FCNCA_10Q_06.30.2014
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________
FORM 10-Q
____________________________________________________
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2014
or
 
¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 001-16715
____________________________________________________
First Citizens BancShares, Inc.
(Exact name of Registrant as specified in its charter)
____________________________________________________
Delaware
56-1528994
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
4300 Six Forks Road, Raleigh, North Carolina
27609
(Address of principle executive offices)
(Zip code)
(919) 716-7000
(Registrant’s telephone number, including area code)
____________________________________________________
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days.    Yes  x   No  ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files)    Yes  x    No  ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of ‘accelerated filer’ and ‘large accelerated filer’ in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer
x
 
Accelerated filer
¨
Non-accelerated filer
¨
 
Smaller reporting company
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Class A Common Stock—$1 Par Value—8,586,058 shares
Class B Common Stock—$1 Par Value—1,032,883 shares
(Number of shares outstanding, by class, as of August 8, 2014)

Table of Contents

INDEX
 
 
 
Page(s)
 
 
 
PART I.
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II.
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.

2
Table of Contents

PART I
 
Item 1.
Financial Statements


First Citizens BancShares, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands, unaudited)
June 30, 2014
 
December 31, 2013
Assets
 
 
 
Cash and due from banks
$
566,952

 
$
533,599

Overnight investments
1,118,474

 
859,324

Investment securities available for sale
5,538,166

 
5,387,703

Investment securities held to maturity
693

 
907

Loans held for sale
49,851

 
47,271

Loans and leases:
 
 
 
Acquired
1,109,933

 
1,029,426

Originated
12,415,023

 
12,104,298

Allowance for loan and lease losses
(206,246
)
 
(233,394
)
Net loans and leases
13,318,710

 
12,900,330

Premises and equipment
883,303

 
876,522

Other real estate owned:
 
 
 
Covered under loss share agreements
40,136

 
47,081

Not covered under loss share agreements
35,151

 
36,898

Income earned not collected
49,019

 
48,390

FDIC loss share receivable
49,959

 
93,397

Goodwill
127,140

 
102,625

Other intangible assets
3,821

 
1,247

Other assets
281,465

 
263,797

Total assets
$
22,062,840

 
$
21,199,091

Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
5,775,322

 
$
5,241,817

Interest-bearing
12,781,436

 
12,632,249

Total deposits
18,556,758

 
17,874,066

Short-term borrowings
788,540

 
511,418

Long-term obligations
314,529

 
510,769

FDIC loss share payable
114,281

 
109,378

Other liabilities
139,587

 
116,785

Total liabilities
19,913,695

 
19,122,416

Shareholders’ Equity
 
 
 
Common stock:
 
 
 
Class A - $1 par value (11,000,000 shares authorized; 8,586,058 shares issued and outstanding at June 30, 2014 and December 31, 2013)
8,586

 
8,586

Class B - $1 par value (2,000,000 shares authorized; 1,032,883 shares issued and outstanding at June 30, 2014 and December 31, 2013)
1,033

 
1,033

Surplus
143,766

 
143,766

Retained earnings
1,991,703

 
1,948,558

Accumulated other comprehensive income (loss)
4,057

 
(25,268
)
Total shareholders’ equity
2,149,145

 
2,076,675

Total liabilities and shareholders’ equity
$
22,062,840

 
$
21,199,091


See accompanying Notes to Consolidated Financial Statements.

3
Table of Contents

First Citizens BancShares, Inc. and Subsidiaries
Consolidated Statements of Income
 
 
Three months ended June 30
 
Six months ended June 30
(Dollars in thousands, except per share data, unaudited)
2014
 
2013
 
2014
 
2013
Interest income
 
 
 
 
 
 
 
Loans and leases
$
164,108

 
$
185,151

 
$
325,142

 
$
396,914

Investment securities interest and dividend income
12,447

 
8,119

 
24,195

 
16,603

Overnight investments
756

 
656

 
1,368

 
1,013

Total interest income
177,311

 
193,926

 
350,705

 
414,530

Interest expense
 
 
 
 
 
 
 
Deposits
6,006

 
8,997

 
12,831

 
19,310

Short-term borrowings
1,551

 
680

 
2,136

 
1,384

Long-term obligations
4,056

 
4,721

 
9,109

 
9,426

Total interest expense
11,613

 
14,398

 
24,076

 
30,120

Net interest income
165,698

 
179,528

 
326,629

 
384,410

Provision (credit) for loan and lease losses
(7,299
)
 
(13,242
)
 
(9,202
)
 
(31,848
)
Net interest income after provision (credit) for loan and lease losses
172,997

 
192,770

 
335,831

 
416,258

Noninterest income
 
 
 
 
 
 
 
Cardholder services
13,257

 
12,026

 
25,089

 
23,097

Merchant services
15,035

 
15,245

 
28,556

 
27,731

Service charges on deposit accounts
15,265

 
14,883

 
29,705

 
29,882

Wealth management services
15,815

 
15,097

 
30,695

 
29,612

Fees from processing services
5,682

 
5,051

 
10,543

 
10,670

Other service charges and fees
4,250

 
3,966

 
8,194

 
7,732

Mortgage income
1,210

 
3,669

 
2,165

 
7,457

Insurance commissions
2,253

 
2,394

 
5,540

 
5,374

ATM income
1,260

 
1,314

 
2,462

 
2,482

Adjustments to FDIC loss share receivable
(15,295
)
 
(14,439
)
 
(27,644
)
 
(38,492
)
Other
6,650

 
5,789

 
11,258

 
16,963

Total noninterest income
65,382

 
64,995

 
126,563

 
122,508

Noninterest expense
 
 
 
 
 
 
 
Salaries and wages
82,683

 
75,802

 
162,557

 
151,921

Employee benefits
19,772

 
23,228

 
39,872

 
48,247

Occupancy expense
20,937

 
18,464

 
41,362

 
37,273

Equipment expense
19,686

 
18,698

 
38,477

 
37,644

FDIC insurance expense
2,640

 
2,423

 
5,276

 
5,089

Foreclosure-related expenses
3,858

 
3,467

 
9,268

 
7,772

Other
49,444

 
46,485

 
93,238

 
94,976

Total noninterest expense
199,020

 
188,567

 
390,050

 
382,922

Income before income taxes
39,359

 
69,198

 
72,344

 
155,844

Provision for income taxes
12,809

 
25,292

 
23,428

 
56,353

Net income
$
26,550

 
$
43,906

 
$
48,916

 
$
99,491

Average shares outstanding
9,618,941

 
9,618,941

 
9,618,941

 
9,618,963

Net income per share
$
2.76

 
$
4.56

 
$
5.09

 
$
10.34


See accompanying Notes to Consolidated Financial Statements.

4
Table of Contents

First Citizens BancShares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income


 
Three months ended June 30
 
Six months ended June 30
(Dollars in thousands, unaudited)
2014
 
2013
 
2014
 
2013
Net income
$
26,550

 
$
43,906

 
$
48,916

 
$
99,491

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
 
 
 
 
 
 
 
Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
Change in unrealized securities gains (losses) arising during period
31,550

 
(38,992
)
 
43,449

 
(40,468
)
Tax effect
(12,225
)
 
15,269

 
(16,868
)
 
15,834

Total change in unrealized gains (losses) on securities, net of tax
19,325

 
(23,723
)
 
26,581

 
(24,634
)
 
 
 
 
 
 
 
 
Change in fair value of cash flow hedges:
 
 
 
 
 
 
 
Change in unrecognized gain on cash flow hedges
568

 
1,388

 
1,287

 
2,202

Tax effect
(218
)
 
(548
)
 
(496
)
 
(869
)
Total change in unrecognized gain on cash flow hedges, net of tax
350

 
840

 
791

 
1,333

 
 
 
 
 
 
 
 
Change in pension obligation:
 
 
 
 
 
 
 
Reclassification adjustment for gains included in income before income taxes
1,598

 
4,294

 
3,197

 
8,598

Tax effect
(622
)
 
(1,682
)
 
(1,244
)
 
(3,367
)
Total change in pension obligation, net of tax
976

 
2,612

 
1,953

 
5,231

 
 
 
 
 
 
 
 
Other comprehensive income (loss)
20,651

 
(20,271
)
 
29,325

 
(18,070
)
 
 
 
 
 
 
 
 
Total comprehensive income
$
47,201

 
$
23,635

 
$
78,241

 
$
81,421


See accompanying Notes to Consolidated Financial Statements.


5
Table of Contents

First Citizens BancShares, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity

 
(Dollars in thousands, unaudited)
Class A
Common Stock
 
Class B
Common Stock
 
Surplus
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
(Loss) Income
 
Total
Shareholders’
Equity
Balance at December 31, 2012
$
8,588

 
$
1,033

 
$
143,766

 
$
1,792,726

 
$
(82,106
)
 
$
1,864,007

Net income
—

 
—

 
—

 
99,491

 
—

 
99,491

Other comprehensive loss, net of tax
—

 
—

 
—

 
—

 
(18,070
)
 
(18,070
)
Repurchase of 1,973 shares of Class A common stock
(2
)
 
—

 
—

 
(319
)
 
—

 
(321
)
Cash dividends ($0.60 per share)
—

 
—

 
—

 
(5,777
)
 
—

 
(5,777
)
Balance at June 30, 2013
$
8,586

 
$
1,033

 
$
143,766

 
$
1,886,121

 
$
(100,176
)
 
$
1,939,330

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
8,586

 
$
1,033

 
$
143,766

 
$
1,948,558

 
$
(25,268
)
 
$
2,076,675

Net income
—

 
—

 
—

 
48,916

 
—

 
48,916

Other comprehensive income, net of tax
—

 
—

 
—

 
—

 
29,325

 
29,325

Cash dividends ($0.60 per share)
—

 
—

 
—

 
(5,771
)
 
—

 
(5,771
)
Balance at June 30, 2014
$
8,586

 
$
1,033

 
$
143,766

 
$
1,991,703

 
$
4,057

 
$
2,149,145

See accompanying Notes to Consolidated Financial Statements.

6
Table of Contents


First Citizens BancShares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows 
 
Six months ended June 30
(Dollars in thousands, unaudited)
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Net income
$
48,916

 
99,491

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Provision (credit) for loan and lease losses
(9,202
)
 
(31,848
)
Deferred tax (benefit) expense
(2,744
)
 
2,360

Change in current taxes payable
5,973

 
(20,649
)
Depreciation
35,455

 
35,545

Change in accrued interest payable
560

 
(145
)
Change in income earned not collected
(629
)
 
2,099

Gain on sale of processing services, net
—

 
(4,085
)
Origination of loans held for sale
(123,144
)
 
(223,128
)
Proceeds from sale of loans held for sale
123,967

 
254,087

Gain on sale of loans
(2,220
)
 
(7,123
)
Net writedowns/losses on other real estate
6,993

 
1,480

Net amortization of premiums and discounts
(18,172
)
 
(74,175
)
FDIC receivable for loss share agreements
17,121

 
20,464

FDIC payable for loss share agreements
4,903

 
95

Net change in other assets
(31,249
)
 
68,587

Net change in other liabilities
35,033

 
21,365

Net cash provided by operating activities
91,561

 
144,420

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Net change in loans outstanding
(57,271
)
 
325,057

Purchases of investment securities available for sale
(1,409,878
)
 
(1,375,766
)
Proceeds from maturities/calls of investment securities held to maturity
214

 
212

Proceeds from maturities/calls of investment securities available for sale
1,529,687

 
1,365,287

Net change in overnight investments
(259,150
)
 
(596,745
)
Cash (paid to) received from the FDIC for loss share agreements
(4,350
)
 
46,534

Proceeds from sale of other real estate
38,370

 
80,010

Additions to premises and equipment
(39,550
)
 
(26,696
)
Business acquisition, net of cash acquired
18,194

 
—

Net cash used by investing activities
(183,734
)
 
(182,107
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Net change in time deposits
(219,297
)
 
(390,329
)
Net change in demand and other interest-bearing deposits
270,118

 
322,319

Net change in short-term borrowings
81,716

 
13,432

Repayment of long-term obligations
(1,240
)
 
(1,608
)
Repurchase of common stock
—

 
(321
)
Cash dividends paid
(5,771
)
 
(2,891
)
Net cash provided (used) by financing activities
125,526

 
(59,398
)
Change in cash and due from banks
33,353

 
(97,085
)
Cash and due from banks at beginning of period
533,599

 
639,730

Cash and due from banks at end of period
$
566,952

 
$
542,645

CASH PAYMENTS FOR:
 
 
 
Interest
$
23,516

 
$
30,265

Income taxes
47,962

 
75,917

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Transfers of loans to other real estate
25,080

 
57,175

Dividends declared but not paid
2,886

 
2,886

Reclassification of long-term obligations to short-term borrowings
195,000

 
—


See accompanying Notes to Consolidated Financial Statements.

7
Table of Contents

First Citizens BancShares, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements


NOTE A - ACCOUNTING POLICIES AND BASIS OF PRESENTATION

First Citizens BancShares, Inc. (BancShares) is a financial holding company organized under the laws of Delaware and conducts operations through its banking subsidiary, First-Citizens Bank & Trust Company (FCB), which is headquartered in Raleigh, North Carolina.

General

These consolidated financial statements and notes are presented in accordance with instructions for Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations and cash flow activity required in accordance with accounting principles generally accepted in the United States of America (GAAP). In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the consolidated financial position and consolidated results of operations have been made. The unaudited interim consolidated financial statements included in this Form 10-Q should be read in conjunction with the consolidated financial statements and footnotes included in BancShares' Annual Report on Form 10-K for the year ended December 31, 2013.

Reclassifications

In certain instances, amounts reported in prior years' consolidated financial statements have been reclassified to conform to the current financial statement presentation. Such reclassifications had no effect on previously reported shareholders' equity or net income.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates, and different assumptions in the application of these policies could result in material changes in BancShares' consolidated financial position, the consolidated results of its operations or related disclosures. Material estimates that are particularly susceptible to significant change include the determination of the allowance for loan and lease losses; determination of the fair value of financial instruments; pension plan assumptions; cash flow estimates on acquired loans; the receivable from and payable to the Federal Deposit Insurance Corporation (FDIC) for loss share agreements; purchase accounting-related adjustments; and income tax assets, liabilities and expense.

Recent Accounting Pronouncements
Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2014-12, “Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period)”
This ASU requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. A reporting entity should apply FASB ASC Topic 718, Compensation—Stock Compensation, to awards with performance conditions that affect vesting.
The guidance in this ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. This update may be adopted either prospectively for share-based payment awards granted or modified on or after the effective date, or retrospectively, using a modified retrospective approach. The modified retrospective approach would apply to share-based payment awards outstanding as of the beginning of the earliest annual period presented in the financial statements on adoption, and to all new or modified awards thereafter. BancShares will adopt the standard effective the first quarter of 2016. Since BancShares does not currently have any share-based stock compensation plans, adoption of Topic 718 is not projected to have an impact on BancShares' consolidated financial position or consolidated results of operations.



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FASB ASU 2014-11, “Transfers and Servicing (Topic 860)”
This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. The ASU requires a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. The ASU also requires expanded disclosures about the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.
The accounting changes in this ASU are effective for fiscal years beginning after December 15, 2014. In addition, the disclosure for certain transactions accounted for as a sale is effective for the fiscal period beginning after December 15, 2014, the disclosure for transactions accounted for as secured borrowings is required to be presented for fiscal periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. We will adopt the guidance effective in the first quarter of 2015, and we do not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption.
FASB ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”
In May 2014, the FASB issued a standard on the recognition of revenue from contracts with customers with the core principle being for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also results in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively and improve guidance for multiple-element arrangements.
The guidance in this ASU is effective for fiscal periods beginning after December 15, 2016, including interim reporting periods within that reporting period. Early adoption is not permitted. We are currently evaluating the impact of the new standard and we will adopt during the first quarter of 2017.
FASB ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”
This ASU limits presentation of discontinued operations and disclosure of disposals to disposals representing a strategic shift in operations in which the strategic shifts should have a major effect on the organization's operations and financial results. Additionally, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The new guidance also requires disclosure of pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting.
The new standard is effective in the first quarter of 2015 for public companies with a calendar year end. We will adopt the standard effective in the first quarter of 2015, and we do not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption.
FASB ASU 2014-04, “Receivables-Troubled Debt Restructurings by Creditors (Subtopic 310-40)”
This ASU clarifies that an in-substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction.

The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. BancShares will adopt the guidance effective in the first quarter of 2015, and is currently evaluating the impact of the new standard on the financial statement disclosures. BancShares does not anticipate any effect on our consolidated financial position or consolidated results of operations as a result of adoption.

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FASB ASU 2014-01 "Investments - Equity Method and Joint Ventures (Topic 323) - Accounting for Investments in Qualified Affordable Housing Projects”
This ASU permits an accounting policy election to account for investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit).
For those investments in qualified affordable housing projects not accounted for using the proportional amortization method, the investment should be accounted for as an equity method investment or a cost method investment in accordance with Subtopic 970-323.
The decision to apply the proportional amortization method of accounting will be applied consistently to all qualifying affordable housing project investments rather than a decision to be applied to individual investments.
The amendments in this ASU should be applied retrospectively to all periods presented and are effective for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted.
BancShares is currently evaluating the impact of the new standard and is targeting a December 31, 2014, adoption and implementation for qualifying affordable housing project investments.
FASB ASU 2013-11, “Income Taxes (Topic 740)”
This ASU states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows: to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require BancShares to use, and BancShares does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date.
The provisions of this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. BancShares adopted the guidance effective in the first quarter of 2014. The initial adoption had no effect on our consolidated financial position or consolidated results of operations.
FASB ASU 2013-04, “Liabilities”
This ASU provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP.
The amendments in this update are effective for fiscal years beginning after December 31, 2013. BancShares adopted the guidance effective first quarter of 2014. The initial adoption did not have any effect on our consolidated financial position or consolidated results of operations.

NOTE B - BUSINESS COMBINATIONS

Merger Agreement with First Citizens Bancorporation, Inc.

On June 10, 2014, BancShares and First Citizens Bancorporation, Inc. (Bancorporation) entered into an Agreement and Plan of Merger (the Merger Agreement). Pursuant to the Merger Agreement, Bancorporation will merge with and into BancShares, whereupon the separate corporate existence of Bancorporation will cease and BancShares will continue (the Merger). The Merger is expected to be completed during the fourth quarter of 2014. Sometime thereafter, First Citizens Bank and Trust Company, Inc. (FCB-SC), a wholly-owned subsidiary of Bancorporation, will merge with and into FCB, whereupon the separate corporate existence of FCB-SC will cease and FCB will continue.

Under the terms of the Merger Agreement, each share of Bancorporation common stock will be converted into the right to receive 4.00 shares of BancShares' Class A common stock and $50.00 cash, unless the holder elects for each share to be converted into the right to receive 3.58 shares of BancShares' Class A common stock and 0.42 shares of BancShares' Class B common stock.

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Consummation of the Merger is subject to customary conditions, including, among others, approval of the shareholders of each company and receipt of regulatory approvals.

The Merger Agreement includes certain termination rights for both BancShares and Bancorporation and under specified circumstances Bancorporation may be required to pay BancShares a termination fee equal to $6.5 million, $10.0 million or $22.6 million, depending on the circumstances of the termination.

1st Financial Services Corporation Merger

On January 1, 2014, FCB completed its merger with 1st Financial Services Corporation (1st Financial) of Hendersonville, NC and its wholly-owned subsidiary, Mountain 1st Bank & Trust Company (Mountain 1st). The merger allowed FCB to expand its presence in Western North Carolina. Mountain 1st had twelve branches located in Asheville, Brevard, Columbus, Etowah, Fletcher, Forest City, Hendersonville, Hickory, Marion, Shelby and Waynesville. FCB requested and received approval from the North Carolina Commissioner of Banks and the FDIC to close seven Mountain 1st branches due to their proximity to legacy FCB branches. The branches in Asheville, Brevard, Fletcher, Forest City, Hendersonville, Hickory and Marion were closed in May. All customer relationships assigned to those branches were transferred to the nearest FCB branch.

FCB paid $10.0 million to acquire 1st Financial, including payments of $8.0 million to the U.S. Treasury to acquire and subsequently retire 1st Financial's Troubled Asset Relief Program (TARP) obligation and $2.0 million paid to the shareholders of 1st Financial. As a result of the merger, FCB recorded $24.5 million in goodwill and $3.8 million in core deposit intangibles.

The 1st Financial transaction was accounted for under the acquisition method of accounting, and the purchased assets, assumed liabilities and identifiable intangible assets were recorded at their estimated fair values as of the acquisition date. Fair values are subject to refinement for up to one year after the closing date of the transaction as additional information regarding closing date fair values becomes available. During the second quarter of 2014, no adjustments were deemed necessary.

The following table provides the carrying value of acquired assets and assumed liabilities, as recorded by 1st Financial, the fair value adjustments calculated at the time of the merger and the resulting fair value recorded by FCB.
 
January 1, 2014
(Dollars in thousands)
As recorded by
1st Financial
 
Fair value adjustments
 
As recorded by FCB
Assets
 
 
 
 
 
Cash and cash equivalents
$
28,194

 
$
—

 
$
28,194

Investment securities
246,890

 
(9,452
)
 
237,438

Loans held for sale
1,183

 
—

 
1,183

Restricted equity securities
3,105

 
671

 
3,776

Loans
338,170

 
(21,843
)
 
316,327

Less: allowance for loan losses
(7,796
)
 
7,796

 
—

Premises and equipment
3,871

 
(1,185
)
 
2,686

Other real estate owned
12,896

 
(1,305
)
 
11,591

Intangible asset
—

 
3,780

 
3,780

Other assets
16,811

 
(465
)
 
16,346

Total assets acquired
$
643,324

 
$
(22,003
)
 
$
621,321

Liabilities
 
 
 
 
 
Deposits:
 
 
 
 
 
Noninterest-bearing
$
152,444

 
$
—

 
$
152,444

Interest-bearing
477,881

 
1,546

 
479,427

Total deposits
630,325

 
1,546

 
631,871

Short-term borrowings
406

 
—

 
406

Other liabilities
3,392

 
167

 
3,559

Total liabilities assumed
$
634,123

 
$
1,713

 
635,836

Fair value of net liabilities assumed

 

 
14,515

Cash paid to shareholders
 
 
 
 
2,000

Cash paid to acquire TARP securities
 
 
 
 
8,000

Goodwill recorded for 1st Financial
 
 
 
 
$
24,515



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Goodwill recorded for 1st Financial represents future revenues to be derived from the existing customer base, including efficiencies that will result from combining operations and other non-identifiable intangible assets. The 1st Financial transaction is a taxable asset acquisition, and goodwill resulting from the transaction is deductible for income tax purposes.

Merger costs related to the 1st Financial transaction are estimated to be between $5.5 million and $6.0 million. Loan related interest income generated from 1st Financial was approximately $4.2 million for the second quarter of 2014 and $8.6 million for the year to date.

All loans acquired with the 1st Financial transaction are accounted for under the expected cash flow method (ASC 310-30).

For loans acquired from 1st Financial, the contractually required payments including principal and interest, cash flows expected to be collected and fair values as of the merger date were:
(Dollars in thousands)
January 1, 2014
Contractually required payments
$
414,233

Cash flows expected to be collected
400,622

Fair value at acquisition date
316,327


The recorded fair values of loans acquired in the 1st Financial transaction as of the merger date were as follows:
(Dollars in thousands)
January 1, 2014
Commercial:
 
Construction and land development
$
41,516

Commercial mortgage
123,925

Other commercial real estate
6,698

Commercial and industrial
29,126

Total commercial loans
201,265

Noncommercial:
 
Residential mortgage
113,177

Consumer
1,885

Total noncommercial loans
115,062

Total loans acquired from 1st Financial
$
316,327




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NOTE C - INVESTMENTS
The amortized cost and fair value of investment securities classified as available for sale and held to maturity at June 30, 2014 and December 31, 2013, are as follows:
 
June 30, 2014
(Dollars in thousands)
Cost
 
Gross
unrealized
gains
 
Gross unrealized
losses
 
Fair
value
Investment securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
1,623,564

 
$
2,084

 
$
18

 
$
1,625,630

Government agency
1,281,724

 
2,020

 
178

 
1,283,566

Mortgage-backed securities
2,605,333

 
8,251

 
17,298

 
2,596,286

Equity securities
543

 
31,955

 
—

 
32,498

Municipal securities
185

 
1

 
—

 
186

Total investment securities available for sale
$
5,511,349

 
$
44,311

 
$
17,494

 
$
5,538,166

 
 
 
 
 
 
 
 
 
December 31, 2013
 
Cost
 
Gross
unrealized
gains
 
Gross unrealized
losses
 
Fair
value
U.S. Treasury
$
373,223

 
$
259

 
$
45

 
$
373,437

Government agency
2,543,223

 
1,798

 
792

 
2,544,229

Mortgage-backed securities
2,486,297

 
4,526

 
43,950

 
2,446,873

Equity securities
543

 
21,604

 
—

 
22,147

Municipal securities
186

 
1

 
—

 
187

Other
863

 
—

 
33

 
830

Total investment securities available for sale
$
5,404,335

 
$
28,188

 
$
44,820

 
$
5,387,703

 
 
 
 
 
 
 
 
 
June 30, 2014
 
Cost
 
Gross
unrealized
gains
 
Gross unrealized
losses
 
Fair
value
Investment securities held to maturity
 
 
 
 
 
 
 
Mortgage-backed securities
$
693

 
$
36

 
$
—

 
$
729

 
 
 
 
 
 
 
 
 
December 31, 2013
 
Cost
 
Gross
unrealized
gains
 
Gross unrealized
losses
 
Fair
value
Mortgage-backed securities
$
907

 
$
67

 
$
—

 
$
974


A single subordinated debt security, previously classified within other, was called during the second quarter of 2014.

Investments in mortgage-backed securities primarily represent securities issued by the Government National Mortgage Association, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation.


