CAROLINA FINANCIAL CORPORATION The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods. We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see "Cautionary Note Regarding Forward-Looking Statements" at the beginning of this report. Company Overview
Carolina Financial Corporation is aDelaware corporation that was organized inFebruary 1997 to serve as a bank holding company. In 2017, it applied for, and received, financial holding company status from theFederal Reserve . The Company operates principally through its wholly-owned subsidiary,CresCom Bank , aSouth Carolina state-chartered bank.CresCom Bank operatesCrescent Mortgage Company ,Carolina Services Corporation of Charleston ("Carolina Services"),DTFS, Inc. ,CresCom Leasing, LLC andWestern Carolina Holdings, LLC , as wholly-owned subsidiaries ofCresCom Bank . Except where the context otherwise requires, the "Company", "we", "us" and "our" refer toCarolina Financial Corporation and its consolidated subsidiaries and the "Bank" refers toCresCom Bank .CresCom Bank provides a full range of commercial and retail banking financial services designed to meet the financial needs of our customers through its branch network inSouth Carolina andNorth Carolina .Crescent Mortgage Company , headquartered inAtlanta, Georgia , is primarily a correspondent/wholesale mortgage company approved to originate loans in 48 states partnering with community banks, credit unions and mortgage brokers. Like most community banks, we derive a significant portion of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, both interest-bearing and noninterest-bearing. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowed funds. In order to maximize our net interest income, we must not only manage the volume of these balance sheet items, but also the yields that we earn on our interest-earning assets and the rates that we pay on interest-bearing liabilities.
There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.
In addition to earning interest on our loans and investments, we derive a portion of our income fromCrescent Mortgage Company through mortgage banking income as well as servicing income. We also earn income through fees that we charge to our customers. Likewise, we incur other operating expenses as well. Economic conditions, competition, and the monetary and fiscal policies of the federal government significantly affect most financial institutions, including the Bank. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions as well as client preferences, interest rate conditions and prevailing market rates on competing products in our market areas. 47
Pending Merger with and into United Bankshares, Inc.
OnNovember 17, 2019 , the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc., ("United") pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The merger agreement provides that at the effective time of the merger, the Bank will merge with and intoUnited Bank , a wholly-owned subsidiary ofUnited Bank , withUnited Bank as the surviving entity. Consummation of the merger is subject to approval of the stockholders of United andCarolina Financial , the receipt of all required regulatory approvals, as well as other customary conditions. Pursuant to the merger agreement, each outstanding share of common stock ofCarolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value$2.50 per share, resulting in an aggregate transaction value of approximately$1.1 billion . The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the merger greement, a copy of which is filed as Exhibit 2.1 to this report and is incorporated herein by reference. United has filed a registration statement on Form S-4 with theSEC to register the shares of United's common stock that will be issued to the Company's stockholders in connection with the proposed merger. The definitive prospectus of United and joint proxy statement of United and the Company, filed on February 13, 2020 has been provided to the stockholders of each of United and the Company in connection with the proposed merger and is incorporated herein by reference. See "Part I, Item 1 - "Pending Merger with and into United Bankshares, Inc."
Executive Summary of Operating Results
The following is a summary of the Company's financial highlights and significant events in 2019:
· The Company reported net income for the year ended
of $62.7 million or $2.80 per diluted share, as compared to
million, or $2.26 per diluted share, for the year ended
2018.
· Accretion income from acquired loans was $7.6 million for the
year ended December 31, 2019 compared to $9.8 million for the
year ended December 31, 2018 . Provision for loan losses during
the years ended December 31, 2019 and 2018 was $2.6 million and
$2.1 million , respectively.
· Operating earnings for the year ended December 31, 2019 , which exclude
certain non-operating income and expenses, increased to $67.6 million ,
or $3.02 per diluted share compared to $62.8 million , or $2.86 per
diluted share, for the same period of 2018.
· Included in net income for the year ended December 31, 2019 was
a fair value loss on interest rate swaps of $3.7 million , a
temporary impairment of mortgage servicing rights of $3.1
million, a gain on sale of securities of $3.9 million , a loss on
early extinguishment of debt of approximately $178,000 and
merger-related expenses of $2.8 million .
· Included in net income for the year ended December 31, 2018 was
a fair value loss on interest rate swaps of approximately
$340,000 , a loss on sale of securities of $1.9 million and
merger-related expenses of $15.2 million .
· On
Trust BancShares, Inc. The acquisition added$481.0 million of loans receivable, gross and$537.8 million of deposits. · Loans receivable, gross grew$703.6 million sinceDecember 31, 2018 . Excluding the impact of loans acquired fromCarolina Trust , loans receivable, gross grew$222.6 million , or 8.8% sinceDecember 31, 2018 . · Total deposits increased$690.2 million sinceDecember 31, 2018 . Excluding the impact of deposits acquired fromCarolina Trust , deposits increased$152.4 million sinceDecember 31, 2018 . · Nonperforming assets to total assets were 0.58% as ofDecember 31, 2019 compared to 0.35% as ofDecember 31, 2018 . Nonperforming loans were$25.2 million as ofDecember 31, 2019 as compared to$11.7 million atDecember 31, 2018 . The increase in nonperforming loans and the NPA ratio was primarily due to two fully collateralized lending relationships. · The Company reported book value per common share of$30.14 and$25.83 as ofDecember 31, 2019 and 2018, respectively. Tangible book value per common share was$22.00 and$19.36 as ofDecember 31, 2019 and 2018, respectively. 48 · AtDecember 31, 2019 , the Company's regulatory capital ratios exceeded the minimum levels currently required. Stockholders' equity totaled$743.4 million as ofDecember 31, 2019 compared to$575.3 million atDecember 31, 2018 . Tangible equity to tangible assets at
2019 was 12.04% compared to 11.83% at December 31, 2018 .
· On
had approved a plan to repurchase up to $25 million in shares of the
Company's common stock through open market and privately negotiated
transactions over the next three years. The Company began stock
repurchases on December 4, 2018 . During 2019, the Company repurchased
approximately 215,000 shares at an average price of $33.13 .
Cumulatively since December 4, 2018 , the Company repurchased
approximately 390,000 shares at an average price of $32.01 .
Operating earnings and related per share measures, as well as core deposits,
tangible common equity and tangible book value per common share are non-GAAP
financial measures. For reconciliations to the most comparable GAAP measures,
see "Non-GAAP Financial Measures" below.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted inthe United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our consolidated financial statements within Item 8 "Financial Statements and Supplementary Data" elsewhere in this report. Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations. Management has reviewed and approved these critical accounting policies and discussed them with the audit committee of the Board of Directors. Non-GAAP Financial Measures Statements included in this management's discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company's management uses these non-GAAP financial measures, including but not limited to, core deposits, tangible book value, operating earnings, allowance for loan losses to non-acquired loans, net interest margin-core and yield on loans receivable-core to evaluate and compare the Company's operating results from period to period in a meaningful manner. Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results or financial condition as reported under GAAP. 49
The following table presents a reconciliation of Non-GAAP performance measures for consolidated operating earnings and corresponding ratios:
For the Years Ended
December 31,
2019 2018 2017
(Dollars in thousands)
As Reported:
Income before income taxes $ 80,688 62,439 41,526
Tax expense 17,948 12,769 12,961
Net income $ 62,740 49,670 28,565
Average equity $ 605,629 526,701 280,877
Average assets 3,893,831 3,629,490 2,306,667
Return on average assets 1.61 % 1.37 % 1.24 %
Return on average equity 10.36 % 9.43 % 10.17 %
Weighted average common shares outstanding:
Basic 22,168,082 21,756,595 16,317,501
Diluted 22,385,127 21,972,857 16,550,357
Earnings per common share:
Basic $ 2.83 2.28 1.75
Diluted $ 2.80 2.26 1.73
Operating:
Income before income taxes $ 80,688 62,439 41,526(Gain) loss on sale of securities (3,891 ) 1,946 (933 ) Net loss on extinguishment of debt 178 - - Fair value adjustments on interest rate swaps 3,659 340 (382 ) Merger-related costs 2,753 15,216 8,301 Impairment of mortgage servicing rights 3,100 - - Operating earnings before income taxes 86,487
79,941 48,512 Tax expense (1) 18,868 17,105 14,706 Operating earnings (Non-GAAP)$ 67,619 62,836 33,806 Average equity$ 605,629 526,701 280,877 Average assets$ 3,893,831 3,629,490 2,306,667
Operating return on average assets (Non-GAAP) 1.74 % 1.73 % 1.47 % Operating return on average equity (Non-GAAP) 11.17 % 11.93 % 12.04 % Weighted average common shares outstanding: Basic 22,168,082 21,756,595 16,317,501 Diluted 22,385,127 21,972,857 16,550,357 Operating earnings per common share: Basic (Non-GAAP)$ 3.05 2.89 2.07 Diluted (Non-GAAP)$ 3.02 2.86 2.04
(1) Tax expense is determined using the effective tax rate adjusted to eliminate
the impact of the non-operating items.
