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FNCB Bancorp, Inc. - Quarter Report: 2013 March (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 


 

FORM 10-Q

 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2013

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from         to         

 

Commission File No. 000-53869

 

FIRST NATIONAL COMMUNITY BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania

 

23-2900790

(State or Other Jurisdiction
of Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

102 E. Drinker St., Dunmore, PA

 

18512

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code  (570) 346-7667

 

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES x  NO  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES x  NO ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer o

 

Accelerated Filer o

 

 

 

Non-Accelerated Filer x

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

 

Common Stock, $1.25 par value

 

16,457,169 shares

(Title of Class)

 

(Outstanding at May 14, 2013)

 

 

 



Table of Contents

 

Contents

 

PART I. Financial Information

3

Item 1. Financial Statements

3

Consolidated Statements of Financial Condition

3

Consolidated Statements of Operations

4

Consolidated Statements of Comprehensive (Loss) Income

5

Consolidated Statements of Changes in Shareholders’ Equity

6

Consolidated Statements of Cash Flows

7

Notes to Consolidated Financial Statements

8

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

34

Item 3. Quantitative and Qualitative Disclosures about Market Risk

51

Item 4. Controls and Procedures

51

PART II.  Other Information

51

Item 1. Legal Proceedings

51

Item 1A. Risk Factors

52

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

52

Item 3. Defaults upon Senior Securities

52

Item 4. Mine Safety Disclosures

52

Item 5. Other Information

52

Item 6. Exhibits

52

 

2



Table of Contents

 

PART I.  Financial Information

Item 1.  Financial Statements

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(unaudited)

 

 

 

March 31,

 

December 31,

 

(in thousands, except share data)

 

2013

 

2012

 

Assets

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

$

11,451

 

$

21,710

 

Interest-bearing deposits in other banks

 

20,892

 

93,561

 

Total cash and cash equivalents

 

32,343

 

115,271

 

Securities

 

 

 

 

 

Available-for-sale at fair value

 

216,849

 

185,361

 

Held-to-maturity at amortized cost (fair value $2,501 and $2,483)

 

2,225

 

2,198

 

Stock in Federal Home Loan Bank of Pittsburgh, at cost

 

5,081

 

5,957

 

Loans held for sale

 

847

 

1,615

 

Loans, net of allowance for loan and lease losses of $18,473 and $18,536

 

597,682

 

579,396

 

Bank premises and equipment, net

 

18,658

 

18,937

 

Accrued interest receivable

 

2,618

 

2,199

 

Refundable federal income taxes

 

11,637

 

11,637

 

Intangible assets

 

591

 

632

 

Bank-owned life insurance

 

27,633

 

27,461

 

Other real estate owned

 

3,910

 

3,983

 

Other assets

 

9,453

 

13,627

 

Total Assets

 

$

929,527

 

$

968,274

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Demand (non-interest-bearing)

 

$

121,187

 

$

131,476

 

Interest-bearing

 

702,559

 

723,137

 

Total deposits

 

823,746

 

854,613

 

Borrowed funds

 

 

 

 

 

FHLB advances

 

12,388

 

18,593

 

Subordinated debentures

 

25,000

 

25,000

 

Junior subordinated debentures

 

10,310

 

10,310

 

Total borrowed funds

 

47,698

 

53,903

 

Accrued interest payable

 

7,001

 

6,427

 

Other liabilities

 

14,264

 

16,406

 

Total liabilities

 

892,709

 

931,349

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred Shares ($1.25 par)

 

 

 

 

 

Authorized: 20,000,000 shares at March 31, 2013 and December 31, 2012

Issued and outstanding: 0 shares at March 31, 2013 and December 31, 2012

 

 

 

Common Shares ($1.25 par)

 

 

 

 

 

Authorized: 50,000,000 shares at March 31, 2013 and December 31, 2012

Issued and outstanding: 16,457,169 shares at March 31, 2013 and December 31, 2012

 

20,571

 

20,571

 

Additional paid-in capital

 

61,584

 

61,584

 

Accumulated deficit

 

(50,197

)

(51,928

)

Accumulated other comprehensive income

 

4,860

 

6,698

 

Total shareholders’ equity

 

36,818

 

36,925

 

Total Liabilities and Shareholders’ Equity

 

$

929,527

 

$

968,274

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

3



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

 

 

Three months ended

 

 

 

March 31,

 

(in thousands, except share data)

 

2013

 

2012

 

Interest income

 

 

 

 

 

Interest and fees on loans

 

$

6,607

 

$

7,789

 

Interest and dividends on securities:

 

 

 

 

 

U.S. government agencies

 

423

 

380

 

State and political subdivisions, tax-free

 

990

 

980

 

State and political subdivisions, taxable

 

116

 

130

 

Other securities

 

35

 

409

 

Total interest and dividends on securities

 

1,564

 

1,899

 

Interest on interest-bearing deposits and federal funds sold

 

39

 

56

 

Total interest income

 

8,210

 

9,744

 

Interest expense

 

 

 

 

 

Deposits:

 

 

 

 

 

Interest-bearing demand

 

159

 

183

 

Savings

 

26

 

46

 

Time ($100,000 and over)

 

317

 

415

 

Other time

 

616

 

888

 

Total interest on deposits

 

1,118

 

1,532

 

Interest on borrowed funds:

 

 

 

 

 

Interest on FHLB advances

 

126

 

414

 

Interest on subordinated debentures

 

562

 

569

 

Interest on junior subordinated debentures

 

51

 

58

 

Total interest on borrowed funds

 

739

 

1,041

 

Total interest expense

 

1,857

 

2,573

 

Net interest income before credit for loan and lease losses

 

6,353

 

7,171

 

Credit for loan and lease losses

 

(1,224

)

(136

)

Net interest income after credit for loan and lease losses

 

7,577

 

7,307

 

Non-interest income

 

 

 

 

 

Deposit service charges

 

678

 

737

 

Net gain on the sale of securities

 

842

 

8

 

Gross other-than-temporary impairment gains

 

 

175

 

Portion of gain recognized in other comprehensive income (before taxes)

 

 

(175

)

Other-than-temporary-impairment losses recognized in earnings

 

 

 

Net gain on the sale of loans held for sale

 

110

 

243

 

Net gain on the sale of other real estate owned

 

13

 

9

 

Loan related fees

 

108

 

124

 

Income from bank-owned life insurance

 

172

 

185

 

Other

 

536

 

144

 

Total non-interest income

 

2,459

 

1,450

 

Non-interest expense

 

 

 

 

 

Salaries and employee benefits

 

3,320

 

3,638

 

Occupancy expense

 

584

 

598

 

Equipment expense

 

376

 

420

 

Advertising expense

 

77

 

148

 

Data processing expense

 

564

 

474

 

FDIC assessment

 

532

 

600

 

Bank shares tax

 

241

 

276

 

Expense of other real estate

 

218

 

178

 

Credit for off-balance sheet commitments

 

(121

)

(65

)

Legal expense

 

615

 

724

 

Professional fees

 

551

 

1,518

 

Insurance expense

 

323

 

232

 

Loan collection expense

 

227

 

229

 

Other operating expenses

 

798

 

952

 

Total non-interest expense

 

8,305

 

9,922

 

Income (loss) before income taxes

 

1,731

 

(1,165

)

Provision for income taxes

 

 

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

 

 

 

 

 

 

Income (loss) Per Share:

 

 

 

 

 

Basic

 

$

0.11

 

$

(0.07

)

Diluted

 

$

0.11

 

$

(0.07

)

 

 

 

 

 

 

Cash dividends declared per common share

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

 

Basic

 

16,457,169

 

16,442,119

 

Diluted

 

16,457,169

 

16,442,119

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

4



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited)

 

 

 

Three months ended

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

Unrealized (losses) gains on securities available-for-sale

 

(1,943

)

3,494

 

Taxes

 

661

 

(1,188

)

Net of tax amount

 

(1,282

)

2,306

 

 

 

 

 

 

 

Non-credit related gains on OTTI securities not expected to be sold

 

 

175

 

Taxes

 

 

(60

)

Net of tax amount

 

 

115

 

 

 

 

 

 

 

Reclassification adjustment for gains included in net income (loss)

 

(842

)

(8

)

Taxes

 

286

 

3

 

Net of tax amount

 

(556

)

(5

)

 

 

 

 

 

 

Total other comprehensive (loss) income

 

(1,838

)

2,416

 

 

 

 

 

 

 

Total comprehensive (loss) income

 

$

(107

)

$

1,251

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

5



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2013 and 2012

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Number

 

 

 

Additional

 

 

 

Other

 

Total

 

 

 

of Common

 

Common

 

Paid-in

 

Accumulated

 

Comprehensive

 

Shareholders’

 

(in thousands, except per share data)

 

Shares

 

Stock

 

Capital

 

Deficit

 

Loss

 

Equity

 

BALANCES, DECEMBER 31, 2011

 

16,442,119

 

$

20,552

 

$

61,557

 

$

(38,217

)

$

(3,967

)

$

39,925

 

Net loss for the period

 

 

 

 

 

 

 

(1,165

)

 

 

(1,165

)

Other comprehensive income, net of tax of $1,245

 

 

 

 

 

 

 

 

 

2,416

 

2,416

 

Balances, March 31, 2012

 

16,442,119

 

$

20,552

 

$

61,557

 

$

(39,382

)

$

(1,551

)

$

41,176

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCES, DECEMBER 31, 2012

 

16,457,169

 

$

20,571

 

$

61,584

 

$

(51,928

)

$

6,698

 

$

36,925

 

Net income for the period

 

 

 

 

 

 

 

1,731

 

 

 

1,731

 

Other comprehensive loss, net of tax of $947

 

 

 

 

 

 

 

 

 

(1,838

)

(1,838

)

Balances, March 31, 2013

 

16,457,169

 

$

20,571

 

$

61,584

 

$

(50,197

)

$

4,860

 

$

36,818

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

Investment securities accretion, net

 

(207

)

(400

)

Equity in trust

 

(1

)

(1

)

Depreciation and amortization

 

329

 

274

 

Credit for loan and lease losses

 

(1,224

)

(136

)

Credit for off balance sheet commitments

 

(121

)

(65

)

Gain on sale of investment securities

 