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The following table provides the amortized cost and fair value by contractual maturity. Expected maturities will differ from contractual maturities on certain securities because borrowers and issuers may have the right to call or prepay obligations with or without prepayment penalties. Repayments of mortgage-backed securities are dependent on the repayments of the underlying loan balances. Equity securities do not have a stated maturity date.
 
June 30, 2014
 
December 31, 2013
(Dollars in thousands)
Cost
 
Fair
value
 
Cost
 
Fair
value
Investment securities available for sale
 
 
 
 
 
 
 
Non-amortizing securities maturing in:
 
 
 
 
 
 
 
One year or less
$
683,598

 
$
684,265

 
$
839,956

 
$
840,883

One through five years
2,221,875

 
2,225,117

 
2,077,539

 
2,077,800

Mortgage-backed securities
2,605,333

 
2,596,286

 
2,486,297

 
2,446,873

Equity securities
543

 
32,498

 
543

 
22,147

Total investment securities available for sale
$
5,511,349

 
$
5,538,166

 
$
5,404,335

 
$
5,387,703

Investment securities held to maturity
 
 
 
 
 
 
 
Mortgage-backed securities held to maturity
$
693

 
$
729

 
$
907

 
$
974

There were no realized securities gains (losses) during any period presented.  
 
 
 
 
The following table provides information regarding securities with unrealized losses as of June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
Less than 12 months
 
12 months or more
 
Total
(Dollars in thousands)
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
135,712

 
$
18

 
$
—

 
$
—

 
$
135,712

 
$
18

Government agency
242,563

 
178

 
—

 
—

 
242,563

 
178

Mortgage-backed securities
728,997

 
2,163

 
1,109,829

 
15,135

 
1,838,826

 
17,298

Total
$
1,107,272

 
$
2,359

 
$
1,109,829

 
$
15,135

 
$
2,217,101

 
$
17,494

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
 
Fair
value
 
Unrealized
losses
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
$
102,105

 
$
45

 
$
—

 
$
—

 
$
102,105

 
$
45

Government agency
780,552

 
761

 
29,969

 
31

 
810,521

 
792

Mortgage-backed securities
2,221,213

 
42,876

 
26,861

 
1,074

 
2,248,074

 
43,950

Other
830

 
33

 
—

 
—

 
830

 
33

Total
$
3,104,700

 
$
43,715

 
$
56,830

 
$
1,105

 
$
3,161,530

 
$
44,820

Investment securities with an aggregate fair value of $1.11 billion and $56.8 million have had continuous unrealized losses for more than 12 months as of June 30, 2014 and December 31, 2013, with an aggregate unrealized loss of $15.1 million and $1.1 million, respectively. As of June 30, 2014, all 104 of these investments are U.S. government agency and government sponsored enterprise-issued mortgage-backed securities. None of the unrealized losses identified as of June 30, 2014 or December 31, 2013 relate to the marketability of the securities or the issuer’s ability to honor redemption obligations. For all periods presented, BancShares had the ability and intent to retain these securities for a period of time sufficient to recover all unrealized losses. Therefore, none of the securities were deemed to be other than temporarily impaired.
Investment securities having an aggregate carrying value of $2.85 billion at June 30, 2014 and $2.75 billion at December 31, 2013 were pledged as collateral to secure public funds on deposit and certain short-term borrowings, and for other purposes as required by law.


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NOTE D - LOANS AND LEASES

BancShares reports acquired and originated loan portfolios separately, and each portfolio is further divided into commercial and non-commercial based on the type of borrower, purpose, collateral, and/or our underlying credit management processes. Additionally, loans are assigned to loan classes, which further disaggregate loans based upon common risk characteristics.
Commercial – Commercial loans include construction and land development, mortgage, other commercial real estate, commercial and industrial, lease financing and other.

Construction and land development – Construction and land development consists of loans to finance land for development, investment, and use in a commercial business enterprise, multifamily apartments and other commercial building that may be owner-occupied or income generating investments for the owner.

Commercial mortgage – Commercial mortgage consists of loans to purchase or refinance owner-occupied nonresidential and investment properties. Investment properties include office buildings and other facilities that are rented or leased to unrelated parties.

Other commercial real estate – Other commercial real estate consists of loans secured by farmland (including farm residential and other improvements) and multifamily (5 or more) residential properties.

Commercial and industrial – Commercial and industrial loans consists of lines of credit to finance corporate credit cards, accounts receivable, inventory and other general business purposes.

Lease financing – Lease financing consists solely of lease financing agreements.

Other – Other loans consists of all other commercial loans not classified in one of the preceding classes. These typically include loans to non-profit organizations such as churches, hospitals, educational and charitable organizations.

Noncommercial – Noncommercial loans consist of residential and revolving mortgage, construction and land development, and consumer.

Residential mortgage – Residential real estate consists of loans to purchase, construct or refinance the borrower's primary dwelling, second residence or vacation home.

Revolving mortgage – Revolving mortgage consists of home equity lines of credit that are secured by first or second liens on the borrower's primary residence.

Construction and land development – Construction and land development consists of loans to construct the borrower's primary or secondary residence or vacant land upon which the owner intends to construct a dwelling at a future date.

Consumer – Consumer loans consist of installment loans to finance purchases of vehicles, unsecured home improvements and revolving lines of credit that can be secured or unsecured, including personal credit cards.


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Loans and leases outstanding include the following at June 30, 2014 and December 31, 2013:
 
(Dollars in thousands)
June 30, 2014
 
December 31, 2013
Acquired loans
 
 
 
Commercial:
 
 
 
Construction and land development
$
80,827

 
$
78,915

Commercial mortgage
637,481

 
642,891

Other commercial real estate
34,688

 
41,381

Commercial and industrial
33,851

 
17,254

Other
1,270

 
866

Total commercial loans
788,117

 
781,307

Noncommercial:
 
 
 
Residential mortgage
270,688

 
213,851

Revolving mortgage
20,129

 
30,834

Construction and land development
28,759

 
2,583

Consumer
2,240

 
851

Total noncommercial loans
321,816

 
248,119

Total acquired loans
1,109,933

 
1,029,426

Originated loans and leases:
 
 
 
Commercial:
 
 
 
Construction and land development
342,021

 
319,847

Commercial mortgage
6,367,096

 
6,362,490

Other commercial real estate
178,899

 
178,754

Commercial and industrial
1,292,213

 
1,081,158

Lease financing
413,422

 
381,763

Other
131,051

 
175,336

Total commercial loans
8,724,702

 
8,499,348

Noncommercial:
 
 
 
Residential mortgage
1,071,089

 
982,421

Revolving mortgage
2,122,675

 
2,113,285

Construction and land development
119,420

 
122,792

Consumer
377,137

 
386,452

Total noncommercial loans
3,690,321

 
3,604,950

Total originated loans and leases
12,415,023

 
12,104,298

Total loans and leases
$
13,524,956

 
$
13,133,724


At June 30, 2014, $816.3 million in acquired loans were covered under loss share agreements, compared to $1.03 billion at December 31, 2013. The remaining acquired loans as of June 30, 2014 are primarily from the 1st Financial merger. The loss share protection will expire for non-single family residential loans acquired from Temecula Valley Bank (TVB) and Venture Bank (VB) during the third quarter of 2014. The acquired loan balance at June 30, 2014 for the expiring agreements from TVB and VB is $195.4 million and $73.3 million, respectively.

At June 30, 2014, $2.65 billion in originated loans were pledged to secure debt obligations, compared to $2.56 billion at December 31, 2013.

Credit quality indicators

Loans and leases are monitored for credit quality on a recurring basis. The credit quality indicators used are dependent on the portfolio segment to which the loan relates. Originated commercial loans and leases, originated noncommercial loans and leases and acquired loans have different credit quality indicators as a result of the unique characteristics relative to each loan segment being evaluated.

The credit quality indicators for commercial loans and leases are developed through a review of individual borrowers on an ongoing basis. Each commercial loan is evaluated annually with more frequent evaluation of more severely criticized loans or leases. The credit quality indicators for noncommercial loans are based on the delinquency status of the borrower. As the

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borrower becomes more delinquent, the likelihood of loss increases. Acquired loans are bifurcated into commercial and noncommercial segments and credit quality indicators are assigned in the same manner as the originated portfolio. The indicators represent the rating for loans or leases as of the date presented based on the most recent assessment performed. These credit quality indicators are defined as follows:

Pass – A pass rated asset is one in which repayment is considered highly likely and there are no observable weaknesses in the asset. Such an asset does not meet any of the characteristics for adverse classification.

Special mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified and do not warrant adverse classification.

Substandard – A substandard asset is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Assets classified as substandard generally have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These assets are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful – An asset classified as doubtful has all the weaknesses inherent in an asset classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable on the basis of currently existing facts, conditions and values.

Loss – Assets classified as loss are considered uncollectible and of such little value that it is inappropriate to be carried as an asset. This classification is not necessarily equivalent to no potential for recovery or salvage value, but rather that it is not appropriate to defer a full charge-off even though partial recovery may be effected in the future.

Ungraded – Ungraded loans represent loans that are not included in the individual credit grading process due to their relatively small balances or borrower type. The majority of originated, ungraded loans at June 30, 2014 and December 31, 2013 relate to business credit cards. Business credit card loans are subject to automatic charge-off when they become 120 days past due in the same manner as unsecured consumer lines of credit. The remaining balance is comprised of a small amount of commercial mortgage loans and other commercial real estate loans. As of December 31, 2013, ungraded loans also included tobacco buyout loans classified as commercial and industrial loans. Final payment from the Commodity Credit Corporation was received during January 2014 for tobacco buyout loans held by FCB. As of June 30, 2014, ungraded also includes $94.7 million of loans resulting from the 1st Financial merger.


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Originated loans and leases outstanding at June 30, 2014 and December 31, 2013 by credit quality indicator are provided below:
 
 
June 30, 2014
(Dollars in thousands)
Originated commercial loans and leases
Grade:
Construction  and land
development
 
Commercial
mortgage
 
Other
commercial real estate
 
Commercial  and
industrial
 
Lease financing
 
Other
 
Total originated commercial loans and leases
Pass
$
330,946

 
$
6,102,219

 
$
175,413

 
$
1,178,124

 
$
405,495

 
$
130,997

 
$
8,323,194

Special mention
7,901

 
121,824

 
1,370

 
25,606

 
4,324

 
8

 
161,033

Substandard
3,174

 
138,451

 
1,966

 
6,474

 
3,122

 
46

 
153,233

Doubtful
—

 
3,296

 
—

 
460

 
481

 
—

 
4,237

Ungraded
—

 
1,306

 
150

 
81,549

 
—

 
—

 
83,005

Total
$
342,021

 
$
6,367,096

 
$
178,899

 
$
1,292,213

 
$
413,422

 
$
131,051

 
$
8,724,702

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Originated commercial loans and leases
 
Construction  and land
development
 
Commercial
mortgage
 
Other
commercial real estate
 
Commercial  and
industrial
 
Lease financing
 
Other
 
Total originated commercial loans and leases
Pass
$
308,231

 
$
6,094,505

 
$
174,913

 
$
964,840

 
$
375,371

 
$
174,314

 
$
8,092,174

Special mention
8,620

 
119,515

 
1,362

 
14,686

 
2,160

 
982

 
147,325

Substandard
2,944

 
141,913

 
2,216

 
6,352

 
3,491

 
40

 
156,956

Doubtful
52

 
5,159

 
75

 
144

 
592

 
—

 
6,022

Ungraded
—

 
1,398

 
188

 
95,136

 
149

 
—

 
96,871

Total
$
319,847

 
$
6,362,490

 
$
178,754

 
$
1,081,158

 
$
381,763

 
$
175,336

 
$
8,499,348


 
June 30, 2014
 
Originated noncommercial loans and leases
(Dollars in thousands)
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
 
Consumer
 
Total originated noncommercial
loans
Current
$
1,047,270

 
$
2,107,889

 
$
118,078

 
$
373,579

 
$
3,646,816

30-59 days past due
11,219

 
7,690

 
949

 
1,949

 
21,807

60-89 days past due
4,693

 
2,434

 
229

 
843

 
8,199

90 days or greater past due
7,907

 
4,662

 
164

 
766

 
13,499

Total
$
1,071,089

 
$
2,122,675

 
$
119,420

 
$
377,137

 
$
3,690,321

 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Originated noncommercial loans and leases
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
 
Consumer
 
Total originated noncommercial
loans
Current
$
955,300

 
$
2,095,480

 
$
121,026

 
$
382,710

 
$
3,554,516

30-59 days past due
12,885

 
10,977

 
1,193

 
2,114

 
27,169

60-89 days past due
4,658

 
2,378

 
317

 
955

 
8,308

90 days or greater past due
9,578

 
4,450

 
256

 
673

 
14,957

Total
$
982,421

 
$
2,113,285

 
$
122,792

 
$
386,452

 
$
3,604,950


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Acquired loans and leases outstanding at June 30, 2014 and December 31, 2013 by credit quality indicator are provided below:

 
June 30, 2014
(Dollars in thousands)
Acquired loans
Grade:
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total acquired
loans
Pass
$
14,193

 
$
349,009

 
$
11,422

 
$
26,313

 
$
138,836

 
$
15,238

 
$
112

 
$
1,469

 
$
556,592

Special mention
10,957

 
106,582

 
16,014

 
3,869

 
5,543

 
2,375

 
—

 
—

 
145,340

Substandard
49,746

 
148,880

 
7,252

 
3,221

 
44,396

 
1,696

 
1,237

 
2

 
256,430

Doubtful
2,214

 
32,503

 
—

 
431

 
1,401

 
612

 
295

 
—

 
37,456

Ungraded
3,717

 
507

 
—

 
17

 
80,512

 
208

 
27,115

 
2,039

 
114,115

Total
$
80,827

 
$
637,481

 
$
34,688

 
$
33,851

 
$
270,688

 
$
20,129

 
$
28,759

 
$
3,510

 
$
1,109,933

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
Acquired loans
 
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total acquired
loans
Pass
$
2,619

 
$
296,824

 
$
22,225

 
$
8,021

 
$
135,326

 
$
26,322

 
$
149

 
$
1,345

 
$
492,831

Special mention
15,530

 
125,295

 
3,431

 
2,585

 
6,301

 
2,608

 
—

 
—

 
155,750

Substandard
52,228

 
179,657

 
7,012

 
5,225

 
52,774

 
1,013

 
2,139

 
—

 
300,048

Doubtful
7,436

 
40,471

 
8,713

 
1,257

 
2,058

 
891

 
295

 
—

 
61,121

Ungraded
1,102

 
644

 
—

 
166

 
17,392

 
—

 
—

 
372

 
19,676

Total
$
78,915

 
$
642,891

 
$
41,381

 
$
17,254

 
$
213,851

 
$
30,834

 
$
2,583

 
$
1,717

 
$
1,029,426



19
Table of Contents

The aging of the outstanding loans and leases, by class, at June 30, 2014 and December 31, 2013 (excluding loans and leases acquired with deteriorated credit quality) is provided in the table below.

The calculation of days past due begins on the day after payment is due and includes all days through which all required interest or principal has not been paid. Loans and leases 30 days or less past due are considered current as various grace periods allow borrowers to make payments within a stated period after the due date and still remain in compliance with the loan agreement.

 
June 30, 2014
(Dollars in thousands)
30-59 days
past due
 
60-89 days
past due
 
90 days or greater
 
Total past
due
 
Current
 
Total loans
and leases
Originated loans and leases:
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
$
657

 
$
40

 
$
462

 
$
1,159

 
$
340,862

 
$
342,021

Commercial mortgage
11,755

 
3,089

 
10,501

 
25,345

 
6,341,751

 
6,367,096

Other commercial real estate
149

 
—

 
52

 
201

 
178,698

 
178,899

Commercial and industrial
5,459

 
805

 
593

 
6,857

 
1,285,356

 
1,292,213

Lease financing
1,110

 
8

 
97

 
1,215

 
412,207

 
413,422

Other
343

 
—

 
—

 
343

 
130,708

 
131,051

Residential mortgage
11,219

 
4,693

 
7,907

 
23,819

 
1,047,270

 
1,071,089

Revolving mortgage
7,690

 
2,434

 
4,662

 
14,786

 
2,107,889

 
2,122,675

Construction and land development - noncommercial
949

 
229

 
164

 
1,342

 
118,078

 
119,420

Consumer
1,949

 
843

 
766

 
3,558

 
373,579

 
377,137

Total originated loans and leases
$
41,280

 
$
12,141

 
$
25,204

 
$
78,625

 
$
12,336,398

 
$
12,415,023

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
30-59 days
past due
 
60-89 days
past due
 
90 days or greater
 
Total past
due
 
Current
 
Total loans
and leases
Originated loans and leases:
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
$
1,603

 
$
9

 
$
457

 
$
2,069

 
$
317,778

 
$
319,847

Commercial mortgage
11,131

 
3,601

 
14,407

 
29,139

 
6,333,351

 
6,362,490

Other commercial real estate
139

 
210

 
470

 
819

 
177,935

 
178,754

Commercial and industrial
3,336

 
682

 
436

 
4,454

 
1,076,704

 
1,081,158

Lease financing
789

 
1,341

 
101

 
2,231

 
379,532

 
381,763

Other
—

 
85

 
—

 
85

 
175,251

 
175,336

Residential mortgage
12,885

 
4,658

 
9,578

 
27,121

 
955,300

 
982,421

Revolving mortgage
10,977

 
2,378

 
4,450

 
17,805

 
2,095,480

 
2,113,285

Construction and land development - noncommercial
1,193

 
317

 
256

 
1,766

 
121,026

 
122,792

Consumer
2,114

 
955

 
673

 
3,742

 
382,710

 
386,452

Total originated loans and leases
$
44,167

 
$
14,236

 
$
30,828

 
$
89,231

 
$
12,015,067

 
$
12,104,298



20
Table of Contents

The recorded investment, by class, in loans and leases on nonaccrual status, and loans and leases greater than 90 days past due and still accruing at June 30, 2014 and December 31, 2013 (excluding acquired loans and leases) are as follows:
 
June 30, 2014
 
December 31, 2013
(Dollars in thousands)
Nonaccrual
loans and
leases
 
Loans and
leases > 90
days and
accruing
 
Nonaccrual
loans and
leases
 
Loans and
leases > 90
days and
accruing
Originated loans and leases:
 
 
 
 
 
 
 
Construction and land development - commercial
$
659

 
$
—

 
$
544

 
$
—

Other commercial real estate
1,385

 
41

 
1,610

 
—

Commercial mortgage
28,591

 
1,802

 
33,529

 
1,113

Commercial and industrial
1,367

 
502

 
1,428

 
294

Lease financing
624

 
5

 
832

 
—

Residential mortgage
13,836

 
1,930

 
14,701

 
1,998

Revolving mortgage
—

 
4,662

 
—

 
4,450

Construction and land development - noncommercial
—

 
164

 
457

 
256

Consumer
23

 
766

 
69

 
673

Total originated loans and leases
$
46,485

 
$
9,872

 
$
53,170

 
$
8,784

Acquired Loans
The following table provides changes in the recorded investment of acquired loans during the six months ended June 30, 2014 and June 30, 2013:
(Dollars in thousands)
2014
 
2013
Balance at January 1
$
1,029,426

 
$
1,809,235

Fair value of acquired loans
316,327

 
—

Accretion
60,660

 
131,909

Payments received and other changes, net
(296,480
)
 
(497,808
)
Balance at June 30
$
1,109,933

 
$
1,443,336

Outstanding principal balance at June 30
$
1,888,475

 
$
2,456,347


The recorded investment of acquired loans on the cost recovery method was $54.0 million at June 30, 2014 and $28.5 million at December 31, 2013. This increase is primarily driven by one large acquired loan relationship that was moved to cost recovery during the first quarter. The cost recovery method is applied to loans when the timing of future cash flows is not reasonably estimable due to borrower nonperformance or uncertainty in the timing and amount of ultimate disposition of the asset.

The following table documents changes to the amount of accretable yield for the first six months of 2014 and 2013.
(Dollars in thousands)
2014
 
2013
Balance at January 1
$
439,990

 
$
539,564

Additions
84,295

 
—

Accretion
(60,660
)
 
(131,909
)
Reclassifications from nonaccretable difference
9,992

 
72,149

Changes in expected cash flows that do not affect nonaccretable difference
(17,126
)
 
42,402

Balance at June 30
$
456,491

 
$
522,206











21
Table of Contents

NOTE E - ALLOWANCE FOR LOAN AND LEASE LOSSES

The following tables present the activity in the allowance for originated loan and lease losses by loan class for the three and six months ended June 30, 2014 and June 30, 2013:
 
Three months ended June 30, 2014
(Dollars in thousands)
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other commercial real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-
commercial
 
Consumer
 
Non-
specific
 
Total
Originated Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 1
$
12,246

 
$
94,217

 
$
945

 
$
24,021

 
$
4,183

 
$
454

 
$
10,944

 
$
16,408

 
$
1,249

 
$
13,282

 
$
—

 
$
177,949

Provision
(1,135
)
 
(1,961
)
 
(155
)
 
3,033

 
176

 
163

 
(1,557
)
 
1,252

 
(323
)
 
2,737

 
—

 
2,230

Charge-offs
—

 
(272
)
 
—

 
(531
)
 
(14
)
 
(5
)
 
(234
)
 
(1,064
)
 
(23
)
 
(2,628
)
 
—

 
(4,771
)
Recoveries
5

 
145

 
16

 
386

 
20

 
—

 
148

 
201

 
2

 
584

 
—

 
1,507

Balance at June 30
$
11,116

 
$
92,129

 
$
806

 
$
26,909

 
$
4,365

 
$
612

 
$
9,301

 
$
16,797

 
$
905

 
$
13,975

 
$
—

 
$
176,915

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2013
 
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other commercial real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-
commercial
 
Consumer
 
Non-
specific
 
Total
Balance at April 1
$
4,311

 
$
82,119

 
$
1,915

 
$
13,661

 
$
3,543

 
$
1,490

 
$
3,790

 
$
24,499

 
$
1,419

 
$
24,027

 
$
15,772

 
$
176,546

Provision
3,296

 
(4,976
)
 
(51
)
 
(1,203
)
 
1,775

 
155

 
878

 
907

 
(244
)
 
1,694

 
—

 
2,231

Charge-offs
(1,286
)
 
(213
)
 
(18
)
 
(988
)
 
(92
)
 
—

 
(450
)
 
(878
)
 
—

 
(2,569
)
 
—

 
(6,494
)
Recoveries
270

 
491

 
26

 
288

 
19

 
3

 
61

 
307

 
23

 
643

 
—

 
2,131

Reclassification (1)
5,141

 
27,421

 
(815
)
 
7,551

 
(253
)
 
(1,288
)
 
5,717

 
(9,838
)
 
(478
)
 
(10,018
)
 
(15,772
)
 
7,368

Balance at June 30
$
11,732

 
$
104,842

 
$
1,057

 
$
19,309

 
$
4,992

 
$
360

 
$
9,996

 
$
14,997

 
$
720

 
$
13,777

 
$
—

 
$
181,782

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2014
 
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other commercial real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-
commercial
 
Consumer
 
Non-
specific
 
Total
Balance at January 1
$
10,335

 
$
100,257

 
$
1,009

 
$
22,362

 
$
4,749

 
$
190

 
$
10,511

 
$
16,239

 
$
681

 
$
13,541

 
$
—

 
$
179,874

Provision
750

 
(8,940
)
 
(229
)
 
5,009

 
(348
)
 
435

 
(948
)
 
2,605

 
254

 
4,012

 
—

 
2,600

Charge-offs
—

 
(440
)
 
—

 
(1,027
)
 
(72
)
 
(13
)
 
(418
)
 
(2,324
)
 
(94
)
 
(4,805
)
 
—

 
(9,193
)
Recoveries
31

 
1,252

 
26

 
565

 
36

 
—

 
156

 
277

 
64

 
1,227

 
—

 
3,634

Balance at June 30
$
11,116

 
$
92,129

 
$
806

 
$
26,909

 
$
4,365

 
$
612

 
$
9,301

 
$
16,797

 
$
905

 
$
13,975

 
$
—

 
$
176,915

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2013
 
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other commercial real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-
commercial
 
Consumer
 
Non-
specific
 
Total
Balance at January 1
$
6,031

 
$
80,229

 
$
2,059

 
$
14,050

 
$
3,521

 
$
1,175

 
$
3,836

 
$
25,185

 
$
1,721

 
$
25,389

 
$
15,850

 
$
179,046

Provision
1,462

 
(2,438
)
 
(151
)
 
(703
)
 
1,797

 
476

 
1,611

 
2,338

 
(357
)
 
2,290

 
(78
)
 
6,247

Charge-offs
(1,540
)
 
(869
)
 
(72
)
 
(2,246
)
 
(92
)
 
(6
)
 
(1,268
)
 
(3,066
)
 
(245
)
 
(5,157
)
 
—

 
(14,561
)
Recoveries
638

 
499

 
36

 
657

 
19

 
3

 
100

 
378

 
79

 
1,273

 
—

 
3,682

Reclassification (1)
5,141

 
27,421

 
(815
)
 
7,551

 
(253
)
 
(1,288
)
 
5,717

 
(9,838
)
 
(478
)
 
(10,018
)
 
(15,772
)
 
7,368

Balance at June 30
$
11,732

 
$
104,842

 
$
1,057

 
$
19,309

 
$
4,992

 
$
360

 
$
9,996

 
$
14,997

 
$
720

 
$
13,777

 
$
—

 
$
181,782


(1) Reclassification results from enhancements to the ALLL calculation during the second quarter of 2013 that resulted in the allocation of $15.8 million previously designated as 'non-specific' to other loan classes and the absorption of $7.4 million of the reserve for unfunded commitments related to unfunded, revocable loan commitments into the ALLL.

The provision for construction and land development - commercial was a credit of $1.1 million for the quarter ended June 30, 2014 compared to expense of $3.3 million for the same period in the prior year. Provision expense for the six month periods ended June 30, 2014 and June 30, 2013 was $0.8 million and $1.5 million, respectively. The decrease in provision expense for both comparative periods is due to improvements in credit risk rating and lower credit default trends.