50
At December 31,
2019 2018
(Dollars in thousands)
Core deposits:Noninterest-bearing demand accounts$ 668,616
547,022
Interest-bearing demand accounts 651,577
566,527
Savings accounts 218,786 192,322
Money market accounts 590,916 431,246Total core deposits (Non-GAAP) 2,129,895
1,737,117
Certificates of deposit:
Less than $250,000 1,159,978 875,749
$250,000 or more 118,488 105,327Total certificates of deposit 1,278,466
981,076
Total deposits $ 3,408,361 2,718,193
At December 31,
2019 2018
(Dollars in thousands)
Tangible book value per share:
Total stockholders' equity $ 743,440 575,285
Less intangible assets (200,880 ) (144,054 ) Tangible common equity (Non-GAAP)$ 542,560
431,231
Issued and outstanding shares 24,777,608
22,387,009
Less nonvested restricted stock awards (112,549 ) (117,966 ) Period end shares used for tangible book value 24,665,059
22,269,043
Total stockholders' equity$ 743,440
575,285
Divided by period end shares used for tangible book value 24,665,059
22,269,043
Common book value per share$ 30.14 25.83 Tangible common equity (Non-GAAP)$ 542,560
431,231
Divided by period end shares used for tangible book value 24,665,059
22,269,043
Tangible common book value per share (Non-GAAP)$ 22.00 19.36
Recent Accounting Standards and Pronouncements
For information relating to recent accounting standards and pronouncements, see Note 1 to the audited consolidated financial statements within Item 8 "Financial Statements and Supplementary Data." 51 Results of Operations Summary 2019 compared to 2018 The Company reported net income available to common stockholders of approximately$62.7 million , or$2.80 per diluted share, for the year endedDecember 31, 2019 , compared to$49.7 million , or$2.26 per diluted share for the year endedDecember 31, 2018 . Operating earnings, which exclude certain non-operating income and expenses, for the year endedDecember 31, 2019 increased 7.6% to$67.6 million , or$3.02 per diluted share, from$62.8 million , or$2.86 per diluted share, for the year endedDecember 31, 2018 . Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see "Non-GAAP Financial Measures". 2018 compared to 2017 The Company reported net income available to common stockholders of approximately$49.7 million , or$2.26 per diluted share, for the year endedDecember 31, 2018 , compared to$28.6 million , or$1.73 per diluted share for the year endedDecember 31, 2017 . Our 2018 and 2017 results include pretax merger related expenses of$15.2 million and$8.3 million , respectively. Operating earnings, which exclude certain non-operating income and expenses, for the year endedDecember 31, 2018 increased 85.9% to$62.8 million , or$2.86 per diluted share, from$33.8 million , or$2.04 per diluted share, for the year endedDecember 31, 2017 . Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see "Non-GAAP Financial Measures".
Details of the changes in the various components of net income are further discussed below.
Net Interest Income and Margin
Net interest income is a significant component of our net income. Net interest income is the difference between income earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is determined by the yields earned on interest-earning assets, rates paid on interest-bearing liabilities, the relative balances of interest-earning assets and interest-bearing liabilities, the degree of mismatch, and the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities. 2019 compared to 2018
For the years endedDecember 31, 2019 and 2018, our net interest income was$139.3 million and$133.8 million , respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year endedDecember 31, 2019 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased$235.8 million from 2018 to 2019, primarily attributable to organic loan growth. Average yields on loans receivable, net increased from 5.54% for the year endedDecember 31, 2018 to 5.60% for the year endedDecember 31, 2019 . 2018 compared to 2017
For the years endedDecember 31, 2018 and 2017, our net interest income was$133.8 million and$81.8 million , respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year endedDecember 31, 2018 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased$862.7 million , or 56.5%, from 2017 to 2018, primarily attributable to theGreer and First South acquisitions as well as organic loan growth. Average yields on loans receivable, net increased 0.40% fromDecember 31, 2017 to 5.54% for the year endedDecember 31, 2018 . 52 The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods indicated (dollars in thousands). We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. Nonaccrual loans are included in earning assets in the following tables. Loan yields reflect the negative impact on our earnings of loans on nonaccrual status. The net capitalized loan costs and fees, which are considered immaterial, are amortized into interest income on loans. For The Years Ended December 31, 2019 2018 2017 Interest Average Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate Balance Paid Rate (Dollars in thousands) Interest-earning assets: Loans held for sale$ 24,271 1,039 4.28 % 22,149 963 4.35 % 23,199 885 3.81 % Loans receivable, net (1) 2,624,667 146,882 5.60 % 2,388,856 132,289 5.54 % 1,526,109 78,415 5.14 % Interest-bearing cash 21,063 444 2.11 % 25,628 479 1.87 % 31,715 350 1.10 % Securities available for sale 811,028 27,424 3.38 % 795,100 26,222 3.30 % 504,555 14,836 2.90 % Federal Home Loan Bank stock 19,739 1,203 6.09 % 17,744 1,004 5.66 % 11,032 496 4.50 % Other investments 3,490 124 3.55 % 3,437 101 2.94 % 2,108 105 4.98 % Total interest-earning assets 3,504,258 177,116 5.05 % 3,252,914 161,058 4.95 % 2,098,718 95,087 4.53 % Noninterest-earning assets 389,573
376,576 207,949
Total assets $ 3,893,831 3,629,490 2,306,667
Interest-bearing liabilities:
Demand accounts 573,745 2,506 0.44 % 564,282 3,121 0.55 % 319,190 817 0.26 %
Money market accounts 442,076 4,647 1.05 % 459,774 3,048 0.66 % 374,770 1,747 0.47 %
Savings accounts 183,843 1,000 0.54 % 201,741 630 0.31 % 89,598 170 0.19 %
Certificates of deposit 1,017,795 18,953 1.86 % 910,433 11,928 1.31 % 622,424 6,653 1.07 %
Short-term borrowed funds 365,429 8,328 2.28 % 316,189 6,064 1.92 % 176,169 1,888 1.07 %
Long-term debt 48,688 2,432 5.00 % 59,465 2,457 4.13 % 58,539 1,978 3.38 %
Total interest-bearing liabilities 2,631,576 37,866 1.44 % 2,511,884 27,248 1.08 % 1,640,690 13,253 0.81 %
Noninterest-bearing deposits 601,133
561,678 355,105
Other liabilities 55,493 29,227 29,995
Stockholders' equity 605,629 526,701 280,877
Total liabilities and
Stockholders' equity $ 3,893,831 3,629,490 2,306,667
Net interest spread 3.61 % 3.87 % 3.72 %
Net interest margin 3.97 % 4.11 % 3.90 %
Net interest margin
(tax-equivalent) (2) 4.02 % 4.15 % 4.02 %
Net interest income $ 139,250 133,810 81,834
(1) Average balances of loans receivable, net include nonaccrual loans.
(2) The tax equivalent net interest margin reflects tax-exempt income on a
tax-equivalent basis.
53
2019 compared to 2018
Our net interest margin was 3.97%, or 4.02% on a tax-equivalent basis, for the year endedDecember 31, 2019 compared to 4.11%, or 4.15% on a tax equivalent basis, for the year endedDecember 31, 2018 . The decrease in margin from period to period is the result of an increase in the cost of funds as well as lower purchase accounting accretion. The increase in rates paid on interest-bearing liabilities is primarily due to repricing because of the increases in the prime rate during 2018 in addition to increased competition in our markets for deposits to fund strong loan growth. The yield on loans receivable during the year endedDecember 31, 2019 reflects accretion income from loans purchased in acquisitions of$7.6 million (22 bps to NIM) and early payoff fees of approximately$704,000 (2 bps to NIM) compared to accretion income of$9.8 million (32 bps to NIM) and early payoff fees of$1.0 million (3 bps to NIM) for the year endedDecember 31, 2018 . Excluding accretion income from acquired loans and early payoff fees, net interest margin-core (Non-GAAP) for the year endedDecember 31, 2019 was 3.78% compared to 3.80% for the year endedDecember 31, 2018 . Our net interest spread, which is not on a tax-equivalent basis, was 3.61% for the year endedDecember 31, 2019 as compared to 3.87% for the same period in 2018. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 26 basis point decrease in net interest spread is a result of the 10 basis point increase in yield on interest-earning assets as well as a 36 basis point increase in rates paid on interest-bearing liabilities. 2018 compared to 2017
Our net interest margin was 4.11%, or 4.15% on a tax-equivalent basis, for the year endedDecember 31, 2018 compared to 3.90%, or 4.02% on a tax equivalent basis, for the year endedDecember 31, 2017 . The increase in margin from period to period is the result of a shift to higher yielding earning assets as well as an increase in yield on securities available for sale and loans receivable, net of the increase in cost of funds. Average loans receivable comprised 73.4% of interest earning assets for the year endedDecember 31, 2018 compared to 72.7% for the year endedDecember 31, 2017 . The yield on loans receivable during the years endedDecember 31, 2018 and 2017 reflects accretion income from loans purchased in acquisitions of$9.8 million and$4.3 million , respectively. Our net interest spread, which is not on a tax-equivalent basis, was 3.87% for the year endedDecember 31, 2018 as compared to 3.72% for the same period in 2017. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 15 basis point increase in net interest spread is a result of the 42 basis point increase in yield on interest-earning assets as well as a 27 basis point increase in rates paid on interest-bearing liabilities.
