Provision (benefit) for income taxes |
11,397 | 4,291 | (29 | ) | (1,537 | ) | — | 14,122 | |||||||||||
| | | | | | | | | | | | | | | | | | | | |
Net income (loss) |
$ | 23,063 | $ | 7,791 | $ | (29 | ) | $ | (2,827 | ) | $ | — | $ | 27,998 | |||||
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Total Assets |
$ | 2,549,326 | $ | 531,403 | $ | 590 | $ | 278,820 | $ | (757,423 | ) | $ | 2,602,716 | ||||||
The Company did not have any operating segments other than those reported. Parent company financial information is included in the "Other" category and represents an overhead function rather than an operating segment. The parent company's most significant assets are its net investments in its subsidiaries. The parent company's net interest expense is comprised of interest income from short-term investments and interest expense on trust preferred securities.
(22) Financial Instruments with Off Balance Sheet Risk
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments usually have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations of the Company to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which the Company operates.
137
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(22) Financial Instruments with Off Balance Sheet Risk (Continued)
The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company evaluates each customer's creditworthiness on a case-by-case basis and requires collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based upon management's evaluation of the counterparty. Collateral held varies but may include deposits held by the Company, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of the contractual obligations by a customer to a third party. The majority of these guarantees extend until satisfactory completion of the customer's contractual obligations. All standby letters of credit outstanding at December 31, 2013 are collateralized.
Commitments to extend credit of $210.9 million as of December 31, 2013 are related to George Mason's mortgage loan funding commitments and are of a short term nature. Commitments to extend credit of $1.3 billion primarily have floating rates as of December 31, 2013.
These off-balance sheet financial instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract. The Company's maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amounts of those instruments. It is uncertain as to the amount, if any, that the Company will be required to fund on these commitments as many such arrangements expire with no amounts drawn.
A summary of the contract amount of the Bank's exposure to off-balance-sheet risk as of December 31, 2013 and 2012 is as follows:
(In thousands)
| |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Financial instruments whose contract amounts represent potential credit risk: |
|||||||
Commitments to extend credit |
$ | 1,486,572 | $ | 1,248,766 | |||
Standby letters of credit |
28,008 | 36,466 | |||||
The fair value of the liability associated with standby letters of credit and commitments to extend credit for the years ended December 31, 2013 and 2012 were $517,000 and $415,000, respectively.
George Mason provides for its estimated exposure to repurchase loans previously sold to investors for which borrowers failed to provide full and accurate information on their loan application or for which appraisals were not acceptable or where the loan was not underwritten in accordance with the loan program specified by the loan investor, and for other exposure to its investors related to loan sales activities. The Company evaluates the merits of each claim and estimates its reserve based on actual and expected claims received and considers the historical amounts paid to settle such claims. The Company recognizes an expense when settlement is deemed probable and the amount of such a settlement is estimable. Given the steps that have been taken to limit the exposure coupled with the
138
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(22) Financial Instruments with Off Balance Sheet Risk (Continued)
passage of time and the expiration of the statute of limitations for loans originated in certain prior years, the Company's current expectation is that future putback claims will be limited in number.
During 2013 and 2012, George Mason either repurchased from or settled with investors on such loans for a total of $302,000 and $375,000, respectively. This reserve had a balance of $261,000 and $628,000 for the years ended December 31, 2013 and 2012, respectively. The expense (benefit) related to this reserve for the years ended December 31, 2013, 2012, and 2011, was ($49,000), $962,000, and $670,000, respectively.
The Company has derivative counter-party risk which may arise from the possible inability of George Mason's third-party investors to meet the terms of their forward sales contracts. George Mason works with third-party investors that are generally well-capitalized, are investment grade and exhibit strong financial performance to mitigate this risk. The Company does not expect any third-party investor to fail to meet its obligation.
The Company has guaranteed payment of the $20.0 million debt of Statutory Trust I. See Note 11 for further discussion of this debt.
(23) Fair Value Measurements
The fair value framework under U.S. generally accepted accounting principles defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring the fair value. There are three levels of inputs that may be used to measure fair value:
Level 1—Quoted prices in active markets for identical assets or liabilities as of the measurement date.
Level 2—Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
Recurring Fair Value Measurements
All classes of the Company's investment securities available-for-sale with the exception of its treasury securities, the Company's trading investment securities, which include cash equivalents and mutual funds, and bank-owned life insurance are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service and therefore fall into the Level 2 category. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. The Company's treasury securities are recorded at fair value using the unadjusted quoted market prices for identical securities and therefore fall under the Level 1 category.
