Nexbank Capital, Inc
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For Use By Tiered Holding Gompanies
Top-tiered holding companies must [.st lfie names, mailing address, and physical locations of each of their subsidiary holding companies below.
The SLHC Trust The Mark and Pamela Okada Family Trust Legal Title of Subsldlary l-loldlng Company Legal Title of Subsldiary Holdlng Company
300 Crescent Court, Suite 700 300 Crescent Court, Suite 700 (MailingAddress of lho Subsidiary Holding Company) Slreet, P.O. Box (Mailing Address of the Subsidlary Holding Company) Slreet/ P.O. Box Dallas Texas E 75201 Dallas Texas H 752a1 Cily stare zip coda City State Zp Cods same as mailins address same as mailinq address Physical Looation (if different from mailing address) Physlcal Location (it different from mailing address)
Legal Title of Subsidiary Holding Company Legal Tltle ofSubsldlary Holding Company
(Mailing Addtess of the Subsidiary Holding Company) Street / P.O, Box (Malllng Address of the Subsidiary Holding Company) Stteet / P.O. Box E EI CIty State Zip Code City State Zip Code
Physlcal Locatlon (if dltrerent from mailing address) Physical Location (if different from malling address)
Legal litlo of Subsidiary Holding Company Legal Title of Subsidiary Holdlng Company
(Mailing Address of the Subsidiary Holding Company) Street / P.O. Box (Mailing Address of the Subsidiary Holding Company) Street / P.O, Box H City State Zp Cods City Slate Zip Code
Physical Location (if different from mailing address) Physical Location (if different from malling address)
Legal Title of Subsldiary Holdlng Company Legal Titlo of Subsidlary Holding Company
(Mailing Address of the Subsidiary Holding Company) Skeet / P.O. Box (Mailing Address of the Subsidiary Holding Company) Street / P.O. Box m E City State Zip Code City Stat€ Zip Code
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:li-9 tEeE o o C 6 o P c EfEE i5 i5 !!> !E 6r I :E F EA€ B a GI E6Ei=dr]E 2 z t rt G F .E !E oo ! t6 qC tq t ( Consolidated Financial Statements with Supplementary Information December Jl, 2016 antl 2015 (With Independent Auditors' Report Thereon) NEXBANK CAPITAL, INC. AND SU BSIDIARI ES Consolidated Balance Sheets December 3 l, 20 I 6 and 20 I 5 (ln Thousands) 2016 2015 ASSETS Cash and cash equivalents $ 435,950 $ 317,766 Interest bearing time deposits in other banks 412 38s Securities available for sale l, I 90,2s6 309,8 I 3 Loans held for sale, at fair value 187,166 65,449 Loans, net 2,630,610 1,892,7t3 Mortgage servicing rights 52,228 20,897 Premises and equipment, net 1,245 2,666 Unconsol idated investments 3,1 l4 2,5t2 C)ther real estate owned 6,000 8,322 Goodwill 750 750 Company owned life insurance s8,9 l 2 41,769 Other assets 76,956 56,956 s 4,64s,s99 $ 2,719,998 LIABILITIES AND STOCKHOLDERS' EOUITY Deposits: Noninterest bearing $ 1317,893 $ 687,863 lnterest bearing r,806,850 1,190,647 Total deposits 3,224,743 1,878,510 Advances from Federal Home Loan Bank l,005,000 555,000 Junior subordinated debentures ts,464 't5,464 Other bonowings ($95,000 and $59,909 face amounts, respectively; less debt issuance costs of$ 1, I 57 and $388, respectively) 93,843 59,52 I Accrued expenses and other liabilities 38.744 3 1.505 Total liabilities 4,317,794 2,540,000 Stockholders' equity: Common stock I I Paid-in capital 86,976 61,53't Retained eamings 204,t70 t21,025 Shareholder loans secured by Company stock (s,44s) Accumulated other comprehensive loss ( l 7.897) (2.s65) Total stockholders' equity 267.805 I 79.998 $ 4-64s-see $_a.7l2.299 See accompanying notes to consolidated financial statements. NEXBANK CAPITAL, INC. AND SUBSIDIARIES Consolidated Statements of lncome For the Years Ended December 3 l, 20 16 and 201 5 (ln Thousands) 2016 2015 Interest income: lnterest and foes on loans $ 86,950 $ 62,929 Interest and dividends on investment securities 14,590 6,777 Other 2 598 11).9 Total interest income 104 l 38 72 975 Interest expense: Interest on deposit accounts r 3,870 8,044 Other 6.227 3.445 Total interest expense 20-09'1 I 1.489 Net interest income 84,04 I 6t,446 Provision for loan losses 1.765 4-54-5 Net interest income after provision fbr loan losses 80.276 55 90r Noninterest income: Net gain on sales of mortgage loans held for sale 10,226 5,756 Net loan servicing fees 8,129 2,t78 Consulting revenue 2.671 5,482 Investment advisory and underwriting fees l,668 3,126 Title prerniums t.239 577 Net gains on sales ofsecurities 8,1 35 Realized/unrealized net gain on interest rate swaps 7.659 I t,958 Gains on company owned life insurance 2.287 Gains on foreclosed assets, net 293 Bargain purchase gain 8,864 Other 5.1 89 t /t\ Total noninterest income 47.496 41.174 Noninterest expense: Salaries and employee benefits 25, I 60 26,433 Occupancy expense 3.565 3,046 Net losses on sales ofsecurities 70s Data processing l,689 1,519 Regulatory assessments 1.967 I.134 Legal and professional fees 3.850 3,t44 Losses on company owned life insurance 2,940 Losses on foreclosed assets, net 631 Other 8-178 5.348 Total noninterest expense 44.409 44.900 Net income $ 83,363 $ 53, I 75 See accompanying notes to consolidated financial statements. -2- NEXBANK CAPITAL, INC. AND SU BSIDIARIES Consolidated SBtements of Comprehensive trnoome For the Years Ended Decernber 3 I, 20 t 5 and 20 1 5 fln Thousands) 2016 20t5 Net inaome $ 83,363 $ 53,175 Other comprohiensive (loss) income: Securities availeble fot sale: Uniralized 0o$es) gains durine the Beriod (7,tgX) l,r 65 Rwlassifrcation adjusfiient for nEtr(g€ins) losses inaluded ia net incorne for the year (8-135) 705 Total scrurities available fot sale 115 312) 1.870 Other cornprehmsive (loss) incorme (15-332) 1.870 Total eornpreheneivo ineome $ 68.031 $ 55;045 See acoompanying notes to consolidated financial stalemeots. -3- N EI$AN K eAP, I f AI; Iffc .d,lVD $iUB^$IDI"z{ ft/EB Consolidated Staternents of Changes in Stockholders' Equity For the Yerrp En=derl kemter 3 l, 2Ol 6 ,and 20I 5 (tn Thousands Except Shart Amounts) eo{m.!on.8t-a*'$.S01 par v€l-rc1 .2,50Q00..0r s&*rs autheri*{l $h!n4oldq. Aoewnri.atd, .at Eesrcabr 3 I, 40.16 ,Logrs OtbE and 2.015:g6pq4ivefu P:id.h, *etaiosd .Ssuredb It€asury Conprdrcrulve Sirffi Amo[t &Eittl en&e CsueslySleq flffiIArffi idlil BrIlaiEoE Jffi rlary 1; 2915 98456i ,S ls 60,6ri $ 69N850, $' r& $ (4;,{3,5,} ,3 N.74i&7'. Ndinaom! 53J75 ',\113 ,Othqoc4lPlt@vthrtros qffi, 1187S. S.har+b$,it oirio@t$ rG,q.'.lre 25rEEq 926 935 .Pls6i!111ji9q!,(o goqBho,ldcrs" Bala!g€!, D€qaq$rf 3.[, 201 5. 1.0@1445 6,1;53? l2:t,0?,5 (?.f5$ ,l?9..99E' Nc imoruo 83:35r, 83,363 'C}tlicr aomprchstsivcJont {!/531t2) ll5)tlti Shaa ba:ied'crulp**arirom*pane e,F4A i,r06 x,ll0r5 lsiridtrEe of oo&ihjoa i*roirk tw;752, 2+,4M 24,40q Shsctroid€i.larnE ildrsil (5,445) (5r.ut5,I n4ol9-da,of u€ailiri r,,mok w+) r(-!-94) &itirlroeo't ot@srly ttook (rtge?), (76): lztg} ?94 Dictiilutions tq Sacldol&rs - -r Bdanceq FrelEobrr 3,i, 201 6 l;204:.158 $l $ ffi97,6 $i 204'[T0 $, ,(5.445)S - g____l_l!J9o $ 267,805 -=: 8ee aqcompanlhlg: ilote. s to'conaolidated financial statgments: -4- NEXBANK CAPITAL, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 3 l, 20 I 6 and 20 I 5 (ln Thousands) 20t6 2015 Cash flows trom operating activities: Net income $ 83,363 $ 53, t 75 Adjustments to reconcile net rncome to net cash (used) provided by operating activities: Depreciation and amortization, net of accretion 4,159 1.874 Net gain on sales of securities available lbr sale (8, r 3s) (ll) Net loss on sales ofsecurities held to maturity 7t6 Gain on sale of mortgage loars held for sale (10,226) (5,7s6) Proceeds from sales of loans held for sale 752,755 528,707 Loans held for sale onginated (870,964) (547,304) Realized/unrealized net gains on interest rate swaps (7.6se) (r 1.9s8) Provision for loan losses 3,765 4,545 Fair value adjustment-mortgage servicing righS (1,883) I,040 Net (gain) Ioss on sales ofother real estate and repossessed assets ( l,004) 248 Write-downs ofother real estate and repossessed assets 7ll 383 Bargain purchase gain from acquisition (8,864) Net (gains) losses on company owled lil'e insurance (2.287\ 2,940 Equity in eamings ofunconsolidated subsidiary (602 ) (48) Share-based compensation expense 1.r06 926 Increase in net def-erred loan costs (1,625) (2,267) Net change in other assets (1.960) 27,335 Net change in accrued expenses and other liabilities ( 3_538 ) 6.636 Net cash (used in) provided by operating activrties (64.024) 52.3t7 Cash tlows from investing activities: Purchases ofsecurities available for sale (3,256.953 ) ( r .620.630 ) Proceeds from sales, maturities, pay downs and calls of securities available lbr sale 2.3'72,748 1,503,941 Proceeds tiom sales, maturities, pay downs and calls of securities held to maturity s.tl6 lncrease in interest bearing time deposits in other banks (27) (61) Net increase in loans (733.524 ) (565,706) Purchase ofcompany owned lil'e insurance ( r 4,85s) ( 10,0 l9) Acquisrtion of mortgage servicing rigls (22.73t) (2.224\ Net additions to premises and equipment (212) (272\ Net proceeds from sales ofother real estate owned/repossessed assets 2.5 l3 80s Net acquisition of FHLB and other stock ( r 3.500) (2 l,l4l ) Net cash exchanged liom acquisrtion 25'\ 786 Net cash used in investing activities il.666.541) (456.905 ) Cash tlows liom financing activrties: Net increase in demand deposits, NOW, and savings accounts 1,407 ,6"79 I 13,653 Net (decrease) increase in certificates ofdeposit (6 r,446) 93.684 Net increase in FHLB advarrces 450.000 360,000 Proceeds fiom other bonowings r 04.258 I 3,845 Repayments of other bonowings (69, I 67) (3.936) Debt issuance costs ( 1.245) Proceeds from issuance ofcommon stock 24.409 Shareholder loans (5,445 ) Purchase oltreasury stock (294\ Net cash provided by linancing activities 1.848.749 577.246 Net increase in cash and cash equivalents r 18,r84 I 72,658 Cash and cash equivalents at beginning ofyear 317 "766 I 45.1 08 Cash and cash equivalents at end ofyear $ 415.950 $ 317 766 See accompanying notes to consolidated financial statements. -5- NEXBA N K CAPI TAL, I NC. AND SU BSI DIA RI ES Notcs to Consolidated Financial Statements December 31" 2016 and 2015 l. Summarv of Sisnificant Accountins Policies The accounting and reporting policies ofNexBank Capital, Inc. and Subsidiaries (together refened to as the Company) conlorm to generally accepted accounting principles and to practices generally followed within the banking and broker dealer industries. The following is a description of the more significant of these policies. Basis of Presentation The accompanying consolidated financial statements include the accounts of NexBank Capital, lnc. (NCl) and its wholly-owned subsidiaries. NexBank Securities. Inc. (NSI), NexBank Title, Inc., and NexBank SSB (Bank) and the Bank's wholly-owned subsidiary, NexBank Land Advisors, Inc. (NLA). On November 30, 201 5. the Bank acquired 100% ol the issued and outstanding common stock of College Savings Bank (CSB), a state savings bank based in Nerv Jersey. Simultaneous with thc acquisition, CSB was merged rvith and into the Bank, w'ith the Bankbeingthesurvivor. CSB'sprimarybusinesswastheoriginationandmarketingnationwideofvariouscertiticatesofdeposit to families saving lbr college through qualilied tuition programs under section 529 ofthe Internal Revenue Code. All significant inter-company transactions and balances have been eliminated in consolidation. The Bank's primary sources ol revenue are interest and fees on loans. fbes it receives for agency services and origination and resale of single family residential mortgage loans. The Bank is sub.iect to competition tiom other tinancial institutions. The Bank is also subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authoritics. NSI is a registered broker-dealer rvith the Securities and Exchange Commission (*SEC") and is a member ol the Financial Industrl' Regulatory' Authority ("FINRA"). NSI operates under certain cxemptive provisions oISEC Rule l5ci-3(k)(2)(i). NSI is subject to the regulations of certain fbderal and state agencies and undergoes periodic examinations by those regulatory authorities. NSI's primary sources of revenue include {'ees it receives lbr providing mutual lund distribution services under a cost plus arrangernent and lbr operational and llnancial advisory services. as well as fees charged tbr merger and acquisition advisory services. it provides to third parties and af-filiatcs through common ownership. lise of Estimates The accompanying consolidated llnancial statemcnts have been prepared in contbnnity rvith accounting principles generally accepted in the United Statcs. In preparing thc llnancial statements, management is required to rnake estimates and assumptions that af'l'cct the reported amounts olassets and liabilities as of the date olthe balance sheet and revenues and expenses lirr the pcriod. Actual results could ditter significantly liorn those estimates. Cash and Cash Eouivalents Cash and cash equivalents consist of cash on harrd and funds due trom banks. For purposes ol the statenrent of cash florvs. the Company considers all highly liquid debt instruments rvith original maturities of three months or less to be cash cquivalents. Cash Flows Net cash florvs are reported fbr customer loan and deposit transactions. interest bearing deposits in other linancial institutions. .FHLB advances. and other borrorvings. Interest-Bearing Denosits in Other Financial Institutions Interest-bearing deposits in other flnancial institutions generally have maturities ofgreater than one year and are carried at cost. 6 NEXBANK CAPITAL, INC. AND SUBSIDIARIES Securities Certain debt securities that management has the positive intent and ability to hold to maturiS- are classified as held to maturity and recorded at amortized cost. net ofany other-than-temporary impairment fbr the credit portion (recognized through earnings) and the noncredit related portion (recognized through accumulated other comprehensive income). Trading securities are recorded at fbir value with changes in lair value included in eamings. Securities not classilicd as held to maturity or trading, including equity securities with readily detenninable f'air values, are classilied as available lbr sale and recorded at fhir value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the level-yield method without anticipating prepayments. except tbr mortgage-backed securities where prepayments are anticipated. Declines in the fhir value of held to maturity and available lbr sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (l) the length oftime and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects ofthe issuer, (3) the intent to sell, or ilit is more likely than not that it will be required to sell, before recovery ofthe amortized cost basis, and (4) pricing model valuations by third parties. For debt securities that do not meet the alorementioned criteria, the amount of impairment is split into two components as lbllows: l) OTTI related to credit loss. which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors. which is recognized in other comprehensivc income. The credit loss is defined as the difference betueen the present value ofthe cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings. Gains and losses on the sale ol securities are recorded on the trade date and are determined using the specific identification method. From time to time, the Company participates in Fannie Mae's MBS Program rvhereby it securitizes homogenous one-to-fbur family loans into mortgage-backed securities and retains l00o/o orvnership interest. During 2016 and 2015. the Company securitized approximately $88.658,000 and $11.848,000 ofsuch loans, respectively. At December 31.2016 and 2015, the fair values ofthesc mortgage-backed securities amounted to approximately $92.8 I 0.000 and $ I 2,060.000. respectively. Loans Held for Sale 'l-he The Company originates mortgage loans both lbr sale and fbr investment purposes. designation of mortgage loans is made by management at the time of origination. 'fhe Company has elected the l'air value option fbr tlnancial reporting. Fair value is based on the contract prices at rvhich the mortgage loans rvill be sold or, if the loans are not committed for sale, the current market price. Net unrealized gains or losses are recognized through earnings. Transfers and Servicins of Financial Assets Transtbrs ol llnancial assets are accounted fbr as sales rvhen control over thc assets has been surrendered. Control over transflerred assets is deemed to be surrendered when (l) the assets have been isolated I'rom the Company. (2) the translbree obtains the right to pledge or cxchange the transf-erred assets. and (3) the Company docs not maintain ellective control over the transGrred assets through an agreement to repurchase them belbre their maturity. The Company acquires mortgage servicing rights (MSRs) through the sale olloans it originates or through thc purchase of bulk sewicing po(lblios. Cenerally. purchased MSRs are capitalized at thc cost to acquirc the rights and are carried at I'air value. Originated MSRs arc capitalized based on the relative lair value of the servicing right to the f'air value of the loan and the servicing right and are carried at fhir value. Fair values olservicing rights arc determined at the date of transl'er. For originations. a portion of the cost of originating a mortgage loan is allocated to the mortgage servicing right based on its relative lair value. To detemrine the fhir value of MSRs the Company uses market prices for comparable mortgage servicing conftacts. rvhen availablc. or altematively, uses a valuation model that calculates the present value ofeslimated future net servicing income. ln using this valuation method. the Company incorporates assumptions that market participants rvould use in estinating tuture nel servicing income. rvhich includes estimates of the cost to service. the discount rate. custodial carnings rate, an inl'lation rate. ancillary income. prepayment speeds and defhult rates. late tbes and losses. See note 9 lbr rnore inlbnnation on the valuation of MSRs. Managemcnt has elected the t'air value measurement method to rcport its MSRs. Under the l'air value measurement method. the Conrpany measures serl'icing rights at tair value at each rcporting datc and reports changes in fhir value of MSRs in carnings in the period in which the changes occur. and are included in net loan servicing income in the accompanying consolidated statements ol'income. The lair values ol'MSRs are subject to signilicant fluctuations as a result ofchanges in estirnated and actual prepayment speeds and det-ault rates and losses. 