ITEM 1. BUSINESS.
THE COMPANY
Great Southern Bancorp, Inc.
Great Southern Bancorp, Inc. ("Bancorp" or "Company") is a bank holding company, a financial holding company and the parent of Great Southern Bank ("Great Southern" or the "Bank"). Bancorp was incorporated under the laws of the State of Delaware in July 1989 as a unitary savings and loan holding company. The Company became a one-bank holding company on June 30, 1998, upon the conversion of Great Southern to a Missouri-chartered trust company. In 2004, Bancorp was re-incorporated under the laws of the State of Maryland.
As a Maryland corporation, the Company is authorized to engage in any activity that is permitted by the Maryland General Corporation Law and not prohibited by law or regulatory policy. The Company currently conducts its business as a financial holding company. Through the financial holding company structure, it is possible to expand the size and scope of the financial services offered by the Company beyond those offered by the Bank. The financial holding company structure provides the Company with greater flexibility than the Bank has to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions of or mergers with other financial institutions as well as other companies. At December 31, 2019, Bancorp's consolidated assets were $5.02 billion, consolidated net loans were $4.15 billion, consolidated deposits were $3.96 billion and consolidated total stockholders' equity was $603.1 million. For details about the Company’s assets, revenues and profits for each of the last five fiscal years, see Item 6. “Selected Financial Data.” The assets of the Company consist primarily of the stock of Great Southern and cash.
Through the Bank and subsidiaries of the Bank, the Company also offers insurance and related services, which are discussed further below. The activities of the Company are funded by retained earnings and through dividends from Great Southern. Activities of the Company may also be funded through borrowings from third parties, sales of additional securities or through income generated by other activities of the Company.
The executive offices of the Company are located at 1451 East Battlefield, Springfield, Missouri 65804, and its telephone number at that address is (417) 887-4400.
Great Southern Bank
Great Southern was formed as a Missouri-chartered mutual savings and loan association in 1923, and, in 1989, converted to a Missouri-chartered stock savings and loan association. In 1994, Great Southern changed to a federal savings bank charter and then, on June 30, 1998, changed to a Missouri-chartered trust company (the equivalent of a commercial bank charter). Headquartered in Springfield, Missouri, Great Southern offers a broad range of banking services through its 97 banking centers located in southern and central Missouri; the Kansas City, Missouri area; the St. Louis, Missouri area; eastern Kansas; northwestern Arkansas; the Minneapolis, Minnesota area and eastern, western and central Iowa. At December 31, 2019, the Bank had total assets of $5.01 billion, net loans of $4.16 billion, deposits of $4.02 billion and equity capital of $650.3 million, or 13.0% of total assets. Its deposits are insured by the Deposit Insurance Fund ("DIF") to the maximum levels permitted by the Federal Deposit Insurance Corporation ("FDIC").
The size and complexity of the Bank’s operations increased substantially in 2009 with the completion of two FDIC-assisted transactions, and again in 2011, 2012 and 2014 with the completion of another FDIC-assisted transaction in each of those years. In 2009, the Bank entered into two separate purchase and assumption agreements (including loss sharing) with the FDIC to assume all of the deposits (excluding brokered deposits) and certain liabilities and acquire certain assets of TeamBank, N.A. and Vantus Bank. In these two transactions we acquired assets with a fair value of approximately $499.9 million (approximately 18.8% of the Company’s total consolidated assets at acquisition) and $294.2 million (approximately 8.8% of the Company’s total consolidated assets at acquisition), respectively, and assumed liabilities with a fair value of $610.2 million (approximately 24.9% of the Company’s total consolidated assets at acquisition) and $440.0 million (approximately 13.2% of the Company’s total consolidated assets at acquisition), respectively. They also resulted in gains of $43.9 million and $45.9 million, respectively, which were included in Noninterest Income in the Company’s Consolidated Statement of Income for the year ended December 31, 2009. Prior to these acquisitions, the Company operated
banking centers in Missouri with loan production offices in Arkansas and Kansas. These acquisitions added 31 banking centers and expanded our footprint to cover five states - Iowa, Kansas, Missouri, Arkansas and Nebraska. In 2011, the Bank entered into a purchase and assumption agreement (including loss sharing) with the FDIC to assume all of the deposits and certain liabilities and acquire certain assets of Sun Security Bank, which added locations in southern Missouri and St. Louis. In this transaction we acquired assets with a fair value of approximately $248.9 million (approximately 7.3% of the Company’s total consolidated assets at acquisition) and assumed liabilities with a fair value of $345.8 million (approximately 10.1% of the Company’s total consolidated assets at acquisition). It also resulted in a gain of $16.5 million which was included in Noninterest Income in the Company’s Consolidated Statement of Income for the year ended December 31, 2011. In 2012, the Bank entered into a purchase and assumption agreement (including loss sharing) with the FDIC to assume all of the deposits and certain liabilities and acquire certain assets of Inter Savings Bank, FSB (“InterBank”), which added four locations in the greater Minneapolis, Minnesota area and represented a new market for the Company. In this transaction we acquired assets with a fair value of approximately $364.2 million (approximately 9.4% of the Company’s total consolidated assets at acquisition) and assumed liabilities with a fair value of approximately $458.7 million (approximately 11.9% of the Company’s total consolidated assets at acquisition). It also resulted in a gain of $31.3 million which was included in Noninterest Income in the Company’s Consolidated Statement of Income for the year ended December 31, 2012.
In 2014, the Bank entered into a purchase and assumption agreement (without loss sharing) with the FDIC to assume all of the deposits and certain liabilities and acquire certain assets of Valley Bank (“Valley”), which added five locations in the Quad Cities area of eastern Iowa and six locations in central Iowa, primarily in the Des Moines market area. These represented new markets for the Company in eastern Iowa and enhanced our market presence in central Iowa. In this transaction we acquired assets with a fair value of approximately $378.7 million (approximately 10.0% of the Company’s total consolidated assets at acquisition) and assumed liabilities with a fair value of approximately $367.9 million (approximately 9.8% of the Company’s total consolidated assets at acquisition). It also resulted in a gain of $10.8 million which was included in Noninterest Income in the Company’s Consolidated Statement of Income for the year ended December 31, 2014.
Also in 2014, the Bank entered into a purchase and assumption agreement to acquire certain assets and depository accounts from Neosho, Mo.-based Boulevard Bank (“Boulevard”), which added one location in the Neosho, Mo. market, where the Company already operated. In this transaction, which was completed in 2014, we acquired assets (primarily cash and cash equivalents) with a fair value of approximately $92.5 million (approximately 2.6% of the Company’s total consolidated assets at acquisition) and assumed liabilities (all deposits and related accrued interest) with a fair value of approximately $93.3 million (approximately 2.6% of the Company’s total consolidated assets at acquisition). This acquisition resulted in recognition of $790,000 of goodwill.
The Company also opened commercial loan production offices in Dallas, Texas and Tulsa, Oklahoma during 2014. The primary products offered in these offices are commercial real estate, commercial business and commercial construction loans.
In 2015, the Company announced plans to consolidate operations of 16 banking centers into other nearby Great Southern banking center locations. As part of an ongoing performance review of its entire banking center network, Great Southern evaluated each location for a number of criteria, including access and availability of services to affected customers, the proximity of other Great Southern banking centers, profitability and transaction volumes, and market dynamics. Subsequent to this announcement, the Bank entered into separate definitive agreements to sell two of the 16 banking centers, including all of the associated deposits (totaling approximately $20 million), to separate bank purchasers. One of those sale transactions was completed on February 19, 2016 and the other was completed on March 18, 2016. The closing of the remaining 14 facilities, which resulted in the transfer of approximately $127 million in deposits and banking center operations to other Great Southern locations, occurred at the close of business on January 8, 2016.
Also in 2015, the Company announced that it entered into a purchase and assumption agreement to acquire 12 branches, including related loans, and to assume related deposits in the St. Louis, Mo., area from Cincinnati-based Fifth Third Bank. The acquisition was completed at the close of business on January 29, 2016. The deposits assumed totaled approximately $228 million and had a weighted average rate of approximately 0.28%. The loans acquired totaled approximately $159 million and had a weighted average yield of approximately 3.92%.
The loss sharing agreements related to the FDIC-assisted transactions in 2009, 2011 and 2012 added to the complexity of our operations by creating the need for new employees and processes to ensure compliance with the loss sharing agreements and the collection of problem assets acquired. See Note 4 included in Item 8. “Financial Statements and Supplementary Information” for a more detailed discussion of these FDIC-assisted transactions and the loss sharing agreements. The loss
sharing agreements related to the 2009 and 2011 FDIC-assisted transactions were terminated during 2016. The loss sharing agreements related to the 2012 FDIC-assisted transaction were terminated during 2017. See “Loss Share Agreements” below for additional information regarding the termination of these agreements.
The Company opened a commercial loan production office in Chicago, Illinois during 2017. The primary products offered in this office are commercial real estate, commercial business and commercial construction loans.
In March 2018, the Bank entered into a definitive agreement to sell its four banking centers, including all of the associated deposits (totaling approximately $56 million), in the Omaha, Nebraska market to Lincoln, Nebraska-based West Gate Bank. This sale transaction was completed in July 2018.
The Company opened two commercial loan production offices - one in Denver, Colorado and one in Atlanta, Georgia - in late 2018. The primary products offered in these offices are commercial real estate, commercial business and commercial construction loans.
In March 2019, the Company ceased operating its indirect automobile financing unit. Market forces, including strong rate competition for well-qualified borrowers, made indirect lending through automobile dealerships a significant challenge to efficient and profitable operations over the long term. Indirect loan balances significantly declined in 2018 and 2019 after tightened underwriting guidelines were implemented in the latter part of 2016, in response to more challenging consumer credit conditions. The Company continues to offer direct consumer loans through its banking center network.
In April 2019, the Company consolidated its Fayetteville, Ark., location into its Rogers, Ark., banking center. The Company now operates one banking center in Arkansas. In September 2019, the Company consolidated its Ames, Iowa, banking center into its North Ankeny, Iowa office. The Company entered the Ames market with only one banking center through an FDIC-assisted acquisition in 2014.
Great Southern is principally engaged in the business of originating commercial real estate loans, construction loans, other commercial loans, residential real estate loans and consumer loans and funding these loans by attracting deposits from the general public, obtaining brokered deposits and through borrowings from the Federal Home Loan Bank of Des Moines (the "FHLBank") and others.
For many years, Great Southern has followed a strategy of emphasizing loan origination through residential, commercial and consumer lending activities in its market areas. The goal of this strategy is to be one of the leading providers of financial services in Great Southern’s market areas, while simultaneously diversifying assets and reducing interest rate risk by originating and holding adjustable-rate loans and fixed-rate loans, primarily with terms of five years or less, in its portfolio and by selling longer-term fixed-rate single-family mortgage loans in the secondary market. The Bank continues to emphasize real estate lending while also expanding and increasing its originations of commercial business loans.
The corporate office of the Bank is located at 1451 East Battlefield, Springfield, Missouri 65804 and its telephone number at that address is (417) 887-4400.
Internet Website
Bancorp maintains a website at www.greatsouthernbank.com. The information contained on that website is not included as part of, or incorporated by reference into, this Annual Report on Form 10-K. Bancorp currently makes available on or through its website Bancorp's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments, if any, to these reports. These materials are also available free of charge (other than a user's regular internet access charges) on the Securities and Exchange Commission's website at www.sec.gov.
Market Areas
The Company currently operates 97 full-service retail banking offices, serving more than 151,000 households in six states - Missouri, Arkansas, Iowa, Kansas, Minnesota and Nebraska. The Company also operates commercial loan production offices in Atlanta, Chicago, Dallas, Denver, Omaha, Neb., and Tulsa, Okla., and a mortgage lending office in Springfield, Mo.
The Company regularly evaluates its banking center network and lines of business to ensure that it is serving customers in the best way possible. The banking center network constantly evolves with changes in customer needs and preferences, emerging technology and local market developments. In response to these changes, the Company opens banking centers and invests resources where customer demand leads, and from time to time, consolidates banking centers when market conditions dictate.
Great Southern's largest concentration of deposits and loans are in the Springfield, Mo., and St. Louis, Mo., market areas. In the last several years, the Company's deposit and loan portfolios have become more diversified because of its participation in five FDIC-assisted acquisitions and organic growth. The FDIC-assisted acquisitions significantly expanded the Company's geographic footprint, which prior to 2009 was primarily in southwest and central Missouri, by adding operations in Iowa, Kansas, Minnesota and Nebraska. In 2018, the Company sold four banking centers in the Omaha, Neb., metropolitan market to a Nebraska-based bank. A commercial loan production office remains in Omaha. In April 2019, the Fayetteville, Ark., banking center was consolidated into the Rogers, Ark., office, leaving one office in Arkansas. Besides the Springfield and St. Louis market areas, the Company has deposit and loan concentrations in the following market areas: Kansas City, Mo.; Sioux City, Iowa; Des Moines, Iowa; Northwest Arkansas; Minneapolis, Minn.; and Eastern Iowa in the area known as the "Quad Cities." Deposits and loans are also generated in banking centers in rural markets in Missouri, Iowa, and Kansas.
At December 31, 2019, the Company's total deposits were $3.96 billion. At that date, the Company had deposits in Missouri of $2.9 billion, including the two largest deposit concentrations in Springfield and St. Louis areas, with $1.6 billion and $525 million, respectively. The Company also had deposits of $559 million in Iowa, $245 million in Kansas, $236 million in Minnesota, $19 million in Nebraska and $19 million in Arkansas.
The Company also has commercial loan production offices in Atlanta, Chicago, Dallas, Denver, Omaha, Neb. and Tulsa, Okla. These offices generate a significant percentage of the Company’s commercial loan production. Commercial lending groups in our Kansas City, Mo., Des Moines, Iowa, Minneapolis, Minn., Springfield, Mo., and St. Louis, Mo., banking offices also generate a significant percentage of the Company’s commercial loan production.
Lending Activities
General
From its beginnings in 1923 through the early 1980s, Great Southern primarily made long-term, fixed-rate residential real estate loans that it retained in its loan portfolio. Beginning in the early 1980s, Great Southern increased its efforts to originate short-term and adjustable-rate loans. Beginning in the mid-1980s, Great Southern increased its efforts to originate commercial real estate and other residential loans, primarily with adjustable rates or shorter-term fixed rates. In addition, some competitor banking organizations merged with larger institutions and changed their business practices or moved operations away from the Springfield, Mo. area, and others consolidated operations from the Springfield, Mo. area to larger cities. This provided Great Southern expanded opportunities in residential and commercial real estate lending as well as in the origination of commercial business and consumer loans.
In addition to origination of these loans, the Bank has expanded and enlarged its relationships with smaller banks and other peer banks to purchase participations (at par, generally with no servicing costs) in loans these other banks originate but are unable to retain the entire balance in their portfolios due to capital or borrower relationship size limitations. The Bank uses the same underwriting guidelines in evaluating these participations as it does in its direct loan originations. At December 31, 2019, the balance of participation loans purchased and held in the portfolio, excluding FDIC-assisted acquired loans, was $264.1 million, or 6.5% of the total loan portfolio. All of these participation loans were performing at December 31, 2019, with the exception of one loan totaling $1.1 million.
One of the principal historical lending activities of Great Southern is the origination of fixed and adjustable-rate conventional residential real estate loans to enable borrowers to purchase or refinance owner-occupied homes. Great Southern originates a variety of conventional, residential real estate mortgage loans, principally in compliance with Freddie Mac and Fannie Mae standards for resale in the secondary market. Great Southern promptly sells most of the fixed-rate residential mortgage loans that it originates. To date, Great Southern has not experienced difficulties selling these loans in the secondary market and has had minimal requests for repurchase. Depending on market conditions, the ongoing servicing of these loans is at times retained by Great Southern, but generally servicing is released to the purchaser of the loan. Great Southern retains in its portfolio substantially all of the adjustable-rate mortgage loans that it originates.
Another principal lending activity of Great Southern is the origination of commercial real estate, other residential (multi-family) and commercial construction loans. Since the early 1990s, commercial real estate, other residential (multi-family) and commercial construction loans have represented the largest percentage of the loan portfolio. At December 31, 2019, commercial real estate, other residential multi-family) and commercial construction loans, excluding loans acquired in FDIC-assisted transactions, accounted for approximately 30%, 17% and 18%, respectively, of the total portfolio. Of the portfolio of acquired loans, commercial real estate loans (net of fair value discounts) accounted for approximately 1% of the total portfolio at December 31, 2019.
In addition, Great Southern in recent years has increased its emphasis on the origination of other commercial loans, home equity loans, and also issues letters of credit. Letters of credit are contingent obligations and are not included in the Bank's loan portfolio. See "-- Other Commercial Lending," "- Classified Assets," and "Loan Delinquencies and Defaults" below.
The percentage of collateral value Great Southern will loan on real estate and other property varies based on factors including, but not limited to, the type of property and its location and the borrower's credit history. As a general rule, Great Southern will loan up to 95% of the appraised value on one-to four-family residential properties. Typically, private mortgage insurance is required for loan amounts above the 80% level. At December 31, 2019 and 2018, loans secured by second liens on residential properties were $106.5 million, or 2.5%, and $118.5 million, or 2.9%, respectively, of our total loan portfolio. For commercial real estate and other residential real property loans, Great Southern may loan up to 85% of the appraised value. The origination of loans secured by other property is considered and determined on an individual basis by management with the assistance of any industry guides and other information which may be available. Collateral values are reappraised or reassessed as loans are renewed or when significant events indicating potential impairment occur. On a quarterly basis, management reviews impaired
loans to determine whether updated appraisals or reassessments are necessary based on loan performance, collateral type and guarantor support. While not specifically required by our policy, we seek to obtain cross-collateralization of loans to a borrower when it is available and it is most frequently done on commercial real estate loans.
Loan applications are approved at various levels of authority, depending on the type, amount and loan-to-value ratio of the loan. Loan commitments of more than $750,000 (or loans exceeding the Freddie Mac loan limit in the case of fixed-rate, one- to four-family residential loans for resale) must be approved by Great Southern's loan committee. The loan committee is comprised of the Chief Executive Officer of the Bank, the Chief Credit Officer of the Bank (chairman of the committee), and other senior officers of the Bank involved in lending activities. All loans, regardless of size or type, are required to conform to certain minimum underwriting standards to assure portfolio quality. These standards and procedures include, but are not limited to, an analysis of the borrower’s financial condition, collateral, repayment ability, verification of liquid assets and credit history as required by loan type. It has been, and continues to be, our practice to verify information from potential borrowers regarding assets, income or payment ability and credit ratings as applicable and as required by the authority approving the loan. Underwriting standards also include loan-to-value ratios which vary depending on collateral type, debt service coverage ratios or debt payment to income ratios, where applicable, credit histories, use of guaranties and other recommended terms relating to equity requirements, amortization, and maturity. Generally, deviations from approved underwriting standards may only be allowed when doing so is not in violation of regulations or statutes and when appropriate lending authority is obtained. The loan committee reviews all new loan originations in excess of lender approval authorities. For secured loans originated and held, most lenders have approval authorities of $250,000 or below while fourteen senior lenders have approval authority of varying amounts up to $1 million. Lender approval authorities are also subject to loans-to-one borrower limits of $500,000 or below for most lenders and of varying amounts up to $3 million for ten senior lenders. These standards, as well as our collateral requirements, have not significantly changed in recent years.
In general, state banking laws restrict loans to a single borrower and related entities to no more than 25% of a bank's unimpaired capital and unimpaired surplus, plus an additional 10% if the loan is collateralized by certain readily marketable collateral. (Real estate is not included in the definition of "readily marketable collateral.”) As computed on the basis of the Bank's unimpaired capital and surplus at December 31, 2019, this limit was approximately $162.6 million. See "Government Supervision and Regulation." At December 31, 2019, the Bank was in compliance with the loans-to-one borrower limit. At December 31, 2019, the Bank's largest relationship for purposes of this limit, which consists of three loans, totaled $56.1 million. This amount represents the total commitment for this relationship at December 31, 2019; the outstanding balance at that date was $31.0 million. The collateral for the loans consists of multiple apartment complexes. Some of the projects are currently under construction, so all funds have not been disbursed on these loans. In addition, we obtained personal guarantees from the principal owner of the borrowing entities for each of these loans. All loans included in this relationship were current at December 31, 2019. In addition at December 31, 2019, we had three other loan relationships that each exceeded $50 million. All loans included in these relationships were current at December 31, 2019. Our policy does not set a loans-to-one borrower limit that is below the legal limits described; however, we do recognize the need to limit credit risk to any one borrower or group of related borrowers upon consideration of various risk factors. Extensions of credit to borrowers whose past due loans were charged-off or whose loans are classified as substandard require special lending approval.
Great Southern is permitted under applicable regulations to originate or purchase loans and loan participations secured by real estate located in any part of the United States. In addition to the market areas where the Company has offices, the Bank has made or purchased loans, secured primarily by commercial real estate, in other states, primarily Arizona, Florida, Michigan, Tennessee and Wisconsin. At December 31, 2019, loans in these states comprised 2% or less each, respectively, of the total loan portfolio.
Loan Portfolio Composition
The following tables set forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages (before deductions for loans in process, deferred fees and discounts and allowance for loan losses) as of the dates indicated. The tables are based on information prepared in accordance with generally accepted accounting principles and are qualified by reference to the Company's Consolidated Financial Statements and the notes thereto contained in Item 8 of this report.
The loans acquired in the four FDIC-assisted transactions completed in 2009 through 2012, which were acquired at discounts and were previously covered by loss sharing agreements between the FDIC and the Bank, and the loans acquired in 2014 from the former Valley Bank, which were acquired at discounts and were never covered by a loss sharing agreement, are shown
combined below in tables separate from the legacy Great Southern portfolio. All of these acquired loan portfolios were initially recorded at their fair values at the acquisition date and are recorded by the Company at their discounted value. The following tables reflect the loan balances excluding discounts.
Legacy Great Southern Loan Portfolio Composition:
(1)
Includes loans held for sale.
(2)
Total commercial real estate loans included industrial revenue bonds of $13.2 million, $13.9 million, $21.7 million, $24.7 million and $37.4 million at December 31, 2019, 2018, 2017, 2016 and 2015.
Loans Acquired and Accounted for Under ASC 310-30 Portfolio Composition:
(1)
Total commercial real estate loans included industrial revenue bonds of $1.2 million, $1.4 million, $2.2 million, $2.5 million, and $3.2 million at December 31, 2019, 2018, 2017, 2016, and 2015, respectively.
(2)
At December 31, 2019, 2018 and 2017, none of these acquired loans were covered by an FDIC loss sharing agreement.
Based upon the collectability analyses performed at the time of the acquisitions, we expected certain levels of foreclosures and charge-offs, and actual results through December 31, 2019, related to the FDIC-assisted acquired portfolios, have been better than our expectations. As a result, cash flows expected to be received from the acquired loan pools have increased, resulting in adjustments that were made to the related accretable yield which are discussed in Note 4 of the accompanying audited financial statements, included in Item 8 of this Report.
The following tables show the fixed- and adjustable-rate composition of the Bank's loan portfolio at the dates indicated. Amounts shown for TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank represent unpaid principal balances, before fair value discounts. The tables are based on information prepared in accordance with generally accepted accounting principles.
Legacy Great Southern Loan Portfolio Composition by Fixed- and Adjustable-Rates:
Loans Acquired and Accounted for Under ASC 310-30 Composition by Fixed- and Adjustable-Rates:
The following tables present the contractual maturities of loans at December 31, 2019. Amounts shown for acquired loans represent unpaid principal balances, before fair value discounts. The tables are based on information prepared in accordance with generally accepted accounting principles.
Legacy Great Southern Loan Portfolio Composition by Contractual Maturities:
As of December 31, 2019, legacy loans due after December 31, 2020 with fixed interest rates totaled $1.3 billion and loans due after December 31, 2020 with adjustable rates totaled $1.9 billion.
Loans Acquired and Accounted for Under ASC 310-30 Portfolio Composition by Contractual Maturities:
As of December 31, 2019, acquired loans due after December 31, 2020 with fixed interest rates totaled $49.7 million and loans due after December 31, 2020 with adjustable rates totaled $57.9 million.
At December 31, 2019, $106.5 million, or 2.5%, of total loans were secured by junior lien mortgages and $8.6 million, or 1.8% of residential real estate loans, were interest only residential real estate loans. At December 31, 2018, $118.5 million, or 2.9%, of total loans were secured by junior lien mortgages and $7.4 million, or 2.0% of residential real estate loans, were interest only residential real estate loans. While high loan-to-value ratio mortgage loans are occasionally originated and held, they are typically either considered low risk based on analyses performed or are required to have private mortgage insurance. The Company does not originate or hold option ARM loans or significant amounts of loans with initial teaser rates or subprime loans in its residential real estate portfolio.
To monitor and control risks related to concentrations of credit in the composition of the loan portfolio, management reviews the loan portfolio by loan types, industries and market areas on a monthly basis for credit quality and known and anticipated market conditions. Changes in loan portfolio composition may be made by management based on the performance of each area of business, known and anticipated market conditions, credit demands, the deposit structure of the Bank and the expertise and/or depth of the lending staff. Loan portfolio industry and market areas are monitored regularly for credit quality and trends. Reports detailed by industry and geography are provided to the Board of Directors on a monthly and quarterly basis.
In response to the economic recession that began in 2008, the composition of the Bank’s loan portfolio has changed over the past several years; speculative construction and land development loan types have been limited, commercial real estate loan types have been stabilized and diversified and emphasis has been placed on increasing our other residential (multi-family), commercial business and, prior to 2017, consumer loan portfolios.
Environmental Issues
Loans secured by real property, whether commercial, residential or other, may have a material, negative effect on the financial position and results of operations of the lender if the collateral is environmentally contaminated. The result can be, but is not necessarily limited to, liability for the cost of cleaning up the contamination imposed on the lender by certain federal and state laws, a reduction in the borrower's ability to pay because of the liability imposed upon it for any clean-up costs, a reduction in the value of the collateral because of the presence of contamination or a subordination of security interests in the collateral to a super priority lien securing the cleanup costs by certain state laws.
Management is aware of the risk that the Bank may be negatively affected by environmentally contaminated collateral and attempts to control this risk through commercially reasonable methods, consistent with guidelines arising from applicable government or regulatory rules and regulations, and to a more limited extent, publications of the lending industry. Management currently is unaware (without, in many circumstances, specific inquiry or investigation of existing collateral, some of which was accepted as collateral before risk controlling measures were implemented) of any environmental contamination of real property securing loans in the Bank's portfolio that would subject the Bank to any material risk. No assurance can be given, however, that the Bank will not be adversely affected by environmental contamination.
Residential Real Estate Lending
At December 31, 2019 and 2018, loans secured by residential real estate, excluding that which is under construction and excluding all FDIC-assisted acquired loans, totaled $1.4 billion and $1.2 billion, respectively, and represented approximately 27.3% and 23.7%, respectively, of the Bank's total loan portfolio. At December 31, 2019 and 2018, FDIC-assisted acquired loans (net of fair value discounts) secured by residential real estate totaled $86 million and $106 million, respectively, and represented approximately 1.7% and 2.1%, respectively, of the Bank’s total loan portfolio. The Bank's legacy residential real estate loan portfolio increased during 2019, due to organic loan growth in both single-family and other residential (multi-family) loans. For many years, other residential (multi-family) loan balances continued to increase as the Bank has emphasized this type of loan. The Bank's legacy other residential (multi-family) loan portfolio grew by about 10% and 5% in 2019 and 2018, respectively. In 2016, the Bank completed a non-FDIC-assisted acquisition of a portfolio of one- to four-family residential loans as part of the acquisition of branches and deposits in St. Louis, Mo. from Fifth Third Bank.
The Bank currently is originating one- to four-family adjustable-rate residential mortgage loans primarily with one-year adjustment periods or with rates that are fixed for the first few years of the loan and then adjust annually. Rate adjustments on loans originated prior to July 2001 are based upon changes in prevailing rates for one-year U.S. Treasury securities. Rate adjustments on loans originated since July 2001 are based upon changes in the average of interbank offered rates for twelve month U.S. Dollar-denominated deposits in the London Market (LIBOR) or changes in prevailing rates for one-year U.S. Treasury securities. Rate adjustments are generally limited to 2% maximum annually as well as a maximum aggregate adjustment over the life of the loan. Accordingly, the interest rates on these loans typically may not be as rate sensitive as is the Bank's cost of funds. Generally, the Bank's adjustable-rate mortgage loans are not convertible into fixed-rate loans, do not permit negative amortization of principal and carry no prepayment penalty. The Bank also currently is originating other residential (multi-family) mortgage loans with interest rates that are generally either adjustable with changes to the prime rate of interest or fixed for short periods of time (three to seven years).
The Bank's portfolio of adjustable-rate mortgage loans also includes a number of loans with different adjustment periods, without limitations on periodic rate increases and rate increases over the life of the loans, or which are tied to other short-term market indices. These loans were originated prior to the industry standardization of adjustable-rate loans. Since the adjustable-rate mortgage loans currently held in the Bank's portfolio have not been subject to an interest rate environment which causes them to adjust to the maximum, these loans entail unquantifiable risks resulting from potential increased payment obligations on the borrower as a result of upward repricing. The indices used by Great Southern for these types of loans have increased, but not significantly, in the past three years. Compared to fixed-rate mortgage loans, these loans are subject to increased risk of delinquency or default if a higher, fully-indexed rate of interest subsequently comes into effect in replacement of a lower rate currently in effect. From 2008 through 2012, as a result of the significant recession in the economy, including residential real estate, the Bank experienced a significant increase in delinquencies in adjustable-rate mortgage loans. In 2013 through 2019, these delinquencies trended lower.
In underwriting one- to four-family residential real estate loans, Great Southern evaluates the borrower's ability to make monthly payments and the value of the property securing the loan. It is the policy of Great Southern that generally all one- to four-family residential loans in excess of 80% of the appraised value of the property be insured by a private mortgage insurance company approved by Great Southern for the amount of the loan in excess of 80% of the appraised value. In addition, Great Southern requires borrowers to obtain title and fire and casualty insurance in an amount not less than the amount of the loan. Real estate loans originated by the Bank generally contain a "due on sale" clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the property securing the loan. The Bank may enforce these due on sale clauses to the extent permitted by law.
Commercial Real Estate and Construction Lending
Commercial real estate lending has been a significant part of Great Southern's business activities since the mid-1980s. Great Southern does commercial real estate lending in order to increase the potential yield on, and the proportion of interest rate sensitive loans in, its portfolio. At December 31, 2008, commercial real estate loans and commercial construction loans each made up about one fourth of the total loan portfolio. The economic recession that began in 2008 resulted in reduced activity in the market caused by the downturn in the economy and reduced real estate values. In response, Great Southern began limiting residential and commercial land development lending to reduce the risk in the portfolio and began originating an increased amount of commercial real estate loans. Since December 31, 2008, the commercial construction loan portfolio has decreased from 32% of the loan portfolio to 17% of the loan portfolio at December 31, 2019, while, overall, commercial real estate loans have trended upward. The increase in commercial real estate loans in 2015-2019 reflects some economic improvement with increased investor activity in sales, purchases and refinancing of these types of properties. Both commercial real estate occupancy and rental rates show improvement in the Bank’s market areas. Excluding FDIC-assisted acquired loans, over the last three years, commercial real estate loans made up approximately 28-30% of the total loan portfolio while commercial construction loans were 15-22%. Great Southern expects to continue to limit lending on land development loans in 2020 with increases in commercial construction and commercial real estate loans anticipated as long as the economy continues to be strong. See "Government Supervision and Regulation" below.
At December 31, 2019 and 2018, loans secured by commercial real estate, excluding that which is under construction and excluding all FDIC-assisted acquired loans, totaled $1.5 billion and $1.4 billion, respectively, or approximately 29.7% and 27.7%, respectively, of the Bank's total loan portfolio. At December 31, 2019 and 2018, FDIC-assisted acquired loans (net of fair value discounts) secured by commercial real estate totaled $30 million and $34 million, respectively, and represented approximately 0.6% and 0.7%, respectively, of the Bank’s total loan portfolio. In addition, at December 31, 2019 and 2018, construction loans, excluding all FDIC-assisted acquired loans, secured by projects under construction and the land on which the projects are located aggregated $1.4 billion and $1.5 billion, respectively, or 27.4% and 30.1%, respectively, of the Bank's total loan portfolio. At December 31, 2019 and 2018, FDIC-assisted acquired construction loans (net of fair value discounts) totaled $4 million and $5 million, respectively, and represented approximately 0.1% and 0.1%, respectively, of the Bank’s total loan portfolio. A majority of the Bank's commercial real estate loans have been originated with adjustable rates of interest, most of which are tied to the national prime rate, or fixed rates of interest with short-term maturities. A large majority of the Bank’s commercial real estate loans (both fixed and adjustable) mature in five years or less. Substantially all of these loans were originated with loan commitments which did not exceed 80% of the appraised value of the properties securing the loans.
The Bank's construction loans generally have a term of eighteen months or less. The construction loan agreements for one- to four-family projects generally require principal reductions as individual condominium units or single-family houses are built and sold to a third party. This insures that the remaining loan balance, as a proportion of the value of the remaining security, does not increase, assuming that the value of the remaining security does not decrease. Loan proceeds are disbursed in increments as construction progresses. Generally, the amount of each disbursement is based on the construction cost estimate with inspections of the project performed in connection with each disbursement request. Normally, Great Southern's commercial real estate and other residential construction loans are made either as the initial stage of a combination loan (i.e., with a commitment from the Bank to provide permanent financing upon completion of the project) or with a commitment from a third party to provide permanent financing.
The Bank's commercial real estate and construction loan portfolios consist of loans with diverse collateral types. The following table sets forth loans that were secured by certain types of collateral at December 31, 2019, excluding FDIC-assisted acquired loans. These collateral types represent the five highest percentage concentrations of commercial real estate and construction loan types in the loan portfolio.
Commercial real estate lending and construction lending generally affords the Bank an opportunity to receive interest at rates higher than those obtainable from residential mortgage lending and to receive higher origination and other loan fees. In addition, commercial real estate loans and construction loans are generally made with adjustable rates of interest or, if made on a fixed-rate basis, for relatively short terms. Nevertheless, commercial real estate lending entails significant additional risks as compared with residential mortgage lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by commercial properties is typically dependent on the successful operation of the related real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy generally.
Construction loans involve additional risks attributable to the fact that loan funds are advanced upon the value of the project under construction, which is of uncertain value prior to the completion of construction. Moreover, because of the uncertainties inherent in estimating construction costs, delays arising from labor problems, material shortages, and other unpredictable contingencies, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, and the related loan-to-value ratios. See also the discussion under the headings "- Classified Assets" and "- Loan Delinquencies and Defaults" below.
The Company executes interest rate swaps with certain commercial banking customers to facilitate their respective risk management strategies. The Company began offering this service during 2011. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2019, the Company had 19 interest rate swaps totaling $96.0 million in notional amount with commercial customers, and 19 interest rate swaps with the same notional amount with third parties related to this program. As of December 31, 2018, the Company had 18 interest rate swaps totaling $78.5 million in notional amount with commercial customers, and 18 interest rate swaps with the same notional amount with third parties related to this program. As part of the Valley Bank FDIC-assisted acquisition, the Company acquired seven loans with related interest rate swaps. Valley’s swap program differed from the Company’s in that Valley did not have back to back swaps with the customer and a counterparty. Five of the seven acquired loans with interest rate swaps have paid off. The notional amount of the two remaining Valley swaps is $689,000 at December 31, 2019. During the years ended December 31, 2019 and 2018, the Company recognized net gains (losses) of $(104,000) and $25,000 respectively, in noninterest income related to changes in the fair value of all of these interest rate swaps.
Other Commercial Lending
At December 31, 2019 and 2018, Great Southern had $313 million and $322 million, respectively, in other commercial loans outstanding, excluding all FDIC-assisted acquired loans, or 6.2% and 6.4%, respectively, of the Bank's total loan portfolio. At December 31, 2019 and 2018, FDIC-assisted acquired other commercial loans (net of fair value discounts) totaled $4 million and $4 million, respectively, and represented approximately 0.1% and 0.1%, respectively, of the Bank’s total loan portfolio. Great Southern's other commercial lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment. Great Southern expects to continue to originate loans in this category subject to market conditions and applicable regulatory restrictions. See "Government Supervision and Regulation" below.
Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment and other income and which are secured by real property, the value of which tends to be more easily ascertainable, other commercial loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. Commercial loans are generally secured by business assets, such as accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of other commercial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
The Bank's management recognizes the generally increased risks associated with other commercial lending. Great Southern's commercial lending policy emphasizes complete credit file documentation and analysis of the borrower's character, capacity to repay the loan, the adequacy of the borrower's capital and collateral as well as an evaluation of the industry conditions affecting the borrower. Review of the borrower's past, present and future cash flows is also an important aspect of Great Southern's credit analysis. In addition, the Bank generally obtains personal guarantees from the borrowers on these types of loans. Historically, the majority of Great Southern's commercial loans have been to borrowers in southwestern and central Missouri and the St. Louis, Mo. area. With the acquisitions in 2009, 2011, 2012 and 2014, geographic concentrations for commercial loans expanded to include the greater Kansas
City, Mo. area, several areas in Iowa, and the Minneapolis-St. Paul, Minn. area. Great Southern has continued its commercial lending in all of these geographic areas.
As part of its commercial lending activities, Great Southern issues letters of credit and receives fees averaging approximately 1% of the amount of the letter of credit per year. At December 31, 2019, Great Southern had 79 letters of credit outstanding in the aggregate amount of $26.3 million. Approximately 43% of the aggregate dollar amount of these letters of credit was secured, including 24 letter of credit totaling $11.4 million secured by real estate.
Consumer Lending
Consumer loans generally have short terms to maturity, thus reducing Great Southern's exposure to changes in interest rates, and carry higher rates of interest than do residential mortgage loans. In addition, Great Southern believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base.
Great Southern offers a variety of secured consumer loans, including automobile loans, boat loans, home equity loans and loans secured by savings deposits. In addition, Great Southern also offers home improvement loans and unsecured consumer loans. Consumer loans, excluding all FDIC-assisted acquired loans, totaled $318 million and $432 million at December 31, 2019 and 2018, respectively, or 6.3% and 8.7%, respectively, of the Bank's total loan portfolio. At December 31, 2019 and 2018, FDIC-assisted acquired consumer loans (net of fair value discounts) totaled $14 million and $19 million, respectively, and represented approximately 0.3% and 0.4%, respectively, of the Bank’s total loan portfolio.
The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the underlying collateral, if any, in relation to the proposed loan amount.
Beginning in 1998, the Bank implemented indirect lending relationships, primarily with automobile dealerships. Through these dealer relationships, the dealer completes the application with the consumer and then submits it to the Bank for credit approval. While the Bank’s initial and ongoing concentrated effort was on automobiles, the program has evolved for use from time to time with other tangible products where financing of the product is provided through the seller, including, to a lesser extent, boats and manufactured homes. At December 31, 2019 and 2018, the Bank had $199 million and $311 million, respectively, of auto, boat, modular home and recreational vehicle loans in its portfolio, including FDIC-assisted acquired loans totaling $2 million and $2 million, respectively.
Indirect consumer loans decreased significantly in 2018 and 2019, primarily due to tightened underwriting guidelines on automobile lending implemented by the Company in the latter part of 2016, and were $110 million and $235 million at December 31, 2019 and 2018, respectively. The total indirect consumer loan portfolio at December 31, 2019 was comprised of the following types of loans: $107 million of used auto loans, $20 million of manufactured home loans, $2 million of new auto loans, and various other loans including loans for RVs, boats, ATVs and motorcycles.
The environment for providing indirect automobile lending services has been difficult over the last several years. In the latter part of 2016, in response to more challenging consumer credit conditions, the Company tightened its underwriting guidelines on automobile lending. Management took this step in an effort to improve credit quality in the portfolio and lower delinquencies and charge-offs. The changes in underwriting guidelines resulted in lower origination volume, and as such, outstanding consumer auto loan balances have decreased significantly since the end of 2016. After a review of the indirect automobile lending model, the decision was made to exit this business line effective March 31, 2019. Market and financial forces, including strong rate competition for well-qualified borrowers, have made indirect automobile lending less profitable over the long term. The Company will continue servicing indirect automobile loans made before March 31, 2019, until each loan agreement is satisfied. Direct consumer lending through the Company’s banking center network is expected to continue as normal.
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial strength, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state consumer bankruptcy and insolvency laws, may limit the amount which can be recovered on
these loans. These loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of these loans such as the Bank, and a borrower may be able to assert against the assignee claims and defenses which it has against the seller of the underlying collateral.
Originations, Purchases, Sales and Servicing of Loans
The Bank originates loans through internal loan production personnel located in the Bank's main and branch offices, as well as loan production offices. Walk-in customers and referrals from existing customers of the Company are also important sources of loan originations.
Great Southern may also purchase whole loans and participation interests in loans (generally without recourse, except in cases of breach of representation, warranty or covenant) from other banks, thrift institutions and life insurance companies (originators). The purchase transaction is governed by a participation agreement entered into by the originator and participant (Great Southern) containing guidelines as to ownership, control and servicing rights, among others. The originator may retain all rights with respect to enforcement, collection and administration of the loan. This may limit Great Southern's ability to control its credit risk when it purchases participations in these loans. For instance, the terms of participation agreements vary; however, generally Great Southern may not have direct access to the borrower, and the institution administering the loan may have some discretion in the administration of performing loans and the collection of non-performing loans.