22
Table of Contents

The commercial mortgage loan class had a net credit provision of $2.0 million and $8.9 million for the three and six months ended June 30, 2014, respectively. The net credit provision for the three and six months ended June 30, 2013 was $5.0 million and $2.4 million, respectively. The net credit provision for all periods was primarily the result of improvements in the credit risk rating mix and lower credit default trends within this loan class. 

The provision for commercial and industrial loans totaled $3.0 million and $5.0 million for the three and six months ended June 30, 2014, respectively. The 2014 provision expense was a result of increased loans during the respective periods. Conversely, the three and six months ended June 30, 2013 credit provisions of $1.2 million and $0.7 million, respectively, resulted from a decline in the outstanding loan balances.

The residential mortgage loan class had a net credit provision of $1.6 million and $0.9 million for the three and six months ended June 30, 2014, respectively. Provision expense for the three and six months ended June 30, 2013 was $0.9 million and $1.6 million. The decrease in provision expense can be attributed to a decline in past due residential mortgage loans.

The following tables present the allowance for originated loan losses and the recorded investment in originated loans, by loan class, based on impairment method as of June 30, 2014 and December 31, 2013:
 
June 30, 2014
(Dollars in thousands)
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-commercial
 
Consumer
 
Total
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL for loans and leases individually evaluated for impairment
$
155

 
$
7,704

 
$
179

 
$
1,425

 
$
297

 
$
—

 
$
1,613

 
$
1,024

 
$
201

 
$
653

 
$
13,251

ALLL for loans and leases collectively evaluated for impairment
10,961

 
84,425

 
627

 
25,484

 
4,068

 
612

 
7,688

 
15,773

 
704

 
13,322

 
163,664

Total allowance for loan and lease losses
$
11,116

 
$
92,129

 
$
806

 
$
26,909

 
$
4,365

 
$
612

 
$
9,301

 
$
16,797

 
$
905

 
$
13,975

 
$
176,915

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases individually evaluated for impairment
$
2,573

 
$
87,046

 
$
1,962

 
$
10,811

 
$
376

 
$
46

 
$
15,448

 
$
3,754

 
$
1,934

 
$
937

 
$
124,887

Loans and leases collectively evaluated for impairment
339,448

 
6,280,050

 
176,937

 
1,281,402

 
413,046

 
131,005

 
1,055,641

 
2,118,921

 
117,486

 
376,200

 
12,290,136

Total loan and leases
$
342,021

 
$
6,367,096

 
$
178,899

 
$
1,292,213

 
$
413,422

 
$
131,051

 
$
1,071,089

 
$
2,122,675

 
$
119,420

 
$
377,137

 
$
12,415,023

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
(Dollars in thousands)
Construction
and land
development
- commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and industrial
 
Lease
financing
 
Other
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development
- non-commercial
 
Consumer
 
Total
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ALLL for loans and leases individually evaluated for impairment
$
103

 
$
6,873

 
$
209

 
$
771

 
$
54

 
$
—

 
$
1,586

 
$
372

 
$
72

 
$
121

 
$
10,161

ALLL for loans and leases collectively evaluated for impairment
10,232

 
93,384

 
800

 
21,591

 
4,695

 
190

 
8,925

 
15,867

 
609

 
13,420

 
169,713

Total allowance for loan and lease losses
$
10,335

 
$
100,257

 
$
1,009

 
$
22,362

 
$
4,749

 
$
190

 
$
10,511

 
$
16,239

 
$
681

 
$
13,541

 
$
179,874

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases individually evaluated for impairment
$
2,272

 
$
97,111

 
$
1,878

 
$
9,300

 
$
188

 
$
—

 
$
15,539

 
$
3,596

 
$
1,108

 
$
1,154

 
$
132,146

Loans and leases collectively evaluated for impairment
317,575

 
6,265,379

 
176,876

 
1,071,858

 
381,575

 
175,336

 
966,882

 
2,109,689

 
121,684

 
385,298

 
11,972,152

Total loan and leases
$
319,847

 
$
6,362,490

 
$
178,754

 
$
1,081,158

 
$
381,763

 
$
175,336

 
$
982,421

 
$
2,113,285

 
$
122,792

 
$
386,452

 
$
12,104,298



The total reserves for individually impaired loans increased during the second quarter of 2014 due to enhancements in the TDR impairment calculation. TDR impairment evaluation, for performing TDRs, has historically been calculated on pools of homogeneous loan groups, as determined by loan type with similar risk characteristics and performance trends, using a discounted cash flow analysis. Management enhanced

23
Table of Contents

this process during the second quarter to include individual loan level impairment analysis for performing TDRs which resulted in higher impairment estimates for some TDR loans.

The following tables show the activity in the allowance for acquired loan and lease losses by loan class for the three and six months ended June 30, 2014 and June 30, 2013.
 
Three months ended June 30, 2014
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
Acquired Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan and lease losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 1
$
4,476

 
$
23,003

 
$
1,204

 
$
2,256

 
$
9,764

 
$
3,493

 
$
583

 
$
214

 
$
44,993

Provision
(77
)
 
(1,185
)
 
(797
)
 
(1,729
)
 
(2,176
)
 
(3,031
)
 
(583
)
 
49

 
(9,529
)
Charge-offs
(596
)
 
(4,503
)
 
—

 
(152
)
 
(495
)
 
(381
)
 
—

 
(6
)
 
(6,133
)
Recoveries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at June 30
$
3,803

 
$
17,315

 
$
407

 
$
375

 
$
7,093

 
$
81

 
$
—

 
$
257

 
$
29,331

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2013
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
Balance at April 1
$
13,306

 
$
38,293

 
$
5,172

 
$
11,876

 
$
17,603

 
$
7,135

 
$
2,756

 
$
332

 
$
96,473

Provision
(5,091
)
 
(2,522
)
 
(576
)
 
(4,936
)
 
55

 
(869
)
 
(1,524
)
 
(10
)
 
(15,473
)
Charge-offs
(626
)
 
(2,183
)
 
—

 
(1,004
)
 
(386
)
 
(235
)
 
—

 
(32
)
 
(4,466
)
Recoveries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at June 30
$
7,589

 
$
33,588

 
$
4,596

 
$
5,936

 
$
17,272

 
$
6,031

 
$
1,232

 
$
290

 
$
76,534

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2014
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
Balance at January 1
$
1,320

 
$
29,906

 
$
1,354

 
$
5,275

 
$
11,802

 
$
2,959

 
$
682

 
$
222

 
$
53,520

Provision
3,278

 
(4,571
)
 
(947
)
 
(2,065
)
 
(4,476
)
 
(2,397
)
 
(682
)
 
58

 
(11,802
)
Charge-offs
(795
)
 
(8,020
)
 
—

 
(2,835
)
 
(233
)
 
(481
)
 
—

 
(23
)
 
(12,387
)
Recoveries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at June 30
$
3,803

 
$
17,315

 
$
407

 
$
375

 
$
7,093

 
$
81

 
$
—

 
$
257

 
$
29,331

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2013
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
Balance at January 1
$
31,186

 
$
50,275

 
$
11,234

 
$
8,897

 
$
19,837

 
$
9,754

 
$
8,287

 
$
502

 
$
139,972

Provision
(18,238
)
 
(4,606
)
 
(5,707
)
 
(704
)
 
(1,450
)
 
(3,373
)
 
(3,837
)
 
(180
)
 
(38,095
)
Charge-offs
(5,359
)
 
(12,081
)
 
(931
)
 
(2,257
)
 
(1,115
)
 
(350
)
 
(3,218
)
 
(32
)
 
(25,343
)
Recoveries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Balance at June 30
$
7,589

 
$
33,588

 
$
4,596

 
$
5,936

 
$
17,272

 
$
6,031

 
$
1,232

 
$
290

 
$
76,534




24
Table of Contents

The following tables show the ending balances of acquired loans and leases and related allowance by class of loans as of June 30, 2014 and December 31, 2013:

 
June 30, 2014
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
ALLL for loans and leases acquired with deteriorated credit quality
$
3,803

 
$
17,315

 
$
407

 
$
375

 
$
7,093

 
$
81

 
$
—

 
$
257

 
$
29,331

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases acquired with deteriorated credit quality
80,827

 
637,481

 
34,688

 
33,851

 
270,688

 
20,129

 
28,759

 
3,510

 
1,109,933

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
(Dollars in thousands)
Construction
and land
development -
commercial
 
Commercial
mortgage
 
Other
commercial
real estate
 
Commercial
and
industrial
 
Residential
mortgage
 
Revolving
mortgage
 
Construction
and land
development -
noncommercial
 
Consumer
and other
 
Total
ALLL for loans and leases acquired with deteriorated credit quality
$
1,320

 
$
29,906

 
$
1,354

 
$
5,275

 
$
11,802

 
$
2,959

 
$
682

 
$
222

 
$
53,520

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases acquired with deteriorated credit quality
78,915

 
642,891

 
41,381

 
17,254

 
213,851

 
30,834

 
2,583

 
1,717

 
1,029,426


As of June 30, 2014 and December 31, 2013, $454.8 million and $459.9 million, respectively, in acquired loans experienced an adverse change in expected cash flows since the date of acquisition.


25
Table of Contents

The following tables provide information on originated loans and leases that are individually evaluated for impairment as of June 30, 2014 and December 31, 2013.
 
 
June 30, 2014
(Dollars in thousands)
With a
recorded
allowance
 
With no
recorded
allowance
 
Total
 
Unpaid
principal
balance
 
Related
allowance
recorded
Impaired originated loans and leases
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
$
1,305

 
$
1,268

 
$
2,573

 
$
3,539

 
$
155

Commercial mortgage
58,223

 
28,823

 
87,046

 
92,164

 
7,704

Other commercial real estate
741

 
1,221

 
1,962

 
2,361

 
179

Commercial and industrial
8,371

 
2,440

 
10,811

 
11,939

 
1,425

Lease financing
376

 
—

 
376

 
376

 
297

Other
—

 
46

 
46

 
46

 
—

Residential mortgage
10,016

 
5,432

 
15,448

 
15,903

 
1,613

Revolving mortgage
3,537

 
217

 
3,754

 
4,801

 
1,024

Construction and land development - noncommercial
1,934

 
—

 
1,934

 
1,934

 
201

Consumer
936

 
1

 
937

 
968

 
653

Total impaired originated loans and leases
$
85,439

 
$
39,448

 
$
124,887

 
$
134,031

 
$
13,251

 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
(Dollars in thousands)
With a
recorded
allowance
 
With no
recorded
allowance
 
Total
 
Unpaid
principal
balance
 
Related
allowance
recorded
Impaired originated loans and leases
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
$
1,025

 
$
1,247

 
$
2,272

 
$
7,306

 
$
103

Commercial mortgage
57,819

 
39,292

 
97,111

 
103,522

 
6,873

Other commercial real estate
783

 
1,095

 
1,878

 
2,279

 
209

Commercial and industrial
7,197

 
2,103

 
9,300

 
10,393

 
771

Lease financing
133

 
55

 
188

 
188

 
54

Residential mortgage
11,534

 
4,005

 
15,539

 
15,939

 
1,586

Revolving mortgage
3,382

 
214

 
3,596

 
3,596

 
372

Construction and land development - noncommercial
651

 
457

 
1,108

 
1,108

 
72

Consumer
1,154

 
—

 
1,154

 
1,154

 
121

Total impaired originated loans and leases
$
83,678

 
$
48,468

 
$
132,146

 
$
145,485

 
$
10,161




26
Table of Contents

The following tables show the average impaired originated loan balance and the interest income recognized by loan class for the three and six months ended June 30, 2014 and June 30, 2013:

 
Three months ended June 30, 2014
 
Three months ended June 30, 2013
(Dollars in thousands)
Average
balance
 
Interest income recognized
 
Average
balance
 
Interest income recognized
Impaired originated loans and leases:
 
 
 
 
 
 
 
Construction and land development - commercial
$
2,592

 
$
28

 
$
8,541

 
$
101

Commercial mortgage
87,687

 
799

 
102,356

 
1,413

Other commercial real estate
1,981

 
7

 
2,647

 
37

Commercial and industrial
11,208

 
113

 
10,298

 
139

Lease financing
384

 
4

 
531

 
9

Other
48

 
1

 
—

 
—

Residential mortgage
15,592

 
107

 
13,855

 
184

Revolving mortgage
3,779

 
29

 
6,976

 
47

Construction and land development - noncommercial
2,061

 
26

 
913

 
13

Consumer
986

 
17

 
1,587

 
25

Average impaired originated loans and leases
$
126,318

 
$
1,131

 
$
147,704

 
$
1,968

 
 
 
 
 
 
 
 
 
Six months ended June 30, 2014
 
Six months ended June 30, 2013
(Dollars in thousands)
Average
balance
 
Interest income recognized
 
Average
balance
 
Interest income recognized
Impaired originated loans and leases:
 
 
 
 
 
 
 
Construction and land development - commercial
$
1,413

 
$
31

 
$
8,899

 
$
213

Commercial mortgage
84,359

 
1,716

 
103,032

 
2,838

Other commercial real estate
2,731

 
60

 
3,028

 
82

Commercial and industrial
15,690

 
353

 
14,465

 
406

Lease financing
732

 
21

 
408

 
14

Other
24

 
1

 
—

 
—

Residential mortgage
15,824

 
284

 
15,003

 
412

Revolving mortgage
4,262

 
76

 
6,390

 
72

Construction and land development - noncommercial
1,946

 
50

 
783

 
25

Consumer
2,058

 
51

 
1,611

 
29

Average impaired originated loans and leases
$
129,039

 
$
2,643

 
$
153,619

 
$
4,091




27
Table of Contents

Troubled Debt Restructurings

BancShares accounts for certain loan modifications or restructurings as troubled debt restructurings (TDRs). In general, the modification or restructuring of a loan is considered a TDR if, for economic reasons or legal reasons related to a borrower's financial difficulties, a concession is granted to the borrower that creditors would not otherwise grant. Concessions may relate to the contractual interest rate, maturity date, payment structure or other actions. In accordance with GAAP, loans acquired under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, are not initially considered to be TDRs, but can be classified as such if a modification is made subsequent to acquisition. Modifications of acquired loans that are part of a pool are not designated as TDRs. The following table provides a summary of total TDRs by accrual status.
 
June 30, 2014
 
December 31, 2013
(Dollars in thousands)
Accruing
 
 Nonaccruing
 
 Total
 
 Accruing
 
 Nonaccruing
 
 Total
Commercial loans
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
$
5,946

 
$
2,248

 
$
8,194

 
$
21,032

 
$
1,002

 
$
22,034

Commercial mortgage
99,843

 
32,019

 
131,862

 
113,323

 
23,387

 
136,710

Other commercial real estate
3,203

 
1,277

 
4,480

 
3,470

 
1,150

 
4,620

Commercial and industrial
10,935

 
818

 
11,753

 
9,838

 
1,142

 
10,980

Lease
233

 
144

 
377

 
49

 
—

 
49

Other
46

 
—

 
46

 
—

 
—

 
—

Total commercial TDRs
120,206

 
36,506

 
156,712

 
147,712

 
26,681

 
174,393

Noncommercial
 
 
 
 
 
 
 
 
 
 
 
Residential
29,598

 
2,919

 
32,517

 
23,343

 
3,663

 
27,006

Revolving mortgage
3,821

 
—

 
3,821

 
3,095

 
—

 
3,095

Construction and land development - noncommercial
1,934

 
—

 
1,934

 
651

 
457

 
1,108

Consumer and other
937

 
—

 
937

 
1,154

 
—

 
1,154

Total noncommercial TDRs
36,290

 
2,919

 
39,209

 
28,243

 
4,120

 
32,363

Total TDRs
$
156,496

 
$
39,425

 
$
195,921

 
$
175,955

 
$
30,801

 
$
206,756


The following table shows the accrual status of acquired and originated TDRs.
(Dollars in thousands)
June 30, 2014
 
December 31, 2013
Accruing TDRs:
 
 
 
Acquired
$
62,592

 
$
90,829

Originated
93,904

 
85,126

Total accruing TDRs
156,496

 
175,955

Nonaccruing TDRs:
 
 
 
Acquired
17,861

 
11,479

Originated
21,564

 
19,322

Total nonaccruing TDRs
39,425

 
30,801

All TDRs:
 
 
 
Acquired
80,453

 
102,308

Originated
115,468

 
104,448

Total TDRs
$
195,921

 
$
206,756


All TDRs are impaired loans. TDRs are, therefore, evaluated for impairment on a quarterly basis or more frequently as needed. The impairment evaluations for performing TDRs has historically been performed by pools of homogeneous loan groups, as determined by loan type with similar risk characteristics and performance trends, using a discounted cash flow analysis. Management enhanced this process during the second quarter to include individual loan level impairment analyses for all performing TDRs.

Impairment is evaluated using one of three approved valuation methodologies: discounted cash flows, market prices or collateral values. Based on the accrual status and credit grade, management determines the most appropriate method to reasonably assess expectations for recovery of the investment. Expected cash flows are discounted at the loan’s original effective interest rate. Specific valuation allowances are established for discounted cash flows or partial charge-offs and are recorded for TDRs in the amount equal to the calculated impairment.


28
Table of Contents

The majority of TDRs are included in the special mention, substandard or doubtful grading categories. When a restructured loan subsequently defaults, it is evaluated and downgraded if appropriate. The more severely graded the loan, the lower the estimated expected cash flows and the greater the allowance recorded.

The following tables provide the types of TDRs made during the three and six months ended June 30, 2014 and June 30, 2013 for originated loans, as well as a summary of originated loans that were modified as a TDR during the 12 months ended June 30, 2014 and June 30, 2013 that subsequently defaulted during the three and six months ended June 30, 2014 and June 30, 2013. BancShares defines payment default as movement of the TDR to nonaccrual status, which is generally 90 days past due for TDRs, foreclosure or charge-off, whichever occurs first.
 
Three months ended June 30, 2014
 
Three months ended June 30, 2013
 
All restructurings
 
Restructurings with payment default
 
All restructurings
 
Restructurings with payment default
(Dollars in thousands)
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
Originated loans
 
 
 
 
 
 
 
 
 
 
 
Interest only period provided
 
 
 
 
 
 
 
 
 
 
 
Commercial mortgage
2

$
720

 
1

$
494

 
1

$
71

 
—

$
—

Other commercial real estate
—

—

 
—

—

 
1

100

 
—

—

Other
1

46

 
—

—

 
—

—

 
—

—

Total interest only
3

766

 
1

494

 
2

171

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Loan term extension
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
2

191

 
—

—

 
—

—

 
—

—

Commercial mortgage
—

—

 
—

—

 
1

242

 
1

223

Commercial and industrial
4

2,069

 
—

—

 
—

—

 
1

22

Residential mortgage
6

260

 
—

—

 
—

—

 
1

106

Consumer
1

10

 
—

—

 
1

46

 
—

—

Total loan term extension
13

2,530

 
—

—

 
2

288

 
3

351

 
 
 
 
 
 
 
 
 
 
 
 
Below market interest rate
 
 
 
 
 
 
 
 
 
 
 
Commercial mortgage
3

1,991

 
5

1,563

 
7

2,035

 
—

—

Commercial and industrial
—

—

 
—

—

 
3

831

 
—

—

Other commercial real estate
1

365

 
—

—

 
3

753

 
—

—

Residential mortgage
10

427

 
—

—

 
6

885

 
1

99

Revolving mortgage
—

—

 
—

—

 
1

99

 
—

—

Construction and land development - noncommercial
—

—

 
—

—

 
2

521

 
—

—

Total below market interest rate
14

2,783

 
5

1,563

 
22

5,124

 
1

99

 
 
 
 
 
 
 
 
 
 
 
 
Discharged from bankruptcy
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
1

13

 
—

—

 
2

87

 
—

—

Revolving mortgage
2

39

 
—

—

 
9

727

 
—

—

Consumer
2

8

 
—

—

 
—

—

 
—

—

Total discharged from bankruptcy
5

60

 
—

—

 
11

814

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Total originated restructurings
35

$
6,139

 
6

$
2,057

 
37

$
6,397

 
4

$
450




29
Table of Contents


 
Six months ended June 30, 2014
 
Six months ended June 30, 2013
 
All restructurings
 
Restructurings with payment default
 
All restructurings
 
Restructurings with payment default
(Dollars in thousands)
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
 
Number of Loans
Recorded investment at period end
Originated loans
 
 
 
 
 
 
 
 
 
 
 
Interest only period provided
 
 
 
 
 
 
 
 
 
 
 
Commercial mortgage
6

$
2,600

 
2

$
708

 
8

$
3,406

 
—

$
—

Commercial and industrial
1

196

 
—

—

 
—

—

 
—

—

Other commercial real estate
—

—

 
—

—

 
1

100

 
—

—

Residential mortgage
—

—

 
—

—

 
1

630

 
—

—

Lease financing
2

144

 
—

—

 
—

—

 
—

—

Other
1

46

 
—

—

 
—

—

 
—

—

Total interest only
10

2,986

 
2

708

 
10

4,136

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Loan term extension
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
2

191

 
—

—

 
—

—

 
—

—

Commercial mortgage
5

2,584

 
—

—

 
5

1,972

 
1

223

Commercial and industrial
4

2,069

 
—

—

 
1

229

 
1

22

Lease financing
2

224

 
—

—

 
—

—

 
—

—

Residential mortgage
11

593

 
—

—

 
3

51

 
1

106

Consumer
3

44

 
—

—

 
1

46

 
—

—

Total loan term extension
27

5,705

 
—

—

 
10

2,298

 
3

351

 
 
 
 
 
 
 
 
 
 
 
 
Below market interest rate
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
10

363

 
—

—

 
1

224

 
—

—

Commercial mortgage
15

6,591

 
6

2,011

 
12

5,819

 
—

—

Commercial and industrial
6

143

 
—

—

 
4

846

 
—

—

Other commercial real estate
1

365

 
—

—

 
3

753

 
—

—

Residential mortgage
18

820

 
1

140

 
14

1,579

 
1

99

Revolving mortgage
5

274

 
—

—

 
1

99

 
—

—

Construction & land development - noncommercial
8

1,248

 
—

—

 
2

521

 
—

—

Consumer
—

—

 
—

—

 
3

235

 
—

—

Total below market interest rate
63

9,804

 
7

2,151

 
40

10,076

 
1

99

 
 
 
 
 
 
 
 
 
 
 
 
Discharged from bankruptcy
 
 
 
 
 
 
 
 
 
 
 
Commercial mortgage
1

983

 
—

—

 
—

—

 
—

—

Residential mortgage
8

649

 
2

85

 
3

352

 
—

—

Revolving mortgage
7

442

 
—

—

 
30

2,383

 
3

93

Construction & land development - noncommercial
1

62

 
—

—

 
—

—

 
—

—

Consumer
3

26

 
—

—

 
—

—

 
—

—

Total discharged from bankruptcy
20

2,162

 
2

85

 
33

2,735

 
3

93

 
 
 
 
 
 
 
 
 
 
 
 
Total originated restructurings
120

$
20,657

 
11

$
2,944

 
93

$
19,245

 
7

$
543




30
Table of Contents

The following tables provide the types of TDRs made during the three and six months ended June 30, 2014 and June 30, 2013 for acquired loans, as well as a summary of acquired loans that were modified as a TDR during the 12 months ended June 30, 2014 and June 30, 2013 that subsequently defaulted during the three and six months ended June 30, 2014 and June 30, 2013. BancShares defines payment default as movement of the TDR to nonaccrual status, which is generally 90 days past due for TDRs, foreclosure or charge-off, whichever occurs first.

 
Three months ended June 30, 2014
 
Three months ended June 30, 2013
 
All restructurings
 
Restructurings with payment default
 
All restructurings
 
Restructurings with payment default
(Dollars in thousands)
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
Acquired loans
 
 
 
 
 
 
 
 
 
 
 
Interest only period provided
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
—

$
—

 
—

$
—

 
—

$
—

 
1

$
104

Commercial mortgage
—

—

 
—

—

 
—

—

 
1

1,699

Residential mortgage
—

—

 
—

—

 
1

134

 
—

—

Total interest only
—

—

 
—

—

 
1

134

 
2

1,803

 
 
 
 
 
 
 
 
 
 
 
 
Loan term extension
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
1

53

 
1

53

 
—

—

 
—

—

Total loan term extension
1

53

 
1

53

 
—

—

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Below market interest rate
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
1

273

 
—

—

 
—

—

 
—

—

Commercial mortgage
5

1,811

 
—

—

 
1

813

 
—

—

Commercial and industrial
1

23

 
—

—

 
—

—

 
—

—

Residential mortgage
23

2,963

 
1

23

 
2

997

 
1

224

Total below market interest rate
30

5,070

 
1

23

 
3

1,810

 
1

224

 
 
 
 
 
 
 
 
 
 
 
 
Discharged from bankruptcy
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
26

1,828

 
2

94

 
—

—

 
—

—

Total discharged from bankruptcy
26

1,828

 
2

94

 
—

—

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Total acquired restructurings
57

$
6,951

 
4

$
170

 
4

$
1,944

 
3

$
2,027



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Table of Contents

 
Six months ended June 30, 2014
 
Six months ended June 30, 2013
 
All restructurings
 
Restructurings with payment default
 
All restructurings
 
Restructurings with payment default
(Dollars in thousands)
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
 
Number of loans
Recorded investment at period end
Acquired loans
 
 
 
 
 
 
 
 
 
 
 
Interest only period provided
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
—

$
—

 
—

$
—

 
—

$
—

 
1

$
104

Commercial mortgage
2

—

 
2

44

 
1

290

 
2

1,989

Residential mortgage
—

—

 
—

—

 
2

177

 
—

—

Total interest only
2

—

 
2

44

 
3

467

 
3

2,093

 
 
 
 
 
 
 
 
 
 
 
 
Loan term extension
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
1

276

 
—

—

 
—

—

 
—

—

Residential mortgage
1

53

 
1

53

 
1

199

 
—

—

Total loan term extension
2

329

 
1

53

 
1

199

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Below market interest rate
 
 
 
 
 
 
 
 
 
 
 
Construction and land development - commercial
2

308

 
—

—

 
4

3,331

 
—

—

Commercial mortgage
9

5,060

 
1

39

 
5

11,871

 
3

3,145

Commercial and industrial
1

23

 
—

—

 
2

435

 
—

—

Residential mortgage
25

3,066

 
2

23

 
7

2,484

 
3

931

Total below market interest rate
37

8,457

 
3

62

 
18

18,121

 
6

4,076

 
 
 
 
 
 
 
 
 
 
 
 
Discharged from bankruptcy
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
26

1,828

 
2

94

 
—

—

 
—

—

Total discharged from bankruptcy
26

1,828

 
2

94

 
—

—

 
—

—

 
 
 
 
 
 
 
 
 
 
 
 
Total acquired restructurings
67

$
10,614

 
8

$
253

 
22

$
18,787

 
9

$
6,169


For the three and six months ended June 30, 2014 and June 30, 2013, the recorded investment in TDRs subsequent to modification was not materially impacted by the modification since forgiveness of principal is not a restructuring option frequently used by BancShares.

