First Community Bankshares Inc: Form 10-Q for the period ended Jun 30, 2019

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, 2018 (the “2018 Form 10-K”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

Executive Overview

First Community Bankshares, 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 June 30, 2019, the Bank operated 44 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. As of June 30, 2019, full-time equivalent employees, calculated using the number of hours worked, totaled 515. 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 trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of investment advisory fees and commissions on assets under management and administration. As of June 30, 2019, the Trust Division and FCWM managed and administered $1.05 billion in combined assets under various fee-based arrangements as fiduciary or agent.

Acquisitions and Divestitures

On September 17, 2018, the Company announced its intention to sell its remaining insurance agency assets to Bankers Insurance, LLC (“BI”) of Glen Allen, Virginia in exchange for an equity interest in BI. The sale, which closed October 1, 2018, strategically allowed the Company to continue offering insurance products to its customers through a larger, more diversified insurance agency. In connection with the decision to divest the insurance agency assets, the Company recognized a one-time goodwill impairment charge of $1.49 million during the third quarter of 2018. The Company used the fair value of the equity interest in BI as the basis for determining the goodwill impairment.

On October 2, 2018, we completed our Plan of Reincorporation and Merger changing our corporate domicile from Nevada to Virginia, along with a slight revision in the spelling of our name from First Community Bancshares, Inc. to First Community Bankshares, Inc.

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,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2019, and in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of our 2018 Form 10-K. Our critical accounting estimates are detailed in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2018 Form 10-K.

Performance Overview

Highlights of our results of operations for the three and six months ended June 30, 2019, and financial condition as of June 30, 2019, include the following:

• Net income increased $1.39 million, or 15.28%, to $10.45 million compared to the same quarter of 2018.
• Diluted earnings per share increased $0.12 to $0.66 compared to the same quarter of 2018, for an increase of 22.22%.
• Return on average assets for the quarter increased to 1.89%. Return on average equity for the quarter increased to 12.57%.
• Net interest margin increased 47 basis points to 4.72% compared to the same quarter of 2018.
• The Company’s remaining wholesale repurchase agreement of $25 million matured during the first quarter of 2019. The Company repaid the borrowing with current liquidity, which should result in annualized net pre-tax savings of $378 thousand. This culminates the Company’s 5-year strategic shift back to a more traditional community bank balance sheet, during which the Company paid off $200 million in wholesale debt.
• The Company received $2.03 million from litigation settlements during the quarter. Year-to-date, the Company has received $3.70 million.
• Book value per common share increased $0.55 to $21.34, and tangible book value per common share increased $0.43 to a record $15.12, compared to December 31, 2018.
• The Company repurchased 194,000 common shares for $6.58 million during the second quarter of 2019. Year to date, the Company has repurchased 426,900 common shares for $14.36 million compared to 474,240 shares for $14.72 million purchased during the same period in 2018.
• The Company and its subsidiary bank both significantly exceed regulatory “well capitalized” targets as of June 30, 2019.

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

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Three-Month Comparison. Net income increased $1.39 million in the second quarter of 2019 due to litigation settlements received of $2.03 million offset by an increase in provision for loan losses of $1.09 million.

Six-Month Comparison. Net income increased $2.15 million in the first six months of 2019 due to litigation settlements received of $3.70 million offset by an increase in provision for loan losses of $1.82 million.

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 tables present the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

(Amounts in thousands)

(1) Interest income and average yield/rate are presented on a FTE, non-GAAP, basis using the federal statutory income tax rate of 21%.

(2) Interest on loans included non-cash purchase accounting accretion of $1.39 million and $1.36 million for the three months ended June 30, 2019 and 2018, respectively.

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

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AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS (Unaudited)

(Amounts in thousands)

(1) Interest income and average yield/rate are presented on a FTE, non-GAAP, basis using the federal statutory income tax rate of 21%.

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

(3) Interest on loans includes non-cash purchase accounting accretion of $2.15 million and $3.06 million for the six months ended June 30, 2019 and 2018, respectively.

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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 21%.

Three-Month Comparison. Net interest income comprised 72.66% of total net interest and noninterest income in the second quarter of 2019 compared to 76.04% in the same quarter of 2018. Net interest income on a GAAP basis increased $727 thousand, or 3.27%, compared to an increase of $725 thousand, or 3.22%, on a FTE basis. The net interest margin on a FTE basis increased 47 basis points and the net interest spread on a FTE basis increased 48 basis points. The increase in the net interest margin and the net interest spread are primarily attributable to the Company’s strategy to shift back to a more traditional community bank balance sheet through the payoffs of higher-rate wholesale debt.