Over the years, a number of banks, both locally and regionally, have sought to diversify the risk in their portfolios. In order to take advantage of this situation, Great Southern purchases participations in commercial real estate, commercial construction and other commercial loans. Great Southern subjects these loans to its normal underwriting standards used for originated loans and rejects any credits that do not meet those guidelines. The originating bank generally retains the servicing of these loans. Excluding all FDIC-assisted acquired loans, the Bank purchased $97.2 million and $128.0 million of these loans in the fiscal years ended December 31, 2019 and 2018, respectively. Of the total $264.1 million of purchased participation loans outstanding at December 31, 2019, the largest aggregate amount outstanding purchased from one institution was $37.9 million. This total was comprised of seven loans, four of which were secured by a hotel in St. Louis, Missouri, two were secured by a warehouse, and one was secured by the assignment of a note secured by retail real estate. One loan totaling $1.1 million was not performing at December 31, 2019. At December 31, 2019 and 2018, loans which were previously covered by loss sharing agreements with the FDIC but are no longer covered included purchased and participation loans of $7,000 and $136,000, respectively. At December 31, 2019 and 2018, FDIC-assisted acquired loans which were never covered by loss sharing agreements included purchased and participation loans of $8.4 million and $14.1 million, respectively. These amounts represent the undiscounted balance of these loans.
From time to time, Great Southern also sells non-residential loan participations generally without recourse to private investors, such as other banks, thrift institutions and life insurance companies (participants). The sales transaction is governed by a participation agreement entered into by the originator (Great Southern) and participant containing guidelines as to ownership, control and servicing rights, among others. Great Southern generally retains servicing rights for these participations sold. These participations are sold with a provision for repurchase upon breach of representation, warranty or covenant.
Great Southern also sells whole residential real estate loans without recourse to Freddie Mac and Fannie Mae as well as to private investors, such as other banks, thrift institutions, mortgage companies and life insurance companies. Whole real estate loans are sold with a provision for repurchase upon breach of representation, warranty or covenant. These representations, warranties and covenants include those regarding the compliance of loan originations with all applicable legal requirements, mortgage title insurance policies when applicable, enforceable liens on collateral, collateral type, borrower credit worthiness, private mortgage insurance when required and compliance with all applicable federal regulations. A minimal number of repurchase requests have been received to date based on a breach of representations, warranties or covenants as outlined in the investor contracts. These loans are generally sold for cash in amounts equal to the unpaid principal amount of the loans adjusted for current market yields to the buyer. The sale amounts generally produce gains to the Bank and allow a margin for servicing income on loans when the servicing is retained by the Bank. However, residential real estate loans sold in recent years have primarily been with Great Southern releasing control of the servicing of the loans.
The Bank sold one- to four-family whole real estate loans, SBA-guaranteed loans and loan participations in aggregate amounts of $128.4 million, $90.6 million and $135.5 million during fiscal 2019, 2018, and 2017, respectively. The Bank typically sells long-term fixed rate mortgages. Sales of whole real estate loans and participations in real estate loans can be beneficial to the Bank since these sales generally generate income at the time of sale, produce future servicing income on loans where servicing is retained, provide funds for additional lending and other investments, and increase liquidity.
Gains, losses and transfer fees on sales of loans and loan participations are recognized at the time of the sale. When real estate loans and loan participations sold have an average contractual interest rate that differs from the agreed upon yield to the purchaser (less the agreed upon servicing fee), resulting gains or losses are recognized in an amount equal to the present value of the differential over the estimated remaining life of the loans. Any resulting discount or premium is accreted or amortized over the same estimated life using a method approximating the level yield interest method. When real estate loans and loan participations are sold with servicing released, as the Bank primarily does, an additional fee is received for the servicing rights. Net gains and transfer fees on sales of loans for the years ended December 31, 2019, 2018 and 2017 were $2.6 million, $1.8 million and $3.2 million, respectively. These gains were primarily from the sale of fixed-rate residential loans, with a small amount resulting from the sale of SBA-guaranteed loans in 2019.
The Bank serviced loans owned by others totaling approximately $349.9 million and $260.2 million at December 31, 2019 and 2018, respectively. Of the total loans serviced at December 31, 2019, $283.0 million related to commercial real estate, commercial business and construction loans, portions of which were sold to other parties. The remaining $66.9 million of loans serviced for others related to one- to four-family real estate loans which the Bank had originated and sold, but retained the obligation to service, or had acquired the servicing through various FDIC-assisted transactions. The servicing of these loans generated fees (net of amortization of the servicing rights) to the Bank for the years ended December 31, 2019, 2018 and 2017, of $167,000, $185,000 and $206,000, respectively.
In addition to interest earned on loans and loan origination fees, the Bank receives fees for loan commitments, letters of credit, prepayments, modifications, late payments, transfers of loans due to changes of property ownership and other miscellaneous services. The fees vary from time to time, generally depending on the supply of funds and other competitive conditions in the market. Fees from prepayments, commitments, letters of credit and late payments totaled $1.7 million, $1.8 million and $2.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. Loan origination fees, net of related costs, are accounted for in accordance with FASB ASC 310-20, Receivables - Nonrefundable Fees and Other Costs. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized in interest income using the level-yield method over the contractual life of the loan. For further discussion of this matter, see Note 1 of the accompanying audited financial statements, included in Item 8 of this Report.
Loan Delinquencies and Defaults
When a borrower fails to make a required payment on a loan, the Bank attempts to cause the delinquency to be cured by contacting the borrower. In the case of loans secured by residential real estate, a late notice is sent 15 days after the due date. If the delinquency is not cured by the 30th day, a delinquent notice is sent to the borrower.
Additional written contacts are made with the borrower 45 and 60 days after the due date. If the delinquency continues for a period of 65 days, the Bank usually institutes appropriate action to foreclose on the collateral. The actual time it takes to foreclose on the collateral varies depending on the particular circumstances and the applicable governing law. If foreclosed upon, the property is sold at public auction and may be purchased by the Bank. Delinquent consumer loans are handled in a generally similar manner, except that initial contacts are made when the payment is five days past due and appropriate action may be taken to collect any loan payment that is delinquent for more than 15 days. The Bank's procedures for repossession and sale of consumer collateral are subject to various requirements under the applicable consumer protection laws as well as other applicable laws and the determination by the Bank that it would be beneficial from a cost basis.
Delinquent commercial business loans and loans secured by commercial real estate are initially handled by the loan officer in charge of the loan, who is responsible for contacting the borrower. Senior management also works with the commercial loan officers to see that necessary steps are taken to collect delinquent loans and may reassign the loan relationship to the special assets group. In addition, the Bank has a Problem Loan Committee which meets at least quarterly and reviews all classified assets, as well as other loans which management feels may present possible collection problems. If an acceptable workout of a delinquent commercial loan cannot be agreed upon, the Bank may initiate foreclosure proceedings on any collateral securing the loan. However, in all cases, whether a commercial or other loan, the prevailing circumstances may be such that management may determine it is in the best interest of the Bank not to foreclose on the collateral.
The following tables set forth our loans by aging category:
Classified Assets
Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets. The regulations require insured institutions to classify their own assets and to establish prudent specific allocations for losses from assets classified "substandard" or "doubtful." “Substandard” assets include those characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as “doubtful,” have all the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge such amount off its books. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess a potential weakness (referred to as “special mention” assets), are required to be listed on the Bank's watch list and monitored for further deterioration. In addition, a bank's regulators may require the establishment of a general allowance for losses based on the general quality of the asset portfolio of the bank. Following are the total classified assets at December 31, 2019 and 2018, per the Bank's internal asset classification list, excluding assets acquired through FDIC-assisted transactions. The allowances for loan losses reflected below are the portions of the Bank’s total allowances for loan losses relating to these classified loans. There were no significant off-balance sheet items classified at December 31, 2019 and 2018.
Non-Performing Assets
The table below sets forth the amounts and categories of gross non-performing assets (classified loans which are not performing under regulatory guidelines and all foreclosed assets, including assets acquired in settlement of loans) in the Bank's loan portfolio as of the dates indicated. Loans generally are placed on non-accrual status when the loan becomes 90 days delinquent or when the collection of principal, interest, or both, otherwise becomes doubtful.
Former TeamBank, Vantus Bank, Sun Security Bank and InterBank non-performing assets, including foreclosed assets, are not included in the totals of non-performing assets below as they were subject to loss sharing agreements with the FDIC, which substantially covered principal losses that may have been incurred in these portfolios for the applicable terms under the agreements. In addition, these assets were initially recorded at their estimated fair values as of their acquisition dates. Former Valley Bank loans are also excluded from the totals of non-performing assets below, although they were not covered by a loss sharing agreement. As in the previous FDIC-assisted acquisitions, former Valley Bank loans are accounted for in pools and were recorded at their fair value at the time of the acquisition as of June 20, 2014; therefore, these loan pools are analyzed rather than the individual loans. The overall performance of the FDIC-assisted acquired loan pools has been better than original expectations as of the acquisition dates. At December 31, 2019, there were no material non-performing assets in these acquired loan portfolios.
________________________
(1)
One relationship was $1.9 million, the entire total of this category, at December 31, 2017.
(2)
The largest two relationships in this category were $1.7 million and $1.7 million, respectively, at December 31, 2016.
(3)
The largest two relationships in this category were $6.5 million and $3.7 million, respectively, at December 31, 2015.
(4)
One relationship was $1.1 million of this total at December 31, 2019.
(5)
One relationship was $1.1 million of this total at December 31, 2018.
(6)
One relationship was $1.5 million of this total at December 31, 2017.
(7)
One relationship was $3.0 million of this total at December 31, 2016.
See Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-performing Assets” for further information.
Gross impaired loans totaled $10.3 million at December 31, 2019 and $13.9 million at December 31, 2018. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. See Note 3 “Loans” of the accompanying audited financial statements included in Item 8 for additional information including further detail of non-accruing loans and impaired loans and details of troubled debt restructurings. See also Note 15 “Disclosures About Fair Value of Financial Instruments” of the accompanying audited financial statements included in Item 8 for additional information.
For the year ended December 31, 2019, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $761,000. No interest income was included on these loans for the year ended December 31, 2019. For the year ended December 31, 2018, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $1.0 million. No interest income was included on these loans for the year ended December 31, 2018. For the year ended December 31, 2017, gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $1.2 million. No interest income was included on these loans for the year ended December 31, 2017.
Restructured Troubled Debt
Included in impaired loans at December 31, 2019 and 2018, were loans modified in troubled debt restructurings as follows:
Allowances for Losses on Loans and Foreclosed Assets
Great Southern maintains an allowance for loan losses to absorb losses known and inherent in the loan portfolio based upon ongoing, monthly assessments of the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include a formula allowance, specific allowances for identified problem loans and portfolio segments and economic conditions that may lead to a concern about the loan portfolio or segments of the loan portfolio.
The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and non-performing loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience and on significant factors that, in management's judgment, affect the
collectability of the portfolio as of the evaluation date. Loan loss factors for portfolio segments are representative of the credit risks associated with loans in those segments. The greater the credit risks associated with a particular segment, the greater the loss factor.
The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas. Other conditions that management considers in determining the appropriateness of the allowance include, but are not limited to, changes to our underwriting standards (if any), credit quality trends (including changes in non-performing loans expected to result from existing economic and other market conditions), trends in collateral values, loan volumes and concentrations, and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of those loans.
Senior management reviews these conditions regularly in discussions with our credit officers. To the extent that any of these conditions are evident in a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance applicable to such loan or portfolio segment. Where any of these conditions are not evident in a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's evaluation of the loss related to these conditions is reflected in the general allowance associated with our loan portfolio. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem loans or portfolio segments.
The amounts actually observed in respect of these losses can vary significantly from the estimated amounts. Our methodology permits adjustments to any loss factor used in the computation of the formula allowances in the event that, in management's judgment, significant factors which affect the collectability of the portfolio, as of the evaluation date, are not reflected in the current loss factors. By assessing the estimated losses inherent in our loan portfolio on a monthly basis, we can adjust specific and inherent loss estimates based upon more current information.
On a quarterly basis, senior management presents a formal assessment of the adequacy of the allowance for loan losses to Great Southern's board of directors for the board's approval of the allowance. Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates including the amount and timing of future cash flows expected to be received on impaired loans or changes in the market value of collateral securing loans that may be susceptible to significant change. In the opinion of management, the allowance when taken as a whole is adequate to absorb reasonable estimated loan losses inherent in Great Southern's loan portfolio.
Allowances for estimated losses on foreclosed assets (real estate and other assets acquired through foreclosure) are charged to expense, when in the opinion of management, any significant and permanent decline in the market value of the underlying asset reduces the market value to less than the carrying value of the asset. Senior management assesses the market value of each foreclosed asset individually on a regular basis.
At December 31, 2019 and 2018, Great Southern had an allowance for losses on loans of $40.3 million and $38.4 million, respectively, of which $929,000 and $2.0 million, respectively, had been allocated to specific loans. All loans with specific allowances were considered to be impaired loans. The allowance and the activity within the allowance during 2019, 2018 and 2017 are discussed further in Note 3 “Loans and Allowance for Loan Losses” of the accompanying audited financial statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in Item 8 and Item 7 of this Report, respectively.
The allocation of the allowance for losses on loans at the dates indicated is summarized as follows.
______________
(1)
Associated with these allowances at December 31, 2019, 2018, 2017, 2016 and 2015, were receivables from the FDIC totaling $-0-, $-0-, $-0-, $56,000, and $275,000, respectively, under the loss sharing agreements which were in place at the time.
(2)
Excludes loans acquired through FDIC-assisted transactions.
The following table sets forth an analysis of activity in the Bank's allowance for losses on loans showing the details of the activity by types of loans.
Investment Activities
Excluding securities issued by the United States Government, or its agencies, there were no investment securities in excess of 10% of the Company’s stockholders’ equity at December 31, 2019, 2018 and 2017, respectively. Agencies, for this purpose, primarily include Freddie Mac, Fannie Mae, Ginnie Mae, Small Business Administration and FHLBank.
As of December 31, 2019 and 2018, the Bank held no investment securities which the Bank intends to hold until maturity. In addition, as of December 31, 2019 and 2018, the Company held approximately $374.2 million and $244.0 million, respectively, in principal amount of investment securities which the Company classified as available-for-sale. See Notes 1 and 2 of the accompanying audited financial statements included in Item 8 of this Report.
The amortized cost and fair values of, and gross unrealized gains and losses on, investment securities at the dates indicated are summarized as follows.
At December 31, 2019, the Company’s agency mortgage-backed securities portfolio consisted of FNMA securities totaling $147.6 million, FHLMC securities totaling $13.3 million and GNMA securities totaling $4.1 million. At December 31, 2019, agency collateralized mortgage obligations consisted of GNMA securities totaling $122.7 million, FNMA securities totaling $23.9 million and FHLMC securities totaling $5.4 million, all of which are commercial multi-family fixed rate securities. At December 31, 2019, $144.3 million of the Company’s agency mortgage-backed securities had fixed rates of interest and $20.7 million had variable rates of
interest. At December 31, 2019, $149.9 million of the Company’s agency collateralized mortgage obligations had fixed rates of interest and $2.1 million had variable rates of interest.
The following tables present the contractual maturities and weighted average tax-equivalent yields of available-for-sale securities at December 31, 2019. 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.
The following table shows our investments' gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019, 2018 and 2017, respectively:
On at least a quarterly basis, the Company evaluates the securities portfolio to determine if an other-than-temporary impairment (OTTI) needs to be recorded. For debt securities with fair values below carrying value, when the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an OTTI of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an OTTI recorded in other comprehensive income for the noncredit portion of a previous OTTI is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. During 2019, 2018 and 2017, no securities were determined to have impairment that had become other than temporary.
The Company’s consolidated statements of income as of December 31, 2019, 2018 and 2017, reflect the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available-for-sale and held-to-maturity debt securities that management has no intent to sell and believes that it more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the noncredit loss is recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected based on cash flow projections.
For equity securities, if any, when the Company has decided to sell an impaired available-for-sale security and the Company does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.
Sources of Funds
General. Deposit accounts have traditionally been the principal source of the Bank's funds for use in lending and for other general business purposes. In addition to deposits, the Bank obtains funds through advances from the Federal Home Loan Bank of Des Moines ("FHLBank") and other borrowings, loan repayments, loan sales, and cash flows generated from operations. Scheduled loan payments are a relatively stable source of funds, while deposit inflows and outflows and the related costs of such funds have varied widely. Borrowings such as FHLBank advances may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis to support expanded lending activities. The availability of funds from loan sales is influenced by general interest rates as well as the volume of originations.
Deposits. The Bank attracts both short-term and long-term deposits from the general public by offering a wide variety of accounts and rates and also purchases brokered deposits from time to time. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed-interest rate certificates with varying maturities, certificates of deposit in minimum amounts of $100,000 ("Jumbo" accounts), brokered certificates and individual retirement accounts. In 2017, the Bank increased its interest-bearing demand and savings deposits and non-interest-bearing demand deposits through internal growth. Additionally in 2017, the Bank decreased its brokered deposits by $64 million and decreased its time deposits in denominations of $100,000 or more by $36 million. In 2018, the Bank increased its deposits primarily through internal growth in time deposits and growth in brokered deposits, partially offset by a decrease in interest-bearing demand and savings deposits. In 2018, the Bank increased its brokered deposits by $101 million. Also in 2018, the Bank sold deposits totaling approximately $56 million. In 2019, the Bank increased its interest-bearing demand and savings deposits and non-interest-bearing demand deposits through internal growth. In 2019, the Bank increased its total time deposits by approximately $130 million. Time deposits originated through the Bank’s internet channel increased by $127 million and brokered deposits, including Certificate of Deposit Account Registry Service (CDARS) purchased funds, increased $45 million. The deposit growth and funds from borrowings were used to fund the Bank’s loan growth and increases in investment securities.
The following table sets forth the dollar amount of deposits, by interest rate range, in the various types of deposit programs offered by the Bank at the dates indicated.
A table showing maturity information for the Bank's time deposits as of December 31, 2019, is presented in Note 8 of the accompanying audited financial statements, which are included in Item 8 of this Report.
The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and has allowed it to respond with flexibility to changes in consumer demand. The Bank has become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious and the Bank’s deposit mix has changed to a smaller percentage of time deposits. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, management believes that its certificate accounts are relatively stable sources of deposits, while its checking accounts have proven to be more volatile. The ability of the Bank to attract and maintain deposits, and the rates paid on these deposits, has been and will continue to be significantly affected by money market conditions.
The following table sets forth the time remaining until maturity of the Bank's time deposits as of December 31, 2019. The table is based on information prepared in accordance with generally accepted accounting principles.
(1)
Deposits from governmental and other public entities.
Brokered deposits. Brokered deposits are marketed through national brokerage firms to their customers in $1,000 increments. The Bank maintains only one account for the total deposit amount while the detailed records of owners are maintained by the Depository Trust Company under the name of CEDE & Co. The deposits are transferable just like a stock or bond investment and the customer can open the account with only a phone call or an online request. This provides a large deposit for the Bank at a lower operating cost
since the Bank only has one account to maintain versus several accounts with multiple interest and maturity dates. At December 31, 2019 and 2018, the Bank had approximately $371.7 million and $326.9 million in brokered deposits, respectively.
Included in the brokered deposits total at December 31, 2019 and 2018, was $209.1 million and $109.3 million, respectively, in CDARS purchased funds accounts. CDARS purchased funds transactions represent an easy, cost-effective source of funding without collateralization or credit limits for the Company. Purchased funds transactions help the Company obtain large blocks of funding while providing control over pricing and diversity of wholesale funding options. Purchased funds transactions are obtained through a bid process that occurs weekly, with varying maturity terms.
Previously included in brokered deposits were CDARS reciprocal customer deposit accounts. In 2018, the FDIC amended its regulations to exclude these deposits from its definition of brokered deposits. CDARS reciprocal customer deposit accounts are accounts that are just like any other deposit account on the Company’s books, except that the account total exceeds the FDIC deposit insurance maximum. When a customer places a large deposit with a CDARS Network bank, that bank uses CDARS to place the funds into deposit accounts issued by other banks in the CDARS Network. This occurs in increments of less than the standard FDIC insurance maximum, so that both principal and interest are eligible for complete FDIC protection. Other Network members do the same thing with their customers' funds. At December 31, 2019 and 2018, the Bank had approximately $35.3 million and $27.9 million in CDARS reciprocal deposits, respectively.
Unlike non-brokered deposits where the deposit amount can be withdrawn prior to maturity with a penalty for any reason, including increasing interest rates, a brokered deposit (excluding CDARS purchased funds) can only be withdrawn in the event of the death, or court declared mental incompetence, of the depositor. This allows the Bank to better manage the maturity of its deposits. Currently, the rates offered by the Bank for brokered deposits are similar to those offered for retail certificates of deposit of similar size and maturity. Because the Bank had kept higher levels of liquidity since the economic recession began in 2008, we had gradually reduced the amount of brokered deposits (excluding CDARS purchased funds) utilized since December 31, 2008. As loan demand began to increase since 2013, we began to gradually increase our usage of brokered deposits again from time to time.
The Company may use interest rate swaps from time to time to manage its interest rate risks from recorded financial liabilities. In the past, the Company entered into interest rate swap agreements with the objective of economically hedging against the effects of changes in the fair value of its liabilities for fixed rate brokered certificates of deposit caused by changes in market interest rates. These interest rate swaps allowed the Company to create funding of varying maturities at a variable rate that in the past has approximated three-month LIBOR. The Company did not utilize these types of interest rate swaps in 2019, 2018 or 2017.
Borrowings. Great Southern's other sources of funds include advances from the FHLBank, a Qualified Loan Review ("QLR") arrangement with the FRB, customer repurchase agreements and other borrowings.
As a member of the FHLBank, the Bank is required to own capital stock in the FHLBank and is authorized to apply for advances from the FHLBank. Each FHLBank credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLBank may prescribe the acceptable uses for these advances, as well as other risks on availability, limitations on the size of the advances and repayment provisions. At both December 31, 2019 and 2018, the Bank had no FHLBank term advances outstanding. Additionally, the Bank had outstanding overnight borrowings from the FHLBank of $196.0 million and $178.0 million at December 31, 2019 and 2018, respectively. Because they are overnight borrowings, the outstanding balances are included in short-term borrowings in the Company’s financial statements. The Bank utilized FHLBank advances from time to time to fund loan growth during 2019 and 2018.
The Federal Reserve Bank of St. Louis (“FRBSL”) has a QLR program where the Bank can borrow on a temporary basis using commercial loans pledged to the FRBSL. Under the QLR program, the Bank can borrow any amount up to a calculated collateral value of the commercial loans pledged, for virtually any reason that creates a temporary cash need. Examples of this could be: (1) the need to fund for late outgoing wires or cash letter settlements, (2) the need to disburse one or several loans but the permanent source of funds will not be available for a few days; (3) a temporary spike in interest rates on other funding sources that are being used; or (4) the need to purchase a security for collateral pledging purposes a few days prior to the funds becoming available on an existing security that is maturing. The Bank had commercial, consumer and other loans pledged to the FRBSL at December 31, 2019 that would have allowed approximately $367.8 million to be borrowed under the above arrangement. There were no outstanding borrowings from the FRBSL at December 31, 2019 or 2018 and the facility was not used during 2019 or 2018.
The Bank enters into sales of securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the statements of financial condition. The dollar amount of securities underlying the agreements remains in the asset accounts. Securities underlying the agreements are being held by the Bank during the agreement period. The agreements generally are written on a term of one-month or less.
In November 2006, Great Southern Capital Trust II ("Trust II"), a statutory trust formed by the Company for the purpose of issuing the securities, issued $25.0 million aggregate liquidation amount of floating rate cumulative trust preferred securities. The Trust II securities bear a floating distribution rate equal to 90-day LIBOR plus 1.60%. The Trust II securities became redeemable at the Company's option in February 2012, and if not sooner redeemed, mature on February 1, 2037. The Trust II securities were sold in a private transaction exempt from registration under the Securities Act of 1933, as amended. The gross proceeds of the offering were used to purchase Junior Subordinated Debentures from the Company totaling $25.8 million and bearing an interest rate identical to the distribution rate on the Trust II securities. The initial interest rate on the Trust II debentures was 6.98%. The interest rate was 3.51% and 4.14% at December 31, 2019 and 2018, respectively.
In 2013, the Company entered into an interest rate cap agreement for a portion of its Junior Subordinated Debentures associated with its trust preferred securities described above. The term of this agreement was four years with a termination date in August 2017. Under the agreement, with a notional amount of $25.0 million, the Company paid interest on its Junior Subordinated Debentures in accordance with the original terms at a floating rate based on LIBOR. Should the interest rate have risen above a certain threshold, the counterparty was to reimburse the Company for interest paid such that the Company would have an effective interest rate on the portion of its Junior Subordinated Debentures no higher than 2.37%. The effective portion of the gain or loss on the derivative was reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The fair value of the interest rate cap at December 31, 2017 was $-0-.
On August 8, 2016, the Company completed the public offering and sale of $75.0 million of its subordinated notes. The notes are due August 15, 2026, and have a fixed interest rate of 5.25% until August 15, 2021, at which time the rate becomes floating at a rate equal to three-month LIBOR plus 4.087%. The Company may call the notes at par beginning on August 15, 2021, and on any scheduled interest payment date thereafter. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions, legal, accounting and other professional fees, of approximately $73.5 million. Total debt issuance costs of approximately $1.5 million were deferred and are being amortized over the expected life of the notes, which is five years. Amortization of the debt issuance costs during the years ended December 31, 2019 and 2018, totaled $434,000 and $154,000, respectively, and is included in interest expense on subordinated notes in the consolidated statements of income, resulting in an imputed interest rate of 5.89% at December 31, 2019.
The following table sets forth the maximum month-end balances, average daily balances and weighted average interest rates of FHLBank advances during the periods indicated. In December 2018, the Company began utilizing FHLBank overnight borrowings instead of term FHLBank Advances. The FHLBank overnight advances are included in other borrowings below.
The following table sets forth certain information as to the Company's FHLBank advances at the dates indicated.
The following tables set forth the maximum month-end balances, average daily balances and weighted average interest rates of other borrowings during the periods indicated.
The following tables set forth year-end balances and weighted average interest rates of the Company's other borrowings at the dates indicated.
The following table sets forth the maximum month-end balances, average daily balances and weighted average interest rates (2017 includes cost of related interest rate caps) of subordinated debentures issued to capital trusts during the periods indicated.
The following table sets forth certain information as to the Company's subordinated debentures issued to capital trusts at the dates indicated.
The following table sets forth the maximum month-end balances, average daily balances and weighted average interest rates of subordinated notes during the periods indicated.
The following table sets forth certain information as to the Company's subordinated notes at the dates indicated.
Subsidiaries
Great Southern. As a Missouri-chartered trust company, Great Southern may invest up to 3%, which was equal to $150.5 million at December 31, 2019, of its assets in service corporations. At December 31, 2019, the Bank's total investment in Great Southern Real Estate Development Corporation ("Real Estate Development") was $2.7 million. Real Estate Development was incorporated and organized in 2003 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in Great Southern Financial Corporation ("GSFC") was $6.2 million. GSFC is incorporated under the laws of the State of Missouri, and has not had any business activity since November 30, 2012, when it sold Great Southern Insurance and Great Southern Travel, two divisions of Great Southern that were operated through GSFC. At December 31, 2019, the Bank's total investment in Great Southern Community Development Company, L.L.C. (“CDC”) and its subsidiary Great Southern CDE, L.L.C. ("CDE") was $715,000. CDC and CDE were formed in 2010 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GS, L.L.C. ("GSLLC") was $34.2 million. GSLLC was formed in 2005 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GSSC, L.L.C. ("GSSCLLC") was $21.0 million. GSSCLLC was formed in 2009 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GSRE
Holding, L.L.C. ("GSRE Holding") was $2.5 million. GSRE Holding was formed in 2009 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GSRE Holding II, L.L.C. ("GSRE Holding II") was $968,000. GSRE Holding II was formed in 2009 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GSRE Holding III, L.L.C. ("GSRE Holding III") was $-0-. GSRE Holding III was formed in 2012 under the laws of the State of Missouri. At December 31, 2019, the Bank's total investment in GSTC Investments, L.L.C. ("GSTCLLC") was $6.5 million. GSTCLLC was formed in 2016 under the laws of the State of Missouri. These subsidiaries are primarily engaged in the activities described below. In addition, Great Southern has four other subsidiary companies that are not considered service corporations, GSB One, L.L.C., GSB Two, L.L.C., VFP Conclusion Holding, L.L.C. and VFP Conclusion Holding II, L.L.C. These companies are also described below.
Great Southern Real Estate Development Corporation. Generally, the purpose of Real Estate Development is to hold real estate assets which have been obtained through foreclosure by the Bank and which require ongoing operation of a business or completion of construction. During 2019 and 2018, Real Estate Development did not hold any real estate assets related to foreclosed property. Real Estate Development had net income of $-0- in each of the years ended December 31, 2019 and 2018.
Great Southern Community Development Company, L.L.C. and Great Southern CDE, L.L.C. Generally, the purpose of CDC is to invest in community development projects that have a public benefit, and are permissible under Missouri and Kansas law. These include such activities as investing in real estate and investing in other community development entities. It also serves as parent to subsidiary CDE which invests in limited liability entities for the purpose of acquiring federal tax credits to be utilized by Great Southern. CDC had consolidated net income of $-0- and $10,000 in the years ended December 31, 2019 and 2018, respectively.
GS, L.L.C. GSLLC was organized in 2005. GSLLC is a limited liability company that invests in multiple limited liability entities for the purpose of acquiring state and federal tax credits which are utilized by Great Southern. GSLLC had net income (loss) of $115,000 and $(194,000) in the years ended December 31, 2019 and 2018, respectively, which primarily resulted from the cost to acquire tax credits. These losses were offset by the tax credits utilized by Great Southern.
GSSC, L.L.C. GSSCLLC was organized in 2009. GSSCLLC is a limited liability company that invests in multiple limited liability entities for the purpose of acquiring state tax credits which are utilized by Great Southern or sold to third parties. GSSCLLC had net income (loss) of $(2,000) and $88,000 in the years ended December 31, 2019 and 2018, respectively.
GSRE Holding, L.L.C. Generally, the purpose of GSRE Holding is to hold real estate assets which have been obtained through foreclosure by the Bank and which require ongoing operation of a business or completion of construction. At December 31, 2019, GSRE Holding held cash of $2.4 million and real estate assets of 69,000. GSRE Holding had net income (loss) of $(86,000) and $82,000 in the years ended December 31, 2019 and 2018, respectively.
GSRE Holding II, L.L.C. Generally, the purpose of GSRE Holding II is to hold real estate assets which have been obtained through foreclosure by the Bank and which require ongoing operation of a business or completion of construction. In 2019 and 2018, GSRE Holding II did not hold any significant real estate assets. GSRE Holding II had net income (loss) of ($32,000) and $-0- in the years ended December 31, 2019 and 2018, respectively.
GSRE Holding III, L.L.C. Generally, the purpose of GSRE Holding III is to hold real estate assets which have been obtained through foreclosure by the Bank and which require ongoing operation of a business or completion of construction. In 2019 and 2018, GSRE Holding III did not hold any significant real estate assets. GSRE Holding III had net income of $-0- in each of the years ended December 31, 2019 and 2018.
GSTC Investments, L.L.C. GSTCLLC was organized in 2016. GSTCLLC is a limited liability company that invests in multiple limited liability entities for the purpose of acquiring state and federal tax credits which are utilized by Great Southern. GSTCLLC had net income of $-0- in each of the years ended December 31, 2019 and 2018.
GSB One, L.L.C. At December 31, 2019, the Bank's total investment in GSB One, L.L.C. ("GSB One") and GSB Two, L.L.C. ("GSB Two") was $2.09 billion. The capital contribution was made by transferring participations in loans to GSB Two. GSB One is a Missouri limited liability company that was formed in 1998. Currently the only activity of this company is the ownership of GSB Two.
GSB Two, L.L.C. This is a Missouri limited liability company that was formed in 1998. GSB Two is a real estate investment trust ("REIT"). It holds participations in real estate mortgages from the Bank. The Bank continues to service the loans in return for a management and servicing fee from GSB Two. GSB Two had net income of $67.5 million and $52.0 million in the years ended December 31, 2019 and 2018, respectively.
VFP Conclusion Holding, L.L.C. VFP Conclusion Holding, L.L.C. (“VFP”) is a Missouri limited liability company that was formed in 2011. Generally, the purpose of VFP is to hold real estate assets which have been obtained through foreclosure by the Bank. The real estate assets obtained through foreclosure were formerly collateral for a participation loan sold by the Bank. The Bank has a 50 percent interest in VFP and at December 31, 2019 its investment totaled $4.2 million. Two other entities also have interests in VFP as a result of their participation in the loan sold by the Bank. At December 31, 2019, the only asset of VFP was cash. VFP had net income of $-0- in each of the years ended December 31, 2019 and 2018.
VFP Conclusion Holding II, L.L.C. VFP Conclusion Holding II, L.L.C. (“VFP II”) is
a Missouri limited liability company that was formed in 2012. Generally, the purpose of VFP II is to hold real estate assets which have been obtained through foreclosure by the Bank. The real estate assets obtained through foreclosure were formerly collateral for a participation loan sold by the Bank. The Bank has a 50 percent interest in VFP II and at December 31, 2019 its investment totaled $2.2 million. One other entity also has an interest in VFP II as a result of its participation in the loan sold by the Bank. At December 31, 2019, the only asset of VFP II was cash. VFP II had net income of $-0- for each of the years ended December 31, 2019 and 2018.
Competition
The banking industry in the Company's market areas is highly competitive. In addition to competing with other commercial and savings banks, the Company competes with credit unions, finance companies, leasing companies, mortgage companies, insurance companies, brokerage and investment banking firms and many other financial service firms. Competition is based on a number of factors including, among others, customer service, quality and range of products and services offered, price, reputation, interest rates on loans and deposits, lending limits and customer convenience. Our ability to continue to compete effectively also depends in large part on our ability to attract new employees and retain and motivate our existing employees, while managing compensation and other costs.
A substantial number of the commercial banks operating in most of the Company's market areas are branches or subsidiaries of large organizations affiliated with statewide, regional or national banking companies and as a result they may have greater resources with which to compete. Additionally, the Company faces competition from a large number of community banks, many of which have senior management who were previously with other local banks or investor groups with strong local business and community ties.
The Company encounters strong competition in attracting deposits throughout its six-state retail footprint. The Company attracts a significant amount of deposits through its branch offices primarily from the communities in which those branch offices are located. Of our total 97 branch offices at the end of 2019, 72.6% of our deposit franchise dollars were located in Missouri, where our total market share at June 30, 2019, was 1.7%, or seventh in the state (based on FDIC market share deposits). The financial institutions with the top three market share positions in Missouri at June 30, 2019, were Bank of America, U.S. Bank, and UMB Bank, which had a combined market share of 28.8%. We also have branch offices in the states of Iowa, Kansas, Minnesota, Nebraska and Arkansas, which made up 13.9%, 6.6%, 5.9%, 0.5%, and 0.5% of our total deposit franchise dollars, respectively (based on our total deposits as of December 31, 2019). The Company's market share in its primary metropolitan statistical areas was as follows at June 30, 2019:
Metropolitan Statistical Area
Number of Branch Offices
Percentage of Total Market Share
Rank
Institution with Leading Market Share Position
Springfield, MO
16.0%
Great Southern Bank
Sioux City, IA-NE-SD
7.0%
Security National Bank of Sioux City
Davenport/Moline/Rock Island, IA-IL
1.2%
Quad City Bank and Trust Co.
Des Moines/West Des Moines, IA
0.8%
Principal Bank
St. Louis, MO-IL
0.6%
Stifel Bank and Trust
Kansas City, MO-KS
0.3%
UMB Bank
Fayetteville/Springdale/Rogers, AR-MO
0.2%
Arvest Bank
Minneapolis/St. Paul/Bloomington, MN-WI
0.1%
US Bank NA
Our most direct competition for deposits has historically come from other commercial banks, savings institutions and credit unions located in our market areas. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch, online, mobile and ATM services. In addition, some competitors located outside of our market areas conduct business primarily over the Internet, which may enable them to realize certain savings and offer certain
deposit products and services at lower rates and with greater convenience to certain customers. Our ability to attract and retain customer deposits depends on our ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.
Competition in originating real estate loans comes primarily from other commercial banks, savings institutions and mortgage bankers making loans secured by real estate located in the Bank's market area. The specific institutions are similar to those discussed above in regards to deposit market share. Commercial banks and finance companies provide vigorous competition in commercial and consumer lending. The Bank competes for real estate and other loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates, the quality of services it provides to borrowers and the locations of our branch office network and loan production offices.
Many of our competitors have substantially greater resources, name recognition and market presence, which benefit them in attracting business. In addition, larger competitors (including nationwide banks that have a significant presence in our market areas) may be able to price loans and deposits more aggressively than we do because of their greater economies of scale. Smaller and newer competitors may also be more aggressive than we are in terms of pricing loan and deposit products in order to obtain a larger share of the market. In addition, some competitors located outside of our market areas conduct business primarily over the Internet, which may enable them to realize certain savings and offer products and services at more favorable rates and with greater convenience to certain customers.
We also depend, from time to time, on outside funding sources, including brokered deposits, where we experience nationwide competition, and Federal Home Loan Bank advances. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on insured depositary institutions and their holding companies. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services.
Despite the highly competitive environment and the challenges it presents to us, management believes the Company will continue to be competitive because of its strong commitment to quality customer service, competitive products and pricing, convenient local branches, online and mobile capabilities, and active community involvement.
Employees
At December 31, 2019, the Company and its affiliates had a total of 1,191 employees, including 279 part-time employees. None of the Company’s employees are represented by any collective bargaining agreement. Management considers its employee relations to be good.
Government Supervision and Regulation
General
The Company and its subsidiaries are subject to supervision and examination by applicable federal and state banking agencies. The earnings of the Company’s subsidiaries, and therefore the earnings of the Company, are affected by general economic conditions, management policies, federal and state legislation, and actions of various regulatory authorities, including the Board of Governors of the Federal Reserve System, often referred to as the Federal Reserve Board (the “FRB”), the Federal Deposit Insurance Corporation (the "FDIC") and the Missouri Division of Finance (the “MDF”). The following is a brief summary of certain aspects of the regulation of the Company and the Bank and does not purport to fully discuss such regulation. Such regulation is intended primarily for the protection of depositors and the Deposit Insurance Fund (the “DIF”), and not for the protection of stockholders.
Significant Legislation Impacting the Financial Services Industry
In 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape.
In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or eliminate certain financial reform rules and regulations, including some implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these amendments could result in meaningful regulatory changes.
The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “Community Bank Leverage Ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered “well-capitalized” under the prompt corrective action rules. Effective January 1, 2020, the Community Bank Leverage Ratio is 9.0%. For additional information regarding the Community Bank Leverage Ratio, see “-Capital.”
In addition, the Economic Growth Act includes regulatory relief in the areas of examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and the forthcoming implementing rules and regulations will have on us.
Bank Holding Company Regulation
The Company is a bank holding company that has elected to be treated as a financial holding company by the FRB. Financial holding companies are subject to comprehensive regulation by the FRB under the Bank Holding Company Act and the regulations of the FRB. The Company is required to file reports with the FRB and such additional information as the FRB may require, and is subject to regular examinations by the FRB. The FRB also has extensive enforcement authority over financial holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
Under FRB policy and the Dodd-Frank Act, a bank holding company must serve as a source of strength for its subsidiary banks. Accordingly, the FRB may require, and has required in the past, that a bank holding company contribute additional capital to an undercapitalized subsidiary bank.
Under the Bank Holding Company Act, a financial holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company that is not a subsidiary if, after such acquisition, it would own or control more than 5% of such shares; (ii) acquiring all or substantially all of the assets of another bank or bank or financial holding company; or (iii) merging or consolidating with another bank or financial holding company.
The Bank Holding Company Act also prohibits a financial holding company generally from engaging directly or indirectly in activities other than those involving banking, activities closely related to banking that are permitted for a bank holding company, and certain securities, insurance and merchant banking activities. Certain investments greater than 5% in companies engaged in activities not permitted for a bank holding company are prohibited.
Volcker Rule
The federal banking agencies have adopted regulations to implement the provisions of the Dodd-Frank Act known as the Volcker Rule. Under the regulations, FDIC-insured depository institutions, their holding companies, subsidiaries and affiliates are generally prohibited, subject to certain exemptions, from proprietary trading of securities and other financial instruments and from acquiring or retaining an ownership interest in a “covered fund.” Effective July 22, 2019, a bank and its holding company are exempt from the Volcker Rule if the bank and every company that controls it have consolidated assets of $10 billion or less and have total consolidated trading assets and liabilities of 5% or less of its consolidated assets.