NOTE F - OTHER REAL ESTATE OWNED (OREO)

The following table explains changes in other real estate owned during the six months ended June 30, 2014 and June 30, 2013.

(Dollars in thousands)
Covered
 
Noncovered
 
Total
Balance at December 31, 2012
$
102,577

 
$
43,513

 
$
146,090

Additions
41,315

 
16,615

 
57,930

Sales
(53,676
)
 
(21,026
)
 
(74,702
)
Writedowns
(5,383
)
 
(2,160
)
 
(7,543
)
Balance at June 30, 2013
$
84,833

 
$
36,942

 
$
121,775

Balance at December 31, 2013
$
47,081

 
$
36,898

 
$
83,979

Additions 1
16,186

 
20,485

 
36,671

Sales
(18,522
)
 
(19,150
)
 
(37,672
)
Writedowns
(4,609
)
 
(3,082
)
 
(7,691
)
Balance at June 30, 2014
$
40,136

 
$
35,151

 
$
75,287

1 Noncovered additions include $11.6 million from the 1st Financial merger.
        



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NOTE G - FDIC LOSS SHARE RECEIVABLE

The following table provides changes in the receivable from the FDIC for the three-month and six-month periods ended June 30, 2014 and June 30, 2013.
 
Three months ended June 30
 
Six months ended June 30
(Dollars in thousands)
2014
 
2013
 
2014
 
2013
Beginning balance
$
74,784

 
$
195,942

 
$
93,397

 
$
270,192

Amortization
(12,922
)
 
(19,069
)
 
(30,667
)
 
(45,181
)
Cash payments to (from) FDIC
859

 
(4,015
)
 
4,350

 
(46,534
)
Post-acquisition adjustments
(12,762
)
 
(14,845
)
 
(17,121
)
 
(20,464
)
Ending balance
$
49,959

 
$
158,013

 
$
49,959

 
$
158,013


The receivable from the FDIC for loss share agreements is measured separately from the related covered assets and is recorded at fair value at the acquisition date using projected cash flows based on the expected reimbursements for losses and the applicable loss share percentages. See Note J for information related to FCB's recorded payable to the FDIC for loss share agreements.

Cash payments to (from) FDIC represent the net impact of loss share loan recoveries, charge-offs and related expenses as calculated and reported in FDIC loss share certificates. Post-acquisition adjustments represent the net change in loss estimates related to acquired loans and covered OREO as a result of changes in expected cash flows and the allowance for loan and lease losses related to those covered loans. For loans covered by loss share agreements, subsequent decreases in the amount expected to be collected from the borrower or collateral liquidation result in a provision for loan and lease losses, an increase in the allowance for loan and lease losses and a proportional adjustment to the receivable from the FDIC for the estimated amount to be reimbursed. Subsequent increases in the amount expected to be collected from the borrower or collateral liquidation result in the reversal of some or all previously recorded provision for loan and lease losses, a decrease in the related allowance for loan and lease losses and a proportional adjustment to the receivable from the FDIC, or prospective adjustment to the accretable yield and the related receivable from the FDIC if no provision for loan and lease losses had been recorded previously. Two of the loss share agreements expire during the third quarter of 2014, and two expire during the first quarter of 2015.

NOTE H - ESTIMATED FAIR VALUES

Fair value estimates are intended to represent the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. Where there is no active market for a financial instrument, BancShares has made estimates using discounted cash flows or other valuation techniques. Inputs to these valuation methods are subjective in nature, involve uncertainties and require significant judgment and therefore cannot be determined with precision. Accordingly, the derived fair value estimates presented below are not necessarily indicative of the amounts BancShares could realize in a current market exchange.

Assets and liabilities are recorded at fair value according to a fair value hierarchy comprised of three levels. The levels are based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The level within the fair value hierarchy for an asset or liability is based on the highest level of input that is significant to the fair value measurement (with level 1 considered highest and level 3 considered lowest). A brief description of each level follows:
•
Level 1 values are based on quoted prices for identical instruments in active markets.
•
Level 2 values are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
•
Level 3 values are generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models and similar techniques.

The methodologies used to estimate the fair value of financial assets and financial liabilities are discussed below:
Investment securities available for sale. U.S.Treasury, government agency, mortgage-backed securities and municipal securities are generally measured at fair value using a third party pricing service and are classified as level 2 instruments. Equity securities are measured at fair value using observable closing prices. Management also considers the amount of market activity by examining the trade volume of each security. Due to the relatively inactive nature of the markets for the existing equity securities at BancShares, the inputs used for these equity securities are considered level 2 inputs.

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Table of Contents


Loans held for sale. Loans held for sale are carried at the lower of aggregate cost or fair value and are, therefore, carried at fair value only when fair value is less than the asset cost. These loans are generally traded in active secondary markets and are priced using current market pricing for similar securities adjusted for servicing, interest rate risk and credit risk. Accordingly, the inputs used to calculate fair value of residential real estate loans are classified as Level 2 inputs.

Net loans and leases (acquired and originated). Fair value is estimated based on discounted future cash flows using the current interest rates at which loans with similar terms would be made to borrowers of similar credit quality. An additional valuation adjustment is made for liquidity. The inputs used in the fair value measurements for loans and leases are considered level 3 inputs.

Receivable from the FDIC for loss share agreements. Fair value is estimated based on discounted future cash flows using current discount rates. Due to post-acquisition improvements in expected losses, significant portions of the FDIC receivable will be recovered through amortization of the receivable over the remaining life of the loss share agreement rather than by cash flows from the FDIC. The estimated amounts to be amortized in future periods have no fair value. The inputs used in the fair value measurement for the FDIC receivable are considered level 3 inputs. The FDIC loss share agreements are not transferable and, accordingly, there is no market for this receivable.

FHLB stock. The carrying amount of FHLB stock is a reasonable estimate of fair value as these securities are not readily marketable and are evaluated for impairment based on the ultimate recoverability of the par value. BancShares considers positive and negative evidence, including the profitability and asset quality of the issuer, dividend payment history and recent redemption experience, when determining the ultimate recoverability of the par value. BancShares believes its investment in FHLB stock is ultimately recoverable at par. The inputs used in the fair value measurement for the FHLB stock are considered level 2 inputs.

Preferred stock issued under the TARP program and other acquired financial assets. Preferred securities issued under the Troubled Asset Recovery Program are recorded at cost and are evaluated quarterly for impairment based on the ultimate recoverability of the purchase price. The fair value of these securities is derived from a third-party proprietary model that is considered to be a level 3 input. Other acquired financial assets represent acquired investments in various entities for Community Reinvestment Act and correspondent banking purposes. These investments were recorded at fair value at acquisition date based on level 2 inputs.

Deposits. For non-time deposits, carrying value is a reasonable estimate of fair value. The fair value of time deposits is estimated by discounting future cash flows using the interest rates currently offered for deposits of similar remaining maturities. The inputs used in the fair value measurement for deposits are considered level 2 inputs.    

Long-term obligations. For fixed rate trust preferred securities, the fair values are determined based on recent trades of the actual security. For other long-term obligations, fair values are estimated by discounting future cash flows using current interest rates for similar financial instruments. The inputs used in the fair value measurement for long-term obligations are considered level 2 inputs.

Payable to the FDIC for loss share agreements. The fair value of the payable to the FDIC for loss share agreements is determined by the projected cash flows based on expected payments to the FDIC in accordance with the loss share agreements. Cash flows are discounted using current discount rates to reflect the timing of the estimated amounts due to the FDIC. The inputs used in the fair value measurement for the payable to the FDIC are considered level 3 inputs. See Note J for more information on the payable to the FDIC.

Interest rate swap. Under the terms of the existing cash flow hedge, BancShares pays a fixed payment to the counterparty in exchange for receipt of a variable payment that is determined based on the three-month LIBOR rate. The fair value of the cash flow hedge is, therefore, based on projected LIBOR rates for the duration of the hedge, values that, while observable in the market, are subject to adjustment due to pricing considerations for the specific instrument. The inputs used in the fair value measurement of the interest rate swap are considered level 2 inputs.

Off-balance-sheet commitments and contingencies. Carrying amounts are reasonable estimates of the fair values for such financial instruments. Carrying amounts include unamortized fee income and, in some cases, reserves for any credit losses from those financial instruments. These amounts are not material to BancShares' financial position.
 
For all other financial assets and financial liabilities, the carrying value is a reasonable estimate of the fair value as of June 30, 2014 and December 31, 2013. The carrying value and fair value for these assets and liabilities are equivalent because they are

34
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relatively short term in nature and there is no interest rate or credit risk that would cause the fair value to differ from the carrying value.
(Dollars in thousands)
June 30, 2014
 
December 31, 2013
Carrying value
 
Fair value
 
Carrying value
 
Fair value
Cash and due from banks
$
566,952

 
$
566,952

 
$
533,599

 
$
533,599

Overnight investments
1,118,474

 
1,118,474

 
859,324

 
859,324

Investment securities available for sale
5,538,166

 
5,538,166

 
5,387,703

 
5,387,703

Investment securities held to maturity
693

 
729

 
907

 
974

Loans held for sale
49,851

 
50,675

 
47,271

 
47,956

Net loans and leases
13,318,710

 
12,846,888

 
12,900,330

 
12,545,537

Receivable from the FDIC for loss share agreements (1)
49,959

 
22,741

 
93,397

 
38,438

Income earned not collected
49,019

 
49,019

 
48,390

 
48,390

Federal Home Loan Bank stock
32,878

 
32,878

 
40,819

 
40,819

Preferred stock and other acquired financial assets
15,462

 
16,199

 
33,564

 
34,786

Deposits
18,556,758

 
18,113,243

 
17,874,066

 
17,898,570

Short-term borrowings
788,540

 
788,540

 
511,418

 
511,418

Long-term obligations
314,529

 
324,874

 
510,769

 
526,037

Payable to the FDIC for loss share agreements
114,281

 
119,465

 
109,378

 
111,941

Accrued interest payable
7,297

 
7,297

 
6,737

 
6,737

Interest rate swap
5,933

 
5,933

 
7,220

 
7,220

(1) The fair value of the FDIC receivable excludes amortization expected to be recognized in prospective periods.


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Table of Contents

Among BancShares’ assets and liabilities, investment securities available for sale and interest rate swaps accounted for as cash flow hedges are reported at their fair values on a recurring basis. Certain other assets are adjusted to their fair value on a nonrecurring basis, including loans held for sale, which are carried at the lower of cost or fair value, and impaired loans, OREO, goodwill and other intangible assets, which are periodically tested for impairment. Non-impaired loans held for investment, deposits, short-term borrowings and long-term obligations are not reported at fair value. BancShares did not elect to voluntarily report any assets or liabilities at fair value.

For assets and liabilities carried at fair value on a recurring basis, the following table provides fair value information as of June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
 
 
Fair value measurements using:
(Dollars in thousands)
Fair value
 
Level 1 inputs
 
Level 2 inputs
 
Level 3 inputs
Assets measured at fair value
 
 
 
 
 
 
 
Investment securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
1,625,630

 
$
—

 
$
1,625,630

 
$
—

Government agency
1,283,566

 
—

 
1,283,566

 
—

Mortgage-backed securities
2,596,286

 
—

 
2,596,286

 
—

Equity securities
32,498

 
—

 
32,498

 
—

Municipal securities
186

 
—

 
186

 
—

Total
$
5,538,166

 
$
—

 
$
5,538,166

 
$
—

Liabilities measured at fair value
 
 
 
 
 
 
 
Interest rate swaps accounted for as cash flow hedges
$
5,933

 
$
—

 
$
5,933

 
$
—

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
Fair value measurements using:
 
Fair value
 
Level 1 inputs
 
Level 2 inputs
 
Level 3 inputs
Assets measured at fair value
 
 
 
 
 
 
 
Investment securities available for sale
 
 
 
 
 
 
 
U.S. Treasury
$
373,437

 
$
—

 
$
373,437

 
$
—

Government agency
2,544,229

 
—

 
2,544,229

 
—

Mortgage-backed securities
2,446,873

 
—

 
2,446,873

 
—

Equity securities
22,147

 
—

 
22,147

 
—

Municipal securities
187

 
—

 
187

 
—

Other
830

 
—

 
830

 
—

Total
$
5,387,703

 
$
—

 
$
5,387,703

 
$
—

Liabilities measured at fair value
 
 
 
 
 
 
 
Interest rate swaps accounted for as cash flow hedges
$
7,220

 
$
—

 
$
7,220

 
$
—


There were no transfers between levels during the six months ended June 30, 2014. A single subordinated debt security, previously classified within other, was called during the second quarter of 2014.

Certain financial assets and liabilities are carried at fair value on a nonrecurring basis, including loans held for sale, impaired loans and OREO.

Impaired loans are deemed to be at fair value if an associated allowance or current period charge-off has been recorded. The value of impaired loans is determined by either collateral valuations or discounted present value of the expected cash flow calculations. Collateral values are determined using appraisals or other third-party value estimates of the subject property with discounts generally between 10 and 14 percent applied for estimated holding and selling costs and other external factors that may impact the marketability of the property. Impaired loans are assigned to an asset manager and monitored monthly for significant changes since the last valuation. If significant changes are noted, the asset manager orders a new valuation or adjusts the valuation accordingly. Expected cash flows are determined using expected loss rates developed from historic experience for loans with similar risk characteristics, discounted using the effective interest rate.

OREO is measured and reported at fair value using collateral valuations. Collateral values are determined using appraisals or other third-party value estimates of the subject property with discounts generally between 10 and 14 percent applied for estimated holding and selling costs and other external factors that may impact the marketability of the property. Changes to the value of the assets between scheduled valuation dates are monitored through continued communication with brokers and monthly reviews by the asset manager assigned to each asset. The asset manager uses the information gathered from brokers

36
Table of Contents

and other market sources to identify any significant changes in the market or the subject property as they occur. Valuations are then adjusted or new appraisals are ordered to ensure the reported values reflect the most current information. OREO that has been recently remeasured is deemed to be at fair value and included in the table below.

For financial assets and liabilities carried at fair value on a nonrecurring basis, the following table provides fair value information as of June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
 
 
Fair value measurements using:
(Dollars in thousands)
Fair value
 
Level 1 inputs
 
Level 2 inputs
 
Level 3 inputs
Loans held for sale
$
32,551

 
$
—

 
$
32,551

 
$
—

Originated impaired loans
73,881

 
—

 
—

 
73,881

Other real estate not covered under loss share agreements remeasured during current year
9,101

 
—

 
—

 
9,101

Other real estate covered under loss share agreements remeasured during current year
22,927

 
—

 
—

 
22,927

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
Fair value measurements using:
 
Fair value
 
Level 1 inputs
 
Level 2 inputs
 
Level 3 inputs
Loans held for sale
29,389

 
—

 
29,389

 
—

Originated impaired loans
77,817

 
—

 
—

 
77,817

Other real estate not covered under loss share agreements remeasured during current year
20,526

 
—

 
—

 
20,526

Other real estate covered under loss share agreements remeasured during current year
37,587

 
—

 
—

 
37,587


No financial liabilities were carried at fair value on a nonrecurring basis as of June 30, 2014 and December 31, 2013.

NOTE I - EMPLOYEE BENEFIT PLANS
Pension expense is a component of employee benefits expense. For the three and six months ended June 30, 2014 and 2013, the components of pension expense are as follows:
 
Three months ended June 30
 
Six months ended June 30
(Dollars in thousands)
2014
 
2013
 
2014
 
2013
Service cost
$
2,785

 
$
4,261

 
$
6,166

 
$
8,483

Interest cost
6,251

 
6,409

 
12,807

 
12,304

Expected return on assets
(8,340
)
 
(7,474
)
 
(16,152
)
 
(14,405
)
Amortization of prior service cost
52

 
53

 
105

 
105

Amortization of net actuarial loss
1,546

 
4,241

 
3,092

 
8,493

Total pension expense
$
2,294

 
$
7,490

 
$
6,018

 
$
14,980

The assumed discount rate for 2014 is 4.90 percent, the expected long-term rate of return on plan assets is 7.50 percent and the assumed rate of salary increases is 4.00 percent. For 2013, the assumed discount rate was 4.00 percent, expected long-term rate of return was 7.25 percent and the assumed rate of salary increases was 4.00 percent.

    
NOTE J - COMMITMENTS AND CONTINGENCIES

To meet the financing needs of its customers, BancShares and its subsidiaries have financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit, standby letters of credit and recourse obligations on mortgage loans sold. These instruments involve elements of credit, interest rate or liquidity risk.

Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. Established credit standards control the credit risk exposure associated with these commitments. In some cases, BancShares requires that collateral be pledged to secure the commitment, including cash deposits, securities and other assets. At June 30, 2014, BancShares had unused commitments totaling $6.20 billion, compared to $5.84 billion at December 31, 2013.

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Table of Contents


Standby letters of credit are commitments guaranteeing performance of a customer to a third party. Those commitments are primarily issued to support public and private borrowing arrangements. To mitigate its risk, BancShares’ follows its credit policies in the issuance of standby letters of credit. At June 30, 2014 and December 31, 2013, BancShares had standby letters of credit amounting to $61.4 million and $54.8 million, respectively. The credit risk related to the issuance of these letters of credit is essentially the same as that involved in extending loans to clients and, therefore, these letters of credit are collateralized when necessary.

Pursuant to standard representations and warranties relating to residential mortgage loan sales, contingent obligations exist for various events that may occur following the loan sale. If underwriting or documentation deficiencies are discovered at any point in the life of the loan or if the loan becomes nonperforming within 120 days of its sale, the investor may require BancShares to repurchase the loan or to repay a portion of the sale proceeds. Other liabilities included reserves of $3.3 million and $3.6 million as of June 30, 2014 and December 31, 2013, respectively, for estimated losses arising from these standard representation and warranty provisions.

BancShares has recorded a receivable from the FDIC totaling $50.0 million and $93.4 million as of June 30, 2014 and December 31, 2013, respectively, for the expected reimbursement of losses on assets covered under the various loss share agreements. These loss share agreements impose certain obligations on us that, in the event of noncompliance, could result in the delay or disallowance of some or all of our rights under those agreements. Requests for reimbursement are subject to FDIC review and may be delayed or disallowed for noncompliance. The loss share agreements are subject to interpretation by both the FDIC and BancShares, and disagreements may arise regarding coverage of losses, expenses and contingencies.

The loss share agreements for four FDIC-assisted transactions include provisions related to contingent payments that may be owed to the FDIC at the termination of the agreements (clawback liability).The clawback liability represents a payment by BancShares to the FDIC if actual cumulative losses on acquired covered assets are lower than the cumulative losses originally estimated by the FDIC at the time of acquisition. The clawback liability is estimated by discounting estimated future payments and is recorded in the Consolidated Balance Sheets as a payable to the FDIC under the relevant loss share agreements. As of June 30, 2014 and December 31, 2013, the estimated clawback liability was $114.3 million and $109.4 million, respectively.

Following announcement of the proposed merger with Bancorporation, BancShares received a shareholder demand from the City of Providence, Rhode Island, pursuant to Section 220 of the Delaware General Corporation Law (“DGCL”) for access to certain books and records of BancShares. The purported basis for the demand was to investigate potential breaches of fiduciary duty and other wrongdoing by BancShares’ officers and directors in connection with the merger. The City of Providence concurrently filed a putative class action lawsuit in the Delaware Court of Chancery against BancShares and its directors challenging Article X, Section 8 of BancShares’ Bylaws, which requires certain litigation to be brought only in North Carolina courts to the fullest extent permitted by law. The Delaware complaint alleges that the Bylaw violates the DGCL and that adoption of the Bylaw constituted a breach of fiduciary duty by BancShares' directors. While not directly challenging the merger, the complaint contains allegations referencing the merger and seeks a declaration that any stockholder action regarding the merger may be brought in the Delaware Court of Chancery. On July 31, 2014, the City of Providence filed a second litigation in Delaware Court of Chancery challenging the merger and seeking to enjoin the BancShares stockholder vote. Any potential claim for damages is not reasonably calculable at this time. BancShares and its directors have moved to dismiss both complaints.

BancShares and various subsidiaries have been named as defendants in legal actions arising from their normal business activities in which damages in various amounts are claimed. BancShares is also exposed to litigation risk relating to the prior business activities of banks from which assets were acquired and liabilities assumed in the various FDIC-assisted transactions. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.

NOTE K - DERIVATIVES

At June 30, 2014, BancShares had an interest rate swap entered into during 2011 that qualifies as a cash flow hedge under GAAP. For all periods presented, the fair value of the outstanding derivative is included in other liabilities in the consolidated balance sheets, and the net change in fair value is included in the consolidated statements of cash flows under the caption net change in other liabilities.

The interest rate swap is used for interest rate risk management purposes and converts variable-rate exposure on outstanding debt to a fixed rate. The 2011 interest rate swap has a notional amount of $93.5 million, representing the amount of variable rate trust preferred capital securities issued during 2006 and still outstanding at the swap inception date. The 2011 interest rate

38
Table of Contents

swap hedges interest payments through June 2016 and requires fixed-rate payments by BancShares at 5.50 percent in exchange for variable-rate payments of 175 basis points above the three-month LIBOR, which is equal to the interest paid to the holders of the trust preferred capital securities. Settlement of the swap occurs quarterly. As of June 30, 2014, collateral with a fair value of $7.0 million was pledged to secure the existing obligation under the interest rate swap.

 
June 30, 2014
 
December 31, 2013
(Dollars in thousands)
Notional  amount
 
Estimated fair value of liability
 
Notional  amount
 
Estimated fair value of liability
2011 interest rate swap hedging variable rate exposure on trust preferred securities 2011-2016
$
93,500

 
$
5,933

 
$
93,500

 
$
7,220


For cash flow hedges, the effective portion of the gain or loss due to changes in the fair value of the derivative hedging instrument is included in other comprehensive income, while the ineffective portion, representing the excess of the cumulative change in the fair value of the derivative over the cumulative change in expected future discounted cash flows on the hedged transaction, is recorded in the consolidated income statement. BancShares’ interest rate swap has been fully effective since inception. Therefore, changes in the fair value of the interest rate swap has had no impact on net income. For the three months ended June 30, 2014 and 2013, BancShares recognized interest expense of $0.8 million during both periods, resulting from incremental interest paid to the interest rate swap counterparty, none of which related to ineffectiveness. For the six months ended June 30, 2014 and 2013, BancShares recognized interest expense of $1.7 million and $1.6 million, respectively, resulting from incremental interest paid to the interest rate swap counterparty, none of which related to ineffectiveness. BancShares monitors the credit risk of the interest rate swap counterparty.

NOTE L - ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Accumulated other comprehensive income (loss) included the following as of June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
(Dollars in thousands)
Accumulated
other
comprehensive
income (loss)
 
Deferred
tax expense
(benefit)
 
Accumulated
other
comprehensive
income (loss),
net of tax
 
Accumulated
other
comprehensive
loss
 
Deferred
tax
benefit
 
Accumulated
other
comprehensive
loss,
net of tax
Unrealized gains (losses) on investment securities available for sale, net
$
26,817

 
$
10,327

 
$
16,490

 
$
(16,632
)
 
$
(6,541
)
 
$
(10,091
)
Unrealized loss on cash flow hedge
(5,933
)
 
(2,290
)
 
(3,643
)
 
(7,220
)
 
(2,786
)
 
(4,434
)
Funded status of defined benefit plan
(14,385
)
 
(5,595
)
 
(8,790
)
 
(17,582
)
 
(6,839
)
 
(10,743
)
Total
$
6,499

 
$
2,442

 
$
4,057

 
$
(41,434
)
 
$
(16,166
)
 
$
(25,268
)



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The following table highlights changes in accumulated other comprehensive income (loss) by component for the three and six months ended June 30, 2014 and June 30, 2013:

 
Three months ended June 30, 2014
(Dollars in thousands)
Unrealized gains (losses) on available for sale securities1
 
Gains (losses) on cash flow hedges1
 
Defined benefit pension items1
 
Total
Beginning balance
$
(2,835
)
 
$
(3,993
)
 
$
(9,766
)
 
$
(16,594
)
Other comprehensive income before reclassifications
19,325

 
350

 
—

 
19,675

Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
976

 
976

Net current period other comprehensive income
19,325

 
350

 
976

 
20,651

Ending balance
$
16,490

 
$
(3,643
)
 
$
(8,790
)
 
$
4,057

 
 
 
 
 
 
 
 
 
Three months ended June 30, 2013
 
Unrealized gains (losses) on available for sale securities1
 
Gains (losses) on cash flow hedges1
 
Defined benefit pension items1
 
Total
Beginning balance
$
19,606

 
$
(5,799
)
 
$
(93,712
)
 
$
(79,905
)
Other comprehensive (loss) income before reclassifications
(23,723
)
 
840

 
—

 
(22,883
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
2,612

 
2,612

Net current period other comprehensive (loss) income
(23,723
)
 
840

 
2,612

 
(20,271
)
Ending balance
$
(4,117
)
 
$
(4,959
)
 
$
(91,100
)
 
$
(100,176
)
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2014
 
Unrealized gains (losses) on available for sale securities1
 
Gains (losses) on cash flow hedges1
 
Defined benefit pension items1
 
Total
Beginning balance
$
(10,091
)
 
$
(4,434
)
 
$
(10,743
)
 
$
(25,268
)
Other comprehensive income before reclassifications
26,581

 
791

 
—

 
27,372

Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
1,953

 
1,953

Net current period other comprehensive income
26,581

 
791

 
1,953

 
29,325

Ending balance
$
16,490

 
$
(3,643
)
 
$
(8,790
)
 
$
4,057

 
 
 
 
 
 
 
 
 
Six months ended June 30, 2013
 
Unrealized gains (losses) on available for sale securities1
 
Gains (losses) on cash flow hedges1
 
Defined benefit pension items1
 
Total
Beginning balance
$
20,517

 
$
(6,292
)
 
$
(96,331
)
 
$
(82,106
)
Other comprehensive (loss) income before reclassifications
(24,634
)
 
1,333

 
—

 
(23,301
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
5,231

 
5,231

Net current period other comprehensive (loss) income
(24,634
)
 
1,333

 
5,231

 
(18,070
)
Ending balance
$
(4,117
)
 
$
(4,959
)
 
$
(91,100
)
 
$
(100,176
)
1 All amounts are net of tax.