The increase in the rate realized on loans is primarily the result of variable rate loans repricing as a result of the increases in the prime rate.
54
Rate/Volume Analysis
Net interest income can be analyzed in terms of the impact of changing interest
rates and changing volume. The following tables set forth the effect which the
varying levels of interest-earning assets and interest-bearing liabilities and
the applicable rates have had on changes in net interest income for the periods
presented.
For The Years Ended December 31,
2019 vs. 2018 2018 vs. 2017
Increase (decrease) Net Increase (decrease) Net
due to Rate/ Dollar due to Rate/ Dollar
Volume Rate Volume Change Volume Rate Volume Change
(In thousands)
Loans held for sale $ 91 (16 ) 1 76 (46 ) 118 6 78
Loans receivable,
net 13,197 1,534 (138 ) 14,593
47,777 9,544 (3,447 ) 53,874
Interest-bearing
cash (96 ) 50 11 (35 ) (114 ) 196 47 129
Securities
available-for-sale 539 677 (14 ) 1,202 9,582 2,843 (1,039 ) 11,386
FHLB stock 122 86 (9 ) 199 380 206 (78 ) 508
Other investments 2 21 - 23 39 (70 ) 27 (4 )Interest income 13,855 2,352 (149 ) 16,058
57,618 12,837 (4,484 ) 65,971
Demand accounts $ 41 (667 ) 11 (615 ) 1,356 1,677 (728 ) 2,305
Money market
accounts (186 ) 1,716 69 1,599 564 905 (167 ) 1,302
Savings accounts (97 ) 426 41 370 350 247 (137 ) 460
Certificates of
deposit 1,999 5,619 (593 ) 7,025 3,773 2,196 (695 ) 5,274
Short-term borrowed
funds 1,122 1,320 (178 ) 2,264 2,685 2,675 (1,185 ) 4,175
Long-term debt (538 ) 420 93 (25 ) 38 448 (7 ) 479
Interest expense $ 2,341 8,834 (557 ) 10,618
8,766 8,148 (2,919 ) 13,995
Net interest income 5,440 51,976
For the Years Ended December 31,
2017 vs. 2016
Increase (decrease) Net
due to Rate/ Dollar
Volume Rate Volume Change
(In thousands)
Loans held for sale $ (213 ) 79 19 (115 )
Loans receivable, net 25,229 4,496 (1,447 ) 28,278
Interest-bearing cash 23 270 (18 ) 275
Securities available-for-sale 5,206 883 (310 ) 5,779
Securities held-to-maturity - - (217 ) (217 )
FHLB stock 141 (27 ) 8 122
Other investments (27 ) 62 16 51
Interest income 30,359 5,763 (1,949 ) 34,173
Demand accounts $ 429 323 (169 ) 583
Money market accounts 466 645 (172 ) 939
Savings accounts 85 52 (26 ) 111
Certificates of deposit 1,459 415 (91 ) 1,783
Short-term borrowed funds 898 917 (436 ) 1,379
Long-term debt (631 ) 255 81 (295 )
Interest expense $ 2,706 2,607 (813 ) 4,500
Net interest income 29,673
55
Provision for Loan Loss
We have established an allowance for loan losses through a provision for loan
losses charged as an expense on our consolidated statements of operations. We
review our loan portfolio periodically to evaluate our outstanding loans and to
measure both the performance of the portfolio and the adequacy of the allowance
for loan losses.
Following is a summary of the activity in the allowance for loan losses during
the years ended
For the Years Ended
2019 2018 2017
(In thousands)
Balance, beginning of period $ 14,463 11,478 10,688
Provision for loan losses 2,580 2,059 779
Loan charge-offs (1,235 ) (872 ) (272 )
Loan recoveries 713 1,798 283
Balance, end of period $ 16,521 14,463 11,478
2019 compared to 2018
The Company experienced net charge-offs of approximately $522,000 for the year
ended December 31, 2019 and net recoveries of $926,000 for the year ended
December 31, 2018 . Provision for loan losses of $2.6 million was recorded during
2019 primarily driven by organic loan growth. Provision expense for loan losses
of $2.1 million was recorded during 2018. The increase in provision expense from
the prior year was primarily due to loan growth and reduced recoveries in 2019.
Non-performing assets were 0.58% and 0.35% of total assets at December 31, 2019
and 2018, respectively. The increase in the NPA ratio was primarily due to two
fully collateralized lending relationships.
2018 compared to 2017
The Company experienced net recoveries of $926,000 for the year ended December
31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017 .
Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December
31, 2017 . Approximately half of the increase related to five purchased
non-credit impaired loans with balances in excess of $500,000 . Provision for
loan losses of $2.1 million was recorded during 2018 primarily driven by organic
loan growth and unknown storm related impacts in the third quarter of 2018.
Provision expense for loan losses of $779,000 was recorded during 2017.
Noninterest Income and Expense
Noninterest income provides us with additional revenues that are significant
sources of income. In 2019, 2018 and 2017, noninterest income comprised 21.0%,
19.8% and 26.3%, respectively, of total interest and noninterest income.
56
The major components of noninterest income for the Company are listed below:
For the Years
Ended December 31,
2019 2018 2017
(In thousands)
Noninterest income:
Mortgage banking income $ 19,326 15,295 15,140
Deposit service charges 6,814 7,755 4,643Net loss on extinguishment of debt (178 ) -
-
Net gain (loss) on sale of securities 3,891 (1,946 )
933
Fair value adjustments on interest rate swaps (3,659 ) (340 )
382
Net increase in cash value life insurance 1,591 1,530
1,116
Mortgage loan servicing income 10,107 9,052
6,790 Debit card income, net 4,839 4,809 2,308 Other 4,379 3,741 2,604 Total noninterest income$ 47,110 39,896 33,916 2019 compared to 2018 Noninterest income increased to$47.1 million for the year endedDecember 31, 2019 from$39.9 million for the year endedDecember 31, 2018 . The increase in noninterest income for the year endedDecember 31, 2019 over the comparable period in 2018 primarily relates to an increase in mortgage banking income due to higher mortgage origination activity and closings as well as gains on sales of securities partially offset by fair value losses on interest rate swaps.
The following table provides a break out of mortgage banking:
For the Years Ended December 31,
Loan Originations Mortgage Banking Income Margin
2019 2018 2019 2018 2019 2018
(Dollars in thousands)
Additional segment information:
Community banking $ 107,452 108,721 2,998 2,352 2.79 % 2.16 %
Wholesale mortgage banking 799,975 744,208 16,328 12,943 2.04 % 1.74 %
Total $ 907,427 852,929 19,326 15,295 2.13 % 1.79 %
Mortgage loan servicing income increased $1.1 million for the year ended
December 31, 2019 compared to the year ended December 31, 2018 . The increase in
mortgage loan servicing income was primarily driven by an increase in loans
serviced for the comparative periods particularly servicing acquired in late
2018.