(842

)

(8

)

Gain on the sale of loans held for sale

 

(110

)

(243

)

Gain on the sale of other real estate owned

 

(13

)

(9

)

Recovery of other real estate owned

 

 

(26

)

Income from bank-owned life insurance

 

(172

)

(185

)

Proceeds from the sale of loans held for sale

 

4,542

 

8,739

 

Funds used to originate loans held for sale

 

(3,664

)

(10,188

)

Increase in interest receivable

 

(419

)

(109

)

Decrease (increase) in prepaid expenses and other assets

 

4,108

 

(240

)

Increase in interest payable

 

574

 

591

 

(Decrease) increase in accrued expenses and other liabilities

 

(1,074

)

80

 

Total Adjustments

 

1,706

 

(1,926

)

Net cash provided by (used in) operating activities

 

3,437

 

(3,091

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Maturities, calls, and principal payments of investment securities available-for-sale

 

3,581

 

8,361

 

Sales of securities available-for-sale

 

17,121

 

 

Purchases of securities available-for-sale

 

(53,953

)

(19,850

)

Redemption of Federal Home Loan Bank of Pittsburgh stock

 

876

 

420

 

Net increase in loans to customers

 

(16,950

)

(8,583

)

Proceeds from the sale of other real estate owned

 

86

 

1,106

 

Purchases of property and equipment

 

(54

)

(712

)

Net cash used in investing activities

 

(49,293

)

(19,258

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net decrease in total deposits

 

(30,867

)

(66,898

)

Proceeds from FHLB advances

 

 

5,313

 

Repayment of FHLB advances

 

(6,205

)

(8,988

)

Net cash used in financing activities

 

(37,072

)

(70,573

)

Net decrease in cash and cash equivalents

 

(82,928

)

(92,922

)

Cash & cash equivalents at beginning of period

 

115,271

 

168,646

 

Cash & cash equivalents at end of period

 

$

32,343

 

$

75,724

 

Supplemental cash flow information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

1,283

 

$

1,982

 

Income taxes

 

 

25

 

Other transactions:

 

 

 

 

 

Settlement of security recorded on trade date

 

 

5,120

 

Principal balance of loans transferred to OREO

 

 

239

 

Transfer from loans held for sale to loans, net

 

 

95

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

7



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.         Basis of Presentation

 

The consolidated financial statements are comprised of the accounts of First National Community Bancorp, Inc., and its wholly owned subsidiary, First National Community Bank (the “Bank”), as well as the Bank’s wholly owned subsidiaries (collectively, the “Company”).  The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and general practices within the banking industry.  In the opinion of management, all adjustments necessary for a fair presentation of the results for the quarterly period ended March 31, 2013 have been included in the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. Prior period amounts have been reclassified when necessary to conform to the current period’s presentation. These reclassifications did not have a material effect on the operating results or financial position of the Company. The operating results and financial position of the Company for the three months ended March 31, 2013, may not be indicative of future results of operations and financial position.

 

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ significantly from those estimates.  Material estimates that are particularly susceptible to change are the allowance for loan and lease losses (“ALLL”), investment security valuations, the evaluation of investment securities and other real estate owned (“OREO”) for impairment, and the evaluation of deferred income taxes.

 

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s audited financial statements, included in our Annual Report filed on Form 10-K as of and for the year ended December 31, 2012.

 

Note 2.         New Authoritative Accounting Guidance

 

Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210): “Disclosures about Offsetting Assets and Liabilities” requires enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Accounting Standards Codification Topic (“ASC”) 210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. The Company adopted ASU No. 2011-11 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): “Testing Indefinite-Lived Intangible Assets for Impairment” simplifies the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU No. 2012-02 allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test.  An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. The Company adopted ASU 2012-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2013-01, Balance Sheet (Topic 210): “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” clarifies the scope of transactions that are subject to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11. This update applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-01 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2013-02, Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” improves the transparency of reporting these reclassifications. The new amendments require an organization to: present either on the face of the statement where income is presented or in the notes to the financial statements the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income; or cross reference to

 

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other disclosures currently required under GAAP for other reclassification items to be reclassified directly to income in their entirety in the same reporting period. The amendments apply to all public and private companies that report other comprehensive income. The Company adopted ASU 2013-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company, however see Note 9 for additional disclosures related to the adoption of ASU No. 2013-02.

 

Note 3.         Regulatory Matters

 

The Bank is under a Consent Order (the “Order”) from the Office of the Comptroller of the Currency (“OCC”) dated September 1, 2010. The Company is also subject to a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”) dated November 24, 2010.

 

OCC Consent Order. The Bank, pursuant to a Stipulation and Consent to the Issuance of a Consent Order dated September 1, 2010, without admitting or denying any wrongdoing, consented and agreed to the issuance of the Order by the OCC, the Bank’s primary regulator. The Order requires the Bank to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The Order is based on the results of an examination of the Bank as of March 31, 2009. Since the examination, management has engaged in discussions with the OCC and has taken steps to improve the condition, policies and procedures of the Bank. Compliance with the Order is monitored by a committee (the “Committee”) of at least three directors, none of whom is an employee or controlling shareholder of the Bank or its affiliates or a family member of any such person. The Committee is required to submit written progress reports on a monthly basis to the OCC and the Agreement requires the Bank to make periodic reports and filings with the Reserve Bank. The members of the Committee are John P. Moses, Joseph Coccia, Joseph J. Gentile and Thomas J. Melone. The material provisions of the Order are as follows:

 

(i) By October 31, 2010, the Board of Directors of the Bank (the “Board”) was required to adopt and implement a three-year strategic plan which must be submitted to the OCC for review and prior determination of no supervisory objection; the strategic plan must establish objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development, and market segments that the Bank intends to promote or develop, and is to include strategies to achieve those objectives; if the strategic plan involves the sale or merger of the Bank, it must address the timeline and steps to be followed to provide for a definitive agreement within 90 days after the receipt of a determination of no supervisory objection;

 

(ii) by October 31, 2010, the Board was required to adopt and implement a three year capital plan, which must be submitted to the OCC for review and prior determination of no supervisory objection;

 

(iii) by November 30, 2010, the Bank was required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets;

 

(iv) the Bank may not pay any dividend or capital distribution unless it is in compliance with the higher capital requirements required by the Order, the Capital Plan, applicable legal requirements and, then only after receiving a determination of no supervisory objection from the OCC;

 

(v) by November 15, 2010, the Committee must have reviewed the Board and the Board’s committee structure; by November 30, 2010, the Board was required to prepare or cause to be prepared an assessment of the capabilities of the Bank’s executive officers to perform their past and current duties, including those required to respond to the most recent examination report, and to perform annual performance appraisals of each officer;

 

(vi) by October 31, 2010, the Board was required to adopt, implement and thereafter ensure compliance with a comprehensive conflict of interest policy applicable to the Bank’s and the Company’s directors, executive officers, principal shareholders and their affiliates and such person’s immediate family members and their related interests, employees, and by November 30, 2010, was required to review existing relationships with such persons to identify those, if any, not in compliance with the policy; and review all subsequent proposed transactions with such persons or modifications of transactions;

 

(vii) by October 31, 2010, the Board was required to develop, implement and ensure adherence to policies and procedures for Bank Secrecy Act (“BSA”) compliance; and account opening and monitoring procedures compliance;

 

(viii) by October 31, 2010, the Board was required to ensure the BSA audit function is supported by an adequately staffed department or third party firm; to adopt, implement and ensure compliance with an independent BSA audit; and to assess the capabilities of the BSA officer and supporting staff to perform present and anticipated duties;

 

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Table of Contents

 

(ix) by October 31, 2010, the Board was required to adopt, implement and ensure adherence to a written credit policy, including specified features, to improve the Bank’s loan portfolio management;

 

(x) the Board was required to take certain actions to resolve certain credit and collateral exceptions;

 

(xi) by October 31, 2010, the Board was required to establish an effective, independent and ongoing loan review system to review, at least quarterly, the Bank’s loan and lease portfolios to assure the timely identification and categorization of problem credits; by October 31, 2010, to adopt and adhere to a program for the maintenance of an adequate ALLL, and to review the adequacy of the Bank’s ALLL at least quarterly;

 

(xii) by October 31, 2010, the Board was required to adopt and the Bank implement and adhere to a program to protect the Bank’s interest in criticized assets; and the Bank may only extend additional credit (including renewals) to a borrower whose loans are criticized under specified circumstances;

 

(xiii) by October 31, 2010, the Board was required to adopt and ensure adherence to action plans for each piece of other real estate owned;

 

(xiv) by November 30, 2010, the Board was required to develop, implement and ensure adherence to a policy for effective monitoring and management of concentrations of credit;

 

(xv) by October 31, 2010, the Board was required to revise and implement the Bank’s other than temporary impairment policy;

 

(xvi) by October 31, 2010, the Board was required to take action to maintain adequate sources of stable funding and liquidity and a contingency funding plan; by October 31, 2010, the Board was required to adopt, implement and ensure compliance with an independent, internal audit program; and

 

(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance management.

 

Federal Reserve Agreement. On November 24, 2010, the Company entered into the Agreement with the Reserve Bank. The Agreement requires the Company to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The material provisions of the Agreement include the following:

 

(i) the Company’s Board was required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with its Consent Order entered into with the OCC;

 

(ii) the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Federal Reserve Board;

 

(iii) the Company may not take dividends or other payments representing a reduction of the Bank’s capital without the prior written approval of the Reserve Bank;

 

(iv) the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director;

 

(v) the Company may not make any payment of interest, principal or other amounts on debt owed to insiders of the Company without the prior written approval of the Reserve Bank and Director;

 

(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the Reserve Bank;

 

(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;

 

(viii) the Company was required to submit to the Reserve Bank, by January 23, 2011, an acceptable written plan to maintain sufficient capital at the Company on a consolidated basis. Thereafter, the Company must notify the Reserve Bank within 45 days of the end of any quarter in which the Company’s capital ratios fall below the approved capital plan’s minimum ratios, and submit an acceptable written plan to increase the Company’s capital ratios above the capital plan’s minimums;

 

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Table of Contents

 

(ix) the Company was required to immediately take all actions necessary to ensure that: (1) each regulatory report accurately reflects the Company’s condition on the date for which it is filed and all material transactions between the Company and its subsidiaries; (2) each such report is prepared in accordance with its instructions; and (3) all records indicating how the report was prepared are maintained for supervisory review;

 

(x) the Company was required to submit to the Reserve Bank, by January 23, 2011, acceptable written procedures to strengthen and maintain internal controls to ensure all required regulatory reports and notices filed with the Board of Governors are accurate and filed in accordance with the instructions for preparation;

 

(xi) the Company was required to submit to the Reserve Bank, by January 8, 2011, a cash flow projection for 2011, reflecting the Company’s planned sources and uses of cash, and submit a cash flow projection for each subsequent calendar year at least one month prior to the beginning of such year;

 

(xii) the Company must comply with: (1) the notice provisions of Section 32 of the FDI Act and Subpart H of Regulation Y in appointing any new director or senior executive officer or changing the duties of any senior executive officer; and (2) the restrictions on indemnification and severance payments of Section 18(k) of the FDI Act and Part 359 of the FDIC’s regulations; and

 

(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.