139
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
The Company had an interest rate swap to hedge against the change in fair value of one fixed rate commercial loan. The loan and associated interest rate swap matured during 2013. This loan was recorded at fair value using published yield curve rates from a national valuation service. These observable rates and inputs were applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category. Commercial and residential loans are evaluated for impairment and the carrying value of such loans is recorded at fair value based on appraisals of the underlying collateral completed by third parties using Level 2 valuation inputs.
The Company had two additional interest rate swap derivatives designated as cash flow hedges which matured during 2013. These swaps were recorded at fair value using published yield curve rates from a national valuation service. These observable rates and inputs are applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category.
The Company records its interest rate lock commitments and forward loan sales commitments at fair value determined as the amount that would be required to settle each of these derivative financial instruments at the balance sheet date. In the normal course of business, George Mason enters into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates. The commitments become effective when the borrowers "lock-in" a specified interest rate within the time frames established by the mortgage company. All borrowers are evaluated for credit worthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the interest rate lock by the borrower and the sale date of the loan to an investor. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, George Mason enters into best efforts forward sales contracts to sell loans to investors. The forward sales contracts lock in an interest rate and price for the sale of loans similar to the specific rate lock commitments. Both the rate lock commitments to the borrowers and the forward sales contracts to the investors through to the date the loan closes are undesignated derivatives and accordingly, are marked to fair value through earnings. These valuations fall into a Level 2 category.
There was one significant transfer from Level 3 to Level 2 measurements in the fair value hierarchy during the year ended December 31, 2013. There were no significant transfers into and out of Level 1, Level 2 and Level 3 measurements in the fair value hierarchy during the years ended December 31, 2012 and 2011. Transfers between levels are recognized at the end of each reporting period. The valuation technique used for fair value measurements using significant other observable inputs (Level 2) is the market approach for each class of assets and liabilities. At December 31, 2013, pooled trust preferred investment securities of $2.8 million were moved to the available-for-sale investment portfolio and transferred from a Level 3 to a Level 2 fair value measurement as a result of the aforementioned interim rule to the Volcker Rule. The Company will be required to divest of these investments by July 2015, and therefore the Company now records a fair value measurement on these investments based on a live market bid at period end, which is a Level 2 measurement. An impairment of $300,000 was recorded for the year ended December 31, 2013 as a result of this change in fair value methodology.
140
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
Assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012 are shown below:
At December 31, 2013
(In thousands)
| |
|
Fair Value Measurements Using | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Description
|
Balance | Quoted Prices in Active markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||
Investment securities available-for-sale: |
|||||||||||||
U.S. treasury securities |
$ | 5,029 | $ | 5,029 | $ | — | $ | — | |||||
U.S. government-sponsored agencies |
76,928 | 76,928 | — | ||||||||||
Mortgage-backed securities |
147,829 | — | 147,829 | — | |||||||||
Municipal securities |
116,738 | — | 116,738 | — | |||||||||
Pooled trust preferred securities |
2,795 | — | 2,795 | — | |||||||||
Total investment securities available-for-sale |
349,319 | 5,029 | 344,290 | — | |||||||||
Investment securities—trading |
3,890 | — | 3,890 | — | |||||||||
Bank-owned life insurance |
32,063 | — | 32,063 | — | |||||||||
Derivative asset—rate lock and forward loan sales commitments |
16,478 | — | 16,478 | — | |||||||||
Derivative asset—interest rate lock commitments |
9 | — | 9 | — | |||||||||
Derivative liability—rate lock and forward loan sales commitments |
4,052 | — | 4,052 | — | |||||||||
Derivative liability—interest rate lock commitments |
1,554 | — | 1,554 | — | |||||||||
141
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
At December 31, 2012
(In thousands)
| |
|
Fair Value Measurements Using | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Description
|
Balance | Quoted Prices in Active markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||
Investment securities available-for-sale: |
|||||||||||||
U.S. treasury securities |
$ | 5,110 | $ | 5,110 | $ | — | $ | — | |||||
U.S. government-sponsored agencies |
61,533 | 61,533 | — | ||||||||||
Mortgage-backed securities |
118,913 | — | 118,913 | — | |||||||||
Municipal securities |
86,347 | — | 86,347 | — | |||||||||
Total investment securities available-for-sale |
271,903 | 5,110 | 266,793 | — | |||||||||
Investment securities—trading |
3,151 | — | 3,151 | — | |||||||||
Loan receivable designated in fair value hedge |
11,652 | — | 11,652 | — | |||||||||
Bank-owned life insurance |
31,652 | — | 31,652 | — | |||||||||
Derivative liability—interest rate swaps |
616 | — | 616 | — | |||||||||
Derivative asset—rate lock and forward loan sales commitments |
26,793 | — | 26,793 | — | |||||||||
Derivative asset—interest rate lock commitments |
449 | — | 449 | — | |||||||||
Derivative liability—rate lock and forward loan sales commitments |
4,072 | — | 4,072 | — | |||||||||
Derivative liability—interest rate lock commitments |
91 | — | 91 | — | |||||||||
Nonrecurring Fair Value Measurements
Certain assets and liabilities are measured at fair value on a nonrecurring basis and are not included in the tables above. These assets include the valuation of the Company's pooled trust preferred securities held in its held-to-maturity investment securities portfolio, loans receivable—evaluated for impairment and other real estate owned.