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The following table presents the amounts reclassified from accumulated other comprehensive income (loss) and the line item affected in the statement where net income is presented for the three and six months ended June 30, 2014 and June 30, 2013:
 
 
Three months ended June 30, 2014
Details about accumulated other comprehensive income (loss)
 
Amount reclassified from accumulated other comprehensive income (loss)1
 
Affected line item in the statement where net income is presented
 
 
 
 
 
Amortization of defined benefit pension items
 
 
 
 
     Prior service costs
 
$
(52
)
 
Employee benefits
     Actuarial losses
 
(1,546
)
 
Employee benefits
 
 
(1,598
)
 
Income before income taxes
 
 
622

 
Provision for income taxes
 
 
$
(976
)
 
Net income
Total reclassifications for the period
 
$
(976
)
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2013
Details about accumulated other comprehensive income (loss)
 
Amount reclassified from accumulated other comprehensive income (loss)1
 
Affected line item in the statement where net income is presented
Amortization of defined benefit pension items
 
 
 
 
     Prior service costs
 
$
(53
)
 
Employee benefits
     Actuarial losses
 
(4,241
)
 
Employee benefits
 
 
(4,294
)
 
Income before income taxes
 
 
1,682

 
Provision for income taxes
 
 
$
(2,612
)
 
Net income
Total reclassifications for the period
 
$
(2,612
)
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2014
Details about accumulated other comprehensive income (loss)
 
Amount reclassified from accumulated other comprehensive income (loss)1
 
Affected line item in the statement where net income is presented
Amortization of defined benefit pension items
 
 
 
 
     Prior service costs
 
$
(105
)
 
Employee benefits
     Actuarial losses
 
(3,092
)
 
Employee benefits
 
 
(3,197
)
 
Income before income taxes
 
 
1,244

 
Provision for income taxes
 
 
$
(1,953
)
 
Net income
Total reclassifications for the period
 
$
(1,953
)
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2013
Details about accumulated other comprehensive income (loss)
 
Amount reclassified from accumulated other comprehensive income (loss)1
 
Affected line item in the statement where net income is presented
Amortization of defined benefit pension items
 
 
 
 
     Prior service costs
 
$
(105
)
 
Employee benefits
     Actuarial losses
 
(8,493
)
 
Employee benefits
 
 
(8,598
)
 
Income before income taxes
 
 
3,367

 
Provision for income taxes
 
 
$
(5,231
)
 
Net income
Total reclassifications for the period
 
$
(5,231
)
 
 

NOTE M - SUBSEQUENT EVENTS

During July, BancShares purchased $25.0 million of FCB/SC Capital Trust II's outstanding Trust Preferred Securities from an unaffiliated third party. BancShares paid approximately $23.0 million, plus unpaid accrued distributions on the securities for the current distribution period, for the Trust Preferred Securities.  FCB/SC Capital Trust II is a trust subsidiary of First Citizens Bancorporation, Inc. (Bancorporation).  The Trust Preferred Securities pay interest at a floating rate based on three month LIBOR plus 2.25 percent, reset quarterly, and mature on June 15, 2034. The securities represent preferred beneficial interests in

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a junior subordinated deferrable interest debenture in a like principal amount issued by Bancorporation and held by FCB/SC Capital Trust II.

BancShares historically has considered Bancorporation and its subsidiaries to be related persons for purposes of BancShares' related person transaction approval policy. BancShares' Audit Committee reviewed and approved BancShares' purchase of Trust Preferred Securities described above.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

Management’s discussion and analysis (MD&A) of earnings and related financial data are presented to assist in understanding the financial condition and results of operations of First Citizens BancShares, Inc. and Subsidiaries (BancShares). This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes presented within this report along with our financial statements and related MD&A of financial condition and results of operations included in our 2013 Annual Report on Form 10-K. In the MD&A, asset yields and net interest margin are presented on a fully taxable equivalent (FTE) basis. Intercompany accounts and transactions have been eliminated. Although certain amounts for prior years have been reclassified to conform to statement presentations for 2014, the reclassifications have no material effect on shareholders’ equity or net income as previously reported. Unless otherwise noted, the terms "we," "us" and "BancShares" refer to the consolidated financial position and consolidated results of operations for BancShares.

BancShares is a financial holding company headquartered in Raleigh, North Carolina, that offers full-service banking through its wholly-owned banking subsidiary, First-Citizens Bank & Trust Company (FCB). FCB is a state-chartered bank organized under the laws of the state of North Carolina. As of August 8, 2014, FCB operated 397 branches in North Carolina, Virginia, West Virginia, Maryland, Tennessee, Washington, California, Florida, Georgia, Texas, Arizona, New Mexico, Oregon, Colorado, Oklahoma, Kansas, Missouri, and Washington, DC.

BancShares’ earnings and cash flows are primarily derived from its commercial banking activities. We gather deposits from retail and commercial customers and also secure funding through various non-deposit sources. We invest the liquidity generated from these funding sources in interest-earning assets, including loans and leases, investment securities and overnight investments. We also invest in bank premises, hardware, software, furniture and equipment used to conduct our commercial banking business. We provide treasury services products, cardholder and merchant services, wealth management services and various other products and services typically offered by commercial banks.

EXECUTIVE OVERVIEW

Recent Economic and Industry Developments
Various external factors influence the focus of our business efforts, and the results of our operations can change significantly based on those external factors. Based on the latest real gross domestic product (GDP) information available, the Bureau of Economic Analysis’ first estimate of second quarter GDP indicated growth of 4.0 percent, a significant rebound from the 2.1 percent contraction during the first quarter of the year. This advancement is primarily due to increases in personal consumption expenditures, inventory investments, exports, and residential and nonresidential fixed investments. Second quarter results indicate improvements in labor market conditions, with the unemployment rate declining further. However, housing activity, while continuing to improve, is behind last year's trends as a result of higher rates, low housing inventory and new regulations.
The Federal Reserve’s Federal Open Market Committee (FOMC) indicated in the second quarter that “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.” In light of this cumulative progress, the FOMC decided to make further reductions in its stimulus program and is on pace to end its monthly asset purchase program in October 2014.
The FOMC stated it will maintain its target range for the federal funds rate and reiterated it would assess the appropriate timing of the first increase in the target rate based on progress toward its objectives of maximum employment and 2 percent inflation. The FOMC stated that it expects to maintain the current target range for a considerable time after the asset purchase program ends.
The trends in the banking industry are similar to those of the broader economy as shown in the latest national banking results from the first quarter of 2014. FDIC-insured institutions reported a decline in aggregate net income of 7.6 percent compared to the first quarter of 2013. Net income fell as banks are experiencing lower noninterest income due to reduced mortgage revenue and declining trading income. Noninterest expense remained relatively unchanged from the same quarter in 2013. Average net interest margin decreased to 3.17 percent from 3.27 percent in the same quarter in 2013. Nonetheless, 54 percent of banks reported higher net interest margins during the same period. Credit improvement remains key to earnings growth.

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Net charge-offs and delinquent loans and lease balances continue to decline, with the largest declines in residential mortgage loans and home equity lines.
Other industry trends noted based on review of first quarter 2014 data, in comparison to the same quarter in 2013 unless otherwise specified, include the following:
•The largest positive contribution to the year-over-year change in net income is due to lower provision for loan and lease losses. This is the 18th consecutive quarter the provision for loan and lease losses has declined year-over-year.
•Earnings declined as a reduction in noninterest income outweighed growth in net interest income; however, 54 percent of FDIC-insured banks reported year-over-year improvements in earnings.
•Total assets increased by 1.2 percent in the first quarter of 2014, compared to the fourth quarter of 2013, with increases in loans and leases of 0.5 percent and investment securities of 1.8 percent. Deposit balances increased 1.1 percent during the quarter, compared to the fourth quarter of 2013, with the primarily increase in domestic deposits.
•Asset quality indicators continued to show improvement. This is the 15th consecutive quarter that net charge-offs have posted a year-over-year decline, and is the lowest quarterly total since second quarter 2007.

Financial Performance Highlights for Second Quarter 2014
Improved economic stability and operational execution has contributed to organic loan growth as well as improved credit quality in comparison to March 31, 2014 and the same quarter in the prior year. However, low interest rates, competitive loan and deposit pricing, and continued reduction in the acquired loan portfolio, continue to constrain interest margins and earnings.
BancShares’ consolidated net income during the second quarter of 2014 equaled $26.6 million, or $2.76 per share, compared to $22.4 million, or $2.33 per share in the first quarter and compared to $43.9 million, or $4.56 per share in the second quarter of 2013. The annualized returns on average assets and equity amounted to 0.48 percent and 5.01 percent, respectively, during the second quarter of 2014, compared to 0.83 percent and 9.13 percent during the second quarter of 2013. Net interest margin for the second quarter of 2014 was 3.29 percent, compared to 3.74 percent for the second quarter of the prior year. Net interest margin excluding acquired loans was 2.85 percent in comparison to 2.88 percent for the same quarter in 2013.
For the first six months of 2014, consolidated net income totaled $48.9 million, compared to $99.5 million for the same period of 2013.The annualized return on average assets was 0.45 percent for the first six months of 2014, compared to 0.95 percent for the same period of 2013. The annualized return on average shareholders' equity was 4.67 percent and 10.55 percent for the respective periods.
Noninterest income for the second quarter of 2014 totaled $65.4 million, compared to $65.0 million in the comparable period of 2013. For the six-month period, noninterest income totaled $126.6 million for 2014, compared to $122.5 million for 2013. Noninterest expense totaled $199.0 million for the second quarter of 2014 , an increase of $10.5 million from the sequential quarter. For the six-month period, noninterest expense totaled $390.1 million, compared to $382.9 million for 2013.
Income tax expense totaled $12.8 million and $25.3 million for the second quarter of 2014 and 2013, respectively, and totaled $23.4 million and $56.4 million for the six months ended June 30, 2014, and 2013, respectively.
Loans for the second quarter of 2014 totaled $13.5 billion, an increase of $53.9 million, or 0.4 percent, compared to the first quarter of 2014, and an increase of $426.2 million, or 3.3 percent, compared to the same quarter of 2013. Loans increased $391.2 million, or 3.0 percent from December 31, 2013 to June 30, 2014. Investment securities available for sale equaled $5.5 billion at June 30, 2014, compared to $5.7 billion and $5.2 billion at March 31, 2014 and June 30, 2013, respectively. Investment securities as of June 30, 2014 increased $150.5 million, or 2.8 percent, from December 31, 2013.
The allowance for loan and lease losses as a percentage of total loans was 1.52 percent for the second quarter of 2014 compared to 1.65 percent for the first quarter of 2014 and 1.97 percent for the second quarter of 2013. Provision credit for acquired loans totaled $9.5 million for the second quarter of 2014 compared to a provision credit of $2.3 million for the first quarter of 2014. The increase in the net credit was partially offset by the originated provision expense increase of $1.9 million.
Annualized net charge-offs as a percentage of average originated loans remained relatively consistent during the second quarter of 2014 at 0.11 percent compared to 0.08 percent and 0.15 percent for the first quarter of 2014 and second quarter of 2013, respectively. Total nonperforming assets as a percent of total loans and leases plus other real estate totaled 1.29 percent at June 30, 2014 compared to 1.37 percent and 1.80 percent at March 31, 2014 and June 30, 2013.

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At June 30, 2014, total deposits equaled $18.6 billion, a decrease of $206.8 million, or 1.1 percent, when compared to the prior quarter, and an increase of $538.7 million, or 3.0 percent, when compared to the second quarter of 2013. Total deposits increased $682.7 million, or 3.8 percent, compared to December 31, 2013.
BancShares remains well-capitalized with a tier 1 leverage capital ratio of 9.71 percent, tier 1 risk-based capital ratio of 14.61 percent and total risk-based capital ratio of 15.95 percent at June 30, 2014.

BUSINESS COMBINATIONS
Merger Agreement with First Citizens Bancorporation, Inc.
On June 10, 2014, BancShares entered into an Agreement and Plan of Merger (the “Merger Agreement”) with First Citizens Bancorporation, Inc., a South Carolina corporation (“Bancorporation”), pursuant to which Bancorporation will merge with and into BancShares. The Merger Agreement provides that each share of Bancorporation common stock will be converted into the right to receive 4.00 shares of BancShares' Class A common stock and $50.00 cash, unless the holder elects for each share of such holder’s Bancorporation common stock to be converted into the right to receive 3.58 shares of BancShares' Class A common stock and 0.42 shares of BancShares' Class B common stock.

The Merger Agreement has been approved by the independent members of the Board of Directors of each company following a recommendation by a special committee of independent members of the board of each company. Subject to certain conditions, including receipt of shareholder and regulatory approvals, the merger is expected to be completed in the fourth quarter of 2014 with the subsidiary banks merging sometime thereafter.
 
See Note B to the Consolidated Financial Statements, "Business Combinations," for additional information related to the Merger.

1st Financial Services Corporation Merger
On January 1, 2014, FCB completed its merger with 1st Financial Services Corporation (1st Financial) and its wholly-owned banking subsidiary Mountain 1st Bank & Trust Company. FCB paid $10.0 million to acquire 1st Financial, including $8.0 million to acquire and subsequently retire the 1st Financial securities that had been issued under the Troubled Asset Relief Program. In accordance with the acquisition method of accounting, all assets and liabilities were recorded at their fair value as of the acquisition date. As a result of the 1st Financial transaction, during the first quarter of 2014, FCB recorded loans with a fair value of $316.3 million, investment securities with a fair value of $237.4 million and other real estate with a fair value of $11.6 million. The fair value of deposits assumed totaled $631.9 million. FCB also recorded $24.5 million of goodwill and $3.8 million in core deposit intangibles.


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Table 1
FAIR VALUE OF 1ST FINANCIAL SERVICES ACQUIRED ASSETS AND LIABILITIES
(Dollars in thousands)
January 1, 2014
Assets
 
Cash and cash equivalents
$
28,194

Investment securities
237,438

Loans and leases
316,327

Other real estate owned
11,591

Intangible assets
3,780

Other assets
23,991

Total assets acquired
$
621,321

Liabilities
 
Deposits:
 
Noninterest-bearing
$
152,444

Interest-bearing
479,427

Total deposits
631,871

Short-term borrowings
406

Other liabilities
3,559

Total liabilities assumed
635,836

Fair value of net liabilities assumed
14,515

Cash paid to shareholders
2,000

Cash paid to acquire TARP securities
8,000

Goodwill recorded
$
24,515


FDIC-Assisted Transactions
We participated in six FDIC-assisted transactions between 2009 and 2011 that provided significant growth opportunities and continue to provide significant contributions to our results of operations. These transactions allowed us to increase our presence in existing markets and to expand our banking presence to adjacent markets. Each of the FDIC-assisted transactions included loss share agreements that, for the term of the loss share agreement, protect us from a substantial portion of the credit and asset quality risk we would otherwise incur. Two of the loss share agreements expire during the third quarter of 2014, and two expire during the first quarter of 2015. We will process all necessary filings in accordance with the agreements before expiration to collect the earned loss share receivables. Going forward, we will continue to manage these loans and loan relationships in accordance with our standard credit administration policies and procedures.

Income Statement Impact of Business Combinations
The 1st Financial merger was accretive to net interest income during the three and six months ended June 30, 2014 and is expected to continue to be accretive going forward. The nonrecurring merger related costs totaled approximately $5.2 million. Loan related interest income generated from 1st Financial was approximately $4.2 million for the second quarter of 2014 and $8.6 million for the first six months of 2014.

When comparing the current quarter of 2014 to the second quarter of 2013, acquired loans had an unfavorable impact on earnings. Unfavorable variances were noted in interest income and provision for loan and lease losses, partially offset by favorable adjustments to the FDIC receivable. The decrease in interest income, and overall earnings, for the second quarter and first six months of 2014 compared to the same quarter and six months in the prior year is primarily driven by sustained runoff in the acquired loan portfolio. The unfavorable six-month comparison is affected by nonrecurring FDIC-assisted acquisition accounting adjustments recorded during the the first quarter of 2013. Due to various factors that affect income or expense related to acquired loans recognized in a given period, these components of net income are not easily predictable for future periods. Variations among these items may affect the comparability of various components of net income.

Acquired loan accretion income, which is included in interest income, may be accelerated in the event of unscheduled repayments and various other post-acquisition events. During the three months ended June 30, 2014, accretion income on acquired loans equaled $30.5 million, compared to $52.0 million during the second quarter of 2013. Accretion income for the six months ended June 30, 2014 and June 30, 2013 was $60.7 million and $131.9 million, respectively. The decrease during both the second quarter and the six-month periods of 2014 is attributed to accelerated repayments, loan portfolio runoff and a decrease in cash basis income. Cash basis income is generated when a loan pays off outside of expectations.


45
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During the three months ended June 30, 2014, we recorded a credit to provision for loan and lease losses for acquired loans totaling $9.5 million compared to a credit of $15.5 million during the same period of 2013. For the six months ended June 30, 2014 and June 30, 2013, the credit to provision expense was $11.8 million and $38.1 million, respectively. For all periods, accelerated loan payments resulted in the reversal of previously-recognized impairment, although as expected, the volume of repayments during 2014 was significantly less than repayments during 2013.

During the three-month period ended June 30, 2014, the net adjustment to the FDIC receivable resulted in a reduction to noninterest income of $15.3 million, compared to a corresponding reduction in noninterest income of $14.4 million during the same period of 2013. The six months ended June 30, 2014 and June 30, 2013 saw reductions to noninterest income of $27.6 million and $38.5 million. The changes result from lower amortization expense of the FDIC receivable as the expiration dates of the loss share agreements approach.

FDIC Loss Share Receivable
The various terms of each loss share agreement and the components of the receivable from the FDIC are provided in Table 2. As of June 30, 2014, the FDIC receivable included $22.7 million of expected FDIC cash receipts and $27.2 million we expect to recover through prospective amortization of the asset due to post-acquisition improvements in the related loans. Generally, losses on single family residential loans are covered for ten years. All other loans are generally covered for five years. During the third quarter of 2014, loss share protection will expire for non-single family residential loans acquired from Temecula Valley Bank (TVB) and Venture Bank (VB). During the first quarter of 2015, loss share protection will expire for loans acquired from First Regional Bank (FRB) and for non-single family residential loans acquired from Sun American Bank (SAB). Protection for all other covered assets extends beyond December 31, 2015.
Table 2
 
Fair value at acquisition date
Losses/expenses incurred through 6/30/2014
Cumulative amount reimbursed by FDIC through 6/30/2014
Carrying value at
June 30, 2014
Current portion of receivable due from (to) FDIC for 6/30/2014 filings
Prospective amortization (accretion)
(Dollars in thousands)
Receivable from FDIC
Payable to FDIC
Entity
TVB - combined losses
$
103,558

$
199,226

$
1,858

$
3,090

$
—

$
2,913

$
1,505

VB - combined losses
138,963

156,155

125,184

1,357

—

(260
)
(316
)
FRB - combined losses
378,695

244,889

165,661

2,289

78,891

(3,203
)
5,766

SAB - combined losses
89,734

97,197

78,211

8,793

2,036

(454
)
6,490

United Western
 
 
 
 
 
 
 
Non-single family residential losses
112,672

111,785

88,880

12,138

17,529

225

4,711

Single family residential losses
24,781

4,884

3,744

10,645

—

164

2,813

Colorado Capital - combined losses
155,070

185,857

149,364

11,647

15,825

(514
)
6,250

Total
$
1,003,473

$
999,993

$
612,902

$
49,959

$
114,281

$
(1,129
)
$
27,219

 
 
 
 
 
 
 
 
Fair value at acquisition date represents the initial fair value of the receivable from FDIC, excluding the payable to FDIC. Prospective amortization (accretion) reflects balances that, due to post-acquisition credit quality improvement, will be amortized over the shorter of the covered asset's life or the term of the loss share period.



46
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Table 3
SELECTED QUARTERLY DATA
 
2014
 
2013
 
Six months ended June 30
 
 
Second
 
First
 
Fourth
 
Third
 
Second
 
 
(Dollars in thousands, except share data)
Quarter
 
Quarter
 
 Quarter
 
Quarter
 
 Quarter
 
2014
 
2013
 
SUMMARY OF OPERATIONS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
$
177,311

 
$
173,394

 
$
189,640

 
$
192,634

 
$
193,926

 
$
350,705

 
$
414,530

 
Interest expense
11,613

 
12,463

 
13,047

 
13,451

 
14,398

 
24,076

 
30,120

 
Net interest income
165,698

 
160,931

 
176,593

 
179,183

 
179,528

 
326,629

 
384,410

 
Provision (credit) for loan and lease losses
(7,299
)
 
(1,903
)
 
7,276

 
(7,683
)
 
(13,242
)
 
(9,202
)
 
(31,848
)
 
Net interest income after provision for loan and lease losses
172,997

 
162,834

 
169,317

 
186,866

 
192,770

 
335,831

 
416,258

 
Noninterest income
65,382

 
61,181

 
69,177

 
71,918

 
64,995

 
126,563

 
122,508

 
Noninterest expense
199,020

 
191,030

 
196,315

 
192,143

 
188,567

 
390,050

 
382,922

 
Income before income taxes
39,359

 
32,985

 
42,179

 
66,641

 
69,198

 
72,344

 
155,844

 
Income taxes
12,809

 
10,619

 
14,953

 
25,659

 
25,292

 
23,428

 
56,353

 
Net income
$
26,550

 
$
22,366

 
$
27,226

 
$
40,982

 
$
43,906

 
$
48,916

 
$
99,491

 
Net interest income, taxable equivalent
$
166,570

 
$
161,694

 
$
177,280

 
$
179,823

 
$
180,188

 
$
328,263

 
$
385,743

 
PER SHARE DATA
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Net income
$
2.76

 
$
2.33

 
$
2.83

 
$
4.26

 
$
4.56

 
$
5.09

 
$
10.34

 
 Cash dividends
0.30

 
0.30

 
0.30

 
0.30

 
0.30

 
0.60

 
0.60

 
 Market price at period end (Class A)
245.00

 
240.75

 
222.63

 
205.60

 
192.05

 
245.00

 
192.05

 
 Book value at period end
223.43

 
218.82

 
215.89

 
206.06

 
201.62

 
223.43

 
201.62

 
SELECTED PERIOD AVERAGE BALANCES
 
 
 
 
 
 
 
 
 
 
 
 
 
 Total assets
$
22,022,465

 
$
21,872,343

 
$
21,562,920

 
$
21,260,384

 
$
21,224,412

 
$
21,947,818

 
$
21,187,274

 
 Investment securities
5,629,467

 
5,606,723

 
5,285,783

 
5,177,729

 
5,162,893

 
5,618,157

 
5,179,818

 
 Loans and leases (acquired and originated)
13,566,612

 
13,459,945

 
13,088,636

 
13,111,710

 
13,167,580

 
13,513,580

 
13,228,367

 
 Interest-earning assets
20,304,777

 
20,139,131

 
19,787,236

 
19,428,949

 
19,332,679

 
20,222,418

 
19,256,916

 
 Deposits
18,561,927

 
18,492,310

 
18,102,752

 
17,856,882

 
17,908,705

 
18,527,311

 
18,014,058

 
 Long-term obligations
398,615

 
500,805

 
510,871

 
449,013

 
443,804

 
449,428

 
444,170

 
 Interest-bearing liabilities
14,020,480

 
14,189,227

 
13,790,088

 
13,757,983

 
13,958,137

 
14,104,388

 
14,048,820

 
 Shareholders' equity
$
2,125,239

 
$
2,094,557

 
$
2,010,191

 
$
1,953,128

 
$
1,929,621

 
$
2,110,533

 
$
1,902,217

 
 Shares outstanding
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,963

 
SELECTED PERIOD-END BALANCES
 
 
 
 
 
 
 
 
 
 
 
 
 
 Total assets
$
22,062,840

 
$
22,154,997

 
$
21,199,091

 
$
21,511,352

 
$
21,308,822

 
$
22,062,840

 
$
21,308,822

 
 Investment securities
5,538,859

 
5,677,019

 
5,388,610

 
5,162,598

 
5,186,106

 
5,538,859

 
5,186,106

 
 Loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
1,109,933

 
1,270,818

 
1,029,426

 
1,188,281

 
1,443,336

 
1,109,933

 
1,443,336

 
Originated
12,415,023

 
12,200,226

 
12,104,298

 
11,884,585

 
11,655,469

 
12,415,023

 
11,655,469

 
 Deposits
18,556,758

 
18,763,545

 
17,874,066

 
18,063,319

 
18,018,015

 
18,556,758

 
18,018,015

 
 Long-term obligations
314,529

 
440,300

 
510,769

 
510,963

 
443,313

 
314,529

 
443,313

 
 Shareholders' equity
$
2,149,145

 
$
2,104,830

 
$
2,076,675

 
$
1,982,057

 
$
1,939,330

 
$
2,149,145

 
$
1,939,330

 
 Shares outstanding
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
9,618,941

 
SELECTED RATIOS AND OTHER DATA
 
 
 
 
 
 
 
 
 
 
 
 
 
 Rate of return on average assets (annualized)
0.48

%
0.41

%
0.50

%
0.76

%
0.83

%
0.45

%
0.95

%
Rate of return on average shareholders' equity (annualized)
5.01

 
4.33

 
5.37

 
8.32

 
9.13

 
4.67

 
10.55

 
Net yield on interest-earning assets (taxable equivalent)
3.29

 
3.26

 
3.55

 
3.67

 
3.74

 
3.27

 
4.04

 
Allowance for loan and lease losses to total loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
2.64

 
3.54

 
5.20

 
5.01

 
5.30

 
2.64

 
5.30

 
Originated
1.43

 
1.46

 
1.49

 
1.50

 
1.56

 
1.43

 
1.56

 
Nonperforming assets to total loans and leases and other real estate at period end:
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired covered
10.97

 
9.34

 
7.02

 
7.05

 
8.62

 
10.97

 
8.62

 
Acquired not covered
3.12

 
3.36

 
—

 
—

 
—

 
3.12

 
—

 
Originated
0.58

 
0.66

 
0.74

 
0.90

 
0.91

 
0.58

 
0.91

 
Tier 1 risk-based capital ratio
14.61

 
14.56

 
14.92

 
15.04

 
14.91

 
14.61

 
14.91

 
Total risk-based capital ratio
15.95

 
16.05

 
16.42

 
16.54

 
16.41

 
15.95

 
16.41

 
Leverage capital ratio
9.71

 
9.66

 
9.82

 
9.84

 
9.68

 
9.71

 
9.68

 
Dividend payout ratio
10.87

 
12.88

 
10.60

 
7.04

 
6.58

 
11.79

 
5.80

 
Average loans and leases to average deposits
73.09

 
72.79

 
72.30

 
73.43

 
73.53

 
72.94

 
73.43

 
Average loan and lease balances include nonaccrual loans and leases.