7 NEXBANK CAPITAL, I NC. AND SU BSIDIARI ES Loan servicing fi:e income is recorded lor f-ees eamed for servicing mortgage loars under servicing agreements with, principally. the Federal National Mortgage Association (FNMA). The fees are based on a contractual percentage of the outstanding principal balance or a fixed amount per loan and are recorded as income when earned. These fees have been included in net loan servicing income in the accompanying consolidated statements of income in the approximate amounts of 56.l 98,000 and $3, I 59.000 lbr the years ended December 3 I . 20 I 6 and 20 I 5, respectively. Loans The Company grants commercial, real estate, and consulner loans to customers. The ability olthe Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area where the underlying collateral is Iocated. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for chargeoffs, the allowance tbr loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. The Company records syndicated loan purchases in the secondary market at the earlier of the settlement date or the delayed settlement compensation comrrencement date (he date of economic ownership). Interest income is recognized on an accrual basis. When a syndicated loan has been recognized but remains unfirnded, a liability is recorded in accrued expenses and other liabilities. At December 31,2016 and 2015, the Company had purchased approximately $6,000,000 and $300,000, respectively, ofsyndicated loans in the secondary market that remain unfunded. Loans are considered past due ifthe required principal and interest payments have not been received as ofthe date such payments rvere due. Loans are placed on nonaccrual status when. in management's opinion. the borrorver may be unable to meet payment obligations as they become due, as rvell as rvhen required by regulatory provisions. In determining whether or not a borrower may be unable to meet payment obligations for each class of loans, the Company considers the borrorver's debt service capacity through the analysis of current financial information, if available, and/or current information rvith regards to the Company's collateral position. Regulatory provisions typically require the placernent ofa loan on nonaccrual status if(i) principal or interest has been in defhult fbr a period of90 days or more unless the loan is both well secured and in the process olcollection or (ii) full payment ol principal and interest is not expected. Loans may be placed on nonaccrual status regardless ol rvhether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest on nonaccrual loans is accounted fbr on the cash basis or cost recovery method until qualilying lor return to accrual status. A loar may be returned to accrual status when all the principal aad interest amounts contractually due are brought current and f'uture principal and interest amounts contractually due are reasonably assured. which is typically evidenced by a sustained period (at least six months) of repayment performance by the borror,'er. Loan Orisination/Risk Manasement The Conrpany has certain lending policies and procedures in place that are designed to marimize loan income with an acceptable level of risk. Management reviervs and approves these policies and procedures on a rcgular basis. A reporting system supplements the revierv process by providing management rvith lrequent reports related to loan production. loan qualiry. concentrations of credit. loan delinquencies. and non-perfbrmirrg and potential problem loans. Diversiflcation in the loan portfolio is a means of rnanaging risk associated rvith fluctuations in economic conditions. One- to- tbur thmily residential loans account lor a significant portion of the Company's loan portfolio. The Company originates these loans through both rvholesale and correspondent channels as well as through the establishment ofu'arehouse tacilities fbr large rnortgage bankers. Additionally, the Company purchases pools of one-to-tbur thmily loans tiom unrelated financial institutions. Originations ofone-to-lbur lbrnily loans are subject to strict underwriting standards that incorporate various firctors. including, but not limited to- analysis ol loan to value. the borrorver's ability to repay. the borrower's credit rating. and the Iocation of the properry-. For purchases of one-to-fbur family loans. management obtains a clata tapc olthe loans to be included. screens the loans. obtains and verilies all underwriting documents. and summarizes the pool highlights. 1'he Company has a concentration of one-to-fbur l-amily loans in the states of Texas. Washington. Califomia. Ceorgia. and Florida. 8 NEXBANK CAPITAL, INC. AND SU BSIDIARI ES Commercial loans at Decemhcr 31.2016 and 2015 include approximately $508,518.000 and $352.881.000, respectively in corporate loan facilities often rel-erred to as shared or syndicated national credits (SNC's). These credit lacilities generally have nrultiple pari-passu tranches including a revolving line of credit and one or more term loans. The Company generally limits its investments in SNC's to larger. broadly syndicated lacilities that are covered under the I'-DIC SNC program. When contemplating investing in one of these fhcilities. management will source the opportunity fiom a host of investment grade rated agent bank originating the credit. A bank book is provided by these institutions which details all data about the company. industry, sponsor. management, and facility. This data is analyzed by the Company's credit and underwriting department in conjunction with other industry market information tiom various sources (Bloomberg, investment reports. etc.). Financial analysis is required to assess the borrower's ability to service the underlying debt. Additionally, a collateral analysis is performed to support a secondary source of repayment. This review includes an analysis of both historical as well as projected financial statements. Per FDIC guidance. the Company has identified four primary criteria and two secondary criteria with regard to ratings on SNC's. The primary criteria are: ( I ) reasonableness of borrower's business plan; (2) ability of borrower to deliver over a five to seven year period (50% of total debt and I 00% of senior secured deb$; (3) ability of borrower to have and maintain a fixed charge coverage ratio of at least l.0X: and (4) ability of borrower to have and maintain a leverage ratio of not more than 4.0X for senior secured debt and 6.0X for total debt. Under the secondary criteria management generally strives to: ( I ) avoid industries with very high Ievels of cyclicality; and (2) avoid borrowers with significant liquidity erosion over the last trvelve months. Other commercial loans include loans to mortgage companies collateralized by mortgage servicing rights and loans to bank holding companies collateralized by stock of the underlying subsidiary bank. Such loans are underwriften after evaluating and understanding the borrower's ability to operate prot'itably and prudently expand its business. Underw,riting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrouer's management possesses sound ethics and solid business acumen, the Company's management examines current and projected cash flows to determine the ability olthe borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash t'lows or borrorvers. however. may not be as expected and the collateral securing these loans may lluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guaranty. In the case of loans secured by accounts receivable, the availability of funds lbr thc repayment ol these loans may be substantially dependent on the ability of the borrorver to collect amounts due fiom its custorners. Commercial real estate loans include NNN lease loans and are subject to undenvriting standards and processes similar to other commercial loans. in addition to those of real estate loans. These loans are viewed primarily as cash llorv loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment ol these loans is largely dependent on the successtul operation ol the property securing the loan or the business conducted on the properfy securing the loan. Commercial real estate loans may be more adversely aff'ected by conditions in the real estate markets or in the general economy. The properties securing the Company's commercial real estate portlblio are diverse in terms of type and geographic location. This diversity helps reduce the Company's exposure to adverse economic events that al-fect any singlc nrarket or industry. Management monitors and evaluatcs cornmercial real estate loans based on collateral, geography, and risk grade criteria. ln addition. management tracks the level ofouner-occupied commercial real estate loans as a percentage ofcapital. lmnaired Loans Loans are considered impaired when. based on current infbrmation and events. it is probable the Company rvill be unable to collect all amounts due in accordance with the original conlractual terms ol'the loan agreement. including scheduled principal and interest payments. Impairrnent is evaluated in total lbr smaller balance loans of a similar nature and on an individual loan basis lor olher loans. Ifa loan is impaired. a specil'ic valualion allorvance is allocated. il'necessary. so that the loan is reported net. at the present value ot'estimated future cash flows using the loan's cxisting rate or at the fair value of collateral up to the unpaid principal balance of the loan. if repayrnent is expected solely fiom the collateral. Largc groups of srnaller balance Iromogeneous loans are collectively evaluatcd lbr impairrnent based on historical loss experience. current economic conditions- and perfonrrancc trends. lnterest payments on impaircd loa:rs are typically applied to principal unless collectibility ol'the principal amount is reasonabll' assured. in rvhich case interest is recognized on a cash basis. lrnpaired loans. or portions thereof. arc charged of'f r.vhen deemed uncollectible. Troubled Debt Restructured (TDR) Loans A TDR loan is a loan which the Company. lbr reasons relatcd to a borrorver's flnancial difllculties. grants a concession to the borrower that the Cornpany rvould not othenvise consider. The loan terms. rvhich have been modilled or restructured due to a borrorver's llnancial difliculty. include. but arc not linrited to. a reduction in the stated interest rate: an extension olthe rnaturit-"'- at an interest rate below current market: a reduction in thc lhce amount ol'the debt: a reduction in the accrued intcrest: or re- aging. extensions. delerrals, renervals. and rervrites. n'lDR loan rvould generally bc considered irrpaired in the 1'ear ol modification and ,will be assessed periodically fbr further irnpairnrent. 9 NEXBANK CAPITAL, INC. AND SUBSI DIARIES Fees and Costs Associated with Originatinq Loans Loan origination fees, net ofcertain direct loan origination costs, are del-erred and recognized in interest income using the level- yield or straight-line methods rvithout anticipating prepayments. The level yield method is used for amortizing loans (those loans rvhich contractually call tbr regularly scheduled principal and interest payments), and the straight line method is used lor loans that are essentially interest only. such as SNC's. Management believes the straight-line method approximates the level-yield method. Allowance for Loan Losses The allowance for loan losses is established through a provision for loan losses charged to expense, which represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to provide for probable incurred loan losses in the loan portfolio. The allowance for loan losses includes allowance allocations calculated in accordance with ASC Topic 3l0, "Receivables" and allowance allocations calculated in accordance with ASC Topic 450, 'Contingencies". The level of the allowance reflects management's continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing. Portions of the allowance may be allocated lbr specific creditsl however. the entire allowance is available lor any credit tha! in management's judgment, should be charged ofl. While management utilizes its best judgment and information available, the ultimate adequacy ofthe allowance is dependent upon a variety offhctors beyond the Company's control, including the performance of the Company's loan portfolio, the economy, changes in interest rates and the view ol the regulatory authorities toward loan classifications. The allorvance consists ol specific and general allocations. The specitic allocation relates to loans that are impaired. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) ofthe impaired loan is lower than the carrying value ofthat loan. The general allocation is calculated using loss rates delineated by risk rating and product type. Factors considered when assessing loss rates include the value olthe underlying collateral, the industry ofthe obligor. the obligor's liquidity, and other financial and qualitative I'actors. These statistical models are updated regularly lbr changes in economic and business conditions. Included in the analysis ofthese loan porllblios are reserves. which are maintained to cover uncertainties that attect the Company's estimate of probable losses including economic uncertainty and large single det'aults. Loans Acquired Throush Transfer Loans acquired through the completion ola transf-er that have evidence oldeterioration ofcredit quality since origination and fbr which it is probable, at acquisition. that the Company rvill be unable to collect all contractually required payments receivable are initially recorded at fhir value (as determined by the present value of expected future cash Iows) rvith no valuation allorvance. The ditlbrence between the undiscounted cash florvs expected at acquisition and the investment in the loan, or the "accretable yield," is recognized as interest income on a level-yield method over the litb olthe loan. Contractually required payments lbr interest and principal that exceed the undiscounted cash flows expccled at acquisition. or the "nonaccretable difllbrence." are not recognized as a yield adjustment or as a loss accrual or a valuation allorvance. Increases in expected cash flows subsequent to the inilial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairnrent. Valuation allowances on these impaired loans reUect only losses incurred after the acquisition (meanirrg the present value olall cash flows expected at acquisition that ultimately are not to be received). Foreclosed Assets Assets acquired through. or in licu of. loan fbreclosure are held fbr sale and are initiall,v recorded at lair value less cost to sell at the date ol foreclosure^ establishing a nerv cost basis. Subsequent to tbreclosure. valuations are periodically perfbrmed by management and the asscts are carried at the lower of carry'ing anlount or thir value less cost to sell. Revenue and expenses fiorr operations and changes in the valuation allorvance are included in net expenses lrorn loreclosed assets. Premises and Equioment Land is carried at cost. Premises and lurniture and equipment are carried at cost. less accunrulated depreciation and amortization conrputed using the straight-line method. Fetleral Home Loan Bank (FIILB) Stock 'l'he Bank is a member ol'the FI ILB system. Mernbers are required to own a certain amount ol stock based on the level of borrorvings and other factors. and may invest in additional amounls. FLILB stock is carried at cost. classilled as an other asset. and periodically evaluated lbr impairment based on ultirnate recovery ofpar value. Bolh cash and stock dividcnds are reported as incorne. - l0 - NEXBANK CAPITAL, I NC. AND SUBSIDIARIES Comnanv Orvned Lifc Insurance The Company has purchased separate account lif'e insurance policies on certain key executives and employees. Company owned lilb insurance is recorded at the amount that can be realized under the insurance contracts at the balance sheet date. which is the cash surrender value adjusted tbr other charges or other amounts that are probable at settlement. Goodwill Goodwill represents the unidenliliable po(ion ofthe excess ofpurchase price paid over net fair value ofassets and identifiable intangible assets. Goodwill is tested annually for impairment. At December3l.2016 and 2015, management has determined that there has been no impairment of recorded goodwill. Denosits Included in deposits at December 31.2016 and 2015 are CSB's exclusive former deposit products known as the CollegeSure@ Certificate of Deposit (the CollegeSure CD) and the InvestorSure@ Certificate of Deposit (the InvestorSure CD). CSB had marketed these deposit products in connection with their management of the Arizona Family College Savings Plan and the Indiana F'amily College Savings Plan. TheCollegeSureCDpaysinterestonJuly3leachyear. CollegeSureCDsissuedpriortoMarch28,201Iaccrueinterestatarate (the index rate) linked to the annual change in the dollar value of the Independent College 500@ Index (lC 500). a college inflation index published by the College Board on an annual basis, subject to a stated minimum interest rate. Since the actual interest rate ofCollegeSure CDs can only be determined retrospectively on each July 3l rvhen the IC 500 is published, the crediting of interest to the respective CollegeSure CD and depositor's account is done on that date. Accordingly. management must accrue for l'inancial statement purposes estimated CollegeSure CD interest expense during all interim periods. Eftbctive March 28. 