 

During the three months ended March 31, 2013, and the year ended December 31, 2012, the Company incurred approximately $45 thousand and $585 thousand, respectively, of expenses related to complying with these regulatory agreements, consisting primarily of professional and consulting fees.  In addition, the Order and the Agreement place restrictions on the Company’s ability to borrow funds and to pay interest and dividends to its security holders.  In the future, the Company may continue to experience increased costs related to compliance with these regulatory agreements and also expects to face certain restrictions on its operations for as long as it continues to operate under the Order and the Agreement.  The Company expects, however, that future compliance expenses will decrease from the 2012 level.

 

The Order and Agreement have not and are not expected to have an impact on the Company’s ability to attract and maintain deposits or the Company’s cost of funds.  In order to meet the increased capital requirements imposed under the Order and the Agreement, however, unless the Company is able to raise additional capital, the Company could be limited in the aggregate amount of loans it can have outstanding, which may constrain loan growth.  While it is not anticipated that the Order and the Agreement will have an impact on the Company’s net interest margin, the overall cost of compliance with the Order and the Agreement will continue to impact profitability at least through the end of 2013.

 

Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency.  As of May 14, 2013, the Company and the Bank are restricted from paying any dividends without regulatory approval.

 

The Company is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices must be met.  Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).

 

In accordance with the Order, the Bank is required to achieve and thereafter maintain total risk-based capital equal to at least 13% of risk-weighted assets and Tier 1 capital equal to at least 9% of adjusted total assets.  At March 31, 2013 and December 31, 2012, the Bank was not in compliance with these requirements.  The minimum capital requirements under the Order take precedence over the standard regulatory capital adequacy definitions described in the tables below. The Company’s and the Bank’s actual capital positions and ratios at March 31, 2013 and December 31, 2012 are presented in the following table:

 

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Table of Contents

 

Capital Analysis

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Company

 

 

 

 

 

Tier I capital:

 

 

 

 

 

Total tier I capital

 

$

41,356

 

$

39,587

 

Tier II capital:

 

 

 

 

 

Subordinated notes

 

20,679

 

19,796

 

Allowable portion of allowance for loan losses

 

8,367

 

8,452

 

Total tier II capital

 

29,046

 

28,248

 

Total risk-based capital

 

70,402

 

67,835

 

Total risk-weighted assets

 

$

658,621

 

$

665,323

 

 

 

 

 

 

 

Bank

 

 

 

 

 

Tier I capital:

 

 

 

 

 

Total tier I capital

 

$

72,343

 

$

69,963

 

Tier II capital:

 

 

 

 

 

Allowable portion of allowance for loan losses

 

8,362

 

8,447

 

Total tier II capital

 

8,362

 

8,447

 

Total risk-based capital

 

80,705

 

78,410

 

Total risk-weighted assets

 

$

658,210

 

$

664,914

 

 

 

 

 

 

 

 

 

 

 

 

To Be Well

 

 

 

 

 

 

 

 

 

 

 

Capitalized

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

For Capital

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

Action Provision

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

70,402

 

10.69

%

$

>52,690

 

>8.00

%

N/A

 

N/A

 

Bank

 

$

80,705

 

12.26

%

$

>52,657

 

>8.00

%

$

>65,821

 

>10.00

%

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

41,356

 

6.28

%

$

>26,345

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

72,343

 

10.99

%

$

>26,328

 

>4.00

%

$

>39,493

 

>6.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

41,356

 

4.42

%

$

>37,449

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

72,343

 

7.73

%

$

>37,434

 

>4.00

%

$

>46,793

 

>5.00

%

 

12



Table of Contents

 

 

 

 

 

 

 

 

 

 

 

To Be Well

 

 

 

 

 

 

 

 

 

 

 

Capitalized

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

For Capital

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

Action Provision

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

67,835

 

10.20

%

$

>53,226

 

>8.00

%

N/A

 

N/A

 

Bank

 

$

78,410

 

11.79

%

$

>53,193

 

>8.00

%

$

>66,491

 

>10.00

%

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

39,587

 

5.95

%

$

>26,613

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

69,963

 

10.52

%

$

>26,597

 

>4.00

%

$

>39,895

 

>6.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

39,587

 

4.07

%

$

>38,879

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

69,963

 

7.20

%

$

>38,865

 

>4.00

%

$

>48,581

 

>5.00

%

 

Note 4.         LOANS

 

The following table presents a summary of loans receivable, net, by category at March 31, 2013 and December 31, 2012:

 

(in thousands)

 

March 31,
2013

 

December 31,
2012

 

Residential real estate

 

$

98,273

 

$

90,228

 

Commercial real estate

 

248,455

 

231,835

 

Construction, land acquisition, and development

 

22,363

 

32,502

 

Commercial and industrial loans

 

112,176

 

110,073

 

Consumer loans

 

109,378

 

109,783

 

State and political subdivisions

 

25,278

 

23,354

 

Total loans, gross

 

615,923

 

597,775

 

Unearned discount

 

(89

)

(103

)

Net deferred loan fees and costs

 

321

 

260

 

Allowance for loan and lease losses

 

(18,473

)

(18,536

)

Loans, net

 

$

597,682

 

$

579,396

 

 

The Company has granted loans, letters of credit and lines of credit to certain executive officers and directors of the Company as well as to certain related parties of executive officers and directors.  See Note 10 to these consolidated financial statements for more information about related party transactions.

 

The Company originates one-to-four family mortgage loans primarily for sale in the secondary market.  During the quarter ended March 31, 2013, the Company sold $3.7 million of one-to-four family mortgages.  The Company retains servicing rights on these mortgages.

 

The Company had $847 thousand and $1.6 million in loans held-for-sale at March 31, 2013 and December 31, 2012, respectively.  All loans held for sale are one-to-four family residential mortgage loans.

 

The Company does not have any lending programs commonly referred to as subprime lending.  Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.

 

See Note 2 to the Company’s consolidated financial statements included in the 2012 Form 10-K for the risk characteristics related to the Company’s loan segments.

 

The Company provides for loan losses based on the consistent application of its documented ALLL methodology.  Loan losses are charged to the ALLL and recoveries are credited to it.  Additions to the ALLL are provided by charges against income based on various factors which, in management’s judgment, deserve current recognition of estimated probable losses.  Loan losses are charged-

 

13



Table of Contents

 

off in the period the loans, or portions thereof, are deemed uncollectible.  Generally, the Company will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated recoverable amount based on its methodology detailed below.  The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the ALLL in accordance with GAAP. The ALLL consists primarily of the following two components:

 

(1)         Specific allowances are established for impaired loans, which are defined by the Company as all loan relationships with an aggregate outstanding balance greater than $100 thousand that are rated substandard and on non-accrual status, rated doubtful or loss, and all troubled debt restructured loans (“TDRs”).  The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the carrying value of the loan and either (a) the present value of expected future cash flows discounted at the loan’s effective interest rate, (b) the loan’s observable market price, or (c) the fair value of the underlying collateral, less estimated costs to sell, for collateral dependent loans.  Impaired loans that have no impairment losses are not considered for general valuation allowances described below.  If the Company determines that collection of the impairment amount is remote, the Company will record a charge-off.

 

(2)         General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired.  The Company divides its portfolio into loan segments, with loans exhibiting similar characteristics.  Loans rated special mention or substandard and accruing which are embedded in these loan segments are then separated from these loan segments.  These loans are then subject to an analysis placing increased emphasis on the credit risk associated with these specific loans.  The Company applies an estimated loss rate to each loan group.  The loss rates applied are based on the Company’s own historical loss experience based on the loss rate for each segment of loans with similar risk characteristics in its portfolio.  In addition, management evaluates and applies certain qualitative or environmental factors that are likely to cause estimated credit losses associated with the Company’s existing portfolio to differ from historical experience, which are discussed below.  This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.  Actual loan losses may be significantly more than the ALLL that is established, which could have a material negative effect on the Company’s operating results or financial condition.

 

Management makes adjustments for loan losses based on its evaluation of several qualitative and environmental factors, including but not limited to:

 

·                  Changes in national, local, and business economic conditions and developments, including the condition of various market segments;

·                  Changes in the nature and volume of the Company’s loan portfolio;

·                  Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results;

·                  Changes in the experience, ability and depth of the Company’s lending management and staff;

·                  Changes in the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors;

·                  Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications;

·                  The existence and effect of any concentrations of credit and changes in the level of such concentrations;

·                  The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s current loan portfolio; and

·                  Analysis of customers’ credit quality, including knowledge of their operating environment and financial condition.

 

Management evaluates the ALLL based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the ALLL methodology results in a higher dollar amount of estimated probable losses. Conversely, when the loan portfolio decreases, absent other factors, the ALLL methodology results in a lower dollar amount of estimated probable losses.

 

Each quarter, management evaluates the ALLL and adjusts the ALLL as appropriate through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the ALLL may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of its examination process, the OCC periodically reviews the Company’s ALLL. The OCC may require the Company to adjust the ALLL based on its analysis of information available to it at the time of its examination.

 

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Table of Contents

 

The following table sets forth activity in the ALLL, by loan category, for the three months ended March 31, 2013 and 2012.