At December 31, 2013
(In thousands)
| |
|
Fair Value Measurements Using | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Description
|
Balance | Quoted Prices in Active markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||
Pooled trust preferred securities |
$ | 2,910 | $ | — | $ | — | $ | 2,910 | |||||
Loans receivable—evaluated for impairment |
3,378 | — | 301 | 3,077 | |||||||||
142
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
At December 31, 2012
(In thousands)
| |
|
Fair Value Measurements Using | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Description
|
Balance | Quoted Prices in Active markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||
Pooled trust preferred securities |
$ | 5,072 | $ | — | $ | — | $ | 5,072 | |||||
Loans receivable—evaluated for impairment |
8,446 | — | 820 | 7,626 | |||||||||
The Company's held-to-maturity portfolio includes investments in two pooled trust preferred securities, totaling $4.0 million of par value at December 31, 2013. The collateral underlying these structured securities are instruments issued by financial institutions. The Company owns the A-3 tranches in each issuance. Observable trading activity remains limited for these types of securities. The Company has estimated the fair value of the securities through the use of internal calculations and through information provided by external pricing services. Given the level of subordination below the A-3 tranches, and the actual and expected performance of the underlying collateral, the Company expects to receive all contractual interest and principal payments recovering the amortized cost basis of each of the two securities, and concluded that these securities are not other-than-temporarily impaired. The Company also utilizes a multi-scenario model which assumes varying levels of additional defaults and deferrals and the effects of such adverse developments on the contractual cash flows for the A-3 tranches. In each of the adverse scenarios, there was no indication of a break to the A-3 contractual cash flows.
The Company's loans receivable—evaluated for impairment are measured at the present value of its expected future cash flows discounted at the loan's coupon rate, or at the loan's observable market price or fair value of the collateral if the loan is collateral dependent. The Company measures the collateral value on loans receivable—evaluated for impairment by obtaining an updated appraisal of the underlying collateral and may discount further the appraised value, if necessary, to an amount equal to the expected cash proceeds in the event the loan is foreclosed upon and the collateral is sold. In addition, an estimate of costs to sell the collateral is assumed. The Company values other real estate owned by obtaining an updated appraisal of the property foreclosed upon, and discounts further the appraised value to an amount equal to the expected cash proceeds upon the sale of the property. Loans receivable—evaluated for impairment and other real estate owned are valued using third party appraisal data that is based on market comparisons and may be subject to further adjustment for certain non-observable criteria.
Loans receivable—evaluated for impairment that are designated at fair value using Level 3 inputs on a nonrecurring basis total $3.1 million at December 31, 2013. The total amount for each period presented represents the entire population of loans receivable—evaluated for impairment, and of this amount, $3.1 million was determined to be impaired and recorded at fair value. Collateral is in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, in certain instances, the Company applies a discount to the valuation of the collateral if the collateral being evaluated is in process of
143
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
construction or a residence. In addition, the Company considers past experience of actual sales of collateral and may further discount the appraisal of the collateral being evaluated. This is considered a Level 3 valuation. The value of business equipment is based upon the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income. At December 31, 2013, the Company's Level 3 loans consisted of one relationship totaling $2.3 million which was secured primarily by commercial real estate which did not have a valuation allowance and one relationship totaling $814,000 which was primarily secured by business assets.
Although management uses its best judgment in estimating the fair value of financial instruments, there are inherent limitations in any estimation technique. Because of the wide range of valuation techniques and the numerous estimates and assumptions which must be made, it may be difficult to make reasonable comparisons between the Company's fair value information and that of other banking institutions. It is important that the many uncertainties be considered when using the estimated fair value disclosures and that, because of these uncertainties, the aggregate fair value amount should not be construed as representative of the underlying value of the Company.
Fair Value of Financial Instruments
The assumptions used and the estimates disclosed represent management's best judgment of appropriate valuation methods for estimating the fair value of financial instruments. These estimates are based on pertinent information available to management at the valuation date. In certain cases, fair values are not subject to precise quantification or verification and may change as economic and market factors and management's evaluation of those factors change.
The following summarizes the significant methodologies and assumptions used in estimating the fair values presented in the following table, and not disclosed elsewhere in this footnote.