201l. terms and conditions olnervly issued CollegeSure CDs rvere revised. CollegeSure CDs issued after that date pay interest each year at a variable interest rate equal to the prior July 3 I college inflation rate. as measured by the IC 500 index change. less an issue margin detennined at the deposit origination date. The variable interest rate is subject to a ma.rimum rate also determined on the deposit origination date. InvestorSure CDs are a five 1,ear variable rate CD indexed to the Standard & Poors@ 500 Composite Stock lndex (S&P 500@). Interest rate exposure on the lnvestorSure CDs is hedged by buying a call option on the S&P 500(D. The hedging derivative instrument and bif'urcated embedded derivative are measured at tbir value, with net changes in thir value recognizcd in eamings. Derivative I nstruments The Cornpany records derivatives on its balance sheet at f'air value. Derivative instruments are recognized as either assets or liabilities on the balance sheet and are measured at f'air value and the corresponding change in lair value is reported in earnings. Derivative instruments that are used as part of the Compan;-'s market risk managernent strategy consist of interest rate s\.,r'aps, interest rate lock commitments. options to buy-sell mortgage backed securities and tbrrvard sale commitments. These instruments are utilized to manage market rate risk on the Company's variable rate loans and investment securities, as rvcll as its mortgage pipeline. The Company uses the lorward sale commitments and options to hedge the risk of changes in the lirir value ol the pipeline due to changcs in market interest rates. Due to the InvestorSure CD coupons being linked to the perfbrmance of'an equity index. contingent payrncnt components of these deposit obligations rneet thc definition of an embedded derivative in the Derivatives and Hedging 1'opic of Financial Accounting Standards Board Accounting Standards Codification (FASB ASC or Coditlcation). Additionally. derivative instruments are utilized to economically hedge exposures to interest rate risks associated rvith these CDs. although hedge accounting is not employ'ed. In accordance with the Derivatives and Hedging Topic of the Codification. embedded derivatives have been bifurcated lionr the host contracts and have been measured al f'air value. The lnvestorSure CD embedded derivatives are reported in the 2016 and 2015 consolidated balance shccts along rvith deposits. and the economic hcdging derivalive is reported in other assets. Off-Balance Sheet Crcdit Related Financial Instruments ln the ordinary course ol-busincss. the Company has entercd into comrnitrnents to extend credit. irrcluding commercial letters of credit and standby letters olcredit. Such t'inancial instruments are recorded rvhen they are funded and are gencrally secured b;" cash or cash equivalents. Revenue Rccoenition - Non-Bank Subsidiaries Consulting. account supervision. investment advisory- and adrninistrative services pcrformed by NSI are accrued and recognized as they are earned. Management fbe and other income are rccognized as lhey are earned and billed. - ll - NEXBANK CAPITAL, INC. AND SU BSI DIARIES Liabilitv for Mortsage Loan Renurchase Losses The Company has established a liability fbr mortgage loan repurchase losses which is included in accrued expenses and other liabilities in the accompanying consolidated financial statements. Because the level ol'mortgage loan repurchase losses depends upon economic factors, investor demand strategies, and other extemal conditions that may change over the tif'e olthe underlying loans, the level of the liability lor rnortgage loan repurchase losses is difficult to estimate and requires considerable management judgrnent. Management maintains regular contact r,vith the Government Sponsored Enterprises (GSEs), the Federal Housing Finance Agency (FHFA). and other significant investors to monitor their repurchase demand practices and issues as part oftheir process to update the repurchase liability estimate as new information becomes available. Advertisins Advertising consists of the Company's advertising in its local market area. Adve(ising is expensed as incurred. Advertising expense was approximately $550,000 and $473,000 flor the years ended December 31,2016 and 2015, respectively. Comnrehensive I ncome (Loss) Comprehensive income (loss) includes all changes in stockholders' equity during a period, except those resulting lrom transactions rvith stockholders. In addition to net income, other components of the Company's comprehensive income include the effect ofchanges in net unrealized gain/loss on securities available fbr sale. Stock-Based Comnensation Compensation cost is recognized for restricted stock awards issued to employees, based on the fair value ofthese awards at the date of grant. The market price of the Company's common stock at the date of grant is used tbr restricted stock awards. Compensation cost is recognized over the required service period. generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period lor the entire award. Income'Iaxes Eftbctive January l. 2005. the Company rvith the consent of its stockholders elected to be an S corporation under the Intemal Revenue Code (Code). In lieu ol corporate income taxes. the stockholders of an S corporation are taxed on their proportionate share of the Company's tarable income. Follorving this election the Company rvill generally' report no lederal incomc tax expense or benefit in its llnancial statements. except lbr the expense incurred in connection with "recognized net built in gains" (as detined in the Code). Accounting principles generally accepted in the United States of America require Company management to evaluate tax positions taken by the Company. Management evaluated the Company's tax positions and concluded that the Company had maintained its S Corporation status and had taken no uncertain tar positions that require recognition or disclosure in the consolidated llnancial statements. Therelbre. no liability fbr tax penalties has been includcd in the consolidated tlnancial statcments. With t'ew exceptions, the Cornpany is no longer subject to income tax examinations by the U.S. l-ederal, state" or local tax authorities fbr years belore 2013. Comncnsated Absences Company employees are entitled to Paid Timc OII(PTO), depending on job classilication and 1'ears of service. P l'O accrues on cach semi-monthly pay date. An emplol'ee ma.v.' carry over PTO from one calendar year to the next. rvith a maximum accrual of trvo weeks. Included in accrucd expenses and othcr liabilities in the accompanying consolidated balance sheets at Dccember 31. 2016 and 2015 are accruals ofapproximately $343,000 and $223,000. respectively. lor PTO. Fair Values of Financial Instruments ASC Topic 820. "Fair Value Measurements and Disclosures." delines lair value. establishes a liarnervork tbr mcasuring t'air value in generally accepted accounting principles. and rcquires certain disclosures aboul l'air value measurcments. In general. fair values oftinancial instruments are based upon quoted market prices. rvhere available. Ifsuch quoted market prices are not available. lhir value is based upon internally developed rnodels that primarily use. as inputs. observable market-based pararneters. Valuation ad.iustments may be made to cnsure that linancial inslruments are recorded at t-air value. These adjustments nray include amounts to reflect counterparty credit quality and the Company's creditworthiness. among other things, as well as unobservablc parameters. An1- such valuation adjustments arc applied consistcntly over time. -t2- NEXBANK CAPITAL, I NC. AND SUBSIDIARIES Subsequent Events The Company has evaluated events and transactions fbr potential recognition or disclosure through March 28. 2017, the date the llnancial statcments r.r'ere available to be issued. Reclassification Certain amounts previously reported have been reclassified to conform to the current format. Adontion ofNew Accounting Pronouncements and Issued Not Yet Effective Accountins Standards ASU 2014-09, Reverute from Contracts rvith Customers (Topic 606), ASU 2015-11, Revenue from Contracts wilh Customers (Topic 6061; Deferral ofrhe Efibctive Date, ASU 2016-08, RevenueJiom Contracts with Customers (Topic 606); Principal versus .4gent Considerations (Reporting Reventte Gross versus Ne!, ASU 2016-10, RevenuejTom Contracts with Ctlstomers (Topic 606); Idenlifying Performance Obligations and Licensing. ASU 2016-ll, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Recission ofSEC Guidance because ofAccotttzting Standards Updates 2014-09 and 2011-16 Purstrunt to StaffAnnouncements at the lllarch 3, 2016 EITF |lfeeting ana ASU 2016-12, Revenue from Contracts with Customers (Topic 606); Narrow-Scope Improvements and Practical Fsoedients In May 2014. the FASB amended exisitingguidance related to revenue fiom contracts rvith customers. This amendment supercedes and replaces nearly all exisiting revenue recogrrition guidance. including industry specitic grridance. cstablishes a nerv control-based revenue recognition model. changes the basis Description lbr deciding u,hen revenue is recognized over time or at a point in time. provides nerv and more detailed guidance on specilic topics and expands and improves disclosure about revenlle. In addition. this amendment soccities the accountins tbr some costs to obtain or fulfill a contract rvith a customer. These amendments are eflectivc for public business entities for annual reportingperiods beginningafler Date of December l5- 2Ol7- including interim periods within that reporting period. Early application is Adoption permitted only as of annual reporting periods beginning alier December 15. 2016. including interim reporting periods rvithin that period. Eftbct on The amendments should be applied retrospectively to all periods presented or retrospectively lvith the the cumulative elTect recognized at the date of initial application. 'Ihe Companv is currently evaluatingthe Financial impact of this ne'w accounting standard on its consolidated llnancial slatements. Statemcnts ASU20l5-03,lnterest-lmputationof lnterest (Subtopic835-30.1:SimplifringtltePresentationofDebtlssuanceCosts and .4StJ 2015-15, Interest - Imputation of lnterest (Strhtopic B35-30): Presentation and Subsequetlt llea.\uremenl oJ[ Debt l.ssuance Costs .lssociated with Line-of-Credit:trrongements - Amendments to SEC Paragrerphs Pursuant lo Stolf .lnnouncement at June 18. 20 l5 EITF llleetinp In April 201 5. the FASB amended existing guidance related to tlre prescntation of debt issuance costs. It requires entities to present debt issuance costs related to a recognizcd debt liability as a direct deduction fiom the carrying anrount of that debt liabilit."". 1'he guidancc does not address presentation or subseqeunt measurement ofdebt issuance costs related to line-o1'-crcdit arrangements. Given the abscnce of authoritative gridancc rvithin for debt issuance costs relatcd to line-of-credit Description arrangements. the SEC stat'l'stated thar the.r- rvould not object to an entity del'erringand presentin-sdebt issuance costs as an asset and subsequentll' anrortizing the def'erred debt issuance costs over the term of the line-c'ri'-credit arrangement: regardless ol rvhcthcr there are an-r- oustandin-e borrouings on the-line- credit arrangement. ASU 2015-15. Interest - lmputation of Interest (Subtopic 835-301 - Presentation and Sttbsequent A,leasurement ol- Debr lssuance Costs Associcttecl v,ith Line-of-Credit ..lrrongements (.4ntendnents to SEC Paragt'aphs Pursuant to Sta/.f .,lnnotrncement at June 18, 2015 ElT"l' lleetingl adrJs these comments to the "S" section of the Codillcation. These amendments are ef}'ectivc for public busincss cntities lbr f-inancial statements issucd fbr fiscal Datc ol 1'ears beginning atter December 15. 2015. and interim periods rvithin those fiscal Early adoption is Adoption 1ears. permitted lbr tlnancial statements that have not been previously issued. Efl'ect or-r The amendments are to be applied on a retrospcctivebasis. rviththe period-specificefll'cts of applying the thenewgrridancereflectedonthebalancesheetof'eachperiodpresented. Theadoptionofthisstandard Financial did not havc a material efl-ecr ol thc Company's consolidated op cratir.rg results or financial condition. Slatcments - r:t - NEXBAN K CAPITAL, INC. AND SU BSIDIA RI ES ASU 201 6-0 I , Financial Instr.tments - Overall (Subtopic 825- l0): Recognition and llfeasttrement of Financial .-!ssets and Finctncial Liabilities In January 2016- the FASB amendcd eistingguidance that reqrrires equity investments (cxcept those accounted tbr under the equity method ofaccoutning or those that result in consolidation of the investee) to be measured at fair value rvith changes in f'air value recognized in net income. It requires public business entities to use the exit price notion lvhen measuring the fair value of financia] instruments tbr Description disclosure purposes. It requires separate presentation of financial assets and financial liabilities by investment category and form of financial asset (i.e., securities, or loans and receivables). It eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fhir value that is required to be disclosed for financial instruments measured at amortized cost. These amendments are effective lbr public business entities for tlscal years beginningafter December 15. 2017, including interim periods within those fiscal years. Date of Adoption The new guidance permits early adoption of the own credit provision. In addition. the new giridance permits early adoption of the provision that exempts private companies and not-for-profit organizations from havins to disclose fair value information about financial instruments measured at amortized cost. Effect on The adoption of this standard is not expected to have a material effect on the Company's consolidated the operating results or financial condition. Fina.ncial Statements n SU 2016-02, Leases (Topic B12t ln February 2016. the FASB amended existingguidance that requires lessees rccognizethe follorvingfor all leases (rvith the exception of short-term leases) at the commencement dale: ( I ) A lease liability. u,hich is a lessee's obligation to malie lease pa1'ments arisingl-rom alease. measuredon adiscounted basis:and Description (2) A right-of'-use asset- rvhich is an asset that represents the lessee's ri-drt to use. or control the use of-. a specified asset fbr the lease term. Under the nerv guidance. lessor accounting is largcly unchanged. Ccnain targetcd improvcments rvere made to aligr. rvhere necessary. lessor accounting rvith the lessee accountins nrodel and Tooic 606- Re'venue fiom Contracts with Customers. These amendnrents are etlbctive tbr public business entities for llscal years bcginningafter December 15. 2018, includin_einterim periods rvithin those fiscal years. Early application is pemritted lbr all public business entities and all nonpublic business entities upon issuance. Lessces (tbr capital and operating leases) and lessors (fbr sales-type- direct tlnancing and operating Datc of Ieases) must apply a moditled retrospectivc transition approach fbr leases existing at" or entered into Adoption allcr. the beginning of the earliest comparative period prescnted in the financial statements. The modilled retrospective approach rvould not require any transition for lea-scs that erpired betorc the earliest conrparative period presented. Lessees and lessors may not apply' a full retrospecti'"'e transition approach. EfJ-ect on 1-hc Companf is ctrrrently evaluating the potential impact of this nerv accounting standard on its the consolidated tinancial statements. Financial Statements - 14 - NEXBANK CAPITAL, INC. AND SU BSIDIARI ES ASU 2016-13, Financial ltt.strttments - Credil Los.ses (Topic 3261 ln .lune 2016. F'ASB issucd guidance to replace the incurred loss modcl with an expected loss model, which is ref'erred to as the current e\pected credit loss (CECL) model. The CECL model is applicable to the measurement of credit losses on financial assets measured at amortized cost. including loan receivables. held-to-maturity debt securities, and reinsurance receivables. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial euarantees- and other similar instruments) and net investments in leases recognized by a lessor. Transition Description o For debt securities with other-than-temporary inpairment (O'ITI), the guidance rvill be applied prospectively o Existing purchased credit impaired (PCl) assets will be grandfathered and classificd as purchased credit deteriorated (PCD) assets at the date of adoption. The asset rvill be grossed up for the allowance for expected credit losses for all PCD assets at the date of adoption and will continueto recognize the noncredit discount in interest income based on the yield of such assets as of the adoption date- Subsequent changes in expected credit losses rvill be recorded through the allowance. o For all other assets within the scope of CECL, a cumulative efTect adjustment will be recognized in retained earnings as of the beginningof the first reportingperiod in which the euidance is eftbctive. For public business entities that do not meet the definition of an SEC filer,the standardrvill beeffective Date of for fiscal y ears beginning after December I 5, 2020. including interim periods rvithin those liscal y ears. For Adoption calendar v ear-end PBEs that are not SEC tilers- it is elfbctive for M arch 3l . 2021 interim tinancial Eft-ect on Thc Company is currently evaluating the impact of this nerv accounting standard on its consolidated the tlnancial statements. Financial Statements ASU 2016-15, Statement ofCtrslt Florts (Topic 3201: Classficcttion ofCertainCash Receipts andCash I'z4,rn4rrt In August 2016. the FASB issued this ASU to address the diversity in how certain cash rcceipts and cash paynlents are presented and classificd in the statemer-rt olcash florvs. includingthe fbllorving o Debt prepa-v"ment or debt e$inguishment costs . Settlement of zero-coupon bonds or debt with coupon interest rates thal are insignilicant in relation to the el'lective interest rate Description o Contingent consideration pa)'ments madc soon after a business combination . Procecds tiom the settlement ol insurance claims o Proceeds l-rom the settlement of BOLI and COLI policies o Distributions received tiom equity method investees o Beneficial interests in securitization transactions o Application of thc Predominance Principle For public business entities. the amendmcnts are eflectivc tbr flscal 1,ears beginningafler December 15. 