47
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Table 4
CONSOLIDATED TAXABLE EQUIVALENT RATE/VOLUME VARIANCE ANALYSIS - THREE MONTHS

 
2014
 
2013
 
Increase (decrease) due to:
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
 
 
 
 
 
 
Average
 
Income/
 
 Yield/
 
Average
 
Income/
 
Yield/
 
 
 
Yield/
 
Total
(Dollars in thousands)
Balance
 
Expense
 
 Rate
 
Balance
 
Expense
 
Rate
 
Volume
 
Rate
 
Change
Assets
 
Loans and leases
$
13,566,612

 
$
164,794

 
4.87

%
$
13,167,580

 
$
185,661

 
5.66

%
$
5,349

 
$
(26,216
)
 
$
(20,867
)
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasury
1,481,051

 
2,435

 
0.66

 
681,893

 
486

 
0.29

 
949

 
1,000

 
1,949

Government agency
1,559,337

 
2,160

 
0.55

 
2,947,308

 
3,197

 
0.43

 
(1,703
)
 
666

 
(1,037
)
Mortgage-backed securities
2,565,403

 
7,813

 
1.22

 
1,512,268

 
4,506

 
1.20

 
3,191

 
116

 
3,307

State, county and municipal
186

 
4

 
8.60

 
187

 
4

 
8.58

 
—

 
—

 
—

Other
23,490

 
220

 
3.76

 
21,237

 
76

 
1.44

 
15

 
129

 
144

Total investment securities
5,629,467

 
12,632

 
0.90

 
5,162,893

 
8,269

 
0.64

 
2,452

 
1,911

 
4,363

Overnight investments
1,108,698

 
756

 
0.27

 
1,002,206

 
656

 
0.26

 
72

 
28

 
100

Total interest-earning assets
20,304,777

 
$
178,182

 
3.52

%
19,332,679

 
$
194,586

 
4.04

%
$
7,873

 
$
(24,277
)
 
$
(16,404
)
Cash and due from banks
464,877

 
 
 
 
 
482,821

 
 
 
 
 
 
 
 
 
 
Premises and equipment
882,256

 
 
 
 
 
873,503

 
 
 
 
 
 
 
 
 
 
Receivable from FDIC for loss share agreements
67,574

 
 
 
 
 
182,766

 
 
 
 
 
 
 
 
 
 
Allowance for loan and lease losses
(216,337
)
 
 
 
 
 
(264,978
)
 
 
 
 
 
 
 
 
 
 
Other real estate owned
81,074

 
 
 
 
 
128,152

 
 
 
 
 
 
 
 
 
 
Other assets
438,244

 
 
 
 
 
489,469

 
 
 
 
 
 
 
 
 
 
 Total assets
$
22,022,465

 
 
 
 
 
$
21,224,412

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Checking with interest
$
2,553,941

 
$
125

 
0.02

%
$
2,378,178

 
$
166

 
0.03

%
$
16

 
$
(57
)
 
$
(41
)
Savings
1,200,145

 
152

 
0.05

 
965,801

 
120

 
0.05

 
31

 
1

 
32

Money market accounts
6,182,997

 
1,540

 
0.10

 
6,295,031

 
2,490

 
0.16

 
(27
)
 
(923
)
 
(950
)
Time deposits
2,999,262

 
4,189

 
0.56

 
3,285,435

 
6,221

 
0.76

 
(468
)
 
(1,564
)
 
(2,032
)
Total interest-bearing deposits
12,936,345

 
6,006

 
0.19

 
12,924,445

 
8,997

 
0.32

 
(448
)
 
(2,543
)
 
(2,991
)
Short-term borrowings
685,520

 
1,551

 
0.91

 
589,888

 
680

 
0.46

 
159

 
712

 
871

Long-term obligations
398,615

 
4,055

 
4.07

 
443,804

 
4,721

 
4.26

 
(337
)
 
(329
)
 
(666
)
Total interest-bearing liabilities
14,020,480

 
$
11,612

 
0.33

%
13,958,137

 
$
14,398

 
0.41

%
$
(626
)
 
$
(2,160
)
 
$
(2,786
)
Demand deposits
5,625,582

 
 
 
 
 
4,984,260

 
 
 
 
 
 
 
 
 
 
Other liabilities
251,164

 
 
 
 
 
352,394

 
 
 
 
 
 
 
 
 
 
Shareholders' equity
2,125,239

 
 
 
 
 
1,929,621

 
 
 
 
 
 
 
 
 
 
 Total liabilities and shareholders' equity
$
22,022,465

 
 
 
 
 
$
21,224,412

 
 
 
 
 
 
 
 
 
 
Interest rate spread
 
 
 
 
3.19

%
 
 
 
 
3.63

%
 
 
 
 
 
Net interest income and net yield
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
on interest-earning assets
 
 
$
166,570

 
3.29

%
 
 
$
180,188

 
3.74

%
$
8,499

 
$
(22,117
)
 
$
(13,618
)
Loans and leases include acquired loans, originated loans, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent for each period and state income tax rates of 6.2 percent and 6.9 percent for 2014 and 2013, respectively. The taxable-equivalent adjustment was $872 and $660 for 2014 and 2013, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.

48
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Table 5
CONSOLIDATED TAXABLE EQUIVALENT RATE/VOLUME VARIANCE ANALYSIS - YEAR TO DATE
 
2014
 
2013
 
Increase (decrease) due to:
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
 
 
 
 
 
 
Average
 
Income/
 
 Yield/
 
Average
 
Income/
 
Yield/
 
 
 
Yield/
 
Total
(Dollars in thousands)
Balance
 
Expense
 
 Rate
 
Balance
 
Expense
 
Rate
 
Volume
 
Rate
 
Change
Assets
 
Loans and leases
$
13,513,580

 
$
326,430

 
4.87

%
$
13,228,367

 
$
397,932

 
6.07

%
$
7,900

 
$
(79,402
)
 
$
(71,502
)
Investment securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury
1,131,539

 
3,521

 
0.63

 
742,511

 
1,004

 
0.27

 
856

 
1,661

 
2,517

Government agency
1,917,664

 
5,122

 
0.53

 
3,021,622

 
6,663

 
0.44

 
(2,649
)
 
1,108

 
(1,541
)
Mortgage-backed securities
2,545,457

 
15,576

 
1.22

 
1,396,026

 
9,085

 
1.31

 
7,290

 
(799
)
 
6,491

State, county and municipal
186

 
7

 
7.53

 
367

 
13

 
7.14

 
(7
)
 
1

 
(6
)
Other
23,311

 
316

 
2.73

 
19,292

 
153

 
1.60

 
43

 
120

 
163

Total investment securities
5,618,157

 
24,542

 
0.87

 
5,179,818

 
16,918

 
0.65

 
5,533

 
2,091

 
7,624

Overnight investments
1,090,681

 
1,368

 
0.25

 
848,731

 
1,013

 
0.24

 
300

 
55

 
355

Total interest-earning assets
20,222,418

 
$
352,340

 
3.51

%
19,256,916

 
$
415,863

 
4.36

%
$
13,733

 
$
(77,256
)
 
$
(63,523
)
Cash and due from banks
471,424

 
 
 
 
 
495,548

 
 
 
 
 
 
 
 
 
 
Premises and equipment
879,849

 
 
 
 
 
877,242

 
 
 
 
 
 
 
 
 
 
Receivable from FDIC for loss share agreements
77,507

 
 
 
 
 
208,575

 
 
 
 
 
 
 
 
 
 
Allowance for loan and lease losses
(220,714
)
 
 
 
 
 
(273,927
)
 
 
 
 
 
 
 
 
 
 
Other real estate owned
85,960

 
 
 
 
 
139,448

 
 
 
 
 
 
 
 
 
 
Other assets
431,374

 
 
 
 
 
483,472

 
 
 
 
 
 
 
 
 
 
Total assets
$
21,947,818

 
 
 
 
 
$
21,187,274

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Checking with interest
$
2,524,474

 
$
278

 
0.02

%
$
2,331,192

 
$
309

 
0.03

%
$
57

 
$
(88
)
 
$
(31
)
Savings
1,190,250

 
443

 
0.08

 
947,246

 
234

 
0.05

 
64

 
145

 
209

Money market accounts
6,268,862

 
3,429

 
0.11

 
6,378,644

 
5,675

 
0.18

 
(65
)
 
(2,181
)
 
(2,246
)
Time deposits
3,056,296

 
8,682

 
0.57

 
3,372,716

 
13,092

 
0.78

 
(1,061
)
 
(3,349
)
 
(4,410
)
Total interest-bearing deposits
13,039,882

 
12,832

 
0.20

 
13,029,798

 
19,310

 
0.30

 
(1,005
)
 
(5,473
)
 
(6,478
)
Short-term borrowings
615,078

 
2,136

 
0.70

 
574,852

 
1,384

 
0.49

 
126

 
626

 
752

Long-term obligations
449,428

 
9,109

 
4.05

 
444,170

 
9,426

 
4.24

 
106

 
(423
)
 
(317
)
Total interest-bearing liabilities
14,104,388

 
$
24,077

 
0.34

%
14,048,820

 
$
30,120

 
0.43

%
$
(773
)
 
$
(5,270
)
 
$
(6,043
)
Demand deposits
5,487,429

 
 
 
 
 
4,984,260

 
 
 
 
 
 
 
 
 
 
Other liabilities
245,468

 
 
 
 
 
251,977

 
 
 
 
 
 
 
 
 
 
Shareholders' equity
2,110,533

 
 
 
 
 
1,902,217

 
 
 
 
 
 
 
 
 
 
 Total liabilities and shareholders' equity
$
21,947,818

 
 
 
 
 
$
21,187,274

 
 
 
 
 
 
 
 
 
 
Interest rate spread
 
 
 
 
3.17

%
 
 
 
 
3.93

%
 
 
 
 
 
Net interest income and net yield
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
on interest-earning assets
 
 
$
328,263

 
3.27

%
 
 
$
385,743

 
4.04

%
$
14,506

 
$
(71,986
)
 
$
(57,480
)
Loans and leases include acquired loans, originated loans, nonaccrual loans and loans held for sale. Yields related to loans, leases and securities exempt from both federal and state income taxes, federal income taxes only, or state income taxes only are stated on a taxable-equivalent basis assuming statutory federal income tax rates of 35.0 percent for each period and state income tax rates of 6.2 percent and 6.9 percent for 2014 and 2013, respectively. The taxable-equivalent adjustment was $1,634 and $1,333 for 2014 and 2013, respectively. The rate/volume variance is allocated equally between the changes in volume and rate.


49
Table of Contents

RESULTS OF OPERATIONS

Net Interest Income and Margins
Second Quarter 2014
The second quarter results were good but show notable differences when compared to the first quarter of 2014 and the same quarter of 2013. The most significant impact on net interest income, net interest margin, and average asset yields resulted from changes in the acquired loan portfolio including loan resolutions, acceleration of payments, and overall portfolio run-off throughout the second quarter, albeit at a slower pace than prior quarters. Other significant drivers for quarterly changes are specifically noted below.
Net interest income increased $4.8 million, or 3.0 percent, compared to the first quarter of 2014, principally due to increased loan and investment income and reduced deposit costs. Conversely, net interest income decreased $13.8 million, or 7.7 percent, compared to the same period of 2013. Accretion income on acquired loans totaled $30.5 million when compared to $52.0 million during the second quarter of 2013. This reduction was partially offset by increases in loan interest income from the 1st Financial loan portfolio of $4.2 million and $4.3 million from improved investment interest income. Net interest income also benefited from decreased interest expense of $2.8 million in comparison to the same quarter of the prior year, due to reduction in funding costs.
Net interest margin improved 3 basis points (bps) compared to the first quarter of 2014 primarily due to improvements in acquired loan yields and investment yields as well as reduced deposit costs over the same period. The increase in net interest margin and net income during the current quarter in comparison to the first quarter was primarily due to reduced acquired loan impact, and improvements in investment yields and deposits costs over the same period. Originated loan growth, increased provision credit, improved investment yields, and lower interest expense contributed to higher net interest income after provision in comparison to the first quarter. While the non-acquired bank operations are helping earnings, our traditional banking products have much tighter margins; therefore, in a neutral interest rate environment, we anticipate continued pressure to replace the yield from the acquired portfolio runoff.
Net interest margin for the second quarter of 2014 was 3.29 percent, a decrease of 45 basis points from 3.74 percent recorded in the second quarter of 2013. The decrease was partially offset by modest improvements in investment yields and funding costs. While margin compression is a continuing concern in the current interest rate environment, the majority of BancShares' quarter-to-date margin compression was directly related to the acquired loan portfolio runoff. Net interest margin excluding acquired loans was 2.85 percent in comparison to 2.88 percent for the same quarter in 2013.
Average quarter-to-date interest earning assets increased $165.6 million, or 0.8 percent, compared to the first quarter of 2014 which was primarily driven by the $106.7 million increase in average outstanding loans. Interest-earning assets averaged $20.3 billion, an increase of $972.1 million compared to the second quarter of 2013. The increase is primarily the result of organic loan growth and the 1st Financial acquisition, offset by reductions in the acquired loan portfolios, while the increase in average investments is principally driven by the addition of the 1st Financial investment portfolio and redeployment of excess cash. Average loans and leases increased $106.7 million and $399.0 million when compared to the first quarter of 2014 and the second quarter of 2013, respectively.
Interest income totaled $177.3 million, a $3.9 million increase from the first quarter of 2014, and a $16.6 million decrease from the second quarter of 2013. The taxable-equivalent yield for total loans remained unchanged when compared to the first quarter of 2014, but decreased by 79 basis points when compared to the same quarter in the prior year. The taxable-equivalent yield on earning assets was 3.52 percent, relatively unchanged in comparison to the first quarter of 2014, and a decline of 52 basis points in comparison to the second quarter of 2013.
Average investment securities increased $22.7 million in comparison to the first quarter of 2014, with a 5 basis point increase in the taxable-equivalent yield. Average investment securities increased $466.6 million in comparison to the second quarter of 2013, with a 26 basis point increase in the taxable-equivalent yield. Interest income earned on the investment securities portfolio totaled $12.4 million when compared to $11.7 million and $8.1 million during the first quarter of 2014 and the same quarter of 2013, respectively. Average overnight investments increased $106.5 million compared to the same quarter in the prior year. Interest income earned on overnight investments totaled $0.8 million during the second quarter compared to $0.7 million during the second quarter of 2013. Average investment and overnight investment balances continue to increase as cash provided by acquired loan repayments and increased deposits are redeployed.
Average interest-bearing liabilities decreased $168.7 million when compared to the first quarter of 2014. Conversely, average interest-bearing liabilities totaled $14.0 billion, an increase of $62.3 million when compared to the second quarter of 2013. Interest expense totaled $11.6 million, a $0.9 million and $2.8 million decrease from the first quarter of 2014 and same quarter of 2013, respectively. The rate on interest-bearing liabilities was 0.33 percent, a decrease of 2 basis points and 8 basis points from the first quarter of 2014 and the second quarter of 2013, respectively. Average interest-bearing deposits equaled $12.9

50
Table of Contents

billion, a decrease of $208.2 million from the first quarter of 2014, and an increase of $11.9 million from the second quarter of 2013.
Year to Date 2014
Similar to the quarter over quarter comparison, the year-to-date 2014 results were good, but show notable differences when compared to the same period of 2013. The most significant impact on net interest income, net interest margin, and average asset yields resulted from changes in the acquired loan portfolio including loan resolutions, acceleration of payments, and overall portfolio run-off throughout the period ending June 30, 2014, albeit at a slower pace than prior periods. Other significant drivers for changes during the period are specifically noted below.
Net interest income for the first six months of 2014 totaled $326.6 million, a decrease of $57.8 million, or 15.0 percent, compared to the same period of 2013. Similar to quarter-to-date results, this reduction was partially offset by organic loan growth and $8.6 million of interest income from the 1st Financial loan portfolio and improved investment interest income. Accretion income on acquired loans totaled $60.7 million compared to $131.9 million during the same period of 2013. Net interest income also benefited from decreased interest expense of $6.0 million in comparison to the same six-month period of the prior year, due to reduction in funding costs.
The net interest margin amounted to 3.27 percent, compared to 4.04 percent for the same six-month period in 2013. The decrease in the year-to-date margin is predominately driven by reductions in the acquired loan portfolio yields, partially offset by modest improvements in investment yields and funding costs. Although the acquired loan portfolio performance and runoff continue to create margin volatility, the overall impact is expected to become less significant as that portfolio continues to decrease. Net interest margin excluding acquired loans was 2.84 percent in comparison to 2.89 percent for the same six-month period in 2013.
Interest-earning assets averaged $20.2 billion, an increase of $965.5 million in comparison to the same period of 2013 primarily due to increases in loans and investments. Average loans and leases increased $285.2 million in comparison to the first six months of 2013 as a result of organic loan growth and the 1st Financial acquisition, offset by reductions in the acquired loan portfolios. Interest income earned from loans and leases decreased $71.8 million as the taxable-equivalent yield for total loans also decreased by 120 basis points compared to the first six months in the prior year. As the acquired portfolio yield is being replaced with higher quality, lower yielding loan instruments, the yield on interest-earning assets declined in proportion, reaching 3.51 percent, compared to 4.36 percent for the same period of 2013. Interest income totaled $350.7 million, a $63.8 million decrease from the same period of 2013. The increase in average investments is primarily driven by the addition of the 1st Financial investment portfolio.
The repositioning of the investment portfolio during the year has helped improve overall investment yields helping to offset the decrease in loan yields. Average investment securities increased $438.3 million in comparison to the first six months of 2013, with a 22 basis point increase in the taxable-equivalent yield. Interest income earned on the investment securities portfolio totaled $24.2 million compared to $16.6 million during the same period of 2013. Average overnight investments increased $242.0 million compared to the year-to-date average in the prior year. Interest income earned on overnight investments totaled $1.4 million during the first six months compared to $1.0 million during the same period of 2013. Average investment and overnight investment balances continue to increase as cash provided by acquired loan repayments and increased deposits are redeployed.
Average interest-bearing liabilities totaled $14.1 billion, an increase of $55.6 million when compared to the same period of 2013. Interest expense totaled $24.1 million, a $6.0 million decrease from the same period of 2013. The rate on interest-bearing liabilities fell 9 basis points from year-to-date 2013 to 0.34 percent during the six months ended June 30, 2014. Average interest-bearing deposits equaled $13.0 billion, an increase of $10.1 million from the same period of 2013. This increase includes deposits acquired in the 1st Financial merger, as well as recurring seasonal trends.
Noninterest Income

The primary sources of noninterest income have traditionally consisted of cardholder services income, merchant services income, service charges on deposit accounts and revenues derived from wealth management services.

FDIC-assisted acquired loan recoveries and related adjustments in the FDIC receivable and payable is another source of noninterest income. As the loss share agreements begin to expire in the third quarter of 2014, we expect the impact on noninterest income to be reduced going forward.


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Table 6
Noninterest Income
 
Three months ended June 30
 
Three-month change
 
Six months ended June 30
 
Six-month change
 
(Dollars in thousands)
2014
 
2013
 
$
 
%
 
2014
 
2013
 
$
 
%
 
Cardholder services
$
13,257

 
$
12,026

 
$
1,231

 
10.2

%
$
25,089

 
$
23,097

 
$
1,992

 
8.6

%
Merchant services
15,035

 
15,245

 
(210
)
 
(1.4
)
 
28,556

 
27,731

 
825

 
3.0

 
Service charges on deposit accounts
15,265

 
14,883

 
382

 
2.6

 
29,705

 
29,882

 
(177
)
 
(0.6
)
 
Wealth management services
15,815

 
15,097

 
718

 
4.8

 
30,695

 
29,612

 
1,083

 
3.7

 
Fees from processing services
5,682

 
5,051

 
631

 
12.5

 
10,543

 
10,670

 
(127
)
 
(1.2
)
 
Other service charges and fees
4,250

 
3,966

 
284

 
7.2

 
8,194

 
7,732

 
462

 
6.0

 
Mortgage income
1,210

 
3,669

 
(2,459
)
 
(67.0
)
 
2,165

 
7,457

 
(5,292
)
 
(71.0
)
 
Insurance commissions
2,253

 
2,394

 
(141
)
 
(5.9
)
 
5,540

 
5,374

 
166

 
3.1

 
ATM income
1,260

 
1,314

 
(54
)
 
(4.1
)
 
2,462

 
2,482

 
(20
)
 
(0.8
)
 
Adjustments to FDIC receivable for loss share agreements
(15,295
)
 
(14,439
)
 
(856
)
 
5.9

 
(27,644
)
 
(38,492
)
 
10,848

 
(28.2
)
 
Recoveries of acquired loans previously charged off
5,400

 
4,219

 
1,181

 
28.0

 
8,869

 
5,850

 
3,019

 
51.6

 
Other
1,250

 
1,570

 
(320
)
 
(20.4
)
 
2,389

 
11,113

 
(8,724
)
 
(78.5
)
 
Total noninterest income
$
65,382

 
$
64,995

 
$
387

 
0.6

%
$
126,563

 
$
122,508

 
$
4,055

 
3.3

%
Noninterest income for the second quarter of 2014 equaled $65.4 million, compared to $65.0 million in the comparable period of 2013. The $0.4 million increase during 2014 is primarily related to improvements in cardholder services resulting from higher volume, higher service charges on deposits due to seasonality, higher wealth management services income from trust asset management and annuity fees, and increases in recoveries of acquired loans previously charged off. These improvements are partially offset by a decline in mortgage income due to reduced mortgage originations and a decline in adjustments to the FDIC receivable for loss share agreements as a result of acquired portfolio performance.
For the six-month period, noninterest income equaled $126.6 million for 2014, compared to $122.5 million for 2013, primarily due to a $2.8 million increase in cardholder and merchant services income, a $10.8 million reduction in unfavorable adjustments to the FDIC loss share receivable, and a $3.0 million increase in recoveries of acquired loans previously charged off. These increases are partially offset by a $5.3 million decline in mortgage income as a result of reduced mortgage originations due to economic conditions, and a decrease in other resulting from a $7.5 million gain generated from the sale of various service agreements during the first quarter of 2013.
During 2014, substantially all fees from processing services relate to payments received from FCB-SC. Following the proposed merger of BancShares and Bancorporation, anticipated to occur during the fourth quarter of 2014, no further fees from processing services will be recorded from Bancorporation. However, this reduction is not expected to have an impact on earnings as the associated processing expenses recorded by Bancorporation will also be eliminated upon consolidation.


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Noninterest Expense

The primary components of noninterest expense are salaries and related employee benefits, occupancy costs and support facilities and equipment and software costs and our technology and operations infrastructure.

Table 7
Noninterest Expense
 
Three months ended June 30
 
Three-month change
 
Six months ended June 30
 
Six-month change
 
(Dollars in thousands)
2014
 
2013
 
$
 
%
 
2014
 
2013
 
$
 
%
 
Salaries and wages
$
82,683

 
$
75,802

 
$
6,881

 
9.1

%
$
162,557

 
$
151,921

 
$
10,636

 
7.0

%
Employee benefits
19,772

 
23,228

 
(3,456
)
 
(14.9
)
 
39,872

 
48,247

 
(8,375
)
 
(17.4
)
 
Occupancy expense
20,937

 
18,464

 
2,473

 
13.4

 
41,362

 
37,273

 
4,089

 
11.0

 
Equipment expense
19,686

 
18,698

 
988

 
5.3

 
38,477

 
37,644

 
833

 
2.2

 
FDIC insurance expense
2,640

 
2,423

 
217

 
9.0

 
5,276

 
5,089

 
187

 
3.7

 
Foreclosure-related expenses
3,858

 
3,467

 
391

 
11.3

 
9,268

 
7,772

 
1,496

 
19.2

 
Merchant processing
9,755

 
9,114

 
641

 
7.0

 
18,236

 
17,347

 
889

 
5.1

 
Processing fees paid to third parties
4,564

 
3,846

 
718

 
18.7

 
9,690

 
8,227

 
1,463

 
17.8

 
Card processing
3,033

 
3,682

 
(649
)
 
(17.6
)
 
5,630

 
6,759

 
(1,129
)
 
(16.7
)
 
Consultant
3,921

 
2,465

 
1,456

 
59.1

 
6,152

 
4,091

 
2,061

 
50.4

 
Collection
2,647

 
5,104

 
(2,457
)
 
(48.1
)
 
4,482

 
10,379

 
(5,897
)
 
(56.8
)
 
Advertising
1,773

 
1,107

 
666

 
60.2

 
3,062

 
1,405

 
1,657

 
(a)

 
Other
23,751

 
21,167

 
2,584

 
12.2

 
45,986

 
46,768

 
(782
)
 
(1.7
)
 
Total noninterest expense
$
199,020

 
$
188,567

 
$
10,453

 
5.5

%
$
390,050

 
$
382,922

 
$
7,128

 
1.9

%
(a) not meaningful
Noninterest expense increased $10.4 million in the second quarter of 2014 to $199.0 million, compared to $188.6 million in the second quarter of 2013. The second quarter 2014 increase is a result of higher salaries and wages of $6.9 million, occupancy expenses of $2.5 million, and consultant and other expenses which increased $1.5 million and $2.6 million, respectively, primarily due to merger-related consultant services expenses. This increase is partially offset by lower employee benefits of $3.5 million primarily due to lower health care costs and pension expenses and reduced collection expenses of $2.5 million due to lower nonperforming assets.