Average earning assets decreased $146.84 million, or 6.93%, primarily due to a decrease in average loans as well as a decrease in the investment portfolio. The yield on earning assets increased 36 basis points as the yields in the loan portfolio, interest-bearing deposits and the available-for-sale investment portfolio increased. Average loans decreased $73.70 million, or 4.11%, and the average loan to deposit ratio decreased to 92.68% from 93.13% in the same quarter of 2018. Non-cash accretion income increased $30 thousand, or 2.21%, due to large payoffs of acquired loans in the second quarter of 2019.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $167.54 million, or 10.75%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 12 basis points. Average borrowings decreased $75.59 million, or 96.15%, largely due to the payoff of $50 million in FHLB advances as well as a $25 million payoff of a wholesale repurchase agreement. Average interest-bearing deposits decreased $91.95 million, or 6.21%, which was driven by a $48.22 million, or 10.09%, decrease in average time deposits and a $30.53 million, or 6.30% decrease in interest-bearing demand deposits.

Six-Month Comparison. Net interest income comprised 72.98% of total net interest and noninterest income for the first six months of 2019 compared to 76.61% in the same period of 2018. Net interest income on a GAAP basis increased $534 thousand, or 1.20%, compared to an increase of $545 thousand, or 1.21%, on a FTE basis. The net interest margin on a FTE basis increased 36 basis points and the net interest spread on a FTE basis increased 38 basis points. The increase in the net interest margin and the net interest spread are primarily attributable to the Company’s strategy to shift back to a more traditional community bank balance sheet through the payoffs of higher-rate wholesale debt.

Average earning assets decreased $141.46 million, or 6.68%, primarily due to a decrease in loans and the investment portfolio. The yield on earning assets increased 28 basis points as the yields in interest-bearing deposits, the available-for-sale investment portfolio and the loan portfolio increased. Average loans decreased $57.30 million, or 3.18%, and the average loan to deposit ratio increased to 94.12% from 93.89% in the same period of 2018. Non-cash accretion income decreased $1.05 million, or 32.80%, due to continued acquired portfolio attrition.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $158.33 million, or 10.17%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities decreased 11 basis points. Average borrowings decreased $68.29 million, or 86.41%, largely due to a $50 million decrease in FHLB advances as well as a decrease in average wholesale repurchase agreements of $17.40 million, or 69.61%. Average interest-bearing deposits decreased $90.03 million, or 6.09%, which was driven by a $51.64 million, or 10.63%, decrease in average time deposits.

Provision for Loan Losses

Three-Month Comparison. The provision charged to operations increased $1.09 million, or 220.20%, to $1.59 million in the second quarter of 2019 compared to the same quarter of 2018. For additional information, see “Allowance for Loan Losses” in the “Financial Condition” section below.

Six-Month Comparison. The provision charged to operations increased $1.82 million, or 183.33%, to $2.81 million for the first six months of 2019 compared to the same period of 2018. For additional information, see “Allowance for Loan Losses” in the “Financial Condition” section below.

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 27.34% of total net interest and noninterest income in the second quarter of 2019 compared to 23.96% in the same quarter of 2018. Noninterest income increased $1.63 million, or 23.28%, primarily due to $2.03 million received from litigation settlements. Other service charges and fees increased $138 thousand, or 6.93%, primarily due to an increase of $159 thousand in net interchange income. Increases in noninterest income were offset by the decrease in insurance commissions as a result of the divestiture of the remaining insurance agency in the fourth quarter of 2018. Excluding the impact from litigation settlements and net FDIC and indemnification asset amortization, noninterest income decreased $451 thousand, or 5.94%, to $7.14 million in the second quarter of 2019, from $7.60 million in the same quarter of 2018.

Six-Month Comparison. Noninterest income comprised 27.02% of total net interest and noninterest income for the first six months of 2019 compared to 23.39% in the same period of 2018. Noninterest income increased $3.10 million, or 22.76%, primarily due to $3.70 million received from litigation settlements. Other service charges and fees increased $387 thousand, or 10.21%, primarily due to an increase of $332 thousand in net interchange income. Increases in noninterest income were offset by the decrease in insurance commissions as a result of the divestiture of the remaining insurance agency in the fourth quarter of 2018. Net amortization related to the FDIC indemnification asset increased as well. Excluding the impact from litigation settlements and net FDIC and indemnification asset amortization, noninterest income decreased $487 thousand, or 3.34%, to $14.10 million for the first six months of 2019, from $14.58 million in the same period of 2018.

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 $566 thousand, or 3.29%, in the second quarter of 2019 compared to the same quarter of 2018, which was largely due to a decrease in other operating expense of $1.06 million offset by increases in services fees of $380 thousand and salaries and employee benefits of $160 thousand. The decrease in other operating expense is primarily attributable to writedowns of bank-owned properties in the second quarter of 2018 of $400 thousand.