2017. and interim periods in thosc fiscal y'ears. rvhich flrst applics to March 31.2018. interim linancial statements for calendar y car-end p ublic busincss entities. Date of Adoption 'I'he ASU should be adopted on a relrospective basis to each pcriod presented. Il a retrospectire transition is impracticablc tbr some olthe isssues. the amcndments tbr thosc issues rvould be applied prospecti\,el-v as of the earliest datc practicable. EfJbct on The Comparrf is currenth evaluating the impact of this ncu accounting standard on its consolidated the llnancial statements. F'inancial Statemt:nts - t5 - NEXBANK CAPITAL, INC. AND SU BSIDIARIES 2. Acouisition On November 30, 2015, the Bank acquired CSB, a New Jersey based state savings bank for a purchase price of approximately $37,509,000. Simultaneous with the acquisition, CSB was merged with and into the Bank, with the Bank being the survivor. A summary of the recorded amounts of assets acquired, liabilities assumed and resultant bargain purchase gain is as follows (in thousands): College Savings Bank: Recorded amount ofassets acquired $ 3,047 Liabilities assumed 247.469 Net assets acquired (244,422) Cash receive( net ofpurchase price 2s3-286 Bargain purchase gain $ 8,864 The acquisition resulted in a fair value adjustment to certain certificates of deposit of CSB in the approximate amount of $2,000,000 in excess ofthe face value, which is being accreted as an adjustment to interest expense on deposit accounts under a method which approximates the effective yield method over a period of four years. The resultant bargain purchase gain was recognized into income at acquisition date and has been reflected in the accompanying consolidated statement ofincome. -16- NEXBANK CAPITAL, INC. AND SUBSIDIARTES 3. Statement of Cash Flows The Company has chosen to report on a net basis its cash receipts and cash payments for time deposits accepted and repayments ofthose deposits, loans made to borrowers and principal collections on those loans and interest bearing deposits in other financial institutions. The Company uses the indirect method to present cash flows from operating activities. Supplemental cash flow information fbr the years ended December 3 I , 201 6 and 201 5 is presented as follows (in thousands): 2016 201 5 Cash transactions: Interest expense paid s 19.429 s 10,086 Noncash transactions: Purchase of loans held for investment to be settled in subsequent year, net of pnor year settlements $ 5,700 $ 299 Purchase of investment securities available for sale settled in subsequent year, net ofprior year settlements $ s.077 $ I 0,000 Net unrealized (depreciation) appreciation on securities available for sale $ ( l 5,332) $ t.870 Transfer ofsecurities from held to maturiry to available for sale $ s 25.31 3 Mortgage servicing rights originated s 6 7t7 s 3,278 Acquisition ofother real estate owned s 2.1 84 Sales ofother real estate owned financed s 813 $ ____4qq Stock grants vested, net offorfeitures $ 1.106 s 926 Retirement of treasury stock s 294 $ Acquisition of College Savings Bank (as more fully discussed in Note 2): Recorded amounts of assets purchased $ $ 3,047 Liabilities assumed 247.469 Net liabilities assumed 244.422 Purchase price 37.509 Total consideration 281 ,931 Cash received 250,79s Bargain purchase gain $ $ 8.864 -17- NEX BA NK CA PI TAL, I NC. AND S U BSIDIA RI ES 4. Debt and Eouitv Securitics Debt and equity securities have been classified in the consolidated balance sheet according to management's intent. The carrying amountof securities and their approximate lair values at December 31,2016 and 2015 are as tbllows (in thousands): Cross Cross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities Available for Sale December 31,2016: Mortgage-backed securities and collateralized mortgage obli gations $ 604.662 S 469 $ 14,091 $ 591,040 Private label mortgage-backed securities and collateralized mortgage obligations 23,2?6 2.9s1 20.3s2 Municipal securities 30t,717 582 8,480 293,8 I 9 Collateralized loan obli gations 278 548 6.497 285.04s $ 1,208,1 53 $ 7.62s S 25,522 $ I,t90,256 December 3l- 2015: U.S, Covemment Agency obligations $ 5,000 s $ 44S 4,956 Mortgage-backed securities and collateralized mongage obligatrons 24.032 2l 419 23.634 Private label mongage-backed sccurities and collateralized mortgage obligations 25.701 3.429 11 1aa Municipal securities I 06,046 2,21 ll I 08.246 Collateralized loan obligations l5 I .598 203 1.096 I 50.705 $ 312,377 $ 2.435 $ 4,999 $ 309.8 I 3 The Company had no securities classified as held to maturity at December 31. 201 6 or 201 5. Proceeds from sales of securities available tbr sale during 2016 and 2015 amounted to approximately $2.344,016.000 and $600,251,000, respectively. Gross gains recognized on these sales during 2016 and 2015 amounted to approximately $8"321.000 and $13.000, respectively. Gross losses recognized on these sales during 2016 and 2015 amounted to approxinrately $170,000 and $2.000. respectively. During 2015. the Cornpany sold two securities classitied as held to maturity immediately prior to management's decision to transtbr the remaining portlblio to available fbr sale. Proceeds l-rom sales of securities held to maturity during 2015 amounted to approximately $4. 166,000. Gross losses rccognized on these sales during 2015 amounted to approximately $7 I 6.000. No gains were recognized on these sales during 2015. During 2015 the Company transf'erred its remaining held to maturity security portfolio to available fbr sale in anticipation of contemplated subsequent sales as a result o f increased regulatory capital risk weightings. The amortized cost and lhir value at the translbr date rvere approximately $25, I I 5.000 and $25.3 I 3,000. respectively. At December 31. 2016 and 2015. investrnent securities rvith lair values of approxin.rately $59.l.040.000 and $28.590"000, respectively. w'ere pledged as collateral lbr Federal Home Loan Bank advance purposes. - 18 - NEXBANK CAPITAL, INC. AND SABSIDIARIES The amortized cost and estimated market value of debt and equity securities at December 31, 2016 are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. Securities Available for Sale Amortized Fair Cost Value Due in one year or less $ $ Due from one year to five years 31,t72 30.699 Due from five years to ten years r 81,286 I 77,038 Due after ten years 89,2s9 86.082 Mortgage-backed securities, collateralized mortgage obligations, and collateralized loan obligations 906.436 896-437 $ 1.208.153 $ I.190.256 Unrealized losses and fair value, asgregated by investment category and length oftime that individual securities have been in a continuous unrealized loss position, as of December 3l, 2016 and 2015 are summarized as follows (in thousands): Less than 12 Months l2 Months or More Total Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses Securities Available for Sale December 3l- 2016: Mortgage-backed securities and collateralized mortgage obligations $ 513,873 $ 14,091 $ $ $ 513,873 $ 14,091 Private label mortgage-backed securities and collateralized mortgage obligations I 5,904 2,9st 15,904 2,95t Municipal securities t79,486 8,47 t 1,233 o 180,719 8,480 Collateralized loan obligations $ 693,359 $ 22,562 $ 17,137 $ 2,960 $ 710,496 S 25,522 December3l- 2015 U.S. Govemment Agency obligations $ $ $ 4.956 $ 44 $ 4.956 $ 44 Mortgage-backed securities and collateralized mortgage obligations I 0,6S I 4ls t 0,691 419 Private label mortgage-backed securities and collateralized mortgage obligations t 1.203 1,482 I 1.069 t,947 )) )1) 3,429 Municipal securities 3.293 lt ? )o1 ll Collateralized loan obligations 18-762 t77 77.5)9 9r9 96-291 t.096 $ 33,258 $ I.670 $ 104,245 $ 3.329 $ 137,503 $ 4.999 - 19 - NEXBANK CAPITAL, INC, AND SU BSIDIARI ES P r iva te Labe I lt4ortgage - Bac ke cl Securi ti e s At December 31,2016. the Company has private label mortgage-backed securities and collateralized mortgage obligations (PLMBS) classified as available lbr sale rvith a fair value of approximately $20,352,000 and an amortized cost of approximately $23.226,000. The Company purchased the most significant portion ofprivate label securities during 2007 at prices ranging from 95.75o/o to 100.00% of par value. All securities rvere rated as investment grade (AAA) securities at purchase date with the Company positioned in the super senior or first tier senior support bonds. All of these bonds have been downgraded since the acquisition date. The price movement on these securities has been adversely affected by the conditions ofthe U.S. financial markets. Distressed market conditions have made it diflicult to obtain fair values on these securities in a trading market that is not active. Price quotations vary substantially and are diflicult to ascertain. Management uses a third party valuation firm to value its portfolio of private label mortgage backed securities and to assist in the determination of whether there was other-than-temporary impairment or other comprehensive income adjustment at December 3 I , 20 16. The third party perlbrms analyses which compare the amortized cost to the fair value and to the held to maturity value of each private label mortgage backed security. To the extent that the held to maturity value is less than the amortized cost of a security, several factors are considered in determining whether other-than-temporary impairment exists. Factors include the materiality of the difference between held to maturity value and amortized cost, the amount of time such diflerence has existed- trends, defaults and loss severity statistics. as well as other factors. Based in part on this analysis, coupled with third party analysis. management does not believe that it is probable that the amortized cost basis will not be recovered and believes that the Company has the ability to hold the securities until value is recovered. Management believes they have developed a rigorous credit liamework in determining potential impairment of the securities as of December 31, 2016, however, it is possible that t'uture loss assumptions could change or that current assumptions are inaccurate, which could result in future other-than- temporary impairment charges. Impairment Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and may perform analysis more lrequently when economic or market concems warrant such evaluation. Consideration is given to ( I ) the length of time and the extent to which the lair value has been less than a security's amortized cost, (2) the financial condition and near-term prospects ofthe issuer, and (3) the intent to sell. or ifit is more likely than not that it will be required to sell, betbre recovery ol the arnortized cost basis. At December 31. 2016 and 2015. certain private label mortgage backed securities have unrealized losses rvith fair values rvhich are signiticantly lorver than the Company's amortized cost basis. With the exception ol certain PLMBS as discussed above. these unrealized losses are generally due to current market conditions. Management believes that the carrying amounts of all other securities are recoverable at December 31. 2016. In analyzing an issuer's flnancial condition. rnanagement considers whether the securities are issued by the federal government or its agencies, rvhether dorvngradcs by bond rating agencies have occurred and reviervs industry analysts' reports. Additionally. management utilizes estimated default rates. prepayment speed assumptions. and severity assumptions to perform a net present value analysis to detennine rvhether the present value ofexpected cash flows or held to maturity value is less than amortized cost basis ofthe securitv. For the purpose of this detcrmination. management discounts projected cash llorvs at a rate equal to the coupon ofthe underlying security. Managerlent bclieves that this discount rate is appropriate since the securities were purchased at or near par. For the purpose ol determining fhir value. management uses discount rates rvhich correlate to required rates of retum by current investors ofsuch securities. The table below presents a rollfbrrvard fbr the years ended December 31,2016 and 2015 olcredit losses recognized in eamings tbr securities held at December 31.2016 and 2015 (in thousands): 2016 20 l5 Beginning balance, January I s 1.58.r $ 7,372 Increase to credit losses on securities lbr rvhich other-than- temporary impairment was previously recognized Reductions lbr previous cre'dit losses realized on sccurities sold during the year ( 5 788) Ending balance, Decernber 3 I S l .s8.r s | .584 -20- NEXBANK CAPITAL, INC. AND SUBSIDIARIES 5. Loans Held for Sale The Company has elecled the tbir value option lor loans held for sale. These loans are intended fbr sale and the Company believesthatfairvalueisthebestindicatoroltheresolutionoftheseloans. Interestincomeisrecordedbasedonthecontractual terms of the loan and in accordance with the Company's policy on loans held lbr investment. None of these loans are 90 days or more past due oron nonaccrual as ofDecember 31.2016 and 2015. As of December 3 I , 20 I 6 and 20 I 5, the aggregate fair value. contractual balance and gain or loss was as follows (in thousands): 2016 201 5 Aggregate fair value $ 1 87,1 66 $ 65.449 Contractual balance I 88.375 64.866 Unrealized (loss) gain $ ( r ,209) $ 583 6. Loans and Allowance for Loan Losses Loans at l)ecember 31. 2016 and 2015 consisted ofthe following (in thousands): 2016 2015 Real estate: Construclion. land development, land $ 66,784 $ s5,e46 I-4 lamily residential properties t.264.462 940,590 M ulti-t'ami ly resident ial 83.870 42.528 Nonlhrm nonresidential orwer occupred 25,966 12.243 Nonfarm nonresidential other 273.841 I 32.546 Total real estate t,714,923 l. I 83.851 Conrmercial 6 l 6,869 401 .105 Consumer 9,067 5.767 Nondepository t'inancial institutions 306.904 3 I 5.784 Lease financing receivables 743 2.648,506 1,906.709 Allowance for loan losses ( r 7.8e6) ( l 3.e96) $____zitqJlq !____l=!92J_11 At December 31.2016 and 2015, the Cornpany had total commercial real estate loans of$450,461.000 and $243,263,000. respectively. Included in these amounts. the Bank had construction, land development, and other land loans representing l7% and 227o respectively. oftotal risk based capital at Deccmber 31, 2016 and 2015. The Bank had non-orvncr occupied commcrcial real estate loans representing lll%and 92o/oof total risk based capital at December 31,2016 and 2015. respectively. Sound risk management practices and appropriate levels olcapital are essential elenrents ofa sound commercial real estate lending program (CRE). Concentrations of CRE exposures add a dimension ol' risk that cornpounds the risk inherent in individual loans. Interagency guidance on CRE concentrations describe sound risk managcment practices rvhich include board and managcmcnt oversight. portfolio management, management inlbnlation systems. market analysis, portfolio stress testing and sensitivity analysis. credit underwriting standards, and credil risk review functions. An institution rvhich has reported loans lbr construction. land development. and other land loans representing 100% or rnore oltotal risk based capital. or total non-owner occupied commercial real estate loans representing 300% or more ofthe institution's total risk-based capital and the outstanding balance of comrnercial real estate loan porflolio has increased by 50o/o or more during the prior 36 months. rnay be identifled tbr t'urther supervisory analysis by regulators to assess the nature and risk posed by the concentration. -21 NEXBAN K CAPITAL, INC. AND SU BSIDIARI ES The Company extends commercial and consumer credit primarily to customers in the states of Texas, Washington. Calilbmia. Ceorgia, and Florida. At December 31. 2016 and 2015, a signilicant portion o[the Company's loans were collateralized rvith real estate. The real estate collateral provides an alternate source ofrepayment in the event ofdefault by the borrower. and may deteriorate in value during the time the credit is extended. The rveakening of real estate markets may have an adverse effect on the Company's profitability. and asset quality. If the Company rvere required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, eamings and capital could be adversely affected. Additionally, the Company has loans secured by inventory. accounts receivable, equipment, marketable securities, or other assets. The debtors' ability to honor their contracts on all loans is substantially dependent upon the general economic conditions ofthe region. Allowance for Loan Losses An analysis ofthe allowance for loan losses for the years ended December 3 l, 2016 and 201 5 is as fbllows (in thousands) Beginning Ending Balance Provision Chargeoffs Recoveries Balance December 31,2016: Real estate: Construction, land development, land $ 1,168 $ (l2l) $ $ 74 $ l.l2l | -4 family residential properties 7,45t (575) 6,918 Multi-family residential 3t7 310 627 Nonfarm nonresidential owner occupied t32 l14 l3 2s9 Nonfarm nonresident ial other 1.434 t.296 2.730 Total real estate I 0,502 t,024 129 I 1.6s5 Commercial 2,827 850 6 3.683 Consumer 399 326 725 Nondepository fi nancial institutions 268 1,565 r ,833 Lease fi nancrng receivables $______1l.e2q $ 3.76s $ $ l3s $ 17,896 December3l,20l5: Real estate: Construction, land development, land $ 708 $ 4ls $ $ 25 $ 1,168 l -4 familv residentral propertics 4,070 3,420 (3e) 7.45t Multi-family residential 232 85 3t7 Nonl'amr nonresidential orvner occupied 77 51 (2t ti2 Nonlarm nonrcsidential othcr 975 +l I il81 1.434 Total real estate 6,062 4.47 4 (s9) 25 l 0.502 Commercial 2,715 106 (2) 8 2.827 Consumer 668 (269) 199 Nondepository llnancial institulions 234 268 !______2tr9 $ 4.545 s r6n !