For the six-month period, noninterest expense totaled $390.1 million, compared to $382.9 million for the six-month period of 2013. The increase results from higher salaries and wages of $10.6 million, higher occupancy expense of $4.1 million, increases in foreclosure-related expenses of $1.5 million, higher processing fees of $1.5 million, a $2.1 million increase in consultant fees resulting from merger-related expenses, and higher advertising expenses of $1.7 million. The increase in salaries and wages is primarily related to annual merit increases and the increase in foreclosure-related expenses is due to increased resolutions of other real estate properties leading to the reduction in other real estate owned (OREO) property balance of $46.5 million when compared to June 30, 2013. These increases are partially offset by lower employee benefit expenses of $8.4 million reflecting lower pension costs resulting from a higher discount rate used to calculate pension expense during 2014, lower card processing fees of $1.1 million, and reduced collection expenses of $5.9 million associated with managing reduced nonperforming assets. The lower card processing fees in the first six months of 2014 are related to card incentive commissions recorded throughout the year, which offset the noninterest expense recognized during the period, whereas these commissions were recorded as a one-time adjustment in the third quarter of the prior year.

Income Taxes

We monitor and evaluate the potential impact of current events on the estimates used to establish income tax expenses and income tax liabilities. On a periodic basis, we evaluate our income tax positions based on current tax law, positions taken by various tax auditors within the jurisdictions where BancShares is required to file income tax returns, as well as potential or pending audits or assessments by tax auditors.
Income tax expense totaled $12.8 million and $25.3 million for the second quarter of 2014 and 2013, representing effective tax rates of 32.5 percent and 36.6 percent during the respective periods. Income tax expense totaled $23.4 million and $56.4 million for the six months ended June 30, 2014, and 2013, respectively. The effective tax rates were 32.4 percent and 36.2

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percent for the respective six-month periods. The decreased effective tax rate is the result of the impact of permanent differences on lower pre-tax earnings.

BALANCE SHEET ANALYSIS

We focus on maintaining high-asset quality, which results in a loan and lease portfolio subjected to strenuous underwriting and monitoring procedures and corresponding tighter margins. We avoid high-risk industry concentrations, but we do maintain a concentration of owner-occupied real estate loans to borrowers in medical and medical-related fields. The credit department actively monitors all loan concentrations to ensure potential risks are identified timely and managed accordingly. Our focus on asset quality also influences the composition of our investment securities portfolio. At June 30, 2014, mortgage-backed securities represented 46.9 percent of investment securities available for sale, compared to U.S. Treasury and government agency securities, which represented 29.4 percent and 23.2 percent, respectively, of the portfolio. Investments in mortgage-backed securities primarily represent securities issued by government entities. The balance of the available-for-sale portfolio includes common stock of other financial institutions and municipal securities. Overnight investments include interest-bearing deposits at the Federal Reserve Bank and other financial institutions and federal funds sold.

Investment Securities

Investment securities available for sale equaled $5.54 billion at June 30, 2014, compared to $5.39 billion and $5.19 billion at December 31, 2013 and June 30, 2013, respectively. Available for sale securities are reported at their aggregate fair value, and unrealized gains and losses are included as a component of other comprehensive income, net of deferred taxes. As of June 30, 2014, investment securities available for sale had a net unrealized gain of $26.8 million, compared to a net unrealized loss of $16.6 million and $6.7 million as of December 31, 2013 and June 30, 2013, respectively. In determining whether we had any other than temporary impairment for securities with unrealized losses we consider the amount and duration of the impairment, whether the impairment is industry wide or specific to the financial condition of the issuer, our ability to hold the investment for recovery, adverse actions by rating agencies, discontinuation of dividends on equity securities and deferred interest payments on debt securities. Management concluded that no other than temporary impairment existed as of June 30, 2014.

Changes in the amount of our investment securities portfolio result from balance sheet trends including loans and leases, deposits and short-term borrowings. When inflows arising from deposit and treasury services products exceed loan and lease demand, we invest excess funds in the securities portfolio. Conversely, when loan demand exceeds growth in deposits and short-term borrowings, we allow overnight investments to decline and use proceeds from maturing securities to fund loan demand.

Table 8
Investment Securities
 
June 30, 2014
December 31, 2013
 
June 30, 2013
(Dollars in thousands)
 Cost
 
 Fair value
 
 Cost
 
Fair value
 
Cost
 
Fair Value
 Investment securities available for sale:
 
 
 
 
 
 U.S. Treasury
$
1,623,564

 
$
1,625,630

 
$
373,223

 
$
373,437

 
$
598,625

 
$
598,666

 Government agency
1,281,724

 
1,283,566

 
2,543,223

 
2,544,229

 
2,725,227

 
2,721,379

Mortgage-backed securities
2,605,333

 
2,596,286

 
2,486,297

 
2,446,873

 
1,866,204

 
1,843,323

 Equity securities
543

 
32,498

 
543

 
22,147

 
543

 
20,593

Municipal securities
185

 
186

 
186

 
187

 
186

 
187

Other
—

 
—

 
863

 
830

 
850

 
828

Total investment securities available for sale
5,511,349

 
5,538,166

 
5,404,335

 
5,387,703

 
5,191,635

 
5,184,976

 Investment securities held to maturity:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
693

 
729

 
907

 
974

 
1,130

 
1,200

 Total investment securities
$
5,512,042

 
$
5,538,895

 
$
5,405,242

 
$
5,388,677

 
$
5,192,765

 
$
5,186,176


Since December 31, 2013, the proceeds from maturing government agency securities were primarily reinvested into U.S. Treasury securities at higher-yielding rates. As of June 30, 2014, equity securities included our investment in Bancorporation stock of $0.5 million and $32.0 million at cost and fair value, respectively. Pursuant to the Merger Agreement, the capital stock of Bancorporation will be retired.



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Table of Contents

Loans and Leases
We report our acquired and originated loan portfolios separately, and each portfolio is further divided into commercial and non-commercial based on the type of borrower, purpose, collateral, and/or our underlying credit management processes. Additionally, we have identified loan classes, which further disaggregate loans based upon common risk characteristics. See Note D to the Consolidated Financial Statements, "Loans and Leases," for definitions of each loan class.

Table 9
Loans and Leases
(Dollars in thousands)
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Acquired loans:
 
 
 
 
 
Commercial:
 
 
 
 
 
Construction and land development
$
80,827

 
$
78,915

 
$
160,733

Commercial mortgage
637,481

 
642,891

 
859,038

Other commercial real estate
34,688

 
41,381

 
81,904

Commercial and industrial
33,851

 
17,254

 
37,336

Other
1,270

 
866

 
1,018

Total commercial loans
788,117

 
781,307

 
1,140,029

Noncommercial:
 
 
 
 
 
Residential mortgage
270,688

 
213,851

 
256,972

Revolving mortgage
20,129

 
30,834

 
36,153

Construction and land development
28,759

 
2,583

 
9,009

Consumer
2,240

 
851

 
1,173

Total noncommercial loans
321,816

 
248,119

 
303,307

Total acquired loans
1,109,933

 
1,029,426

 
1,443,336

Originated loans and leases:
 
 
 
 
 
Commercial:
 
 
 
 
 
Construction and land development
342,021

 
319,847

 
305,789

Commercial mortgage
6,367,096

 
6,362,490

 
6,135,068

Other commercial real estate
178,899

 
178,754

 
176,031

Commercial and industrial
1,292,213

 
1,081,158

 
997,504

Lease financing
413,422

 
381,763

 
352,818

Other
131,051

 
175,336

 
172,861

Total commercial loans
8,724,702

 
8,499,348

 
8,140,071

Noncommercial:
 
 
 
 
 
Residential mortgage
1,071,089

 
982,421

 
884,020

Revolving mortgage
2,122,675

 
2,113,285

 
2,123,814

Construction and land development
119,420

 
122,792

 
119,253

Consumer
377,137

 
386,452

 
388,311

Total noncommercial loans
3,690,321

 
3,604,950

 
3,515,398

Total originated loans and leases
12,415,023

 
12,104,298

 
11,655,469

Total loans and leases
$
13,524,956

 
$
13,133,724

 
$
13,098,805


At June 30, 2014, total acquired loans increased $80.5 million, or 7.8 percent, compared to December 31, 2013 and decreased $333.4 million, or 23.1 percent compared to June 30, 2013. The increase in acquired loans from December 31, 2013 is attributable to the 1st Financial merger, which resulted in additional acquired loans totaling $291.7 million at June 30, 2014, and is partially offset by continued loan run off. The decrease in the acquired portfolio from June 30, 2013 is due to continued loan run off.

Total originated loans increased $310.7 million, or 2.6 percent, and $759.6 million, or 6.5 percent compared to December 31, 2013 and June 30, 2013, respectively. The increases are primarily driven by increases in commercial mortgage, commercial and industrial and residential mortgage loans.

While the current economic conditions continue to suppress loan demand, we believe the 2014 growth to date points to general improvement in consumer confidence, and we expect originated loan growth to continue for the remainder of 2014.


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Table of Contents

Allowance for Loan and Lease Losses

At June 30, 2014, the allowance for loan and lease losses allocated to originated loans totaled $176.9 million, or 1.43 percent of originated loans and leases, compared to $179.9 million, or 1.49 percent, and $181.8 million, or 1.56 percent, at December 31, 2013 and June 30, 2013, respectively. An additional allowance of $29.3 million relates to acquired loans at June 30, 2014, compared to $53.5 million at December 31, 2013 and $76.5 million at June 30, 2013.

Management considers the allowance adequate to absorb estimated inherent losses that relate to loans and leases outstanding at June 30, 2014, although future adjustments may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan and lease losses. Such agencies may require adjustments to the allowance based on information available to them at the time of their examination.

BancShares recorded a $7.3 million credit to provision for loan and lease losses during the second quarter of 2014, compared to a credit to provision expense of $13.2 million in the same quarter of 2013. For the six months ended June 30, 2014, the credit to provision for loan and lease losses totaled $9.2 million in comparison to $31.8 million credit for the same period of 2013. The credit for acquired loans totaled $9.5 million and $11.8 million during the second quarter and first six months of 2014, respectively, compared to credits of $15.5 million and $38.1 million for the same periods of 2013. The quarter over quarter and year-to-date change is the result of loan runoff and repayments. Provision expense for originated loans totaled $2.2 million and $2.6 million during the second quarter and first six months of 2014, respectively, compared to $2.2 million and $6.2 million during the same periods of 2013, the result of credit quality improvements in the originated loan portfolio and a reduction in net charge-offs.

Net charge-offs for originated loans equaled $3.3 million and $5.6 million during the second quarter and first six months of 2014, respectively, compared to $4.4 million and $10.9 million during the same periods of 2013. On an annualized basis, net charge-offs represented 0.11 percent and 0.09 percent of average originated loans and leases during the second quarter and first six months of 2014, respectively, compared to 0.15 percent and 0.19 percent during the same periods of 2013. Net charge-offs on acquired loans equaled $6.1 million and $12.4 million in the second quarter and first six months of 2014, respectively, compared to $4.5 million and $25.3 million recorded in the same periods of 2013. Loss estimates for most acquired loans are made at the individual loan level using loan-specific information. Therefore, fluctuations in charge-off levels on acquired loans are indicative of updated cash flow information but are not indicative of future performance of other acquired loans.

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Table 10
Allowance for Loan and Lease Losses (ALLL)
 
2014
 
2013
 
Six months ended June 30
 
 
Second
 
First
 
Fourth
 
Third
 
Second
 
 
(Dollars in thousands)
Quarter
 
Quarter
 
 Quarter
 
Quarter
 
 Quarter
 
2014
 
2013
 
ALLL at beginning of period
$
222,942

 
$
233,394

 
$
237,799

 
$
258,316

 
$
273,019

 
$
233,394

 
$
319,018

 
Reclassification of reserve due to implementation of enhanced model (1)
—

 
—

 
—

 
—

 
7,368

 
—

 
7,368

 
Provision (credit) for loan and lease losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired loans
(9,529
)
 
(2,273
)
 
(834
)
 
(12,615
)
 
(15,473
)
 
(11,802
)
 
(38,095
)
 
Originated loans
2,230

 
370

 
8,110

 
4,932

 
2,231

 
2,600

 
6,247

 
Net charge-offs of loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Charge-offs
(10,904
)
 
(10,676
)
 
(13,494
)
 
(14,628
)
 
(10,960
)
 
(21,580
)
 
(39,904
)
 
Recoveries
1,507

 
2,127

 
1,813

 
1,794

 
2,131

 
3,634

 
3,682

 
Net charge-offs of loans and leases
(9,397
)
 
(8,549
)
 
(11,681
)
 
(12,834
)
 
(8,829
)
 
(17,946
)
 
(36,222
)
 
ALLL at end of period
$
206,246

 
$
222,942

 
$
233,394

 
$
237,799

 
$
258,316

 
$
206,246

 
$
258,316

 
ALLL at end of period allocated to loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
$
29,331

 
$
44,993

 
$
53,520

 
$
59,517

 
$
76,534

 
$
29,331

 
$
76,534

 
Originated
176,915

 
177,949

 
179,874

 
178,282

 
181,782

 
176,915

 
181,782

 
ALLL at end of period
$
206,246

 
$
222,942

 
$
233,394

 
$
237,799

 
$
258,316

 
$
206,246

 
$
258,316

 
Net charge-offs of loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
$
6,133

 
$
6,254

 
$
5,163

 
$
4,402

 
$
4,466

 
$
12,387

 
$
25,343

 
Originated
3,264

 
2,295

 
6,518

 
8,432

 
4,363

 
5,559

 
10,879

 
Total net charge-offs
$
9,397

 
$
8,549

 
$
11,681

 
$
12,834

 
$
8,829

 
$
17,946

 
$
36,222

 
Reserve for unfunded commitments (1)
$
380

 
$
324

 
$
357

 
$
375

 
$
376

 
$
380

 
$
376

 
Average loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
$
1,183,464

 
$
1,282,816

 
$
1,086,469

 
$
1,310,010

 
$
1,535,796

 
$
1,249,989

 
$
1,616,348

 
Originated
12,383,148

 
12,177,129

 
12,002,167

 
11,801,700

 
11,631,784

 
12,263,591

 
11,612,019

 
Loans and leases at period-end:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
1,109,933

 
1,270,818

 
1,029,426

 
1,188,281

 
1,443,336

 
1,109,933

 
1,443,336

 
Originated
12,415,023

 
12,200,226

 
12,104,298

 
11,884,585

 
11,655,469

 
12,415,023

 
11,655,469

 
Ratios
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net charge-offs (annualized) to average loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
2.08
%
 
1.98
%
 
1.89
%
 
1.33
%
 
1.17
%
 
2.00
%
 
3.16
%
 
Originated
0.11

 
0.08

 
0.22

 
0.28

 
0.15

 
0.09

 
0.19

 
ALLL to total loans and leases:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquired
2.64

 
3.54

 
5.20

 
5.01

 
5.30

 
2.64

 
5.30

 
Originated
1.43

 
1.46

 
1.49

 
1.50

 
1.56

 
1.43

 
1.56

 
(1) During the second quarter of 2013, BancShares enhanced its ALLL model that included estimated losses on unfunded commitments. As a result of these modifications, $7.4 million of the balance previously reported as a reserve of unfunded commitments was reclassified to the ALLL.

Asset Quality

Asset quality continues to be very strong as we continue to ensure appropriate underwriting standards are followed and all nonperforming assets are managed appropriately. Nonperforming assets include nonaccrual loans and leases and OREO resulting from both acquired and originated loans.
As of June 30, 2014, BancShares’ nonperforming assets amounted to $175.8 million, a decrease of $62.0 million from $237.8 million at June 30, 2013. Nonperforming assets as a percentage of total loans and leases plus OREO amounted to 1.29 percent, compared to 1.80 percent at June 30, 2013. Of the $175.8 million in nonperforming assets at June 30, 2014, $94.2 million related to acquired covered loans and OREO, $9.4 million related to acquired non-covered loans and OREO, and $72.2 million relates to originated loans and OREO. Acquired nonperforming assets for the second quarter decreased $28.1 million, or 21.4 percent, when compared to the second quarter of 2013. Acquired covered nonperforming assets represent 10.97 percent of acquired covered loans and OREO, compared to 7.02 percent and 8.62 percent as of December 31, 2013 and June 30, 2013,

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respectively. Originated nonperforming assets represented 0.58 percent of originated loans and leases plus OREO as of June 30, 2014, in comparison to 0.74 percent and 0.91 percent as of December 31, 2013 and June 30, 2013, respectively, due to a reduction in originated nonaccrual loans.
Nonperforming assets as a percentage of total loans and leases plus OREO amounted to 1.29 percent at June 2014 compared to 1.25 percent at December 31, 2013. Total originated nonperforming assets decreased $17.8 million during the second quarter of 2014 in comparison to December 31, 2013. Originated nonperforming assets represented 0.58 percent of originated loans and leases plus OREO as of June 30, 2014, in comparison to 0.74 percent at December 31, 2013. The change is primarily a result of overall reduction in originated OREO balances. Acquired covered nonperforming assets represented 10.97 percent of originated loans and leases plus OREO as of June 30, 2014, in comparison to 7.02 percent at December 31, 2013.

Table 11
Nonperforming Assets
 
2014
 
2013
 
Second
 
First
 
Fourth
 
Third
 
Second
(Dollars in thousands)
Quarter
 
Quarter
 
 Quarter
 
Quarter
 
 Quarter
Risk Elements
 
 
 
 
 
 
 
 
 
Nonaccrual loans and leases:
 
 
 
 
 
 
 
 
 
Acquired
$
54,036

 
$
52,108

 
$
28,493

 
$
29,194

 
$
46,892

Originated
46,485

 
46,952

 
53,170

 
66,840

 
69,133

Other real estate:
 
 
 
 
 
 
 
 
 
Acquired covered
40,136

 
41,855

 
47,081

 
58,769

 
84,833

Acquired not covered
9,406

 
10,664

 
—

 
—

 
—

Originated
25,745

 
33,840

 
36,898

 
40,338

 
36,942

 Total nonperforming assets
$
175,808

 
$
185,419

 
$
165,642

 
$
195,141

 
$
237,800

Nonperforming assets:
 
 
 
 
 
 
 
 
 
Acquired covered
$
94,172

 
$
93,963

 
$
75,574

 
$
87,963

 
$
131,725

Acquired not covered
9,406

 
10,664

 
—

 
—

 
—

Originated
72,230

 
80,792

 
90,068

 
107,178

 
106,075

 Total nonperforming assets
$
175,808

 
$
185,419

 
$
165,642

 
$
195,141

 
$
237,800

Accruing loans and leases greater than 90 days past due:
 
 
 
 
 
 
 
 
 
Acquired
$
69,660

 
$
137,102

 
$
193,892

 
$
205,847

 
$
253,935

Originated
9,872

 
9,471

 
8,784

 
9,363

 
11,187

Nonperforming assets to total loans and leases plus other real estate:
 
 
 
 
 
 
 
 
 
Acquired covered
10.97
%
 
9.34
%
 
7.02
%
 
7.05
%
 
8.62
%
Acquired not covered
3.12

 
3.36

 
—

 
—

 
—

Originated
0.58

 
0.66

 
0.74

 
0.90

 
0.91

Total
1.29

 
1.37

 
1.25

 
1.48

 
1.80



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Troubled Debt Restructurings

Troubled debt restructurings (TDRs) are selectively made to provide relief to customers experiencing liquidity challenges or other circumstances that could affect their ability to meet their debt obligations. Typical modifications include short-term deferral of interest or modification of payment terms. Nonperforming TDRs are not accruing interest and are included as nonperforming assets within nonaccrual loans and leases. TDRs, which are accruing at the time of restructure and continue to perform based on the restructured terms, are considered performing.

Table 12
Troubled Debt Restructurings
(Dollars in thousands)
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Accruing TDRs:
 
 
 
 
 
Acquired
$
62,592

 
$
90,829

 
$
131,156

Originated
93,904

 
85,126

 
84,617

Total accruing TDRs
156,496

 
175,955

 
215,773

Nonaccruing TDRs:
 
 
 
 
 
Acquired
17,861

 
11,479

 
27,338

Originated
21,564

 
19,322

 
34,490

Total nonaccruing TDRs
39,425

 
30,801

 
61,828

All TDRs:
 
 
 
 
 
Acquired
80,453

 
102,308

 
158,494

Originated
115,468

 
104,448

 
119,107

Total TDRs
$
195,921

 
$
206,756

 
$
277,601


Interest-Bearing Liabilities
Interest-bearing liabilities include interest-bearing deposits, short-term borrowings and long-term obligations. Interest-bearing liabilities totaled $13.88 billion as of June 30, 2014, and June 30, 2013, and an increase of $230.1 million since December 31, 2013. The increase from December 31, 2013 is primarily due to the increase in interest-bearing deposits as a result of organic growth and the 1st Financial acquisition.
Deposits
At June 30, 2014, total deposits equaled $18.56 billion, an increase of $682.7 million, or 3.8 percent, since December 31, 2013 and an increase of $538.7 million, or 3.0 percent, since June 30, 2013. The increase from both periods resulted from the 1st Financial merger and additional organic growth in legacy markets.

Due to our focus on maintaining a strong liquidity position, core deposit retention remains a key business objective. We believe that traditional bank deposit products remain an attractive option for many customers, but as economic conditions improve, we recognize that our liquidity position could be adversely affected as bank deposits are withdrawn and invested elsewhere. Our ability to fund future loan growth is dependent on our success at retaining existing deposits and generating new deposits at a reasonable cost.
Short-Term Borrowings
At June 30, 2014, short-term borrowings totaled $788.5 million compared to $581.9 million and $511.4 million as of June 30, 2013 and December 31, 2013, respectively. The increase in short-term borrowings is due to subordinated debt with maturities less than one year being reclassified from long-term obligations.
Long-Term Obligations
Long-term obligations equaled $314.5 million at June 30, 2014, down $128.8 million and $196.2 million from June 30, 2013 and December 31, 2013, respectively. The decrease is primarily the result of subordinated debt of $125.0 million with maturities less than one year being reclassified to short-term borrowings.

At June 30, 2014, December 31, 2013 and June 30, 2013, long-term obligations included $96.4 million in junior subordinated debentures representing obligations to FCB/NC Capital Trust III, a special purpose entity and the grantor trust for $93.5 million of trust preferred securities. FCB/NC Capital Trust III's trust preferred securities mature in 2036 and may be redeemed at par in whole or in part at any time. BancShares has guaranteed all obligations of FCB/NC Capital Trust III. The proceeds from the trust preferred securities were used to purchase the junior subordinated debentures issued by BancShares.
Shareholders' Equity and Capital Adequacy

BancShares and FCB are required to meet minimum requirements imposed by regulatory authorities. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our consolidated financial statements.

In accordance with accounting principles generally accepted in the United States of America (GAAP), unrealized gains and losses on certain assets and liabilities and adjustment for pension funded status, net of deferred taxes, are included in accumulated other comprehensive income within shareholder's equity and directly impact the calculation of our capital ratios. In the aggregate, these items represented a net increase in shareholders' equity of $4.1 million at June 30, 2014, compared to net reductions of $100.2 million at June 30, 2013. The $104.2 million favorable impact on shareholders' equity from June 30, 2013, reflects the combined impact of changes in the funded status of the pension plan and unrealized gains on investment securities available for sale.

Table 13
Analysis of Capital Adequacy
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
 
Regulatory
minimum
 
Well-capitalized requirement
BancShares
 
 
 
 
 
 
 
 
 
Risk-based capital ratios
 
 
 
 
 
 
 
 
 
Tier 1 capital
14.61
%
 
14.92
%
 
14.91
%
 
4.00
%
 
6.00
%
Total capital
15.95

 
16.42

 
16.41

 
8.00

 
10.00

Tier 1 leverage ratio
9.71

 
9.82

 
9.68

 
3.00

 
5.00

 
 
 
 
 
 
 
 
 
 
Bank
 
 
 
 
 
 
 
 
 
Risk-based capital ratios
 
 
 
 
 
 
 
 
 
Tier 1 capital
13.88
%
 
14.14
%
 
14.42
%
 
4.00
%
 
6.00
%
Total capital
15.13

 
15.57

 
15.86

 
8.00

 
10.00

Tier 1 leverage ratio
9.28

 
9.36

 
9.43

 
3.00

 
5.00


BancShares continues to exceed minimum capital standards and FCB remains well-capitalized.

In July 2013, Bank regulatory agencies approved new global regulatory capital guidelines (Basel) aimed at strengthening existing capital requirements for bank holding companies through a combination of higher minimum capital requirements, new capital conservation buffers and more conservative definitions of capital and balance sheet exposure. BancShares will be subject to the requirements of Basel effective January 1, 2015, subject to a transition period for several aspects of the rule.