2018 compared to 2017
Noninterest income increased to $39.9 million for the year ended December 31,
2018 from $33.9 million for the year ended December 31, 2017 . The increase in
noninterest income for the year ended December 31, 2018 over the comparable
period in 2017 primarily relates to an increase in mortgage loan servicing
income due to higher average balances of serviced loans and an increase in
deposit service charges, debit card income and other noninterest income due to
organic growth in addition to the impact of the First South and Greer
acquisitions in 2017, partially offset by a net loss on sale of securities.57
The following table provides a break out of mortgage banking:
For the Years Ended December 31,
Loan Originations Mortgage Banking Income Margin
2018 2017 2018 2017 2018 2017
(Dollars in thousands)
Additional segment information:
Community banking $ 108,721 86,732 2,352 2,009 2.16 % 2.32 %
Wholesale mortgage banking 744,208 824,282 12,943 13,131 1.74 % 1.59 %
Total $ 852,929 911,014 15,295 15,140 1.79 % 1.66 %
Mortgage loan servicing income increased
The following table sets forth for the periods indicated the primary components
of noninterest expense:
For the Years
Ended December 31,
2019 2018 2017
(In thousands)
Noninterest expense:Salaries and employee benefits$ 53,822 53,517
37,827
Occupancy and equipment 16,902 15,961
10,347
Marketing and public relations 1,614 1,330
1,417
FDIC insurance 502 1,090
721
Recovery of mortgage loan repurchase losses (400 ) (600 )
(900 ) Legal expense 438 422
507
Other real estate expense (income), net 422 (13 )
54
Mortgage subservicing expense 2,872 2,468
1,986
Amortization of mortgage servicing rights 5,721 4,206
2,966
Impairment of mortgage servicing rights 3,100 -
-
Amortization of core deposit intangible 2,910 3,139
1,037 Merger-related expenses 2,753 15,216 8,301 Other 12,436 12,472 9,182 Total noninterest expense$ 103,092 109,208 73,445 2019 compared to 2018
Noninterest expense decreased to$103.1 million for the year endedDecember 31, 2019 from$109.2 million for the year endedDecember 31, 2018 . The decrease in noninterest expense is primarily the result of a decrease in merger-related expenses year over year. Noninterest expense for the year endedDecember 31, 2019 also included a temporary impairment of mortgage servicing rights of$3.1 million . The Company does not hedge the mortgage servicing rights positions and the impact of falling long-term interest rates increased prepayment speed assumptions driving down the value of the MSR asset. 58 2018 compared to 2017
Noninterest expense increased to$109.2 million for the year endedDecember 31, 2018 from$73.4 million for the year endedDecember 31, 2017 . The increase in noninterest expense is primarily the result of an increase in salaries and employee benefits and occupancy and equipment as well as merger related expenses related to the acquisitions of First South andGreer during 2017. Merger related expenses totaled$15.2 million for the year endedDecember 31, 2018 as compared to$8.3 million for the year endedDecember 31, 2017 . Income Tax Expense 2019 compared to 2018 Our effective tax rate was 22.2% for the year endedDecember 31, 2019 , compared to 20.4% for the year endedDecember 31, 2018 . The increase in the effective tax rate from period to period reflects lower interest income on municipal securities, lower tax benefits related to excess stock-based compensation and the impact of certain non-deductible merger related expenses in 2019. 2018 compared to 2017 Our effective tax rate was 20.4% for the year endedDecember 31, 2018 , compared to 31.2% for the year endedDecember 31, 2017 . The decrease in the effective tax rate from period to period reflects a reduction in the federal income tax rate from 35% to 21% as enacted in the 2017 Tax Cuts and Jobs Act onDecember 22, 2017 . In addition to the lower federal tax rate, the decrease in the effective tax rate from period to period reflects an increase in interest income on municipal securities during 2018 and tax benefits related to excess stock-based compensation. Balance Sheet ReviewInvestment Securities
Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk. AtDecember 31, 2019 , our securities portfolio, excluding FHLB stock and other investments, was$879.2 million or approximately 18.7% of our assets. Our available-for-sale securities portfolio included municipal securities, US agency securities, collateralized loan obligations, corporate securities, mortgage-backed securities (agency and non-agency), and trust preferred securities with a fair value of$879.2 million and an amortized cost of$868.2 million resulting in a net unrealized gain of$11.0 million .
At
As securities are purchased, they are designated as held-to-maturity or available-for-sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. We do not currently hold, nor have we ever held, any securities that are designated as trading securities. 59
The amortized costs and the fair value of our investments are as follows:
At December 31,
2019 2018 2017
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
(In thousands)
Securities
available-for-sale:
Municipal
securities $ 210,810 218,968 212,215 213,714 240,904 247,350
US government
agencies 23,968 23,923 24,772 25,277 11,983 12,008
Collateralized loan
obligations 301,249 299,982 231,172 230,699 128,080 128,643
Corporate
securities 6,940 6,988 6,915 6,960 6,891 7,006
Mortgage-backed
securities:
Agency 164,114 166,714 199,518 197,520 243,075 243,595
Non-agency 150,019 151,942 158,803 157,531 94,834 95,125
Total
mortgage-backed
securities 314,133 318,656 358,321 355,051 337,909 338,720
Trust preferred
securities 11,114 10,718 11,066 11,100 11,208 9,512
Total securities
available-for-sale $ 868,214 879,235 844,461 842,801 736,975 743,239
The Company uses prices from third party pricing services to estimate the fair
value of our investment securities. While we obtain fair value information from
multiple sources, we generally obtain one price/quote for each individual
security. For securities priced by third party pricing services, we determine
the most appropriate and relevant pricing service for each security class and
have that vendor provide the price for each security in the class. We record the
value provided by the third party pricing service/broker in our consolidated
financial statements, subject to our internal price verification procedures,
which include periodic comparisons to other brokers and Bloomberg pricing
screens.
Contractual maturities and yields on our investments are shown in the following
table. Municipal yields were not tax effected in the table below. Expected
maturities may differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties. Securities available-for-sale are presented at fair value and
held-to-maturity securities are presented at amortized cost.
60
At December 31, 2019
Less than 12 Months One to Five Years Five to Ten Years Over Ten Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
(Dollars in thousands)
Securities
available-for-sale:
Municipal securities $ 681 2.78 % 6,141 2.59 % 44,003 3.21 % 168,143 3.12 % 218,968 3.13 %
US government agencies - - 8,050 2.07 % 13,813 2.45 % 2,060 2.56 % 23,923 2.33 %
Collateralized loan
obligations - - - - 74,430 3.72 % 225,552 3.62 % 299,982 4.20 %
Corporate securities - - 6,988 4.28 % - - - - 6,988 4.28 %
Mortgage-backed
securities:
Agency - - 1,113 2.76 % 16,831 2.84 % 148,770 2.55 % 166,714 2.58 %
Non-agency - - 3 5.38 % 1,366 2.82 % 150,573 3.54 % 151,942 3.53 %
Total mortgage-backed
securities - - 1,116 2.77 % 18,197 2.84 % 299,343 3.05 % 318,656 3.03 %
Trust preferred
securities - - - - - - 10,718 4.10 % 10,718 4.10 %
Total securities
available-for-sale $ 681 2.78 % 22,295 2.94 % 150,443 3.35 % 705,816 3.26 % 879,235 3.46 %
For disclosures related to the Company's evaluation of securities for OTTI, see Note 4 - Securities within Item 8. "Financial Statements and Supplementary Data."
Non-marketable investments are comprised of the following and are recorded at cost which approximates fair value since no readily available market exists
for
these securities.
At December 31,
2019 2018
(In thousands)
Community Reinvestment Act fund $ 2,405 2,334
Investment in Trust Preferred subsidiaries 1,116 1,116 Total other investments
3,521 3,450
$ 26,801 25,146 Loans by Type
Since loans typically provide higher interest yields than other types of
interest-earning assets, a substantial percentage of our earning assets are
invested in our loan portfolio. Gross loans receivable at
Our loan portfolio consists primarily of loans secured by real estate mortgages. As ofDecember 31, 2019 , our loan portfolio included$2.7 billion , or 84.7%, of gross loans secured by real estate. As ofDecember 31, 2018 , our loan portfolio included$2.1 billion , or 84.8%, of gross loans secured by real estate. Substantially all of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types. 61 As shown in the table below, loans receivable, gross grew$703.6 million sinceDecember 31, 2018 . Excluding the impact of loans acquired fromCarolina Trust , loans receivable, gross grew$222.6 million , or 8.8% sinceDecember 31, 2018 . The growth in loan balances was primarily the result of strong organic growth in both commercial and residential lending. The following table summarizes loans by type and percent of total at the end of the periods indicated: At December 31, 2019 2018 2017 % of Total % of Total % of Total All Loans: Amount Loans Amount Loans Amount Loans (Dollars in thousands) Loans secured by real estate: One-to-four family$ 785,572 24.34 % 732,717 29.03 % 665,774 28.70 % Home equity 110,016 3.41 % 83,770 3.32 % 90,141 3.89 % Commercial real estate 1,394,626 43.20 % 1,034,117 40.96 % 933,820 40.26 % Construction and development 442,657 13.71 % 290,494 11.51 % 294,793 12.71 % Consumer loans 26,500 0.82 % 23,845 0.94 % 19,990 0.86 % Commercial business loans 468,566 14.52 % 359,393 14.24 % 315,010 13.58 % Total gross loans receivable 3,227,937 100.00 % 2,524,336 100.00 % 2,319,528 100.00 %
Less:
Allowance for loan losses 16,521 14,463 11,478 Total loans receivable, net$ 3,211,416 2,509,873 2,308,050 At December 31, 2016 2015 % of Total % of Total Amount Loans Amount Loans (Dollars in thousands) Loans secured by real estate: One-to-four family$ 411,399 34.91 % 344,928 37.38 % Home equity 36,026 3.06 % 23,256 2.52 % Commercial real estate 445,344 37.80 % 341,658 37.03 %
Construction and development 115,682 9.82 % 91,362
9.90 %
Consumer loans 5,714 0.48 % 5,179 0.56 %
Commercial business loans 164,101 13.93 % 116,340 12.61 %Total gross loans receivable 1,178,266 100.00 % 922,723 100.00 % Less: Allowance for loan losses 10,688 10,141 Total loans receivable, net$ 1,167,578 912,582
62
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.