______ll $ 13.996 al NEXBANK CAPITAL, I NC. AND SA BSIDIARIES The Company's individual ALLL allocations are established for probable losses on specific loans. The Company's general ALLL allocations are established based upon historical loss experience for similar loans with similar characteristics and on economic conditions and other qualitative risk factors both intemal and extemal to the Company. Further information pertaining to the allowance for loan losses (AILL) at December 31,2016 and 2015 is as follows (in thousands): Loan Evaluation ALLL Allocations Individuallv General Total loans Individualh Ceneral Total ALLL December 31,2016: Real estate: Construction, land development, land $ $ 66,784 $ 66,784 $ $ r,l2l $ I,t2l l-4 family residential prcperties t2t t,264,34t t,264,462 6,918 6,9r8 Multi-family residential 83,870 83,870 627 627 Nonfarm nonresidential owner occupied 25,96:6 25,966 259 2s9 Nonfarm nonresidential other 273.841 273.841 2.730 2.730 Total real estate 12t 1,7t4,802 t,7t4,923 I I,655 l l.655 Commercial 2,902 613,967 616,869 3,683 3,683 Consumer 175 8,892 9,067 175 s50 725 Nondepository financial institutions 306,904 306,904 I,833 I,833 Lease fi nancing receivables 743 743 $ 3,r98 $ 2,545,308 $ 2,648,506 $ 175 s t7,'t2t $ 17,896 - - December3l- 20I5: Real estate: Construction, land development, land $ $ 55,946 $ 55,946 $- $ r,168 $ I ,168 I 4 family residential properties 1,075 939,5 l 5 940,590 7.451 7,451 Multi-family residential 42,528 42,528 317 3t7 Nonfarm nonresidential owner occupied t2,243 t2,243 132 t32 Nonfarm nonresidential other 132.546 132.546 t.434 Total real estate 1,075 t.182,778 l, l 83,853 I 0.502 10,502 - Commercial 2,932 398.373 40 r ,305 2,827 2.827 Consumer 189 5,578 5,767 189 2r0 399 Nondepository fi nancial institutions 3 l 5-784 3 r 5.784 268 268 $ 4,196 $ 1,902,513 $ 1,906,709 $ 189 $ 13,807 !___!p9q -23- NEXBANK CAPITAL, INC. AND SU BSIDIARI ES Impaired Loans Impaired loans include loans moditied in troubled debt restnrcturings where concessions have been granted to borrowers experiencing financial dit'ficulties. Average impaired loans during 2016 and 2015 were approximately 53,697,000 and $3,399,000, respectively. No significant interest income was recognized on impaired loans during 2016 and 2015. Approximately $134,000 and $132.000 ofadditional interest would have been recognized ifthe loans had been on accrual status during2016and20l5,respectively. ThetbllowingisasummaryofinformationpertainingtoimpairedloansatDecember3l, 2016 and 2015 (in thousands): Unpaid Recorded Investment Principal With No with Related Balance Allowance Allowance Total Allowance December 3 l, 20 I 6: Real estate: Constmction, land development, land s $ $ $ s l-4 fhmily residential properties t2l l2l t2t Multi-family residential Nonfarm nonresidential owner occupied Nonfarm nonresidential other Total real estate t2l t2t t21 Commercial 2,902 2,902 2,902 Consumer 175 175 175 175 Nondepository fi nancial institutions Lease fi nancing receivables s 3,198 S 3,021 s t75 s 3.198 t75 December3l,20l5: Real estate: Construction, land development, land s $ $ l-4 family residential properties 1,07s I,075 t,075 Multi-family residential Noniarm nonresidential owner occupied Nonf'arm nonresidential trther Total real eslate r,07s 1.075 1,075 Commercial 2.932 ? q1') 2932 Consumer 189 189 189 r89 Nondepository fi nancial institulions $ 4,007 $ 189 S 4,196 S 189 The recorded investment in loans excludes accrued interest receivable due to immateriality. For purposes olthis disclosure. the unpaid principal balance is not reduced for partial charge-oft's. The Company is not committed to lend additional funds to debtors whose loans have been moditled. -24- NEXBANK CAPITAL, INC. AND SA BSIDIARIES Past Due Loons The following table presents the aging ofthe recorded investment in past due loans at December 31, 2016 and 2015 by class of loans (in thousands): 30-89 Days Past Due 90 Davs or More Loans Not Past Due Still Accruing Non-accrual Past Due Total December 3 l, 20 I 6: Real estate: Construction, land development, land $ $ $ 781 $ 66,003 $ 66,784 l4 family residential properties 1 0,1 89 92 I,254,1 8 I t,264,462 Multi-family residential 83,870 83,870 Nonfarm nonresidential owner occupied 2s,966 25,966 Nonfarm nonresidential other 273.84t 273.841 Total real estate I 0,1 89 873 I,703,86 I t,714,923 Commercial 6 l 6,869 6 I 6,869 Consumer t74 8,893 9,06'l Nondepository fi nancial institutions 306,904 306,904 Lease financing receivables 7 43= 743 $ 10,189 $ q______l=qq $ 2,637,270 $ 2,648,506 December 3 l, 201 5: Real estate: Construction, land development, land $ $ ( 78r $ 55, I 65 $ ss,946 l-4 family residential properties 7.734 t,022 93 I,834 940,590 Multi-family residential 42.528 42,528 Nonfarm nonresidential owner occupied 12,243 t2,241 Nonfarm nonresidential other 1i2.546 t32.546 Total real estate 7,734 1,803 1,1'14,316 t, I 83,853 Commercial 40 1.305 401 ,305 Consumer 197 5,570 5,767 Nondepository fi nancial institutions 3 l s.781 3 l 5.784 $7.734$-$2,000 $ 1,896.975 $____l.e!!J92 25 NEXBAN K CAPITAL, I NC. AND SU BSIDIARI ES Troubled Debt Restru cturings The restructuring of a loan is considered a troubled debt restructuring (TDR) il both the borrower is experiencing llnancial difficulties and the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates. principal forgiveness. restructuring amortization schedules and other actions intended to minimize potential losses. During 2016. the Company did not modifl any loans as TDRs. During 2015. the Company had modified one l-4 family residential loan as a TDR. The relating unpaid principal balance and recorded investment amounts on this loan were approximately $99,000, and $99,000,respectively. TherewasnoallocatedallowanceforloanlossesatDecember3l,20l6and20l5. C redit Qu al ity I nfor mati o n The Company categorizes loans into risk categories based on relevant information about the ability ofbonowers to service their debt. including: current financial intbrmation, historical payment experience, credit documentation, public infbrmation, and current economic trends, among other factors. The Company analyzes loans individually by classiSing the loans as to credit risk. All loans are analyzed on a monthly basis. The Company uses the following definitions for risk ratings: Pass Loans classified as pass are loans with low to average risk. Special Mention Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected. these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some luture date. Substandard Loans classified as substandard are inadequately protected by the current net rvorth and paying capacity ofthe obligor or of the collateral pledged. if any. Loans so classified have a lvell-dehned weakness or weaknesses that jeopardize the liquidation of the debt. They' are characterized by the distinct possibility that the institution rvill sustain some loss if the det'iciencies are not corrected. Doubtful Loans classilied as doubtful have all the weaknesses inherent in those classiiled as substandard, lvith the added characteristic that the rveaknesses make collection or [iquidation in full, on the basis ofcurrently existing t-acts, conditions, and values, highly questionable and improbable. 26 NEXBANK CAPITAL, INC. AND SU BSIDIARIES As of December 31,2016 and 201 5. and based on the most recent analysis performed, the risk category ofloans by class of loans is as follows (in thousands): Special Pass Mention Substandard Doubtful Total December 31,2016: Real estate: Constnrction, land development, land $ 66,784 $- $ $ $ 66,784 l-4 family residential properties 1,264,342 120 t,264,462 Multi-family residential 83,870 83,870 Nonfarm nonresidential owner occupied 25,966 25,966 Nonfarm nonresidential other 273.078 76; .------273.841 Total real estate 1,714,040 763 120 I,714,923 Commercial 613,961 2,902 616,869 Consumer 9,067 9,067 Nondepository fi nancial institutions 306,904 306,904 Lease fi nancing receivables 743 743 $ 2,644,721 $ 763 $ 3,022 $ $ 2,648,506 - December3l-2015 Real estate: Construction, land development, land $ 56,01s $ $ $ $ ss,946 I 4 family residential propertres 933,763 I.076 940.590 Multi-family residential 42,528 42,528 Nonfann nonresidential owner occupied I 2,009 213 t2,243 Nonfarm nonresidential other l3 I .402 805 't32.546 Total real estate t,t7 5,717 1,01 8 I,076 l, l 83,851 Commercial 398,1 5 I 2,932 40 r ,30s Consumer 5,754 5,767 Nondepository fi nancial institutions 3t5.771 3 l s-784 $ 1,895.393 $ 1,0r 8 $ 4,008 $ $ 1,906.709 27 NEXBANK CAPITAL, INC. AND SUBSIDIARIES 7, Loan Pool Purchases During the years ended December 31,2016 and 2015, the Company purchased individual loans as well as various pools of residential l-4 family loans. The Company has applied the provisions of FASB ASC 310-20, "Nonrefundable Fees and Other Costs" to all loans and loan pools acquired. The purchase price of these loans is included in the accompanying consolidated balance sheet as loans receivable at December 31,2016 and 2015. A summary ofthe unpaid principal balances ofthe loans acquired and the relating purchase price is as follows (in thousands): 2016 201 5 Loans purchased at a premium: Purchase price $ 456,523 $ 332,332 Unpaid principal balance at acquisition 448.548 326293 Premium paid $ 7,975 $ 6,039 Loans purchased at a discount: Purchase price $ 34,742 $ 22,796 Unpaid principal balance at acquisition 16 620 24.065 Discount $ (r,878) $ (1,269) None ofthe above loans acquired at a discount had evidence ofdeterioration ofcredit quality since origination at the purchase date. Management believes that the discount was solely attributable to interest rate movements, and, thus, non-credit related. Accordingly, the entire discount was deemed to be accretable by management. The premium and discount have been included as a component of the carrying value of the purchased loans and are being recognized as an adjustment of yield over the life of the relating loans under methods which approximate the interest method. At December 31,2016 and 2015, management determined that the acquired loan pools are not impaired and. accordingly, no specihc valuation allowance was required. Management believed that the general reserve portion of the allowance lbr loan losses was sufficient to cover inherent losses within the acquired loan pools. 8. Premises and Eouioment Premises and equipment at December 31, 2016 and 2015 are summarized as lbllows (in thousands): 2016 20 15 Land $ 891 $ Building and improvements 4,391 4,1 68 Fumiture fixtures and equipment 4.00 t 3.1 l3 9,283 7,281 Accumulated depreciation (6.038) (4.615) $ 3.245 $ 2,666 28 NEXBANK CAPITAL, INC. AND SUBSIDIARI ES 9. Nfortsase Bankine Activities lvlo r t ga ge Se rv i c i ng Ri ght s Mortgage loans serviced tbr others are not included in the accompanying consolidated balance sheet. The unpaid principal balance of mortgage loans serviced lbrothers was as follows at December 31,2016 and 2015 (inthousands): 20t6 201 5 Mortgage loan portfolios serviced lbr: FNMA $ 3,674,428 $ I,833,03 r FHLMC 3s0.964 38.500 GNMA 213,146 4t4 FHLB 5 t.597 $ 4.290,135 $ r.871.94s Custodial escrow balances maintained in connection with serviced loans were approximately $72,169,000 and $15,499,000 at December 31,2016 and 2015. respectively. These balances are included in noninterest bearing deposits in the accompanying consolidated balance sheets at December 31,2016 and 2015. An analysis o f net mortgage servicing rights lbr the years ended December 3 I , 201 6 and 201 5 is as follows ( in thousands) 2016 2015 Balance, January I $ 20.897 $ r 6.43 5 Originations 6,717 3,278 Purchases 22,731 2.224 Change in fhir value 1.883 ( 1.040) Balance, December 3l $ 52.228 $ 20.897 As previously discussed in Note I to the accompanying consolidated financial statements, the Company has elected the fair value option for accounting for its mortgage servicing rights. Key economic assumptions used in measuring the initial servicing rights resulting from sales and securitizations ol residential mortgage loans during the year include expected prepayment speed, lveighted average lile. and discount rate. Management uses current prepayment speed assumptions of Bloomberg consensus broker opinions as of the month oI sale or securitization. Weighted average lives are based on contractual terms and prepayment speeds lbr the respective residential mortgage loans as of the date olsale or securitization. Management uses a discount rate ofbetween 9.50 perccnt and 12.50 perccnt to value estimated cash flows lor all sales and securitizations. Key economic assurnptions and the sensitivity olthe current thir value of residual cash florvs to immediate l0% and 20%o adverse changes in market rates are as lbllorvs as olDecember 31.2016 and 2015 (dollaramounts in thousands): Residential Mortgase Loans 2016 2015 Fair value of scrvicing rights $ s2,2?8 $ 20.897 Weighted-average life (in years) 7.64 6.7 | Prepayment speed assumption/Constant prepayment rate 139Yo/8.3o/o 175Yo/10.5% lntpact on fair value of I 0'% adt'erse change $ ( 1.452) $ (684) lmpact on fair valne of 20oZ adterse chonge $ (2.821) $ ( 1.321) Residual cash flows discount rate (annual) 9.50o/o 8.50% lmpqct on Iair volue of 1094 adt,erse clmnge $ 12,069) $ (713) lmpocl on .foir vlue of 20o.4t adterse change $ (i.993 ) $ ( 1.383) 29 NEXBANK CAPITAL, INC, AND SU BSIDIARI ES The fair value olservicing rights is estimated by management. The susceptibility to movements in intcrest rates affect the cash flows generated from the mortgage servicing rights. Interest rate risk is a significant market risk ,,vhich could potentially have a significant ell'ect on the financial statements. These sensitivities are hypothetical and should be used with caution. As the ligures indicate, changes in fair value based on various assumptions generally cannot be extrapolated because the relationship olthe change in assumption to the change in fair value may not be linear. Also, in the above table, the effect of a variation in a particular assumption on the lhir value of the retained interest is calculated without changing any other assumption: in reality. changes in one factor may result in changes in another (for example. increases in market interest rates may result in lower prcpayments and increased credit losses), which might magni$ or counteract the sensitivities. L i a b i I i ty fo r Mo r t ga ge Loa n R e pu r c h ase los.ses lncluded in accrued expenses and other liabilities in the accompanying consolidated balance sheet is the liability for mortgage loan repurchase losses. Because the level ofmortgage loan repurchase losses depends upon economic factors, investor demand strategies, and other extemal conditions that may change over the life of the underlying loans. the level ol the liability for mortgage loan repurchase losses is ditlcult to estimate and requires considerable management judgment. Management maintains regular contact with the GSEs- the FHFA, and other significant investors to monitor their repurchase demand practices and issues as part of its process to update the repurchase liability estimate as new information becomes available. Because of the uncertainty in the various estimates underlying the mortgage repurchase liability. therc is a range of losses in excess of the recorded mortgage repurchase liability that is reasonably possible. The estimate ofthe range ofpossible loss for representations and warranties does not represent a probable loss, and is based on currently available intbrmation. significantjudgment. and a number of assumptions that are subject to change. An analysis of the changes in the liability for mortgage loan repurchase losses for the years ended December 3 I , 201 6 and 201 5 is as follows (in thousands): 2016 201 5 Balance, beginning of year $ 182 $ 100 Provision fbr repurchasc losses 2il 99 Losses ( l2) 1t7\ Balance, end oiyear s 38r $ t82 10. Other Assets Other assets at December 3 l. 2016 and 20 l5 consisted of the tbllowing (in thousands): 2016 201 5 Federal llorne Loan Bank and other stock $ 46.676 s i2,815 Accrued interest recei vablc 15.624 R q57 Mortgagc and other reccivublcs 7,320 , t r< Derivative instruments 2.876 2.7 53 Repossessed assets 1.65i 3.944 Software I.057 t.184 Lots held for residential developrnent I ,021 r .166 Prepaid expenses and othcr asscts 729 4.01 2 $ 76.956 $ 56.956 -30- NEXBANK CAPITAL, INC. AND SUBSIDIARIES I l. flnconsolidated Investments and Junior Subordinated Debentures Unconsolidated investments at both December 31,2016 and 2015 consisted olthe Company's investrnent in a Special Purpose Entity in the amounts of $464,000. Additionally, unconsolidated investments at December 3'i,,2016 and 2015 consisted ofNSl's 600lo investment as a limited partner in two land development partnerships in the aggregate approximate amounts of $2,650,000 and $2,048,000. respectively. NSI lnvestment in Partnerships The partnerships also have outstanding debt due the Bank, in an aggregate maximum amount ol$7,500,000 (unpaid balances of approximately 52,566,000 and $4,915,000 at December 31, 2016 and 2015, respectively). Pursuant to the terms of the partnership agreements, NSI is to receive an 8olo preferred retum and a60140 split of profits upon completion of the projects and sale ofthe underlying lots, respectively. These partnerships have been identified as variable interest entities under the guidance ofFASB ASC 810-10. In determining whether the Company is the primary beneficiary of these partnerships, management has considered whether the Company has both: (a) the power to direct the activities of the partnerships that most significantly impact their economic performance; and (b) the obligation to absorb losses ofthe partnerships or to receive benefits from the partnerships that could potentially be significant to them. The Company's losses are limited to its initial collective investment of $2,000,000; any additional losses are to be absorbed by the partnerships' general partner. Additionatly, the general partner ofthe partnerships directs and controls the day- to-day activities without involvement of the Company or any other limited partners. Accordingly, management has determined that the Company is not the prirnary beneficiary ofthese partnerships, and, therelbre. these entities have not been consolidated in the accompanying financial statements. Condensed linancial information of these partnerships as of December 3 l, 20 I 6 and 2015 is as fbllows (in thousands): 20 l6 20t5 ASSETS Land held for development $ 3,662 s i 1r7 Capitalized development costs 2.288 2.568 Other assels 78 t03 Total assets s 6.028 $ 7 998 I-TABILITIES AND PARTNERS' CAPITAL Earnest money deposits and accrued liabilities $ 812 s I,0i5 Notes payable 2.566 4.91 5 Total Iiabilities J.J /6 s qso Partne/s capital 2_650 2.048 Total Iiabilitics and partners' capital !