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Three months ended March 31, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance, January 1, 2013

 

$

1,764

 

$

8,062

 

$

2,162

 

$

4,167

 

$

1,708

 

$

673

 

$

18,536

 

Charge-offs

 

(159

)

(48

)

(110

)

(45

)

(194

)

 

(556

)

Recoveries

 

8

 

45

 

5

 

1,516

 

143

 

 

1,717

 

Provisions (credits)

 

271

 

823

 

(381

)

(2,033

)

82

 

14

 

(1,224

)

Ending balance, March 31, 2013

 

$

1,884

 

$

8,882

 

$

1,676

 

$

3,605

 

$

1,739

 

$

687

 

$

18,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance, January 1, 2012

 

$

1,823

 

$

11,151

 

$

2,590

 

$

3,292

 

$

1,526

 

$

452

 

$

20,834

 

Charge-offs

 

(312

)

(154

)

 

(49

)

(79

)

 

(594

)

Recoveries

 

19

 

317

 

21

 

125

 

78

 

 

560

 

Provisions (credits)

 

269

 

(573

)

234

 

37

 

(68

)

(35

)

(136

)

Ending balance, March 31, 2012

 

$

1,799

 

$

10,741

 

$

2,845

 

$

3,405

 

$

1,457

 

$

417

 

$

20,664

 

 

The following table represents the allocation of the allowance for loan losses and the related loan by loan portfolio segment disaggregated based on the impairment methodology at March 31, 2013 and December 31, 2012:

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

26

 

$

408

 

$

84

 

$

 

$

 

$

 

$

518

 

Collectively evaluated for impairment

 

1,858

 

8,474

 

1,592

 

3,605

 

1,739

 

687

 

17,955

 

Total

 

$

1,884

 

$

8,882

 

$

1,676

 

$

3,605

 

$

1,739

 

$

687

 

$

18,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

2,158

 

$

10,857

 

$

943

 

$

 

$

 

$

 

$

13,958

 

Collectively evaluated for impairment

 

96,115

 

237,598

 

21,420

 

112,176

 

109,378

 

25,278

 

601,965

 

Total

 

$

98,273

 

$

248,455

 

$

22,363

 

$

112,176

 

$

109,378

 

$

25,278

 

$

615,923

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

40

 

$

268

 

$

2

 

$

 

$

 

$

 

$

310

 

Collectively evaluated for impairment

 

1,724

 

7,794

 

2,160

 

4,167

 

1,708

 

673

 

18,226

 

Total

 

$

1,764

 

$

8,062

 

$

2,162

 

$

4,167

 

$

1,708

 

$

673

 

$

18,536

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

2,773

 

$

11,459

 

$

993

 

$

 

$

 

$

 

$

15,225

 

Collectively evaluated for impairment

 

87,455

 

220,376

 

31,509

 

110,073

 

109,783

 

23,354

 

582,550

 

Total

 

$

90,228

 

$

231,835

 

$

32,502

 

$

110,073

 

$

109,783

 

$

23,354

 

$

597,775

 

 

Credit Quality Indicators — Commercial Loans

 

The Company continuously monitors the credit quality of its commercial loans.  Credit quality is monitored by reviewing certain credit quality indicators. Management has determined that credit risk ratings are the key credit quality indicator that best help management monitor the credit quality of the Company’s loan receivables.

 

The Bank’s commercial loan classification and credit grading processes are part of the lending, underwriting, and credit administration functions to ensure an ongoing assessment of credit quality. Accurate and timely loan classification or credit grading is a critical component of loan portfolio management. Loan officers are required to review their loan portfolio risk ratings regularly for accuracy. The loan review function uses the same risk rating system in the loan review process. This allows an independent third party to assess the quality of the portfolio and compare the accuracy of ratings with the loan officer’s and management’s assessment.

 

A formal loan classification and credit grading system reflects the risk of default and credit losses.  A written description of the risk ratings is maintained that includes a discussion of the factors used to assign appropriate classifications of credit grades to loans.  The process identifies groups of loans that warrant the special attention of management.  The risk grade groupings provide a mechanism to identify risk within the loan portfolio and provide management and the Board with periodic reports by risk category.  The credit risk ratings play an important role in the establishment and evaluation of the provision for loan and lease losses and the ALLL.  After determining the historical loss factor which is adjusted for qualitative and environmental factors for each portfolio segment, the portfolio segment balances that have been collectively evaluated for impairment are multiplied by the general reserve loss factor for the respective portfolio segments to determine the general reserve.  Loans that have an internal credit rating of special mention or substandard follow the same process; however, the qualitative and environmental factors are further adjusted for the increased risk.

 

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Table of Contents

 

The Company utilizes a loan rating system that assigns a degree of risk to commercial loans based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  The Company analyzes these non-homogeneous loans individually by grading the loans as to credit risk and probability of collection for each type of loan. Commercial loans include commercial indirect auto loans which are not individually risk rated, and Construction, Land Acquisition and Development Loans include residential construction loans which are also not individually risk rated.  These loans are monitored on a pool basis due to their homogeneous nature as described in “Credit Quality Indicators — Other Loans” below. The Company risk rates certain residential real estate loans and consumer loans that are part of a larger commercial relationship using its credit grading system. These loans are described in “Credit Quality Indicators — Commercial Loans.”  The grading system contains the following basic risk categories:

 

1. Minimal Risk

2. Above Average Credit Quality

3. Average Risk

4. Acceptable Risk

5. Pass - Watch

6. Special Mention

7. Substandard - Accruing

8. Substandard - Non-Accrual

9. Doubtful

10. Loss

 

This analysis is performed on a quarterly basis using the following definitions for risk ratings:

 

Pass - Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully collectible. All such loans are considered collectively for ALLL calculation purposes.  However, accruing TDRs that have been performing for an extended period of time, do not represent a higher risk of loss, and have been upgraded to a pass rating are evaluated individually for impairment.

 

Special Mention — Assets classified as special mention assets do not currently expose the Company to a sufficient degree of risk to warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention.  Special Mention assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk in the future.

 

Substandard - Assets classified as substandard have well defined weaknesses based on objective evidence, and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

Doubtful - Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable based on current circumstances.

 

Loss - Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.

 

The following tables detail the recorded investment in loans receivable by the aforementioned class of loan and credit quality indicator at March 31, 2013 and December 31, 2012.

 

Commercial Credit Quality Indicators

March 31, 2013

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial
Real Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Internal risk rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

18,943

 

$

214,785

 

$

13,622

 

$

97,101

 

$

2,445

 

$

19,962

 

$

366,858

 

Special mention

 

1,234

 

12,174

 

56

 

6,985

 

 

819

 

21,268

 

Substandard

 

1,714

 

21,496

 

7,221

 

2,804

 

171

 

4,497

 

37,903

 

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total

 

$

21,891

 

$

248,455

 

$

20,899

 

$

106,890

 

$

2,616

 

$

25,278

 

$

426,029

 

 

16



Table of Contents

 

Commercial Credit Quality Indicators

December 31, 2012

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Internal risk rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

17,138

 

$

200,147

 

$

23,052

 

$

93,864

 

$

3,324

 

$

17,580

 

$

355,105

 

Special mention

 

564

 

8,587

 

57

 

7,437

 

 

849

 

17,494

 

Substandard

 

2,309

 

23,101

 

7,395

 

3,395

 

143

 

4,925

 

41,268

 

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total

 

$

20,011

 

$

231,835

 

$

30,504

 

$

104,696

 

$

3,467

 

$

23,354

 

$

413,867

 

 

Credit Quality Indicators — Other Loans

 

Residential, consumer and commercial indirect auto loans are monitored on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are considered to be non-accrual. The Company utilizes accruing versus non-accruing status as the credit quality indicator for these loan pools.  The following table presents the recorded investment in residential, consumer and indirect auto loans based on payment activity as of March 31, 2013 and December 31, 2012.

 

 

 

March 31, 2013

 

December 31, 2012

 

 

 

Accruing

 

Non-Accruing

 

 

 

Accruing

 

Non-Accruing

 

 

 

(in thousands)

 

Loans

 

Loans

 

Total

 

Loans

 

Loans

 

Total

 

Construction, land acquisition and development - residential

 

$

1,464

 

$

 

$

1,464

 

$

1,998

 

$

 

$

1,998

 

Residential real estate

 

74,544

 

1,838

 

76,382

 

68,446

 

1,771

 

70,217

 

Commercial - indirect auto

 

5,268

 

18

 

5,286

 

5,377

 

 

5,377

 

Consumer

 

106,708

 

54

 

106,762

 

106,272

 

44

 

106,316

 

Total

 

$

187,984

 

$

1,910

 

$

189,894

 

$

182,093

 

$

1,815

 

$

183,908

 

 

Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded investment in these non-accrual loans was $8.8 million and $9.7 million at March 31, 2013 and December 31, 2012, respectively. Included in non-accrual loans at March 31, 2013 and December 31, 2012 was one loan in the amount of $4.4 million which was 90.0% guaranteed by a United States government agency. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist.  Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent and still be on a non-accrual status.  Loans past due 90 days or more and still accruing interest were $0 and $57 thousand at March 31, 2013 and December 31, 2012, respectively, and consisted of loans that are well secured and are in the process of renewal.