The following table summarizes the loan maturity distribution by type and related interest rate characteristics.
At December 31, 2019
After one
One Year but within After five
or Less five years years Total
(In thousands)
Loans secured by real estate:
One-to-four family $ 43,586 194,817 547,169 785,572
Home equity 12,276 25,520 72,220 110,016
Commercial real estate 176,990 899,643 317,993 1,394,626
Construction and development 123,718 272,749 46,190 442,657
Consumer loans 3,168 11,105 12,227 26,500
Commercial business loans 72,100 293,312 103,154 468,566
Total gross loans receivable $ 431,838 1,697,146 1,098,953 3,227,937
Loans maturing - after one year
Variable rate loans $ 1,007,928
Fixed rate loans 1,788,171
$ 2,796,099 Nonperforming and Problem Assets
Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower's loan default. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction of principal when received. In general, a nonaccrual loan may be placed back onto accruing status once the borrower has made a minimum of six consecutive payments in accordance with the loan terms. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As ofDecember 31, 2019 , andDecember 31, 2018 , the Company had$2.0 million and$0.6 million , respectively, of PCI loans that were 90 days past due and accruing. 63
Troubled Debt Restructurings ("TDRs")
The Company designates loan modifications as TDRs when, for economic or legal reasons related to the borrower's financial difficulties, it grants a concession to the borrower that it would not otherwise consider. Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of modification are initially classified as accruing TDRs at the date of modification, if the note is reasonably assured of repayment and performance is in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the modification date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accrual status when there is economic substance to the restructuring, there is well documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated repayment performance in accordance with the modified terms for a reasonable period of time, generally a minimum of six months.
The following table summarizes nonperforming and problem assets, excluding purchased credit impaired loans, at the end of the periods indicated.
At December 31,
2019 2018 2017 2016 2015
(In thousands)
Loans receivable:
90 days and still accruing $ - 20 - - -
Nonaccrual
loans-renegotiated loans 6,636 3,086 1,140 1,227 1,136
Nonaccrual loans-other 18,530 8,635 2,793 4,398 3,166
Real estate acquired through
foreclosure, net 2,325 1,534 3,106 1,179 2,374
Total non-performing assets $ 27,491 13,275 7,039 6,804 6,676
Problem assets not included
in non-performing assets:
Accruing renegotiated loans
outstanding $ 4,473 3,327 5,324 5,216 13,212
AtDecember 31, 2019 , nonperforming assets were$27.5 million , or 0.58% of total assets. Comparatively, nonperforming assets were$13.3 million , or 0.35% of total assets, atDecember 31, 2018 . Nonperforming loans were 0.78% and 0.47% of gross loans receivable atDecember 31, 2019 andDecember 31, 2018 , respectively. AtDecember 31, 2018 , nonperforming assets were$13.3 million , or 0.35% of total assets. Comparatively, nonperforming assets were$7.0 million , or 0.20% of total assets, atDecember 31, 2017 . Nonperforming loans were 0.47% and 0.17% of gross loans receivable atDecember 31, 2018 andDecember 31, 2017 , respectively. Potential problem loans, which are not included in nonperforming loans, amounted to approximately$4.5 million atDecember 31, 2019 , compared to$3.3 million atDecember 31, 2018 . Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. Potential problem loans, which are not included in nonperforming loans, amounted to approximately$3.3 million atDecember 31, 2018 , compared to$5.3 million atDecember 31, 2017 . Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower's ability to comply with present repayment terms. Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans for fiscal years 2019 and 2018 are collateralized by real estate. The Bank utilizes third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require the Bank to obtain updated appraisals on loans greater than$250,000 at a minimum of every 18 months, either through a new external appraisal or an internal appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. Management believes based on information known and available currently, the probable losses related to problem assets are adequately reserved in the allowance for loan losses. 64 Allowance for Loan Losses The allowance for loan losses is management's estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Management determines the allowance based on an ongoing evaluation. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The allowance consists of specific and general components. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by major loan category and is based on the actual loss history trends for the previous 20 quarters. The actual loss experience is supplemented with internal and external qualitative factors as considered necessary at each period and given the facts at the time. These qualitative factors adjust the 20 quarter historical loss rate to recognize the most recent loss results and changes in the economic conditions to ensure the estimated losses in the portfolio are recognized in the period incurred and that the allowance at each balance sheet date is adequate and appropriate in accordance with GAAP. Qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries for the most recent twelve quarters; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. Impaired loans are evaluated for impairment using the discounted cash flow methodology or based on the net realizable value of the underlying collateral. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. See additional discussion in section "Nonperforming and Problem Assets." While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates. To the extent actual outcomes differ from management's estimates, additional provisions for loan losses could be required that could adversely affect the Bank's earnings or financial position in future periods. There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with ASC 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20. The allowance for loan losses was$16.5 million , or 0.74% of non-acquired loans, atDecember 31, 2019 , compared to$14.5 million , or 0.79% of total non-acquired loans, atDecember 31, 2018 . Loans acquired in business combinations were$989.5 million and$686.4 million atDecember 31, 2019 andDecember 31, 2018 , respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. AtDecember 31, 2019 andDecember 31, 2018 , acquired non-credit impaired loans had a purchase discount remaining of$9.5 million and$10.9 million , respectively. The allowance for loan losses was$14.5 million , or 0.79% of non-acquired loans, atDecember 31, 2018 , compared to$11.5 million , or 0.84% of total non-acquired loans, atDecember 31, 2017 . Loans acquired in business combinations were$686.4 million and$952.2 million atDecember 31, 2018 andDecember 31, 2017 , respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. AtDecember 31, 2018 andDecember 31, 2017 , acquired non-credit impaired loans had a purchase discount remaining of$10.9 million and$17.7 million , respectively. 65
The table below shows a reconciliation of acquired and non-acquired loans and allowance for loan losses to non-acquired loans:
At December 31,
2019 2018
(Dollars in thousands)
Acquired and non-acquired loans:
Acquired loans receivable $ 989,534 686,401
Non-acquired loans receivable 2,238,403 1,837,935
Total loans receivable $ 3,227,937 2,524,336
% Acquired 30.66 % 27.19 %
Non-acquired loans $ 2,238,403 1,837,935
Allowance for loan losses 16,521 14,463
Allowance for loan losses to non-acquired
loans (Non-GAAP) 0.74 % 0.79 %
Total loans receivable $ 3,227,937 2,524,336
Allowance for loan losses 16,521 14,463
Allowance for loan losses to total loans
receivable 0.51 % 0.57 %
The Company experienced net charge-offs of approximately $522,000 for the year
ended December 31, 2019 and net recoveries of $926,000 for the year ended
December 31, 2018 . Provision for loan losses of $2.6 million was recorded during
2019 primarily driven by organic loan growth. Provision expense for loan losses
of $2.1 million was recorded during 2018. The increase was primarily due to loan
growth and reduced recoveries in 2019. Non-performing assets were 0.58% and
0.35% of total assets at December 31, 2019 and 2018, respectively. The increase
in the NPA ratio was primarily due to two fully collateralized lending
relationships.
The Company experienced net recoveries of $926,000 for the year ended December
31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017 .
Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December
31, 2017 . Provision expense was $2.1 million and $779,000 for 2018 and 2017,
respectively.
