First Community Bankshares Inc: Form 10-Q for the period ended Mar 31, 2017

Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bancshares, Inc. and its subsidiaries as a consolidated entity. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”).

Executive Overview

First Community Bancshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of March 31, 2017, the Bank operated 45 branches as First Community Bank in Virginia, West Virginia, and North Carolina and as People’s Community Bank, a Division of First Community Bank, in Tennessee. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network and, to a lesser extent, retail and wholesale repurchase agreements and Federal Home Loan Bank (“FHLB”) borrowings. We invest our funds primarily in loans to retail and commercial customers and various investment securities. Our common stock is traded on the NASDAQ Global Select Market under the symbol FCBC.

The Bank offers commercial and personal insurance services through its wholly owned subsidiary First Community Insurance Services (“FCIS”). Revenues are primarily derived from commissions paid by issuing companies on the sale of policies. As of March 31, 2017, FCIS operated 6 in-branch locations in Virginia and West Virginia. The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). Revenues consist primarily of commissions on assets under management and investment advisory fees. As of March 31, 2017, the Trust Division and FCWM managed $906 million in combined assets under various fee-based arrangements as fiduciary or agent.

Our acquisition and divestiture activity during the twelve months ended March 31, 2017, included the sale of Greenpoint Insurance Agency Inc. on October 1, 2016, and the simultaneous sale of six branches to and purchase of seven branches from First Bank on July 15, 2016.

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles (“GAAP”) in the U.S. and conform to general practices within the banking industry. Our financial position and results of operations may require management to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Estimates, assumptions, and judgments, which are periodically evaluated, are based on historical experience and other factors, including expectations of future events believed reasonable under the circumstances. These estimates are generally necessary when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve, or when an asset or liability needs recorded based on the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, when available, or third-party sources. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates.

Our accounting policies are fundamental in understanding MD&A and the disclosures presented in Item 1, “Financial Statements,” of this report. Our accounting policies are described in detail in Note 1, “Basis of Presentation and Accounting Policies,” to the Consolidated Financial Statements in Part II, Item 8 of our 2016 Form 10-K and our critical accounting estimates are detailed in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2016 Form 10-K.

Performance Overview

Highlights of our results of operations for the three months ended March 31, 2017, and financial condition as of March 31, 2017, include the following:

• Net income available to common shareholders increased $118 thousand, or 1.94%, to $6.20 million and diluted earnings per share increased $0.02, or 5.88%, to $0.36 for the first quarter of 2017 compared to the same quarter of 2016.
• Net interest margin increased 16 basis points to 4.17%, and normalized net interest margin increased 21 basis points to 3.95% compared to the same quarter of 2016.
• The Company’s book value per common share increased $0.23 to $20.18 compared to December 31, 2016.
• The Company redeemed all of its previously issued trust preferred securities totaling $15.46 million. The callable trust preferred securities bore an interest rate of three-month LIBOR plus 2.95% with a maturity date of October 8, 2033.
• The Company significantly exceeds regulatory “well capitalized” targets as of March 31, 2017.

Results of Operations

Net Income

The following table presents the changes in net income and related information for the periods indicated:

(Amounts in thousands, except per share data)

Three-Month Comparison. Net income increased in the first quarter of 2017 due to decreases in the provision for loan losses and noninterest expense and a slight increase in net interest income. These changes were offset by a decrease in noninterest income and an increase in income tax.

Net Interest Income

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” below.

The following table presents the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

(Amounts in thousands)

(1) Fully taxable equivalent ("FTE") basis based on the federal statutory rate of 35%

(2) Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.

The following table presents the impact to net interest income on a FTE basis due to changes in volume (average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

(Amounts in thousands)

(1) FTE basis based on the federal statutory rate of 35%

(2) Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.

The following table presents the net interest analysis on a FTE basis excluding the impact of non-cash purchase accounting accretion from acquired loan portfolios for the periods indicated:

(Amounts in thousands)

(1) FTE basis based on the federal statutory rate of 35%

(2) Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.

(3) Normalized totals are non-GAAP financial measures that exclude non-cash loan interest accretion related to PCI loans.