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents is used as a reasonable estimate of fair value.
Investment Securities Held-to-Maturity and Other Investments
Fair values for investment securities held-to-maturity are based on quoted market prices or prices quoted for similar financial instruments.
Loans Held for Sale
Loans held for sale are carried at the lower of cost or estimated fair value. The estimated fair value is based upon the related purchase price commitments from secondary market investors.
Loans Receivable, Net
In order to determine the fair market value for loans receivable, the loan portfolio was segmented based on loan type, credit quality and maturities. For certain variable rate loans with no significant credit concerns and frequent repricings, estimated fair values are based on current carrying amounts.
144
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
The fair values of other loans are estimated using discounted cash flow analyses, at interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The fair value analysis also included other assumptions to estimate fair value, intended to approximate those a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, and liquidity, as appropriate. This method of estimating fair value does not incorporate the exit-price concept of fair value which is appropriate for this disclosure.
Deposits
The fair values for demand deposits are equal to the carrying amount since they are payable on demand at the reporting date. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit (CDs) approximate their fair value at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on CDs to a schedule of aggregated expected monthly maturities on time deposits.
Other Borrowed Funds
The fair value of other borrowed funds is estimated using a discounted cash flow calculation that applies interest rates currently available for loans with similar terms.
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its fair value.
The following summarizes the carrying amount of these financial assets and liabilities that the Company has not recorded at fair value on a recurring basis at December 31, 2013 and 2012:
| |
December 31, 2013 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
|
Fair Value Measurements Using | |||||||||||||
| |
Carrying Amount |
Estimated Fair Value |
||||||||||||||
| (In thousands) |
Level 1 | Level 2 | Level 3 | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 29,209 | $ | 29,209 | $ | 29,209 | $ | — | $ | — | ||||||
Investment securities available-for-sale |
349,319 | 349,319 | 5,029 | 344,290 | — | |||||||||||
Investment securities held-to-maturity and other investments |
25,545 | 24,595 | — | 21,685 | 2,910 | |||||||||||
Loans held for sale |
373,993 | 373,993 | — | 373,993 | — | |||||||||||
Loans receivable, net |
2,012,304 | 2,024,835 | — | 301 | 2,024,534 | |||||||||||
Accrued interest receivable |
7,939 | 7,939 | 7,939 | — | — | |||||||||||
Financial liabilities: |
||||||||||||||||
Demand deposits |
$ | 433,749 | $ | 433,749 | $ | 433,749 | $ | — | $ | — | ||||||
Interest checking |
398,136 | 398,136 | 398,136 | — | — | |||||||||||
Money market and statement savings |
475,707 | 475,707 | 475,707 | — | — | |||||||||||
Certificates of deposit |
751,267 | 756,191 | — | 756,191 | — | |||||||||||
Other borrowed funds |
475,232 | 491,236 | — | 491,236 | — | |||||||||||
Accrued interest payable |
869 | 869 | 869 | — | — | |||||||||||
145
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(23) Fair Value Measurements (Continued)
| |
December 31, 2012 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
|
|
Fair Value Measurements Using | |||||||||||||
| |
Carrying Amount |
Estimated Fair Value |
||||||||||||||
| (In thousands) |
Level 1 | Level 2 | Level 3 | |||||||||||||
Financial assets: |
||||||||||||||||
Cash and cash equivalents |
$ | 67,140 | $ | 67,140 | $ | 67,140 | $ | — | $ | — | ||||||
Investment securities available-for-sale |
271,903 | 271,903 | 5,110 | 266,793 | — | |||||||||||
Investment securities held-to-maturity and other investments |
25,668 | 23,321 | — | 18,249 | 5,072 | |||||||||||
Loans held for sale |
785,751 | 785,751 | — | 785,751 | — | |||||||||||
Loans receivable, net |
1,776,029 | 1,823,356 | — | 12,472 | 1,810,884 | |||||||||||
Accrued interest receivable |
7,333 | 7,333 | 7,333 | — | — | |||||||||||
Financial liabilities: |
||||||||||||||||
Demand deposits |
$ | 351,815 | $ | 351,815 | $ | 351,815 | $ | — | $ | — | ||||||
Interest checking |
347,697 | 347,697 | 347,697 | — | — | |||||||||||
Money market and statement savings |
430,391 | 430,391 | 430,391 | — | — | |||||||||||
Certificates of deposit |
1,113,855 | 1,124,235 | — | 1,124,235 | — | |||||||||||
Other borrowed funds |
392,275 | 418,808 | — | 418,808 | — | |||||||||||
Accrued interest payable |
974 | 974 | 974 | — | — | |||||||||||
146