Interstate Banking and Branching
Federal law allows the FRB to approve an application of a bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The FRB may not approve the acquisition of a bank that has not been in existence for the
minimum time period (not exceeding five years) specified by the statutory law of the host state. Federal law also prohibits the FRB from approving such an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or if the applicant would control 30% or more of the deposits in any state in which the target bank maintains a branch and in which the applicant or any of its depository institution affiliates controls a depository institution or branch immediately prior to the acquisition of the target bank. Federal law does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit. Missouri law prohibits a bank holding company from acquiring a depository institution if total deposits would exceed 13% of statewide deposits excluding bank certificates of deposit of $100,000 or more.
The federal banking agencies are generally authorized to approve interstate bank merger transactions and de novo branching without regard to whether such transactions are prohibited by the law of any state. Interstate acquisitions of branches are generally permitted only if the law of the state in which the branch is located permits such acquisitions.
As required by federal law, federal regulations prohibit any out-of-state bank from using the interstate branching authority primarily for the purpose of deposit production, including guidelines to ensure that interstate branches operated by an out-of-state bank in a host state reasonably help to meet the credit needs of the communities which they serve.
Certain Transactions with Affiliates and Other Persons
Transactions involving the Bank and its affiliates are subject to sections 23A and 23B of the Federal Reserve Act, and regulations thereunder, which impose certain quantitative limits and collateral requirements on such transactions, and require all such transactions to be on terms at least as favorable to the Bank as are available in transactions with non-affiliates.
All loans by the Bank to the principal stockholders, directors and executive officers of the Bank or any affiliate are subject to regulations restricting loans and other transactions with insiders of the Bank and its affiliates. Transactions involving such persons must be on terms and conditions as favorable to the bank as those that apply in similar transactions with non-insiders. A bank may allow favorable rate loans to insiders pursuant to an employee benefit program available to bank employees generally. The Bank has such a program.
Dividends
The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB's view that a bank holding company should pay cash dividends only to the extent that its net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company's capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, a bank holding company may be prohibited from paying any dividends if the holding company's bank subsidiary is not adequately capitalized, and dividends payable by a bank holding company and its depository institutions subsidiaries can be restricted if the capital conservation buffer requirement is not met. See “Capital” below.
A bank holding company is required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company's consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. This notification requirement does not apply to any company that meets the well-capitalized standard for bank holding companies, is well-managed, and is not subject to any unresolved supervisory issues. Under Missouri law, the Bank may pay dividends from certain undivided profits and may not pay dividends if its capital is impaired. Dividends of the Company and the Bank may also be restricted under the capital conservation buffer rules, as discussed below under “-Capital.”
Capital
The Company and the Bank are subject to new capital regulations adopted by the FRB and the FDIC, which established minimum required ratios for common equity Tier 1 (“CET1”) capital, Tier 1 capital and total capital and the minimum leverage ratio; set forth the risk-weightings of assets and certain off-balance sheet items for purposes of the risk-based capital ratios; require an additional capital conservation buffer over the required risk-based capital ratios, and define what qualifies as capital for purposes of meeting the capital requirements.
Under the capital regulations, the minimum capital ratios are: (1) a CET1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (3) a total risk-based capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total adjusted assets) of 4.0%. CET1 generally consists of common stock; retained earnings; accumulated other comprehensive income (“AOCI”) unless an institution has elected to exclude AOCI from regulatory capital; and certain minority interests; all subject to applicable regulatory adjustments and deductions. Tier 1 capital generally consists of CET1 and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated debt meeting certain conditions plus an amount of the allowance for loan and lease losses up to 1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
Mortgage servicing and deferred tax assets over designated percentages of CET1 are deducted from capital. In addition, Tier 1 capital includes AOCI, which includes all unrealized gains and losses on available for sale debt and equity securities. However, because of our asset size, we were eligible to elect to permanently opt out of the inclusion of unrealized gains and losses on available for sale debt and equity securities in our capital calculations. We elected this option.
For purposes of determining risk-based capital, assets and certain off-balance sheet items are risk-weighted from 0% to 1,250%, depending on the risk characteristics of the asset or item. The risk weights include, for example, a 150% risk weight for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in nonaccrual status; a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and a 250% risk weight for mortgage servicing and deferred tax assets that are not deducted from capital.
In addition to the minimum CET1, Tier 1 and total capital ratios, the Company and the Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses.
The Financial Accounting Standards Board has adopted a new accounting standard for US Generally Accepted Accounting Principles that became effective for us on January 1, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, requires FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses expected over the life of certain financial assets. CECL covers a broader range of assets than the current method of recognizing credit losses and generally results in earlier recognition of credit losses. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under CECL. For a banking organization, implementation of CECL is generally likely to reduce retained earnings, and to affect other items, in a manner that reduces its regulatory capital. The federal banking regulators (the Federal Reserve, the OCC and the FDIC) have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital.
Under the FDIC’s prompt corrective action standards, in order to be considered well-capitalized, the Bank must have a ratio of CET1 capital to risk-weighted assets of 6.5%, a ratio of Tier 1 capital to risk-weighted assets of 8%, a ratio of total capital to risk-weighted assets of 10%, and a leverage ratio of 5%; and must not be subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. In order to be considered adequately capitalized, an institution must have the minimum capital ratios described above. As of December 31, 2019, the Bank was “well-capitalized.” An institution that is not well-capitalized is subject to certain restrictions on brokered deposits and interest rates on deposits.
The federal banking regulators are required to take prompt corrective action if an institution fails to satisfy the requirements to qualify as adequately capitalized. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees that would cause the institution to fail to satisfy the requirements to qualify as adequately capitalized. An institution that is not at least adequately capitalized is: (i) subject to increased monitoring by the appropriate federal banking regulator; (ii) required to submit an acceptable capital restoration plan (including certain guarantees by any company controlling the institution) within 45 days; (iii) subject to asset growth limits; and (iv) required to obtain prior regulatory approval for acquisitions, branching and new lines of business. Additional restrictions and appointment of a receiver or conservator, can apply, depending on the institution's capital level. The FDIC has jurisdiction over the Bank for purposes of prompt corrective action. When the FDIC as receiver liquidates an institution, the claims of depositors and the FDIC as their successor (for deposits covered by FDIC insurance) have priority over other unsecured claims against the institution, including claims of stockholders.
To be considered "well-capitalized," a bank holding company must have, on a consolidated basis, a total risk-based capital ratio of 10.0% or greater and a Tier 1 risk-based capital ratio of 6.0% or greater and must not be subject to an individual order, directive or agreement under which the FRB requires it to maintain a specific capital level. As of December 31, 2019, the Company was "well-capitalized."
The federal banking agencies consider concentrations of credit risk and risks from non-traditional activities, as well as an institution's ability to manage those risks, when determining the adequacy of an institution's capital. This evaluation is generally made as part of the institution's regular safety and soundness examination. Under their regulations, the federal banking agencies also consider interest rate risk (when the interest rate sensitivity of an institution's assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a bank's capital adequacy. The banking agencies have issued guidance on evaluating interest rate risk.
Although we continue to evaluate the impact that the capital rules have on the Company and the Bank, we anticipate that the Company and the Bank will remain well-capitalized, and will continue to meet the capital conservation buffer requirement.
Effective January 1, 2020, a bank that elects to use the Community Bank Leverage Ratio will generally be considered well-capitalized and to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0%. To be eligible to elect the Community Bank Leverage Ratio, the bank also must have total consolidated assets of less than $10 billion, off-balance sheet exposures of 25% or less of its total consolidated assets, and trading assets and trading liabilities of 5.0% or less of its total consolidated assets, all as of the end of the most recent quarter. Similarly, effective January 1, 2020, a bank holding company that elects to use the Community Bank Leverage Ratio will generally be considered to have met the risk-based and leverage capital requirements of the capital regulations if it has a leverage ratio greater than 9.0% if it elects the Community Bank Leverage Ratio based on the same eligibility criteria as described for the bank. We do not intend to elect the Community Bank Leverage Ratio for either the Company or the Bank in their March 31, 2020 regulatory reports.
Insurance of Accounts and Regulation by the FDIC
Great Southern is a member of the DIF, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC, backed by the full faith and credit of the United States Government. The general deposit insurance limit is $250,000.
The FDIC assesses deposit insurance premiums on all FDIC-insured institutions quarterly based on annualized rates. These premiums are assessed on an institution’s total assets minus its tangible equity. Under these rules, assessment rates for an institution with total assets of less than $10 billion are determined by weighted average CAMELS composite ratings and certain financial ratios, and range from 3.0 to 30.0 basis points, subject to certain adjustments. In an emergency, the FDIC may also impose a special assessment.
Through March 2019, the FDIC also assessed insured institutions to service the debt on bonds issued during the 1980s to resolve the thrift bailout. For the final quarter for which assessments were made, the assessment rate was 0.12 basis points applied to the same assessment base as is used for deposit insurance assessments.
The Dodd-Frank Act establishes 1.35% as the minimum reserve ratio. The FDIC adopted a plan to meet this ratio, which was achieved on September 30, 2018, ahead of the September 30, 2020 statutory deadline. In addition to the statutory minimum ratio, the FDIC has the authority to establish a reserve ratio known as the designated reserve ratio or DRR, which may exceed the statutory minimum. The FDIC has established 2.0% as the DRR. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum reserve ratio to 1.35% from the former statutory minimum of 1.15%. To implement the offset requirement, the FDIC imposed a surcharge on institutions with assets of $10 billion or more during a temporary period that ended on September 30, 2018. Smaller institutions will receive credits against their deposit insurance assessments which will reduce regular assessments by 2.0 basis points for quarters when the reserve ratio is at least 1.38%.
The FDIC is authorized to conduct examinations of and to require reporting by FDIC-insured institutions, and is the primary federal banking regulator of state banks that are not members of the Federal Reserve, such as the Bank. The FDIC examines the Bank regularly. The FDIC may prohibit any insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against banks and savings associations.
Federal Reserve System
The FRB requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At December 31, 2019, the Bank was in compliance with these reserve requirements.
Banks are authorized to borrow from the FRB "discount window," but FRB regulations only allow this borrowing for short periods of time and generally require banks to exhaust other reasonable alternative sources of funds where practical, including FHLBank advances, before borrowing from the FRB. See "Sources of Funds Borrowings" above.
Federal Home Loan Bank System
The Bank is a member of the FHLBank of Des Moines, which is one of 11 regional FHLBanks.
As a member, Great Southern is required to purchase and maintain stock in the FHLBank of Des Moines in an amount equal to the greater of 1% of its outstanding home loans or 5% of its outstanding FHLBank advances. At December 31, 2019, Great Southern had $13.5 million in FHLBank of Des Moines stock, which was in compliance with this requirement. In past years, the Bank has received dividends on its FHLBank stock. Over the past five years, such dividends have averaged 4.31% and were 5.75% for the year ended December 31, 2019.
Legislative and Regulatory Proposals
Any changes in the extensive regulatory scheme to which the Company or the Bank is and will be subject, whether by any of the federal banking agencies or Congress, or the Missouri legislature or MDF, could have a material effect on the Company or the Bank, and the Company and the Bank cannot predict what, if any, future actions may be taken by legislative or regulatory authorities or what impact such actions may have.
Federal and State Taxation
General
The following discussion contains a summary of certain federal and state income tax provisions applicable to the Company and the Bank. It is not a comprehensive description of the federal or state income tax laws that may affect the Company and the Bank. The following discussion is based upon current provisions of the Internal Revenue Code of 1986 (the "Code") and Treasury and judicial interpretations thereof.
The Company and its subsidiaries file a consolidated federal income tax return using the accrual method of accounting, with the exception of GSB Two which files a separate return as a REIT. All corporations joining in the consolidated federal income tax return are jointly and severally liable for taxes due and payable by the consolidated group. The following discussion primarily focuses upon the taxation of the Bank, since the federal income tax law contains certain special provisions with respect to banks.
Financial institutions, such as the Bank, are subject, with certain exceptions, to the provisions of the Code generally applicable to corporations.
Bad Debt Deduction
As of December 31, 2019 and 2018, retained earnings included approximately $17.5 million for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only for tax years prior to 1988. If the Bank were to liquidate, the entire amount would have to be recaptured and would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $3.9 million at both December 31, 2019 and 2018.
The Bank is required to follow the specific charge-off method which only allows a bad debt deduction equal to actual charge-offs, net of recoveries, experienced during the fiscal year of the deduction. In a year where recoveries exceed charge-offs, the Bank would be required to include the net recoveries in taxable income.
Interest Deduction
In the case of a financial institution, such as the Bank, no deduction is allowed for the pro rata portion of its interest expense which is allocable to tax-exempt interest on obligations acquired after August 7, 1986. A limited class of tax-exempt obligations acquired after August 7, 1986 will not be subject to this complete disallowance rule. For certain tax exempt obligations issued in 2009 and 2010, an amount of tax-exempt obligations that are not generally considered part of the “limited class of tax-exempt obligations” noted above may be treated as part of the “limited class of tax-exempt obligations” to the extent of two percent of a financial institutions total assets. For tax-exempt obligations acquired after December 31, 1982 and before August 8, 1986 and for obligations acquired after August 7, 1986 that are not subject to the complete disallowance rule, 80% of interest incurred to purchase or carry such obligations will be deductible. No portion of the interest expense allocable to tax-exempt obligations acquired by a financial institution before January 1, 1983, which is otherwise deductible, will be disallowed. The interest expense disallowance rules cited above have not significantly impacted the Bank.
FDIC-Assisted Bank Transactions
During 2009, 2011 and 2012, the Bank acquired assets and liabilities of four unrelated failed institutions in transactions with the FDIC. As part of these transactions, the Bank and the FDIC entered into loss sharing agreements whereby the FDIC agreed to share losses incurred associated with the assets purchased by the Bank. In 2014, the Bank acquired assets and liabilities of an unrelated failed institution in a transaction with the FDIC. The Bank and the FDIC did not enter into a loss sharing agreement on this transaction.
The Bank recognized financial statement gains associated with these transactions. The ultimate tax treatment of these transactions is similar to the financial statement treatment; however, the approaches to valuing the acquired assets and liabilities is different, and results in carrying value differences in the underlying assets and liabilities, for tax purposes. In addition, any gain recognized on the transactions for tax purposes is recognized over a six year period.
During 2016, the Bank and the FDIC reached an agreement to terminate the loss sharing agreements associated with the 2009 and 2011 acquisition transactions. During 2017, the Bank and the FDIC reached an agreement to terminate the loss sharing agreements associated with the 2012 acquisition transaction.
Alternative Minimum Tax
Through 2017, corporations generally were subject to a 20% corporate alternative minimum tax ("AMT"). A corporation must pay the AMT to the extent it exceeds that corporation's regular federal income tax liability The AMT is imposed on "alternative minimum taxable income," defined as taxable income with certain adjustments and tax preference items, less any available exemption. Such adjustments and items include, but are not limited to, (i) net interest received on certain tax-exempt bonds issued after August 7, 1986; and (ii) 75% of the difference between adjusted current earnings and alternative minimum taxable income, as otherwise determined with certain adjustments. Net operating loss carryovers may be utilized, subject to adjustment, to offset up to 90% of the alternative minimum taxable income, as otherwise determined. Any AMT paid may be credited against future regular federal income tax liabilities to the extent the regular federal income tax liability exceeds the AMT liability. In addition, certain credits may be used to reduce AMT obligations. The Company has invested in certain partnerships that generate tax credits (low-income housing and rehabilitation tax credits) that may be used to reduce their AMT.
State Taxation
Missouri-based banks, such as the Bank, are subject to a franchise tax which is imposed on the bank's taxable income at the rate of 7% of the taxable income (determined without regard for any net operating losses) - income-based calculation. Missouri-based banks are entitled to a credit against the income-based franchise tax for all other state or local taxes on banks, except taxes on real estate, unemployment taxes, bank tax, and taxes on tangible personal property owned by the Bank and held for lease or rental to others. Beginning in 2020, the Missouri franchise tax rate is reduced to 4.48%.
The Company and all subsidiaries are subject to a Missouri income tax that is imposed on the corporation's taxable income at the rate of 6.25%. The return is filed on a consolidated basis by all members of the consolidated group including the Bank, but excluding GSB Two. As a REIT, GSB Two files a separate Missouri income tax return. Beginning in 2020, the Missouri corporate income tax rate is reduced to 4.00%.
The Bank also has full service offices in Kansas, Iowa, Minnesota, Nebraska and Arkansas, and has commercial loan production offices in Texas, Oklahoma, Nebraska, Illinois, Colorado and Georgia. As a result, the Bank is subject to franchise and income taxes that are imposed on the corporation's taxable income attributable to those states.
As a Maryland corporation, the Company is required to file an annual report with and pay an annual fee to the State of Maryland.
Examinations
The Company and its consolidated subsidiaries have not been audited recently by the Internal Revenue Service (IRS) except as described here. The Company, through one of its subsidiaries, is a partner in two partnerships which were under IRS examination for 2006 and 2007. As a result, the Company’s 2006 and subsequent tax years remained open for examination. The examinations of these partnerships were completed during 2019. The completion of these examinations did not result in significant changes to the Company’s tax position. As a result, federal tax years through December 31, 2015 are now closed.
The Company is currently under State of Missouri income and franchise tax examinations for its 2014 and 2015 tax years. The Company does not currently expect significant adjustments to its financial statements from this state examination.
Tax Reform
In the fourth quarter of 2017 the Company re-measured its deferred tax assets and liabilities as a result of the enactment of the new tax law “H.R.1,” originally known as the “Tax Cuts and Jobs Act” (the “Tax Reform Legislation”). Enactment occurred on December 22, 2017. The Tax Reform Legislation became effective January 1, 2018 and modifies the tax law in many ways. The centerpiece of the Tax Reform Legislation is the reduction of the federal corporate income tax rate from 35% to 21%. All deferred tax items as of December 22, 2017 needed to be re-valued using the new federal corporate income tax rate of 21%. As a result, income tax expense decreased $2.1 million in 2017 associated with re-valuing the deferred tax asset.
The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Legislation. The Company recognized the provisional tax impact related to the revaluation of deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts, possibly materially, due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Reform Legislation. The Company completed its accounting during 2018 without any significant adjustments from the provisional amounts.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in the common stock of the Company is speculative in nature and is subject to certain risks inherent in the business of the Company and the Bank. The material risks and uncertainties that management believes affect the Company and the Bank are described below. You should carefully consider the risks described below, as well as the other information included in this Annual Report on Form 10-K, before making an investment in the Company’s common stock. The risks described below are not the only ones we face in our business. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also impair our business operations. If any of the following risks occur, our business, financial condition or operating results could be materially harmed. In such an event, our common stock could decline in value.
References to “we,” “us,” and “our” in this “Risk Factors” section refer to the Company and its subsidiaries, including the Bank, unless otherwise specified or unless the context otherwise requires.
Risks Relating to the Company and the Bank
Difficult market conditions and economic trends have adversely affected our industry and our business.
The United States experienced a severe economic recession in 2008 and 2009. While economic growth has resumed, the rate of this growth generally has been slower than previous periods of economic recovery. Many lending institutions, including us, experienced declines in the performance of their loans, including construction loans and commercial real estate loans, during the economic recession and for a few years after. In addition, the values of real estate collateral supporting many loans declined. The values of real estate collateral may increase or decrease over time and are subject to many factors. At times in the past, bank and bank holding company stock prices have been negatively affected, as has the ability of banks and bank holding companies to raise capital and borrow in the debt markets. Conditions such as these may have a material adverse effect on our financial condition and results of operations. In addition, as a result of the foregoing factors, there is a potential for new laws and regulations regarding lending and funding practices and capital and liquidity standards (some of which have already been proposed or implemented), and bank regulatory agencies have been and are expected to continue to be very aggressive in responding to concerns and trends identified in examinations.
Adverse developments in the financial services industry and the impact of new legislation and regulations in response to those developments could restrict our business operations, including our ability to originate loans, and adversely impact our results of operations and financial condition. Overall, during some of the past several years, the general business environment had an adverse effect on our business. The past few years have seen some areas of improvement in the general business environment; however, our business, financial condition and results of operations could be adversely affected by negative circumstances in the general business environment. In addition, other events beyond our control could have an adverse effect on our business, financial condition and results of operations. For example, there are broad and continuing concerns related to the potential effects of the coronavirus outbreak on international trade (including supply chains and export levels), travel, employee productivity, consumer and business demand and confidence levels and other matters that could have a destabilizing effect on financial markets and economic activity. If the coronavirus or any other pandemic has an adverse effect on the ability of our borrowers to satisfy their obligations to us, on the demand for our loans or our other products and services, on other aspects of our business operations or on financial markets or economic growth, our financial condition and results of operations could be adversely affected.
Since our business is primarily concentrated in Missouri, Iowa, Kansas and Minnesota, a significant downturn in these state or local economies, particularly in St. Louis and the Springfield, Mo. areas, may adversely affect our business. We also have originated a significant dollar amount of loans in Texas and Oklahoma from our commercial loan offices in Dallas and Tulsa. A significant downturn in these state economies may adversely affect our business.
Our lending and deposit gathering activities historically were concentrated primarily in the Springfield and southwest Missouri areas. Our success continues to depend heavily on general economic conditions in Springfield and the surrounding areas. Although we believe the economy in these areas has recently been favorable relative to other areas, we do not know whether these conditions will continue. Until the past few years, our greatest concentration of loans and deposits has traditionally been in the Greater Springfield area. With a population of approximately 467,000, the Greater Springfield area is the third largest metropolitan area in Missouri. At December 31, 2019, approximately $368.6 million of our loan portfolio (excluding those loans acquired in FDIC-assisted transactions) consisted of loans to borrowers in or secured by properties in the Springfield, Missouri metropolitan area.
Contiguous to Springfield is the Branson, Mo. area, which is a vacation and entertainment center, attracting tourists to its lakes, theme parks, resorts, country music and novelty shows and other recreational facilities. The Branson area experienced rapid growth in the early 1990s, with stable to slightly negative growth trends occurring in the late 1990s and into the early 2000s. Branson experienced growth again in the late 2000s as a result of a large retail, hotel, and convention center project which was constructed in Branson’s historic downtown. In addition, several large national retailers opened new stores in Branson. In 2010 through 2017, Branson experienced some negative growth trends with fewer visitors and the closing of some motels and shows. Residential construction has been very limited in the past few years and little net growth has occurred in Branson’s commercial real estate market segments. At December 31, 2019, approximately $63.6 million of our loan portfolio (excluding those loans acquired in FDIC-assisted transactions) consisted of loans to borrowers in or secured by properties in the two-county region that includes the Branson area.
In addition to the concentrations in the southwest Missouri area, we now have our largest concentration of loans to borrowers in or secured by properties in the St. Louis, Mo. metropolitan area. At December 31, 2019, approximately $725.0 million of our loan portfolio consisted of loans for apartments, industrial revenue bonds and other types of commercial properties in the St. Louis, Mo. metropolitan area.
In addition to the concentrations discussed above, we have a concentration of loans to borrowers in or secured by properties in the States of Texas and Oklahoma. At December 31, 2019, approximately $406.9 million and $337.6 million of our loan portfolio consisted of loans primarily for various types of commercial real estate in the States of Texas and Oklahoma, respectively.
With the FDIC-assisted transactions that were completed in 2009, we now have additional concentrations of loans in Western and Central Iowa and in Eastern Kansas. The FDIC-assisted transaction completed in 2011 added to our concentrations in Missouri, particularly in St. Louis. As a result of the FDIC-assisted transaction completed in 2012, we have additional concentrations of loans in the Minneapolis, Minnesota metropolitan area. With the FDIC-assisted transaction that was completed in 2014, we now have additional loans in Eastern and Central Iowa.
More recently, we opened commercial loan production offices in Atlanta, Chicago and Denver. We expect loan growth in these offices to result in significant loan balances in Georgia, Illinois, and Colorado.
Adverse changes in regional and general economic conditions could reduce our growth rate, impair our ability to collect loans, increase loan delinquencies, increase problem assets and foreclosures, increase claims and lawsuits, decrease demand for our products and services, and decrease the value of collateral for loans, especially real estate, thereby having a material adverse effect on our financial condition and results of operations. Real estate values can also be affected by governmental rules or policies and natural disasters.
Our loan portfolio possesses increased risk due to our relatively high concentration of commercial and residential construction, commercial real estate, other residential (multi-family) and other commercial loans.
Our commercial and other residential (multi-family) construction, commercial real estate, other residential (multi-family) and other commercial loans accounted for approximately 81.8% of our total loan portfolio as of December 31, 2019. Generally, we consider these types of loans to involve a higher degree of risk compared to first mortgage loans on one- to four-family, owner-occupied residential properties. At December 31, 2019, we had $1.36 billion of loans secured by apartments (including those under construction), $452.0 million of loans secured by retail-related projects, $430.9 million of loans secured by office/warehouse facilities, $298.8 million of loans secured by healthcare facilities, and $194.8 million of loans secured by motels/hotels, which are particularly sensitive to certain risks, including the following:
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large loan balances owed by a single borrower;
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payments that are dependent on the successful operation of the project; and
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loans that are more directly impacted by adverse conditions in the real estate market or the economy generally.
The risks associated with construction lending include the borrower’s inability to complete the construction process on time and within budget, the sale of the project within projected absorption periods, the economic risks associated with real estate collateral, and the potential of a rising interest rate environment. This activity may involve financing land purchases, infrastructure development (e.g., roads, utilities, etc.), as well as construction of residences or other residential (multi-family) dwellings for subsequent sale by the developer/builder. Because the sale of developed properties is critical to the success of the developer’s business, loan repayment may be especially subject to the volatility of real estate market sales activity. Management has established underwriting and monitoring criteria to help minimize the inherent risks of commercial real estate construction lending. However, there is no guarantee that these controls and procedures will reduce losses on this type of lending.
Commercial and other residential (multi-family) lending typically involves higher loan principal amounts and the repayment of these loans generally is dependent, in large part, on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Other commercial loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business or investment. These loans may therefore be more adversely affected by conditions in the real estate markets or in the economy generally. For example, if the cash flow from the borrower’s project is reduced due to leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. In addition, many commercial and other residential (multi-family) loans are not fully amortized over the loan period, but have balloon payments due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or complete a timely sale of the underlying property.
We plan to continue to originate commercial real estate and construction loans based on economic and market conditions. In the years prior to 2013, there was not significant demand for these types of loans. In the current economic situation, demand for these types of loans has increased and we expect to continue to originate these types of loans. Because of the increased risks related to these types of loans, we may determine it necessary to increase the level of our provision for loan losses. Increased provisions for loan losses would adversely impact our operating results. See “Item 1. Business-The Company-Lending Activities-Commercial Real Estate and Construction Lending,” “-Other Commercial Lending,” “-Residential Real Estate Lending” and “-Allowance for Losses on Loans and Foreclosed Assets” and “Item 7. Management’s Discussion of Financial Condition and Results of Operations - Non-performing Assets” in this Report.
A slowdown in the residential or commercial real estate markets may adversely affect our earnings and liquidity position.
The overall credit quality of our construction loan portfolio is impacted by trends in real estate values. We continually monitor changes in key regional and national economic factors because changes in these factors can impact our residential and commercial construction loan portfolio and the ability of our borrowers to repay their loans. Across the United States for several years, the residential real estate market experienced significant adverse trends, including accelerated price depreciation and rising delinquency and default rates, and weaknesses arose in the commercial real estate market as well. The conditions in the residential real estate market led to significant increases in loan delinquencies and credit losses as well as higher provisioning for loan losses, which in turn had a negative effect on earnings for many banks across the country. Likewise, we also experienced delinquencies in our construction loan portfolio, almost entirely related to loans originated prior to 2009. Many of these older construction projects were “build to sell” types of projects where repayment of the loans was reliant on the borrower completing the project and then selling it. Conditions of both the residential and the commercial real estate markets could negatively impact real estate values and the ability of our borrowers to liquidate properties. A lack of liquidity in the real estate market or tightening of credit standards within the banking industry could diminish sales, further reducing our borrowers’ cash flows and weakening their ability to repay their debt obligations to us, which could lead to material adverse impacts on our financial condition and results of operations.
Our loan portfolio also possesses increased risk due to our concentration in consumer loans.
Our consumer loan portfolio, which includes home equity loans, grew significantly between 2010 and 2016. Consumer loan growth peaked at December 31, 2016 at $673.0 million, or 15.3% of our total loan portfolio. Since 2016, consumer loans have decreased to $317.6 million (this total includes $119.0 million of home equity loans), or 6.3% of our total loan portfolio as of December 31, 2019. Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial strength, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state consumer bankruptcy and insolvency laws, may limit the amount which can be recovered on these loans. These loans may also give rise to claims and defenses by a consumer loan borrower against an assignee of these loans such as the Bank, and a borrower may be able to assert against the assignee claims and defenses which it has against the seller of the underlying collateral.
The majority of our consumer loans are secured by automobiles and, to a lesser extent, boats, recreational vehicles and manufactured homes, most of which are made by us indirectly through dealers in these products. Through these dealer relationships, the dealer completes the application with the consumer and then submits it to us for credit approval. As a result, we have limited personal contact with the borrower, creating an additional risk element for us. Effective March 2019, we stopped originating new indirect automobile loans through dealers.
Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.
Lending money is a substantial part of our business. However, every loan we make carries a certain risk of non-payment. This risk is affected by, among other things:
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cash flows of the borrower and/or the project being financed;
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in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;
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the credit history of a particular borrower;
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changes in economic and industry conditions; and
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the duration of the loan.
We maintain an allowance for loan losses that we believe reflects a reasonable estimate of known and inherent losses within the loan portfolio. We make various assumptions and judgments about the collectability of our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances for growing portfolios is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. Excessive loan losses and significant additions to our allowance for loan losses could have a material adverse impact on our financial condition and results of operations.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.
We may be adversely affected by interest rate changes.
Our earnings are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, in particular, the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but these changes could also affect our ability to originate loans and obtain deposits, the fair values of our financial assets and liabilities and the average duration of our loan and mortgage-backed securities portfolios. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. In addition, a substantial portion of our loans (approximately 50% of our total loan portfolio as of December 31, 2019) have adjustable rates of interest. While the higher payment amounts we would receive on these loans in a rising interest rate environment may increase our interest income, some borrowers may be unable to afford the higher payment amounts, which may result in a higher rate of default. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
We generally seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period. As such, we have adopted asset and liability management strategies to attempt to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of fixed-rate and variable-rate loans, investments and funding sources, including interest rate derivatives, so that we may reasonably maintain the Company’s net interest income and net interest margin. However, interest rate fluctuations, the level and shape of the interest rate yield curve, maintaining excess liquidity levels, loan prepayments, loan production and deposit flows are constantly changing and influence the ability to maintain a neutral position. Accordingly, we may not be successful in maintaining a neutral position and, as a result, our net interest margin may be adversely impacted.
The fair value of our investment securities can fluctuate due to market conditions outside of our control.
Factors beyond our control can significantly influence the fair value of securities in our investment securities portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency downgrades of the securities, defaults by the issuer or with respect to the underlying securities, changes in market rates of interest and instability in the credit markets. Any of these mentioned factors could cause an impairment of these assets, which would lead to accounting charges which could have a material negative effect on our financial condition and/or results of operations.
Conditions in the financial markets may limit our access to additional funding to meet our liquidity needs.
Liquidity is essential to our business, as we must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a substantial adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could negatively affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as severe disruption of the financial markets or negative news and expectations about the prospects for the financial services industry as a whole.
Our operations may depend upon our continued ability to access brokered deposits and Federal Home Loan Bank advances.
Due to the high level of competition for deposits in our markets, we have from time to time utilized a sizable amount of certificates of deposit obtained through deposit brokers and advances from the Federal Home Loan Bank of Des Moines to help fund our asset base. Brokered deposits are marketed through national brokerage firms that solicit funds from their customers for deposit in banks, including our bank. Brokered deposits and Federal Home Loan Bank advances may generally be more sensitive to changes in interest rates and volatility in the capital markets than retail deposits attracted through our branch network, and our reliance on these sources of funds increases the sensitivity of our portfolio to these external factors. Our brokered deposits and Federal Home Loan Bank advances totaled $371.7 million and $-0- at December 31, 2019, compared with $326.9 million and $-0- million at December 31, 2018. We had overnight borrowings from the Federal Home Loan Bank totaling $196.0 million and $178.0 million at December 31, 2019 and 2018, respectively. These overnight borrowings are included in short-term borrowings in the Company’s consolidated financial statements. We expect to continue to utilize brokered deposits from time to time as a supplemental funding source.
Bank regulators can restrict our access to these sources of funds in certain circumstances. For example, if the Bank’s regulatory capital ratios declined below the “well-capitalized” status, banking regulators would require the Bank to obtain their approval prior to obtaining or renewing brokered deposits. The regulators might not approve our acceptance of brokered deposits in amounts that we desire or at all. In addition, the availability of brokered deposits and the rates paid on these brokered deposits may be volatile as the balance of the supply of and the demand for brokered deposits changes. Market credit and liquidity concerns may also impact the availability and cost of brokered deposits. Similarly, Federal Home Loan Bank advances are only available to borrowers that meet certain conditions. If Great Southern were to cease meeting these conditions, our access to Federal Home Loan Bank advances could be significantly reduced or eliminated.
Certain Federal Home Loan Banks, including the Federal Home Loan Bank of Des Moines, have experienced lower earnings from time to time and paid out lower dividends to their members. Future problems at the Federal Home Loan Banks may impact the collateral necessary to secure borrowings and limit the borrowings extended to its member banks, as well as require additional capital contributions by its member banks. Should this occur, our short term liquidity needs could be negatively impacted. Should Great Southern be restricted from using FHLBank advances due to weakness in the system or with the FHLBank of Des Moines, Great Southern may be forced to find alternative funding sources. These alternative funding sources may include the utilization of existing lines of credit with third party banks or the Federal Reserve Bank along with seeking other lines of credit, borrowing under repurchase agreement lines, increasing deposit rates to attract additional funds, accessing additional brokered deposits, or selling loans or investment securities in order to maintain adequate levels of liquidity. At December 31, 2019, the Bank owned $13.5 million of stock in the FHLBank of Des Moines, which declared and paid an annualized dividend approximating 5.75% during the fourth quarter of 2019. The FHLBank of Des Moines may eliminate or reduce dividend payments at any time in the future in order for it to maintain or restore its retained earnings.
Our strategy of pursuing acquisitions exposes us to financial, execution and operational risks that could adversely affect us.
We have in the past pursued, and may again in the future pursue, a strategy of supplementing internal growth by acquiring other financial institutions or branches that we believe will help us fulfill our strategic objectives and enhance our earnings. There are risks associated with this strategy, however, including the following:
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We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks or businesses we acquire. If these issues or liabilities exceed our estimates, our earnings and financial condition may be adversely affected;
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Prices at which acquisitions can be made fluctuate with market conditions. We have experienced times during which acquisitions could not be made in specific markets at prices our management considered acceptable and expect that we will experience this condition in the future in one or more markets;
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The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity in order to make the transaction economically feasible. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful;
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To finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing stockholders; and
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We may not be able to continue to sustain our past rate of growth or to grow at all in the future. We completed two acquisitions in 2009, one acquisition in 2011, one acquisition in 2012, one acquisition in 2014 and opened additional banking offices and commercial loan production offices in recent years that enhanced our rate of growth. Also in 2014, we acquired certain loans, deposits and branches from Boulevard Bank. In 2016, we completed an acquisition of certain loans, deposits and branches in St. Louis from Fifth Third Bank.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed. If available, the cost of that capital may also be very high.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support the growth of our business or to finance acquisitions, if any, or we may elect to raise additional capital for other reasons. Should we be required by regulatory authorities or otherwise elect to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or securities convertible into our common stock, which could dilute your ownership interest in the Company.
Our ability to raise additional capital, if needed or desired, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances of our ability to raise additional capital if needed or desired, or if the terms will be acceptable to us. If we cannot raise additional capital when needed or desired, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our financial condition and liquidity could be materially adversely affected.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face substantial competition in all phases of our operations from a variety of different competitors. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. To date, we have grown our business successfully by focusing on our geographic market, expanding into complementary markets and emphasizing the high level of service and responsiveness desired by our customers. We compete for loans, deposits and other financial services with other commercial banks, thrifts, credit unions, consumer finance companies, insurance companies and brokerage firms. Many of our competitors offer products and services that we do not offer, and many have substantially greater resources, name recognition and market presence that benefit them in attracting business. In addition, larger competitors (including certain nationwide banks that have a significant presence in our market areas) may be able to price loans and deposits more aggressively than we do, and smaller and newer competitors may also be more aggressive in terms of pricing loan and deposit products than us in order to obtain a larger share of the market. As we have grown, we have become dependent from time to time on outside funding sources, including funds borrowed from the FHLBank of Des Moines and brokered deposits, where we face nationwide competition. Some of the financial institutions and financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on insured depositary institutions and their holding companies. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services.
We also experience competition from a variety of institutions outside of our market areas. Some of these institutions conduct business primarily over the Internet and may thus be able to realize certain cost savings and offer products and services at more favorable rates and with greater convenience to the customer.
Our business may be adversely affected by the highly regulated environment in which we operate, including the various capital adequacy guidelines we are required to meet.
We are subject to extensive federal and state legislation, regulation, examination and supervision. Recently enacted, proposed and future legislation and regulations have had, will continue to have, or may have an adverse effect on our business and operations. For example, a federal rule which took effect on July 1, 2010 prohibits a financial institution from automatically enrolling customers in overdraft protection programs, on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service. This rule has adversely affected, and is likely to continue to adversely affect, the results of our operations by reducing the amount of our non-interest income.
Our success depends on our continued ability to maintain compliance with the various regulations to which we are subject. Some of these regulations may increase our costs and thus place other financial institutions in stronger, more favorable competitive positions. We cannot predict what restrictions may be imposed upon us with future legislation. See “Item 1.-The Company -Government Supervision and Regulation” in this Report.
The Company and the Bank are required to meet certain regulatory capital adequacy guidelines and other regulatory requirements imposed by the FRB, the FDIC and the Missouri Division of Finance. If the Company or the Bank fails to meet these minimum capital guidelines and other regulatory requirements, our financial condition and results of operations could be materially and adversely affected and could compromise the status of the Company as a financial holding company. See “Item 1.-The Company -Government Supervision and Regulation” in this Report.
Our exposure to operational risks may adversely affect us.
Similar to other financial institutions, we are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, the risk that sensitive customer or Company data is compromised, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors. If any of these risks occur, it could result in material adverse consequences for us.
We continually encounter technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. Our future success will depend, in part, upon our ability to address the needs of our clients by using technology to provide products and services that will satisfy client demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients.
We are also subject to security-related risks in connection with our use of technology, and our security measures may not be sufficient to mitigate the risk of a cyber attack or to protect us from systems failures or interruptions.
Communications and information systems are essential to the conduct of our business. We use such systems to manage our client relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our clients’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our clients or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
As a service to our clients, we currently offer an Internet PC banking product and a smartphone application for iPhone and Android users. Use of these services involves the transmission of confidential information over public networks. We cannot be sure that advances in computer capabilities, new discoveries in the field of cryptography or other developments will not result in a compromise or breach in the commercially available encryption and authentication technology that we use to protect our clients' transaction data. If we were to experience such a breach or compromise, we could suffer losses and reputational damage and our results of operations could be materially adversely affected.
While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. If our third-party providers encounter difficulties, or if we have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely impacted. Threats to information security also exist in the processing of client information through various other vendors and their personnel.
The occurrence of any systems failure or interruption could damage our reputation and result in a loss of clients and business, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our results of operations.
Our accounting policies and methods impact how we report our financial condition and results of operations. Application of these policies and methods may require management to make estimates about matters that are uncertain.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances yet might result in our reporting materially different amounts than would have been reported under a different alternative. Our significant accounting policies are described in Note 1 of the accompanying audited financial statements included in Item 8 of this Report. These accounting policies are critical to presenting our financial condition and results of operations. They may require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions.
Changes in accounting standards could materially impact our consolidated financial statements.
The accounting standard setters, including the Financial Accounting Standards Board, Securities and Exchange Commission and other regulatory bodies, from time to time may change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings.
New accounting standards may result in a significant change to our recognition of credit losses and may materially impact our financial condition or results of operations.
In June 2016, the Financial Accounting Standards Board issued new authoritative accounting guidance under ASC Topic 326 "Financial Instruments - Credit Losses" amending the incurred loss impairment methodology in accounting principles generally accepted in the United States of America ("GAAP") with a methodology that reflects expected credit losses (referred to as the "CECL model") and requires consideration of a broader range of reasonable and supportable information for credit loss estimates, which went into effect for us on January 1, 2020. Under the incurred loss model utilized until 2020, we delayed recognition of losses until it was probable that a loss was incurred. The CECL model represents a dramatic departure from the incurred loss model. The CECL model requires a financial asset (or a group of financial assets) measured at amortized cost basis, such as loans held for investment and held-to-maturity debt securities, to be presented at the net amount expected to be collected (net of the allowance for credit losses). Similarly, the credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses rather than a write-down. In addition, the measurement of expected credit losses will take place at the time the financial asset is first added to the balance sheet (with periodic updates thereafter) and will be based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount.
As such, the CECL model will materially impact how we determine our allowance for loan losses and may require us to significantly increase our allowance for loan losses. Furthermore, we may experience more fluctuations in our allowance for loan losses, which may be significant. If we are required to materially increase our allowance for loan losses, it may negatively impact our financial condition and results of operations.