 

17



Table of Contents

 

The following tables set forth the detail, and delinquency status, of past due and non-accrual loans at March 31, 2013 and December 31, 2012:

 

 

 

March 31, 2013

 

 

 

Delinquency Status

 

(in thousands)

 

0-29 Days Past
Due

 

30-59 Days Past
Due

 

60-89 Days Past
Due

 

>/= 90 Days Past
Due

 

Total

 

Performing (accruing) loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

$

94,950

 

$

260

 

$

136

 

$

 

$

95,346

 

Commercial real estate

 

242,848

 

481

 

 

 

243,329

 

Construction, land acquisition and development

 

21,909

 

 

 

 

21,909

 

Total real estate

 

359,707

 

741

 

136

 

 

360,584

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

111,511

 

503

 

15

 

 

112,029

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

107,487

 

1,329

 

384

 

 

109,200

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

25,278

 

 

 

 

25,278

 

 

 

 

 

 

 

 

 

 

 

 

 

Total performing (accruing) loans

 

603,983

 

2,573

 

535

 

 

607,091

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accrual loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

1,194

 

4

 

 

1,729

 

2,927

 

Commercial real estate

 

90

 

184

 

 

4,852

 

5,126

 

Construction, land aquisition and development

 

53

 

382

 

 

19

 

454

 

Total real estate

 

1,337

 

570

 

 

6,600

 

8,507

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

48

 

5

 

64

 

30

 

147

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

95

 

9

 

6

 

68

 

178

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-accrual loans

 

1,480

 

584

 

70

 

6,698

 

8,832

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable

 

$

605,463

 

$

3,157

 

$

605

 

$

6,698

 

$

615,923

 

 

18



Table of Contents

 

Performing and Non-Performing Loan Delinquency Status

 

 

 

December 31, 2012

 

 

 

Delinquency Status

 

(in thousands)

 

0-29 Days Past
Due

 

30-59 Days Past
Due

 

60-89 Days Past
Due

 

>/= 90 Days Past
Due

 

Total

 

Performing (accruing) loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

$

86,301

 

$

422

 

$

31

 

$

30

 

$

86,784

 

Commercial real estate

 

226,344

 

194

 

 

 

226,538

 

Construction, land acquisition and development

 

31,899

 

29

 

 

 

$

31,928

 

Total real estate

 

344,544

 

645

 

31

 

30

 

345,250

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

109,312

 

517

 

20

 

27

 

109,876

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

107,821

 

1,489

 

333

 

 

109,643

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

23,354

 

 

 

 

23,354

 

 

 

 

 

 

 

 

 

 

 

 

 

Total performing (accruing) loans

 

585,031

 

2,651

 

384

 

57

 

588,123

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accrual loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

953

 

105

 

230

 

2,156

 

3,444

 

Commercial real estate

 

250

 

121

 

4,352

 

574

 

5,297

 

Construction, land acquisition and development

 

446

 

 

 

128

 

574

 

Total real estate

 

1,649

 

226

 

4,582

 

2,858

 

9,315

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

61

 

30

 

11

 

95

 

197

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

2

 

 

2

 

136

 

140

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-accrual loans

 

1,712

 

256

 

4,595

 

3,089

 

9,652

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable

 

$

586,743

 

$

2,907

 

$

4,979

 

$

3,146

 

$

597,775

 

 

The total recorded investment in impaired loans, which consists of non-accrual loans with an aggregate loan relationship of greater than $100,000 and performing TDRs, amounted to $14.0 million and $15.2 million at March 31, 2013 and December 31, 2012, respectively.  The related allowance on impaired loans was $0.5 million and $0.3 million as of March 31, 2013 and December 31, 2012, respectively.

 

19


 


Table of Contents

 

The following tables provide a distribution of the recorded investment, unpaid principal balance and the related allowance for the Company’s impaired loans, which have been analyzed for impairment under ASC 310, at March 31, 2013 and December 31, 2012. Non-accrual loans other than TDRs, with individual balances less than $100 thousand are not evaluated individually for impairment and are accordingly not included in the following tables. However, these loans are evaluated collectively for impairment as homogenous pools in the general allowance under ASC 450. Total non-accrual loans, other than TDRs, with individual balances less than $100 thousand that were evaluated under ASC 450 amounted to $1.7 million at March 31, 2013 and $1.9 million at December 31, 2012, respectively.

 

Impaired Loans

 

 

 

March 31, 2013

 

(in thousands)

 

Recorded
Investment

 

Unpaid
Principal
Balance

 

Related
Allowance

 

With no allowance recorded:

 

 

 

 

 

 

 

Real estate

 

 

 

 

 

 

 

Residential real estate

 

$

1,264

 

$

1,376

 

$

 

Commercial real estate

 

4,735

 

5,012

 

 

Construction, land acquisition & development

 

 

 

 

Total real estate

 

5,999

 

6,388

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

Total impaired loans with no allowance recorded

 

5,999

 

6,388

 

 

 

 

 

 

 

 

 

 

With a related allowance recorded:

 

 

 

 

 

 

 

Real estate

 

 

 

 

 

 

 

Residential real estate

 

894

 

919

 

26

 

Commercial real estate

 

6,122

 

6,122

 

408

 

Construction, land acquisition & development

 

943

 

1,044

 

84

 

Total real estate

 

7,959

 

8,085

 

518

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

Total impaired loans with a related allowance recorded

 

7,959

 

8,085

 

518

 

 

 

 

 

 

 

 

 

Total impaired loans

 

 

 

 

 

 

 

Real estate

 

 

 

 

 

 

 

Residential real estate

 

2,158

 

2,295

 

26

 

Commercial real estate

 

10,857

 

11,134

 

408

 

Construction, land acquisition & development

 

943

 

1,044

 

84

 

Total real estate

 

13,958

 

14,473

 

518

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

Total impaired loans

 

$

13,958

 

$

14,473

 

$

518

 

 

20



Table of Contents

 

Impaired Loans

 

 

 

December 31, 2012

 

(in thousands)

 

Recorded
Investment

 

Unpaid Principal
Balance

 

Related
Allowance

 

With no allowance recorded:

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

Residential real estate

 

$

1,275

 

$

1,378

 

$

 

Commercial real estate

 

389

 

665

 

 

Construction, land acquisition & development

 

709

 

804

 

 

Total real estate

 

2,373

 

2,847

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

Total impaired loans with no allowance recorded

 

2,373

 

2,847

 

 

 

 

 

 

 

 

 

 

With a related allowance recorded:

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

Residential real estate

 

1,498

 

1,512

 

40

 

Commercial real estate

 

11,069

 

11,069

 

268

 

Construction, land acquisition & development

 

285

 

285

 

2

 

Total real estate

 

12,852

 

12,866

 

310

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

Total impaired loans with a related allowance recorded

 

12,852

 

12,866

 

310

 

 

 

 

 

 

 

 

 

Total impaired loans:

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

Residential real estate

 

2,773

 

2,890

 

40

 

Commercial real estate

 

11,459

 

11,734

 

268

 

Construction, land acquisition & development

 

993

 

1,088

 

2

 

Total real estate

 

15,225

 

15,712

 

310

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

Total impaired loans

 

$

15,225

 

$

15,712

 

$

310

 

 

21



Table of Contents

 

The following table presents by loan portfolio class, the average balance and interest income recognized on impaired loans for the three months ended March 31, 2013 and 2012:

 

 

 

Three Months Ended March 31,

 

 

 

2013

 

2012

 

(in thousands)

 

Average
Balance

 

Interest
Income (1)

 

Average
Balance

 

Interest
Income (1)

 

Residential real estate

 

$

2,168

 

$

2

 

$

2,834

 

$

3

 

Commercial real estate

 

10,875

 

93

 

12,873

 

70

 

Construction, land acquisition & development

 

1,013

 

9

 

2,734

 

12

 

Total real estate

 

14,056

 

104

 

18,441

 

85

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

 

 

3,806

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total impaired loans

 

$

14,056

 

$

104

 

$

22,278

 

$

85

 

 


(1) Interest income represents income recognized on performing TDRs.

 

The additional interest income that would have been earned on non-accrual and restructured loans for the quarter ended on March 31, 2013 and 2012 in accordance with their original terms approximated $200 thousand and $405 thousand, respectively.

 

Troubled Debt Restructured Loans

 

TDRs at March 31, 2013 and December 31, 2012 were $8.2 million and $8.9 million, respectively.  Accruing and non-accruing TDRs were $6.8 million and $1.4 million, respectively at March 31, 2013 and $7.5 million and $1.4 million, respectively at December 31, 2012.  Approximately $505 thousand and $257 thousand in specific reserves have been established for these loans as of March 31, 2013 and December 31, 2012, respectively.

 

The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan, an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk, or a permanent reduction of the recorded investment in the loan.

 

The following tables show the pre- and post- modification recorded investment in loans modified as TDRs by portfolio segment and class of financing receivable during the three months ended March 31, 2013 and 2012:

 

 

 

Three Months Ended March 31, 2013

 

Three Months Ended March 31, 2012

 

(in thousands)

 

Number of
Contracts

 

Pre-Modification
Outstanding
Recorded
Investments

 

Post-Modification
Outstanding
Recorded
Investments

 

Number of
Contracts

 

Pre-Modification
Outstanding
Recorded
Investments

 

Post-Modification
Outstanding
Recorded
Investments

 

Troubled Debt Restructuring:

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

 

$

 

$

 

 

$

 

$

 

Commercial real estate

 

1

 

477

 

477

 

 

 

 

Construction, land acquisition and development

 

 

 

 

1

 

39

 

39

 

Commercial and industrial

 

 

 

 

 

 

 

Total new troubled debt restructurings

 

1

 

$

477

 

$

477

 

1

 

$

39

 

$

39

 

 

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The one loan modified as a TDR during the three months ended March 31, 2013 increased the ALLL by $1 thousand at March 31, 2013. There was no effect on the ALLL at March 31, 2012 with respect to loans modified as TDRs during the three months ended March 31, 2012.

 

The following table shows the types of modifications made during the three months ended March 31, 2013 and 2012:

 

 

 

Three months ended March 31, 2013

 

Three months ended March 31, 2012

 

 

 

 

 

 

 

Construction,

 

 

 

 

 

 

 

Construction,

 

 

 

 

 

 

 

 

 

Land Acquistion

 

 

 

 

 

 

 

Land Acquisition

 

 

 

 

 

Residential

 

Commercial

 

and

 

 

 

Residential

 

Commercial

 

and

 

 

 

(in thousands)

 

Real Estate

 

Real Estate

 

Development

 

Total

 

Real Estate

 

Real Estate

 

Development

 

Total

 

Type of modification

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Extension of term

 

$

 

$

 

$

 

$

 

$

 

$

 

$

39

 

$

39

 

Principal forebearance

 

 

477

 

 

477

 

 

 

 

 

Total TDRs

 

$

 

$

477

 

$

 

$

477

 

$

 

$

 

$

39

 

$

39

 

 

There were no TDRs which re-defaulted (defined as past due 90 days) during the three months ended March 31, 2013 and 2012 and for which the payment re-default occurred within one year of the modification.