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(24) Parent Company Only Financial Statements
The Cardinal Financial Corporation (Parent Company only) condensed financial statements are as follows:
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CONDITION
December 31, 2013 and 2012
(In thousands)
| |
2013 | 2012 | |||||
|---|---|---|---|---|---|---|---|
Assets |
|||||||
Cash and cash equivalents |
$ |
4,311 |
$ |
7,141 |
|||
Investment securities—Trading |
3,890 | 3,151 | |||||
Other investments |
113 | 113 | |||||
Investment in subsidiaries |
333,076 | 315,367 | |||||
Premises and equipment, net |
632 | 671 | |||||
Goodwill |
24 | 24 | |||||
Other assets |
5,242 | 2,861 | |||||
| | | | | | | | |
Total assets |
$ | 347,288 | $ | 329,328 | |||
| | | | | | | | |
| | | | | | | | |
Liabilities and Shareholders' Equity |
|||||||
Debt to Cardinal Statutory Trust I |
$ |
20,619 |
$ |
20,619 |
|||
Other liabilities |
6,137 | 643 | |||||
| | | | | | | | |
Total liabilities |
26,756 | 21,262 | |||||
Total shareholders' equity |
$ | 320,532 | $ | 308,066 | |||
| | | | | | | | |
Total liabilities and shareholders' equity |
$ | 347,288 | $ | 329,328 | |||
| | | | | | | | |
| | | | | | | | |
PARENT COMPANY ONLY CONDENSED STATEMENTS OF OPERATIONS
Years Ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Income: |
||||||||||
Net interest expense |
$ | (692 | ) | $ | (834 | ) | $ | (816 | ) | |
Net realized and unrealized trading losses |
68 | 158 | 144 | |||||||
Other income |
17 | 18 | 17 | |||||||
| | | | | | | | | | | |
Total income (loss) |
(607 | ) | (658 | ) | (655 | ) | ||||
Expense—general and administrative |
4,044 | 3,706 | 3,709 | |||||||
| | | | | | | | | | | |
Net loss before income taxes and equity in undistributed earnings of subsidiaries |
(4,651 | ) | (4,364 | ) | (4,364 | ) | ||||
| | | | | | | | | | | |
Income tax benefit |
(1,657 | ) | (1,528 | ) | (1,537 | ) | ||||
Equity in undistributed earnings of subsidiaries |
28,504 | 48,133 | 30,825 | |||||||
| | | | | | | | | | | |
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
147
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(24) Parent Company Only Financial Statements (Continued)
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 2013, 2012, and 2011
(In thousands)
| |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Cash flows from operating activities: |
||||||||||
Net income |
$ | 25,510 | $ | 45,297 | $ | 27,998 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||||
Equity in undistributed earnings of subsidiaries |
(28,504 | ) | (48,133 | ) | (30,825 | ) | ||||
Depreciation |
39 | 42 | 44 | |||||||
Proceeds from sale of investment securities—trading |
— | — | 743 | |||||||
Purchase of investment securities—trading |
(1,707 | ) | (1,174 | ) | (1,182 | ) | ||||
Unreliazed gain on investment securities—trading |
(68 | ) | (158 | ) | (144 | ) | ||||
Impairment of goodwill and other intangible assets |
— | — | — | |||||||
Increase (decrease) in other assets and liabilities |
7,782 | 1,430 | (3,670 | ) | ||||||
| | | | | | | | | | | |
Net cash provided by (used in) operating activities |
3,050 | (2,696 | ) | (7,036 | ) | |||||
| | | | | | | | | | | |
Cash flows from investing activities: |
||||||||||
Net cash used in investing activities |
— | — | — | |||||||
| | | | | | | | | | | |
Cash flows from financing activities: |
||||||||||
Dividends on common stock |
(6,964 | ) | (5,892 | ) | (3,474 | ) | ||||
Stock options exercised |
1,084 | 9,090 | 2,627 | |||||||
| | | | | | | | | | | |
Net cash provided by (used in) financing activities |
(5,880 | ) | 3,198 | (847 | ) | |||||
| | | | | | | | | | | |
Net increase (decrease) in cash and cash equivalents |
(2,830 | ) | 502 | (7,883 | ) | |||||
Cash and cash equivalents at beginning of year |
7,141 | 6,639 | 14,522 | |||||||
| | | | | | | | | | | |
Cash and cash equivalents at end of year |
$ | 4,311 | $ | 7,141 | $ | 6,639 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
(25) Other Operating Expenses
The following shows the composition of other operating expenses for the years ended December 31, 2013, 2012, and 2011:
| (In thousands) |
2013 | 2012 | 2011 | |||||||
|---|---|---|---|---|---|---|---|---|---|---|
Stationary and supplies |
$ | 1,808 | $ | 1,693 | $ | 1,183 | ||||
Other taxes |
624 | 467 | 284 | |||||||
Travel and entertainment |
764 | 763 | 632 | |||||||
Premises and equipment |
4,164 | 3,524 | 2,669 | |||||||
Business memberships |
500 | 447 | 328 | |||||||
Employment services |
141 | 253 | 172 | |||||||
Board of directors expenses |
698 | 538 | 575 | |||||||
Loan expense |
589 | 454 | 463 | |||||||
Miscellaneous |
3,944 | 3,236 | 2,106 | |||||||
| | | | | | | | | | | |
Total other operating expense |
$ | 13,232 | $ | 11,375 | $ | 8,412 | ||||
| | | | | | | | | | | |
| | | | | | | | | | | |
148
CARDINAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(26) Subsequent Events