The adoption of the CECL model required us to recognize a one-time cumulative adjustment to our allowance for loan losses and a liability for potential losses related to the unfunded portion of our loans and commitments in order to fully transition from the incurred loss model to the CECL model. Upon adoption in the first quarter of 2020, we expect to increase the balance of our allowance for credit losses in a range of $11 million to $14 million and create a liability for potential losses related to the unfunded portion of our loans and commitments in a range of $7 million to $10 million. The after-tax effect of this is expected to result in a decrease in our retained earnings of $14 million to $18 million. These estimates are subject to change as material assumptions are refined and model validations are completed as we finalize our first quarter 2020 financial statements. This reduction in retained earnings is not expected to change our well capitalized status. The federal banking agencies have adopted final rules allowing all banking organizations that experience a reduction in retained earnings from the adoption of CECL to elect a three-year phase-in of the initial adverse impact to regulatory capital.
Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect us.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicated that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, debentures, or other securities or financial arrangements, given LIBOR's role in determining market interest rates globally. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have a material adverse effect on our results of operations and financial condition.
Our controls and procedures may be ineffective.
We regularly review and update our internal controls, disclosure controls and procedures and corporate governance policies and procedures. As a result, we may incur increased costs to maintain and improve our controls and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls or procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations or financial condition.
Risks Relating to our Common Stock
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock when you want or at prices you find attractive.
We cannot predict how our common stock will trade in the future. The market value of our common stock will likely continue to fluctuate in response to a number of factors including the following, most of which are beyond our control, as well as the other factors described in this “Risk Factors” section:
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actual or anticipated quarterly fluctuations in our operating and financial results;
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developments related to investigations, proceedings or litigation that involve us;
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changes in financial estimates and recommendations by financial analysts;
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dispositions, acquisitions and financings;
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actions of our current stockholders, including sales of common stock by existing stockholders and our directors and executive officers;
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fluctuations in the stock price and operating results of our competitors;
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regulatory developments; and
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other developments related to the financial services industry.
The market value of our common stock may also be affected by conditions affecting the financial markets in general, including price and trading fluctuations. These conditions may result in (i) volatility in the level of, and fluctuations in, the market prices of stocks generally and, in turn, our common stock and (ii) sales of substantial amounts of our common stock in the market, in each case that could be unrelated or disproportionate to changes in our operating performance. These broad market fluctuations may adversely affect the market value of our common stock. Our common stock also has a low average daily trading volume relative to many other stocks, which may limit an investor’s ability to quickly accumulate or divest themselves of large blocks of our stock. This can lead to significant price swings even when a relatively small number of shares are being traded.
There may be future sales of additional common stock or other dilution of our equity, which may adversely affect the market price of our common stock.
We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.
Our board of directors is authorized to cause us to issue additional common stock, as well as classes or series of preferred stock, generally without any action on the part of the stockholders. In addition, the board has the power, generally without stockholder approval, to set the terms of any such classes or series of preferred stock that may be issued, including voting rights, dividend rights and preferences over the common stock with respect to dividends or upon the liquidation, dissolution or winding-up of our business and other terms. If we issue preferred stock in the future that has a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue preferred stock with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market value of the common stock could be adversely affected.
Regulatory and contractual restrictions may limit or prevent us from paying dividends on and repurchasing our common stock.
Great Southern Bancorp, Inc. is an entity separate and distinct from its principal subsidiary, Great Southern Bank, and derives substantially all of its revenue in the form of dividends from that subsidiary. Accordingly, Great Southern Bancorp, Inc. is and will be dependent upon dividends from the Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. The Bank’s ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to Great Southern Bancorp, Inc., Great Southern Bancorp, Inc. may not be able to pay dividends on its common stock. Also, Great Southern Bancorp, Inc.’s right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. This includes claims under the liquidation account maintained for the benefit of certain eligible deposit account holders of the Bank established in connection with the Bank’s conversion from the mutual to the stock form of ownership.
As described below in the next risk factor, the terms of our outstanding junior subordinated debt securities prohibit us from paying dividends on or repurchasing our common stock at any time when we have elected to defer the payment of interest on such debt securities or certain events of default under the terms of those debt securities have occurred and are continuing. These restrictions could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our board of directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our board of directors could reduce, suspend or eliminate our common stock cash dividend in the future.
If we defer payments of interest on our outstanding junior subordinated debt securities or if certain defaults relating to those debt securities occur, we will be prohibited from declaring or paying dividends or distributions on, and from making liquidation payments with respect to, our common stock.
As of December 31, 2019, we had outstanding $25.8 million aggregate principal amount of junior subordinated debt securities issued in connection with the sale of trust preferred securities by one of our subsidiaries that is a statutory business trust. We have also guaranteed those trust preferred securities. The indenture governing the junior subordinated debt securities, together with the related guarantee, prohibits us, subject to limited exceptions, from declaring or paying any dividends or distributions on, or redeeming, repurchasing, acquiring or making any liquidation payments with respect to, any of our capital stock (including any preferred stock and our common stock) at any time when (i) there shall have occurred and be continuing an event of default under the indenture or any event, act or condition that with notice or lapse of time or both would constitute an event of default under the indenture; or (ii) we are in default with respect to payment of any obligations under the related guarantee; or (iii) we have deferred payment of interest on the junior subordinated debt securities. In that regard, we are entitled, at our option but subject to certain conditions, to defer payments of interest on the junior subordinated debt securities from time to time for up to five years.
Events of default under the indenture generally consist of our failure to pay interest on the junior subordinated debt securities under certain circumstances, our failure to pay any principal of or premium on the junior subordinated debt securities when due, our failure to comply with certain covenants under the indenture, and certain events of bankruptcy, insolvency or liquidation relating to us or Great Southern Bank.
As a result of these provisions, if we were to elect to defer payments of interest on the junior subordinated debt securities, or if any of the other events described in clause (i) or (ii) of the first paragraph of this risk factor were to occur, we would be prohibited from declaring or paying any dividends on our stock, from redeeming, repurchasing or otherwise acquiring any of our stock, and from making any payments to holders of our stock in the event of our liquidation, which would likely have a material adverse effect on the market value of our common stock. Moreover, without notice to or consent from our stockholders, we may issue additional series of junior subordinated debt securities in the future with terms similar to those of our existing junior subordinated debt securities or enter into other financing agreements that limit our ability to purchase or to pay dividends or distributions on our capital stock, including our common stock.
The voting limitation provision in our charter could limit your voting rights as a holder of our common stock.
Our charter provides that any person or group who acquires beneficial ownership of our common stock in excess of 10.0% of the outstanding shares may not vote the excess shares. Accordingly, if you acquire beneficial ownership of more than 10.0% of the outstanding shares of our common stock, your voting rights with respect to the common stock will not be commensurate with your economic interest in the Company.
Anti-takeover provisions could adversely impact our stockholders.
Provisions in our charter and bylaws, the corporate law of the state of Maryland and federal regulations could delay or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the market price of any class of our equity securities, including our common stock. These provisions include: a prohibition on voting shares of common stock beneficially owned in excess of 10% of total shares outstanding, supermajority voting requirements for certain business combinations with any person who beneficially owns 10% or more of our outstanding common stock; the election of directors to staggered terms of three years; advance notice requirements for nominations for election to our board of directors and for proposing matters that stockholders may act on at stockholder meetings, a requirement that only directors may fill a vacancy in our board of directors, and supermajority voting requirements to remove any of our directors. Our charter also authorizes our board of directors to issue preferred stock, and preferred stock could be issued as a defensive measure in response to a takeover proposal. In addition, because we are a bank holding company, purchasers of 10% or more of our common stock may be required to obtain approvals under the Change in Bank Control Act of 1978, as amended, or the Bank Holding Company Act of 1956, as amended (and in certain cases such approvals may be required at a lesser percentage of ownership). Specifically, under regulations adopted by the Federal Reserve Board, (a) any other bank holding company may be required to obtain the approval of the Federal Reserve Board to acquire or retain 5% or more of our common stock and (b) any person other than a bank holding company may be required to obtain the approval of the Federal Reserve Board to acquire or retain 10% or more of our common stock.
These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions also could discourage proxy contests and make it more difficult for holders of our common stock to elect directors other than the candidates nominated by our board of directors.
Three members of the Turner family may exert substantial influence over the Company through their board and management positions and their ownership of the Company’s stock.
The Company’s Chairman of the Board, William V. Turner, and the Company’s Director, President and Chief Executive Officer, Joseph W. Turner, are father and son, respectively. Julie Turner Brown, a director of the Company, is the sister of Joseph Turner and the daughter of William Turner. These three Turner family members hold three of the Company’s nine Board positions. As of December 31, 2019, they also collectively beneficially owned approximately 2,114,324 shares of the Company’s common stock (excluding 59,250 shares underlying stock options exercisable as of or within 60 days after that date), representing approximately 14.8% of total shares outstanding, though they are subject to the voting limitation provision in our charter which precludes any person or group with beneficial ownership in excess of 10% of total shares outstanding from voting shares in excess of that threshold. Through their board and management positions and their ownership of the Company’s stock, these three members of the Turner family may exert substantial influence over the direction of the Company and the outcome of Board and stockholder votes.
In addition to the Turner family members, we are aware of other beneficial owners of more than five percent of the outstanding shares of our common stock. One of these beneficial owners is also a director of the Company.
As of December 31, 2019, one of the Company’s directors, Earl A. Steinert, beneficially owned 940,096 shares of our common stock, representing approximately 6.6% of total shares outstanding. The shares that can be voted by the Turner family members (1,426,105 shares, per the ten percent voting limitation in our charter) and the shares beneficially owned by Mr. Steinert (940,096) total 2,366,201, representing approximately 16.6% of total shares outstanding. While they have no agreement to do so, to the extent they vote in the same manner, these stockholders may be able to exercise influence over the management and business affairs of our Company. For example, using their collective voting power, these stockholders may be able to affect the outcome of director elections or block significant transactions, such as a merger or acquisition, or any other matter that might otherwise be favored by other stockholders.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES.
The Company’s corporate offices and operations center are located in Springfield, Missouri. At December 31, 2019, the Company operated 97 retail banking centers and over 200 automated teller machines ("ATMs") in Missouri, Iowa, Minnesota, Kansas, Nebraska and Arkansas. Of the 97 banking centers, the Company owns 88 of its locations and 9 were leased for various terms. The majority of our banking center locations are in southwest and central Missouri, including the Springfield, Mo. metropolitan area, with additional concentrations in the Sioux City, Iowa, Des Moines, Iowa, Quad Cities, Iowa, Minneapolis, Minn., St. Louis Mo. and Kansas City, Mo. metropolitan areas. The ATMs are located at various banking centers and primarily convenience stores and retail centers located throughout southwest and central Missouri. At December 31, 2019, the Company also operated six commercial and one mortgage loan production offices. The Company owns one of its loan production office locations and six locations are leased. All buildings which are owned are owned free of encumbrances or mortgages. In the opinion of management, the facilities are adequate and suitable for the needs of the Company. The aggregate net book value of the Company's premises and equipment was $141.9 million and $132.4 million at December 31, 2019 and 2018, respectively. See also Note 6 of the accompanying audited financial statements, which are included in Item 8 of this Report.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 4A. INFORMATION ABOUT OUR EXECUTIVE OFFICERS.
Pursuant to General Instruction G(3) of Form 10-K and the instruction to Item 401 of Regulation S-K, the following information is furnished in lieu of being included in the Registrant's definitive proxy statement.
The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company and its subsidiaries who are not directors of the Company and its subsidiaries. There are no arrangements or understandings between the persons named and any other person pursuant to which such officers were selected. The executive officers are elected annually and serve at the discretion of the respective Boards of Directors of the Company and its subsidiaries.
Kevin L Baker. Mr. Baker, age 52, is Vice President and Chief Credit Officer of the Bank. He joined the Bank in 2005 and is responsible for the overall credit approval process, commercial and consumer loan collection process and the loan documentation and servicing processes. Prior to joining the Bank, Mr. Baker was a lending officer at a commercial bank.
John M. Bugh. Mr. Bugh, age 52, is Vice President and Chief Lending Officer of the Bank. He joined the Bank in 2011 and is in charge of all loan production for the Bank, including commercial, residential and consumer loans. Prior to joining the Bank, Mr. Bugh was a lending officer at other commercial banks and was an examiner for the FDIC.
Rex A. Copeland. Mr. Copeland, age 55, is Treasurer of the Company and Senior Vice President and Chief Financial Officer of the Bank. He joined the Bank in 2000 and is responsible for the financial functions of the Company, including the internal and external financial reporting of the Company and its subsidiaries. Mr. Copeland is a Certified Public Accountant. Prior to joining the Bank, Mr. Copeland served other financial services companies in the areas of corporate accounting, internal audit and independent public accounting.
Douglas W. Marrs. Mr. Marrs, age 62, is Secretary of the Company and Secretary, Vice President - Operations of the Bank. He joined the Bank in 1996 and is responsible for all operations functions of the Bank. Prior to joining the Bank, Mr. Marrs was a bank officer in the areas of operations and data processing at a commercial bank.
Linton J. Thomason. Mr. Thomason, age 64, is Vice President - Information Services of the Bank. He joined the Bank in 1997 and is responsible for information services for the Company and all of its subsidiaries and all treasury management sales/operations of the Bank. Prior to joining the Bank, Mr. Thomason was a bank officer in the areas of technology and data processing, operations and treasury management at a commercial bank.
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
The Company's Common Stock is listed on The NASDAQ Global Select Market under the symbol "GSBC."
As of December 31, 2019 there were 14,261,052 total shares of common stock outstanding and approximately 2,000 stockholders of record.
The Company's ability to pay dividends is substantially dependent on the dividend payments it receives from the Bank. For a description of the regulatory restrictions on the ability of the Bank to pay dividends to the Company, and the ability of the Company to pay dividends to its stockholders, see "Item 1. Business - Government Supervision and Regulation - Dividends."
Stock Repurchases
On April 18, 2018, the Company's Board of Directors authorized management to repurchase up to 500,000 shares of the Company's outstanding common stock, under a program of open market purchases or privately negotiated transactions. The program does not have an expiration date. The authorization of this program terminated the previous repurchase program, which was approved in November 2006 with an authorization to repurchase up to 700,000 shares of the Company's outstanding common stock. From time to time, the Company may utilize a pre-arranged trading plan pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934 to repurchase its shares under the current repurchase program.
As indicated below, the Company repurchased the following shares of its common stock during the three months ended December 31, 2019.
__________________
(1)
Amount represents the number of shares available to be repurchased under the current program as of the last calendar day of the month shown.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial information and other financial data of the Company. The summary statement of financial condition information and statement of income information are derived from our consolidated financial statements, which have been audited by BKD, LLP. See Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
When used in this Annual Report and in other documents filed or furnished by Great Southern Bancorp, Inc. (the “Company”) with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or stockholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including, among other things, (i) expected revenues, cost savings, earnings accretion, synergies and other benefits from the Company's merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (ii) changes in economic conditions, either nationally or in the Company's market areas; (iii) fluctuations in interest rates; (iv) the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; (v) the possibility of other-than-temporary impairments of securities held in the Company's securities portfolio; (vi) the Company's ability to access cost-effective funding; (vii) fluctuations in real estate values and both residential and commercial real estate market conditions; (viii) demand for loans and deposits in the Company's market areas; (ix) the potential adverse effects of the coronavirus or any other pandemic on the ability of the Company's borrowers to satisfy their obligations to the Company, on the demand for the Company's loans or its other products and services, on other aspects of the Company's business operations and on financial markets and economic growth; (x) the ability to adapt successfully to technological changes to meet customers' needs and developments in the marketplace; (xi) the possibility that security measures implemented might not be sufficient to mitigate the risk of a cyber-attack or cyber theft, and that such security measures might not protect against systems failures or interruptions; (xii) legislative or regulatory changes that adversely affect the Company's business, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and its implementing regulations, the overdraft protection regulations and customers' responses thereto and the Tax Reform Legislation; (xiii) changes in accounting principles, policies or guidelines; (xiv) monetary and fiscal policies of the Federal Reserve Board and the U.S. Government and other governmental initiatives affecting the financial services industry; (xv) results of examinations of the Company and Great Southern Bank by their regulators, including the possibility that the regulators may, among other things, require the Company to limit its business activities, change its business mix, increase its allowance for loan losses, write-down assets or increase its capital levels, or affect its ability to borrow funds or maintain or increase deposits, which could adversely affect its liquidity and earnings; (xvi) costs and effects of litigation, including settlements and judgments; and (xvii) competition. The Company wishes to advise readers that the factors listed above and other risks described from time to time in documents filed or furnished by the Company with the SEC could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
The Company does not undertake -and specifically declines any obligation- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Allowance for Loan Losses and Valuation of Foreclosed Assets
The Company believes that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining an allowance level believed by management to be sufficient to absorb estimated loan losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates of, among other things, expected default probabilities, loss once loans default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses, and general amounts for historical loss experience.
The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which would adversely impact earnings in future periods. In addition, the Bank’s regulators could require additional provisions for loan losses as part of their examination process.
Additional discussion of the allowance for loan losses is included in "Item 1. Business - Allowances for Losses on Loans and Foreclosed Assets." Inherent in this process is the evaluation of individual significant credit relationships. From time to time certain credit relationships may deteriorate due to payment performance, cash flow of the borrower, value of collateral, or other factors. In these instances, management may revise its loss estimates and assumptions for these specific credits due to changing circumstances. In some cases, additional losses may be realized; in other instances, the factors that led to the deterioration may improve or the credit may be refinanced elsewhere and allocated allowances may be released from the particular credit. In the fourth quarter of 2014, the Company began using a three-year average of historical losses for the general component of the allowance for loan loss calculation. The Company had previously used a five-year average. The Company believes that the three-year average provides a better representation of the current risks in the loan portfolio. This change was made after consultation with our regulators and third-party consultants, as well as a review of the practices used by the Company’s peers. No significant changes were made to management's overall methodology for evaluating the allowance for loan losses during the periods presented in the financial statements of this report.
Beginning in 2020, the Company will adopt the new accounting standard related to the Allowance for Credit Losses. For assets held at amortized cost basis, this standard eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. See Note 1 of the accompanying audited financial statements for additional information.
In addition, the Company considers that the determination of the valuations of foreclosed assets held for sale involves a high degree of judgment and complexity. The carrying value of foreclosed assets reflects management’s best estimate of the amount to be realized from the sales of the assets. While the estimate is generally based on a valuation by an independent appraiser or recent sales of similar properties, the amount that the Company realizes from the sales of the assets could differ materially from the carrying value reflected in the financial statements, resulting in losses that could adversely impact earnings in future periods.
Carrying Value of Loans Acquired in FDIC-assisted Transactions and Indemnification Asset
The Company considers that the determination of the carrying value of loans acquired in the FDIC-assisted transactions and the carrying value of the related FDIC indemnification asset involves a high degree of judgment and complexity. The carrying value of the acquired loans and, prior to June 30, 2017, the FDIC indemnification asset reflect management’s best ongoing estimates of the amounts to be realized on each of these assets. The Company has now terminated all loss sharing agreements with the FDIC and, accordingly, no longer has an indemnification asset. The Company determined initial fair value accounting estimates of the acquired assets and assumed liabilities in accordance with FASB ASC 805, Business Combinations. However, the amount that the Company realizes on its acquired loan assets could differ materially from the carrying value reflected in its financial statements, based upon the timing of collections on the acquired loans in future periods. Because of the loss sharing agreements with the FDIC on certain of these assets, the Company did not expect to incur any significant losses related to these assets. To the extent the actual values realized for the acquired loans are different from the estimates, the indemnification asset was generally impacted in an offsetting manner due to the loss sharing support from the FDIC. Subsequent to the initial valuation, the Company continued to monitor identified loan pools for changes in estimated cash flows projected for the loan pools, anticipated credit losses and changes in the accretable yield. Analysis of these variables requires significant estimates and a high degree of judgment. See Note 4 of the accompanying audited financial statements for additional information regarding the TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank FDIC-assisted transactions.
As noted above, in 2020, the Company will adopt the new accounting standard related to the Allowance for Credit Losses. The adoption of this standard will required the Company to reclassify any remaining non-accretable yield adjustment to the Allowance for Credit Losses. FDIC-assisted acquired loans will still be evaluated in their original pools that were determined at the acquisition date of the loans. See Note 1 of the accompanying audited financial statements for additional information.
Goodwill and Intangible Assets
Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually and more frequently if circumstances indicate their value may not be recoverable. Goodwill is tested for impairment using a process that estimates the fair value of each of the Company’s reporting units compared with its carrying value. The Company defines reporting units as a level below each of its operating segments for which there is discrete financial information that is regularly reviewed. As of December 31, 2019, the Company has one reporting unit to which goodwill has been allocated - the Bank. If the fair value of a reporting unit exceeds its carrying value, then no impairment is recorded. If the carrying value amount exceeds the fair value of a reporting unit, further testing is completed comparing the implied fair value of the reporting unit’s goodwill to its carrying value to measure the amount of impairment. Intangible assets that are not amortized will be tested for impairment at least annually by comparing the fair values of those assets to their carrying values. At December 31, 2019, goodwill consisted of $5.4 million at the Bank reporting unit, which included goodwill of $4.2 million that was recorded during 2016 related to the acquisition of 12 branches from Fifth Third Bank. Other identifiable intangible assets that are subject to amortization are amortized on a straight-line basis over a period of seven years. At December 31, 2019, the amortizable intangible assets consisted of core deposit intangibles of $2.7 million, including $1.9 million related to the Fifth Third Bank transaction in January 2016, $600,000 related to the Valley Bank transaction in June 2014 and $153,000 related to the Boulevard Bank transaction in March 2014. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value. See Note 1 of the accompanying audited financial statements for additional information.
For purposes of testing goodwill for impairment, the Company used a market approach to value its reporting unit. The market approach applies a market multiple, based on observed purchase transactions for each reporting unit, to the metrics appropriate for the valuation of the operating unit. Significant judgment is applied when goodwill is assessed for impairment. This judgment may include developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables and incorporating general economic and market conditions.
Based on the Company’s goodwill impairment testing, management does not believe any of the Company's goodwill or other intangible assets were impaired as of December 31, 2019. While management believes no impairment existed at December 31, 2019, different conditions or assumptions used to measure fair value of the reporting unit, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company’s impairment evaluation in the future.
Current Economic Conditions
Changes in economic conditions could cause the values of assets and liabilities recorded in the financial statements to change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, or capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
Following the housing and mortgage crisis and correction beginning in mid-2007, the United States entered a prolonged economic downturn. Unemployment rose from 4.7% in November 2007 to peak at 10.0% in October 2009. The elevated unemployment levels negatively impacted consumer confidence, which had a detrimental impact on industry-wide performance nationally as well as in the Company's Midwest market area. Economic conditions have significantly improved since then, as indicated by consumer confidence levels, increased economic activity and low unemployment levels.
In December 2019, the economy marked its 111th straight month of net job gains with 145,000 jobs added. Hiring was below economists’ estimates of 164,000 added jobs but the national unemployment rate held steady at 3.5%. The rate compares to a 3.9% rate at December 2018 and is still the lowest rate of unemployed Americans recorded since December 1969. Employment in health care and in professional and business services continued to trend higher. As of December 2019, the U.S. labor force participation rate (the share of working-age Americans employed or actively looking for a job) was 63.2% and the employment population ratio was 61.0%, with both ratios unchanged over the past few months. The unemployment rate for the Midwest, where most of the Company’s
business is conducted, remained stable and in-line with the national average at 3.5% in December 2019. Unemployment rates for December 2019 were: Missouri at 3.3%, Arkansas at 3.6%, Kansas at 3.2%, Iowa at 2.7%, Minnesota at 3.3%, Illinois at 3.7%, Oklahoma at 3.4%, Texas at 3.5%, Georgia at 3.2% and Colorado at 2.5%. Of the metropolitan areas in which the Company does business, the St. Louis area had the highest unemployment level at 3.3% as of December 2019 while the unemployment rate for the Springfield market areas was at 3.2%, below the national average. Metropolitan areas in Iowa, Missouri, Nebraska and Minnesota continued to boast unemployment levels amongst the lowest in the nation.
Sales of newly built single-family homes fell 0.4% in December 2019. However, 2019 was the strongest year for home sales since 2006. Sales were a seasonally adjusted annual rate of 681,000 according to the U.S. Census Bureau and the Department of Housing and Urban Development estimates increased 10.3% from the 2018 seasonally adjusted annual rate of 617,000. The median sales price of new houses sold in December 2019 was $331,400, up slightly from $329,700 a year earlier. The December 2019 average sales price of $382,300 was down slightly from $384,000 a year ago. The inventory of new homes for sale at the end of December would support 5.7 months’ supply at the current sales pace, down from 6.6 months’ supply as of December 2018.
According to the National Association of Realtors (NAR), U.S. existing-home sales grew to a seasonally adjusted rate of 5.54 million in December 2019. Overall sales increased by 10.8% from 5.00 million in December 2018. Sales in the Midwest reflected a 1.6% decline from November 2019 but an annual gain of 8.9% during 2019. On a full-year basis, total existing-home sales ended at 5.34 million, the same level as in 2018, with sales in the South region (+2.2%) offsetting declines in the West (-1.8%) and Midwest (-1.6%).
Total housing inventory at the end of December 2019 was at 1.4 million units, down 14.6% from November 2019 and 8.5% from one year ago (1.53 million units). Unsold inventory totals have dropped for seven consecutive months and are causing home sales declines due to a lack of inventory. The median existing home price for all housing types in December 2019 was $274,500, up 7.8% from December 2018. In the Midwest region, existing home sales decreased 1.5% to an annual rate of 1.30 million units. The median price in the Midwest was $208,500, a 9.2% increase from December 2018.
First-time buyers accounted for 31% of sales in December 2019, down slightly from 32% seen in November 2019 and December 2018. According to Freddie Mac, the average commitment rate for a 30-year, conventional, fixed-rate mortgage increased to 3.72% in December 2019, down from 3.70% in November 2019. The average commitment rate for all of 2019 was 3.94%, down from 4.54% in 2018. Since the end of 2019, the average commitment rate for this type of loan has declined further.
The other residential (multi-family) sector rebounded in 2017 - 2019, with demand approaching the highest level on record. National vacancy rates were 6.2% at the end of December 2019, while our market areas reflected the following vacancy levels: Springfield, Mo. at 4.7%, St. Louis at 9.1%, Kansas City at 7.3%, Minneapolis at 4.6%, Tulsa, Okla. at 8.8%, Dallas-Fort Worth at 8.2% , Chicago at 6.5%, Atlanta at 8.5% and Denver at 7.9%. Transaction volume has slowed, but pricing has remained on an upward trajectory. Cap rates are still at low levels. Continued increase in the homeownership rate is the largest risk to the apartment sector. Vacancy rates have increased somewhat in a few of our markets, partially due to the volume of units coming on-line. Developers continue to favor more-expensive submarkets. Despite the decline in affordability and rigid mortgage origination standards, about two-thirds of consumers still believe now is a good time to buy a home, according to a recent University of Michigan consumer survey. The homeownership rate has risen by more than a percentage point since 2016, to 64.2% in 2019. Per information provided by Integra IRR Viewpoint, the overwhelming majority of other residential (multi-family) markets across the country are deemed to be in expansion with all of the Company’s market areas in the expansion phase with the exception of Denver and Atlanta - currently in a hyper-supply phase. Those markets in hyper-supply phase exhibit increasing vacancy rates, moderate/high new construction, low/negative absorption, moderate/low employment growth and medium/low rental rate growth.
Macroeconomic basics such as low unemployment, expectations of continued job growth and sold economies are considered strong for the office sector. Per Integra, nationally approximately 63% of the suburban office markets are in an expansion market cycle -- characterized by decreasing vacancy rates, moderate/high new construction, high absorption, moderate/high employment growth and medium/high rental rate growth. While most markets are in recovery or expansion, risk is anticipated to increase in the coming years. The Company’s larger market areas in the suburban office market cycle include; Minneapolis, Dallas-Ft. Worth, and St. Louis. Tulsa, Okla., Chicago and Kansas City are currently in the recovery/expansion market cycle -- typified by decreasing vacancy rates, low new construction, moderate absorption, low/moderate employment growth and negative/low rental rate growth.
The continued rise of e-commerce has disrupted the retail market segment significantly. In the third quarter of 2019, e-commerce sales accounted for 11.2% of total sales with more than $145 billion in online transactions. E-commerce is projected to grow its share to 16.2% by 2023, according to industry source eMarketer. This means 55% of all additional retail sales for the next four years will be internet-based, as opposed to the remaining 45% of growth captured by brick and mortar facilities. Approximately 54% of the retail sector is in the expansion phase of the market cycle, with another 35% in recovery mode and the remaining 11% in hyper-supply and recession. The Company’s larger market areas in the retail expansion market segments are: Chicago, Kansas City, Dallas-Ft. Worth, and St. Louis. Denver and Minneapolis are in the hyper-supply cycle. The Atlanta and Tulsa, Okla. markets are each in recovery phase.
The industrial segment, once concentrated in manufacturing, is now epitomized by a dense network of warehousing, distribution, logistics, and R&D/Flex properties, which is the conduit of the current global e-commerce revolution. All of the Company’s larger industrial market areas are included in the expansion cycle with prospects of continuing good economic growth. Three market areas, Chicago, Minneapolis and Kansas City, are in the latter stages of the expansion cycle.
Occupancy, absorption and rental income levels of commercial real estate properties located throughout the Company’s market areas remain stable according to information provided by real estate services firm CoStar Group. Moderate real estate sales and financing activity is continuing to support loan growth.
While current economic indicators show stability nationally in employment, housing starts and prices, commercial real estate occupancy, absorption and rental rates, our management will continue to closely monitor regional, national and global economic conditions, as these could significantly impact our market areas.
Loss Sharing Agreements
On April 26, 2016, Great Southern Bank executed an agreement with the FDIC to terminate the loss sharing agreements for Team Bank, Vantus Bank and Sun Security Bank, effective immediately. The agreement required the FDIC to pay $4.4 million to settle all outstanding items related to the terminated loss sharing agreements.
On June 9, 2017, Great Southern Bank executed an agreement with the FDIC to terminate the loss sharing agreements for InterBank, effective immediately. Pursuant to the termination agreement, the FDIC paid $15.0 million to the Bank to settle all outstanding items related to the terminated loss sharing agreements. The Company recorded a pre-tax gain on the termination of $7.7 million.
The terminations of the loss sharing agreements for the TeamBank, Vantus Bank, Sun Security Bank and InterBank transactions have had no impact on the yields for the loans that were previously covered under these agreements, as the remaining accretable yield adjustments that affect interest income have not been changed and will continue to be recognized for all FDIC-assisted transactions in the same manner as they have been previously. All post-termination recoveries, gains, losses and expenses related to these previously covered assets are recognized entirely by Great Southern Bank since the FDIC no longer shares in such gains or losses. Accordingly, the Company’s earnings are positively impacted to the extent the Company recognizes gains on any sales or recoveries in excess of the carrying value of such assets. Similarly, the Company’s earnings are negatively impacted to the extent the Company recognizes expenses, losses or charge-offs related to such assets. After 2017, there are no effects on non-interest income (expense) related to adjustments or amortization of the indemnification assets for Team Bank, Vantus Bank, Sun Security Bank or InterBank. All rights and obligations of the Bank and the FDIC under the terminated loss sharing agreements, including the settlement of all existing loss sharing and expense reimbursement claims, have been resolved and terminated.
General
The profitability of the Company and, more specifically, the profitability of its primary subsidiary, the Bank, depend primarily on its net interest income, as well as provisions for loan losses and the level of non-interest income and non-interest expense. Net interest income is the difference between the interest income the Bank earns on its loans and investment portfolios, and the interest it pays on interest-bearing liabilities, which consists mainly of interest paid on deposits and borrowings. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on these balances. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
In the year ended December 31, 2019, Great Southern's total assets increased $338.9 million, or 7.2%, from $4.68 billion at December 31, 2018, to $5.02 billion at December 31, 2019. Full details of the current year changes in total assets are provided in the “Comparison of Financial Condition at December 31, 2019 and December 31, 2018” section.
Loans. In the year ended December 31, 2019, Great Southern's net loans increased $165.0 million, or 4.1%, from $3.99 billion at December 31, 2018, to $4.15 billion at December 31, 2019. Excluding FDIC-assisted acquired loans and mortgage loans held for sale, total gross loans increased $99.2 million, or 2.1%, from December 31, 2018 to December 31, 2019. This increase was primarily in commercial real estate loans, owner occupied one- to four-family residential loans and other residential (multi-family) loans. These increases were partially offset by decreases in construction loans and consumer auto loans. FDIC-assisted acquired loan portfolios decreased $40.4 million. As loan demand is affected by a variety of factors, including general economic conditions, and because of the competition we face and our focus on pricing discipline and credit quality, we cannot be assured that our loan growth will match or exceed the level of increases achieved in 2019 or prior years. The Company's strategy continues to be focused on maintaining credit risk and interest rate risk at appropriate levels.
Recent loan growth has occurred in several loan types, primarily construction loans, other residential (multi-family) real estate loans and commercial real estate loans and in most of Great Southern's primary lending locations, including Springfield, St. Louis, Kansas City, Des Moines and Minneapolis, as well as the loan production offices in Atlanta, Chicago, Dallas, Denver, Omaha and Tulsa. Certain minimum underwriting standards and monitoring help assure the Company's portfolio quality. Great Southern's loan committee reviews and approves all new loan originations in excess of lender approval authorities. Generally, the Company considers commercial construction, consumer, and commercial real estate loans to involve a higher degree of risk compared to some other types of loans, such as first mortgage loans on one- to four-family, owner-occupied residential properties. For commercial real estate, commercial business and construction loans, the credits are subject to an analysis of the borrower's and guarantor's financial condition, credit history, verification of liquid assets, collateral, market analysis and repayment ability. It has been, and continues to be, Great Southern's practice to verify information from potential borrowers regarding assets, income or payment ability and credit ratings as applicable and as required by the authority approving the loan. To minimize construction risk, projects are monitored as construction draws are requested by comparison to budget and with progress verified through property inspections. The geographic and product diversity of collateral, equity requirements and limitations on speculative construction projects help to mitigate overall risk in these loans. Underwriting standards for all loans also include loan-to-value ratio limitations which vary depending on collateral type, debt service coverage ratios or debt payment to income ratio guidelines, where applicable, credit histories, use of guaranties and other recommended terms relating to equity requirements, amortization, and maturity. Consumer loans are primarily secured by new and used motor vehicles and these loans are also subject to certain minimum underwriting standards to assure portfolio quality. Great Southern's consumer underwriting and pricing standards were fairly consistent over the past several years through the first half of 2016. In response to a more challenging consumer credit environment, the Company tightened its underwriting guidelines on automobile lending in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and lower delinquencies and charge-offs. The underwriting standards employed by Great Southern for consumer loans include a determination of the applicant's payment history on other debts, credit scores, employment history and an assessment of ability to meet existing obligations and payments on the proposed loan. In 2019, the Company made the decision to discontinue indirect auto loan originations.
Of the total loan portfolio at December 31, 2019 and 2018, 87.2% and 84.4%, respectively, was secured by real estate, as this is the Bank’s primary focus in its lending efforts. At December 31, 2019 and 2018, commercial real estate and commercial construction loans were 47.6% and 49.7% of the Bank’s total loan portfolio (excluding loans acquired through FDIC-assisted transactions), respectively. Commercial real estate and commercial construction loans generally afford the Bank an opportunity to increase the yield on, and the proportion of interest rate sensitive loans in, its portfolio. They do, however, present somewhat greater risk to the Bank because they may be more adversely affected by conditions in the real estate markets or in the economy generally. At December 31, 2019 and 2018, loans made in the Springfield, Mo. metropolitan statistical area (Springfield MSA) were 9% and 9% of the Bank’s total loan portfolio (excluding loans acquired through FDIC-assisted transactions), respectively. The Company’s headquarters are located in Springfield and we have operated in this market since 1923. Because of our large presence and experience in the Springfield MSA, many lending opportunities exist. However, if the economic conditions of the Springfield MSA were worse than those of other market areas in which we operate or the national economy overall, the performance of these loans could decline comparatively. At December 31, 2019 and 2018, loans made in the St. Louis, Mo. metropolitan statistical area (St. Louis MSA) were 17% and 19% of the Bank’s total loan portfolio (excluding loans acquired through FDIC-assisted transactions), respectively. The Company’s expansion into the St. Louis MSA beginning in May 2009 has provided an opportunity to not only expand its markets and provide diversification from the Springfield MSA, but also has provided access to a larger economy with increased lending opportunities despite higher levels of competition. Loans made in the St. Louis MSA are primarily commercial real estate, commercial business and other residential (multi-family) loans which are less likely to be impacted by the higher levels of unemployment rates, as mentioned above under “Current Economic Conditions,” than if the focus were on one- to four-family residential and consumer loans. For further discussions of the Bank’s loan portfolio, and specifically, commercial real estate and commercial construction loans, see “Item 1. Business - Lending Activities.”
The percentage of fixed-rate loans in our loan portfolio has been as much as 58% in recent years and was 50% as of December 31, 2019. This was due to customer preference for fixed rate loans during this period of relatively low interest rates. The majority of the increase in fixed rate loans over the past few years was in commercial construction and commercial real estate, both of which typically have short durations within our portfolio. Of the total amount of fixed rate loans in our portfolio as of December 31, 2019, approximately 79% mature within one to five years and therefore are not considered to create significant long-term interest rate risk for the Company. Fixed rate loans make up only a portion of our balance sheet and our overall interest rate risk strategy. As of December 31, 2019, our interest rate risk models indicated a one-year interest rate earnings sensitivity position that is modestly positive in an increasing rate environment. For further discussion of our interest rate sensitivity gap and the processes used to manage our exposure to interest rate risk, see “Quantitative and Qualitative Disclosures About Market Risk - How We Measure the Risks to Us Associated with Interest Rate Changes.” For discussion of the risk factors associated with interest rate changes, see “Risk Factors - We may be adversely affected by interest rate changes.”
While our policy allows us to lend up to 95% of the appraised value on one-to four-family residential properties, originations of loans with loan-to-value ratios at that level are minimal. Private mortgage insurance is typically required for loan amounts above the 80% level. Few exceptions occur and would be based on analyses which determined minimal transactional risk to be involved. We consider these lending practices to be consistent with or more conservative than what we believe to be the norm for banks our size. At December 31, 2019 and 2018, an estimated 0.0% and 0.1%, respectively, of total owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination. At December 31, 2019 and 2018, an estimated 0.6% and 0.9%, respectively, of total non-owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination.
At December 31, 2019, troubled debt restructurings totaled $1.9 million, or 0.05% of total loans, down $5.0 million from $6.9 million, or 0.17% of total loans, at December 31, 2018. Concessions granted to borrowers experiencing financial difficulties may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. For troubled debt restructurings occurring during the year ended December 31, 2019, five loans totaling $34,000 were restructured into multiple new loans. For troubled debt restructurings occurring during the year ended December 31, 2018, five loans totaling $31,000 were restructured into multiple new loans. For further information on troubled debt restructurings, see Note 3 of the accompanying audited financial statements, which are included in Item 8 of this report.
Loans that were acquired through FDIC-assisted transactions, which are accounted for in pools, are currently included in the analysis and estimation of the allowance for loan losses. If expected cash flows to be received on any given pool of loans decreases from previous estimates, then a determination is made as to whether the loan pool should be charged down or the allowance for loan losses should be increased (through a provision for loan losses). As noted above, the loss sharing agreements for Team Bank, Vantus Bank and Sun Security Bank were terminated on April 26, 2016 and the loss sharing agreements for InterBank were terminated on June 9, 2017. Acquired loans are described in detail in Note 4 of the accompanying audited financial statements, included in Item 8 of this Report. For acquired loan pools, the Company may allocate, and at December 31, 2019, has allocated, a portion of its allowance for loan losses related to these loan pools in a manner similar to how it allocates its allowance for loan losses to those loans which are collectively evaluated for impairment.
The level of non-performing loans and foreclosed assets affects our net interest income and net income. We generally do not accrue interest income on these loans and do not recognize interest income until the loans are repaid or interest payments have been made for a period of time sufficient to provide evidence of performance on the loans. Generally, the higher the level of non-performing assets, the greater the negative impact on interest income and net income.
Available-for-sale Securities. In the year ended December 31, 2019, available-for-sale securities increased $130.2 million, or 53.4%, from $244.0 million at December 31, 2018, to $374.2 million at December 31, 2019. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities and FNMA and GNMA fixed rate collateralized mortgage obligation securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities.
Deposits. The Company attracts deposit accounts through its retail branch network, correspondent banking and corporate services areas, and brokered deposits. The Company then utilizes these deposit funds, along with FHLBank advances and other borrowings, to meet loan demand or otherwise fund its activities. In the year ended December 31, 2019, total deposit balances increased $235.1 million, or 6.3%. Transaction account balances increased $105.4 million and retail certificates of deposit increased $84.9 million compared to December 31, 2018. The
increase in transaction accounts were primarily a result of increases in money market deposit accounts and certain NOW account types. Retail certificates of deposit increased due to an increase of approximately $127 million in certificates of deposit opened through the Company’s internet deposit acquisition channels during 2019, partially offset by a decrease
of approximately $49 million in retail certificates generated through our banking centers. Some of these deposits were generated as a result of our rates intentionally being in the top tier compared to our competitors in the internet channels during 2019. Brokered deposits, including CDARS program purchased funds, were $371.7 million at December 31, 2019, an increase of $44.8 million from $326.9 million at December 31, 2018.