 

Note 5.  Other Real Estate Owned

 

The following table presents the components of OREO at March 31, 2013 and December 31, 2012:

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Land/Lots

 

$

2,856

 

$

2,929

 

Commercial Real Estate

 

1,054

 

1,054

 

Total

 

$

3,910

 

$

3,983

 

 

The following table presents the activity in OREO for the three months ended March 31, 2013 and 2012:

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Balance, January 1,

 

$

3,983

 

$

6,958

 

Additions

 

 

239

 

Valuation adjustments

 

 

26

 

Carrying value of OREO sold

 

(73

)

(1,097

)

Balance, March 31,

 

$

3,910

 

$

6,126

 

 

The following table details the components of net expense of OREO for the three months ended March 31, 2013 and 2012:

 

 

 

Three Months Ended
March 31,

 

(in thousands)

 

2013

 

2012

 

Insurance

 

35

 

$

21

 

Legal fees

 

33

 

33

 

Maintenance

 

25

 

16

 

Income from the operation of foreclosed properties

 

(7

)

(4

)

Professional fees

 

14

 

11

 

Real estate taxes

 

56

 

98

 

Utilities

 

7

 

4

 

Other

 

55

 

25

 

Impairment charges (credits)

 

 

(26

)

Total

 

$

218

 

$

178

 

 

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Note 6.  Securities

 

Securities have been classified as available-for-sale or held-to-maturity in the consolidated financial statements according to management’s intent.  The amortized cost, gross unrealized gains and losses, and the fair value of the Company’s securities at March 31, 2013 and December 31, 2012 are as follows:

 

 

 

March 31, 2013

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

 

 

Unrealized

 

Unrealized

 

 

 

 

 

Amortized

 

Holding

 

Holding

 

 

 

(in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Available-for-sale

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

1,816

 

$

54

 

$

 

$

1,870

 

Obligations of state and political subdivisions

 

95,834

 

7,901

 

1,026

 

102,709

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

collateralized mortgage obligations

 

16,214

 

306

 

112

 

16,408

 

Government sponsorded agency

 

 

 

 

 

 

 

 

 

residential mortgage-backed securities

 

94,112

 

664

 

323

 

94,453

 

Corporate debt securities

 

500

 

 

85

 

415

 

Equity securities

 

1,010

 

 

16

 

994

 

Total available-for-sale securities

 

$

209,486

 

$

8,925

 

$

1,562

 

$

216,849

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity

 

 

 

 

 

 

 

 

 

Obligations of state and political subdivisions

 

$

2,225

 

$

276

 

$

 

$

2,501

 

 

 

 

December 31, 2012

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

 

 

Unrealized

 

Unrealized

 

 

 

 

 

Amortized

 

Holding

 

Holding

 

 

 

(in thousands)

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Available-for-sale

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

1,821

 

$

70

 

$

 

$

1,891

 

Obligations of state and political subdivisions

 

95,312

 

8,922

 

733

 

103,501

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

collateralized mortgage obligations

 

8,805

 

311

 

13

 

9,103

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

residential mortgage-backed securities

 

67,765

 

1,920

 

229

 

69,456

 

Corporate debt securities

 

500

 

 

90

 

410

 

Equity securities

 

1,010

 

 

10

 

1,000

 

Total available-for-sale securities

 

$

175,213

 

$

11,223

 

$

1,075

 

$

185,361

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity

 

 

 

 

 

 

 

 

 

Obligations of state and political subdivisions

 

$

2,198

 

$

285

 

$

 

$

2,483

 

 

At March 31, 2013 and December 31, 2012, securities with a carrying amount of $217.1 million and $185.0 million, respectively, were pledged as collateral to secure public deposits and for other purposes.

 

The following table shows the approximate fair value of the Company’s debt securities at March 31, 2013 using contractual maturities.  Expected maturities will differ from contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.  Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.

 

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Available-for-Sale

 

Held-to-Maturity

 

 

 

Amortized

 

Fair

 

Amortized

 

Fair

 

(in thousands)

 

Cost

 

Value

 

Cost

 

Value

 

Amounts maturing in:

 

 

 

 

 

 

 

 

 

One year or less

 

$

 

$

 

$

 

$

 

One year through five years

 

1,025

 

984

 

 

 

After five years through ten years

 

31,541

 

33,743

 

2,225

 

2,501

 

After ten years

 

65,584

 

70,267

 

 

 

Collateralized mortgage obligations

 

16,214

 

16,408

 

 

 

Mortgage-backed securities

 

94,112

 

94,453

 

 

 

Total

 

$

208,476

 

$

215,855

 

$

2,225

 

$

2,501

 

 

Gross proceeds from the sale of securities were $17.1 million for the three months ended March 31, 2013, with gross gains of $842 thousand realized upon the sales. The Company did not sell any securities during the three months ended March 31, 2012.  The Company recognized gains of $8 thousand on securities called during the three months ended March 31, 2012. There were no gains recognized on securities called during the three months ended March 31, 2013.

 

The tables below indicate the length of time that individual securities held-to-maturity and available-for-sale have been in a continuous unrealized loss position at March 31, 2013 and December 31, 2012:

 

 

 

March 31, 2013

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(in thousands)

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

Obligations of state and political subdivisions

 

$

14,314

 

$

643

 

$

3,988

 

$

383

 

$

18,302

 

$

1,026

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

 

 

 

 

collateralized mortgage obligations

 

10,166

 

112

 

 

 

10,166

 

112

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

 

 

 

 

residential mortgage-backed securities

 

56,504

 

323

 

 

 

56,504

 

323

 

Corporate debt securities

 

 

 

415

 

85

 

415

 

85

 

Equity securities

 

984

 

16

 

 

 

984

 

16

 

Total

 

$

81,968

 

$

1,094

 

$

4,403

 

$

468

 

$

86,371

 

$

1,562

 

 

 

 

December 31, 2012

 

 

 

Less than 12 Months

 

12 Months or Greater

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

(in thousands)

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

Obligations of state and political subdivisions

 

$

8,649

 

$

398

 

$

4,139

 

$

335

 

$

12,788

 

$

733

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

 

 

 

 

collateralized mortgage obligations

 

1,485

 

13

 

2

 

 

1,487

 

13

 

Government sponsored agency

 

 

 

 

 

 

 

 

 

 

 

 

 

residential mortgage-backed securities

 

12,899

 

229

 

 

 

12,899

 

229

 

Corporate debt securities

 

 

 

410

 

90

 

410

 

90

 

Equity securities

 

990

 

10

 

 

 

990

 

10

 

Total

 

$

24,023

 

$

650

 

$

4,551

 

$

425

 

$

28,574

 

$

1,075

 

 

The majority of the Company’s securities portfolio is comprised of obligations of states and political subdivisions, residential mortgage-backed securities, including home equity conversion mortgages, and collateralized mortgage obligations. The Company held 71 securities that were in an unrealized loss position at March 31, 2013. Substantially all of the unrealized losses relate to debt securities.

 

In determining whether unrealized losses are other-than-temporary, management considers the following factors:

 

·                  The causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility;

·                  The severity and duration of the decline;

 

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·                  The Company’s ability and intent to hold the security to allow for recovery in fair value, as well as the likelihood of such a recovery in the near term;

·                  The Company’s intent to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss.

 

Management performed a review of the fair values of all securities at March 31, 2013 and determined that movements in the values of the securities were consistent with the change in market interest rates. As a result of its review and considering the attributes of these debt securities, the Company concluded that other than temporary impairment (“OTTI”) did not exist at March 31, 2013. To date, the Company has received all scheduled principal and interest payments and expects to fully collect all future contractual principal and interest payments. The Company does not intend to sell the securities nor is it more likely than not that the Company will be required to sell the securities.

 

Management does not believe that any individual unrealized loss at March 31, 2013 represents OTTI. The unrealized losses reported for residential mortgage-backed securities and collateralized mortgage obligations relate entirely to securities issued by GNMA, FHLMC and FNMA that are currently rated AAA by Moody’s Investor Services or Aaa by Standard & Poor’s and are guaranteed by the U.S. government. The obligations of state and political subdivisions are comprised entirely of general-purpose debt obligations. The majority of these obligations have a credit quality rating of A or better and are secured by the unlimited taxing power of the issuer. In addition, the Company utilized a third party to perform an independent credit analysis of its state and political subdivision bonds that were either non-rated or had a rating below A. There were two obligations of state and political subdivisions that were either non-rated or had a rating below A. According to this analysis, these two bonds were considered investment grade.

 

OTTI of Pooled Trust Preferred Collateralized Debt Obligations (“PreTSLs”):

 

At March 31, 2012, the Company’s PreTSLs were comprised of four securities that were collateralized by debt issued by bank holding companies and insurance companies with an aggregate amortized cost of $10.5 million and an estimated fair value of $4.0 million. The Company divested its entire holdings of PreTSLs during 2012 and held no such securities at March 31, 2013.

 

The table below provides a cumulative roll forward of OTTI credit losses recognized:

 

(in thousands)

 

2013

 

2012

 

Beginning Balance, January 1

 

$

 

$

8,619

 

Credit losses on debt securities for which OTTI was not previously recognized

 

 

 

Additional credit losses on debt securities for which OTTI was previously recognized

 

 

 

Less: Sale of PreTSLs for which OTTI was previously recognized

 

 

 

Ending Balance, March 31

 

$

 

$

8,619

 

 

Investments in FHLB and FRB stock, which have limited marketability, are carried at cost and totaled $6.4 million and $7.3 million at March 31, 2013 and December 31, 2012, respectively.  FRB stock of $1.3 million is included in Other Assets at March 31, 2013 and December 31, 2012.  Management noted no indicators of impairment for the FHLB of Pittsburgh and FRB of Philadelphia at March 31, 2013.

 

Note 7.   Fair Value Measurements

 

In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches.  Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of the Company.  Unobservable inputs reflects the Company’s assumptions about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

 

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).  A financial asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

·                  Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

 

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Table of Contents

 

·                  Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

 

·                  Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that use significant assumptions not observable in the market.  These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

 

A description of the valuation methodologies used for assets recorded at fair value, and for estimating fair value of financial instruments not recorded at fair value, is set forth below.