On January 16, 2014, the Company announced the completion of its acquisition of United Financial Banking Companies, Inc. ("UFBC"), the holding company of The Business Bank ("TBB"), pursuant to a previously announced definitive merger agreement. The merger of UFBC into Cardinal was effective January 16, 2014. Under the terms of the merger agreement, UFBC shareholders received $19.13 in cash and 1.154 shares of the Company's common stock in exchange for each share of UFBC common stock they owned immediately prior to the merger, for a total purchase price of $53.6 million. TBB, which was headquartered in Vienna, Virginia, merged into Cardinal Bank effective March 8, 2014 adding eight (8) banking locations in northern Virginia, one of the Company's target markets.
149
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
No changes in the Company's independent accountants or disagreements on accounting and financial disclosure required to be reported hereunder have taken place.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission and that such information is accumulated and communicated to the Company's management including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report was carried out under the supervision and with the participation of management, including the Company's Chief Executive Officer and Chief Financial Officer. Based on the evaluation, the aforementioned officers concluded that the Company's disclosure controls and procedures were effective as of the end of such period.
Management's Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on management's assessment, management believes that as of December 31, 2013, the Company's internal control over financial reporting was effective based on criteria set forth by COSO in Internal Control—Integrated Framework.
Our independent registered public accounting firm, KPMG LLP, has issued an attestation report on the effectiveness of our internal controls over financial reporting which appears in Item 8.
Changes in Internal Control Over Financial Reporting
There was no change in the Company's internal control over financial reporting identified in connection with the evaluation of internal controls that occurred during the fourth quarter of 2013 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
None.
150
Item 10. Directors, Executive Officers and Corporate Governance
Pursuant to General Instruction G(3) of Form 10-K, the information contained in the "Election of Directors" section and under the headings "Executive Officers," "The Committees of the Board of Directors," "Code of Ethics" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.
Item 11. Executive Compensation
Pursuant to General Instruction G(3) of Form 10-K, the information contained in the "Executive Compensation" section and under the heading "Director Compensation" in the Company's Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Security Ownership of Certain Beneficial Owners and Management. Pursuant to General Instruction G(3) of Form 10-K, the information contained under the headings "Security Ownership of Directors and Executive Officers" and "Security Ownership of Certain Beneficial Owners" in the Company's Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.
Equity Compensation Plan Information. The following table sets forth information as of December 31, 2013, with respect to compensation plans under which shares of our Common Stock are authorized for issuance.
Plan Category
|
Number of Securities to Be Issued upon Exercise of Outstanding Options, Warrants and Rights |
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights |
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans(1) |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Equity Compensation Plans Approved by Shareholders |
||||||||||
1999 Stock Plan |
9,750 | $ | 8.04 | — | ||||||
2002 Equity Compensation Plan |
1,001,803 | $ | 12.07 | 701,818 | ||||||
Equity Compensation Plans Not Approved by Shareholders(2) |
— | — | — | |||||||
Total |
1,011,553 | $ | 12.03 | 701,818 | ||||||
- (1)
- Amounts
exclude any securities to be issued upon exercise of outstanding options, warrants and rights.
- (2)
- The Company does not have any equity compensation plans that have not been approved by shareholders.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the heading "Certain Relationships and Related Transactions" and "Independence of the Directors" in the Company's Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.
151
Item 14. Principal Accounting Fees and Services
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the headings "Fees of Independent Public Accountants" and "Audit Committee Pre-Approval Policies and Procedures," in the Company's Proxy Statement for the 2014 Annual Meeting of Shareholders is incorporated herein by reference.
Item 15. Exhibits, Financial Statement Schedules
- (a)
- (1) and (2) The response to this portion of Item 15 is included in Item 8 above.