66
The following table summarizes the activity related to our allowance for loan
losses for the five years ended
For the Years Ended December 31,
2019 2018 2017 2016 2015
(Dollars in thousands)
Balance, beginning of period $ 14,463 11,478 10,688 10,141 9,035
Provision for loan losses 2,580 2,059 779 - -
Loan charge-offs:
Loans secured by real
estate:
One-to-four family (293 ) (226 ) (253 ) (84 ) (1,050 )
Home equity (78 ) (31 ) - - -
Commercial real estate (380 ) (86 ) - - -
Construction and development (19 ) (24 ) - - (90 )
Consumer loans (320 ) (308 ) (19 ) (53 ) (20 )
Commercial business loans (145 ) (197 ) - (127 ) (70 )
Total loan charge-offs (1,235 ) (872 ) (272 ) (264 ) (1,230 )
Loan recoveries:
Loans secured by real
estate:
One-to-four family 174 142 4 464 576
Home equity 6 7 3 - 150
Commercial real estate 35 77 31 - 350
Construction and development 248 1,112 81 76 479
Consumer loans 165 93 45 24 38
Commercial business loans 85 367 119 247 743
Total loan recoveries 713 1,798 283 811 2,336
Net loan (charge-offs)
recoveries (522 ) 926 11 547 1,106
Balance, end of period $ 16,521 14,463 11,478 10,688 10,141
Allowance for loan losses as
a percentage of loans
receivable (end of period) 0.51 % 0.57 % 0.49 % 0.91 % 1.10 %
Net charge-offs (recoveries)
to average loans receivable 0.02 % (0.04 )% - (0.05 )% (0.13 )%
67
The following table summarizes an allocation of the allowance for loan losses
and the related percentage of loans outstanding in each category for the five
years ended December 31, 2019 .
At December 31,
2019 2018 2017 2016 2015
Amount % Amount % Amount % Amount % Amount %
(Dollars in thousands)Loans receivable: One-to-four family$ 3,531 24.34 % 3,540 29.03 % 2,719 28.70 % 2,636 34.91 % 2,903 37.23 % Home equity 225 3.41 % 203 3.32 % 168 3.89 % 197 3.06 % 151 2.52 % Commercial real estate 5,746 43.20 % 5,097 40.96 % 3,986 40.26 % 3,344 37.80 % 3,402 37.10 % Construction and development 2,542 13.71 % 1,969 11.51 % 1,201 12.71 % 1,132 9.82 % 1,138 9.94 % Consumer loans 392 0.82 % 352 0.94 % 79 0.86 % 80 0.48 % 27 0.56 % Commercial business loans 3,448 14.52 % 2,940 14.24 % 2,840 13.58 % 2,805 13.93 % 2,100 12.65 % Unallocated 637 - 362 - 485 - 494 - 420 - Total$ 16,521 100.00 % 14,463 100.00 % 11,478 100.00 % 10,688 100.00 % 10,141 100.00 % Mortgage Operations
Mortgage Activities and Servicing
Our wholesale mortgage banking operations are conducted through our mortgage origination subsidiary,Crescent Mortgage Company . Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to third party market guidelines throughCrescent Mortgage Company . Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company's profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned. Discussion related to the impact and changes within the mortgage operations is provided in "Results of Operations - Noninterest Income and Expense". Additional segment information is provided in Note 21 - Supplemental Segment Information in the accompanying financial statements.
Loan Servicing
We retain the rights to service a portion of the loans we sell on the third party market, as part of our mortgage banking activities, for which we receive service fee income. These rights are known as mortgage servicing rights, or MSRs, where the owner of the MSR acts on behalf of the mortgage loan owner and has the contractual right to receive a stream of cash flows in exchange for performing specified mortgage servicing functions. These duties typically include, but are not limited to, performing loan administration, collection, and default activities, including the collection and remittance of loan payments, responding to customer inquiries, accounting for principal and interest, holding custodial (impound) funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures and property dispositions. We subservice the duties and responsibilities obligated to the owner of the MSR to a third party provider for which we pay a fee. We recognize the rights to service mortgage loans for others as an asset. We initially record the MSR at fair value and subsequently account for the asset at lower of cost or market using the amortization method. Servicing assets are amortized in proportion to, and over the period of, the estimated net servicing income and are carried at amortized cost. A valuation is performed by an independent third party on a quarterly basis to assess the servicing assets for impairment based on the fair value at each reporting date. The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees. This valuation is performed on a disaggregated basis, based on loan type and year of production. Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase). As discussed in detail in notes to the consolidated financial statements, we use an appropriate weighted average constant prepayment rate, discount rate, and other defined assumptions to model the respective cash flows and determine the fair value of the servicing asset at each reporting date. The Company was servicing$3.6 billion loans for others atDecember 31, 2019 and$4.0 billion atDecember 31, 2018 . Mortgage servicing rights asset had a balance of$25.9 million and$32.9 million atDecember 31, 2019 andDecember 31, 2018 , respectively. The midpoint economic estimated fair value of the mortgage servicing rights was$31.4 million and$40.9 million atDecember 31, 2019 andDecember 31, 2018 , respectively. Amortization expense related to the mortgage servicing rights was$5.7 million and$4.2 million during the years endedDecember 31, 2019 and 2018, respectively. 68
Below is a roll-forward of activity in the balance of the servicing assets for
the years ended
At December 31,
2019 2018
(In thousands)
MSR beginning balance $ 32,933 21,003
Amount capitalized 1,368 6,283
Purchased servicing 461 9,853
Amount amortized (5,721 ) (4,206 )
MSR Impairment (3,100 ) -
MSR ending balance $ 25,941 32,933
Reserve for Mortgage Repurchase Losses
Loans held for sale have primarily been fixed-rate single-family residential mortgage loans under contracts to be sold in the third party market. In most cases, loans in this category are sold within 30 days of closing. Buyers generally have recourse to return a purchased loan to the Company under limited circumstances. An estimation of mortgage repurchase losses is reviewed on a quarterly basis. The representations and warranties in our loan sale agreements provide that we repurchase or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. In addition to these representations and warranties, our loan sale contracts define a condition in which the borrower defaults during a short period of time, typically 120 days to one year, as an early payment default, or EPD. In the event of an EPD, we are required to return the premium paid by the investor for the loan as well as certain administrative fees, and in some cases repurchase the loan or indemnify the investor. Because the level of mortgage loan repurchase losses depends upon economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of the liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment.
The following table demonstrates the activity for the mortgage repurchase
reserve for the years ended
For the Years Ended
December 31,
2019 2018 2017
(In thousands)
Beginning balance $ 1,292 1,892 2,880
Losses paid - - (88 )
Recovery of mortgage loan repurchase losses (400 ) (600 ) (900 )
Ending balance $ 892 1,292 1,892
For the years ended December 31, 2019 and 2018, the Company recorded a recovery
for mortgage repurchase losses of $400,000 and $600,000 , respectively. The
recovery for mortgage loan repurchase losses is related to several factors. The
Company sells mortgage loans to various third parties, including
government-sponsored entities ("GSEs"), under contractual provisions that
include various representations and warranties as previously stated. The Company
establishes the reserve for mortgage loan repurchase losses based on a
combination of factors, including estimated levels of defects on internal
quality assurance, default expectations, historical investor repurchase demand
and appeals success rates, reimbursement by correspondent and other third party
originators, and projected loss severity. As a result of the Company's analysis
of its reserve for mortgage loan repurchase losses, the reserve was reducedaccordingly. 69 Deposits We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management's desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. AtDecember 31, 2019 , deposits totaled$3.4 billion , an increase from deposits of$2.7 billion atDecember 31, 2018 . The increase in deposits sinceDecember 31, 2018 relates to deposits acquired fromCarolina Trust as well as continued efforts to fund our balance sheet growth with core deposits through business development. The following table shows the average balance amounts and the average rates paid on deposits held by us. For the Years Ended December 31, 2019 2018 2017 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate (Dollars in thousands) Interest-bearing demand accounts$ 573,745 0.44 % 564,282 0.55 % 319,190 0.26 % Money market accounts 442,076 1.05 % 459,774 0.66 % 374,770 0.47 % Savings accounts 183,843 0.54 % 201,741 0.31 % 89,598 0.19 % Certificates of deposit less than$100,000 523,052 1.83 % 330,815 1.18 % 220,742 0.92 % Certificates of deposit of$100,000 or more 494,743 1.89 % 579,618 1.38 % 401,682 1.10 % Total interest-bearing average deposits 2,217,459 1.22 % 2,136,230
0.88 % 1,405,982 0.67 %
Noninterest-bearing deposits 601,133 561,678 355,105 Total average deposits$ 2,818,592 2,697,908 1,761,087 The maturity distribution of our time deposits of$100,000 or more is as follows: At December 31, 2019 2018 (In thousands) Three months or less$ 143,658 126,653
Over three through six months 235,092 75,425 Over six through twelve months 114,602 110,300 Over twelve months
185,126 160,006
Total certificates of deposits
70 Borrowings The following table outlines our various sources of short-term borrowed funds during the years endedDecember 31, 2019 , 2018 and 2017, and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown. Stated period end rates are contractual rates. The average for the period rates reflect the impact of purchase accounting. Maximum Contractual Month Average for the Ending Period End End Period
At or for the year ended December 31, 2019 Balance Rate
Balance Balance Rate(1)
(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances $ 437,700 1.66%-2.02% 437,700 365,429 2.28 %
Long-term borrowed funds
Long-term FHLB advances, due 2021 through 2029 12,114 0.88%-2.39% 27,000 16,134 1.82 %
Subordinated debentures, due 2026 through 2037 42,761 3.67%-6.90% 42,761 32,554 6.57 %
Stated Maximum
Period Month Average for the
Ending End End PeriodAt or for the year ended December 31, 2018 Balance Rate
Balance Balance Rate(1)
(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances $ 405,500 1.05%-2.78% 405,500 316,189 1.92 %
Long-term borrowed funds
Long-term FHLB advances, due 2019 through 2020 27,000 1.72%-2.60% 42,500 27,117 1.59 %
Subordinated debentures, due 2032 through 2037 32,436 4.25%-5.75% 32,436 32,348 6.26 %
Stated Maximum
Period Month Average for the
Ending End End PeriodAt or for the year ended December 31, 2017 Balance Rate
Balance Balance Rate(1)
(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances $ 340,500 0.87%-2.71% 340,500 176,169 1.07 %
Long-term borrowed funds Long-term FHLB advances, due 2019 through 2020 40,000 1.05%-1.98% 52,000 35,357 2.33 % Subordinated debentures, due 2032 through 2037 32,259 3.11%-4.75% 32,259 23,182 4.97 %
(1) Subordinated debentures average rate for the period reflects the amortization of the related purchase accounting mark, if any.