Our deposit balances may fluctuate depending on customer preferences and our relative need for funding. We do not consider our retail certificates of deposit to be guaranteed long-term funding because customers can withdraw their funds at any time with minimal interest penalty. When loan demand trends upward, we can increase rates paid on deposits to increase deposit balances and utilize brokered deposits to provide additional funding. The level of competition for deposits in our markets is high. It is our goal to gain deposit market share, particularly checking accounts, in our branch footprint. To accomplish this goal, increasing rates to attract deposits may be necessary, which could negatively impact the Company’s net interest margin.
Our ability to fund growth in future periods may also depend on our ability to continue to access brokered deposits and FHLBank advances. In times when our loan demand has outpaced our generation of new deposits, we have utilized brokered deposits and FHLBank advances to fund these loans. These funding sources have been attractive to us because we can create either fixed or variable rate funding, as desired, which more closely matches the interest rate nature of much of our loan portfolio. It also gives us greater flexibility in increasing or decreasing the duration of our funding. While we do not currently anticipate that our ability to access these sources will be reduced or eliminated in future periods, if this should happen, the limitation on our ability to fund additional loans could have a material adverse effect on our business, financial condition and results of operations.
Federal Home Loan Bank Advances and Short Term Borrowings. The Company’s Federal Home Loan Bank term advances were $-0- at both December 31, 2019 and December 31, 2018. At December 31, 2019 and 2018, there were no borrowings from the FHLBank, other than overnight advances, which are included in the short term borrowings category.
Short term borrowings and other interest-bearing liabilities increased $35.5 million from $192.7 million at December 31, 2018 to $228.2 million at December 31, 2019. The short term borrowings included overnight FHLBank borrowings of $196.0 million at December 31, 2019 and $178.0 million at December 31, 2018. The Company utilizes both overnight borrowings and short-term FHLBank advances depending on relative interest rates.
Net Interest Income and Interest Rate Risk Management. Our net interest income may be affected positively or negatively by changes in market interest rates. A large portion of our loan portfolio is tied to one-month LIBOR, three-month LIBOR or the "prime rate" and adjusts immediately or shortly after the index rate adjusts (subject to the effect of contractual interest rate floors on some of the loans, which are discussed below). We monitor our sensitivity to interest rate changes on an ongoing basis (see "Quantitative and Qualitative Disclosures About Market Risk"). In addition, our net interest income has been impacted by changes in the cash flows expected to be received from acquired loan pools. As described in Note 4 of the accompanying audited financial statements, included in Item 8 of this report, the Company’s evaluation of cash flows expected to be received from acquired loan pools has been on-going and increases in cash flow expectations have been recognized as increases in accretable yield through interest income. Decreases in cash flow expectations have been recognized as impairments through the allowance for loan losses.
The current level and shape of the interest rate yield curve poses challenges for interest rate risk management. Prior to its increase of 0.25% on December 16, 2015, the FRB had last changed interest rates on December 16, 2008. This was the first rate increase since September 29, 2006. The FRB also implemented rate change increases of 0.25% on eight additional occasions beginning December 14, 2016 and through December 31, 2018, with the Federal Funds rate reaching as high as 2.50%. After December 2018, the FRB paused its rate increases and, in July, September and October 2019, implemented rate change decreases of 0.25% on each of those occasions. At December 31, 2019, the Federal Funds rate stood at 1.75%. A substantial portion of Great Southern’s loan portfolio ($1.89 billion at December 31, 2019) is tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days after December 31, 2019. Of these loans, $1.71 billion had interest rate floors. Great Southern also has a portfolio of loans ($210 million at December 31, 2019) tied to a "prime rate" of interest and will adjust immediately with changes to the "prime rate" of interest. A rate cut by the FRB generally would have an anticipated immediate negative impact on the Company's net interest income due to the large total balance of loans tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days or loans which generally adjust immediately as the Federal Funds rate adjusts. Interest rate floors may at least partially mitigate the negative impact of interest rate decreases. Loans at their floor rates are, however, subject to the risk that borrowers will seek to refinance elsewhere at the lower market rate. Because the Federal Funds rate is still generally low, there may also be a negative impact on the Company's net interest income due to the Company's inability to significantly lower its funding costs in the current competitive rate environment, although interest rates on assets may decline further. Conversely, interest rate increases would normally result in increased interest rates on our LIBOR-based and prime-based loans. As of December 31, 2019, Great
Southern's interest rate risk models indicate that, generally, rising interest rates are expected to have a positive impact on the Company's net interest income, while declining interest rates are expected to have a negative impact on net interest income. We model various interest rate scenarios for rising and falling rates, including both parallel and non-parallel shifts in rates. The results of our modeling indicate that net interest income is not likely to be significantly affected either positively or negatively in the first twelve months following a rate change, regardless of any changes in interest rates, because our portfolios are relatively well matched in a twelve-month horizon. The effects of interest rate changes, if any, on net interest income are expected to be greater in the 12 to 36 months following rate changes. During the latter half of 2019, we did experience some compression of our net interest margin percentage due to 0.75% of Federal Funds rate cuts over a 12-week period during July through October. Margin compression primarily resulted from generally unchanged average interest rates on deposits and certain borrowings and lower yields on loans and other interest-earning assets. LIBOR interest rates have decreased, putting pressure on loan yields, and strong pricing competition for loans and deposits remains in most of our markets. For further discussion of the processes used to manage our exposure to interest rate risk, see “Quantitative and Qualitative Disclosures About Market Risk - How We Measure the Risks to Us Associated with Interest Rate Changes.”
Non-Interest Income and Operating Expenses. The Company's profitability is also affected by the level of its non-interest income and operating expenses. Non-interest income consists primarily of service charges and ATM fees, late charges and prepayment fees on loans, gains on sales of loans and available-for-sale investments and other general operating income. In 2017, increases in the cash flows expected to be collected from the FDIC-covered loan portfolios resulted in amortization (expense) recorded relating to reductions of expected reimbursements under the loss sharing agreements with the FDIC, which were recorded as indemnification assets. This is no longer the case for the InterBank transaction subsequent to June 2017 (due to the termination of the related loss sharing agreements effective as of that date). Therefore, no further amortization (expense) will be recorded relating to the reductions of expected reimbursements under the loss sharing agreements with the FDIC as all indemnification assets and other balances due to/from the FDIC have been settled. The Company recorded a gain in non-interest income during 2017 related to the termination of the InterBank loss sharing agreements. Non-interest income may also be affected by the Company's interest rate derivative activities, if the Company chooses to implement derivatives.
Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, expenses related to foreclosed assets, postage, FDIC deposit insurance, advertising and public relations, telephone, professional fees, office expenses and other general operating expenses. Details of the current period changes in non-interest income and non-interest expense are provided under “Results of Operations and Comparison for the Years Ended December 31, 2019 and 2018.”
Business Initiatives
The Company implemented several business and operational initiatives in 2019.
For the long-term success of the Company, the performance of all business lines is regularly evaluated. From this review, a Business Banking initiative was implemented in 2019 to increase the Company’s focus on serving the lending needs of business owners. The Business Banking group works with established operating businesses by providing lines of credit, equipment loans, and commercial real estate loans, as well as cash management and depository services.
In the first quarter of 2019, the Company exited the indirect automobile lending business, which provided financing for customers of automobile dealerships. Market forces, including strong rate competition for well qualified borrowers, made indirect lending through automobile dealerships a significant barrier to efficient and profitable operations over the long term. The Company continues to offer direct consumer loans as normal through its extensive banking center network.
The Company’s 97 banking centers are also consistently reviewed to measure performance and to ensure responsiveness to changing customer needs and preferences. As such, the Company may open banking centers and invest resources where customer demand leads, and from time to time, consolidate banking centers or even exit markets when conditions dictate.
As a complement to its internal evaluation process, at the end of 2019, the Company engaged a third-party vendor to begin analyzing all banking center facilities and the in-branch customer experience to ensure that this physical access channel is efficiently evolving to the changing landscape.
Several banking center changes were initiated in 2019. In April 2019, the Company consolidated its Fayetteville, Arkansas, location into its Rogers, Arkansas, banking center. The Fayetteville office opened in 2014 and did not meet performance expectations. The Company now operates one banking center in Arkansas.
In September 2019, the Company consolidated its Ames, Iowa, banking center into its North Ankeny, Iowa office. The Company entered the Ames market with only one banking center through an FDIC-assisted acquisition in 2014. The Ames office building was sold during the fourth quarter of 2019. The Company now operates 18 banking centers in Iowa.
During the fourth quarter of 2019, several banking center improvement projects began or were already underway. In the Parsons, Kansas, market, remodeling is proceeding on the downtown office at 1900 Main, which includes the addition of drive-through banking lanes. Once completed in mid-2020, the nearby drive-through facility will be consolidated into the downtown office, leaving one office serving the Parsons market.
In the Joplin market, the Company recently purchased a banking facility vacated by another financial institution. This facility is located in close proximity to other current Great Southern banking centers. After a contractual black-out period that ends in April 2021, the Company expects to consolidate some of these existing operations into the purchased facility, which provides better customer accessibility.
The two-story office in Rogers, Arkansas is currently being remodeled to move the commercial lending offices from the second floor to space adjacent to the retail banking center offices on the first floor. The space vacated on the second floor is expected to be leased to third parties. Four other third-party tenants also lease space in this facility. The banking center at 1701 W. Jackson in Ozark, Missouri, is also undergoing construction to reconfigure excess space to be leased to third parties.
The Company continues to develop or enhance its technology platforms. During the first quarter of 2019, the Company upgraded its online account opening platform to provide a faster and easier customer experience. The online platform, available on GreatSouthernBank.com, allows customers within and beyond the Company’s geographic footprint to conveniently open certain depository accounts.
The Company’s retail online banking platform and mobile banking application are currently being upgraded to enhance customer functionality and convenience. The new platform and app are expected to be available to customers during the second quarter of 2020.
A transition to a new debit card payment processing vendor was completed at the end of January 2020. The move to MasterCard as the payment processing partner allows for more streamlined processing of debit card transactions and the ability to more quickly respond to advancing technology.
Effect of Federal Laws and Regulations
General. Federal legislation and regulation significantly affect the operations of the Company and the Bank, and have increased competition among commercial banks, savings institutions, mortgage banking enterprises and other financial institutions. In particular, the capital requirements and operations of regulated banking organizations such as the Company and the Bank have been and will be subject to changes in applicable statutes and regulations from time to time, which changes could, under certain circumstances, adversely affect the Company or the Bank.
Dodd-Frank Act. In 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape. Certain aspects of the Dodd-Frank Act have been affected by the recently Economic Growth Act, as defined and discussed below under “-Economic Growth Act.”
Capital Rules. The federal banking agencies have adopted regulatory capital rules that substantially amend the risk-based capital rules applicable to the Bank and the Company. The rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various documents released by the Basel Committee on Banking Supervision. For the Company and the Bank, the general effective date of the rules was January 1, 2015, and, for certain provisions, various phase-in periods and later effective dates apply. The chief features of these rules are summarized below.
The rules refine the definitions of what constitutes regulatory capital and add a new regulatory capital element, common equity Tier 1 capital. The minimum capital ratios are (i) a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6%; (iii) a total risk-based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. In addition to the minimum capital ratios, the rules include a capital conservation buffer, under which a banking organization must have CET1 more than 2.5% above each of its minimum risk-based capital ratios in order to avoid restrictions on paying dividends, repurchasing shares, and paying certain discretionary bonuses. The capital conservation buffer requirement began phasing in on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increased an equal amount each year until the buffer requirement of greater than 2.5% of risk-weighted assets became fully implemented on January 1, 2019.
Effective January 1, 2015, these rules also revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels show signs of weakness. Under the revised prompt corrective action requirements, insured depository institutions are required to meet the following in order to qualify as “well capitalized:” (i) a common equity Tier 1 risk-based capital ratio of at least 6.5%, (ii) a Tier 1 risk-based capital ratio of at least 8%, (iii) a total risk-based capital ratio of at least 10% and (iv) a Tier 1 leverage ratio of 5%, and must not be subject to an order, agreement or directive mandating a specific capital level.
Economic Growth Act. In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or eliminate certain financial reform rules and regulations, including some implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these amendments could result in meaningful regulatory changes.
The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “Community Bank Leverage Ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered “well-capitalized” under the prompt corrective action rules. Effective January 1, 2020, the Community Bank Leverage Ratio is 9.0%.
In addition, the Economic Growth Act includes regulatory relief in the areas of examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and the forthcoming implementing rules and regulations will have on us.
Recent Accounting Pronouncements
See Note 1 to the accompanying audited financial statements, which are included in Item 8 of this Report, for
a description of recent accounting pronouncements including the respective dates of adoption and expected effects on the Company’s financial position and results of operations.
Comparison of Financial Condition at December 31, 2019 and December 31, 2018
During the year ended December 31, 2019, total assets increased by $338.9 million to $5.02 billion. The increase was primarily attributable to increases in loans receivable and available-for-sale investment securities.
Cash and cash equivalents were $220.2 million at December 31, 2019, an increase of $17.5 million, or 8.6%, from $202.7 million at December 31, 2018. During 2019, cash increased primarily due to increases in interest-bearing deposits. This increase in cash was partially offset by funding the origination of loans and purchase of available for sale securities.
The Company’s available for sale securities increased $130.2 million, or 53.4%, compared to December 31, 2018. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities and agency collateralized mortgage obligation securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities. The available-for-sale securities portfolio was 7.5% and 5.2% of total assets at December 31, 2019 and 2018, respectively.
Net loans increased $165.0 million from December 31, 2018, to $4.15 billion at December 31, 2019. Excluding FDIC-assisted acquired loans and mortgage loans held for sale, total gross loans (including the undisbursed portion of loans) increased $99.2 million, or 2.1%, from December 31, 2018 to December 31, 2019. Increases primarily occurred in commercial real estate loans, other residential (multi-family) loans and one- to four-family residential mortgage loans. Outstanding and undisbursed balances of commercial real estate loans increased $122.7 million, or 8.9%, one- to four-family residential loans increased $108.1 million, or 27.1%, and other residential (multi-family) loans increased $81.1 million, or 10.3%. Partially offsetting the increases in these loans were a reduction of $88.3 million, or 5.9%, in commercial construction loans, a decrease of $101.7 million, or 40.1%, in consumer auto loans and a decrease of $40.4 million, or 24.1%, in the FDIC-assisted acquired loan portfolios.
Other real estate owned and repossessions were $5.5 million at December 31, 2019, a decrease of $2.9 million, or 34.5%, from $8.4 million at December 31, 2018. The decrease was primarily due to sales of other real estate properties and properties which were not acquired through foreclosure during the period, and is discussed in more detail in the Non-performing Assets section below.
Total liabilities increased $267.8 million from $4.14 billion at December 31, 2018 to $4.41 billion at December 31, 2019. The increase was primarily attributable to an increase in deposits and short-term borrowings, partially offset by a decrease in securities sold under reverse repurchase agreements.
Total deposits increased $235.1 million, or 6.3%, from $3.73 billion at December 31, 2018 to $3.96 billion at December 31, 2019. Customer retail certificates initiated through our banking center network decreased by $49.5 million during the year ended December 31, 2019 and certificates of deposit opened through the Company's internet deposit acquisition channels increased by $127.1 million. Brokered deposits, including CDARS program purchased funds, were $371.7 million at December 31, 2019, an increase of $44.8 million from $326.9 million at December 31, 2018.
The Company’s Federal Home Loan Bank advances were $-0- at both December 31, 2019 and 2018. At both December 31, 2019 and 2018, there were no borrowings from the FHLBank, other than overnight borrowings, which are included in the short term borrowings category. The Company utilizes both overnight borrowings and short-term FHLBank advances depending on relative interest rates.
Short term borrowings and other interest-bearing liabilities increased $35.5 million from $192.7 million at December 31, 2018 to $228.2 million at December 31, 2019. The short term borrowings included overnight FHLBank borrowings of $196.0 million at December 31, 2019 and $178.0 million at December 31, 2018.
Securities sold under reverse repurchase agreements with customers decreased $21.1 million, or 20.0%, from $105.3 million at December 31, 2018 to $84.2 million at December 31, 2019. These balances fluctuate over time based on customer demand for this product.
Total stockholders' equity increased $71.1 million from $532.0 million at December 31, 2018 to $603.1 million at December 31, 2019. The Company recorded net income of $73.6 million for the year ended December 31, 2019. Accumulated other comprehensive income increased $22.6 million due to increases in the fair value of available-for-sale investment securities and the fair value of cash flow hedges. In addition, total stockholders’ equity increased $5.1 million due to stock option exercises. Dividends declared on common stock, which decreased total stockholders’ equity, were $29.4 million. Total stockholders’ equity also decreased $849,000 due to repurchases of the Company’s common stock.
Results of Operations and Comparison for the Years Ended December 31, 2019 and 2018
General
Net income increased $6.5 million, or 9.7%, during the year ended December 31, 2019, compared to the year ended December 31, 2018. Net income was $73.6 million for the year ended December 31, 2019 compared to $67.1 million for the year ended December 31, 2018. This increase was due to an increase in net interest income of $12.2 million, or 7.3%, a decrease in provision for loan losses of $1.0 million, or 14.0%, and a decrease in non-interest expenses of $172,000, or 0.1%, partially offset by a decrease in non-interest income of $5.3 million, or 14.5%, and an increase in provision for income taxes of $1.6 million, or 10.8%. Net income available to common shareholders was $73.6 million for the year ended December 31, 2019 compared to $67.1 million for the year ended December 31, 2018.
Total Interest Income
Total interest income increased $29.0 million, or 14.1%, during the year ended December 31, 2019 compared to the year ended December 31, 2018. The increase was due to a $24.8 million, or 12.5%, increase in interest income on loans and a $4.2 million, or 54.7%, increase in interest income on investment securities and other interest-earning assets. Interest income on loans increased in 2019 compared to 2018 due to higher average rates of interest and higher average balances of loans. Interest income from investment securities and other interest-earning assets increased during 2019 compared to 2018 due to higher average rates of interest and higher average balances.
Interest Income - Loans
During the year ended December 31, 2019 compared to the year ended December 31, 2018, interest income on loans increased due to higher average interest rates and higher average balances. Interest income increased $12.0 million as the result of higher average interest rates on loans. The average yield on loans increased from 5.07% during the year ended December 31, 2018 to 5.37% during the year ended December 31, 2019. Interest income increased $12.8 million as a result of higher average loan balances, which increased from $3.91 billion during the year ended December 31, 2018, to $4.16 billion during the year ended December 31, 2019. The higher average balances were primarily due to organic loan growth in commercial real estate loans, one- to four- family residential loans, and other residential (multi-family) loans, partially offset by decreases in consumer loans.
On an on-going basis, the Company has estimated the cash flows expected to be collected from the acquired loan pools. For each of the loan portfolios acquired, the cash flow estimates have increased, based on the payment histories and the collection of certain loans, thereby reducing loss expectations of certain loan pools, resulting in adjustments to be spread on a level-yield basis over the remaining expected lives of the loan pools. The entire amount of the discount adjustment has been and will be accreted to interest income over time. For the years ended December 31, 2019 and 2018, the adjustments increased interest income and pre-tax income by $7.4 million and $5.1 million, respectively.
As of December 31, 2019, the remaining accretable yield adjustment that will affect interest income was $7.6 million. Of the remaining adjustments affecting interest income, we expect to recognize $5.6 million of interest income during 2020. In the first quarter of 2020, we will adopt the new accounting standard related to accounting for credit losses. With the adoption of this standard, there will be no more reclassification of discounts from non-accretable to accretable subsequent to December 31, 2019. All adjustments made prior to December 31, 2019 will continue to be accreted to interest income. Apart from the yield accretion, the average yield on loans was 5.19% during the year ended December 31, 2019, compared to 4.94% during the year ended December 31, 2018, as a result of higher current market rates on adjustable rate loans and new loans originated during the year.
In October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $400 million with a termination date of October 6, 2025. Under the terms of the swap, the Company will receive a fixed rate of interest of 3.018% and will pay a floating rate of interest equal to one-month USD-LIBOR. The floating rate will be reset monthly and net settlements of interest due to/from the counterparty will also occur monthly. The floating rate of interest was 1.710% as of December 31, 2019. Therefore, in the near term, the Company will receive net interest settlements which will be recorded as loan interest income, to the extent that the fixed rate of interest continues to exceed one-month USD-LIBOR. If USD-LIBOR exceeds the fixed rate of interest in future periods, the Company will be required to pay net settlements to the counterparty and will record those net payments as a reduction of interest income on loans. The Company recorded loan interest income of $3.1 million and $673,000 during the years ending December 31, 2019 and 2018, respectively, related to this interest rate swap.
In March 2020, the Company and its swap counterparty mutually agreed to terminate the $400 million interest rate swap prior to its contractual maturity. The Company received a payment of $45.9 million from its swap counterparty as a result of this termination. The termination of this interest rate swap is discussed further in Note 28 of the accompanying audited financial statements, which are included in Item 8 of this Report. The Company’s interest rate derivatives and hedging activities are discussed further in Note 16 of the accompanying audited financial statements, which are included in Item 8 of this Report.
Interest Income - Investments and Other Interest-earning Assets
Interest income on investments increased $4.2 million in the year ended December 31, 2019 compared to the year ended December 31, 2018. Interest income increased $3.8 million as a result of an increase in average balances from $201.3 million during the year ended December 31, 2018, to $326.5 million during the year ended December 31, 2019. Average balances of securities increased primarily due to significant purchases of securities in 2019. Interest income increased $395,000 due to an increase in average interest rates from 2.90% during the year ended December 31, 2018 to 3.08% during the year ended December 31, 2019, due to higher market rates of interest on investment securities and a decrease in the volume of prepayments on mortgage-backed securities.
Interest income on other interest-earning assets decreased $7,000 in the year ended December 31, 2019 compared to the year ended December 31, 2018. Interest income decreased $58,000 as a result of a decrease in average balances from $104.2 million during the year ended December 31, 2018, to $87.8 million during the year ended December 31, 2019. Interest income increased $51,000 due to an increase in average interest rates from 1.81% during the year ended December 31, 2018, to 2.14% during the year
ended December 31, 2019, primarily due to higher market rates of interest on other interest-bearing deposits in financial institutions.
Total Interest Expense
Total interest expense increased $16.8 million, or 44.6%, during the year ended December 31, 2019, when compared with the year ended December 31, 2018, due to an increase in interest expense on deposits of $17.6 million, or 63.0%, an increase in interest expense on short-term borrowings and repurchase agreements of $2.9 million, or 375.2%, an increase in interest expense on subordinated notes of $281,000, or 6.9%, and an increase in interest expense on subordinated debentures issued to capital trust of $66,000, or 6.9%. Partially offsetting these increases, interest expense decreased $4.0 million, or 100%, due to having no FHLB advances outstanding during the year ended December 31, 2019.
Interest Expense - Deposits
Interest on demand deposits increased $2.1 million due to an increase in average rates from 0.39% during the year ended December 31, 2018, to 0.53% during the year ended December 31, 2019. Partially offsetting that increase, interest on demand deposits decreased $92,000 due to a decrease in average balances from $1.53 billion in the year ended December 31, 2018, to $1.51 billion in the year ended December 31, 2019. The increase in average interest rates of interest-bearing demand deposits was primarily a result of increased market interest rates on these types of accounts from December 2016 through the first half of 2019.
Interest expense on time deposits increased $9.4 million as a result of an increase in average rates of interest from 1.60% during the year ended December 31, 2018, to 2.19% during the year ended December 31, 2019. In addition, interest expense on time deposits increased $6.3 million due to an increase in average balances of time deposits from $1.38 billion during the year ended December 31, 2018, to $1.72 billion during the year ended December 31, 2019. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a higher rate of interest due to market interest rate increases in 2018 and the first half of 2019. The increase in average balances of time deposits was primarily a result of increases in brokered deposits, including CDARS program purchased funds, and increases in deposits originated through the Company’s internet deposit acquisition channels.
Interest Expense - FHLBank Advances, Short-term Borrowings and Repurchase Agreements, Subordinated Debentures Issued to Capital Trust and Subordinated Notes
FHLBank advances were not utilized during the year ended December 31, 2019. The Company had a higher amount of overnight borrowings from the FHLBank in 2019, as discussed below.
Interest expense on short-term borrowings and repurchase agreements increased $1.8 million due to average rates that increased from 0.56% in the year ended December 31, 2018, to 1.40% in the year ended December 31, 2019. The increase was due to increases in market interest rates and a change in the mix of funding during the period, with more overnight borrowings from the FHLBank in 2019. In addition to this increase, interest expense on short-term borrowings and repurchase agreements increased $1.1 million due to an increase in average balances from $137.3 million during the year ended December 31, 2018, to $260.0 million during the year ended December 31, 2019.
During the year ended December 31, 2019, compared to the year ended December 31, 2018, interest expense on subordinated debentures issued to capital trusts increased $66,000 due to slightly higher average interest rates. The average interest rate was 3.70% in 2018, compared to 3.95% in 2019. There was no change in the average balance of the subordinated debentures between 2019 and 2018.
In August 2016, the Company issued $75 million of 5.25% fixed-to-floating rate subordinated notes due August 15, 2026. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions and other issuance costs, of approximately $73.5 million. These issuance costs are amortized over the expected life of the notes, which is five years from the issuance date, and therefore impact the overall interest expense on the notes. Interest expense on the subordinated notes increased $276,000 due to average rates that increased from 5.55% in the year ended December 31, 2018, to 5.91% in the year ended December 31, 2019.
Net Interest Income
Net interest income for the year ended December 31, 2019 increased $12.2 million, or 7.3%, to $180.4 million, compared to $168.2 million for the year ended December 31, 2018. Net interest margin was 3.95% for the year ended December 31, 2019, compared to 3.99% in 2018, a decrease of four basis points. In both years, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-assisted acquired loan pools and the resulting increase to accretable yield, which was discussed previously in “Interest Income - Loans” and is discussed in Note
4 of the accompanying audited financial statements, which are included in Item 8 of this Report. The positive impact of these changes on the years ended December 31, 2019 and 2018 were increases in interest income of $7.4 million and $5.1 million, respectively, and increases in net interest margin of 16 basis points and 12 basis points, respectively. Excluding the positive impact of the additional yield accretion, net interest margin decreased eight basis points during the year ended December 31, 2019. The decrease in net interest margin is primarily due to an increase in the average interest rates on interest-bearing demand and time deposits and an increase in the average interest rate on short term borrowings and repurchase agreements including overnight borrowings from the FHLBank, partially offset by increased yields in most loan categories and higher overall yields on investments and interest-earning deposits at the Federal Reserve Bank.
The Company's overall interest rate spread decreased 13 basis points, or 3.5%, from 3.75% during the year ended December 31, 2018, to 3.62% during the year ended December 31, 2019. The decrease was due to a 39 basis point increase in the weighted average rate paid on interest-bearing liabilities, partially offset by a 26 basis point increase in the weighted average yield on interest-earning assets. In comparing the two years, the yield on loans increased 30 basis points, the yield on investment securities increased 18 basis points and the yield on other interest-earning assets increased 33 basis points. The rate paid on deposits increased 45 basis points, the rate paid on FHLBank advances decreased 209 basis points, the rate paid on subordinated debentures issued to capital trust increased 25 basis points, the rate paid on short-term borrowings increased 84 basis points, and the rate paid on subordinated notes increased 36 basis points.
For additional information on net interest income components, refer to the "Average Balances, Interest Rates and Yields" table in this Report.
Provision for Loan Losses and Allowance for Loan Losses
Management records a provision for loan losses in an amount it believes sufficient to result in an allowance for loan losses that will cover current net charge-offs as well as risks believed to be inherent in the loan portfolio of the Bank. The amount of provision charged against current income is based on several factors, including, but not limited to, past loss experience, current portfolio mix, actual and potential losses identified in the loan portfolio, economic conditions, and internal as well as external reviews. The levels of non-performing assets, potential problem loans, loan loss provisions and net charge-offs fluctuate from period to period and are difficult to predict.
Weak economic conditions, higher inflation or interest rates, or other factors may lead to increased losses in the portfolio and/or requirements for an increase in loan loss provision expense. Management maintains various controls in an attempt to limit future losses, such as a watch list of possible problem loans, documented loan administration policies and loan review staff to review the quality and anticipated collectability of the portfolio. Additional procedures provide for frequent management review of the loan portfolio based on loan size, loan type, delinquencies, financial analysis, on-going correspondence with borrowers and problem loan work-outs. Management determines which loans are potentially uncollectible, or represent a greater risk of loss, and makes additional provisions to expense, if necessary, to maintain the allowance at a satisfactory level.
The provision for loan losses for the year ended December 31, 2019 decreased $1.0 million, to $6.2 million, compared with $7.2 million for the year ended December 31, 2018. At December 31, 2019 and December 31, 2018, the allowance for loan losses was $40.3 million and $38.4 million, respectively. Total net charge-offs were $4.3 million and $5.2 million for the years ended December 31, 2019 and 2018, respectively. During the year ended December 31, 2019, $2.8 million of the $4.3 million of net charge-offs were in the consumer auto category. In response to a more challenging consumer credit environment, the company tightened its underwriting guidelines on automobile lending beginning in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and lower delinquencies and charge-offs. In February 2019, the Company ceased providing indirect lending services to automobile dealerships. These actions also reduced origination volume and, as such, the outstanding balance of the Company's automobile loans declined approximately $102 million in the year ended December 31, 2019. At December 31, 2019, indirect automobile loans totaled approximately $119 million. We expect this total balance will be largely paid off in the next two years. General market conditions and unique circumstances related to individual borrowers and projects contributed to the level of provisions and charge-offs. Collateral and repayment evaluations of all assets categorized as potential problem loans, non-performing loans or foreclosed assets were completed with corresponding charge-offs or reserve allocations made as appropriate.
All acquired loans were grouped into pools based on common characteristics and were recorded at their estimated fair values, which incorporated estimated credit losses at the acquisition date. These loan pools are systematically reviewed by management to determine the risk of losses that may exceed those identified at the time of the acquisition. Techniques used in determining risk of loss are similar to those used to determine the risk of loss for the legacy Great Southern Bank portfolio, with most focus being placed on those loan pools which include the larger loan relationships and those loan pools which exhibit higher risk characteristics. Review of the acquired loan portfolio also includes monitoring of payment performance, review of financial information and credit scores, collateral valuations and customer interaction to determine if additional reserves are warranted.
The Bank’s allowance for loan losses as a percentage of total loans, excluding FDIC-assisted acquired loans, was 1.00% and 0.98% at December 31, 2019 and December 31, 2018, respectively. Management considers the allowance for loan losses adequate to cover losses inherent in the Bank’s loan portfolio at December 31, 2019, based on recent reviews of the Bank’s loan portfolio and current economic conditions. If economic conditions were to deteriorate or management’s assessment of the loan portfolio were to change, it is possible that additional loan loss provisions would be required, thereby adversely affecting future results of operations and financial condition.
Effective January 1, 2020, we adopted a new accounting standard, referred to as Current Expected Credit Loss, or CECL. This accounting standard require FDIC-insured institutions and their holding companies (banking organizations) to recognize credit losses expected over the life of certain financial assets. CECL covers a broader range of assets than the current incurred loss method of recognizing credit losses and generally results in earlier recognition of credit losses.
Non-performing Assets
Non-performing assets acquired through FDIC-assisted transactions, including foreclosed assets and potential problem loans, are not included in the totals or in the discussion of non-performing loans, potential problem loans and foreclosed assets below. These assets were initially recorded at their estimated fair values as of their acquisition dates and are accounted for in pools; therefore, these loan pools are analyzed rather than the individual loans. The overall performance of the loan pools acquired in each of the five FDIC-assisted transactions has been better than original expectations as of the acquisition dates.
As a result of changes in balances and composition of the loan portfolio, changes in economic and market conditions that occur from time to time, and other factors specific to a borrower's circumstances, the level of non-performing assets will fluctuate.
Non-performing assets, excluding all FDIC-assisted acquired assets, at December 31, 2019, were $8.2 million, a decrease of $3.6 million from $11.8 million at December 31, 2018. Non-performing assets, excluding all FDIC-assisted acquired assets, as a percentage of total assets were 0.16% at December 31, 2019, compared to 0.25% at December 31, 2018.
Compared to December 31, 2018, non-performing loans decreased $1.8 million to $4.5 million at December 31, 2019, and foreclosed assets decreased $1.8 million to $3.7 million at December 31, 2019. Non-performing one-to four-family residential loans comprised $1.4 million, or 30.5%, of the total $4.5 million of non-performing loans at December 31, 2019. Non-performing consumer loans comprised $1.3 million, or 28.2%, of the total non-performing loans at December 31, 2019. Non-performing commercial business loans comprised $1.2 million, or 27.3%, of total non-performing loans at December 31, 2019. Non-performing commercial real estate loans comprised $632,000, or 14.0%, of total non-performing loans at December 31, 2019.
Non-performing Loans. Activity in the non-performing loans category during the year ended December 31, 2019, was as follows:
At December 31, 2019, the non-performing one- to four-family residential category included 23 loans, 13 of which were added during 2019. The largest relationship in this category was added in 2019 totaling $158,000, or 11.5% of the total category, which is collateralized by a residential home in the St. Louis, Mo. area. The non-performing consumer category included 111 loans, 64 of which were added during 2019, and the majority of which are indirect used automobile loans. The non-performing commercial business category included four loans, one of which was added during 2019. The largest relationship in this category was added in 2018, and totaled $1.1 million, or 85.7% of the total category. This relationship is collateralized by an assignment of an interest in a real estate project. The non-performing commercial real estate category included two loans, one of which was added during 2019. The largest relationship in this category was added in 2019 totaling $530,000, or 83.9% of the total category, and was collateralized by a multi-tenant building in Arkansas.
The significant increases and decreases in non-performing loans during 2019 primarily related to one borrower. This relationship totaled approximately $6.7 million, with collateral consisting of commercial development ground and a single-family property in central Missouri and agricultural ground in Iowa. The loans in this relationship were all cross-collateralized. This relationship was represented in the non-performing land development, commercial real estate and one- to four-family categories. During 2019, the borrower deeded the properties to the Bank in lieu of foreclosure and this relationship was then moved to the Other Real Estate Owned and Repossessed category. The land development and commercial real estate assets were then sold prior to the end of 2019.
Other Real Estate Owned and Repossessions. Of the total $5.5 million of other real estate owned and repossessions at December 31, 2019, $1.0 million represents the fair value of foreclosed and repossessed assets related to loans acquired in FDIC-assisted transactions and $871,000 represents properties which were not acquired through foreclosure. The foreclosed and other assets acquired in the FDIC-assisted transactions and the properties not acquired through foreclosure are not included in the following table and discussion of other real estate owned and repossessions. Because sales and write-downs of foreclosed and repossessed properties exceeded additions, total foreclosed assets and repossessions decreased. Activity in foreclosed assets and repossessions during the year ended December 31, 2019, was as follows:
Excluding the consumer category, during the year ended December 31, 2019, the Company reduced its foreclosed assets by $9.0 million through asset sales. At December 31, 2019, the land development category of foreclosed assets included three properties, the largest of which was located in the Branson, Mo. area and had a balance of $768,000, or 42.3% of the total category. Of the total dollar amount in the land development category of foreclosed assets, 70.3% was located in the Branson, Mo. area, including the largest property previously mentioned. The subdivision construction category of foreclosed assets included three properties, the largest of which was located in the Branson, Mo. area and had a balance of $350,000, or 50.8% of the total category. Of the total dollar amount in the subdivision construction category of foreclosed assets, 90.0% is located in the Branson, Mo. area, including the largest property previously mentioned. The one- to four-family category of foreclosed assets included two properties, one of which was added during 2019 with a balance of $291,000. The amount of additions and sales under consumer loans are due to a higher volume of repossessions of automobiles, which generally are subject to a shorter repossession process. The level of delinquencies and repossessions in indirect and used automobile loans decreased in 2018 and 2019 compared to 2016 and 2017, though potential problem loans in this category increased in 2019, as indicated below.
The large additions and sales items in the land development and commercial real estate categories are related to the $6.7 million relationship discussed above under Non-Performing Loans.
Potential Problem Loans. Potential problem loans increased $1.1 million during the year ended December 31, 2019, from $3.3 million at December 31, 2018 to $4.4 million at December 31, 2019. This increase was primarily due to the addition of $2.5 million of loans to potential problem loans. Partially offsetting the added loans was $1.1 million in payments on potential problem loans, $154,000 in loans removed from potential problem loans due to improvements in the credits, and $173,000 in loans transferred to the non-performing category. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems that may cause the borrowers difficulty in complying with current repayment terms. These loans are not reflected in non-performing assets, but are considered in determining the adequacy of the allowance for loan losses. Activity in the potential problem loans category during the year ended December 31, 2019, was as follows:
At December 31, 2019, the commercial real estate category of potential problem loans included two loans, one of which was added during 2019. The largest relationship in this category (added during 2018), totaling $1.8 million, or 60.0% of the total category, is collateralized by a mixed use commercial retail building. The other relationship in the category, which totaled $1.2 million, or 40.0% of the total category, is collateralized by a commercial retail building. Payments on both loans were current at December 31, 2019. The one- to four-family residential category of potential problem loans included 16 loans, four of which were added during 2019. The consumer category of potential problem loans included 55 loans, 45 of which were added during 2019.
Non-Interest Income
Non-interest income for the year ended December 31, 2019 was $31.0 million compared with $36.2 million for the year ended December 31, 2018. The decrease of $5.2 million, or 14.5%, was primarily as a result of the following items:
Gain on sale of business units: On July 20, 2018, the Company closed on the sale of four banking centers in the Omaha, Neb., metropolitan market. The Bank sold branch deposits of approximately $56 million and sold substantially all branch-related real estate, fixed assets and ATMs. The Company recorded a pre-tax gain of $7.4 million on the sale during the year ended December 31, 2018.
Other income: Other income increased $2.8 million compared to the year ended December 31, 2018. This increase was primarily due to gains totaling $677,000 in 2019 from the sale of, or recovery of, receivables and assets that were acquired several years ago in FDIC-assisted transactions. The Company recognized approximately $1.1 million more in income as a result of the new debit card contracts than was recognized in the prior year. These contracts became effective at the beginning of 2019. The Company recognized approximately $787,000 in income related to interest rate swaps in the Company’s back-to-back swap program with loan customers and swap counterparties in 2019 compared to $50,000 in 2018. The Company also recognized approximately $184,000 in income related to the exit of certain tax credit partnerships in 2019.
New gains on loan sales: Net gains on loan sales increased $819,000 compared to the year ended December 31, 2018. This increase was primarily due to an increase in originations of fixed-rate loans during 2019 compared to 2018. Fixed rate single-family mortgage loans originated and generally subsequently sold in the secondary market. In 2019, the Company began originating SBA loans with the intention of selling the guaranteed portion in the secondary market. During 2019, a gain on sale of $230,000 was recorded related to the Company's SBA loan sales.
Service charges and ATM fees: Service charges and ATM fees decreased $797,000 compared to the year ended December 31, 2018. This decrease was primarily due to a decrease in net ATM transaction fees and a decrease in overdraft and insufficient funds fees on customer accounts due to decreased levels of such activity. This decrease was partially offset by an increase in point-of-sale transaction fees due to a higher volume of such transactions in 2019. The decrease in net ATM transaction fees resulted from less volume of transactions that generate such fee income and increased costs on a temporary basis as we migrate to a new card transation processor.
Non-Interest Expense
Total non-interest expense decreased $172,000, or 0.1%, from $115.3 million in the year ended December 31, 2018, to $115.1 million in the year ended December 31, 2019. The Company’s efficiency ratio for the year ended December 31, 2019 was 54.48%, a decrease from 56.41% for 2018. The improvement in the ratio for 2019 was primarily due to an increase in net interest income, partially offset by a decrease in non-interest income due to the gain on sale of certain branches and deposits in 2018. In the year ended December 31, 2019, the Company’s efficiency ratio was positively impacted by a decrease in expense on other real estate and repossessions and negatively impacted by an increase in salaries and employee benefits expense. In the year ended December 31, 2018, the Company’s efficiency ratio was positively impacted by the significant gain recorded related to the sale of the Bank’s branches and deposits in Omaha, Neb. The Company’s ratio of non-interest expense to average assets was 2.37% for the year ended December 31, 2019 compared to 2.56% for the year ended December 31, 2018. This improvement was primarily due to an increase in average assets. Average assets for the year ended December 31, 2019, increased $351.7 million, or 7.8%, from the year ended December 31, 2018, primarily due to increases in loans receivable and investment securities.
The following were key items related to the decrease in non-interest expense for the year ended December 31, 2019 as compared to the year ended December 31, 2018:
Expense on other real estate and repossessions: Expense on other real estate and repossessions decreased $2.7 million compared to the year ended December 31, 2018, primarily due to decreased valuation write-downs of certain foreclosed assets of $958,000 during 2019, compared to $3.6 million during 2018. Also, the Company recorded lower levels of expense related to consumer repossessions during the year ending December 31, 2019.