(3) Exhibits
| 2.1 | Agreement and Plan of Reorganization, dated as of September 9, 2013, between Cardinal Financial Corporation and United Financial Banking Companies, Inc. (incorporate by reference to Exhibit 2.1 to the Current Report on Form 8-K filed September 10, 2013). | ||
3.1 |
Articles of Incorporation of Cardinal Financial Corporation (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form SB-2, Registration No. 333-82946 (the "Form SB-2")). |
||
3.2 |
Articles of Amendment to the Articles of Incorporation of Cardinal Financial Corporation, setting forth the designation for the Series A Preferred Stock (incorporated by reference to Exhibit 3.2 to the Form SB-2). |
||
3.3 |
Articles of Amendment to the Articles of Incorporation of Cardinal Financial Corporation, setting forth the designation for the Series B Preferred Stock (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed January 22, 2009). |
||
3.4 |
Bylaws of Cardinal Financial Corporation (restated in electronic format as of February 19, 2014). |
||
4.1 |
Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Form SB-2). |
||
10.1 |
Employment Agreement, dated as of November 1, 2010, between Cardinal Financial Corporation and Bernard H. Clineburg (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed November 1, 2010).* |
||
10.2 |
Executive Employment Agreement, dated as of February 12, 2002, between Cardinal Financial Corporation and Christopher W. Bergstrom (incorporated by reference to Exhibit 10.5 to the Form SB-2).* |
||
10.3 |
Addendum to Executive Employment Agreement for Christopher W. Bergstrom, dated August 17, 2011 (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed August 23, 2011).* |
||
10.4 |
Cardinal Financial Corporation 1999 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.7 to the Form SB-2).* |
||
10.5 |
Cardinal Financial Corporation 2002 Equity Compensation Plan, as amended and restated April 21, 2006 (incorporated by reference to Exhibit 4.4 to the Registration Statement on Form S-8, Registration No. 333-134923).* |
152
| 10.6 | Cardinal Financial Corporation Executive Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* | ||
10.7 |
Cardinal Financial Corporation Directors Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.8 |
George Mason Mortgage, LLC Executive Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.9 |
Executive Employment Agreement, dated November 7, 2007, between Cardinal Financial Corporation and Kendal E. Carson (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the period ended September 30, 2007).* |
||
10.10 |
Amendment to Executive Employment Agreement of Kendal E. Carson (incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.11 |
Supplemental Executive Retirement Plan, dated November 7, 2007, between Cardinal Financial Corporation and Kendal E. Carson (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the period ended September 30, 2007).* |
||
10.12 |
Executive Employment Agreement, dated March 17, 2010, between Cardinal Financial Corporation and Alice P. Frazier (incorporated by reference to exhibit 10.11 to the Annual Report on Form 10-K for the period ended December 31, 2010).* |
||
10.13 |
Form of Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.11 to the Annual Report on Form 10-K for the period ended December 31, 2007).* |
||
21 |
Subsidiaries of Cardinal Financial Corporation. |
||
23 |
Consent of KPMG LLP. |
||
31.1 |
Rule 13a-14(a) Certification of Chief Executive Officer. |
||
31.2 |
Rule 13a-14(a) Certification of Chief Financial Officer. |
||
32.1 |
Statement of Chief Executive Officer Pursuant to 18 U.S.C. § 1350. |
||
32.2 |
Statement of Chief Financial Officer Pursuant to 18 U.S.C. § 1350. |
||
101 |
The following materials from the Registrant's Annual Report on Form 10-K for the year ended December 31,2013, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes (furnished herewith). |
- *
- Management contracts and compensatory plans and arrangements.
- (b)
- Exhibits
See Item 15(a)(3) above.
- (c)
- Financial Statement Schedules
See Item 15(a)(2) above.
153
Pursuant to the requirements of Section 13 and 15 (d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| CARDINAL FINANCIAL CORPORATION | ||||||
March 14, 2014 |
By: |
/s/ BERNARD H. CLINEBURG |
||||
| Name: | Bernard H. Clineburg | |||||
| Title: | Chairman and Chief Executive Officer | |||||
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 14, 2014.