______!p?_q $ 7,ee8 L-or the year ended December 31. 2016, these partnerships generated approximately 53,828,000 and $3.269,000 ofrevenue and costol'sales.respectively.throughsaleoft'ullydevelopedsinglcfhmilyresidential lots. FortheyearendedDecember3l.20l5. these partnerships generated approximately $700.000 and $531.000 ofrevenue and cost ofsales- respectively. through sale of t'ully developed single larnil.v residential lots. lnveslmenl in Special Purpose Entity and Jttnior Subordintrted Debentures Junior subordinated debentures ol$15.464,000 at both December 31.2016 and 2015 represent amounts payable to a Special Purpose Entity (SPE) irr coniunction rvith the Company's sponsorship olthe SPE. The SPE has one issuance outstanding totaling $15.000.000 in trust pref-erred securities and $464.000 in common stock (rvholly-owned by NCI) at Dcccmber 31.2016 and 2015, respectively. Both the.lunior subordinated debentures and the related trust pret'ened securities yield annual distribution rates at the 90 day LIBOR rate plus 1.75% (2.60Yo ai December 31. 2016). becanre redeemable beginning March 15. 2012 (rvithout penalty) and rnature March 2037. -3t- NEXBANK CAPITAL, I NC. AND SUBSIDIARI ES The trust prelbrred securities are tax-advantaged issues that currently qualify as Tier I Capital fbr the Company. Distributions on these securities are included as interest expense on other borrowings. The underlying trust is a statutory business trust organized for the sole purpose of issuing trust preferred securities and investing the proceeds thereof in junior subordinated debentures ol -fhe the Company, the sole asset ofthe trust. trust preferred securities ofthe trust represent preferred beneficial interests in the assets ofthe trust and are subject to mandatory redemption upon payment ofthejunior subordinated debentures held by the trust. The common securities ol the trust are wholly-owned by the Company. The trust's ability to pay amounts due on the trusl preferred securities is solely dependent upon the Company making payment on the related junior subordinated debentures. 'fhe Company's obligations under the junior subordinated debentures and other relevant trust agreements, in aggregate. constitute a full and unconditional guarantee by the Company of the trust's obligations under the trust securities issued by the trust. The Dodd-Frank Act eliminated the use of trust preferred securities issued after May 19, 2010 as a component of Tier I capital for depository institution holding companies. such as the Company. However, because the Company had less than $15 billion of consolidated assets as June 30, 201I, the Company will be permitted to include any trust pretbned securities issued before May 19,2010 as an element ofTier I capital, but not be able to include any trust preferred securities issued after May 19,2010 as a component of Tier I capital. Further, the Board of Governors of the Federal Reserve System (Board) has determined that trust prelerred securities are restrictive core capital elements in computing Tier I capital of bank holding companies. The Board has limited restricted core capital elements (as defined) to 257o of core capital elements. Accordingly, the Company is limited on the trust preGrred securities which it can include in its Tier I capital. Underthe revised BASEL III guidelines etlective January l,2015. these borrowings qualified lbr Tier I Capital Ratio purposes up ro 25%o, but did not qualify tbr Common Equity Tier I Capital Ratio purposes. I2, Deoosits Deposits at December 31, 2016 and 2015 are summarized as follorvs (in thousands): 2016 20t5 Amount Percent Amount Percent Noninterest bearing demand accounts S I ,41 7,893 44.0 S 687.863 36.6 lnterest bearing demand accounts l.35l.ll4 4l .9 634.516 JJ 6 Savings accounts 391 00 i9.342 2.1 Certifi cates of deposit, S2-50.000 and greatcr i 5,2 59 3 8.380 2.0 Cenificates of deposit. less than S250.000 420 086 ti 0 478 409 255 S 3.2?.4-743 100.0 s I .878.5 I 0 100.0 At Decernber 31,2016 and 2015. the Cornpany held approximately $140.300.000 and 553.341.000. respcctively, in brokered deposits. At December 31- 2016. schcduled maturities of certificates of deposit accounts are as lbllor.r,s (in thousands): Years Amount Less than one Year S 267,9'78 Onc to three years I i4,i5 I Ovcr thrce years 53 0r6 s 455 145 Included in certificates oldeposit at Dccember 31,2016 are CollegeSure and InvestorSurc CDs in the approxirnate amounts ol' $101.703.000 and $15,184.000. respectively'. lncluded in certificates oldeposit at Decernber 31.2015 arc CollegeSure and InvestorSure CDs in the approximate amounts oi$l 19.286.000 and $.l6"726"000, respcctively. 32 NEXBANK CAPITAL, INC. AND SUBSIDIARIES 13. Advances From Fedcral IIome Loan Bank Advances liom the Federal Horne Loan Bank amounted to $1,005,000,000 and $555,000.000 at December 31. 2016 and 2015, 'fhe respectively. borrowings are collateralized by a security agreement. which requires the Company to maintain a certain level of qualified first mortgage collateral and investment securities in relation to the amount of outstanding debt. The borrowings at December 31,2016 mature on January 3,2017 with all unpaid principal and interest due at maturity. and bear interest at 0.550%. The Company has additional borrowing capacity under this line of credit olapproximately $225,900,000 at December 31, 2016. The borror.r,ings rvhich mature in January 2017 r.rere renewed lorone-day periods. The Company has lines of credit (LOC's) outstanding for the benefit of Fannie Mae and certain public fund depositors in the aggregate amount of $405,132,000 at December 31, 2016. These LOC's mature at various dates beginning January 10,2017 throughDecember20,2017. AsolDecember3l.2016,noamountshadbeendrawnundertheseLOC's. 14. Other Borrowines Other borrowings consist olthe following at December 31, 2016 and 2015: December 3 l. 20 I 6 December 3 I 201 5 Unamortized Unamortized Debt Debt lssuance Net lssuance Net Princioal Costs Amount Princioal Costs Amount Senior unsecured notes payable $ 75,000 $ I .085 $ 73.9rs $ $- $ Revolving line ofcredit - unaffiliated commercial bank 20.000 72 19.928 Notes payable - unaffiliated commercial bank 59.909 388 59.52 I s 95.000 s I ,1 57 s 93,841 s 59,909 s 388 s 59.52 l Senior Unsecured Notes Payable On March 15" 2016. lhe Company completed a senior unsecured notes ofTering in the amount of $50,000.000 etfectively relinancing its existing other borrowings rvith an unpaid principal balance of approximately $59.909,000 at Dccember 31. 2015. Additionally, the Company reopened its senior unsecured notes oft-ering on September l. 2016, increasing them by S25,000,000. The senior unsecured notes aggregate $75.000,000 at December 31,2016: call fbr quarterly interest only payments beginning June I 5. 2016 at a fixed rate ol5.50olo through March 15.2021l. and are redee mable beginning on March 15.2021 (at which time they convert to a floating rate of three-month LIBOR plus 435.5 basis points). The notes mature March 15.2026. Revolving Line of Credit - Unalfiliated Cotnrnercial Bank Additionally. eflbctive on March 15. 2016, the Company executed a revolving line of credit with an unatliliated commercial bank in the maxirnum principal amount ol$10.000.000. Effective December 15,2016, the Company retinanced this revolving line of credit rvith another unaflliated commercial bank and increased its borrowing capacity to $30,000,000. The Conrpany irnmediately drew $20.000.000 under this line olcredit, paid-ol'fthe existing revolving line of credit and injected S10.000,000 into its subsidiary Bank in the fbrm of subordinated debt (See Note 15.). The revolving line of credit calls lbr monthly interest payments only beginning January 15.2017 at a lloating rate ofprime plus one halfolone percent (4.257o at December 31. 2016): contains a maturity date olDecember 15, 2018. is collateralized by substantially all assets olthe Conrpany, including the stock of its wholly-owned subsidiaries. and contains cornpliance requirements with certain financial covenants. all olwhich the Company r,vas in compliance rvith as oland tbr thc year errded Dccernber 31. 2016. The company has additional borrorving capacity under this revolving line olcredit ol'S10.000.000 at December 31.2016. Note Pcry,crble Uneffilictted Conrnercial Bank Other borrorvings in the approximate amount o1559.909.000 at December 31,2015. consisted ofthree individually executed notes payable ($39.959.000. $10.000.000. and $9.950.000 lranches) rvith an unalllliated conrnrercial bank. The 539.959.000 trarche carried a tixed interest rate of5.25%o. l'he $10.000.000 and $9,950.000 tranches both carried an interest rate olWall Street Journal prime ratc and containcd a lloor rate of 4.50o/o. Collectively. the borrowings required monthly principal and interest payments sullicient to amortize the borrowings over a ten-year period (approximately $635.000 per month). The borrowings matured December 22.2019 and rvere collateralized by 100% ol the issued and outstanding common stock of NexBank, SSB. The borros'ings also required conrpliance rvith certain financial covenants. all olrvhich the Cornpany had rnet duringtheyearendedDccemberil"20l5. Thesenotesrverepaidinlull inMarch.20l6.asdiscussedabove. JJ NEXBANK CAPITAL, I NC. AND SUBSIDIARIES 15. Related Partv Transactions ln the ordinary course of business. the Company has and may continue to have transactions. including borrowings. rvith its executive ol'ficers, directors and their alfiliates. At December 31, 2016 and 2015, the aggregate amounts ofsuch loans were approximately $36,970,000 and $36,174,000, respectively. During the year ended December 31, 2016, new loans funded amounted to approximately $8,799-000 and repayments totaled approximately $4,097,000. Additionally, unpaid loan balances in the aggregate amount of approximately $3.906,000 were related to loans to affiliates of former executive officers and directors who ceased being in that capacity during 2016. During the year ended December 31, 2015, nerv loans funded amounted to approximately $28,979,000 and repayments totaled approximately 5859,000. Additionally, unpaid loan balances in the aggregate amount ofapproximately $3.902,000 rvere related to former executive officers and directors who ceased being in that capacity during 2015. Included in loans to related parties at December 31, 2016 and 2015, are loans to certain officers and directors of the Company under the Company's Otficer and Director Loan Program (ODLP) in the approximate amounts of $5,445,000 and 5405.000, respectively. All such loans are collateralized by shares of Company stock wholly owned by the participants in the ODLP. During the years ended December 31,2016 and 2015, new loans lunded amounted to approximately 55,040,000 and $405,000, respectively. The Company funded an additional amount of approximately $2,398,000 under the ODLP on January 3, 20 17. The ODLP assists in the payment of federal income taxes incurred by the recipients as a result of taxable corporate eamings being allocated to them. Al[ amounts due under the ODLP have been reported as contra-equity in the accompanying 2016 consolidated financial statements. Subsequent to December 31,2016, the Company terminated the ODLP and is contemplating the formalization of a debt fbrgiveness program whereby the balance of the loans under the ODLP would be forgiven ratably over a three installment period. NSI derives a significant portion of its income on products, marketing. and management services it performs lbr and on behalf of Highland Capital Management- L.P. (HCMLP) and its affiliates. HCMLP is an afliliate through common ownership. Approximately 53.266,000 (50% of NSI's total revenue) and $4,632.000 (45% of NSI's total revenue) was derived from transactions involving HCMLP and/or various other affiliated entities during 2016 and 2015. respectively. Certain expenses incurred by HCMLP or other Company afl'iliates are allocated to NSI pursuant to the terms of a management agreement between these entities. Tolal expenses allocated to NSI and expensed by NSI during 2016 amounted to approximately $207,000. including rent allocation olapproximately S121,000. as discussed in Note 18. Total expenses allocated to NSI and expensed by NSI during 2015 amounted to approximately S231,000, including rent allocation olapproximately $121,000- as discussed in Note 18. NSlhadtotal receivablesliomatlliatcsofapproximately$94.000atDecember3l,20l5. NSI hadnoreceivablestiornalhliates at December 31. 2016. NSI had total payables to al'filiates of approximately $5,000 and $6.000 at December 31.2016 and 2015. respectively. At December 31, 2016 and 2015. the Company had approximately $48.633.000 and $271,460.000. respectively. in deposits lrom related parties. including directors, stockholders. and their related al'llliates. During 2016. the Conrpany sold certain other real estale orvned to an afllliate oIHCMLP. The aggregate carrying amount of this property was approxirnately $557.000. and the Company received net proceeds oiapproximately S1,250,000. resulting in a net gain olapproxinrately $693.000. A portion ofthe proceeds (approxirnately 5813.000) was linanced by the Company. During 2015. the Company sold certain other real estate o\rmed and repossessed assets to an at'flliate ol'HCMLP. The aggregate carrying amount ofthese properties rvas approximately $3.400.000, and the Company received net proceeds of$3.238.000, resulting in a net loss olapproximately $162,000. A portion ofthe proceeds (approxinrately $2,480,000) was financed by the Company. These notes rvere paid in I'ull during 2016. 31 NEXBANK CAPITAL, INC, AND SUBSIDIARIES 16. Financial Instruments The Company is a party to tinancial instruments with ofFbalance sheet risk in the normal course ol business to meet the financing needs of its customers. These financial instruments include comrnitments to extend credit and standby lefters of'credit. Those instruments involve. to varying degrees. elements ofcredit and interest rate risk in excess ofthe arnount recognized in the consolidated balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party to the linancial instrument for commitments to extend credit is represented by the contractual amount olthese instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. At December 3 I , 201 6 and 2015, the approximate amounts ofthese linancial instruments were as lbllows (in thousands): 20t6 2015 Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 275,235 $ t89.494 Standby letters of credit 655 t.9:10 $ 275.890 $ 19t,424 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts do not necessarily represent future cash requirements. ln addition, the ma-iority of the commitments are secured by cash deposits at the Company. The Company evaluates each customer's creditworthiness on a case-by-case basis. '[he amount and type ofcollateral obtained ifdeemed necessary by the Company upon extension ofcredit" varies and is based on management's credit evaluation of the borrower. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a thirdparry. Standbylettersofcreditgenerallyhavellxedexpirationdatesorotherterminationclausesandmayrequirepayment ofa l'ee. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loan facilities to customers. 'fhe Company's policy lor obtaining collateral and the nature ol such collateral is essentially the same as that involved in making commitments to extend credit. Although the rnarimum exposure to loss is the anrount of such commitments, management currently anticipates no material losses I'rom such activities. -35- NEXBANK CAPITAL, INC. AND SU BSIDIARI ES 17. Emoloyee Benefits The Company has a noncontributory prolit sharing plan integrated rvith a contributory 401(k) employee benefit plan (Plan) covering substantially all employees. Employees generally become eligible in the Plan upon attainmentolthe age ol 21, with entry dates ofJanuary I and July I ofeach year. Under the Plan, the Board ofDirectors may contribute, at their discretion and subject to annual limitations. certain amounts in the form ofmatching. profit sharing and/or qualified non-elective contributions. Plan expense for the years ended December 31.2016 and 2015 amounted to approximately $2,121,000 and $1,603.000. respectively. During 2015" the company amended its stock arvard plan providing tbr up to 300,000 shares of Company stock that is administered by the compensation commiftee of the board of directors. Prior to the amendment, the stock award plan provided for up to I 00,000 shares of Company stock It is a performance based plan that is dependent on the results of operations, but involvesjudgment on the part ofthe committee. Stock awards for any given year are generally granted shortly afler year end. Stock compensation expense is recognized over the requisite service period. A portion of the awards are typically vested on the grant date in order to reflect the prior year service (service inception date). An accrual is necessary to recognize the expense when the service inception date is prior to the grant date and that accrual is carried in accrued expenses and other liabilities on the balance sheet. In some cases, the Company has paid additional bonuses in amounts necessary to cover the participant's income tar burden. At December 3 l. 201 6 and 201 5 approximately $738.000 and $674,000, respectively, was accrued related to stock awards and related bonuses to cover the participant's tax burden. At December 31. 2016, there are 228.348 shares available lor grant under the stock award plan. A summar-v of stock grant transactions and slock grants outstanding during the years ended December 31" 2016 and 2015 is as follows: 20t6 2015 Average Grant Shares Under Averagc Grant Shares Under Date Fair Value Grant Date Fair Value Grant Outstanding at beginning ofyear $ $ 3000 7.500 Granted during the _vear $ I i0.00 9,848 $ 65.00 20.752 Issued during the year $ 13000 (9.848) $ 55 71 (28.252) Outstanding at the end ofyear s $ Included in shares granted. are 54,496 shares that vest over a four year period fbr which the arvardecs elected to be taxed at the time ofthe grant under special provisions ofthe Internal Revenue Code. and. accordingly contain alI rights associated uith orwership of the stock during the vesting pcriod. At December 3 I . 