Legal, audit and other professional fees: Legal, audit and other professional fees decreased $799,000 in the year ended December 31, 2019 compared to 2018. The decrease in 2019 was primarily due to higher fees during 2018 for professional services related to process improvement initiatives, fees paid to advisors for the negotiation and implementation of derivative transactions, consulting fees related to the ongoing implementation of an accounting system which will be utilized for the new loan loss accounting standard and legal costs related to the sale of the Omaha-area banking centers. During 2019, legal fees decreased as a result of fewer foreclosures and repossessions during the year.
Insurance: Insurance decreased $659,000 from the year ended December 31, 2018. This decrease was primarily due to a decrease in FDIC deposit insurance premiums for the final six months of 2019. The Bank has a credit with the FDIC for a portion of premiums previously paid to the deposit insurance fund. The deposit insurance fund balance was sufficient to result in no premium being due for the second half of 2019. The Bank’s remaining credit balance should be sufficient to result in no deposit insurance premiums for the first quarter of 2020, provided the deposit insurance fund balance remains at a sufficient level under the banking regulations.
Acquired deposit intangible asset amortization: Acquired deposit intangible amortization expense decreased $372,000 in the year ended December 31, 2019 when compared to 2018. The Company generally amortizes its acquired deposit intangibles over a period of seven years. The amortization of the intangible related to the InterBank acquisition was completed during the first quarter of 2019 and the amortization of the intangible related to the Sun Security Bank acquisition was completed during the third quarter of 2018.
Salaries and employee benefits: Salaries and employee benefits increased $3.0 million from the prior year. This increase was primarily related to increased incentives in the lending and operations areas, annual compensation merit increases, along with staffing additions in the lending areas, including the new loan production offices in Atlanta and Denver, which opened in late 2018. Mortgage lending incentives increased due to the much higher volume of loan originations during 2019.
Net occupancy and equipment expense: Net occupancy expense increased $589,000 in the year ended December 31, 2019 compared to the year ended December 31, 2018. This increase was primarily due to increased depreciation related to new ATM/ITMs purchased and expenses related to ATM operating software upgrades implemented during 2019.
Provision for Income Taxes
On December 22, 2017, H.R.1, originally known as the Tax Cuts and Jobs Act (the “TCJ Act”) was signed into law. Among other things, the TCJ Act permanently lowers the corporate federal income tax rate to 21% from the prior maximum rate of 35%, effective for tax years including or commencing January 1, 2018.
For the years ended December 31, 2019 and 2018, the Company's effective tax rate was 18.3% and 18.1%, respectively. These effective rates were lower than the statutory federal tax rate of 21%, due primarily to the utilization of certain investment tax credits and to tax-exempt investments and tax-exempt loans, which reduced the Company’s effective tax rate. The Company’s effective tax rate may fluctuate in future periods as it is impacted by the level and timing of the Company’s utilization of tax credits and the level of tax-exempt investments and loans and the overall level of pre-tax income. The Company currently expects its effective tax rate (combined federal and state) to be approximately 17.5% to 18.5% in future periods, mainly as a result of the TCJ Act. The Company's effective income tax rate is expected to continue to be less than the statutory rate due primarily the factors noted above. The Company’s effective tax rate could change in future periods based on changes in the level of investments in tax credit projects and tax-exempt obligations, as well as changes in the level of overall pre-tax earnings.
Average Balances, Interest Rates and Yields
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Average balances of loans receivable include the average balances of non-accrual loans for each period. Interest income on loans includes interest received on non-accrual loans on a cash basis. Interest income on loans includes the amortization of net loan fees, which were deferred in accordance with accounting standards. Net fees included in interest income were $4.0 million, $3.5 million and $2.9 million for 2019, 2018 and 2017, respectively. Tax-exempt income was not calculated on a tax equivalent basis. The table does not reflect any effect of income taxes.
*
Defined as the Company's net interest income divided by total interest-earning assets.
(1)
Of the total average balance of investment securities, average tax-exempt investment securities were $41.7 million, $53.6 million and $61.5 million for 2019, 2018 and 2017, respectively. In addition, average tax-exempt industrial revenue bonds were $20.8 million, $24.8 million and $28.6 million in 2019, 2018 and 2017, respectively. Interest income on tax-exempt assets included in this table was $2.4 million, $3.1 million and $3.3 million for 2019, 2018 and 2017, respectively. Interest income net of disallowed interest expense related to tax-exempt assets was $2.2 million, $2.9 million and $3.1 million for 2019, 2018 and 2017, respectively.
(2)
The yield/rate on loans at December 31, 2019 does not include the impact of the accretable yield (income) on loans acquired in the FDIC-assisted transactions. See “Net Interest Income” for a discussion of the effect on 2019 results of operations.
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods shown. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in rate (i.e., changes in rate multiplied by old volume) and (ii) changes in volume (i.e., changes in volume multiplied by old rate). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to volume and rate. Tax-exempt income was not calculated on a tax equivalent basis.
Results of Operations and Comparison for the Years Ended December 31, 2018 and 2017
General
Net income increased $15.5 million, or 30.1%, during the year ended December 31, 2018, compared to the year ended December 31, 2017. Net income was $67.1 million for the year ended December 31, 2018 compared to $51.6 million for the year ended December 31, 2017. This increase was due to an increase in net interest income of $13.0 million, or 8.4%, a decrease in provision for income taxes of $3.9 million, or 20.9%, and a decrease in the provision for loan losses of $2.0 million, or 21.4%, partially offset by a decrease in non-interest income of $2.3 million, or 6.0%, and an increase in non-interest expense of $1.0 million, or 0.9%. Net income available to common shareholders was $67.1 million for the year ended December 31, 2018 compared to $51.6 million for the year ended December 31, 2017.
Total Interest Income
Total interest income increased $22.9 million, or 12.5%, during the year ended December 31, 2018 compared to the year ended December 31, 2017. The increase was due to a $21.6 million, or 12.2%, increase in interest income on loans and a $1.3 million, or 20.5%, increase in interest income on investment securities and other interest-earning assets. Interest income on loans increased in 2018 due to higher average rates of interest and higher average balances of loans. Interest income from investment securities and other interest-earning assets increased during 2018 compared to 2017 primarily due to higher average rates of interest, partially offset by lower average balances.
Interest Income - Loans
During the year ended December 31, 2018 compared to the year ended December 31, 2017, interest income on loans increased due to higher average interest rates and higher average balances. Interest income increased $17.0 million as the result of higher average interest rates on loans. The average yield on loans increased from 4.63% during the year ended December 31, 2017 to 5.07% during the year ended December 31, 2018. This increase was primarily due to increased yields in most loan categories as a result of increased LIBOR and Federal Funds interest rates. Interest income increased $4.5 million as the result of higher average loan balances, which increased from $3.81 billion during the year ended December 31, 2017, to $3.91 billion during the year ended December 31, 2018. The higher average balances were primarily due to organic loan growth in commercial construction loans, commercial real estate loans and other residential (multi-family) loans, partially offset by decreases in consumer loans.
On an on-going basis, the Company estimates the cash flows expected to be collected from the acquired loan pools. For each of the loan portfolios acquired, the cash flow estimates have increased, based on the payment histories and the collection of certain loans, thereby reducing loss expectations of certain loan pools, resulting in adjustments to be spread on a level-yield basis over the remaining expected lives of the loan pools. The loss sharing agreements for the Team Bank, Vantus Bank and Sun Security Bank transactions were terminated in April 2016, and the related indemnification assets were reduced to $-0- at that time. The loss sharing agreements for InterBank were terminated in June 2017, and the related indemnification asset was reduced to $-0- at that time. The Valley Bank transaction does not include a loss sharing agreement with the FDIC. The entire amount of the discount adjustment has been and will be accreted to interest income over time with no further offsetting impact to non-interest income. For the years ended December 31, 2018 and 2017, the adjustments increased interest income by $5.1 million and $5.0 million, respectively, and decreased non-interest income by $-0- and $634,000, respectively. The net impact to pre-tax income was $5.1 million and $4.4 million, respectively, for the years ended December 31, 2018 and 2017.
Interest Income - Investments and Other Interest-earning Assets
Interest income on investments increased $640,000 in the year ended December 31, 2018 compared to the year ended December 31, 2017. Interest income increased $796,000 due to an increase in average interest rates from 2.50% during the year ended December 31, 2017 to 2.90% during the year ended December 31, 2018, due to higher market rates of interest on investment securities and a decrease in the volume of prepayments on mortgage-backed securities. Partially offsetting that increase in average interest rates, interest income decreased $156,000 as a result of a decrease in average balances from $207.8 million during the year ended December 31, 2017, to $201.3 million during the year ended December 31, 2018. Average balances of securities decreased primarily due to certain municipal securities being called and the normal monthly payments received on the portfolio of mortgage-backed securities.
Interest income on other interest-earning assets increased $676,000 in the year ended December 31, 2018 compared to the year ended December 31, 2017. Interest income increased $819,000 due to an increase in average interest rates from 1.00% during the year ended December 31, 2017, to 1.81% during the year ended December 31, 2018, primarily due to higher market rates of interest on other interest-bearing deposits in financial institutions. Partially offsetting that increase, interest income decreased $143,000 as a result of a decrease in average balances from $121.6 million during the year ended December 31, 2017, to $104.2 million during the year ended December 31, 2018.
Total Interest Expense
Total interest expense increased $9.9 million, or 35.3%, during the year ended December 31, 2018, when compared with the year ended December 31, 2017, due to an increase in interest expense on deposits of $7.4 million, or 35.7%, an increase in interest expense on FHLBank advances of $2.5 million, or 162.9%, an increase in interest expense on short-term and repurchase agreement borrowings of $18,000, or 2.4%, and an increase in interest expense on subordinated debentures issued to capital trust of $4,000, or 0.4%.
Interest Expense - Deposits
Interest on demand deposits increased $1.4 million due to an increase in average rates from 0.30% during the year ended December 31, 2017, to 0.39% during the year ended December 31, 2018. Partially offsetting that increase, interest on demand deposits decreased $71,000 due to a decrease in average balances from $1.56 billion in the year ended December 31, 2017, to $1.53 billion in the year ended December 31, 2018. The increase in average interest rates of interest-bearing demand deposits was primarily a result of increased market interest rates on these types of accounts since December 2016.
Interest expense on time deposits increased $6.5 million as a result of an increase in average rates of interest from 1.12% during the year ended December 31, 2017, to 1.60% during the year ended December 31, 2018. Partially offsetting that increase, interest expense on time deposits decreased $422,000 due to a decrease in average balances of time deposits from $1.41 billion during the year ended December 31, 2017, to $1.38 billion during the year ended December 31, 2018. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a higher rate of interest due to market interest rate increases in 2017 and 2018. The decrease in average balances of time deposits was primarily a result of decreases in CDARS program purchased funds brokered deposits.
Interest Expense - FHLBank Advances, Short-term Borrowings and Structured Repurchase Agreements, Subordinated Debentures Issued to Capital Trust and Subordinated Notes
Interest expense on FHLBank advances increased due to higher average balances and higher average rates of interest. Interest expense on FHLBank advances increased $1.9 million due to an increase in average balances from $93.5 million during the year ended December 31, 2017, to $190.2 million during the year ended December 31, 2018. This increase was primarily due to an increase in borrowings to fund loan growth and the replacement of overnight borrowings with short-term three week FHLBank advances due to the short-term advances having a more favorable interest rate from time to time. The $31.5 million of the Company’s long-term higher fixed-rate FHLBank advances were repaid in June 2017. In addition, interest expense on FHLBank advances increased $544,000 due to an increase in average interest rates from 1.62% in the year ended December 31, 2017, to 2.09% in the year ended December 31, 2018. The increase in the average rate was due to market interest rate increases during 2018.
Interest expense on short-term borrowings and repurchase agreements increased $55,000 due to average rates that increased from 0.40% in the year ended December 31, 2017, to 0.56% in the year ended December 31, 2018. The increase was due to increases in market interest rates and a change in the mix of funding during the period, with a lower percentage of the total made up of customer repurchase agreements, which have a lower interest rate. Partially offsetting the increase, interest expense on short-term borrowings and repurchase agreements decreased $37,000 due to a decrease in average balances from $186.4 million during the year ended December 31, 2017, to $137.3 million during the year ended December 31, 2018, which is primarily due to changes in the Company’s funding needs and the mix of funding, which can fluctuate. The Company had a higher amount of overnight borrowings from the FHLBank in 2017.
During the year ended December 31, 2018, compared to the year ended December 31, 2017, interest expense on subordinated debentures issued to capital trusts increased $4,000 due to slightly higher average interest rates. The average interest rate was 3.68% in 2017, compared to 3.70% in 2018. There was no change in the average balance of the subordinated debentures between the 2018 and the 2017 years.
In August 2016, the Company issued $75 million of 5.25% fixed-to-floating rate subordinated notes due August 15, 2026. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions and other issuance costs, of approximately $73.5 million. Interest expense on the subordinated notes for both of the years ended December 31, 2018 and 2017, was $4.1 million.
Net Interest Income
Net interest income for the year ended December 31, 2018 increased $13.0 million, or 8.4%, to $168.2 million, compared to $155.2 million for the year ended December 31, 2017. Net interest margin was 3.99% for the year ended December 31, 2018, compared to 3.74% in 2017, an increase of 25 basis points. In both years, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-assisted acquired loan pools and the resulting increase to accretable yield, which was discussed previously in “Interest Income - Loans” and is discussed in Note
4 of the accompanying audited financial statements, which are included in Item 8 of this Report. The positive impact of these changes on the years ended December 31, 2018 and 2017 were increases in interest income of $5.1 million and $5.0 million, respectively, and increases in net interest margin of 12 basis points and 12 basis points, respectively. Excluding the positive impact of the additional yield accretion, net interest margin increased 25 basis points during the year ended December 31, 2018. The increase in net interest margin is primarily due to increased yields in most loan categories and higher overall yields on investments and interest-earning deposits at the Federal Reserve Bank, partially offset by an increase in the average interest rate on deposits and FHLBank advances and other borrowings.
The Company's overall interest rate spread increased 16 basis points, or 4.4%, from 3.59% during the year ended December 31, 2017, to 3.75% during the year ended December 31, 2018. The increase was due to a 46 basis point increase in the weighted average yield on interest-earning assets, partially offset by a 30 basis point increase in the weighted average rate paid on interest-bearing liabilities. In comparing the two years, the yield on loans increased 44 basis points, the yield on investment securities increased 40 basis points and the yield on other interest-earning assets increased 81 basis points. The rate paid on deposits increased 27 basis points, the rate paid on FHLBank advances increased 47 basis points, the rate paid on subordinated debentures issued to capital trust increased two basis points, the rate paid on short-term borrowings increased 16 basis points, and the rate paid on subordinated notes decreased two basis points.
For additional information on net interest income components, refer to the "Average Balances, Interest Rates and Yields" table in this Report.
Provision for Loan Losses and Allowance for Loan Losses
The provision for loan losses for the year ended December 31, 2018 decreased $1.9 million, to $7.2 million, compared with $9.1 million for the year ended December 31, 2017. At December 31, 2018 and December 31, 2017, the allowance for loan losses was $38.4 million and $36.5 million, respectively. Total net charge-offs were $5.2 million and $10.0 million for the years ended December 31, 2018 and 2017, respectively. During the year ended December 31, 2018, $3.9 million of the $5.2 million of net charge-offs were in the consumer auto category. In response to a more challenging consumer credit environment, the Company tightened its underwriting guidelines on automobile lending beginning in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and lower delinquencies and charge-offs. This action also reduced origination volume and, as such, the outstanding balance of the Company's automobile loans declined approximately $104 million in the year ended December 31, 2018. In February 2019, the Company ceased providing indirect lending services to automobile dealerships. In addition, six commercial loan relationships amounted to $1.3 million of the total net charge-offs during the year ended December 31, 2018. Charge-offs were partially offset by recoveries on multiple loans during the year. General market conditions and unique circumstances related to individual borrowers and projects contributed to the level of provisions and charge-offs. As assets were categorized as potential problem loans, non-performing loans or foreclosed assets, evaluations were made of the values of these assets with corresponding charge-offs as appropriate.
The Bank’s allowance for loan losses as a percentage of total loans, excluding FDIC-assisted acquired loans, was 0.98% and 1.01% at December 31, 2018 and December 31, 2017, respectively.
Non-performing Assets
Non-performing assets acquired through FDIC-assisted transactions, including foreclosed assets and potential problem loans, are not included in the totals or in the discussion of non-performing loans, potential problem loans and foreclosed assets below. These assets were initially recorded at their estimated fair values as of their acquisition dates and are accounted for in pools; therefore, these loan pools are analyzed rather than the individual loans. The overall performance of the loan pools acquired in each of the five FDIC-assisted transactions has been better than original expectations as of the acquisition dates.
As a result of changes in balances and composition of the loan portfolio, changes in economic and market conditions that occur from time to time, and other factors specific to a borrower's circumstances, the level of non-performing assets will fluctuate.
Non-performing assets, excluding all FDIC-assisted acquired assets, at December 31, 2018, were $11.8 million, a decrease of $16.0 million from $27.8 million at December 31, 2017. Non-performing assets, excluding all FDIC-assisted acquired assets, as a percentage of total assets were 0.25% at December 31, 2018, compared to 0.63% at December 31, 2017.
Compared to December 31, 2017, non-performing loans decreased $5.0 million to $6.3 million at December 31, 2018, and foreclosed assets decreased $11.1 million to $5.5 million at December 31, 2018. Non-performing one-to four-family residential loans comprised $2.7 million, or 42.3%, of the total $6.3 million of non-performing loans at December 31, 2018. Non-performing consumer loans comprised $1.8 million, or 28.8%, of the total non-performing loans at December 31, 2018. Non-performing commercial business loans comprised $1.4 million, or 22.8%, of total non-performing loans at December 31, 2018. Non-performing commercial real estate loans comprised $334,000, or 5.3%, of total non-performing loans at December 31, 2018. The majority of the decrease in the non-performing commercial real estate category was due to one relationship totaling approximately $650,000 being transferred to foreclosed assets during 2018. Non-performing other residential loans were $-0- at December 31, 2018. The decrease in non-performing other residential loans was due to the one loan previously in this category being transferred to foreclosed assets during 2018.
Non-performing Loans. Activity in the non-performing loans category during the year ended December 31, 2018, was as follows:
At December 31, 2018, the non-performing one- to four-family residential category included 28 loans, eight of which were added during 2018. The largest relationship in this category was added in 2017 and included nine loans totaling $1.3 million, or 48.4% of the total category, which are collateralized by residential rental homes in the Springfield, Mo. area. The non-performing consumer category included 176 loans, 104 of which were added during 2018, and the majority of which are indirect used automobile loans. The non-performing commercial business category included five loans, all of which were added during 2018. The largest relationship in this category totaled $1.1 million, or 78.6% of the total category. This relationship is collateralized by an assignment of an interest in a real estate project. A relationship in the commercial business category, which previously totaled $1.5 million, received payments during the year ended December 31, 2018, to satisfy the remaining recorded balance. The non-performing commercial real estate category included five loans, two of which were added during 2018 and were part of the same customer relationship. Three loans in the category were transferred to foreclosed assets during 2018, the largest of which totaled $652,000 and was collateralized by commercial property in the St. Louis, Mo., area. The non-performing other residential category had a balance of $-0- at December 31, 2018. The one loan previously in this category, which was collateralized by an apartment project in the central Missouri area, had charge-offs of $279,000 during the year ended December 31, 2018 and the remaining balance of $1.6 million was transferred to foreclosed assets.
Other Real Estate Owned and Repossessions. Of the total $8.4 million of other real estate owned and repossessions at December 31, 2018, $1.4 million represents the fair value of foreclosed and repossessed assets related to loans acquired in FDIC-assisted transactions and $1.6 million represents properties which were not acquired through foreclosure. The foreclosed and other assets acquired in the FDIC-assisted transactions and the properties not acquired through foreclosure are not included in the following table and discussion of other real estate owned and repossessions. Because sales and write-downs of foreclosed and repossessed properties exceeded additions, total foreclosed assets and repossessions decreased. Activity in foreclosed assets and repossessions during the year ended December 31, 2018, was as follows:
Excluding the consumer category, during the year ended December 31, 2018, the Company reduced its foreclosed assets by $9.7 million through asset sales. At December 31, 2018, the land development category of foreclosed assets included seven properties, the largest of which was located in the Branson, Mo. area and had a balance of $913,000, or 28.6% of the total category. Of the total dollar amount in the land development category of foreclosed assets, 66.8% was located in the Branson, Mo. area, including the largest property previously mentioned. The subdivision construction category of foreclosed assets included seven properties, the largest of which was located in the Branson, Mo. area and had a balance of $350,000, or 32.1% of the total category. Of the total dollar amount in the subdivision construction category of foreclosed assets, 65.0% was located in the Branson, Mo. area, including the largest property previously mentioned. The write-downs in the land development and subdivision construction categories resulted from management’s decision during the three months ended June 30, 2018, after marketing these assets for an extended period, to reduce the asking price for several parcels of land. The Company experienced increased levels of delinquencies and repossessions in indirect and used automobile loans throughout 2016 and 2017. The amount of additions and sales under consumer loans are due to a higher volume of repossessions of automobiles, which generally are subject to a shorter repossession process. The level of delinquencies and repossessions in indirect and used automobile loans decreased in 2018. The commercial real estate category of foreclosed assets had a zero balance at December 31, 2018. All of the previously remaining properties in the commercial real estate category, totaling $1.9 million, were sold during 2018. The other residential category of foreclosed assets had a zero balance at December 31, 2018. The previously remaining property in the category, an apartment building in central Missouri totaling $1.7 million, was sold during 2018.
Potential Problem Loans. Potential problem loans decreased $4.6 million during the year ended December 31, 2018, from $7.9 million at December 31, 2017 to $3.3 million at December 31, 2018. This decrease was primarily due to $5.3 million in loans removed from potential problem loans due to improvements in the credits, $1.6 million in payments on potential problem loans and $489,000 in loans transferred to the non-performing category, partially offset by the addition of $2.8 million of loans to potential problem loans. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems that may cause the borrowers difficulty in complying with current repayment terms. These loans are not reflected in non-performing assets, but are considered in determining the adequacy of the allowance for loan losses. Activity in the potential problem loans category during the year ended December 31, 2018, was as follows:
At December 31, 2018, the commercial real estate category of potential problem loans included two loans, both of which were added during 2018. The largest relationship in this category, totaling $1.9 million, or 93.9% of the total category, is collateralized by a mixed use commercial retail building. One relationship previously in this category consisted of three loans totaling $4.7 million collateralized by theatre and retail property in Branson, Mo. The decision to remove this relationship from potential problem loans during the year was due to an improvement in debt service coverage, and timely principal and interest payments on these loans, including over $1.0 million in payments during 2018. The one- to four-family residential category of potential problem loans included 18 loans, four of which were added during 2018. The consumer category of potential problem loans included 18 loans, 15 of which were added during 2018.
Non-Interest Income
Non-interest income for the year ended December 31, 2018 was $36.2 million compared with $38.5 million for the year ended December 31, 2017. The decrease of $2.3 million, or 6.0%, was primarily as a result of the following items:
2017 gain on early termination of FDIC loss sharing agreements for Inter Savings Bank: In 2017, the Company recognized a one-time gross gain of $7.7 million from the termination of the loss sharing agreements for Inter Savings Bank, which was recorded in the gain on termination of loss sharing agreements line item of the consolidated statements of income for the year ended December 31, 2017.
Net gains on loan sales: Net gains on loan sales decreased $1.4 million compared to the prior year. The decrease was due to a decrease in originations of fixed-rate loans during 2018 compared to 2017. Fixed rate single-family mortgage loans originated are generally subsequently sold in the secondary market. In 2018, the Company originated more variable-rate single-family mortgage loans, partially due to higher market rates of interest, which have been retained in the Company’s portfolio.
Late charges and fees on loans: Late charges and fees on loans decreased $609,000 compared to the prior year. The decrease was primarily due to fees totaling $632,000 on loan payoffs received on four loan relationships in 2017 which were not repeated in 2018.
Other income: Other income decreased $695,000 compared to the prior year period. The decrease was primarily due to income from interest rate swaps entered into in 2017, the receipt of approximately $260,000 more income related to the exit of certain tax credit partnerships in 2017 compared to 2018 and $250,000 less in merchant card services fees compared to 2017.
Sale of Omaha-area banking centers: On July 20, 2018, the Company closed on the sale of four banking centers in the Omaha, Neb., metropolitan market. The Bank sold branch deposits of approximately $56 million and sold substantially all branch-related real estate, fixed assets and ATMs. The Company recorded a pre-tax gain of $7.4 million on the sale during the year ended December 31, 2018.
Amortization of income related to business acquisitions: Because of the termination of the remaining loss sharing agreements in June 2017, the net amortization expense related to business acquisitions was $-0- for the year ended December 31, 2018, compared to $486,000 for the year ended December 31, 2017, which reduced non-interest income by that amount in the previous year.
Non-Interest Expense
Total non-interest expense increased $1.0 million, or 0.9%, from $114.3 million in the year ended December 31, 2017, to $115.3 million in the year ended December 31, 2018. The Company’s efficiency ratio for the year ended December 31, 2018 was 56.41%, a decrease from 58.99% for 2017. The improvement in the ratio for 2018 was primarily due to an increase in net interest income, partially offset by a decrease in non-interest income and an increase in non-interest expense. In the year ended December 31, 2018, the Company’s efficiency ratio was positively impacted by the significant gain recorded related to the sale of the Bank’s branches and deposits in Omaha, Neb. In the year ended December 31, 2017, the Company’s efficiency ratio was positively impacted by the significant gain recorded related to the termination of the Inter Savings Bank loss sharing agreements. The Company’s ratio of non-interest expense to average assets was 2.56% for each of the years ended December 31, 2018 and 2017. Average assets for the year ended December 31, 2018, increased $43.1 million, or 1.0%, from the year ended December 31, 2017, primarily due to organic loan growth, partially offset by decreases in investment securities and other interest-earning assets.
The following were key items related to the increase in non-interest expense for the year ended December 31, 2018 as compared to the year ended December 31, 2017:
Net occupancy and equipment expense: Net occupancy expense increased $1.0 million in the year ended December 31, 2018 compared to the year ended December 31, 2017. This increase was primarily due to increased expenses related to hardware and software costs for loan loss accounting and commercial loan systems and data servers at the Company’s disaster recovery site, increased depreciation expense for upgraded ATM/ITM machines, deconversion expenses related to the sale of the Omaha-area banking centers and repairs and maintenance costs for various banking centers.
Expense on other real estate and repossessions: Expense on other real estate and repossessions increased $990,000 compared to the prior year primarily due to the valuation write-down of certain foreclosed assets during the second quarter 2018, totaling approximately $2.1 million, partially offset by gains on sales of foreclosed and repossessed assets in 2018 and lower repossession and collection expenses in 2018.
Legal, audit and other professional fees: Legal, audit and other professional fees increased $561,000 in the year ended December 31, 2018 compared to 2017. The increase was primarily due to fees for professional services related to process improvement initiatives, fees paid to advisors for the negotiation and implementation of derivative transactions, consulting fees related to the ongoing implementation of an accounting system which will be utilized for the new loan loss accounting standard and legal costs related to the sale of the Omaha-area banking centers.
Other operating expenses: Other operating expenses decreased $691,000 in the year ended December 31, 2018 compared to 2017. During 2017, the Company incurred a $340,000 prepayment penalty when FHLB advances totaling $31.4 million were repaid prior to maturity, which was not repeated in the 2018 period. In addition, the Company experienced significantly lower debit card and check fraud losses in 2018 compared to 2017.
Office supplies and printing expense: Office supplies and printing expense decreased $399,000 in the year ended December 31, 2018 compared to 2017. During 2017 the Bank incurred printing and other costs totaling $373,000 related to the replacement of a portion of customer debit cards with chip-enabled cards, which was not repeated in 2018.
Partnership tax credit: Partnership tax credit expense decreased $355,000 in the year ended December 31, 2018 compared to the 2017 year. The Company periodically invests in certain tax credits and amortizes those investments over the period that the tax credits are used. The tax credit period for certain of these credits ended in 2017 and so the final amortization of the investment in those credits also ended in 2017.
Provision for Income Taxes
For the years ended December 31, 2018 and 2017, the Company's effective tax rate was 18.1% and 26.7%, respectively. These effective rates were lower than the statutory federal tax rates of 21% (2018) and 35% (2017), due primarily to the utilization of certain investment tax credits and to tax-exempt investments and tax-exempt loans which reduced the Company’s effective tax rate. The Company’s effective tax rate may fluctuate as it is impacted by the level and timing of the Company’s utilization of tax credits and the level of tax-exempt investments and loans and the overall level of pre-tax income. The Company’s effective income tax rate was slightly higher than its typical effective tax rate in the 2018 and 2017 years due to gains on the sale of the Omaha branches and related deposits (2018) and increased net income resulting from the gain on termination of the loss sharing agreements for the Inter Savings Bank FDIC-assisted transaction (2017).
In 2017, based upon current accounting guidance and the utilization and recognition of the timing differences referred to above, the Company recorded a net decrease in income tax expense of approximately $250,000. This net decrease in income tax expense was comprised of a $2.1 million decrease from the adjustment of net deferred tax liabilities resulting from enactment of the TCJ Act, partially offset by the impacts of other tax planning strategies implemented. This impact on the Company’s net deferred tax liabilities, which included, among other things, the timing of recognition of various revenues and expenses, was based upon a review and analysis of the Company’s net deferred tax liabilities at December 31, 2017, as well as expected adjustments to various deferred tax assets and deferred tax liabilities in the year ended December 31, 2017, including those accounted for in accumulated other comprehensive income.
Liquidity
Liquidity is a measure of the Company's ability to generate sufficient cash to meet present and future financial obligations in a timely manner through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. These obligations include the credit needs of customers, funding deposit withdrawals and the day-to-day operations of the Company. Liquid assets include cash, interest-bearing deposits with financial institutions and certain investment securities and loans. As a result of the Company's management of the ability to generate liquidity primarily through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs. At December 31, 2019, the Company had commitments of approximately $161.7 million to fund loan originations, $1.31 billion of unused lines of credit and unadvanced loans, and $26.3 million of outstanding letters of credit.
The following table summarizes the Company's fixed and determinable contractual obligations by payment date as of December 31, 2019. Additional information regarding these contractual obligations is discussed further in Notes 6, 8, 9, 10, 11, 12, 13 and 18 of the accompanying audited financial statements, which are included in Item 8 of this Report.
The Company's primary sources of funds are customer deposits, short term borrowings at the FHLBank, other borrowings, loan repayments, unpledged securities, proceeds from sales of loans and available-for-sale securities, and funds provided from operations. The Company utilizes particular sources of funds based on the comparative costs and availability at the time. The Company has from time to time chosen not to pay rates on deposits as high as the rates paid by certain of its competitors and, when believed to be appropriate, supplements deposits with less expensive alternative sources of funds.
At December 31, 2019 and 2018, the Company had these available secured lines and on-balance sheet liquidity:
Statements of Cash Flows. During the years ended December 31, 2019, 2018 and 2017, the Company had positive cash flows from operating activities. The Company experienced negative cash flows from investing activities during the years ended December 31, 2019 and 2018 and positive cash flows from investing activities during the year ended December 31, 2017. The Company experienced positive cash flows from financing activities during the years ended December 31, 2019 and 2018 and negative cash flows from financing activities during the year ended December 31, 2017.
Cash flows from operating activities for the periods covered by the Statements of Cash Flows have been primarily related to changes in accrued and deferred assets, credits and other liabilities, the provision for loan losses, realized gains on the sale of investment securities and loans, depreciation and amortization, gains or losses on the termination of loss sharing agreements and the amortization of deferred loan origination fees and discounts (premiums) on loans and investments, all of which are non-cash or non-operating adjustments to operating cash flows. Net income adjusted for non-cash and non-operating items and the origination and sale of loans held-for-sale were the primary sources of cash flows from operating activities. Operating activities provided cash flows of $86.4 million, $94.2 million and $62.8 million during the years ended December 31, 2019, 2018 and 2017, respectively.
During the years ended December 31, 2019 and 2018, investing activities used cash of $295.1 million and $381.3 million, respectively, primarily due to the net increases and purchases of loans and investment securities and the cash paid for the sale of deposits and branches (2018), partially offset by the sales of investment securities (2019). During the year ended December 31, 2017, investing activities provided cash of $81.4 million, primarily due to the cash received from the FDIC loss sharing termination reimbursement, proceeds from the sale of other real estate owned and the net repayment of investment securities.
Changes in cash flows from financing activities during the periods covered by the Statements of Cash Flows are primarily due to changes in deposits after interest credited, changes in FHLBank advances, changes in short-term borrowings, and dividend payments to stockholders. Financing activities provided cash flows of $226.1 million and $247.6 million during the years ended December 31, 2019 and 2018, respectively, primarily due to increases in customer deposit balances and net increases or decreases in various borrowings, partially offset by dividend payments to stockholders. Financing activities used cash flows of $181.7 million during the year ended December 31, 2017, primarily due to reduction of customer certificate of deposit balances, net decreases in various borrowings and dividend payments to stockholders.
Capital Resources
Management continuously reviews the capital position of the Company and the Bank to ensure compliance with minimum regulatory requirements, as well as to explore ways to increase capital either by retained earnings or other means.
As of December 31, 2019, total stockholders’ equity and common stockholders’ equity were each $603.1 million, or 12.0% of total assets, equivalent to a book value of $42.29 per common share. As of December 31, 2018, total stockholders’ equity and common stockholders’ equity were each $532.0 million, or 11.4% of total assets, equivalent to a book value of $37.59 per common share. At December 31, 2019, the Company’s tangible common equity to tangible assets ratio was 11.9%, compared to 11.2% at December 31, 2018. Included in stockholders’ equity at December 31, 2019 and 2018, were unrealized gains (net of taxes) on the Company’s available-for-sale investment securities and cash flow hedges (interest rate swap) totaling $32.2 million and $9.6 million, respectively. This increase in unrealized gains primarily resulted from lower market interest rates which increased the fair value of the derivatives and investment securities.
Banks are required to maintain minimum risk-based capital ratios. These ratios compare capital, as defined by the risk-based regulations, to assets adjusted for their relative risk as defined by the regulations. Under current guidelines, which became effective January 1, 2015, banks must have a minimum common equity Tier 1 capital ratio of 4.50%, a minimum Tier 1 risk-based capital ratio of 6.00%, a minimum total risk-based capital ratio of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%.
To be considered "well capitalized," banks must have a minimum common equity Tier 1 capital ratio of 6.50%, a minimum Tier 1 risk-based capital ratio of 8.00%, a minimum total risk-based capital ratio of 10.00%, and a minimum Tier 1 leverage ratio of 5.00%. On December 31, 2019, the Bank's common equity Tier 1 capital ratio was 13.1%, its Tier 1 capital ratio was 13.1%, its total capital ratio was 14.0% and its Tier 1 leverage ratio was 12.3%. As a result, as of December 31, 2019, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2018, the Bank's common equity Tier 1 capital ratio was 12.4%, its Tier 1 capital ratio was 12.4%, its total capital ratio was 13.3% and its Tier 1 leverage ratio was 12.2%. As a result, as of December 31, 2018, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such.
The FRB has established capital regulations for bank holding companies that generally parallel the capital regulations for banks. On December 31, 2019, the Company's common equity Tier 1 capital ratio was 12.0%, its Tier 1 capital ratio was 12.5%, its total capital ratio was 15.0% and its Tier 1 leverage ratio was 11.8%. To be considered well capitalized, a bank holding company must have a Tier 1 risk-based capital ratio of at least 6.00% and a total risk-based capital ratio of at least 10.00%. As of December 31, 2019, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2018, the Company's common equity Tier 1 capital ratio was 11.4%, its Tier 1 capital ratio was 11.9%, its total capital ratio was 14.4% and its Tier 1 leverage ratio was 11.7%. As of December 31, 2018, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such.
In addition to the minimum common equity Tier 1 capital ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio, the Company and the Bank have to maintain a capital conservation buffer consisting of additional common equity Tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. This capital conservation buffer requirement began phasing in on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increased by an additional 0.625% as of January 1, 2017, and increased an equal amount each year until the buffer requirement of greater than 2.5% of risk-weighted assets was fully implemented on January 1, 2019.
Dividends. During the year ended December 31, 2019, the Company declared common stock cash dividends of $2.07 per share (40.3% of net income per common share) and paid common stock cash dividends of $2.05 per share. During the year ended December 31, 2018, the Company declared common stock cash dividends of $1.20 per share (25.5% of net income per common share) and paid common stock cash dividends of $1.12 per share. The Board of Directors meets regularly to consider the level and the timing of dividend payments. The $0.34 per share dividend declared but unpaid as of December 31, 2019, was paid to stockholders in January 2020.
Common Stock Repurchases and Issuances. The Company has been in various buy-back programs since May 1990. During the years ended December 31, 2019 and 2018, the Company repurchased 16,040 shares of its common stock at an average price of $52.93 per share and 17,542 shares of its common stock at an average price of $51.52 per share, respectively. During the years ended December 31, 2019 and 2018, the Company issued 125,894 shares of stock at an average price of $33.03 per share and 81,207 shares of stock at an average price of $27.60 per share, respectively, to cover stock option exercises.
Management has historically utilized stock buy-back programs from time to time as long as management believed that repurchasing the stock would contribute to the overall growth of shareholder value. The number of shares of stock that will be repurchased at any particular time and the prices that will be paid are subject to many factors, several of which are outside of the control of the Company. The primary factors, however, are the number of shares available in the market from sellers at any given time, the price of the stock within the market as determined by the market and the projected impact on the Company’s earnings per share and capital.
Non-GAAP Financial Measures
This document contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States ("GAAP"). These non-GAAP financial measures include the ratio of tangible common equity to tangible assets.
In calculating the ratio of tangible common equity to tangible assets, we subtract period-end intangible assets from common equity and from total assets. Management believes that the presentation of these measures excluding the impact of intangible assets provides useful supplemental information that is helpful in understanding our financial condition and results of operations, as they provide a method to assess management's success in utilizing our tangible capital as well as our capital strength. Management also believes that providing measures that exclude balances of intangible assets, which are subjective components of valuation, facilitates the comparison of our performance with the performance of our peers. In addition, management believes that these are standard financial measures used in the banking industry to evaluate performance.
These non-GAAP financial measures are supplemental and are not a substitute for any analysis based on GAAP financial measures. Because not all companies use the same calculation of non-GAAP measures, this presentation may not be comparable to other similarly titled measures as calculated by other companies.
Non-GAAP Reconciliation: Ratio of Tangible Common Equity to Tangible Assets
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Asset and Liability Management and Market Risk
A principal operating objective of the Company is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. The Company has sought to reduce its exposure to adverse changes in interest rates by attempting to achieve a closer match between the periods in which its interest-bearing liabilities and interest-earning assets can be expected to reprice through the origination of adjustable-rate mortgages and loans with shorter terms to maturity and the purchase of other shorter term interest-earning assets.
Our Risk When Interest Rates Change
The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure the Risk to Us Associated with Interest Rate Changes
In an attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor Great Southern's interest rate risk. In monitoring interest rate risk we regularly analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and their sensitivity to actual or potential changes in market interest rates.
The ability to maximize net interest income is largely dependent upon the achievement of a positive interest rate spread that can be sustained despite fluctuations in prevailing interest rates. Interest rate sensitivity is a measure of the difference between amounts of interest-earning assets and interest-bearing liabilities which either reprice or mature within a given period of time. The difference, or the interest rate repricing "gap," provides an indication of the extent to which an institution's interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest-rate sensitive assets exceeds the amount of interest-rate sensitive liabilities repricing during the same period, and is considered negative when the amount of interest-rate sensitive liabilities exceeds the amount of interest-rate sensitive assets during the same period. Generally, during a period of rising interest rates, a negative gap within shorter repricing periods would adversely affect net interest income, while a positive gap within shorter repricing periods would result in an increase in net interest income. During a period of falling interest rates, the opposite would be true. As of December 31, 2019, Great Southern's interest rate risk models indicate that, generally, rising interest rates are expected to have a positive impact on the Company's net interest income, while declining interest rates would have a negative impact on net interest income. We model various interest rate scenarios for rising and falling rates, including both parallel and non-parallel shifts in rates. The results of our modeling indicate that net interest income is not likely to be significantly affected either positively or negatively in the first twelve months following a rate change, regardless of any changes in interest rates, because our portfolios are relatively well matched in a twelve-month horizon. The effects of interest rate changes, if any, on net interest income are expected to be greater in the 12 to 36 months following rate changes.