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Three-Month Comparison. Net interest income comprised 78.79% of total net interest and noninterest income in the first quarter of 2017 compared to 72.76% in the same quarter of 2016. Net interest income on a GAAP basis increased $30 thousand, or 0.14%, and net interest income on a FTE basis decreased $4 thousand, or 0.02%. Normalized net interest income on a FTE basis is a non-GAAP measure that excludes non-cash loan accretion income related to PCI loans. For additional information, see “Non-GAAP Financial Measures” below. Normalized net interest margin increased 21 basis points compared to an increase of 16 basis points on a FTE basis. Normalized net interest spread increased 22 basis points compared to an increase of 17 basis points on a FTE basis.

Average earning assets decreased $69.65 million, or 3.20%, primarily due to a decrease in securities available for sale offset by loan growth and an increase in interest-bearing deposits. The normalized yield on earning assets increased 21 basis points compared to an increase of 12 basis points on a GAAP basis. Average loans increased $108.44 million, or 6.27%, and the average loan to deposit ratio increased to 99.52% fr om 92.99%. The normalized yield on loans decreased 10 basis points compared to a decrease of 19 basis points on a GAAP basis. Non-cash accretion income decreased $313 thousand, or 21.63%, as the effect of accretion income continued to decline from acquired portfolio attrition.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $70.66 million, or 4.28%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 6 basis points, largely driven by a decrease in the average balance of borrowings. Average interest-bearing deposits increased $10.20 million, or 0.72%, which was driven by a $38.53 million, or 11.25%, increase in average interest-bearing demand deposits offset by an $18.13 million, or 3.40%, decrease in average time deposits, and a $10.20 million, or 1.90%, decrease in average savings deposits, which include money market and savings accounts. Average borrowings decreased $80.87 million, or 33.77%, largely due to a $41.40 million, or 38.32%, decrease in average FHLB advances and other borrowings, a $25.00 million, or 50.00%, decrease in average wholesale repurchase agreements, and an $11.05 million, or 14.16%, decrease in average retail repurchase agreements.

Provision for Loan Losses

Three-Month Comparison. The provision charged to operations decreased $695 thousand to $492 thousand in the first quarter of 2017 compared to the same quarter of 2016, which was attributed to the non-PCI provision.

Noninterest Income

The following table presents the components of, and changes in, noninterest income for the periods indicated:

(Amounts in thousands)

Three-Month Comparison. Noninterest income comprised 21.21% of total net interest and noninterest income in the first quarter of 2017 compared to 27.24% in the same quarter of 2016. Noninterest income decreased $2.21 million, or 27.99%, primarily due to a decrease in insurance commissions resulting from the Greenpoint divestiture in the fourth quarter of 2016. Other operating income decreased primarily due to the absence of a $357 thousand gain on the sale of closed branches in the first quarter of 2016. Net negative amortization related to the FDIC indemnification asset increased due to an additional $203 thousand in reserve provisions as the loss share agreement for commercial loans approaches the end of its term. Excluding the impact from sales of securities and branches, and net FDIC indemnification asset amortization, noninterest income decreased $1.67 million, or 19.25%, to $7.02 million in the first quarter of 2017, from $8.70 million in the same quarter of 2016.

Noninterest Expense

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

(Amounts in thousands)

Three-Month Comparison. Noninterest expense decreased $1.73 million, or 9.20%, in the first quarter of 2017 compared to the same quarter of 2016, which was largely due to a decrease in salaries and employee benefits. Salaries and employee benefits decreased $1.59 million, or 15.19%, as full-time equivalent employees, calculated using the number of hours worked, decreased to 579 as of March 31, 2017, from 660 as of March 31, 2016, primarily due to the First Bank and Greenpoint transactions that occurred during the second half of 2016. Other operating expense included a $382 thousand increase in legal fees and a $218 thousand increase in accounting fees. These increases were offset by a $383 thousand decrease in the net loss on sales and expenses related to other real estate owned (“OREO”) to $328 thousand from $711 thousand in the first quarter of 2016. Occupancy, furniture, and equipment expense decreased $288 thousand, or 10.96%, due to branch closures and divestitures that occurred during the prior year.

Income Tax Expense

Three-Month Comparison. The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies. Income tax expense increased $126 thousand, or 4.30%, and the effective tax rate increased 50 basis points to 33.00% in the first quarter of 2017 compared to the same quarter of 2016. The increase in the effective tax rate was largely due to an increase in taxable revenues as a percent of operating earnings.

Non-GAAP Financial Measures

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that management believes provide investors with important information useful in understanding our operational performance and comparing our financial measures with other financial institutions. The non-GAAP financial measures presented in this report include net interest income on a FTE basis and normalized net interest income on a FTE basis. While we believe these non-GAAP financial measures enhance understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared on a GAAP basis. Our non-GAAP financial measures may not be comparable to those reported by other financial institutions. The reconciliations of these measures to GAAP measures are presented below.