20I6, I9.668 shares remain nonr,ested in connection r,vith those grants. A summary of the status olthe Company's nonvested shares at December 31.2016 and 2015 is as follows: 20 l6 201 5 WeigJrted Average Weighted Average Crant Date Grant Date Shares Fair Value Sharcs Fair Value Nonvested at January I 24.060 $ 4 t.38 27.2s 1 $ 41 38 Granted during the ycar 9.848 $ ]]0,00 20.152 $ 65.00 Vested during the year ( r4,240) $ 68.66 (2 r.57r ) S 46.03 Forf-eited during the 1-c'ar -$ (2.372\ $ 59.07 Nonvested at Deccmhcr i l 19.668 $ 83 69 24.060 s 55 84 Tolal stock compensation (benetlt) e\pense (included in salaries and benefits in the accompanfing consolidated tinancial slalements) fbr the 1'ears ended Decembcr 31. 2016 and 2015 amounted to approximatel: $(181.000) and 54.032.000. respectively. As of Decembcr 31. 2016. there rvas approximatcly $1.646,000 oltotal unrecognized compensation cost rclated to nonvcstcd stookarvards. Thccostisexpcctedtoberccognizedoverarvcigl"rtedaverage periodof2.5years. 36 NEXBANK CAPITAL, INC, AND SUBSIDIARIES The Company is the benetlciary of rvhole [if'e insuranoe policies covering certain key executives and ofllcers. The recorded values ofthe related policies at December 31.2016 and 2015 were approximately $58,912,000 and $41,769.000. respectively. Management has classified certain investments rvithin its separate account company orvned life insurance as substandard. At December 31,2016 and 2015. investments classilled substandard amounted to approximately $8,225,000 and $11,041.000. respectively. Cains recognized on these policies amounted to approximately $2,287,000 for the year ended December 31. 2016. Losses recognized on these policies amounted to approximately $2,940,000 for the year ended December 31,2015. At both December 31, 2016 and 2015, the Company had all olits cash surrender value policies with one insurance company, all of which are separate account insurance policies. 18. Commitments and Continsencies Contingencies: NSI is named as a co-defendant in a lawsuit that alleges, among other things: (l) NSI and other co-defendants fraudulently induced the plaintifl's into participating in a loan by tailing to fully disclose the borrower's financial condition; and (2) NSI negligently performed certain financial advisory services for the borrower. There are substantial uncertainties inherent to all litigation, and NSI cannot yet predict the outcome of the litigation or whether the litigation will have a material impact. NSI continues to vigorously detbnd itselfagainst all ofthe claims, and has filed a motion lbr sanctions (including for the recovery of attomeys' Ges and costs) against the plaintitls for filing a suit in bad faith and without a factual basis. As of December 31,2016 and 2015, no amounts have been accrued in connection rvith this lawsuit. During 2016, the Company entered the Federal Home Loan Bank's Mortgage Partnership Finance Program (MPF Program) whereby it agrees to sell certain l-4 family residential loans to the Federal Home l,oan Bank (FIILB) and, in turn, commits to indemnity the F'HLB lbr a portion ol f'uture losses incurred should one or more of the sold loans det-ault. At December 31. 2016. the Company had sold approximately $5 1,597,000 in such loans. resulting in a maximum indemnification contingent liability of approximately $2,746,000. The conrpany believes that its liability for mortgage loan repurchase losses (as more fully discussed in note 9) is sufficient to absorb an1' potential losses inherent in its participation in the MPF Program. From time to time, the Company is involved in various other legal actions arising from normal business activities. Lease Commitments: The Company leases portions of its faoilities fronr unatlliated third parties under operating lease agreements rvhich expire at various dates through 2022. These leases require minimum annual rentals in the approximate flollowing amounts (in thousands): Year Amount '72t 20t7 $ 201 8 605 201 9 619 2020 613 2021 506 Thereafter ,1t $ 3.4 l7 Total lease expense under the above lease agreements was approximately $884.000 and $820.000 for the years ended December 3 l. 2016 and 2015. respectively. lncluded in lease expense arc amounts paid to related parties of approximately $12.l.000 lbr both the years ended December 31. 20l6and20l5(seealsoNotel5). Thercntexpenseincurredduring20l6and20l5rvasallocatedtoNSlbytheBank. Employment Contracts: Pursuant to its acquisition of'CSB, the Company entered into contracts with certain lbrnrer CSB executive oll'icers (norv current Company employees) fbr continued employment through Novernber 30- 2016. As of December 31.2016, thesc contracts \vere substantially paid-in lull. -37 - NEXBANK CAPITAL, INC. AND SU BSIDIARI ES 19. Derivatives The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help rnanage its interest rate risk position. The notional amount ol the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by refbrence to the notional amount and the other terms of the individual interest rate swap agreements. lnterest Rate Swaps During 2016 and 2015, the Company entered into various interest rate swap agreements. There were no outstanding interest rate swap agreements at December 31,2016. At December 31, 2015, the combined notional amounts outstanding of these interest rate swap agreements amounted to $800,000,000. These interest rate swap agreements generally do not qualify tbr hedge accounting treatment. and, therelore changes in fair value are reported in current year eamings. Summary information relating to these interest rale swaps at December 31, 2015, is as follows (dollar amounts in thousands): Notional amount $ 800,000 Pay rate 3 Month LIBOR Receive rate 0.93o/olo l.llo/o Maturity November 201 7 to December 20 I 7 Fair value ofcombined interest rate swaps $ (1.e27) The liability associated rvith unrealized losses on interest rate swaps at December 31.2015 had been recorded in accrued expenses and other liabilities in the accompanying consolidated balance sheet. These interest rate swaps were subsequently terminated in January'2016, and the Company realized a net gain of approximately $4,700,000. Following is a summary of unrealized and realized interest rate srvap gains and losses for the years ended December 3 l. 20 I 6 and 20 I 5 (in thousands): 20t6 20t5 Unrealized (losses) gains recorded in consol idated statcment of incorne $ $ ( 1,927) Realized gains recorded in consolidated statement of income 7.659 I 1.885 $ 7.659 $ ll 958 illortgage Banki ng De r ivative s As olDecember 31,2016 and 2015. the Cornpany had short-term rate cornmitments amounting to approximately $92.634,000 and $47.875,000, respectively. to I'und mortgage loan applications in process (the Committed Pipeline). Substantially all olthese comrnitments are lor periods ol60 days or less. In order to mitigate thc risk that a change in interest rates will result in a decline in the value olthe Committed Pipeline. the Company enters into derivative transactions. l'he Cornmitted Pipeline is hedged rvith fbrrvard contracts fbr the sale of mortgage backed securities (MBS). Due to the variability of closings in the Committed Pipelinc. rvhich is driven primarily by interest rates. the Company hedges a substantial portionoftheComrnittedPipeline. AsofDecember3l.20l6and20l5.theCompanl'hadnettbruardcontractsto sell MBS rvith aggregate notional amounts ol approximately $85.750.000 and $44.250.000. respcctivell'. These lbrrvard contracts are short-tern'l in naturc, generally with expiration dates olless than 90 days. All derivatives are recognized on the balance sheet at their thir value. rvith changcs in fhir value recogniz-ed through earnings. As olDecember 3l- 2016, the Corrrpany has rccorded an asset fbr the fhir value of lbrward contracts olapproxin"rately $3 15.000 in other assets in the accompanying consolidated balance sheets. As ofDccember 31,2015, thc Company has recorded a liabilitv tirrthelairvalueolfbrrvardcontractsol-approxinrately$16.000 inotherassetsintheaccompanyingconsolidatedbalancesheets. Changesinthelairvalueolthefbrrvardcontractsarerecordedincurrentperiodearnings. TheCompanl,recognizednetgainson thc rnark to market of fbrrvard salc cornmitments and interest rate lock commitnrcnts of approximately 5239.000 and $116.000 fbrthcyearsendedDecember3l.20l6and20l5.respectively.'IhenetrecognizedgainsforthcyearscndedDecember3l.20l6 and 2015 have been included as a component olthe net gain on sale olloans in thc acconrpanfing consolidated staternent ol income. -38- NEXBANK CAPITAL, INC. AND SUBSI DIARIES By using derivative instruments, the Company exposes itself to credit and market risk. [f a counterparty fails to fulfill its performance obligations under a derivative contract, the Company's credit risk will equal the fair-value gain in a derivative. The Company minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company's risk management department. The Company's derivative activities are monitored by its investment committee as part of that committee's oversight of the Company's asset/liability and treasury functions. The Company enters into interest rate lock commitments to fund loans at specified rates within specified time frames. These products are not linked to specific assets and liabilities that appear on the balance sheet or to a forecasted transaction and, therefore, interest rate locks are marked to market in the consolidated statement ofoperations. The Company is exposed to the risk that the actual closings in the Committed Pipeline may deviate from the estimated closings due to a change in interest rates. Although interest rates are the primary determinant, the actual loan closings from the Committed Pipeline are influenced by many factors, including the composition of the Committed Pipeline and remaining commitment periods. The Company's estimated closings are based on historical data of loan closings as influenced by recent developments. As of December 31,2016 and 2015, the fair values of interest rate lock commitments of approximately $346,000 and $438,000, respectively, have been included in other assets in the accompanying consolidated financial statements. The Company does not expect to incur significant losses nor does it expect to realize significant gains related to its Committed Pipeline due to changes in interest rates, net ofgains or losses on associated hedge positions. InvestorSure CD Option Contracts A summary of lnvestorSure CD option contracts at December 31,2016 and 2015 is as follows (in thousands): 20t6 2015 Notional amounts $ 10,399,000 $ t2,070,000 S&P call option $ 2,081 ,000 $ 2,584,000 Embedded derivative $ (2,081,000) $ (2,584,000) Maturity January 20 I 7 to July 202 I February 2016 to November 2020 Generally, the above CD option contracts are comprised of 5-year S&P 500 index call option trades. The S&P call option (included in other assets) and InvestorSure CD embedded derivative (included as a component ofdeposits) are marked to market with unrealized gains or losses reflected in current eamings. 39 NEXBANK CAPITAL, I NC. AND SU BSIDIARI ES 20. Fair Value Disclosures The fair value ofan asset or liability is the price that rvould be received to sell that asset or paid to transfbr that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence ofa principal market) Ibr such asset or liability. In estimating fair value. the Company utilizes valuation techniques that are consistent with the market approach" the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would usc in pricing an asset or liability. ASC Topic 820, "Fair Value Measurements and Disclosures," establishes a fair value hierarchy for valuation hputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows: a Level I Inputs -Unadjustedquotedpricesinactivemarketsforidentical assetsorliabilitiesthatthereportingentity has the ability to access at the measurement date. a Level 2 Inputs - Inputs other than quoted prices included in Level I that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable lor the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means. a Le,-el 3 Inputs - Unobservable inputs lbr determining the fair values of assets or liabilities that rellect an entity's own assumptions about the assumptions that market participants rvould use in pricing the assets or liabilities. [n general, fair value is based upon quoted market prices, where available. Ifsuch quoted market prices are not available, Ihir value is based upon intemally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at lhir value. These adjustments may include amounts to reflect counterparty credit quality and the Company's creditworthiness. among other things. as rvell as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or rcflective ol future fair values. While management believes the Company's valuation methodologies are appropriate and consistent rvith other market participants. the use ol' difl'erent methodologies or assumptions to determine the l'air value of certain financial instruments could result in a dilferent estimate of thir value at the reporting date. Furthermore" the reported f-air value amounts have not been comprehensively revalued since the presentation dates, and therefbre. estimates offbir value after the balance sheet date may ditler significantly liom the amounts presented herein. 40 NEXBANK CAPITAL, INC. AND SUBSIDIARIES Assets and liabilities measured at fair value at December 31, 2016 and 2015 are as follows (in thousands): Fair Value M Usins Level I Level 2 Level 3 December 31.2016: Asset (liability): Securities available for sale (l) $ s 1,t90,2s6 $ Loans held for sale (2) I 87,1 66 Mortgage servicing rights (3) 52,228 Interest rate locks (5) 480 Forward sale commitments (5) 3r5 Hedging derivative instrument (S&P call option) (6) 2.081 Embedded derivative (6) (2.081) December 3 l, 201 5: Asset (liability): Securities available for sale ( I ) $ s 309,8 I 3 $ Loans held for sale (2) 65,449 Mortgage servicing rights (3) 20,897 Interest rate swap (4) (t,927\ lnterest rate locks (5) 438 Forward sale commitments (5) ( l6) Hedging derivative instrument (S&P call option) (6) 2,584 Embedded derivative (6) (2.584) (t) Securities available for sale are measured at fair value on a recurring basis. generally monthly. (2) Fair value of loans held for sale is based on contract prices at which the loans will be sold and is measured on a recurring basis, generally monthly. (3) Fair value of mortgage servicing rights is measured on a recurring basis, generally quarterly, utilizing various market inputs. (4) Fair value of the interest rate swap is measured daily, utilizing observable market input data. (5) Rate locks and forward sale commitments are measured at fair value generally monthly using significant observable market inputs and assumptions. (6) The hedging derivative instrument (S&P call option) and relating embedded derivative are measured at fair value generally monthly using significant observable market inputs and assumptions. -41- NEXBANK CAPITAL, INC. AND SUBSIDIARIES Certain non-financial asscts measured at fair value include other real estate owned and rcpossessed assets (upon initial acquisition and subsequent impainnent). Other real estate owned, repossessed assets, and lots held for residential development upon initial acquisition" are remeasured and reported at t'air value through a charge to the allowance for loan losses and certain other real estate owned, repossessed assets. and lots held for residential development, subsequent to their initial recognition, are remeasured at fair value through a rwite-down included in other non-interest expense. The fair values ofother real estate owned, repossessed assets, and lots held for residential development are estimated using Level 3 inputs based on observable market data. The following table presents other real estate owned" repossessed assets, and lots held lbr residential development that were remeasured and reported at fair value on a non-recurring basis during the years ended December 3 l, 201 6 and 201 5 (in thousands): 2016 2015 Repossessed Assets: Remeasured subsequent to in it ial acquisitio n : Carrying value prior to measurement $ 2,364 $ 2,747 Write-downs included in other non-interest expense (7ll) (383) $ 1,6s3 $ 2,364 Lo ts He ld for Reside n tia I Develo pm e nt: Remeasured subsequent t o in it ial acquisit ion : Carrying value prior to measurement $ 696 s r.20 I Write-downs included in other non-interest expense (t23) (3s ) ( s73 $ r. t66 There lvas no other real cstate owned that was remeasured and reported at fair value on a non-recurring basis during the years ended December 31,2016 or 2015. The following table presents quantitative infbrmation about level 3 lair value measurernents I'or assets measured at tair value on a non-recurring basis at Deccnrber i l. 20 | 6 and 20 I 5 (in thousands): Valuation Fair Value Technioue [Jnobscrvable lnnuts December 31. 2016 Repossessed assets - comnrercial $ 1.653 Sales comparison Adjust ment [br diflerences betueen approach the comparable sales Lots held for resi&ntial developnrent - $ s73 Sales comparison Adjustment lor differences bet*een real est ate approach the con.rparable sales December 3 [. 2015 Repossessed assets - conrmercial s 2.36,1 Sales comparison Adjrst ment lbr dilferences betueen approach the comparable sales Lots held lbr residential development - $ 1.166 Sales comparison A{jr,rstment fbr diff'erenccs betueen real est atL. approach the comparable sales At December 31.2016 and 2015. the Company also had approximately $175.000 and $189.000. respectively. olimpaired loans measured at lair value on a nonrecurring basis. Management believes that impaired loans are immaterial to the consolidatcd financial statements 10 mcrit disclosure relating to quantitative inlormation about level 3 fhir value measurcments. 