 

Cash, Short-term Investments, Accrued Interest Receivable and Accrued Interest Payable

 

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Securities

 

The estimated fair values of available-for-sale equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs).  The estimated fair values for the Company’s investments in obligations of U.S. government agencies, obligations of state and political subdivisions, government sponsored agency collateralized mortgage obligations, government- sponsored agency residential mortgage backed securities, and corporate debt securities are obtained by the Company from a nationally-recognized pricing service.  This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations.  Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.  The fair value measurements consider observable data that may include dealer quotes, market spreads,  cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things and are based on market data obtained from sources independent from the Company.  The Level 2 investments in the Company’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets.  The Company has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in the Company’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data.  The Company has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.

 

For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, the Company evaluated the appropriateness and quality of each price.  The Company reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume.  For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs).  If applicable, the adjustment to fair value was derived based on present value cash flow model projections prepared by the Company or obtained from third party providers utilizing assumptions similar to those incorporated by market participants.  The estimated fair value of the PreTSLs and the private label collateralized mortgage obligations  that were previously held in the Company’s securities portfolio during 2012 were obtained from third-party service providers that prepared the valuation using a discounted cash flow approach with inputs derived from unobservable market information (Level 3 inputs).

 

At March 31, 2013, the Company owned two securities issued by state and political subdivisions having an amortized cost of $1.6 million that are valued using Level 3 inputs. These securities had credit ratings that were either withdrawn or downgraded by nationally recognized credit rating agencies, and as a result of the ratings withdrawals and downgrade, the market for these securities at March 31, 2013 is no longer active.  These securities were historically priced using Level 2 inputs.  The credit ratings withdrawal and downgrade have resulted in a decline in the level of significant other observable inputs for these investment securities at the measurement date.  Broker pricing and bid/ask spreads are very limited for these securities. One security was valued based on similar nonrated Pennsylvania Sewer bonds adjusted for coupon and maturity. For the other security, the Company obtained a bid indication from a third-party municipal trading desk to determine the fair value of this security.

 

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Table of Contents

 

Loans

 

Except for collateral dependent impaired loans, fair values are estimated by discounting the projected future cash flows using market discount rates that reflect the credit, liquidity, and interest rate risk inherent in the loan.  Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal.  The estimated fair value of collateral dependent impaired loans is based on the appraised loan value or other reasonable offers less estimated costs to sell.  The Company does not record loans at fair value on a recurring basis.  However from time to time, a loan is considered impaired and an allowance for credit losses is established.  The specific reserves for collateral dependent impaired loans are based on the fair value of the collateral less estimated costs to sell.  The fair value of the collateral is based on appraisals.  In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral.  When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.

 

Loans Held For Sale

 

Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

 

Mortgage Servicing Rights

 

The fair value of mortgage servicing rights is estimated using a discounted cash flow model that applies current estimated prepayments derived from the mortgage-backed securities market and utilizes a current market discount rate for observable credit spreads.  The Bank does not record mortgage servicing rights at fair value on a recurring basis.

 

Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock

 

Ownership in equity securities of FHLB of Pittsburgh and the FRB is restricted and there is no established market for their resale.  The carrying amount is a reasonable estimate of fair value.

 

Deposits

 

The fair value of demand deposits, savings deposits, and certain money market deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated based on discounted cash flows using FHLB advance rates currently offered for similar remaining maturities.

 

Borrowed funds

 

The Bank uses discounted cash flows using rates currently available for debt with similar terms and remaining maturities to estimate fair value.

 

Commitments to extend credit and standby letters of credit

 

The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of off-balance sheet commitments is insignificant and therefore not included in the table for non-recurring assets and liabilities.

 

Assets measured at fair value on a recurring basis

 

The following tables detail the financial asset amounts that are carried at fair value and measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

 

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Table of Contents

 

 

 

 

 

Fair value measurements at March 31, 2013

 

 

 

 

 

 

 

Significant

 

Significant

 

 

 

 

 

Quoted prices

 

other

 

other

 

 

 

 

 

in active markets

 

observable

 

unobservable

 

 

 

 

 

for identical assets

 

inputs

 

inputs

 

(in thousands)

 

Fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

1,870

 

$

 

$

1,870

 

$

 

Obligations of political and state subdivisions

 

102,709

 

 

101,105

 

1,604

 

Government sponsored agency CMOs

 

16,408

 

 

16,408

 

 

Residential mortgage-backed securities

 

94,453

 

 

94,453

 

 

Corporate debt securities

 

415

 

 

415

 

 

Equity securities

 

994

 

994

 

 

Total securities available-for-sale

 

$

216,849

 

$

994

 

$

214,251

 

$

1,604

 

 

 

 

 

 

Fair value measurements at December 31, 2012

 

 

 

 

 

 

 

Significant

 

Significant

 

 

 

 

 

Quoted prices

 

other

 

other

 

 

 

 

 

in active markets

 

observable

 

unobservable

 

 

 

 

 

for identical assets

 

inputs

 

inputs

 

(in thousands)

 

Fair value

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

1,891

 

$

 

$

1,891

 

$

 

Obligations of state and political subdivisions

 

103,501

 

 

101,762

 

1,739

 

Government sponsored agency CMO

 

9,103

 

 

9,103

 

 

Residential mortgage-backed securities

 

69,456

 

 

69,456

 

 

Corporate debt securities

 

410

 

 

410

 

 

Equity securities

 

1,000

 

1,000

 

 

 

Total securities available-for-sale

 

$

185,361

 

$

1,000

 

$

182,622

 

$

1,739

 

 

The table below presents reconciliation and statement of operations classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three month periods ended March 31, 2013 and 2012:

 

Fair Value Measurements

Using Significant Unobservable Inputs (Level 3)

 

(in thousands)

 

State and
Political
Subdivisions

 

Balance at December 31, 2012

 

$

1,739

 

Amortization

 

 

Accretion

 

 

Payments received

 

(140

)

Purchases

 

 

 

Total gains or losses (realized/unrealized):

 

 

 

Included in earnings

 

 

Included in other comprehensive income

 

5

 

Balance at March 31, 2013

 

$

1,604

 

 

Fair Value Measurements

Using Significant Unobservable Inputs (Level 3)

 

(in thousands)

 

PreTSLs

 

State and
Political
Subdivisions

 

Private
Label
CMOs

 

Total

 

Balance at December 31, 2011

 

$

3,801

 

$

2,811

 

$

36,256

 

$

42,868

 

Amortization

 

 

 

(119

)

(119

)

Accretion

 

 

 

29

 

29

 

Payments received

 

(27

)

(135

)

(3,065

)

(3,227

)

Purchases

 

 

 

 

 

14,730

 

14,730

 

Total gains or losses (realized/unrealized):

 

 

 

 

 

 

 

 

 

Included in earnings

 

 

 

 

 

Included in other comprehensive income

 

201

 

47

 

79

 

327

 

Balance at March 31, 2012

 

$

3,975

 

$

2,723

 

$

47,910

 

$

54,608

 

 

There were no transfers between levels within the fair value hierarchy during the periods ended March 31, 2013 and 2012.

 

Assets measured at fair value on a non-recurring basis

 

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

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Table of Contents

 

 

 

Fair Value Measurements at March 31, 2013

 

(in thousands)

 

Fair Value (1)

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant Other
Unobservable
Inputs
(Level 3)

 

Collateral-dependent impaired loans

 

$

7,039

 

 

 

 

 

$

7,039

 

 

 

 

Fair Value Measurements at December 31, 2012

 

(in thousands)

 

Fair Value (1)

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Other
Unobservable
Inputs
(Level 3)

 

Collateral-dependent impaired loans

 

$

7,816

 

 

 

 

 

$

7,816

 

Other real estate owned

 

$

2,455

 

 

 

 

 

$

2,455

 

 


(1)         Represents carrying value and related write-downs for which adjustments are based on appraised value.  Management makes adjustments to the appraised values as necessary to consider declines in real estate values since the time of the appraisal.  Such adjustments are based on management’s knowledge of the local real estate markets.

 

Collateral dependent impaired loans are classified as Level 3 assets and the estimated fair value of the collateral is based on independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not observable.  Appraisals are adjusted by management for estimated costs to sell, which equals 10% and is recorded through a valuation allowance.  When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged-off.  The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for loan losses.

 

Other real estate owned properties are recorded at the fair value based on independent appraisals, which generally include various Level 3 inputs which are not observable, less the estimated cost to sell at the date of foreclosure.  Subsequent to foreclosure, the balance might be subject to additional write-downs.  It is the Company’s policy to obtain certified external appraisals of real estate collateral underlying impaired loans, including OREO, and it estimates fair value using those appraisals.  Other valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements.  The amount in the table above represents the value of OREO properties at December 31, 2012, which were subject to additional write-downs subsequent to foreclosure.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the Statement of Financial Condition, for which it is practicable to estimate that value.  The following estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies.  However, management judgment is required to interpret data and develop fair value estimates.  Accordingly, the estimates below are not necessarily indicative of the amounts the Company could realize in a current market exchange.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.  The estimated fair values of the Company’s financial instruments are as follows:

 

 

 

Fair Value

 

March 31, 2013

 

December 31, 2012

 

(in thousands)

 

Measurement

 

Carrying Value

 

Fair Value

 

Carrying Value

 

Fair Value

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

Cash and short term investments

 

Level 1

 

$

32,343

 

$

32,343

 

$

115,271

 

$

115,271

 

Securities

 

See previous table

 

219,074

 

219,350

 

187,559

 

187,844

 

FHLB and FRB Stock

 

Level 2

 

6,432

 

6,432

 

7,308

 

7,308

 

Loans, net

 

Level 3

 

597,682

 

604,311

 

579,396

 

592,504

 

Loans held for sale

 

Level 2

 

847

 

847

 

1,615

 

1,615

 

Accrued interest receivable

 

Level 2

 

2,618

 

2,618

 

2,199

 

2,199

 

Mortgage servicing rights

 

Level 3

 

637

 

915

 

675

 

884

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

Level 2

 

823,746

 

827,780

 

854,613

 

858,970

 

Borrowed funds

 

Level 2

 

47,698

 

52,357

 

53,903

 

59,021

 

Accrued interest payable

 

Level 2

 

7,001

 

7,001

 

6,427

 

6,427

 

 

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Table of Contents

 

Note 8.  Earnings per Share

 

For the Company, the numerator of both the basic and diluted earnings per common share is net income available to common shareholders (which is equal to net income less dividends on preferred stock and related discount accretion). The weighted average number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the denominator used for diluted earnings per common share by the effect of potentially dilutive common share equivalents utilizing the treasury stock method. For the Company, common share equivalents are outstanding stock options to purchase the Company’s common shares.