We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. The FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory rate of 35%. Normalized net interest income on a FTE basis is a non-GAAP measure that excludes non-cash loan accretion income related to PCI loans.

The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

(Amounts in thousands)

(1) FTE basis based on the federal statutory rate of 35%

(2) Includes non-cash purchase accounting accretion income from acquired loan portfolios

Financial Condition

Total assets as of March 31, 2017, increased $44.12 million, or 1.85%, to $2.43 billion from $2.39 billion as of December 31, 2016. Total liabilities as of March 31, 2017, increased $39.77 million, or 1.94%, to $2.09 billion from $2.05 billion as of December 31, 2016.

Investment Securities

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

Available-for-sale securities as of March 31, 2017, decreased $6.89 million, or 4.16%, compared to December 31, 2016, primarily due to the maturity of municipal and mortgage-backed Agency securities. The market value of securities available for sale as a percentage of amortized cost was 99.86% as of March 31, 2017, compared to 99.48% as of December 31, 2016. Held-to-maturity securities as of March 31, 2017, decreased $41 thousand, or 0.09%, compared to December 31, 2016. The market value of securities held to maturity as a percentage of amortized cost was 100.22% as of March 31, 2017, compared to 100.28% as of December 31, 2016.

Investment securities are reviewed quarterly for possible other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt or equity securities for the three months ended March 31, 2017, or for the same period of the prior year. For additional information, see Note 2, “Investment Securities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

Loans Held for Investment

Loans held for investment, our largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose. Certain loans acquired in FDIC-assisted transactions are covered under loss share agreements (“covered loans”). Total loans held for investment, net of unearned income, as of March 31, 2017, decreased $17.68 million, or 0.96%, compared to December 31, 2016, primarily due to an $11.58 million, or 0.64%, decrease in non-covered loans, which was driven by the non-farm, non-residential segment of the loan portfolio, and a $5.58 million, or 9.79%, decrease in covered loans due to continued runoff in the covered Waccamaw portfolio. For additional information, see Note 3, “Loans,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents loans, net of unearned income, with non-covered loans by loan class as of the dates indicated:

(Amounts in thousands)

The following table presents covered loans, by loan class, as of the dates indicated:

(Amounts in thousands)

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Risk Elements

We seek to mitigate credit risk by adhering to specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company’s loan review function generally analyzes all commercial loan relationships greater than $4.0 million annually and at various times during the year. Smaller commercial and retail loans are sampled for review during the year.

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. For additional information, see Note 4, “Credit Quality,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents the components of nonperforming assets and related information as of the periods indicated:

(Amounts in thousands)

(1) TDRs restructured within the past six months and nonperforming TDRs exclude nonaccrual TDRs of $24 thousand, $224 thousand, and $825 thousand for the periods ended March 31, 2017, December 31, 2016, and March 31, 2016, respectively.

(2) TDRs with six months or more of satisfactory payment performance exclude nonaccrual TDRs of $1.40 million, $1.06 million, and $377 thousand for the periods ended March 31, 2017, December 31, 2016, and March 31, 2016, respectively.

(3) Total TDRs exclude nonaccrual TDRs of $1.43 million, $1.28 million, and $1.20 million for the periods ended March 31, 2017, December 31, 2016, and March 31, 2016, respectively.

Non-covered nonperforming assets as of March 31, 2017, increased $1.96 million, or 9.29%, from December 31, 2016, due to an increase in non-covered nonaccrual loans. Non-covered nonaccrual loans as of March 31, 2017, increased $2.68 million, or 16.92%, from December 31, 2016. As of March 31, 2017, non-covered nonaccrual loans were largely attributed to single family owner occupied (57.67%) and non-farm, non-residential (18.71%) loans. As of March 31, 2017, approximately $505 thousand, or 2.73%, of non-covered nonaccrual loans were attributed to performing loans acquired in business combinations. Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $25.09 million as of March 31, 2017, a slight increase of $79 thousand, or 0.32%, compared to $25.02 million as of December 31, 2016. Non-covered delinquent loans as a percent of total non-covered loans totaled 1.41% as of March 31, 2017, which includes past due loans (0.37%) and nonaccrual loans (1.04%).