42 NEXBANK CAPITAL, INC. AND SU BSTDIARIES The estimated fair values of the Company's financial instruments at December 31. 2016 and 2015 were as fbllows (in thousands): 2016 2015 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets: Cash and due from banks s 435,950 $ 435,950 $ 317,766 $ 3t7.766 lnterest bearing deposits with banks 412 412 3Es 185 Securities available for sale l,l 90,256 l, I 90.256 309,8 l 3 109.8 I 3 Loans held for sale r87.166 187,t66 65,449 65,449 Loans, net 2.630,610 2,616,9t6 1.892,713 1,873,068 Accrued interest receivable t5,624 ts.624 8,957 8,957 Federal Home Loan Bank and other stock 46,676 nla 32,8 l s n/a Interest rate locks 480 480 438 438 Forward sale commitments 315 315 S&P call option 2.081 2,081 2.584 2.584 Financial liabilities: Deposits 3,224,743 3,051,682 1.878,5 I 0 1.800,290 FHLB bonowings l.005.000 1,005,004 555,000 555,161 Junior subordinated debenlures l s.464 I 5,464 15,464 I 5,464 Other borrowings 93.841 93.843 -s9.521 59,52 I Accrued interest payable l,166 I.366 I.563 1.563 Embedded derivatives 2.081 2.08 r 2.584 2.584 Forward sale commitments l6 t6 Interest rate swaps 1.927 1.927 The following methods and assumptions were used by the Cornpany in estimating the fhir values ol financial instruments as disclosed herein: Cash and ctsh equivalenls and interest bedring lime deposits in other banks The canying amounts ofcash and cash equivalents and interest bearing time deposits in other banks approxirnate their tair value. Securilies ovailable for sale Fair values tbr securities. excluding restricted equity securities. are based on quoted market prices or analysis by third parties. 1'he carrying values olrestricted equity securities approximate fair values. Loans held for sale Fair values ofloans held for sale are based on the contract prices at which the undcrlying rnortgage loans r.vill be sold. or. ilthe loans are not committed for sale, the current market price. Loans For variable-rate loans that reprice frequently and have no significant changes in credit risk. Ihir values are bascd on carrying values. Fair values fbr certain rnortgage loans (fbr example. one-to-lbur lhmily residential) and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, ad.iusted ibr diflerences in loan characteristics. Fair values tbr cornmercial real estate and commercial loans are estimated using discounted cash t'lorv analyses and interest rates currently being oflered fbr loans with similar terms to borrorvers ol sinrilar credit qualiq-. Fair valucs lor inrpaired loans are estimated using discounted cash llow analyses or r.rnderlying collatcral values. rvherc applicable. 43 NEXBANK CAPITAL, INC. AND SUBSIDIARIES Inlerest role locks ondfontard sale commilmenls Interest rate locks and forward sale commitments are carried at fair value on the consolidated balance sheet. Fair values ol interest rate lock commitments are primarily based on quoted market prices for the sale of individual loans with similar terms as those represented by the rate locks. Fair values of forward sale commitments are based on quoted market prices tbr mortgage backed securities rvith similar terms as those represented by the forward contract. S&P call option and embedded derivalive S&P call options and embedded derivatives are carried at fair value on the consolidated balance sheet. Fair values are determined using quantitative models that utilized multiple market inputs. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions, and third-party pricing services. lnterest rate $eaps Interest rate swaps are carried at fair value on the consolidated balance sheet. Fair values are calculated by discounting the future cash flows ofboth the fixed rate and variable rate interest payments using discount rates appropriate with consideration given to the Company's non-performance risk. The inputs used in determining thir value fatl within Level 2 of the fair value hierarchy. Deposits The lair values disclosed lor demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, hxed term money market accounts and certitlcates of deposit (CD's) approximate their thir values at the reporting date. Fair values for fixed-rate CD's are estimated using a discounted cash f'lorv calculation that applies interest rates currently being ofTered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Included in CD's are the CollegeSureCD and the InvestorSure CD. CollegeSure CD pricing depends on market and other lactors existing at the time ofthe deposit. Such factors include. but are not limited to, the current value ofthe IC 500- the historical rate spread betrveen college inflation and market interest (e.g. Treasury) rates. and the length oltime to maturity date. lnvestorSure CD valuation depends on the current rate offered lor similar deposits with the same remaining maturities as well as fair value ol the S&P embedded derivatives rvithin the lnvestorSure CD otlerings, rvhich equate the S&P 500 index call option fair value due to etlective economic hedging. Management's overall intent is to identi! a rvholesale rate. a rate at which unlimited dollars could be obtained lor a given rate, in addition to consideration of the above factors. Management fbels that the Federal Home Loan Bank advance rates are a supportable alternative, and. thus. uses these rates as a signilicant component of its fhir value estimate. FHLB borrowings The carr-l'ing amounts of short-term FI{LB borrowings approxirnate their tair values. Fair values tbr fixed-rate long-term FHLB borrorvings are estimated using a discounted cash florv calculation that applies intcrest rates currently being oflered on sirnilar borrowings to a schedule ol'aggregated expected monthly maturities. J u n ior su bordi nated debentu res 'l'he carrying anrounts olvariable-rate, lixed term.junior subordinated debentures approximate their lbir values at the reporting date. Other borrowings The carrying amounts olvariable-rate and flxed-rate other borrorvings approxinratc their lair values at the reporting date. Accrued interest The carrying amounts of accrued intercst approximate their fair values. Off- b a I a n c e s h eet i n st ru m e nt s Fair values for ofl'-balancc sheet lending commitments are based on f'ees currently charged to enter into similar agreements taking into account the rernaining terms olthe agrcements and the counterparties' credit standings. 44 NEXBANK CAPITAL, INC. AND SUBSI DIARIES 2I. Sienificant Grouo Concentrations of Credit Risk The distribution of commitments to extend credit approximates the dishibution of loans outstanding. Commercial and standby letters of credit were granted primarily to commercial borrowers. The contractual amounts of credit related financial instruments such as commitments to extend credit and letters of credit represent the amounts ofpotential accounting loss should the conhact be fully drawn upon, the customer default, and the value of any existing collateral become worthless. The nature of the Company's business requires that it maintain amounts due from banks which, at times, may exceed federally insured limits. Significant concentrations ofthe Company's loan servicing are indicated below as ofDecember 31,2016 and 2015 (dollar amounts in thousands): 2016 20t5 Principal Pcrccnt of Principal Percent of Brlance Total Balance Total of Lonns Servicing of Loens Servicing State Serviced Portfolio Serviced Portfotio Texas $ I ,899,5 l 4 44.28% $ 673,172 3s.96% Califomia 363,904 8.48o/o 289,267 15.4s% Georgia 259,87t 6.06% 60,056 3.21% Colorado l 93,065 4.50o/o l 50,366 8.03% Washingon 147.094 3.43% 50,835 2.72% Illinois 1 25,1 83 2.92% 42,639 2.28% Arkansas I 25,107 2.92% 93,632 5.00% Florida 122,532 2.860/o 56,451 3.02o/o New York r 12,188 2.62% 70,807 3.78o/o Louisiana 98,88 l 230% 4,925 0.26% Arizona 88,854 2.07o/o 75,840 4.05% Oklahoma 66,609 1 55% 72,567 1.88% Virginia 66,451 1.55o/o 4,956 0.26% Utah 61, l 85 1.4'7o/o 2,866 0.1 5% New Jersey 48,138 t.t2% 28,75t t54% 0ther 509.559 l 1.88% l94.8rs 10.41o/o $ 4,290,135 100.00% $ l.87 r ,945 100.00% 45 NEXBANK CAPITAL, INC. AND SUBSIDIARI ES 22. Resulaton' Nlattcrs Under banking law. there are legal restrictions limiting the amount of dividends that the Bank can declarc. Approval of the regulatory authorities is required if thc efl-ect of dividends declared would cause the regulatory capital olthe Bank to thll below specified minimurn levels. Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets. liabilities, and certain otT-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classillcations are also subject to qualitativejudgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision's capital guidelines fbr U.S. banks (Basel lll rules) became eflective for the Company on January 1,2015 with full compliance with all olthe requirements being phased in over a multi-year schedule, and fully phased in by January 1,2019. Basel III added a 2.570 "capital conservation buffer" which w'as designed for banking institutions to absorb losses during periods of economic stress. The implementation of the capital conservation bufler began on January l, 2016 at the 0.6250/o level and will be phased in over a four-year period (increasing by 0.6250/o on each subsequent January l- until it reaches 2.57o on January l, 2019). Banking institutions rvith capital ratios below the minimum for capital adequacy purposes plus the capital conservation buffer will face constraints on dividends, equity repurchases, and executive compensation relative to the amount of the shortfall. Management believes as of December 31, 2016, the Company and Bank meet all capital adequacy requirements to which they are subject. Prompt corrective action regulations provide five classitjcations: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized. and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized. capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year end 2016 and 2015, the most recent regulatory notitications categorized the Bank as rvell capitalized under the regulatory liamework for prompt corrective action. 'l'here are no conditions or events since that notification that management believes have changed the Bank's category. Unrealized gains or losses on available tbr sale securities are not included in computing regulatory capital. The Company's actual and required capital anrounts and ratios are as follows at December 31. 2016 and 2015 (dollar amounts in thousands): To Be Well Required for Capitalized Under Capital Prompt Corrective Actual Adeouacy Pumoses Action Provisions Amount Ratio Amount Ratio Amount Ratio Company: As of December .3 l. 201 6: Comrnon equitv tier I (to ( nsk-\\eighted assets) 270,7 t3 9.4o/o >S 1 30.1 94 nrja n,la 'frcr I capital (to risk weighted assets) $ 286.177 9.99',o >S 173,592 nla nla -l'otal capital 1to nsk rveighted assets) s i04.073 10.5% >S 2i 1.4-s6 n/a n/a Tier I capital (to total assets) S 286.177 6.60h >S ! 71 ni? nla nla As ol Decenrber i l. 20 | 5: Common equilv tier I (to ( risk-rveighted assets ; I 80.826 9.60/0 > S 84,6i3 il/a n./a Tier I capital 1to risk weighled assels ) s I 96.290 l0 4o/" > S I I 2.8.t4 n/a n,/a 'fotal capital 1to nsk weighted assets) $ I 10.286 1l .2o/o > $ I 50,458 n/a nla Trer I capital (to total assets ) S I 96.290 7.79/o > S t02.607 n/a n1a -46- NEXBANK CAPITAL, INC. AND SU BSIDIARIES The Bank's actual capital amounts and ratios along with the capital requirements under the framework for prompt corrective action are as follows at December 3 I . 20 l6 and 20 l5 (dollar amounts in thousands): To Be Well Required for Capitalized Under Capital Adequacy Prompt Corrective Actual Pumoses Action Provisions Amount Ratio Amount Ratio Amount Ratio Bank: As ofDecember3l- 2016: Common equity tier I (to risk-weighted assets) s 350,661 12.20/. > S t29.652 > 4.50/" > s 187,27 5 2 6.50,/o Tier I capital (to risk weighted assets) $ 3s0.663 12.2% > S t72,869 6.00/o > S 230,492 > 8.0% Total capital (to risk weighted assets) S 178,559 l3.lo/o > $ ).30.192 8.09',o > $ 288, il 5 > l0 00/. Tier I capital (to average jo/n total assets) S 350,663 8.lo/o > $ 172,424 4.0o/o > $ 2 I 5,530 2 5 As of December 3 1, 20 1 5: Common equity tier I (to risk-rveighted assets) S 237,580 l2.8Yo > S 83.765 > 4.5Vo > S I 20,994 > 6.5Yo Tier I capital (to risk weighted assets) S 237,580 t2.8% > $ I I 1,687 > 6.00/0 > S 148,915 > 8,0% Total capital 1to risk weighted assets) s 251.576 ll.5% > s 148,91 5 > 8.0% >s I 86.144 2 l0 0olo Tier I capital (to average total assets) s 237.580 9.3Vo > $ 10t.774 2 4.00/o > $ t27.2t8 2 5.0o/o The Qualified Thrift Lender test requires at least 657o of assets be maintained in housing-related tinance and other specified areas. Ifthistestisnotmet. limitsareplaceongrowth.branching.nervinvestments,FI{LBadvances-anddividends,ortheBank must convert to a commercial bank charter. Management believes that this test is met. NSI NSI is required by Rule l5c3-3(kX2)(i) of the Securities Exchange Act of 1934 to maintain minimum net capital as deflned. which is the greater of$5.000 ot 6 213 o/o oftotal aggregate indebtedness. At December 31, 2016, NSI had total net capital and total aggregate indebtedness. as defined. olapproximately $946.000 and $1,601,000. respectively. resulting in a ratio ofaggregate irdebtedness to net capital of 1.69 to 1.00. Total net capital was approximately $839.000 above the minimum required net capital of approxirnately $ 107.000. At December 31,2015. NSI had total net capital and total aggregate indebtedness- as defined. olapproximately $1,314.000 and $1.227.000, respectively, resulting in a ratio ol'aggregate indebtedness to net capital of0.93 to 1.00. Total net capital \,vas approximately $ I.232,000 above the minimum required net capital of approximately $82.000. 23. Subseouent Events On February 15,2017. the Company reopened its senior unsecured notes otlbring and raised an additional $80,000,000. The notes were issued at 99.094o/o. resulting in net proceeds to the Conrpany olapproximately $79.275,000. Other than being issued at a discount. the senior unsccured notes are sinrilar in terms and conditions as the e.\isting notes (see note I 4). Thc Company is conternplating an equity capital raise during the second quarter of 2017 in a ma\imum amount ol $20.000,000. -47 - NEXBANK CAPITAL, INC. AND SUBSIDIARIES Consolidating Balance Sheet December 31, 2016 (ln thousands of dollars) NexBank NexBank Securities, NexBank Caoital- Inc. Inc. SSB Elim. Consolidated ASSETS Cash and cash equivalents $ 11,483 S 2,547 $ 433,413 $ (11,493) (a) $ 43s,9s0 Interest bearing time deposits in other banks 412 - 4t2 Securities available for sale t, I 90,256 - I,190,256 Investment in subsidiaries 347,t63 (347,r63) (b) Loans held for sale t87,166 - 187,166 Loans, net 2,63t 2,627,979 - 2,630,610 Mortgage servicing rights, net 52,228 - 52,228 Premises and equipment l,098 233 1,9 t4 - 3,245 Unconsolidated investments 464 2,650 - 3,1 14 Other real estate owned 5,099 901 - 6,000 Goodwill 750 - 750 Company owned life insurance 58,9 l2 - 58,912 Other assets 12.76s 104 74.081 (10.000) (c) 76.956 $ 380,703 s 5,534 $_1'6?!.01q $ (368,656) $ 4.64s,s99 LIABILITIES AND STOCKHOLDERS' EOUTTY Deposits: Noninterest bearing $ $ $ r,429,386 $ (l1393) (a) $ 1,417,893 Interest bearing r -806.8s0 t.806-850 Total deposits 3,236,236 (r 1,493) 3,224,741 Advances from Federal Home Loan Bank r,005,000 - 1,00s,000 - Junior subordinated debentures t5,464 - 15,464 Other borrowings 93,843 10,000 (10,000) (c) 93,843 Accrued expenses and other liabilities 3-591 l -601 33.552 38-744 Total [iabilities r l 2,898 1,60r 4,284,788 (21393) 4,377;t94 Stockholders' equity: - Common stock I I Additional paid-in capital 86,e76 3,440 16t.749 (165.189) (b) 86,916 Retained eamings 204,t70 493 r 99,378 (199.871) (b) 204,170 Shareholder loans secured by Company stock (5"44s) - (s,44s) Accumulated other comprehensive loss ( I 7-897) ( l 7.897) t7.897 (b) il7.897) Total stockholders' equity 267.805 3-933 343.230 (147.r63) 267.80s - s 380.703 $ 5.534 $_4628.qL8 s (368.6s6) S 4.645.s99 See independent auditors' report. -48- NEXBANK CAPITAL, INC. AND SUBSIDIARIES Coasolidating Statement of Income F-or the. Year ended Decernber 31, 2016 (In thousands of dollars) lbliBa* NexBank SerxErities, l.IexBank Capital- Inc. .bc. Ssts Elitr. Consolidded IDtorest income: IoEre3tandfees on loans $ 502 $- $ 86.366 $ (t8) (e) $ 86,9s0. Ihterest and divid€nds on ceourifi€p 2t l4;569 14"590 Other ------2.58it 2J98 Tual interstincome 634 i03-s22 il8) 104_l:,8 --i Interest expence: Itrtprc$t on deposit tlodounts 13,&70 - 13,870 o.ther 4"fi1 l:63E (18) te) 6227 Total intolestexpense 4.6j07 1s"508 (1$ N.M? N€t interest (cxpeme) ircome (3973) 88pr4 - 84,041 Provision for loaa lo$ses 3-7n5 _- 3-165 Net interest (er(pense) income after provision (3.93) u249 ffing Nonint€r€st incqne: Net gain oil sales ofmortgage loans held for sale t0,226 - 10226 lilet loan servicing fees 8,129 I,129 Coinsulting niv.enue 2$71 L67t Investment advisory and underwriting fees 1,668 1,668 Title pemiuhs r239 r?3e lilet mins on sales of wutities 759 7316 8.135 Realized net gains on ints.fi,Bt rate sn6!6 7,659 7,6s9 Gails on oompany o\rmetl lifo insraoee 2p$X 2,281, qqihs (losser) oa foreslosrod assets, tret 368 (7s) 29? F4uity in subcidiary eaningr (lo$€s) 85,604 (E5,604) (d) Otter 964 22s4 t-971 5.lq Total noninerixt income 88934 6-593 37-573 (85-604) 41-4t6 Noninterest expense: Salaries and employee bonefits 274 4;625 t91969 2: t&\ 2s,!tu Occupancy orpenee )<', 299 3,014 3,565 Data processing 30 I,659 1,6,89 Regulatory rB{tqssmefi s 66 t,90r 1,967 Legal and professisnal fsee l9; 422 322e 3.850 Gher 873 344 v253 f292) (e) 8_178 Total noniater,est expeas+ l-59E 5.146 37,O25 _ . 44-4W Na inoome $ 83J63 $ 807 ,$ &1,797 $ (8f,604) $ 83,363 See inde,pendent auditors' report. -49- NEXBANK CAPITAL, INC. AND SU BSIDIARI ES Description of Consolidating Entries For the Year Ended December 3 I . 20 I 6 (a) To eliminate intercompany cash and deposits. (b) To eliminate investment accounts against the stockholders'equity ofthe consolidated subsidiaries. (c) To eliminate subordinated debt due NCI from the Bank. (d) To eliminate equity in earnings of subsidiaries. (e) To eliminate intercompany income and expense. See independent auditors' report. -50-