71 Liquidity Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. The Company utilizes borrowing facilities in order to maintain adequate liquidity including: the FHLB ofAtlanta , theFederal Reserve Bank ("FRB"), and federal funds purchased. The Company also uses wholesale deposit products, including brokered deposits as well as national certificate of deposit services. Additionally, the Company holds investment securities classified as available-for-sale that are carried at market value with changes in market value, net of tax, recorded through stockholders' equity. Lines of credit with the FHLB ofAtlanta are based upon FHLB-approved percentages of Bank assets, but must be supported by appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential mortgage, residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket lien agreements. AtDecember 31, 2019 , the Company had FHLB advances of$449.8 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately$416.1 million .
Lines of credit with the FRB are based on collateral pledged. At
At
AtDecember 31, 2019 , the Company has pledged$141.6 million of securities to secure public agency funds. In addition, the Company has pledged a$15 million letter of credit to secure public agency funds. Capital Resources The Company and the Bank are subject to various federal and state regulatory requirements, including regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions that if undertaken could have a direct material effect on the Company's and the Bank's financial statements. EffectiveJanuary 2, 2015 , the Company and Bank became subject to the regulatory risk-based capital rules adopted by the federal banking agencies implementing Basel III. Under the new capital guidelines, applicable regulatory capital components consist of (1) common equity Tier 1 capital (common stock, including related surplus, and retained earnings, plus limited amounts of minority interest in the form of common stock, net of goodwill and other intangibles (other than mortgage servicing assets), deferred tax assets arising from net operating loss and tax credit carry forwards above certain levels, mortgage servicing rights above certain levels, gain on sale of securitization exposures and certain investments in the capital of unconsolidated financial institutions, and adjusted by unrealized gains or losses on cash flow hedges and accumulated other comprehensive income items (subject to the ability of a non-advanced approaches institution to make a one-time irrevocable election to exclude from regulatory capital most components of AOCI), (2) additional Tier 1 capital (qualifying non-cumulative perpetual preferred stock, including related surplus, plus qualifying Tier 1 minority interest and, in the case of holding companies with less than$15 billion in consolidated assets atDecember 31, 2009 , certain grandfathered trust preferred securities and cumulative perpetual preferred stock in limited amounts, net of mortgage servicing rights, deferred tax assets related to temporary timing differences, and certain investments in financial institutions) and (3) Tier 2 capital (the allowance for loan and lease losses in an amount not exceeding 1.25% of standardized risk-weighted assets, plus qualifying preferred stock, qualifying subordinated debt and qualifying total capital minority interest, net of Tier 2 investments in financial institutions). Total Tier 1 capital, plus Tier 2 capital, constitutes total risk-based capital. 72
The required minimum ratios are as follows:
· Common equity Tier 1 capital ratio (common equity Tier 1 capital to total
risk-weighted assets) of 4.5%
· Tier 1 Capital Ratio (Tier 1 capital to total risk-weighted assets) of 6%
· Total capital ratio (total capital to total risk-weighted assets) of 8%; and
· Leverage ratio (Tier 1 capital to average total consolidated assets) of 4%
The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The phase-in of the capital conservation buffer requirement began onJanuary 1, 2016 and became fully phased in as ofJanuary 1, 2019 . The final regulatory capital rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for "adequately capitalized" banking organizations are equal to the new minimum capital requirements. Under this framework, in order to be considered "well capitalized", insured depository institutions are required to maintain a Tier 1 leverage ratio of 5%, a common equity Tier 1 risk-based capital measure of 6.5%, a Tier 1 risked-based capital ratio of 8% and a total risk-based capital ratio of 10%. OnJune 11, 2018 , the Company completed the sale of 1.5 million shares of its common stock. The net proceeds of the offering to the Company, after estimated expenses, were approximately$63.0 million . OnDecember 3, 2018 , the Company announced that the Board of Directors had approved a plan to repurchase up to$25 million in shares of the Company's common stock through open market and privately negotiated transactions over the next three years. The Company began stock repurchases onDecember 4, 2018 . During 2019, the Company repurchased approximately 215,000 shares at an average price of$33.13 . Cumulatively sinceDecember 4, 2018 , the Company repurchased approximately 390,000 shares at an average price of$32.01 . 73 The actual capital amounts and ratios as well as minimum amounts for each regulatory defined category for the Company and the Bank atDecember 31, 2019 and 2018 are as follows: To Be Well Minimum Capital Minimum Capital Capitalized Under Required - Basel III Required - Basel III Prompt Corrective Actual Phase-In Schedule Fully Phased-In Action Regulations Amount Ratio Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) December 31, 2019Carolina Financial Corporation CET1 capital (to risk weighted assets)$ 534,742 15.10 % 247,915 7.000 % 247,915 7.000 % N/A
N/A
Tier 1 capital (to risk weighted assets) 566,240 15.99 % 301,040 8.500 % 301,040 8.500 % N/A
N/A
Total capital (to risk weighted assets) 592,908 16.74 % 371,873 10.500 % 371,873 10.500 % N/A
N/A
Tier 1 capital (to total average assets) 566,240 15.03 % 150,695 4.000 % 150,695 4.000 % N/A N/A CresCom Bank CET1 capital (to risk weighted assets) 580,752 16.41 % 247,744 7.000 % 247,744 7.000 % 230,048 6.50 % Tier 1 capital (to risk weighted assets) 580,752 16.41 % 300,832 8.500 % 300,832 8.500 % 283,136 8.00 % Total capital (to risk weighted assets) 597,273 16.88 % 371,616 10.500 % 371,616 10.500 % 353,920 10.00 % Tier 1 capital (to total average assets) 580,752 15.42 % 150,663 4.000 % 150,663 4.000 % 188,329 5.00 % December 31, 2018Carolina Financial Corporation CET1 capital (to risk weighted assets)$ 431,568 15.19 % 181,094 6.375 % 198,848 7.000 % N/A
N/A
Tier 1 capital (to risk weighted assets) 462,888 16.29 % 223,704 7.875 % 241,459 8.500 % N/A
N/A
Total capital (to risk weighted assets) 477,351 16.80 % 280,518 9.875 % 298,273 10.500 % N/A
N/A
Tier 1 capital (to total average assets) 462,888 13.01 % 142,270 4.000 % 142,270 4.000 % N/A N/A CresCom Bank CET1 capital (to risk weighted assets) 454,181 16.00 % 180,948 6.375 % 198,688 7.000 % 184,496 6.50 % Tier 1 capital (to risk weighted assets) 454,181 16.00 % 223,524 7.875 % 241,264 8.500 % 227,072 8.00 % Total capital (to risk weighted assets) 468,644 16.51 % 280,292 9.875 % 298,032 10.500 % 283,840 10.00 % Tier 1 capital (to total average assets) 454,181 12.76 % 142,392 4.000 % 142,392 4.000 % 177,990 5.00 % 74
The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the three years endedDecember 31, 2019 , 2018 and 2017. For the Years Ended December 31, 2019 2018 2017 Return on average assets 1.61 % 1.37 % 1.24 % Return on average equity 10.36 % 9.43 % 10.17 %
Average equity to average assets ratio 15.55 % 14.51 %
12.18 %
The following table provides the amount of dividends and payout ratios (dividends declared divided by net income) for the years endedDecember 31, 2019 , 2018 and 2017. For the Years Ended December 31, 2019 2018 2017 (Dollars in thousands) Dividends declared$ 8,021 5,563 2,920 Dividend payout ratios 12.78 % 11.20 % 10.22 % We retain earnings to have capital sufficient to grow our loan and investment portfolios and to support certain acquisitions or other business expansion opportunities as they arise. The dividend payout ratio is calculated by dividing dividends paid during the year by net income for the year.