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms. Certain TDRs are classified as nonperforming when modified and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Accruing TDRs as of March 31, 2017, decreased $4.36 million, or 33.66%, to $8.59 million from December 31, 2016. There were no nonperforming accruing TDRs as of March 31, 2017, compared to $114 thousand as of December 31, 2016. Nonperforming accruing TDRs as a percent of total accruing TDRs totaled 0.88% as of December 31, 2016. Specific reserves on TDRs totaled $707 thousand as of March 31, 2017, compared to $670 thousand as of December 31, 2016.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, decreased $632 thousand, or 12.37%, as of March 31, 2017, compared to December 31, 2016. Non-covered OREO consisted of 28 properties with an average holding period of 11 months as of March 31, 2017. The net loss on the sale of OREO totaled $241 thousand for the three months ended March 31, 2017, compared to $711 thousand for the same period of the prior year. The following table presents the changes in OREO during the periods indicated:

(Amounts in thousands)

Allowance for Loan Losses

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates. As of December 31, 2016, our qualitative risk factors reflect a stable risk of loan losses due to consistent asset quality metrics and relatively stable business and economic conditions in our primary market areas. The loan portfolio is continually monitored for deterioration in credit, which may result in the need to increase the allowance for loan losses in future periods. Management considered the allowance adequate as of March 31, 2017; however, no assurance can be made that additions to the allowance will not be required in future periods. For additional information, see Note 5, “Allowance for Loan Losses,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The allowance for loan losses as of March 31, 2017, increased $510 thousand, or 2.84%, from December 31, 2016. The increase was largely attributed to a $451 thousand increase in specific reserves on impaired loans. The non-PCI allowance as a percent of non-covered loans totaled 1.03% as of March 31, 2017, compared to 1.00% as of December 31, 2016. PCI loans were aggregated into five loan pools as of March 31, 2017, and December 31, 2016: Waccamaw commercial, Waccamaw serviced home equity lines, Waccamaw residential, Peoples Bank of Virginia (“Peoples”) commercial, and Peoples residential. The cash flow analysis performed for the PCI loan pools as of March 31, 2017, and December 31, 2016, identified one pool as impaired with a cumulative impairment of $12 thousand. We recorded a net recovery of $18 thousand for the three months ended March 31, 2017, compared to a net charge-off of $962 thousand in the same period of the prior year, largely due to an overall reduction in charge-offs for commercial and consumer real estate loans.

The following table presents the changes in the allowance for loan losses, by loan class, during the periods indicated:

(Amounts in thousands)

Deposits

Total deposits as of March 31, 2017, increased $65.26 million, or 3.54%, compared to December 31, 2016. Noninterest-bearing deposits increased $39.97 million; interest-bearing deposits increased $14.57 million; savings deposits, which include money market accounts and savings accounts, increased $5.90 million; and time deposits, which include certificates of deposit and individual retirement accounts, increased $4.82 million as of March 31, 2017, compared to December 31, 2016.

Borrowings

Total borrowings as of March 31, 2017, decreased $22.82 million, or 12.77%, compared to December 31, 2016. Short-term borrowings consisted of retail repurchase agreements, which decreased $7.35 million, or 10.07%, while the weighted average rate remained constant at 0.07%, as of March 31, 2017, and December 31, 2016.

Long-term borrowings consisted of wholesale repurchase agreements; FHLB borrowings, including convertible and callable advances; and other obligations as of March 31, 2017. Wholesale repurchase agreements totaled $25.00 million with a weighted average rate of 3.18% as of March 31, 2017, and December 31, 2016. Long-term FHLB borrowings totaled $65.00 million with a weighted average rate of 4.04% as of March 31, 2017, and December 31, 2016. The Company redeemed all of its trust preferred securities on January 9, 2017, resulting in a decrease of $15.46 million in subordinate debt.

Liquidity and Capital Resources

Liquidity

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”), which reports to the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of March 31, 2017, the Company’s cash reserves and investment securities totaled $8.79 million and availability on an unsecured, committed line of credit with an unrelated financial institution totaled $15.00 million. There was no outstanding balance on the line of credit as of March 31, 2017. The Company’s cash reserves and investments provide adequate working capital to meet obligations, projected dividends to shareholders, and anticipated debt repayments for the next twelve months.

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of March 31, 2017, unencumbered cash totaled $152.85 million, unused borrowing capacity from the FHLB of $555.78 million, available credit from the FRB Discount Window of $9.09 million, available lines from correspondent banks of $90.00 million, and unpledged available-for-sale securities of $24.89 million.