Six-Month Comparison. Noninterest expense decreased $840 thousand, or 2.45%, in the first six months of 2019 compared to the same period of 2018, which was largely due to a decrease in other operating expense of $1.20 million offset by increases in services fees of $582 thousand. The decrease in other operating expense is primarily attributable to writedowns of bank-owned properties in the first six months of 2018 in the amount of $910 thousand.

Income Tax Expense

The Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted on December 22, 2017. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21%; eliminates the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable year; limits the deduction for net interest expense incurred by U.S. corporations; allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets for tax purposes; eliminates or reduces certain deductions related to meals and entertainment expenses; modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee; and limits the deductibility of deposit insurance premiums.

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. The Tax Reform Act enacted on December 22, 2017, reduced our federal statutory income tax rate from 35% to 21% beginning January 1, 2018.

Three-Month Comparison. Income tax expense increased $451 thousand, or 18.04%, primarily due to the increase in pretax net income. The effective tax rate increased to 22.02% in the second quarter of 2019 from 21.62% in the same quarter of 2018.

Six-Month Comparison. Income tax expense increased $513 thousand, or 10.12%, and the effective tax rate decreased to 21.75% in the second quarter of 2018 from 22.03% in the same quarter of 2018.

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 measure presented in this report includes net interest income on a FTE basis. 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 21%. While we believe certain 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 non-GAAP to GAAP measures are presented below.

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 21% for periods after January 1, 2018.

Financial Condition

Total assets as of June 30, 2019, decreased $32.35 million, or 1.44% from December 31, 2018. In addition, total liabilities as of June 30, 2019, decreased $33.18 million, or 1.74% from December 31,2018.

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 debt securities as of June 30, 2019, decreased $34.04 million, or 22.23%, compared to December 31, 2018. The market value of debt securities available for sale as a percentage of amortized cost was 101.05% as of June 30, 2019, compared to 99.76% as of December 31, 2018. The remaining debt securities in the held-to-maturity portfolio matured during the first quarter of 2019. The funds were used to repay the Company’s remaining wholesale repurchase agreement of $25 million.

Investment securities are reviewed quarterly for possible other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt securities for the three and six months ended June 30, 2019 or 2018. For additional information, see Note 2, “Debt 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 June 30, 2019, decreased $54.16 million, or 3.05%, compared to December 31, 2018, primarily due to a $50.86 million, or 2.90%, decrease in non-covered loans, which was driven by declines in non-farm, non-residential, single family owner occupied, and commercial and industrial segments. Covered loans decreased $3.30 million, or 17.51%, as the covered Waccamaw portfolio continues to pay down. 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 following 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 $4.00 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 $ 666 thousand, $898 thousand, and $82 thousand for the periods ended June 30, 2019, December 31, 2018, and June 30, 2018, respectively.

(2) TDRs with six months or more of satisfactory payment performance exclude nonaccrual TDRs of $2.02 million, $1.68 million, and $1.93 million for the periods ended June 30, 2019, December 31, 2018, and June 30, 2018, respectively.

(3) Total TDRs exclude nonaccrual TDRs of $2.73 million, $2.58 million, and $2.01 million for the periods ended June 30, 2019, December 31, 2018, and June 30, 2018, respectively.

Non-covered nonperforming assets as of June 30, 2019, decreased $2.57 million, or 10.89%, from December 31, 2018, primarily due to a decrease in non-covered nonaccrual loans offset by an increase in troubled debt restructurings. Non-covered nonaccrual loans as of June 30, 2019, decreased $3.22 million, or 16.42%, from December 31, 2018. As of June 30, 2019, non-covered nonaccrual loans were largely attributed to single family owner occupied 53.91% and non-farm, non-residential (20.17%) loans. As of June 30, 2019, approximately $1.31 million, or 7.99%, 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 $25.06 million as of June 30, 2019, a decrease of $4.82 million, or 16.14%, compared to $29.89 million as of December 31, 2018. Non-covered delinquent loans as a percent of total non-covered loans totaled 1.47% as of June 30, 2019, which includes past due loans (0.51%) and nonaccrual loans (0.96%).