Signatures
|
Titles
|
|
|---|---|---|
| /s/ BERNARD H. CLINEBURG Name: Bernard H. Clineburg |
Chairman and Chief Executive Officer (Principal Executive Officer) | |
/s/ MARK A. WENDEL Name: Mark A. Wendel |
Executive Vice President and Chief Financial Officer (Principal Financial Officer) |
|
/s/ JENNIFER L. DEACON Name: Jennifer L. Deacon |
Executive Vice President and Chief Accounting Officer (Principal Accounting Officer) |
|
/s/ B.G. BECK Name: B. G. Beck |
Director |
|
/s/ WILLIAM G. BUCK Name: William G. Buck |
Director |
|
/s/ SIDNEY O. DEWBERRY Name: Sidney O. Dewberry |
Director |
|
/s/ MICHAEL A. GARCIA Name: Michael A. Garcia |
Director |
154
Signatures
|
Titles
|
|
|---|---|---|
| /s/ J. HAMILTON LAMBERT Name: J. Hamilton Lambert |
Director | |
/s/ BARBARA B. LANG Name: Barbara B. Lang |
Director |
|
/s/ WILLIAM J. NASSETTA Name: William J. Nassetta |
Director |
|
/s/ WILLIAM E. PETERSON Name: William E. Peterson |
Director |
|
/s/ ALICE M. STARR Name: Alice M. Starr |
Director |
|
/s/ STEVEN M . WILTSE Name: Steven M. Wiltse |
Director |
155
| Number | Description | ||
|---|---|---|---|
| 2.1 | Agreement and Plan of Reorganization, dated as of September 9, 2013, between Cardinal Financial Corporation and United Financial Banking Companies, Inc. (incorporate by reference to Exhibit 2.1 to the Current Report on Form 8-K filed September 10, 2013). | ||
3.1 |
Articles of Incorporation of Cardinal Financial Corporation (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form SB-2, Registration No. 333-82946 (the "Form SB-2")). |
||
3.2 |
Articles of Amendment to the Articles of Incorporation of Cardinal Financial Corporation, setting forth the designation for the Series A Preferred Stock (incorporated by reference to Exhibit 3.2 to the Form SB-2). |
||
3.3 |
Articles of Amendment to the Articles of Incorporation of Cardinal Financial Corporation, setting forth the designation for the Series B Preferred Stock (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed January 22, 2009). |
||
3.4 |
Bylaws of Cardinal Financial Corporation (restated in electronic format as of February 19, 2014). |
||
4.1 |
Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Form SB-2). |
||
10.1 |
Employment Agreement, dated as of November 1, 2010, between Cardinal Financial Corporation and Bernard H. Clineburg (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed November 1, 2010).* |
||
10.2 |
Executive Employment Agreement, dated as of February 12, 2002, between Cardinal Financial Corporation and Christopher W. Bergstrom (incorporated by reference to Exhibit 10.5 to the Form SB-2).* |
||
10.3 |
Addendum to Executive Employment Agreement for Christopher W. Bergstrom, dated August 17, 2011 (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed August 23, 2011).* |
||
10.4 |
Cardinal Financial Corporation 1999 Stock Option Plan, as amended (incorporated by reference to Exhibit 10.7 to the Form SB-2).* |
||
10.5 |
Cardinal Financial Corporation 2002 Equity Compensation Plan, as amended and restated April 21, 2006 (incorporated by reference to Exhibit 4.4 to the Registration Statement on Form S-8, Registration No. 333-134923).* |
||
10.6 |
Cardinal Financial Corporation Executive Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.7 |
Cardinal Financial Corporation Directors Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.8 |
George Mason Mortgage, LLC Executive Deferred Income Plan, as amended and restated February 25, 2009 (incorporated by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
156
| Number | Description | ||
|---|---|---|---|
| 10.9 | Executive Employment Agreement, dated November 7, 2007, between Cardinal Financial Corporation and Kendal E. Carson (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q for the period ended September 30, 2007).* | ||
10.10 |
Amendment to Executive Employment Agreement of Kendal E. Carson (incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009).* |
||
10.11 |
Supplemental Executive Retirement Plan, dated November 7, 2007, between Cardinal Financial Corporation and Kendal E. Carson (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q for the period ended September 30, 2007).* |
||
10.12 |
Executive Employment Agreement, dated March 17, 2010, between Cardinal Financial Corporation and Alice P. Frazier (incorporated by reference to exhibit 10.11 to the Annual Report on Form 10-K for the period ended December 31, 2010).* |
||
10.13 |
Form of Incentive Stock Option Agreement (incorporated by reference to Exhibit 10.11 to the Annual Report on Form 10-K for the period ended December 31, 2007).* |
||
21 |
Subsidiaries of Cardinal Financial Corporation. |
||
23 |
Consent of KPMG LLP. |
||
31.1 |
Rule 13a-14(a) Certification of Chief Executive Officer. |
||
31.2 |
Rule 13a-14(a) Certification of Chief Financial Officer. |
||
32.1 |
Statement of Chief Executive Officer Pursuant to 18 U.S.C. § 1350. |
||
32.2 |
Statement of Chief Financial Officer Pursuant to 18 U.S.C. § 1350. |
||
101 |
The following materials from the Registrant's Annual Report on Form 10-K for the year ended December 31,2013, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Condensed Consolidated Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) related notes (furnished herewith). |
||
- *
- Management contracts and compensatory plans and arrangements.
157