Cash Flows

The following table summarizes the components of cash flow for the periods indicated:

(Amounts in thousands)

Cash and cash equivalents increased $76.54 million for the three months ended March 31, 2017, compared to a decrease of $12.20 million for the same period of the prior year primarily due to investing and financing activities. Net cash provided by investing activities increased $53.74 million for the three months ended March 31, 2017, compared to the same period of the prior year, which was largely the result of a decrease in loan originations. Net cash provided by financing activities increased $35.50 million for the three months ended March 31, 2017, compared to the same period of the prior year primarily due to increases in deposit accounts. Net cash provided by operating activities decreased $496 thousand for the three months ended March 31, 2017, compared to the same period of the prior year.

Capital Resources

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of March 31, 2017, increased $4.35 million, or 1.28%, to $343.40 million from $339.06 million as of December 31, 2016. The change in stockholders’ equity was largely due to net income of $6.20 million and other comprehensive income (“OCI”) of $530 thousand offset by dividends declared on our common stock of $2.72 million. OCI was primarily due to an increase in net unrealized gains on securities. In accordance with current regulatory guidelines, accumulated other comprehensive income/(loss) is largely excluded from stockholders' equity in the calculation of our capital ratios. We repurchased 6,800 shares of our common stock totaling $164 thousand in the first quarter of 2017. Our book value per common share increased $0.23, or 1.15%, to $20.18 as of March 31, 2017, from $19.95 as of December 31, 2016.

Capital Adequacy Requirements

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements, based on the international capital standards known as Basel III, became effective on January 1, 2015, subject to a four-year phase-in period. Basel III’s capital conservation buffer became effective on January 1, 2016, at 0.625%, and will be phased in over a four-year period (increasing by an additional 0.625% each year until it reaches 2.5% on January 1, 2019). A description of the Basel III capital rules is included in Part I, Item 1 of the 2016 Form 10-K. Our current required capital ratios are as follows:

• 4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 5.75% including the capital conservation buffer)
• 6.0% Tier 1 capital to risk-weighted assets (effectively 7.25% including the capital conservation buffer)
• 8.0% Total capital to risk-weighted assets (effectively 9.25% including the capital conservation buffer)
• 4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

The following table presents our capital ratios as of the dates indicated:

Our capital ratios as of March 31, 2017, increased from December 31, 2016, primarily due to a decrease in risk-weighted assets. As of March 31, 2017, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events since those notifications that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules on a fully phased-in basis, if such requirements were in effect, as of March 31, 2017.

Off-Balance Sheet Arrangements

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument. The following table presents our off-balance sheet arrangements as of the dates indicated:

(Amounts in thousands)

(1) Includes FHLB letters of credit

Market Risk and Interest Rate Sensitivity

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

In order to manage our exposure to interest rate risk, we periodically review third-party and internal simulation models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

On March 15, 2017, the Federal Open Market Committee raised the benchmark federal funds rate 25 basis points to a range of 75 to 100 basis points. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated. Due to the current target rate, we do not reflect a decrease of more than 100 basis points from current rates in our analysis.

(Dollars in thousands)

We have established policy limits for tolerance of interest rate risk in various interest rate scenarios and exposure limits to changes in the economic value of equity. As of March 31, 2017, exposure to interest rate risk is within our defined policy limits.

The Company primarily uses derivative instruments to manage exposure to market risk and meet customer financing needs. As of March 31, 2017, we maintained interest rate swap agreements with notional amounts totaling $4.76 million to modify our exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The fair value of the swap agreements, which are accounted for as fair value hedges and recorded as derivative liabilities, totaled $142 thousand as of March 31, 2017, and $167 thousand as of December 31, 2016. For additional information, see Note 9, “Derivative Instruments and Hedging Activities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

Inflation and Changing Prices

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not be material to our financial performance.

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 2 of this report.

Evaluation of Disclosure Controls and Procedures

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of March 31, 2017, our disclosure controls and procedures were effective.

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

Changes in Internal Control over Financial Reporting

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended March 31, 2017, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our risk factors discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our company. Individuals should carefully consider our risk factors and information included, or incorporated by reference, in this report before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, our risk factors are not intended to be an exhaustive list of all risks we face. There have been no material changes to the risk factors included in Part I, Item 1A, “Risk Factors,” of our 2016 Form 10-K.