Under the revised rules, BancShares' tier 1 common equity ratio based on the current tier 1 capital and risk-weighted assets calculations, excluding trust preferred securities, would be 13.96 percent at June 30, 2014, compared to the fully phased-in, well-capitalized minimum of 9.0 percent, which includes the 2.5 percent minimum conservation buffer. Management continues to monitor Basel developments and remains committed to managing our capital levels in a prudent manner. The proposed tier 1 common equity ratio is calculated in Table 14.

Table 14
Tier 1 Common Equity
(Dollars in thousands)
June 30, 2014
Tier 1 capital
$
2,125,528

Less: restricted core capital
93,500

Tier 1 common equity
$
2,032,028

Risk-adjusted assets
$
14,551,757

 
 
Tier 1 common equity ratio
13.96
%


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Table 15
BASEL Capital Requirements

This table describes the minimum and well-capitalized requirements for the transitional period beginning during 2016 and the fully phased-in requirements that become effective during 2019.
Basel final rules
Basel minimum requirement 2016
 
Basel well-capitalized 2016
 
Basel minimum requirement 2019
 
Basel well-capitalized 2019
Leverage ratio
4.00
%
 
5.00
%
 
4.00
%
 
5.00
%
Common equity tier 1
4.50

 
6.50

 
4.50

 
6.50

Common equity plus conservation buffer
5.13

 
7.13

 
7.00

 
9.00

Tier 1 capital ratio
6.00

 
8.00

 
6.00

 
8.00

Total capital ratio
8.00

 
10.00

 
8.00

 
10.00

Total capital ratio plus conservation buffer
8.63

 
10.63

 
10.50

 
12.50


RISK MANAGEMENT

Effective risk management is critical to our success. The board of directors has established a Risk Committee that provides oversight of enterprise-wide risk management. The Risk Committee is responsible for establishing risk appetite and supporting tolerances for credit, market and operational risk and ensuring that risk is managed within those tolerances, monitoring compliance with laws and regulations, reviewing the investment securities portfolio to ensure that portfolio returns are managed within market risk tolerance and monitoring our legal activity and associated risk. With guidance from and oversight by the Risk Committee, management continually refines and enhances its risk management policies and procedures to maintain effective risk management programs and processes.

Mortgage reform rules mandated by the Dodd-Frank Act became effective in January 2014, requiring lenders to make a reasonable, good faith determination of a borrower's ability to repay any consumer credit transaction secured by a dwelling and to limit prepayment penalties. Increased risks of legal challenge, private right of action and regulatory enforcement are presented by these rules. BancShares implemented the required system, process, procedural and product changes prior to the effective date of the new rules. We have also modified our underwriting standards to ensure compliance with the ability to repay requirements and have determined that we will continue to offer both qualified and non-qualified mortgage products. Historical performance and conservative underwriting of impacted loan portfolios mitigates the risks of non-compliance.

Credit risk management. Credit risk is the risk of not collecting payments pursuant to the contractual terms of loans, leases and investment securities. Loans and leases not covered by loss share agreements with the FDIC were underwritten in accordance with our credit policies and procedures and are subject to periodic ongoing reviews. Acquired loans were recorded at fair value as of the acquisition date and are subject to periodic reviews to identify any further credit deterioration. Our independent credit review function conducts risk reviews and analyses of both acquired and originated loans to ensure compliance with credit policies and to monitor asset quality trends. The risk reviews include portfolio analysis by geographic location, industry, collateral type and product. We strive to identify potential problem loans as early as possible, to record charge-offs or write-downs as appropriate and to maintain adequate allowances for loan and lease losses that are inherent in the loan and lease portfolio.

Interest rate risk management. Interest rate risk (IRR) results principally from assets and liabilities maturing or repricing at different points in time, from assets and liabilities repricing at the same point in time but in different amounts and from short-term and long-term interest rates changing in different magnitudes.

We assess our short term interest rate risk by forecasting net interest income under various interest rate scenarios and comparing those results to forecast net interest income assuming stable rates. Rate shock scenarios represent an instantaneous and parallel shift in rates, up or down, from a base yield curve. Due to the existence of contractual floors on certain loans, competitive pressures that constrain our ability to reduce deposit interest rates and the extraordinarily low current level of interest rates, it is unlikely that the rates on most interest-earning assets and interest-bearing liabilities can decline materially from current levels. Our shock projections incorporate assumptions of likely customer migration of short-term deposit instruments to long-term, higher rate instruments as rates rise. Various other IRR scenarios are modeled to supplement shock scenarios. This may include interest rate ramps, changes in the shape of the yield curve and changes in the relationships of FCB rates to market rates.


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Table 16
Net Interest Income Sensitivity Simulation Analysis

This table provides the impact on net interest income resulting from various interest rate shock scenarios as of June 30, 2014 and December 31, 2013.
 
Estimated increase in net interest income
Change in interest rate (basis point)
June 30, 2014
 
December 31, 2013
+100
3.37
%
 
2.95
%
+200
4.33

 
4.56

+300
1.22

 
3.62


Table 17
Economic Value of Equity Modeling Analysis

Long-term interest rate risk exposure is measured using the economic value of equity (EVE) sensitivity analysis to study the impact of long-term cash flows on earnings and capital. EVE involves discounting cash flows of balance sheet items under different interest rate scenarios. EVE represents the difference between the sum of the present value of all asset cash flows and the sum of the present value of the liability cash flows. Cash flows will vary by interest rate scenario, resulting in variations in EVE. The amount of base-case measurement and its sensitivity to shifts in the yield curve allow management to measure longer-term repricing and option risk in the balance sheet. This table presents the EVE profile as of June 30, 2014 and December 31, 2013.
 
Estimated increase (decrease) in EVE
Change in interest rate (basis point)
June 30, 2014
 
December 31, 2013
+100
3.55
 %
 
2.68
 %
+200
2.84

 
0.70

+300
(1.13
)
 
(3.05
)

We do not typically utilize interest rate swaps, floors, collars or other derivative financial instruments to attempt to hedge our overall balance sheet rate sensitivity and interest rate risk. However, we have entered into an interest rate swap to synthetically convert the variable rate on $93.5 million of junior subordinated debentures to a fixed rate of 5.50 percent through June 2016. The interest rate swap qualifies as a hedge under GAAP. See Note K to the Consolidated Financial Statements, "Derivatives," for additional discussion of this interest rate swap.

Liquidity risk management. Liquidity risk is the risk that an institution is unable to generate or obtain sufficient cash or its equivalents on a cost-effective basis to meet commitments as they fall due. The most common sources of liquidity risk arise from mismatches in the timing and value of on-balance sheet and off-balance sheet cash inflows and outflows. In general, on-balance sheet mismatches generate liquidity risk when the effective maturity of assets exceeds the effective maturity of liabilities. A commonly cited example of a balance sheet liquidity mismatch is when long-term loans (assets) are funded with short-term deposits (liabilities). Other forms of liquidity risk include market constraints on the ability to convert assets into cash at expected levels, an inability to access funding sources at sufficient levels at a reasonable cost, and changes in economic conditions or exposure to credit, market, operation, legal and reputation risks that can affect an institution’s liquidity risk profile.

We utilize various limit-based measures to monitor, measure and control liquidity risk across three different types of liquidity:
•
Tactical liquidity measures the risk of a negative cash flow position whereby cash outflows exceed cash inflows over a short-term horizon out to nine weeks;
•
Structural liquidity measures the amount by which illiquid assets are supported by long-term funding; and
•
Contingent liquidity utilizes cash flow stress testing across three crisis scenarios to determine the adequacy of our liquidity.

We aim to maintain a diverse mix of existing and potential liquidity sources to support the liquidity management function. At its core is a reliance on the retail deposit book, due to the generally stable balances and low cost it offers. Other sources of liquidity include asset-based liquidity in the form of cash and unencumbered securities, as well as access to wholesale funding from external counterparties, primarily FHLB advances and Federal Funds lines. We aim to avoid funding concentrations by diversifying our external funding with respect to maturities, counterparties and nature (i.e. secured versus unsecured).


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One of our principal sources of noncore funding is advances from the Federal Home Loan Bank (FHLB) of Atlanta. Outstanding FHLB advances equaled $250.3 million as of June 30, 2014, and we had sufficient collateral pledged to secure $1.11 billion of additional borrowings. Additionally, we maintain Federal Funds lines and other borrowing facilities. At June 30, 2014, BancShares had access to $665.0 million in unsecured borrowings through various sources.

Free liquidity includes cash on deposit at various banks, overnight investments and the unpledged portion of investment securities available for sale, all of which can be easily converted to cash. Free liquidity totaled $3.73 billion at June 30, 2014 compared to $3.39 billion at December 31, 2013.
CRITICAL ACCOUNTING POLICIES

There have been no significant changes in our Critical Accounting Policies as described in our 2013 Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS
Statements in this Report and exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents filed by us from time to time with the Securities and Exchange Commission.

Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “projects,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of BancShares’ management about future events.

Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, customer acceptance of our services, products and fee structure, the competitive nature of the financial services industry, our ability to compete effectively against other financial institutions in our banking markets, actions of government regulators, the level of market interest rates and our ability to manage our interest rate risk, changes in general economic conditions that affect our loan and lease portfolio, the abilities of our borrowers to repay their loans and leases, the values of real estate and other collateral, the impact of the FDIC-assisted transactions and other developments or changes in our business that we do not expect.
Actual results may differ materially from those expressed in or implied by any forward-looking statements. Except to the extent required by applicable law or regulation, BancShares undertakes no obligation to revise or update publicly any forward-looking statements for any reason.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Market risk is the potential economic loss resulting from changes in market prices and interest rates. This risk can either result in diminished current fair values of financial instruments or reduced net interest income in future periods. As of June 30, 2014, BancShares’ market risk profile has not changed significantly from December 31, 2013, as discussed in the Form 10-K. Changes in fair value that result from movement in market rates cannot be predicted with any degree of certainty. Therefore, the impact that future changes in market rates will have on the fair values of financial instruments is uncertain.
Item 4.
Controls and Procedures
BancShares' management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of BancShares' disclosure controls and procedures as of the end of the period covered by this Quarterly Report, in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (Exchange Act). Based upon that evaluation, as of the end of the period covered by this report, the Chief Executive Officer and the Chief Financial Officer concluded that BancShares' disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in the reports it files under the Exchange Act.

No change in BancShares' internal control over financial reporting occurred during the second quarter of 2014 that had materially affected or is reasonably likely to materially affect, BancShares' internal control over financial reporting.

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PART II

Item 1. Legal Proceedings

BancShares and various subsidiaries have been named as defendants in various legal actions arising from our normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those other matters cannot be determined, in the opinion of management, any such liability will not have a material effect on BancShares’ consolidated financial statements.

Additional information relating to legal proceedings is set forth in Note J of BancShares' Notes to Unaudited Consolidated Financial Statements.
 
Item 1A.
Risk Factors

Except as discussed below, there have been no material changes from the risk factors previously disclosed in our Form 10-K for the year ended December 31, 2013.

Additional risks and uncertainties that are not currently known or that management does not currently deem to be material could also have a material adverse impact on our financial condition, the results of our operations or our business. If such risks and uncertainties were to become reality or the likelihood of those risks was to increase, the market price of our common stock could decline significantly.

Proposed merger with First Citizens Bancorporation, Inc.
On June 10, 2014, BancShares entered into an Agreement and Plan of Merger (the “Merger Agreement”) with First Citizens Bancorporation, Inc., a Bancorporation Carolina corporation (“Bancorporation”), pursuant to which Bancorporation will merge with and into BancShares. The Merger Agreement provides that each share of Bancorporation common stock will be converted into the right to receive 4.00 shares of BancShares' Class A common stock and $50.00 cash, unless the holder elects for each share of such holder’s Bancorporation common stock to be converted into the right to receive 3.58 shares of BancShares' Class A common stock and 0.42 shares of BancShares' Class B common stock.
The Merger Agreement has been approved by the independent members of the Board of Directors of each company following a recommendation by a special committee of independent members the board of each company. Subject to certain conditions, including the receipt of shareholder and regulatory approvals, the merger is expected to be completed in the fourth quarter of 2014.
On July 17, 2014, as amended August 6, 2014, BancShares filed a Registration Statement on Form S-4 with the Securities and Exchange Commission. Within that Form S-4, BancShares has identified various risk factors that are related to the proposed Merger.

Certain Risk Factors Relating to the Proposed Merger

The market price of BancShares common stock may fluctuate, which could affect the approval of the merger by Bancorporation's shareholders.Under the terms of the Merger Agreement, each share of Bancorporation common stock outstanding immediately prior to the effective time of the merger (with certain exceptions) will be converted into the right to receive 4.0 shares of BancShares Class A common stock and $50.00 in cash, unless the holder of such share elects, pursuant to a letter of transmittal that will be delivered after closing of the merger, for each share of such holder’s Bancorporation common stock to be converted into the right to receive 3.58 shares of BancShares Class A common stock and 0.42 shares of BancShares Class B common stock. Cash will be paid in lieu of issuing fractional shares of BancShares common stock. The value of the shares of BancShares Class A common stock and BancShares Class B common stock to be issued to Bancorporation shareholders in the merger may fluctuate between now and the closing date of the merger due to a variety of factors, including general market and economic conditions, changes in the parties’ respective businesses, operations and prospects, and regulatory considerations, among other things. Many of these factors are beyond the control of BancShares and Bancorporation. A decrease in the value of BancShares' common stock could cause Bancorporation's shareholders to withhold their approval of the merger. There can be no assurance as to whether or when the merger will be completed.

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BancShares may fail to realize all of the anticipated benefits and cost savings of the merger.
The success of the merger will depend on, among other things, BancShares’ ability to realize anticipated cost savings and to combine the businesses of BancShares and Bancorporation in a manner that does not materially disrupt the existing customer relationships of either BancShares or Bancorporation or result in decreased revenues from customers of either of them. If BancShares is not able to successfully achieve these objectives, then the anticipated benefits and cost savings of the merger may not be realized fully, if at all, or may take longer to realize than expected.
BancShares and Bancorporation have operated and, until the completion of the merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of either BancShares’ or Bancorporation’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the ability of BancShares or Bancorporation to maintain relationships with their respective clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. The loss of key employees could adversely affect BancShares’ ability to successfully conduct its business in the markets in which Bancorporation now operates, which could have an adverse effect on BancShares’ financial results and the value of its stock. Integration efforts by BancShares and Bancorporation will also divert management attention and resources. These integration matters could have an adverse effect on each of BancShares and Bancorporation during the transition period and on the combined company for an undetermined period following completion of the merger. Additionally, the actual benefits and cost savings of the merger could be less than anticipated.
Completion of the merger is subject to many conditions and if these conditions are not satisfied or, where permissible, waived, the merger will not be completed.
The obligations of BancShares and Bancorporation to complete the merger are subject to satisfaction or, where permissible, waiver of a number of conditions, including, among others: (i) the adoption of the merger agreement by BancShares stockholders and Bancorporation shareholders, (ii) the approval of the BancShares charter amendment proposal by BancShares stockholders, (iii) receipt of approval of various governmental authorities without the imposition of a burdensome condition, (iv) the authorization for listing on the NASDAQ Global Select Market of the shares of BancShares Class A common stock to be issued in the merger, (v) the effectiveness of the Registration Statement on Form S-4 filed by BancShares and the absence of any stop order suspending the effectiveness of that Registration Statement (or proceedings for that purpose initiated or threatened by the SEC and not withdrawn), (vi) the absence of any order, injunction or decree by any court or agency of competent jurisdiction or other legal restraint or prohibition preventing the consummation of the merger, the bank merger or any of the other material transactions contemplated by the merger agreement, (vii) the absence of any statute, rule, regulation, order, injunction or decree enacted, entered, promulgated or enforced by any governmental entity that prohibits or makes illegal consummation of the merger, the bank merger or any of the other material transactions contemplated by the merger agreement, (viii) the accuracy of the representations and warranties of each other party in the merger agreement as of the day on which the merger is completed, subject to the materiality standards provided in the merger agreement and the performance of the other party in all material respects of all obligations required to be performed by it at or prior to the effective time of the merger under the merger agreement (and the receipt by each party of certificates from the other party to such effect), (ix) receipt by each party of an opinion of legal counsel as to certain tax matters, (x) the absence of any events or occurrences that, individually or in the aggregate, have had or would reasonably be expected to have a material adverse effect on the other party, and (xi) a majority of the shares held by the minority holders of Bancorporation common stock must not have voted against the merger. There can be no assurance that the conditions to closing of the merger will be satisfied or, where permissible, waived, or that the merger will be completed. Further, it is possible that one or more of the conditions to closing the merger will not be met and that the board of directors of the party for whom the condition exists will waive the condition, allowing the merger to be completed.
Termination of the merger agreement or failure to complete the merger after approval by Bancorporation shareholders could negatively impact BancShares or Bancorporation.
If the merger agreement is terminated, there may be various consequences. For example, BancShares’ or Bancorporation’s businesses may have been affected adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. Additionally, if the merger agreement is terminated, the market price of BancShares’ or Bancorporation’s common stock could decline to the extent that the current market prices reflect a market assumption that the merger will be completed. If the merger agreement is terminated under specified circumstances, Bancorporation has agreed to pay BancShares a termination fee of $6,450,000, $10,000,000 or $22,574,000 (and in certain instances, BancShares’ documented expenses), depending on the timing and circumstances of the termination.

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BancShares and Bancorporation will be subject to business uncertainties and contractual restrictions while the merger is pending.
Uncertainty about the effect of the merger on employees and customers may have an adverse effect on BancShares and/or Bancorporation. These uncertainties may impair BancShares and/or Bancorporation’s ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers and others that deal with Bancorporation to seek to change existing business relationships with Bancorporation. Retention of certain employees by Bancshares or Bancorporation may be challenging while the merger is pending, as certain employees may experience uncertainty about their future roles with Bancorporation or BancShares. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with Bancorporation or BancShares, Bancorporation’s and/or BancShares' businesses could be harmed.
BancShares and Bancorporation will incur significant transaction and merger-related costs in connection with the merger.
BancShares expects to incur a number of costs associated with the merger and combining the operations of the two companies. The substantial majority of expenses will be comprised of transaction costs related to the merger. The significant costs associated with the merger include, among others, fees and expenses of financial advisors and other advisors and representatives, certain employment-related costs relating to employees of Bancorporation, filing fees and printing costs required by applicable law and regulations. Some of these costs have already been incurred or may be incurred regardless of whether the merger is consummated, including a portion of the fees and expenses of financial advisors and other advisors and representatives and filing fees. BancShares also will incur transaction fees and costs related to formulating and implementing integration plans with respect to the two companies, including facilities and systems consolidation costs. BancShares continues to assess the magnitude of these costs, and additional unanticipated costs may be incurred in the merger and the integration of the two companies’ businesses. Although BancShares expects that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, should allow BancShares to offset integration-related costs over time, this net benefit may not be achieved in the near term or at all.
The merger will result in an increase in the number of shares of BancShares Class A common stock and BancShares Class B common stock available for trading, which could depress the price of such shares and increase the volatility of the price of such shares, both before and after completion of the merger.
The merger will increase the number of shares of BancShares Class A common stock and BancShares Class B common stock available for sale in the public markets. As of June 30, 2014, approximately 8,586,058 shares of BancShares Class A common stock and 1,032,883 shares of BancShares Class B common stock were outstanding.
Because Bancorporation shareholders are entitled to elect whether to exchange their shares of Bancorporation common stock for BancShares Class A common stock and cash or a combination of BancShares Class A common stock and BancShares Class B common stock, the number of new shares of BancShares Class A common stock and new shares of BancShares Class B common stock that will be issued to holders of Bancorporation common stock and become immediately available for sale following the merger is unknown.
Sales of large amounts of shares of BancShares Class A common stock or BancShares Class B common stock could depress the market price of BancShares Class A common stock or BancShares Class B common stock, respectively. In addition, the potential that such sales may occur could depress prices, even in advance of such sales. Neither BancShares nor Bancorporation can predict the effects that any such sales, or the perception that such sales could occur, will have on the price of BancShares common stock, either before or after completion of the merger.
Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or cannot be met.
Before the transactions contemplated by the merger agreement, including the BancShares and Bancorporation merger and the bank merger, may be completed, various approvals must be obtained from bank regulatory authorities. These governmental entities may impose conditions on the granting of such approvals. Such conditions and the process of obtaining regulatory approvals could have the effect of delaying consummation of the merger(s) or of imposing additional costs or limitations on BancShares following the merger(s). The regulatory approvals may not be received at all, may not be received in a timely fashion, and may contain conditions on the completion of the merger that are not anticipated or cannot be met. If the consummation of the merger(s) is delayed, including by a delay in receipt of necessary governmental approvals, the business, financial condition and results of operations of each company may also be materially adversely affected.

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BancShares is, and Bancorporation may be, subject to litigation in connection with the merger; an adverse ruling in any such lawsuit may prevent the merger from being completed.
BancShares and Bancorporation, and their respective directors and officers, may be subject to lawsuits challenging the merger. Following announcement of the merger, BancShares received a shareholder demand from the City of Providence pursuant to Section 220 of the Delaware General Corporation Law ("DGCL") for access to certain books and records of BancShares. The purported basis for the demand was to investigate potential breaches of fiduciary duty and other wrongdoing by BancShares’ officers and directors in connection with the merger. The City of Providence concurrently filed a putative class action lawsuit in the Delaware Court of Chancery against BancShares and its directors challenging Article X, Section 8 of BancShares’ bylaws, which requires certain litigation to be brought only in North Carolina courts to the fullest extent permitted by law. That Delaware complaint, captioned City of Providence v. First Citizens BancShares, Inc., et al., C. A. No. 9795, alleges that the bylaw violates the DGCL and that adoption of the bylaw constituted a breach of fiduciary duty by BancShares’ directors. While not directly challenging the merger, the complaint contains allegations referencing the merger and seeks a declaration that any stockholder action regarding the merger may be brought in the Delaware Court of Chancery. On July 31, 2014, the City of Providence filed a second litigation in Delaware Court of Chancery challenging the merger and seeking to enjoin the BancShares stockholder vote, captioned City of Providence V. Holding, et al., C. A. No. 9988. BancShares and its directors have moved to dismiss both complaints.
If any litigation challenging the merger is successful, the relevant court may issue an order enjoining completion of the merger, which could prevent the merger from being completed or from being completed within the expected time-frame. Regardless of whether any claims are successful, such litigation is often expensive and diverts management’s attention and resources, which could adversely affect the operation of BancShares' and/or Bancorporation’s businesses.

Risk Factors Relating to Technology:
Certain information security risks continue to receive attention from regulators and financial statement users and therefore have been included in the 10-Q.
We are subject to information security risks
We maintain and transmit large amounts of sensitive information electronically, including personal and financial information of our customers. In addition to our own systems, we also rely on external vendors to provide certain services and are, therefore, exposed to their information security risk. While we seek to mitigate internal and external information security risks, the volume of business conducted through electronic devices continues to grow, and our computer systems and network infrastructure, as well as the systems of external vendors and customers, present security risks and could be susceptible to hacking or identity theft.
We are also subject to risks arising from a broad range of attacks by doing business on the Internet, which arise from both domestic and international sources and seek to obtain customer information for fraudulent purposes or, in some cases, to disrupt business activities. Information security risks could result in reputational damage and lead to a material adverse impact on our business, financial condition and financial results of operations.

We continue to encounter technological change for which we expect to incur significant expense
The financial services industry continues to experience an increase in technological complexity required to provide a competitive array of products and services to customers. Our future success requires that we maintain technology and associated facilities that will support our ability to provide products and services that satisfactorily meet the banking and other financial needs of our customers. In 2013, we undertook projects to modernize our systems and associated facilities, strengthen our business continuity and disaster recovery efforts and reduce operational risk. As the projects have evolved over time, we have identified other areas that require infrastructure improvement. As a result of the expanded scope, BancShares has increased the total projected spend to approximately $130 million. The projects will be implemented in phases over the next several years. If the projects’ objectives are not achieved or if the cost of the projects is materially in excess of the estimate, our business, financial condition and financial results could be adversely impacted.

We rely on external vendors
Third party vendors provide key components of our business infrastructure, including certain data processing and information services. A number of our vendors are large national entities with dominant market presence in their respective fields, and their services could be difficult to quickly replace in the event of failure or other interruption in service. Failures of certain vendors to provide services for any reason could adversely affect our ability to deliver products and services to our customers. External

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vendors also present information security risk. We monitor vendor risks, including the financial stability of critical vendors. The failure of a critical external vendor could disrupt our business and cause us to incur significant expense.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
PURCHASES OF COMMON STOCK

During the second quarter of 2013, our board granted authority to purchase up to 100,000 and 25,000 shares of Class A and Class B common stock, respectively, beginning on July 1, 2013 and continuing through June 30, 2014. As of June 30, 2014, no purchases had occurred pursuant to that authorization. This authorization terminated on June 30, 2014 and was not extended.

Item 6.
Exhibits
31.1
Certification of Chief Executive Officer (filed herewith)
 
 
31.2
Certification of Chief Financial Officer (filed herewith)
 
 
32.1
Certification of Chief Executive Officer (filed herewith)
 
 
32.2
Certification of Chief Financial Officer (filed herewith)
 
 
101.INS
XBRL Instance Document
 
 
101.SCH
XBRL Taxonomy Extension Schema
 
 
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
 
 
101.DEF
XBRL Taxonomy Extension Definition Linkbase
 
 
101.LAB
XBRL Taxonomy Extension Label Linkbase
 
 
101.PRE
XBRL Taxonomy Extension Presentation Linkbase


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SIGNATURES
Pursuant to the requirements 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.
 
Date:
August 8, 2014
 
 
FIRST CITIZENS BANCSHARES, INC.
 
 
 
 
(Registrant)
 
 
 
 
 
By:
 
/s/ GLENN D. MCCOY
 
 
 
 
Glenn D. McCoy
 
 
 
 
Vice President and Chief Financial Officer

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