The current level and shape of the interest rate yield curve poses challenges for interest rate risk management. Prior to its increase of 0.25% on December 16, 2015, the FRB had last changed interest rates on December 16, 2008. This was the first rate increase since June 29, 2006. The FRB also implemented rate increases of 0.25% on eight additional occasions beginning December 14, 2016 and through December 31, 2018, with the Federal Funds rate reaching as high as 2.50%. After December 31, 2018, the FRB paused its rate increases and, in July, September and October 2019, implemented rate change decreases of 0.25% on each of those occasions. At December 31, 2019, the Federal Funds rate stood at 1.75%. A substantial portion of Great Southern's loan portfolio ($1.89 billion at December 31, 2019) is tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days after December 31, 2019. Of these loans, $1.71 billion as of December 31, 2019 had interest rate floors. Great Southern also has a portfolio of loans ($210 million at December 31, 2019) tied to a "prime rate" of interest and will adjust immediately with changes to the "prime rate" of interest.
Interest rate risk exposure estimates (the sensitivity gap) are not exact measures of an institution's actual interest rate risk. They are only indicators of interest rate risk exposure produced in a simplified modeling environment designed to allow management to gauge the Bank's sensitivity to changes in interest rates. They do not necessarily indicate the impact of general interest rate movements on the Bank's net interest income because the repricing of certain categories of assets and liabilities is subject to competitive and other factors beyond the Bank's control. As a result, certain assets and liabilities indicated as maturing or otherwise repricing within a stated period may in fact mature or reprice at different times and in different amounts and cause a change, which potentially could be material, in the Bank's interest rate risk.
In order to minimize the potential for adverse effects of material and prolonged increases and decreases in interest rates on Great Southern's results of operations, Great Southern has adopted asset and liability management policies to better match the maturities and repricing terms of Great Southern's interest-earning assets and interest-bearing liabilities. Management recommends and the Board of Directors sets the asset and liability policies of Great Southern which are implemented by the Asset and Liability Committee. The Asset and Liability Committee is chaired by the Chief Financial Officer and is comprised of members of Great Southern's senior management. The purpose of the Asset and Liability Committee is to communicate, coordinate and control asset/liability management consistent with Great Southern's business plan and board-approved policies. The Asset and Liability Committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The Asset and Liability Committee meets on a monthly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital positions and anticipated changes in the volume and mix of assets and liabilities. At each meeting, the Asset and Liability Committee recommends appropriate strategy changes based on this review. The Chief Financial Officer or his designee is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Board of Directors at their monthly meetings.
In order to manage its assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, Great Southern has focused its strategies on originating adjustable rate loans or loans with fixed rates that mature in less than five years, and managing its deposits and borrowings to establish stable relationships with both retail customers and wholesale funding sources.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, we may determine to increase our interest rate risk position somewhat in order to maintain or increase our net interest margin.
The Asset and Liability Committee regularly reviews interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and market value of portfolio equity, which is defined as the net present value of an institution's existing assets, liabilities and off-balance sheet instruments, and evaluating such impacts against the maximum potential changes in net interest income and market value of portfolio equity that are authorized by the Board of Directors of Great Southern.
In the normal course of business, the Company may use derivative financial instruments (primarily interest rate swaps) from time to time to assist in its interest rate risk management. In 2011, the Company began executing interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. Because the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. These interest rate derivatives result from a service provided to certain qualifying customers and, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions.
In 2013, the Company entered into an interest rate cap agreement related to its floating rate debt associated with its trust preferred securities. The agreement provided that the counterparty would reimburse the Company if interest rates rise above a certain threshold, thus creating a cap on the effective interest rate paid by the Company. This agreement was classified as a hedging instrument, and the effective portion of the gain or loss on the derivative was reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The interest rate cap related to the $25.0 million trust preferred security terminated per its contractual terms in the third quarter of 2017.
In October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $400 million with a termination date of October 6, 2025. Under the terms of the swap, the Company will receive a fixed rate of interest of 3.018% and will pay a floating rate of interest equal to one-month USD-LIBOR. The floating rate will be reset monthly and net settlements of interest due to/from the counterparty will also occur monthly. The floating rate of interest was 1.71% as of December 31, 2019. The Company receives net interest settlements which will be recorded as loan interest income to the extent that the fixed rate of interest continues to exceed one-month USD-LIBOR. If USD-LIBOR exceeds the fixed rate of interest in future periods, the Company is required to pay net settlements to the counterparty and record those net payments as a reduction of interest income on loans. The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
In March 2020, the Company and its swap counterparty mutually agreed to terminate the $400 million interest rate swap prior to its contractual maturity. The Company received a payment of $45.9 million from its swap counterparty as a result of this termination. The termination of this interest rate swap is discussed further in Note 28 of the accompanying audited financial statements, which are included in Item 8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Great Southern Bancorp, Inc.
Springfield, Missouri
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of Great Southern Bancorp, Inc. (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 6, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits.
We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BKD, LLP
We have served as the Company’s auditor since 1975.
Springfield, Missouri
March 6, 2020
Great Southern Bancorp, Inc.
Consolidated Statements of Financial Condition
December 31, 2019 and 2018
(In Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements
Great Southern Bancorp, Inc.
Consolidated Statements of Income
Years Ended December 31, 2019, 2018 and 2017
(In Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements
Great Southern Bancorp, Inc.
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2019, 2018 and 2017
(In Thousands)
See Notes to Consolidated Financial Statements
Great Southern Bancorp, Inc.
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2019, 2018 and 2017
(In Thousands, Except Per Share Data)
[1] $.94 per share dividend.
[2] $1.20 per share dividend.
[3] $2.07 per share dividend.
See Notes to Consolidated Financial Statements
Great Southern Bancorp, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 2019, 2018 and 2017
(In Thousands)
Note 1:
Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations and Operating Segments
Great Southern Bancorp, Inc. (“GSBC” or the “Company”) operates as a one-bank holding company. GSBC’s business primarily consists of the operations of Great Southern Bank (the “Bank”), which provides a full range of financial services to customers primarily located in Missouri, Iowa, Kansas, Minnesota, Nebraska and Arkansas. The Bank also originates commercial loans from lending offices in Atlanta, Ga., Chicago, Ill., Dallas, Texas, Denver, Colo., Omaha, Neb. and Tulsa, Okla. The Company and the Bank are subject to regulation by certain federal and state agencies and undergo periodic examinations by those regulatory agencies.
The Company’s banking operation is its only reportable segment. The banking operation is principally engaged in the business of originating residential and commercial real estate loans, construction loans, commercial business loans and consumer loans and funding these loans by attracting deposits from the general public, accepting brokered deposits and borrowing from the Federal Home Loan Bank and others. The operating results of this segment are regularly reviewed by management to make decisions about resource allocations and to assess performance. Selected information is not presented separately for the Company’s reportable segment, as there is no material difference between that information and the corresponding information in the consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, the valuation of loans acquired with indication of impairment and other-than-temporary impairments (OTTI) and fair values of financial instruments. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management obtains independent appraisals for significant properties. In addition, the Company considers that the determination of the carrying value of goodwill and intangible assets involves a high degree of judgment and complexity
Principles of Consolidation
The consolidated financial statements include the accounts of Great Southern Bancorp, Inc., its wholly owned subsidiary, the Bank, and the Bank’s wholly owned subsidiaries, Great Southern Real Estate Development Corporation, GSB One LLC (including its wholly owned subsidiary, GSB Two LLC), Great Southern Financial Corporation, Great Southern Community Development Company, LLC (including its wholly owned subsidiary, Great Southern CDE, LLC), GS, LLC, GSSC, LLC, GSTC Investments, LLC, GS-RE Holding, LLC (including its wholly owned subsidiary, GS RE Management, LLC), GS-RE Holding II, LLC, GS-RE Holding III, LLC, VFP Conclusion Holding, LLC and VFP Conclusion Holding II, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation.
Federal Home Loan Bank Stock
Federal Home Loan Bank common stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in common stock is based on a predetermined formula, carried at cost and evaluated for impairment.
Securities
Available-for-sale securities, which include any security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value. Unrealized gains and losses are recorded, net of related income tax effects, in other comprehensive income.
Held-to-maturity securities, which include any security for which the Company has the positive intent and ability to hold until maturity, are carried at historical cost adjusted for amortization of premiums and accretion of discounts.
Amortization of premiums and accretion of discounts are recorded as interest income from securities. Realized gains and losses are recorded as net security gains (losses). Gains and losses on sales of securities are determined on the specific-identification method.
For debt securities with fair value below carrying value when the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment (“OTTI”) of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an OTTI recorded in other comprehensive income for the noncredit portion of a previous OTTI is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
The Company’s consolidated statements of income reflect the full impairment (that is, the difference between the security’s amortized cost basis and fair value) on debt securities that the Company intends to sell or would more likely than not be required to sell before the expected recovery of the amortized cost basis. For available-for-sale and held-to-maturity debt securities that management has no intent to sell and believes that it more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment is recognized in earnings, while the noncredit loss is recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security based on cash flow projections.
For equity securities, if any, when the Company has decided to sell an impaired available-for-sale security and the Company does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed OTTI in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other-than-temporary even if a decision to sell has not been made.
Mortgage Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Write-downs to fair value are recognized as a charge to earnings at the time the decline in value occurs. Nonbinding forward commitments to sell individual mortgage loans are generally obtained to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sale. Gains and losses resulting from sales of mortgage loans are recognized when the respective loans are sold to investors. Fees received from borrowers to guarantee the funding of mortgage loans held for sale and fees paid to investors to ensure the ultimate sale of such mortgage loans are recognized as income or expense when the loans are sold or when it becomes evident that the commitment will not be used.
Loans Originated by the Company
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Past due status is based on the contractual terms of a loan. Generally, loans are placed on nonaccrual status at 90 days past due and interest is considered a loss, unless the loan is well secured and in the process of collection. Payments received on nonaccrual loans are applied to principal until the loans are returned to accrual status. Loans are returned to accrual status when all payments contractually due are brought current, payment performance is sustained for a period of time, generally six months, and future payments are reasonably assured. With the exception of consumer loans, charge-offs on loans are recorded when available information indicates a loan is not fully collectible and the loss is reasonably quantifiable. Consumer loans are charged-off at specified delinquency dates consistent with regulatory guidelines.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For loans classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for certain loan segments after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.
A loan is considered impaired when, based on current information and events, it is probable that not all of the principal and interest due under the loan agreement will be collected in accordance with contractual terms. For non-homogeneous loans, such as commercial loans, management determines which loans are reviewed for impairment based on information obtained by account officers, weekly past due meetings, various analyses including annual reviews of large loan relationships, calculations of loan debt coverage ratios as financial information is obtained and periodic reviews of all loans over $1.0 million. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and reasons for the delay, the borrower’s prior payment record and the amount of any collateral shortfall in relation to the principal and interest owed.
Large groups of smaller balance homogenous loans, such as consumer and residential loans, are collectively evaluated for impairment. In accordance with regulatory guidelines, impairment in the consumer and mortgage loan portfolio is primarily identified based on past-due status. Consumer and mortgage loans which are over 90 days past due or specifically identified as troubled debt restructurings will generally be individually evaluated for impairment.
Impairment is measured on a loan-by-loan basis for both homogeneous and non-homogeneous loans by either the present value of expected future cash flows or the fair value of the collateral if the loan is collateral dependent. Payments made on impaired loans are treated in accordance with the accrual status of the loan. If loans are performing in accordance with their contractual terms but the ultimate collectability of principal and interest is questionable, payments are applied to principal only.
Loans Acquired in Business Combinations
Loans acquired in business combinations under ASC Topic 805, Business Combinations, require the use of the purchase method of accounting. Therefore, such loans are initially recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic 820, Fair Value Measurements and Disclosures. No allowance for loan losses related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.
For acquired loans not acquired in conjunction with an FDIC-assisted transaction that are not considered to be purchased credit-impaired loans, the Company evaluates those loans acquired in accordance with the provisions of ASC Topic 310-20, Nonrefundable Fees and Other Costs. The fair value discount on these loans is accreted into interest income over the weighted average life of the loans using a constant yield method. These loans are not considered to be impaired loans. The Company evaluates purchased credit-impaired loans in accordance with the provisions of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Loans acquired in business combinations with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase dates may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Acquired credit-impaired loans that are accounted for under the accounting guidance for loans acquired with deteriorated credit quality are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans.
The Company evaluates all of its loans acquired in conjunction with its FDIC-assisted transactions in accordance with the provisions of ASC Topic 310-30. For purposes of applying ASC 310-30, loans acquired in FDIC-assisted business combinations are aggregated into pools of loans with common risk characteristics. All loans acquired in the FDIC transactions, both covered and not covered by loss sharing agreements, were deemed to be purchased credit-impaired loans as there is general evidence of credit deterioration since origination in the pools and there is some probability that not all contractually required payments will be collected. As a result, related discounts are recognized subsequently through accretion based on changes in the expected cash flows of these acquired loans.
The expected cash flows of the acquired loan pools in excess of the fair values recorded is referred to as the accretable yield and is recognized in interest income over the remaining estimated lives of the loan pools for impaired loans accounted for under ASC Topic 310-30. Subsequent to acquisition date, the Company has estimated cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques. Increases in the Company’s cash flow expectations have been recognized as increases to the accretable yield while decreases have been recognized as impairments through the allowance for loan losses.
FDIC Indemnification Asset
Through two FDIC-assisted transactions during 2009, one during 2011 and one during 2012, the Bank acquired certain loans and foreclosed assets which were covered under loss sharing agreements with the FDIC. These agreements committed the FDIC to reimburse the Bank for a portion of realized losses on these covered assets. Therefore, as of the dates of acquisitions, the Company calculated the amount of such reimbursements it expected to receive from the FDIC using the present value of anticipated cash flows from the covered assets based on the credit adjustments estimated for each pool of loans and the estimated losses on foreclosed assets. In accordance with FASB ASC 805, each FDIC Indemnification Asset was initially recorded at its fair value, and was measured separately from the loan assets and foreclosed assets because the loss sharing agreements were not contractually embedded in them or transferrable with them in the event of disposal. The balance of the FDIC Indemnification Asset increased and decreased as the expected and actual cash flows from the covered assets fluctuated, as loans were paid off or impaired and as loans and foreclosed assets were sold. There were no contractual interest rates on the contractual receivables from the FDIC; however, a discount was recorded against the initial balance of the FDIC Indemnification Asset in conjunction with the fair value measurement as the receivable was to be collected over the terms of the loss sharing agreements. This discount was accreted to income up until the termination of the loss sharing agreements. During 2016 and 2017, the Company and the FDIC mutually agreed to terminate all of these loss sharing agreements prior to their contractual termination dates. These acquisitions and agreements are more fully discussed in Note 4.
Other Real Estate Owned and Repossessions
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expense on foreclosed assets. Other real estate owned also includes bank premises formerly, but no longer, used for banking, as well as property originally acquired for future expansion but no longer intended to be used for that purpose.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line and accelerated methods over the estimated useful lives of the assets. Leasehold improvements are capitalized and amortized using the straight-line and accelerated methods over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter.
Material lease obligations consist of leases for various loan offices and banking centers, all of which are categorized as “operating leases.” Under current accounting guidance, lessees are required to recognize a lease liability and a right-of-use asset for these leases. This right-of-use asset is included in Premises and Equipment.
Long-Lived Asset Impairment
The Company evaluates the recoverability of the carrying value of long-lived assets whenever events or circumstances indicate the carrying amount may not be recoverable. If a long-lived asset is tested for recoverability and the undiscounted estimated future cash flows expected to result from the use and eventual disposition of the asset is less than the carrying amount of the asset, the asset cost is adjusted to fair value and an impairment loss is recognized as the amount by which the carrying amount of a long-lived asset exceeds its fair value.
No asset impairment was recognized during the years ended December 31, 2019, 2018 and 2017. At December 31, 2019, the remaining valuation allowance related to various properties was $220,000.
Goodwill and Intangible Assets
Goodwill is evaluated annually for impairment or more frequently if impairment indicators are present. A qualitative assessment is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not the fair value is less than the carrying amount, including goodwill. If, based on the evaluation, it is determined to be more likely than not that the fair value is less than the carrying value, then goodwill is tested further for impairment. If the implied fair value of goodwill is lower than its carrying amount, a goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill fair value are not recognized in the financial statements.
Intangible assets are being amortized on the straight-line basis generally over a period of seven years. Such assets are periodically evaluated as to the recoverability of their carrying value.
A summary of goodwill and intangible assets is as follows:
Loan Servicing and Origination Fee Income
Loan servicing income represents fees earned for servicing real estate mortgage loans owned by various investors. The fees are generally calculated on the outstanding principal balances of the loans serviced and are recorded as income when earned. Loan origination fees, net of direct loan origination costs, are recognized as income using the level-yield method over the contractual life of the loan.
Stockholders’ Equity
The Company is incorporated in the State of Maryland. Under Maryland law, there is no concept of “Treasury Shares.” Instead, shares purchased by the Company constitute authorized but unissued shares under Maryland law. Accounting principles generally accepted in the United States of America state that accounting for treasury stock shall conform to state law. The cost of shares purchased by the Company has been allocated to common stock and retained earnings balances.
Earnings Per Common Share
Basic earnings per common share are computed based on the weighted average number of common shares outstanding during each year. Diluted earnings per common share are computed using the weighted average common shares and all potential dilutive common shares outstanding during the period.
Earnings per common share (EPS) were computed as follows:
Options outstanding at December 31, 2019, 2018 and 2017, to purchase 201,400, 424,833 and 253,711 shares of common stock, respectively, were not included in the computation of diluted earnings per common share for each of the years because the exercise prices of such options were greater than the average market prices of the common stock for the years ended December 31, 2019, 2018 and 2017, respectively.
Stock Compensation Plans
The Company has stock-based employee compensation plans, which are described more fully in Note 20. In accordance with FASB ASC 718, Compensation - Stock Compensation, compensation cost related to share-based payment transactions is recognized in the Company’s consolidated financial statements based on the grant-date fair value of the award using the modified prospective transition method. For the years ended December 31, 2019, 2018 and 2017, share-based compensation expense totaling $922,000, $737,000 and $564,000, respectively, was included in salaries and employee benefits expense in the consolidated statements of income.
Cash Equivalents
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2019 and 2018, cash equivalents consisted of interest-bearing deposits in other financial institutions. At December 31, 2019, nearly all of the interest-bearing deposits were uninsured with nearly all of these balances held at the Federal Home Loan Bank or the Federal Reserve Bank.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance (FASB ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term “more likely than not” means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. At December 31, 2019 and 2018, no valuation allowance was established.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
The Company files consolidated income tax returns with its subsidiaries.
Derivatives and Hedging Activities
FASB ASC 815, Derivatives and Hedging, provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. Further, qualitative disclosures are required that explain the Company’s objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. For detailed disclosures on derivatives and hedging activities, see Note 16.
As required by FASB ASC 815, the Company records all derivatives in the statement of financial condition at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
Restriction on Cash and Due From Banks
The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2019 and 2018, respectively, was $69.4 million and $62.6 million.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) and in July 2018 FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases. The amendments in this Update revise the accounting related to lessee accounting. Under the new guidance, lessees are required to recognize a lease liability and a right-of-use asset for all leases. The Update became effective for the Company on January 1, 2019. Adoption of the standard required the use of a modified retrospective transition approach for all periods presented at the time of adoption. Based on the Company’s leases outstanding at December 31, 2018, which totaled less than 20 leased properties and no significant leased equipment, the adoption of the new standard did not have a material impact on our consolidated statements of financial condition or our consolidated statements of income, although an increase to assets and liabilities occurred at the time of adoption. In the first quarter of 2019, the Company recognized a lease liability and a corresponding right-of-use asset for all leases of $9.5 million based on the lease portfolio at that time. The Company’s lease terminations, new leases and lease modifications and renewals will impact the amount of lease liability and a corresponding right-of-use asset recognized. The Company’s leases are currently all “operating leases” as defined in the Update; therefore, no material change in the income statement presentation of lease expense occurred in the year ended December 31, 2019. The Company’s lease activities are discussed further in Note 6 of the Notes to Consolidated Financial Statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326). The Update amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. This Update affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The Update became effective for the Company on January 1, 2020. The Company applied the amendments in this update on a modified retrospective basis, through a cumulative-effect adjustment to retained earnings in the first quarter of 2020. The adoption of the CECL model required us to recognize a one-time cumulative adjustment to our allowance for loan losses and a liability for potential losses related to the unfunded portion of our loans and commitments in order to fully transition from the incurred loss model to the CECL model. Upon adoption, we expect to increase the balance of our allowance for credit losses in a range of $11 million to $14 million and created a liability for potential losses related to the unfunded portion of our loans and commitments in a range of $7 million to $10 million. The after-tax effect of this is expected to result in a decrease in our retained earnings of $14 million to $18 million. These estimates are subject to change as material assumptions are refined and model validations are completed as we finalize our first quarter 2020 financial statements.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles: Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350). To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test should be performed by comparing the fair value of a reporting unit with its carrying amount and an impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the qualitative impairment test is necessary. The nature of and reason for the change in accounting principle should be disclosed upon transition. The amendments in this update should be adopted for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The impact of adopting this new guidance in 2020 is not expected to have a material impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 is effective for periods beginning after December 15, 2019. The impact of adopting this new guidance in 2020 is not expected to have a material impact on the Company’s consolidated financial statements.
Note 2:
Investments in Securities
The amortized cost and fair values of securities classified as available-for-sale were as follows:
At December 31, 2019, the Company’s agency mortgage-backed securities portfolio consisted of FNMA securities totaling $147.6 million, FHLMC securities totaling $13.3 million and GNMA securities totaling $4.1 million. At December 31, 2019, agency collateralized mortgage obligations consisted of GNMA securities totaling $122.7 million, FNMA securities totaling $23.9 million, and FHLMC securities totaling $5.4 million. At December 31, 2019, $144.3 million of the Company’s agency mortgage-backed securities had fixed rates of interest and $20.7 million had variable rates of interest. At December 31, 2019, $149.9 million of the Company’s agency collateralized mortgage obligations had fixed rates of interest and $2.1 million had variable rates of interest.
The amortized cost and fair value of available-for-sale securities at December 31, 2019, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
There were no securities classified as held to maturity at December 31, 2019 or December 31, 2018.
The amortized cost and fair values of securities pledged as collateral was as follows at December 31, 2019 and 2018:
Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2019 and 2018, was approximately $116.2 million and $95.7 million, respectively, which is approximately 31.1% and 39.2% of the Company’s available-for-sale and held-to-maturity investment portfolio, respectively.
Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these debt securities are temporary.
The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2019 and 2018:
Other-than-Temporary Impairment
Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.
The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model. The Company does not currently have securities within the scope of this guidance for beneficial interests in securitized financial assets.
The Company routinely conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. The Company considers the length of time a security has been in an unrealized loss position, the relative amount of the unrealized loss compared to the carrying value of the security, the type of security and other factors. If certain criteria are met, the Company performs additional review and evaluation using observable market values or various inputs in economic models to determine if an unrealized loss is other than temporary. The Company uses quoted market prices for marketable equity securities and uses broker pricing quotes based on observable inputs for equity investments that are not traded on a stock exchange. For non-agency collateralized mortgage obligations, to determine if the unrealized loss is other than temporary, the Company projects total estimated defaults of the underlying assets (mortgages) and multiplies that calculated amount by an estimate of realizable value upon sale in the marketplace (severity) in order to determine the projected collateral loss. The Company also evaluates any current credit enhancement underlying these securities to determine the impact on cash flows. If the Company determines that a given security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.
During 2019, 2018 and 2017, no securities were determined to have impairment that had become other-than-temporary.
Credit Losses Recognized on Investments
During 2019, 2018 and 2017, there were no debt securities that experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.
Note 3:
Loans and Allowance for Loan Losses
Classes of loans at December 31, 2019 and 2018, included:
Classes of loans by aging were as follows:
Non-accruing loans are summarized as follows:
The following tables present the activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2019, 2018 and 2017, respectively. Also presented are the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of the years ended December 31, 2019, 2018, and 2017, respectively:
The portfolio segments used in the preceding three tables correspond to the loan classes used in all other tables in Note 3 as follows:
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The one- to four-family residential and construction segment includes the one- to four-family residential construction, subdivision construction, owner occupied one- to four-family residential and non-owner occupied one- to four-family residential classes.
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The other residential segment corresponds to the other residential class.
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The commercial real estate segment includes the commercial real estate and industrial revenue bonds classes.
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The commercial construction segment includes the land development and commercial construction classes.
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The commercial business segment corresponds to the commercial business class.
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The consumer segment includes the consumer auto, consumer other and home equity lines of credit classes.
The weighted average interest rate on loans receivable at December 31, 2019 and 2018, was 4.97% and 5.16%, respectively.
Loans serviced for others are not included in the accompanying consolidated statements of financial condition. The unpaid principal balance of loans serviced for others at December 31, 2019, was $349.9 million, consisting of $283.0 million of commercial loan participations sold to other financial institutions and $66.9 million of residential mortgage loans sold. The unpaid principal balance of loans serviced for others at December 31, 2018, was $260.2 million, consisting of $181.5 million of commercial loan participations sold to other financial institutions and $78.7 million of residential mortgage loans sold. In addition, available lines of credit on these loans were $102.1 million and $121.0 million at December 31, 2019 and 2018, respectively.
A loan is considered impaired, in accordance with the impairment accounting guidance (FASB ASC 310-10-35-16) when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include not only nonperforming loans but also loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.
The following summarizes information regarding impaired loans at and during the years ended December 31, 2019, 2018 and 2017:
At December 31, 2019, $5.2 million of impaired loans had specific valuation allowances totaling $929,000. At December 31, 2018, $8.4 million of impaired loans had specific valuation allowances totaling $2.0 million. At December 31, 2017, $12.7 million of impaired loans had specific valuation allowances totaling $4.0 million. For impaired loans which were non-accruing, interest of approximately $761,000, $1.0 million and $1.2 million would have been recognized on an accrual basis during the years ended December 31, 2019, 2018 and 2017, respectively.
Included in certain loan categories in the impaired loans are troubled debt restructurings that were classified as impaired. Troubled debt restructurings are loans that are modified by granting concessions to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The types of concessions made are factored into the estimation of the allowance for loan losses for troubled debt restructurings primarily using a discounted cash flows or collateral adequacy approach.
The following table presents newly restructured loans during the years ended December 31, 2019, 2018 and 2017 by type of modification:
At December 31, 2019, the Company had $1.9 million of loans that were modified in troubled debt restructurings and impaired, as follows: $251,000 of construction and land development loans, $768,000 of single family residential mortgage loans, $412,000 of commercial real estate loans, $156,000 of commercial business loans and $343,000 of consumer loans. Of the total troubled debt restructurings at December 31, 2019, $1.4 million were accruing interest and $562,000 were classified as substandard using the Company’s internal grading system which is described below. The Company had no troubled debt restructurings which were modified in the previous 12 months and subsequently defaulted during the year ended December 31, 2019. When loans modified as troubled debt restructuring have subsequent payment defaults, the defaults are factored into the determination of the allowance for loan losses to ensure specific valuation allowances reflect amounts considered uncollectible. At December 31, 2018, the Company had $6.9 million of loans that were modified in troubled debt restructurings and impaired, as follows: $283,000 of construction and land development loans, $3.9 million of single family residential mortgage loans, $1.3 million of commercial real estate loans, $548,000 of commercial business loans, and $803,000 of consumer loans. Of the total troubled debt restructurings at December 31, 2018, $4.7 million were accruing interest and $2.5 million were classified as substandard using the Company’s internal grading system. During the year ended December 31, 2019, borrowers with loans designated as troubled debt restructurings totaling $63,000, all of which consisted of consumer loans, met the criteria for placement back on accrual status. This criteria is generally a minimum of six months of consistent and timely payment performance under original or modified terms.
The Company reviews the credit quality of its loan portfolio using an internal grading system that classifies loans as “Satisfactory,” “Watch,” “Special Mention,” “Substandard” and “Doubtful.” Loans classified as watch are being monitored because of indications of potential weaknesses or deficiencies that may require future classification as special mention or substandard. Special mention loans possess potential weaknesses that deserve management’s close attention but do not expose the Bank to a degree of risk that warrants substandard classification. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if certain deficiencies are not corrected. Doubtful loans are those having all the weaknesses inherent to those classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans not meeting any of the criteria previously described are considered satisfactory. The FDIC-assisted acquired loans are evaluated using this internal grading system. These loans are accounted for in pools. Minimal adverse classification in these acquired loan pools was identified as of December 31, 2019 and 2018 respectively. See Note 4 for further discussion of the acquired loan pools and termination of the loss sharing agreements.
The Company evaluates the loan risk internal grading system definitions and allowance for loan loss methodology on an ongoing basis. The general component of the allowance for loan losses is affected by several factors, including, but not limited to, average historical losses, average life of the loans, current composition of the loan portfolio, current and expected economic conditions, collateral values and internal risk ratings. Management considers all these factors in determining the adequacy of the Company’s allowance for loan losses. No significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the past year.
The loan grading system is presented by loan class below:
Certain of the Bank’s real estate loans are pledged as collateral for borrowings as set forth in Notes 9 and 11.
Certain directors and executive officers of the Company and the Bank, and their related interests, are customers of and had transactions with the Bank in the ordinary course of business. Except for the interest rates on loans secured by personal residences, in the opinion of management, all loans included in such transactions were made on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties. Generally, residential first mortgage loans and home equity lines of credit to all employees and directors have been granted at interest rates equal to the Bank’s cost of funds, subject to annual adjustments in the case of residential first mortgage loans and monthly adjustments in the case of home equity lines of credit. At December 31, 2019 and 2018, loans outstanding to these directors and executive officers, and their related interests, are summarized as follows:
Note 4:
FDIC-Acquired Loans, Loss Sharing Agreements and FDIC Indemnification Assets
TeamBank
On March 20, 2009, Great Southern Bank entered into a purchase and assumption agreement with loss share with the Federal Deposit Insurance Corporation (FDIC) to assume all of the deposits (excluding brokered deposits) and acquire certain assets of TeamBank, N.A., a full service commercial bank headquartered in Paola, Kansas.
The loans, commitments and foreclosed assets purchased in the TeamBank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans. The five-year period ended March 31, 2014 and the ten-year period was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. See “Loss Sharing Agreements” below. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
Vantus Bank
On September 4, 2009, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Vantus Bank, a full service thrift headquartered in Sioux City, Iowa.
The loans, commitments and foreclosed assets purchased in the Vantus Bank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans. The five year period ended September 30, 2014 and the ten-year period was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. See “Loss Sharing Agreements” below. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
Sun Security Bank
On October 7, 2011, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Sun Security Bank, a full service bank headquartered in Ellington, Missouri.
The loans and foreclosed assets purchased in the Sun Security Bank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans but was terminated early, effective April 26, 2016, by mutual agreement of Great Southern Bank and the FDIC. See “Loss Sharing Agreements” below. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded.
InterBank
On April 27, 2012, Great Southern Bank entered into a purchase and assumption agreement with loss share with the FDIC to assume all of the deposits and acquire certain assets of Inter Savings Bank, FSB (“InterBank”), a full service bank headquartered in Maple Grove, Minnesota.
The loans and foreclosed assets purchased in the InterBank transaction were covered by a loss sharing agreement between the FDIC and Great Southern Bank. This agreement originally was to extend for ten years for 1-4 family real estate loans and for five years for other loans but was terminated early, effective June 9, 2017, by mutual agreement of Great Southern Bank and the FDIC. See “Loss Sharing Agreements” below. Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded. A premium was recorded in conjunction with the fair value of the acquired loans and the amount amortized to yield during 2019, 2018 and 2017 was $99,000, $175,000 and $269,000, respectively.
Valley Bank
On June 20, 2014, Great Southern Bank entered into a purchase and assumption agreement with the FDIC to purchase a substantial portion of the loans and investment securities, as well as certain other assets, and assume all of the deposits, as well as certain other liabilities, of Valley Bank, a full-service bank headquartered in Moline, Illinois, with significant operations in Iowa. This transaction did not include a loss sharing agreement.
Based upon the acquisition date fair values of the net assets acquired, no goodwill was recorded. A premium was recorded in conjunction with the fair value of the acquired loans and the amount amortized to yield during 2019, 2018 and 2017 was $0, $11,000 and $217,000, respectively.
Loss Sharing Agreements
On April 26, 2016, Great Southern Bank executed an agreement with the FDIC to terminate the loss sharing agreements for Team Bank, Vantus Bank and Sun Security Bank, effective immediately. The agreement required the FDIC to pay $4.4 million to settle all outstanding items related to the terminated loss sharing agreements. As a result of entering into the termination agreement, assets that were covered by the terminated loss sharing agreements were reclassified as non-covered assets effective April 26, 2016. All rights and obligations of the Bank and the FDIC under the terminated loss sharing agreements, including the settlement of all existing loss sharing and expense reimbursement claims, have been resolved and terminated.
On June 9, 2017, Great Southern Bank executed an agreement with the FDIC to terminate the loss sharing agreements for InterBank, effective immediately. Pursuant to the termination agreement, the FDIC paid $15.0 million to the Bank to settle all outstanding items related to the terminated loss sharing agreements. The Company recorded a pre-tax gain on the termination of $7.7 million. As a result of entering into the termination agreement, assets that were covered by the terminated loss sharing arrangements were reclassified as non-covered assets effective June 9, 2017. All rights and obligations of the Bank and the FDIC under the terminated loss sharing agreements, including the settlement of all existing loss sharing and expense reimbursement claims, have been resolved and terminated.
The termination of the loss sharing agreements for the TeamBank, Vantus Bank, Sun Security Bank and InterBank transactions has no impact on the yields for the loans that were previously covered under these agreements. All post-termination recoveries, gains, losses and expenses related to these previously covered assets are recognized entirely by Great Southern Bank since the FDIC no longer shares in such gains or losses. Accordingly, the Company’s earnings are positively impacted to the extent the Company recognizes gains on any sales or recoveries in excess of the carrying value of such assets. Similarly, the Company’s future earnings are negatively impacted to the extent the Company recognizes expenses, losses or charge-offs related to such assets.
The following table presents the balances of the acquired loans related to the various FDIC-assisted transactions at December 31, 2019 and December 31, 2018.
Fair Value and Expected Cash Flows
At the time of these acquisitions, the Company determined the fair value of the loan portfolios based on several assumptions. Factors considered in the valuations were projected cash flows for the loans, type of loan and related collateral, classification status, fixed or variable interest rate, term of loan, current discount rates and whether or not the loan was amortizing. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. Management also estimated the amount of credit losses that were expected to be realized for the loan portfolios. The discounted cash flow approach was used to value each pool of loans. For non-performing loans, fair value was estimated by calculating the present value of the recoverable cash flows using a discount rate based on comparable corporate bond rates. This valuation of the acquired loans is a significant component leading to the valuation of the loss sharing assets recorded.
The amount of the estimated cash flows expected to be received from the acquired loan pools in excess of the fair values recorded for the loan pools is referred to as the accretable yield. The accretable yield is recognized as interest income over the estimated lives of the loans. On an ongoing basis, the Company has evaluated the fair value of the loans including cash flows expected to be collected. Increases in the Company’s cash flow expectations are recognized as increases to the accretable yield while decreases are recognized as impairments through the allowance for loan losses. During the years ended December 31, 2019, 2018 and 2017, improvements in expected cash flows related to the acquired loan portfolios resulted in adjustments to the accretable yield to be spread over the estimated remaining lives of the loans on a level-yield basis. The increases in expected cash flows also reduced the amount of expected reimbursements under the loss sharing agreements, when applicable, until they were terminated or expired. This resulted in corresponding adjustments during the year ended December 31, 2017, to the indemnification assets (which during 2017 were reduced to $-0- due to the termination of the loss sharing agreements). The amounts of these adjustments were as follows:
The adjustments, along with those made in previous years, impacted the Company’s Consolidated Statements of Income as follows:
On an on-going basis the Company has estimated the cash flows expected to be collected from the acquired loan pools. For each of the loan portfolios acquired, the cash flow estimates have increased, based on payment histories and reduced credit loss expectations. This resulted in increased income that has been spread, on a level-yield basis, over the remaining expected lives of the loan pools (and, therefore, has decreased over time). Increases in expected cash flows also reduced the amount of expected reimbursements under the loss sharing agreements with the FDIC (when such agreements were in place), which were recorded as indemnification assets. Therefore, the expected indemnification assets had also been reduced, resulting in adjustments to be amortized on a comparable basis over the remainder of the loss sharing agreements or the remaining expected lives of the loan pools, whichever was shorter. Additional estimated cash flows totaling approximately $12.3 million were recorded in the year ended December 31, 2019 related to these loan pools, with no corresponding reduction in expected reimbursement from the FDIC as the remaining loss sharing agreements were terminated in 2017.
Because these adjustments to accretable yield will be recognized generally over the remaining lives of the loan pools, they will impact future periods as well. As of December 31, 2019, the remaining accretable yield adjustment that will affect interest income was $7.6 million. Of the remaining adjustments affecting interest income, we expect to recognize $5.6 million of interest income during 2020. As there is no longer, nor will there be in the future, indemnification asset amortization related to TeamBank, Vantus Bank, Sun Security Bank or InterBank due to the termination or expiration of the related loss sharing agreements for those transactions, there is no remaining indemnification asset or related adjustments that will affect non-interest income (expense). During the three months ending March 31, 2020, we will adopt the new accounting standard related to accounting for credit losses. With the adoption of this standard, there will be no more reclassification of discounts from non-accretable to accretable subsequent to December 31, 2019. All adjustments made prior to December 31, 2019 will continue to be accreted to interest income.
Changes in the accretable yield for acquired loan pools were as follows for the years ended December 31, 2019, 2018 and 2017:
(1)
Represents increases in estimated cash flows expected to be received from the acquired loan pools, primarily due to lower estimated credit losses. The numbers also include changes in expected accretion of the loan pools for TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank for the year ended December 31, 2019, totaling $667,000, $480,000, $810,000, $3.9 million and $2.5 million, respectively; for TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank for the year ended December 31, 2018, totaling $312,000, $778,000, $756,000, $4.1 million and $3.5 million, respectively; and for TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank for the year ended December 31, 2017, totaling $1.1 million, $663,000, $850,000, $3.5 million and $3.0 million, respectively
Note 5:
Other Real Estate Owned and Repossessions
Major classifications of other real estate owned at December 31, 2019 and 2018, were as follows:
At December 31, 2019, other real estate owned not acquired through foreclosure included six properties all of which were branch locations that were closed and held for sale. During the year ended December 31, 2019, one former branch location was both added to this category and sold at a gain of $115,000, which is included in the net gains on sales of other real estate owned and repossessions amount in the table below.
At December 31, 2018, other real estate owned not acquired through foreclosure included nine properties, eight of which were branch locations that were closed and held for sale, and one of which is land acquired for a potential branch location. During the year ended December 31, 2018, one former branch location was sold at a loss of $24,000, which is included in the net gains on sales of other real estate owned and repossessions amount in the table below.
At December 31, 2019, residential mortgage loans totaling $1.6 million were in the process of foreclosure, $1.4 million of which were acquired loans. Of the $1.4 million of acquired loans, $738,000 were previously covered by loss sharing agreements and $689,000 were acquired in the Valley Bank transaction.
At December 31, 2018, residential mortgage loans totaling $1.3 million were in the process of foreclosure, $1.0 million of which were acquired loans. Of the $1.0 million of acquired loans, $873,000 were previously covered by loss sharing agreements and $171,000 were acquired in the Valley Bank transaction.
Expenses applicable to other real estate owned and repossessions for the years ended December 31, 2019, 2018 and 2017, included the following:
Note 6:
Premises and Equipment
Major classifications of premises and equipment at December 31, 2019 and 2018, stated at cost, were as follows:
Leases. The Company adopted ASU 2016-02, Leases (Topic 842), on January 1, 2019, using the modified retrospective transition approach whereby comparative periods were not restated. The Company also elected certain relief options under the ASU, including the option not to recognize right of use asset and lease liabilities that arise from short-term leases (leases with terms of twelve months or less). The Company has 17 total lease agreements in which it is the lessee, with lease terms exceeding twelve months, substantially all of which are for branch locations and commercial loan production offices. All of our lease agreements where we have offsite ATMs are for terms not exceeding twelve months. Adoption of this ASU resulted in the Company initially recognizing a right of use asset and corresponding lease liability of $9.5 million during the three months ended March 31, 2019. The amount of the right of use asset and corresponding lease liability will fluctuate based on the Company’s lease terminations, new leases and lease modifications and renewals. As of December 31, 2019, the lease right of use asset value was $8.7 million and the corresponding lease liability was $8.7 million.
All of our leases are classified as operating leases (as they were prior to January 1, 2019), and therefore were previously not recognized on the Company’s consolidated statements of financial condition. With the adoption of ASU 2016-02, these operating leases are now included as a right of use asset in the premises and equipment line item on the Company’s consolidated statements of financial condition. The corresponding lease liability is included in the accrued expenses and other liabilities line item on the Company’s consolidated statements of financial condition. Because these leases are classified as operating leases, the adoption of the new standard did not have a material effect on lease expense on the Company’s consolidated statements of income.
ASU 2016-02 provides a number of optional practical expedients in transition. The Company has elected the “package of practical expedients,” which permits the Company not to reassess under the new standard the prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected the use of the hindsight, a practical expedient which permits the use of information available after lease inception to determine the lease term via the knowledge of renewal options exercised not available as of the lease’s inception. The practical expedient pertaining to land easements is not applicable to the Company.