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 June 30, 2019, increased $70 thousand, or 1.09%, to $6.50 million from December 31, 2018. Unseasoned and nonperforming accruing TDRs as of June 30, 2019, increased $660 thousand to $821 thousand compared to December 31, 2018. Unseasoned and nonperforming accruing TDRs as a percent of total accruing TDRs totaled 12.64% as of June 30, 2019, compared to 2.51% as of December 31, 2018. Specific reserves on TDRs totaled $475 thousand as of June 30, 2019, compared to $568 thousand as of December 31, 2018.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, increased $4 thousand, or 0.11%, as of June 30, 2019, compared to December 31, 2018, and consisted of 23 properties with an average holding period of 11 months. The net loss on the sale of OREO totaled $192 thousand for the three months ended June 30, 2019, compared to $671 thousand for the same period of the prior year and $556 thousand for the six months ended June 30, 2019, compared to $774 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 June 30, 2019, 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 June 30, 2019; 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 June 30, 2019, increased $273 thousand, or 1.49%, from December 31, 2018. The non-PCI allowance as a percent of non-covered loans totaled 1.09% as of June 30, 2019, compared to 1.03% as of December 31, 2018. PCI loans were aggregated into five loan pools as of June 30, 2019, and December 31, 2018: Waccamaw commercial, Waccamaw serviced home equity lines, Waccamaw residential, Peoples Bank of Virginia (“Peoples”) commercial, and Peoples residential. The cash flow analysis identified no impaired PCI loan pools as of June 30, 2019, or December 31, 2018. Net charge-offs increased $1.85 million for the six months ended June 30, 2019, compared to the same period of the prior year. The increase in net charge-offs was driven by one loan relationship in the commercial real estate segment and three larger relationships in the owner occupied single family segment.

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

(Amounts in thousands)

(Amounts in thousands)

Deposits

Total deposits as of June 30, 2019, decreased $7.71 million, or 0.42%, compared to December 31, 2018. The decrease was largely attributable to time deposits which decreased $24.30 million offset by an increase in non-interest bearing demand accounts of $21.02 million, or 4.57%. Other decreases occurred in the interest-bearing transaction category of $5.19 million or 1.15%.

Borrowings

Total borrowings as of June 30, 2019, decreased $26.29 million, or 89.50%, compared to December 31, 2018. During the first quarter of 2019 the Company’s remaining wholesale repurchase agreement of $25 million matured. The Company repaid the borrowing with current liquidity, which should result in annualized net pre-tax savings of $378 thousand.

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”) of 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 June 30, 2019, the Company’s cash reserves totaled $12.87 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 June 30, 2019. 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 June 30, 2019, our unencumbered cash totaled $156.48 million, unused borrowing capacity from the FHLB totaled $379.09 million, available credit from the FRB Discount Window totaled $6.00 million, available lines from correspondent banks totaled $90.00 million, and unpledged available-for-sale securities totaled $93.11 million.

Cash Flows

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

(Amounts in thousands)

Cash and cash equivalents increased $79.61 million for the six months ended June 30, 2019, compared to a decrease of $49.99 million for the same period of the prior year. The increase was primarily due to a $124.70 million increase in net cash provided by investing activities due to a net increase in proceeds from repayment of loans as well as proceeds from maturities, calls, and prepayments in the investment portfolios. Net cash used in financing activities decreased $593 thousand largely due to the repayment of the Company’s remaining wholesale repurchase agreement offset by increases in deposits. Net cash provided by operating activities increased $4.31 million primarily due to a decrease in accretion on acquired loans and an increase in the provision for loan losses.

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 June 30, 2019, increased $829 thousand, or 0.25%, to $333.69 million from $332.86 million as of December 31, 2018. The change in stockholders’ equity was largely due to the repurchase of 426,900 shares of our common stock totaling $14.36 million and dividends declared on our common stock of $7.26 million, offset by net income of $20.08 million. Accumulated other comprehensive loss decreased $1.05 million to $381 thousand as of June 30, 2019, compared to December 31, 2018, primarily due to 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. Our book value per common share increased $0.55 or 2.65% to $21.34 as of June 30, 2019, from $20.79 as of December 31, 2018.

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 was phased in over a four-year period (increasing by an additional 0.625% each year, reaching 2.5% on January 1, 2019). A description of the Basel III capital rules is included in Part I, Item 1 of the 2018 Form 10-K. Our current required capital ratios are as follows:

• 4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 6.50% including the capital conservation buffer)
• 6.0% Tier 1 capital to risk-weighted assets (effectively 8.00% including the capital conservation buffer)
• 8.0% Total capital to risk-weighted assets (effectively 10.00% 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 risk-based capital ratios as of June 30, 2019, increased from December 31, 2018, due to a decrease in risk-weighted assets. As of June 30, 2019, 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 as of June 30, 2019.

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 internal simulation and third-party 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.

As of June 30, 2019, the Federal Open Market Committee had set the benchmark federal funds rate to a range of 225 to 250 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.

(Dollars in thousands)

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 1 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 June 30, 2019, 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 June 30, 2019, 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, the following 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 2018 Form 10-K.