Off Balance Sheet Arrangements
Through the operations of the Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. AtDecember 31, 2019 , we had issued commitments to extend credit of approximately$659.1 million through various types of lending arrangements. There were 72 standby letters of credit in the amount of$23.8 million . Total variable rate commitments were$481.8 million and fixed rate commitments were$201.1 million . Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. A significant portion of the unfunded commitments relate to consumer equity lines of credit and commercial lines of credit. Based on historical experience, we anticipate that a portion of these lines of credit will not be funded. Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings. 75
Market Risk Management and Interest Rate Risk
The effective management of market risk is essential to achieving the Company's objectives. As a financial institution, the Company's most significant market risk exposure is interest rate risk. The primary objective of managing interest rate risk is to minimize the effect that changes in interest rates have on net income. This is accomplished through active asset and liability management, which requires the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The expected result of these strategies is the development of appropriate maturity and re-pricing opportunities in those accounts to produce consistent net income during periods of changing interest rates. The Bank's asset/liability management committee, or ALCO, monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes under various interest rate scenarios. The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or re-pricing opportunities of interest-earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of interest-earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO meets regularly to review the Company's interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards. The Board of Directors also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity. The Company uses interest rate sensitivity analysis to measure the sensitivity of projected net interest income to changes in interest rates. Management monitors the Company's interest sensitivity by means of a computer model that incorporates current volumes, average rates earned and paid, and scheduled maturities, payments of asset and liability portfolios, together with multiple scenarios of prepayments, repricing opportunities and anticipated volume growth. Interest rate sensitivity analysis shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next 12 months under the current interest rate environment. The resulting change in net interest income reflects the level of sensitivity that net interest income has in relation to changing interest rates. As ofDecember 31, 2019 , the following table summarizes the forecasted impact on net interest income using a base case scenario given downward movements in interest rates of 100 and 200 and upward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the consolidated financial statements. Therefore, management's assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market condition. Annualized Hypothetical Interest Rate Scenario Percentage Change in Change Prime Rate Net Interest Income (2.00)% 2.75% (4.10)% (1.00)% 3.75% (1.70)% 0.00% 4.75% 0.00% 1.00% 5.75% 0.30% 2.00% 6.75% 0.70% 3.00% 7.75% 0.90% 76 The primary uses of derivative instruments are related to the mortgage banking activities of the Company. As such, the Company holds derivative instruments, which consist of rate lock agreements related to expected funding of fixed-rate mortgage loans to customers (interest rate lock commitments) and forward commitments to sell mortgage-backed securities and individual fixed-rate mortgage loans. The Company's objective in obtaining the forward commitments is to mitigate the interest rate risk associated with the interest rate lock commitments and the mortgage loans that are held for sale. Derivatives related to these commitments are recorded as either a derivative asset or a derivative liability in the balance sheet and are measured at fair value. Both the interest rate lock commitments and the forward commitments are reported at fair value, with adjustments recorded in current period earnings within the noninterest income of the consolidated statements of operations. Derivative instruments not related to mortgage banking activities, including financial futures commitments and interest rate swap agreements that do not satisfy the hedge accounting requirements, are recorded at fair value and are classified with resultant changes in fair value being recognized in noninterest income in the consolidated statement of operations. When using derivatives to hedge fair value and cash flow risks, the Company exposes itself to potential credit risk from the counterparty to the hedging instrument. This credit risk is normally a small percentage of the notional amount and fluctuates as interest rates change. The Company analyzes and approves credit risk for all potential derivative counterparties prior to execution of any derivative transaction. The Company seeks to minimize credit risk by dealing with highly rated counterparties and by obtaining collateralization for exposures above certain predetermined limits. If significant counterparty risk is determined, the Company would adjust the fair value of the derivative recorded asset balance to consider such risk. The derivative positions of the Company atDecember 31, 2019 and 2018 are as follows: At December 31, 2019 2018 Fair Notional Fair Notional Value Value Value Value (In thousands) Derivative assets: Cash flow hedges: Interest rate swaps $ - - 1,232 45,000 Non-hedging derivatives: Interest rate swaps 138 35,000 1,198 50,000 Mortgage loan interest rate lock commitments 1,073 86,819 1,199 76,571 Mortgage loan forward sales commitments 580 26,240 403 13,241 Total derivative assets$ 1,791 148,059 4,032 184,812 Derivative liabilities: Cash flow hedges: Interest rate swaps$ 620 45,000 - - Non-hedging derivatives: Interest rate swaps 2,767 40,000 937 50,000 Mortgage-backed securities forward sales commitments 40 61,000 295 52,000 Total derivative liabilities$ 3,427 146,000 1,232 102,000 77
The Company has entered into interest rate swaps to reduce the exposure to variability in interest-related cash outflows attributable to changes in forecasted LIBOR based FHLB borrowings. These derivative instruments are designated as cash flow hedges. The hedged item is the LIBOR portion of the series of future adjustable rate borrowings over the term of the interest rate swap. Accordingly, changes to the amount of interest payment cash flows for the hedged transactions attributable to a change in credit risk are excluded from our assessment of hedge effectiveness. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company has not recorded any hedge ineffectiveness since inception. As ofDecember 31, 2019 , the Company had three outstanding interest rate derivatives with a notional value of$45.0 million that were designated as cash flow hedges of interest rate risk with a weighted average remaining term of
4.43 years. As ofDecember 31, 2018 , the Company had three outstanding interest rate derivatives with a notional value of$45.0 million that were designated as cash flow hedges of interest rate risk with a weighted average remaining term of
5.43 years. For cash flow hedges, in the event that the forecasted transaction was no longer probable, the Company would recognize a loss of approximately$600,000 directly into earnings, the current fair value, as ofDecember 31, 2019 . Contractual Obligations The following table presents payment schedules for certain of our contractual obligations as ofDecember 31, 2019 . Operating lease obligations of$23.0 million pertain to banking facilities and equipment. Certain lease agreements include payment of property taxes and insurance and contain various renewal options. Additional information regarding leases is contained in Note 14 of the audited consolidated financial statements. Trust Preferred subordinated debentures reflect the contractual principal owed excluding purchase accounting fair value adjustments. Less than 1 to 3 3 to 5 More than Total 1 Year Years Years 5 Years (In thousands) Advances from FHLB$ 449,814 437,700 8,038 - 4,076 Interest rate swap - cash flow hedge derivative 45,000 - 15,000 30,000 - Interest rate swap - non-hedging derivative 75,000 30,000 10,000 - 35,000 Subordinated debentures issued toCarolina Financial Capital Trust I, due 2032 5,155 - - - 5,155 Subordinated debentures issued toCarolina Financial Capital Trust II, due 2034 10,310 - - - 10,310 Subordinated debentures issued toGreer Capital Trust I, due 2034 6,186 - - - 6,186 Subordinated debentures issued toGreer Capital Trust II, due 2037 5,155 - - - 5,155 Subordinated debentures issued to FSB Preferred Trust I, due 2033 10,310 - - - 10,310 Subordinated debentures issued toCarolina Trust , due 2026 10,000 - - - 10,000 Operating lease obligations 23,040 2,595 4,113 3,451 12,881 Total$ 639,970 470,295 37,151 33,451 99,073 78
Accounting, Reporting, and Regulatory Matters
Information regarding recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of the financial information by the Company are included in Note 1 - Summary of Significant Accounting Polices in the accompanying financial statements.
Effect of Inflation and Changing Prices
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with GAAP.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk and Interest Rate Sensitivity and - Liquidity and Capital Resources.
79
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