ASU 2016-02 also requires certain other accounting elections. The Company elected the short-term lease recognition exemption for all leases that qualify, meaning those with terms under twelve months. Right of use assets or lease liabilities are not to be recognized for short-term leases. The Company also elected the practical expedient to not separate lease and non-lease components for all leases. The Company’s short-term leases related to offsite ATMs have both fixed and variable lease payment components, based on the number of transactions at the various ATMs. The variable portion of these lease payments is not material and the total lease expense related to ATMs was $286,000 for the year ended December 31, 2019.
The calculated amounts of the right of use assets and lease liabilities in the table below are impacted by the length of the lease term and the discount rate used to present value the minimum lease payments. The Company’s lease agreements often include one or more options to renew extended term in the calculation of the right of use asset and lease liability. Regarding the discount rate, the ASU requires the use of the rate implicit in the lease at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the right of use asset lease liability. Regarding the discount rate, the ASU requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception over a similar term. The discount rate utilized was the FHLBank borrowing rate for the term corresponding to the expected term of the lease. The expected lease terms range from 2.3 years to 18.9 years with a weighted-average lease term of 10.6 years. The weighted-average discount rate was 3.40%.
For the years ended December 31, 2019 and 2018, lease expense was $1.5 million and $1.2 million, respectively. At December 31, 2019, future expected lease payments for leases with terms exceeding one year were as follows (in thousands):
The Company does not sublease any of its leased facilities; however, it does lease to other third parties portions of facilities that it owns. In terms of being the lessor in these circumstances, all of these lease agreements are classified as operating leases. In the years ended December 31, 2019 and 2018, income recognized from these lessor agreements was $1.1 million and $1.0 million, respectively, and was included in occupancy and equipment expense.
Note 7:
Investments in Limited Partnerships
Investments in Affordable Housing Partnerships
The Company has invested in certain limited partnerships that were formed to develop and operate apartments and single-family houses designed as high-quality affordable housing for lower income tenants throughout Missouri and contiguous states. At December 31, 2019 the Company had 15 such investments, with a net carrying value of $22.8 million. At December 31, 2018 the Company had 17 such investments, with a net carrying value of $22.9 million. Due to the Company’s inability to exercise any significant influence over any of the investments in Affordable Housing Partnerships, they all are accounted for using the proportional amortization method. Each of the partnerships must meet the regulatory requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credits may be denied for any period in which the projects are not in compliance and a portion of the credits previously taken may be subject to recapture with interest.
The remaining federal affordable housing tax credits to be utilized through 2029 were $25.2 million as of December 31, 2019, assuming no tax credit recapture events occur and all projects currently under construction are completed as planned. Amortization of the investments in partnerships is expected to be approximately $22.8 million, assuming all projects currently under construction are completed and funded as planned. The Company’s usage of federal affordable housing tax credits approximated $8.0 million, $6.6 million and $6.6 million during 2019, 2018 and 2017, respectively. Investment amortization amounted to $5.8 million, $5.0 million and $5.2 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Investments in Community Development Entities
The Company has invested in certain limited partnerships that were formed to develop and operate business and real estate projects located in low-income communities. At December 31, 2019, the Company had no such investment. At December 31, 2018, the Company had one such investment, with a net carrying value of $365,000. Due to the Company’s inability to exercise any significant influence over any of the investments in qualified Community Development Entities, they are all accounted for using the cost method. Each of the partnerships provides federal New Market Tax Credits over a seven-year credit allowance period. In each of the first three years, credits totaling five percent of the original investment are allowed on the credit allowance dates and for the final four years, credits totaling six percent of the original investment are allowed on the credit allowance dates. Each of the partnerships must be invested in a qualified Community Development Entity on each of the credit allowance dates during the seven-year period to utilize the tax credits. If the Community Development Entities cease to qualify during the seven-year period, the credits may be denied for any credit allowance date and a portion of the credits previously taken may be subject to recapture with interest. The investments in the Community Development Entities cannot be redeemed before the end of the seven-year period.
The Company’s usage of federal New Market Tax Credits approximated $480,000, $480,000 and $1.2 million during 2019, 2018 and 2017, respectively. Investment amortization amounted to $365,000, $575,000 and $930,000 for the years ended December 31, 2019, 2018 and 2017, respectively.
Investments in Limited Partnerships for Federal Rehabilitation/Historic Tax Credits
From time to time, the Company has invested in certain limited partnerships that were formed to provide certain federal rehabilitation/historic tax credits. Previously, the Company utilized these credits in their entirety in the year the project was placed in service and the impact to the Consolidated Statements of Income has not been material. In future periods, such partnerships provide federal rehabilitation/historic tax credits over a five-year credit allowance period.
Investments in Limited Partnerships for State Tax Credits
From time to time, the Company has invested in certain limited partnerships that were formed to provide certain state tax credits. The Company has primarily syndicated these tax credits and the impact to the Consolidated Statements of Income has not been material.
Note 8:
Deposits
Deposits at December 31, 2019 and 2018, are summarized as follows:
The weighted average interest rate on certificates of deposit was 2.09% and 1.98% at December 31, 2019 and 2018, respectively.
The aggregate amount of certificates of deposit originated by the Bank in denominations greater than $100,000 was approximately $830.8 million and $733.9 million at December 31, 2019 and 2018, respectively. The Bank utilizes brokered deposits as an additional funding source. The aggregate amount of brokered deposits was approximately $371.7 million and $326.9 million at December 31, 2019 and 2018, respectively.
At December 31, 2019, scheduled maturities of certificates of deposit were as follows:
A summary of interest expense on deposits for the years ended December 31, 2019, 2018 and 2017, is as follows:
Note 9:
Advances From Federal Home Loan Bank
At December 31, 2019 and 2018, there were no outstanding term advances from the Federal Home Loan Bank of Des Moines (FHLBank advances). There were overnight funds from the Federal Home Loan Bank of Des Moines, which are included below in Note 10.
The Bank has pledged FHLB stock, investment securities and first mortgage loans free of pledges, liens and encumbrances as collateral for outstanding advances. No investment securities were specifically pledged as collateral for advances at December 31, 2019 and 2018. Loans with carrying values of approximately $1.60 billion and $1.36 billion were pledged as collateral for outstanding advances at December 31, 2019 and 2018, respectively. The Bank had potentially available $867.1 million remaining on its line of credit under a borrowing arrangement with the FHLB of Des Moines at December 31, 2019.
Note 10:
Short-Term Borrowings
Short-term borrowings at December 31, 2019 and 2018, are summarized as follows:
The Bank enters into sales of securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the statements of financial condition. The dollar amount of securities underlying the agreements remains in the asset accounts. Securities underlying the agreements are being held by the Bank during the agreement period. All agreements are written on a term of one-month or less.
At December 31, 2019, other interest-bearing liabilities consist of cash collateral held by the Company to satisfy minimum collateral posting thresholds with its derivative dealer counterparties representing the termination value of derivatives, which at such time were in a net asset position. Under the collateral agreements between the parties, either party may choose to provide cash or securities to satisfy its collateral requirements.
Short-term borrowings had weighted average interest rates of 1.25% and 1.68% at December 31, 2019 and 2018, respectively. Short-term borrowings averaged approximately $260.0 million and $137.3 million for the years ended December 31, 2019 and 2018, respectively. The maximum amounts outstanding at any month end were $346.9 million and $298.0 million, respectively, during those same periods.
The following table represents the Company’s securities sold under reverse repurchase agreements, by collateral type and remaining contractual maturity at December 31, 2019 and 2018:
Note 11:
Federal Reserve Bank Borrowings
At December 31, 2019 and 2018, the Bank had $367.8 million and $460.7 million, respectively, available under a line-of-credit borrowing arrangement with the Federal Reserve Bank. The line is secured primarily by consumer and commercial loans. There were no amounts borrowed under this arrangement at December 31, 2019 or 2018.
Note 12:
Subordinated Debentures Issued to Capital Trusts
In November 2006, Great Southern Capital Trust II (Trust II), a statutory trust formed by the Company for the purpose of issuing the securities, issued a $25.0 million aggregate liquidation amount of floating rate cumulative trust preferred securities. The Trust II securities bear a floating distribution rate equal to 90-day LIBOR plus 1.60%. The Trust II securities became redeemable at the Company’s option in February 2012, and if not sooner redeemed, mature on February 1, 2037. The Trust II securities were sold in a private transaction exempt from registration under the Securities Act of 1933, as amended. The gross proceeds of the offering were used to purchase Junior Subordinated Debentures from the Company totaling $25.8 million and bearing an interest rate identical to the distribution rate on the Trust II securities. The initial interest rate on the Trust II debentures was 6.98%. The interest rate was 3.51% and 4.14% at December 31, 2019 and 2018, respectively.
At December 31, 2019 and 2018, subordinated debentures issued to capital trusts are summarized as follows:
Note 13:
Subordinated Notes
On August 8, 2016, the Company completed the public offering and sale of $75.0 million of its subordinated notes. The notes are due August 15, 2026, and have a fixed interest rate of 5.25% until August 15, 2021, at which time the rate becomes floating at a rate equal to three-month LIBOR plus 4.087%. The Company may call the notes at par beginning on August 15, 2021, and on any scheduled interest payment date thereafter. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions, legal, accounting and other professional fees, of approximately $73.5 million. Total debt issuance costs, totaling approximately $1.5 million, were deferred and are being amortized over the expected life of the notes, which is five years from the issuance date. Amortization of the debt issuance costs during the years ended December 31, 2019 and 2018, totaled $434,000 and $154,000, respectively, and is included in interest expense on subordinated notes in the consolidated statements of income, resulting in an imputed interest rate of 5.89%.
At December 31, 2019 and 2018, subordinated notes are summarized as follows:
Note 14:
Income Taxes
The Company files a consolidated federal income tax return. As of December 31, 2019 and 2018, retained earnings included approximately $17.5 million for which no deferred income tax liability had been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only for tax years prior to 1988. If the Bank were to liquidate, the entire amount would have to be recaptured and would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount was approximately $3.9 million at both December 31, 2019 and 2018, respectively.
During the years ended December 31, 2019, 2018 and 2017, the provision for income taxes included these components:
The tax effects of temporary differences related to deferred taxes shown on the statements of financial condition were:
Reconciliations of the Company’s effective tax rates from continuing operations to the statutory corporate tax rates were as follows:
Tax at statutory rate
21.0
%
21.0
%
35.0
%
Nontaxable interest and dividends
(0.5)
(0.8)
(1.6)
Tax credits
(3.6)
(3.4)
(6.1)
State taxes
1.3
1.1
1.1
Initial impact of enactment of 2017 Tax Act
0.0
0.0
(0.4)
Other
0.1
0.2
(1.3)
18.3
%
18.1
%
26.7
%
The Tax Cuts and Jobs Act (“TCJ Act”) was signed into law on December 22, 2017, making several changes to U. S. corporate income tax laws, including reducing the corporate Federal income tax rate from 35% to 21% effective for tax years beginning on or after January 1, 2018. U. S. GAAP requires that the impact of the provisions of the TCJ Act be accounted for in the period of enactment. The Company recognized the income tax effects of the TCJ Act in its 2017 financial statements. The TCJ Act is complex and required significant detailed analysis. During the preparation of the Company’s 2017 income tax returns in 2018, no additional adjustments related to enactment of the TCJ Act were identified.
The Company and its consolidated subsidiaries have not been audited recently by the Internal Revenue Service (IRS), except as described here. The Company, through one of its subsidiaries, is a partner in two partnerships which were under IRS examination for 2006 and 2007. As a result, the Company’s 2006 and subsequent tax years remained open for examination. The examinations of these partnerships were completed during 2019. The completion of these examinations did not result in significant changes to the Company’s tax positions. As a result, federal tax years through December 31, 2015 are now closed.
The Company is currently under State of Missouri income and franchise tax examinations for its 2014 and 2015 tax years. The Company does not currently expect significant adjustments to its financial statements from this state examination.
Note 15:
Disclosures About Fair Value of Financial Instruments
ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
•
Quoted prices in active markets for identical assets or liabilities (Level 1): Inputs that are quoted unadjusted prices in active markets for identical assets that the Company has the ability to access at the measurement date. An active market for the asset is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
•
Other observable inputs (Level 2): Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity including quoted prices for similar assets, quoted prices for securities in inactive markets and inputs derived principally from or corroborated by observable market data by correlation or other means.
•
Significant unobservable inputs (Level 3): Inputs that reflect assumptions of a source independent of the reporting entity or the reporting entity's own assumptions that are supported by little or no market activity or observable inputs.
Financial instruments are broken down as follows by recurring or nonrecurring measurement status. Recurring assets are initially measured at fair value and are required to be remeasured at fair value in the financial statements at each reporting date. Assets measured on a nonrecurring basis are assets that, due to an event or circumstance, were required to be remeasured at fair value after initial recognition in the financial statements at some time during the reporting period.
The Company considers transfers between the levels of the hierarchy to be recognized at the end of related reporting periods.
Recurring Measurements
The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2019 and 2018:
The following is a description of inputs and valuation methodologies used for assets recorded at fair value on a recurring basis and recognized in the accompanying statements of financial condition at December 31, 2019 and 2018, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the year ended December 31, 2019.
Available-for-Sale Securities
Investment securities available for sale are recorded at fair value on a recurring basis. The fair values used by the Company are obtained from an independent pricing service, which represent either quoted market prices for the identical asset or fair values determined by pricing models, or other model-based valuation techniques, that consider observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems. Recurring Level 1 securities include exchange traded equity securities. There were no recurring Level 1 securities at December 31, 2019 or 2018. Recurring Level 2 securities include U.S. government agency securities, mortgage-backed securities, state and municipal bonds and certain other investments. Inputs used for valuing Level 2 securities include observable data that may include dealer quotes, benchmark yields, market spreads, live trading levels and market consensus prepayment speeds, among other things. Additional inputs include indicative values derived from the independent pricing service’s proprietary computerized models. There were no recurring Level 3 securities at December 31, 2019 or 2018.
Interest Rate Derivatives
The fair value is estimated using forward-looking interest rate curves and is determined using observable market rates and, therefore, are classified within Level 2 of the valuation hierarchy.
Nonrecurring Measurements
The following tables present the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2019 and 2018:
Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying statements of financial condition, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Loans Held for Sale
Mortgage loans held for sale are recorded at the lower of carrying value or fair value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies mortgage loans held for sale as Nonrecurring Level 2. Write-downs to fair value typically do not occur as the Company generally enters into commitments to sell individual mortgage loans at the time the loan is originated to reduce market risk. The Company typically does not have commercial loans held for sale. At December 31, 2019 and 2018, the aggregate fair value of mortgage loans held for sale exceeded their cost. Accordingly, no mortgage loans held for sale were marked down and reported at fair value.
Impaired Loans
A loan is considered to be impaired when it is probable that all of the principal and interest due may not be collected according to its contractual terms. Generally, when a loan is considered impaired, the amount of reserve required under FASB ASC 310, Receivables, is measured based on the fair value of the underlying collateral. The Company makes such measurements on all material loans deemed impaired using the fair value of the collateral for collateral dependent loans. The fair value of collateral used by the Company is determined by obtaining an observable market price or by obtaining an appraised value from an independent, licensed or certified appraiser, using observable market data. This data includes information such as selling price of similar properties and capitalization rates of similar properties sold within the market, expected future cash flows or earnings of the subject property based on current market expectations, and other relevant factors. All appraised values are adjusted for market-related trends based on the Company’s experience in sales and other appraisals of similar property types as well as estimated selling costs. Each quarter management reviews all collateral dependent impaired loans on a loan-by-loan basis to determine whether updated appraisals are necessary based on loan performance, collateral type and guarantor support. At times, the Company measures the fair value of collateral dependent impaired loans using appraisals with dates more than one year prior to the date of review. These appraisals are discounted by applying current, observable market data about similar property types such as sales contracts, estimations of value by individuals familiar with the market, other appraisals, sales or collateral assessments based on current market activity until updated appraisals are obtained. Depending on the length of time since an appraisal was performed and the data provided through our reviews, these appraisals are typically discounted 10-40%. The policy described above is the same for all types of collateral dependent impaired loans.
The Company records impaired loans as Nonrecurring Level 3. If a loan’s fair value as estimated by the Company is less than its carrying value, the Company either records a charge-off for the portion of the loan that exceeds the fair value or establishes a reserve within the allowance for loan losses specific to the loan. Loans for which such charge-offs or reserves were recorded during the years ended December 31, 2019 and 2018, are shown in the table above (net of reserves).
Foreclosed Assets Held for Sale
Foreclosed assets held for sale are initially recorded at fair value less estimated cost to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Foreclosed assets held for sale are classified within Level 3 of the fair value hierarchy. The foreclosed assets represented in the table above have been re-measured during the years ended December 31, 2019 and 2018, subsequent to their initial transfer to foreclosed assets.
Fair Value of Financial Instruments
The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying statements of financial condition at amounts other than fair value.
Cash and Cash Equivalents and Federal Home Loan Bank Stock
The carrying amount approximates fair value.
Loans and Interest Receivable
The fair value of loans is estimated on an exit price basis incorporating contractual cash flow, prepayments discount spreads, credit loss and liquidity premiums. Loans with similar characteristics are aggregated for purposes of the calculations. The carrying amount of accrued interest receivable approximates its fair value.
Deposits and Accrued Interest Payable
The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date, i.e., their carrying amounts. The fair value of fixed maturity certificates of deposit is estimated using a discounted cash flow calculation using the average advances yield curve from 11 districts of the FHLB for the as of date.
Federal Home Loan Bank Advances
Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing advances.
Short-Term Borrowings
The carrying amount approximates fair value.
Subordinated Debentures Issued to Capital Trusts
The subordinated debentures have floating rates that reset quarterly. The carrying amount of these debentures approximates their fair value.
Subordinated Notes
The fair values used by the Company are obtained from independent sources and are derived from quoted market prices of the Company’s subordinated notes and quoted market prices of other subordinated debt instruments with similar characteristics.
Commitments to Originate Loans, Letters of Credit and Lines of Credit
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
The following table presents estimated fair values of the Company’s financial instruments. The fair values of certain of these instruments were calculated by discounting expected cash flows, which method involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate.
Note 16:
Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of its assets and liabilities. In the normal course of business, the Company may use derivative financial instruments (primarily interest rate swaps) from time to time to assist in its interest rate risk management. The Company has interest rate derivatives that result from a service provided to certain qualifying loan customers that are not used to manage interest rate risk in the Company’s assets or liabilities and are not designated in a qualifying hedging relationship. The Company manages a matched book with respect to its derivative instruments in order to minimize its net risk exposure resulting from such transactions. In addition, the Company has interest rate derivatives that are designated in a qualified hedging relationship.
Nondesignated Hedges
The Company has interest rate swaps that are not designated in a qualifying hedging relationship. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain loan customers, which the Company began offering during 2011. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
As part of the Valley Bank FDIC-assisted acquisition, the Company acquired seven loans with related interest rate swaps. Valley’s swap program differed from the Company’s in that Valley did not have back to back swaps with the customer and a counterparty. Five of the seven acquired loans with interest rate swaps have paid off. The notional amount of the two remaining Valley swaps was $689,000 at December 31, 2019. At December 31, 2019, excluding the Valley Bank swaps, the Company had 19 interest rate swaps totaling $96.0 million in notional amount with commercial customers, and 19 interest rate swaps with the same notional amount with third parties related to its program. In addition at December 31, 2019, the Company had five participation loans purchased totaling $37.4 million, in which the lead institution has an interest rate swap with their customer and the economics of the counterparty swap are passed along to us through the loan participation. At December 31, 2018, excluding the Valley Bank swaps, the Company had 18 interest rate swaps totaling $78.5 million in notional amount with commercial customers, and 18 interest rate swaps with the same notional amount with third parties related to its program. In addition at December 31, 2018, the Company had three participation loans purchased totaling $31.2 million, in which the lead institution has an interest rate swap with their customer and the economics of the counterparty swap are passed along to us through the loan participation. During the years ended December 31, 2019, 2018 and 2017, the Company recognized net gains (losses) of $(104,000), $25,000 and $28,000, respectively, in noninterest income related to changes in the fair value of these swaps.
Cash Flow Hedges
Interest Rate Swap. As a strategy to maintain acceptable levels of exposure to the risk of changes in future cash flows due to interest rate fluctuations, in October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap is $400 million with a termination date of October 6, 2025. Under the terms of the swap, the Company will receive a fixed rate of interest of 3.018% and will pay a floating rate of interest equal to one-month USD-LIBOR. The floating rate will be reset monthly and net settlements of interest due to/from the counterparty will also occur monthly. The floating rate of interest was 1.71% as of December 31, 2019. Therefore, in the near term, the Company will receive net interest settlements which will be recorded as loan interest income, to the extent that the fixed rate of interest continues to exceed one-month USD-LIBOR. If USD-LIBOR exceeds the fixed rate of interest in future periods, the Company will be required to pay net settlements to the counterparty and will record those net payments as a reduction of interest income on loans. The Company recorded interest income of $3.1 million and $673,000 on this interest rate swap during the year ended December 31, 2019 and 2018, respectively. The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. During each of the years ended December 31, 2019 and 2018, the Company recognized $-0- in noninterest income related to changes in the fair value of this derivative.
Interest Rate Cap. Previously, the Company entered into two interest rate cap agreements for a portion of its floating rate debt associated with its trust preferred securities. One agreement terminated in 2015 and one agreement terminated in 2017. The effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affected earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. During the year ended December 31, 2017, the Company recognized $-0- in noninterest income related to changes in the fair value of these derivatives. During the year ended December 31, 2017, the Company recognized $244,000 in interest expense related to the amortization of the cost of these interest rate caps.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Statements of Financial Condition:
The following table presents the effect of cash flow hedge accounting on the statements of comprehensive income:
The following table presents the effect of cash flow hedge accounting on the statements of operations:
Agreements with Derivative Counterparties
The Company has agreements with its derivative counterparties. If the Company defaults on any of its indebtedness, including a default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. If the Bank fails to maintain its status as a well-capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements. Similarly, the Company could be required to settle its obligations under certain of its agreements if certain regulatory events occurred, such as the issuance of a formal directive, or if the Company’s credit rating is downgraded below a specified level.
At December 31, 2019, the termination value of derivatives with our derivative dealer counterparties (related to loan level swaps with commercial lending customers) in a net liability position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $1.1 million. In addition, as of December 31, 2019, the termination value of derivatives with our derivative dealer counterparty (related to the balance sheet hedge commenced in October 2018) in a net asset position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $30.1 million. The Company has minimum collateral posting thresholds with its derivative dealer counterparties. At December 31, 2019, the Company’s activity with one of its derivative counterparties met the level at which the minimum collateral posting thresholds take effect (collateral to be received by the Company) and the derivative counterparties had posted collateral of $30.9 million to the Company to satisfy the balance sheet hedge agreement. Additionally, the Company’s activity with one of its derivative counterparties met the level at which the minimum collateral posting thresholds take effect (collateral to be given by the Company) and the Company had posted collateral of $1.1 million to the derivative counterparties to satisfy the loan level agreements. If the Company had breached any of these provisions at December 31, 2019 or December 31, 2018, it could have been required to settle its obligations under the agreements at the termination value. At December 31, 2018, the termination value of derivatives with our derivative dealer counterparties (related to loan level swaps with commercial lending customers) in a net asset position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $396,000. In addition, as of December 31, 2018, the termination value of derivatives with our derivative dealer counterparty (related to the balance sheet hedge commenced in October 2018) in a net asset position, which included accrued interest but excluded any adjustment for nonperformance risk, related to these agreements was $12.3 million. At December 31, 2018, the Company’s activity with certain of its derivative counterparties met the level at which the minimum collateral posting thresholds take effect (collateral to be received by the Company) and the derivative counterparties had posted collateral of $704,000 to the Company to satisfy the loan level agreements and collateral of $12.8 million to the Company to satisfy the balance sheet hedge agreement.
Note 17:
Commitments and Credit Risk
Commitments to Originate Loans
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a significant portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, commercial real estate and residential real estate.
At December 31, 2019 and 2018, the Bank had outstanding commitments to originate loans and fund commercial construction loans aggregating approximately $92.4 million and $105.3 million, respectively. The commitments extend over varying periods of time with the majority being disbursed within a 30- to 180-day period.
Mortgage loans in the process of origination represent amounts that the Bank plans to fund within a normal period of 60 to 90 days, many of which are intended for sale to investors in the secondary market. Total mortgage loans in the process of origination amounted to approximately $69.3 million and $24.3 million at December 31, 2019 and 2018, respectively.
Letters of Credit
Standby letters of credit are irrevocable conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under nonfinancial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. Fees for letters of credit issued are initially recorded by the Bank as deferred revenue and are included in earnings at the termination of the respective agreements. Should the Bank be obligated to perform under the standby letters of credit, the Bank may seek recourse from the customer for reimbursement of amounts paid.
The Company had total outstanding standby letters of credit amounting to approximately $26.3 million and $28.9 million at December 31, 2019 and 2018, respectively, with $26.3 million and $28.4 million, respectively, of the letters of credit having terms up to five years and $-0- and $476,000, respectively, of the letters of credit having terms over five years. Of the amount having terms over five years, $0 and $476,000 at December 31, 2019 and 2018, respectively, consisted of an outstanding letter of credit to guarantee the payment of principal and interest on a Multifamily Housing Refunding Revenue Bond Issue.
Purchased Letters of Credit
The Company has purchased letters of credit from the Federal Home Loan Bank as security for certain public deposits. The amount of the letters of credit was $0 and $2.1 million at December 31, 2019 and 2018, respectively, and they expire in less than one year from issuance.
Lines of Credit
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, commercial real estate and residential real estate. The Bank uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments.
At December 31, 2019, the Bank had granted unused lines of credit to borrowers aggregating approximately $1.2 billion and $155.8 million for commercial lines and open-end consumer lines, respectively. At December 31, 2018, the Bank had granted unused lines of credit to borrowers aggregating approximately $1.1 billion and $150.9 million for commercial lines and open-end consumer lines, respectively.
Credit Risk
The Bank grants collateralized commercial, real estate and consumer loans primarily to customers in its market areas. Although the Bank has a diversified portfolio, loans (excluding those covered by loss sharing agreements) aggregating approximately $725.0 million and $750.3 million at December 31, 2019 and 2018, respectively, are secured primarily by apartments, condominiums, residential and commercial land developments, industrial revenue bonds and other types of commercial properties in the St. Louis, Missouri, area.
Note 18:
Additional Cash Flow Information
Note 19:
Employee Benefits
The Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra DB Plan), a multiemployer defined benefit pension plan covering all employees who have met minimum service requirements. Effective July 1, 2006, this plan was closed to new participants. Employees already in the plan continue to accrue benefits. The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan Number is 333. The Company’s policy is to fund pension cost accrued. Employer contributions charged to expense for this plan for the years ended December 31, 2019, 2018 and 2017, were approximately $1.8 million, $1.3 million and $1.1 million, respectively. The Company’s contributions to the Pentegra DB Plan were not more than 5% of the total contributions to the plan. The funded status of the plan as of July 1, 2019 and 2018, was 93.7% and 96.3%, respectively. The funded status was calculated by taking the market value of plan assets, which reflected contributions received through June 30, 2019 and 2018, respectively, divided by the funding target. No collective bargaining agreements are in place that require contributions to the Pentegra DB Plan.
The Company has a defined contribution retirement plan covering substantially all employees. The Company matches 100% of the employee’s contribution on the first 3% of the employee’s compensation and also matches an additional 50% of the employee’s contribution on the next 2% of the employee’s compensation. Employer contributions charged to expense for this plan for the years ended December 31, 2019, 2018 and 2017, were approximately $1.4 million, $1.4 million and $1.3 million, respectively.
Note 20:
Stock Compensation Plans
The Company established the 2003 Stock Option and Incentive Plan (the “2003 Plan”) for employees and directors of the Company and its subsidiaries. Under the plan, stock options or other awards could be granted with respect to 598,224 shares of common stock. On May 15, 2013, the Company’s stockholders approved the Great Southern Bancorp, Inc. 2013 Equity Incentive Plan (the “2013 Plan”). Upon the stockholders’ approval of the 2013 Plan, the Company’s 2003 Plan was frozen. As a result, no new stock options or other awards may be granted under the 2003 Plan; however, existing outstanding awards under the 2003 Plan were not affected. At December 31, 2019, 42,941 options were outstanding under the 2003 Plan.
The Company established the 2013 Stock Option and Incentive Plan (the “2013 Plan”) for employees and directors of the Company and its subsidiaries. Under the plan, stock options or other awards could be granted with respect to 700,000 shares of common stock. On May 9, 2018, the Company’s stockholders approved the Great Southern Bancorp, Inc. 2018 Omnibus Incentive Plan (the “2018 Plan”). Upon the stockholders’ approval of the 2018 Plan, the Company’s 2013 Plan was frozen. As a result, no new stock options or other awards may be granted under the 2013 Plan; however, existing outstanding awards under the 2013 Plan were not affected. At December 31, 2019, 401,827 options were outstanding under the 2013 Plan.
The 2018 Plan provides for the grant from time to time to directors, emeritus directors, officers, employees and advisory directors of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares and performance units. The number of shares of Common Stock available for awards under the 2018 Plan is 800,000 (the “2018 Plan Limit”). Shares utilized for awards other than stock options and stock appreciation rights will be counted against the 2018 Plan Limit on a 2.5-to-1 basis. At December 31, 2019, 363,100 options were outstanding under the 2018 Plan.
Stock options may be either incentive stock options or nonqualified stock options, and the option price must be at least equal to the fair value of the Company’s common stock on the date of grant. Options generally are granted for a 10-year term and generally become exercisable in four cumulative annual installments of 25% commencing two years from the date of grant. The Stock Option Committee may accelerate a participant’s right to purchase shares under the plan.
Stock awards may be granted to key officers and employees upon terms and conditions determined solely at the discretion of the Stock Option Committee.
The table below summarizes transactions under the Company’s stock compensation plans, all of which related to stock options granted under such plans:
The Company’s stock option grants contain terms that provide for a graded vesting schedule whereby portions of the options vest in increments over the requisite service period. These options typically vest one-fourth at the end of years two, three, four and five from the grant date. As provided for under FASB ASC 718, the Company has elected to recognize compensation expense for options with graded vesting schedules on a straight-line basis over the requisite service period for the entire option grant. In addition, ASC 718 requires companies to recognize compensation expense based on the estimated number of stock options for which service is expected to be rendered. The Company’s historical forfeitures of its share-based awards have not been material.
The fair value of each option award is estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions for the years ended December 31, 2019, 2018 and 2017:
Expected volatilities are based on the historical volatility of the Company’s stock, based on the monthly closing stock price. The expected term of options granted is based on actual historical exercise behavior of all employees and directors and approximates the graded vesting period of the options. Expected dividends are based on the annualized dividends declared at the time of the option grant. The risk-free interest rate is based on the five-year treasury rate on the grant date of the options.
The following table presents the activity related to options under all plans for the year ended December 31, 2019:
For the years ended December 31, 2019, 2018 and 2017, options granted were 186,400, 186,750, and 157,800, respectively. The total intrinsic value (amount by which the fair value of the underlying stock exceeds the exercise price of an option on exercise date) of options exercised during the years ended December 31, 2019, 2018 and 2017, was $3.1 million, $2.2 million and $3.0 million, respectively. Cash received from the exercise of options for the years ended December 31, 2019, 2018 and 2017, was $4.2 million, $2.3 million and $3.3 million, respectively. The actual tax benefit realized for the tax deductions from option exercises totaled $2.7 million, $1.6 million and $2.7 million for the years ended December 31, 2019, 2018 and 2017, respectively. The total intrinsic value of options outstanding at December 31, 2019, 2018 and 2017, was $11.5 million, $4.7 million and $8.8 million, respectively. The total intrinsic value of options exercisable at December 31, 2019, 2018 and 2017, was $6.6 million, $3.9 million and $5.7 million, respectively.
The following table presents the activity related to nonvested options under all plans for the year ended December 31, 2019.
At December 31, 2019, there was $4.7 million of total unrecognized compensation cost related to nonvested options granted under the Company’s plans. This compensation cost is expected to be recognized through 2024, with the majority of this expense recognized in 2020 and 2021.
The following table further summarizes information about stock options outstanding at December 31, 2019:
Note 21:
Significant Estimates and Concentrations
Accounting principles generally accepted in the United States of America require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations. Estimates related to the allowance for loan losses are reflected in Note 3. Estimates used in valuing acquired loans, loss sharing agreements and FDIC indemnification assets and in continuing to monitor related cash flows of acquired loans are discussed in Note 4. Current vulnerabilities due to certain concentrations of credit risk are discussed in the footnotes on loans, deposits and on commitments and credit risk.
Other significant estimates not discussed in those footnotes include valuations of foreclosed assets held for sale. The carrying value of foreclosed assets reflects management’s best estimate of the amount to be realized from the sales of the assets. While the estimate is generally based on a valuation by an independent appraiser or recent sales of similar properties, the amount that the Company realizes from the sales of the assets could differ materially in the near term from the carrying value reflected in these financial statements.
Note 22:
Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income (AOCI), included in stockholders’ equity, are as follows:
Amounts reclassified from AOCI and the affected line items in the statements of income during the years ended December 31, 2019, 2018 and 2017, were as follows:
Note 23:
Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct and material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting practices, and regulatory capital standards. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulatory reporting standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below as of December 31, 2019) of Total and Tier I Capital (as defined) to risk-weighted assets (as defined), of Tier I Capital (as defined) to adjusted tangible assets (as defined) and of Common Equity Tier 1 Capital (as defined) to risk-weighted assets (as defined). Management believes, as of December 31, 2019, that the Bank met all capital adequacy requirements to which it was then subject.
As of December 31, 2019, the most recent notification from the Bank’s regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized as of December 31, 2019, the Bank must have maintained minimum Total capital, Tier I capital, Tier 1 Leverage capital and Common Equity Tier 1 capital ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The Company and the Bank are subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 2019 and 2018, the Company and the Bank exceeded their minimum capital requirements then in effect. The entities may not pay dividends which would reduce capital below the minimum requirements shown above. In addition to the minimum capital ratios, the new capital rules include a capital conservation buffer, under which a banking organization must have CET1 more than 2.5% above each of its minimum risk-based capital ratios in order to avoid restrictions on paying dividends, repurchasing shares, and paying certain discretionary bonuses. The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital.
The Company’s and the Bank’s actual capital amounts and ratios are presented in the following table. No amount was deducted from capital for interest-rate risk.
Note 24:
Litigation Matters
In the normal course of business, the Company and its subsidiaries are subject to pending and threatened legal actions, some of which seek substantial relief or damages. While the ultimate outcome of such legal proceedings cannot be predicted with certainty, after reviewing pending and threatened litigation with counsel, management believes at this time that the outcome of such litigation will not have a material adverse effect on the Company’s business, financial condition or results of operations.
Note 25:
Summary of Unaudited Quarterly Operating Results
Following is a summary of unaudited quarterly operating results for the years 2019, 2018 and 2017:
Note 26:
Condensed Parent Company Statements
The condensed statements of financial condition at December 31, 2019 and 2018, and statements of income, comprehensive income and cash flows for the years ended December 31, 2019, 2018 and 2017, for the parent company, Great Southern Bancorp, Inc., were as follows:
Note 27:
Sale of Branches and Related Deposits
On July 20, 2018, the Company closed on the sale of four banking centers and related deposits in the Omaha, Neb., metropolitan market to Lincoln, Neb.-based West Gate Bank. Pursuant to the purchase and assumption agreement, the Bank sold branch deposits of approximately $56 million and sold substantially all branch-related real estate, fixed assets and ATMs. The Company recorded a pre-tax gain (excluding transaction expenses of $165,000) of $7.4 million on the sale based on the contractual deposit premium and the sales price of the branch assets.
Note 28:
Subsequent Event -- Interest Rate Swap Termination
As discussed in Note 16, in October 2018, the Company entered into an interest rate swap transaction with a notional amount of $400 million. The swap’s contractual termination date was October 6, 2025.
On March 2, 2020, the Company and its swap counterparty mutually agreed to terminate the swap, effective immediately. The Company received a payment of $45.9 million, including accrued but unpaid interest, from its swap counterparty as a result of this termination. This $45.9 million, less the accrued interest portion and net of deferred income taxes, will be reflected in the Company’s equity as Accumulated Other Comprehensive Income and a portion of it will be accreted to interest income monthly through the original contractual termination date of October 6, 2025. This will have the effect of reducing Accumulated Other Comprehensive Income and increasing Net Interest Income and Retained Earnings over the period.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES.
We maintain a system of disclosure controls and procedures (as defined in Rule 13(a)-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) that is designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported accurately and within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate. An evaluation of our disclosure controls and procedures was carried out as of December 31, 2019, under the supervision and with the participation of our principal executive officer, principal financial officer and several other members of our senior management. Our principal executive officer and principal financial officer concluded that, as of December 31, 2019, our disclosure controls and procedures were effective in ensuring that the information we are required to disclose in the reports we file or submit under the Act is (i) accumulated and communicated to our management (including the principal executive officer and principal financial officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. The annual report of management on the effectiveness of internal control over financial reporting and the attestation report thereon issued by our independent registered public accounting firm are set forth below under "Management's Report on Internal Control Over Financial Reporting" and "Report of the Independent Registered Public Accounting Firm."
We do not expect that our internal control over financial reporting will prevent all errors and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
MANAGEMENT'S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
The management of Great Southern Bancorp, Inc. (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2019, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on that assessment, management concluded that, as of December 31, 2019, the Company's internal control over financial reporting was effective.
The Company's internal control over financial reporting as of December 31, 2019, has been audited by BKD, LLP, an independent registered public accounting firm. Their attestation report on the effectiveness of the Company's internal control over financial reporting as of December 31, 2019 is set forth below.
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
Great Southern Bancorp, Inc.
Springfield, Missouri
Opinion on the Internal Control over Financial Reporting
We have audited Great Southern Bancorp, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework: (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company and our report dated March 6, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definitions and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
/s/ BKD, LLP
Springfield, Missouri
March 6, 2020
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
Effective as of March 5, 2020, the Amended and Restated Employment Agreement, dated as of November 4, 2019 (the “Employment Agreement”), between Great Southern Bancorp, Inc. (the “Company”) and Joseph W. Turner, the Company’s President and Chief Executive Officer, was amended to increase the annual bonus to which Mr. Turner is entitled under the Employment Agreement from 0.75% of the Company’s fiscal year pre-tax earnings to 1.00% of the Company’s fiscal year pre-tax earnings.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors and Executive Officers. The information concerning our directors and executive officers and corporate governance matters required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
Delinquent Section 16(a) Reports. Any information concerning compliance with the reporting requirements of Section 16 of the Securities Exchange Act of 1934 by our directors, officers and ten percent stockholders required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
Code of Ethics. We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions, and to all of our other employees and our directors. A copy of our code of ethics was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2007.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION.
The information concerning compensation and other matters required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information concerning security ownership of certain beneficial owners and management required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
The following table sets forth information as of December 31, 2019 with respect to compensation plans under which shares of our common stock may be issued:
_________________________
(1) Represents shares available for future awards under the Company’s 2018 Omnibus Incentive Plan. Awards in the form of restricted stock, restricted stock units, performance shares and performance units will reduce the number of shares available under the Company’s 2018 Omnibus Incentive Plan on a 2.5-to-1 basis.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information concerning certain relationships and related transactions and director independence required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed with the Securities and Exchange Commission not later than 120 days after the end of our fiscal year.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information concerning principal accounting fees and services required by this item is incorporated herein by reference from our definitive proxy statement for our 2020 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after the end of our fiscal year.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
We, the undersigned officers and directors of Great Southern Bancorp, Inc., hereby severally and individually constitute and appoint Joseph W. Turner and Rex A. Copeland, and each of them, the true and lawful attorneys and agents of each of us to execute in the name, place and stead of each of us (individually and in any capacity stated below) any and all amendments to this Annual Report on Form 10-K and all instruments necessary or advisable in connection therewith and to file the same with the Securities and Exchange Commission, each of said attorneys and agents to have the power to act with or without the other and to have full power and authority to do and perform in the name and on behalf of each of the undersigned every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as any of the undersigned might or could do in person, and we hereby ratify and confirm our signatures as they may be signed by our said attorneys and agents or each of them to any and all such amendments and instruments.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Signature
Capacity in Which Signed
Date
/s/ Joseph W. Turner
Joseph W. Turner
President, Chief Executive Officer and Director
(Principal Executive Officer)
March 6, 2020
/s/ William V. Turner
William V. Turner
Chairman of the Board
March 6, 2020
/s/ Rex A. Copeland
Rex A. Copeland
Treasurer
(Principal Financial Officer and
Principal Accounting Officer)
March 6, 2020
/s/ Kevin R. Ausburn
Kevin R. Ausburn
Director
March 6, 2020
/s/ Julie T. Brown
Julie T. Brown
Director
March 6, 2020
/s/ Thomas J. Carlson
Thomas J. Carlson
Director
March 6, 2020
/s/ Larry D. Frazier
Larry D. Frazier
Director
March 6, 2020
/s/ Debra M. Hart
Debra M. Hart
Director
March 6, 2020
/s/ Douglas M. Pitt
Douglas M. Pitt
Director
March 6, 2020
/s/ Earl A. Steinert, Jr.
Earl A. Steinert, Jr.
Director
March 6, 2020