 

The following table presents the calculation of both basic and diluted earnings per common share for the three months ended March 31, 2013 and 2012:

 

 

 

Three months ended

 

 

 

March 31,

 

(in thousands, except share data)

 

2013

 

2012

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

 

 

 

 

 

 

Basic weighted-average number of common shares outstanding

 

16,457,169

 

16,442,119

 

Plus: Common share equivalents

 

 

 

Diluted weighted-average number of common shares outstanding

 

16,457,169

 

16,442,119

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

Basic

 

$

0.11

 

$

(0.07

)

Diluted

 

$

0.11

 

$

(0.07

)

 

Common share equivalents, in the table above, exclude 129,170 (2013) and 188,193 (2012) stock options with exercise prices that exceed the average market price of the Company’s common shares during the periods presented.  Inclusion of these stock options would be anti-dilutive to the diluted earnings per common share calculation.

 

Note 9. Other Comprehensive Income

 

The following tables summarize the reclassifications out of accumulated other comprehensive income (loss):

 

 

 

Three Months Ended March 31, 2013

 

 

 

Amount

 

 

 

 

 

Reclassified from

 

 

 

 

 

Accumulated

 

 

 

 

 

Other

 

 

 

 

 

Comprehensive

 

Affected Line Item in the

 

(in thousands)

 

Income

 

Consolidated Statements of Operations

 

Available-for-sale securities:

 

 

 

 

 

Reclassification adjustment for net gains reclassified into net income

 

$

(842

)

Net gain on sale of securities

 

Taxes

 

286

 

Income taxes

 

Net of tax amount

 

$

(556

)

 

 

 

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Table of Contents

 

 

 

Three Months Ended March 31, 2012

 

 

 

Amount

 

 

 

 

 

Reclassified from

 

 

 

 

 

Accumulated

 

 

 

 

 

Other

 

 

 

 

 

Comprehensive

 

Affected Line Item in the

 

(in thousands)

 

Loss

 

Consolidated Statements of Operations

 

Available-for-sale securities:

 

 

 

 

 

Reclassification adjustment for net gains reclassified into net loss

 

$

(8

)

Net gain on sale of securities

 

Taxes

 

3

 

Income taxes

 

Net of tax amount

 

$

(5

)

 

 

 

The following table summarizes the changes in accumulated other comprehensive income (loss), net of tax:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Beginning balance

 

$

6,698

 

$

(3,967

)

Other comprehensive (loss) income before reclassifications

 

(1,282

)

2,421

 

Amounts reclassified from accumulated other comprehensive income (loss)

 

(556

)

(5

)

Net other comprehensive (loss) income during the period

 

(1,838

)

2,416

 

Ending balance

 

$

4,860

 

$

(1,551

)

 

Note 10.  Related Party Transactions

 

The Company and the Bank have engaged in and intend to continue to engage in banking and financial transactions in the conduct of its business with directors and executive officers of the Company and the Bank and their related parties.

 

The Bank has granted loans, letters of credit and lines of credit to directors, executive officers and their related parties.  The following table summarizes the changes in the total amounts of such outstanding loans, advances under lines of credit as well as repayments during the three months ended March 31, 2013 and 2012.

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Outstanding at beginning of the year

 

$

33,296

 

$

87,442

 

New loans and advances

 

12,188

 

9,870

 

Repayments / reductions

 

(10,853

)

$

(10,814

)

Other (1) 

 

(256

)

 

Outstanding at end of period

 

$

34,375

 

$

86,498

 

 


(1) “Other” represents loans to related parties that ceased being related parties during the period.

 

At March 31, 2013, loans to directors, executive officers and their related parties which were not performing in accordance with the terms of the loan agreements totaled $190 thousand.

 

Included in related party loans is $6.6 million outstanding under a commercial line of credit (“line”) to a company owned by a director.  The Company also sold a participation interest in this line to the same director in the amount of $5.2 million, of which $2.6 million is outstanding.  The Bank receives a 25 basis point annual servicing fee from this director on the participation balance.

 

Deposits from directors, executive officers and their related parties held by the Bank at March 31, 2013 and December 31, 2012 amounted to $57.0 million and $66.7 million, respectively.  Interest paid on the deposits amounted to $35 thousand and $81 thousand for the three months ended on March 31, 2013 and 2012, respectively.

 

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Table of Contents

 

In the course of its operations, the Company acquires goods and services from and transacts business with various companies affiliated with related parties.  The Company believes these transactions were made on the same terms as those for comparable transactions with unrelated parties.  The Company recorded payments for these services of $1.2 million and $217 thousand for the three months ended March 31, 2013 and 2012, respectively.

 

Subordinated notes held by officers and directors and/or their related parties totaled $10 million at both March 31, 2013 and December 31, 2012.  There was no interest paid to directors on these notes for the three months ended on March 31, 2013 and 2012.  Interest accrued and unpaid on the notes totaled $2.4 million at March 31, 2013.

 

Note 11.  Stock Compensation Plans

 

On August 30, 2000, the Company’s Board adopted the 2000 Employee Stock Incentive Plan (the “Stock Incentive Plan”) in which options may be granted to key officers and other employees of the Company.  The aggregate number of shares which may be issued upon exercise of the options under the plan cannot exceed 1,100,000 shares.  Options and rights granted under the Stock Incentive Plan become exercisable six months after the date the options are awarded and expire ten years after the award date.  Upon exercise, the shares are issued from the Company’s authorized but unissued stock.  The Stock Incentive Plan expired on August 30, 2010, therefore, no further grants will be made under the plan.

 

The Board also adopted on August 30, 2000, the 2000 Independent Directors Stock Option Plan (the “Directors’ Stock Plan”) for directors who are not officers or employees of the Company.  The aggregate number of shares issuable under the Directors’ Stock Plan cannot exceed 550,000 shares and are exercisable six months from the date the awards are granted and expire three years after the award date.  Upon exercise, the shares are issued from the Company’s authorized but unissued shares.  The Directors’ Stock Plan expired on August 30, 2010, therefore, no further grants will be made under the plan.

 

On November 28, 2012, the Board of Directors adopted the 2012 Employee Stock Grant Plan (the “Employee Stock Plan”) under which 16,000 shares of common stock were authorized to be granted to employees.  In December, 2012, the Company granted 15,050 shares of the Company’s common stock to employees under this plan.  There was no compensation expense related to options or stock under the Stock Incentive Plan, the Directors’ Stock Plan, and the Employee Stock Plan for the three months ended March 31, 2013 and 2012.

 

In accordance with current accounting guidance, all options are charged against income at their fair value.  Awards granted under the plans vest immediately and the entire expense of the award is recognized in the year of grant.

 

A summary of the status of the Company’s stock option plans is presented below:

 

 

 

Three Months Ended March 31,

 

 

 

2013

 

2012

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

Average

 

 

 

 

 

Exercise

 

 

 

Exercise

 

 

 

Shares

 

Price

 

Shares

 

Price

 

Outstanding at January 1.

 

129,170

 

$

14.26

 

188,193

 

$

12.62

 

Granted

 

 

 

 

 

Exercised

 

 

 

 

 

Forfeited

 

 

 

 

 

Outstanding at March 31,

 

129,170

 

$

14.26

 

188,193

 

$

12.62

 

Options exercisable at March 31,

 

129,170

 

$

14.26

 

188,193

 

$

12.62

 

Weighted average fair value of options granted during the period

 

 

 

$

 

 

 

$

 

Stock-based compensation expense

 

 

 

$

 

 

 

$

 

 

At March 31, 2013 and 2012 the exercisable options had no total intrinsic value and there was no unrecognized compensation expense.

 

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Table of Contents

 

Information pertaining to options outstanding at March 31, 2013 is as follows:

 

 

 

Options Outstanding

 

Options Excercisable

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

Average

 

Weighted

 

 

 

Weighted

 

 

 

 

 

Remaining

 

Average

 

 

 

Average

 

 

 

Number

 

Contractual

 

Exercise

 

Number

 

Exercise

 

Range of Exercise Price

 

Outstanding

 

Life

 

Price

 

Exercisable

 

Price

 

$ 10.01 - $23.13

 

129,170

 

3.2

 

$

14.26

 

129,170

 

$

14.26

 

 

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

 

This Quarterly Report should be read in conjunction with the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2012.  In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.

 

We are in the business of providing customary retail and commercial banking services to individuals and businesses.  Our core market is Northeastern Pennsylvania.

 

FORWARD-LOOKING STATEMENTS

 

The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the Securities and Exchange Commission (“SEC”) (including this report and exhibits hereto), in its reports to shareholders, and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

 

These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in the Company’s markets; the effects of, and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services; the ability of the Company to compete with other institutions for business; the composition and concentrations of the Company’s lending risk and the adequacy of the Company’s reserves to manage those risks; the valuation of the Company’s investment securities; the aqbility of the Company to pay dividends of repurchase common shares; the ability of the Company to retain key personnel; the impact of any pending or threatened litigation against the Company; the marketability of shares of the Company and fluctuations in the value of the Company’s share price; the impact of the Company’s ability to comply with its regulatory agreements and orders; the effectiveness of the Company’s system of internal controls; the ability of the Company to attract additional capital investment; the timing of the Company’s annual shareholder meeting; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); the impact of technological changes and security risks upon the Company’s information technology systems; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, and the success of the Company at managing the risks involved in the foregoing.

 

The Company cautions that the foregoing list of important factors is not all inclusive.  Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently made available by the Company on its website or otherwise.  The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company to reflect events or circumstances occurring after the date of this report.

 

Readers should carefully review the risk factors described in the Annual Report and other documents that the Company periodically files with the Securities and Exchange Commission, including its Form 10-K for the year ended December 31, 2012.

 

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Table of Contents

 

CRITICAL ACCOUNTING POLICIES

 

In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated.  Actual results could differ significantly from those estimates.

 

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations.  Management has identified the policies on the Allowance for Loan and Lease Losses (“ALLL”), securities valuation, valuation of other real estate owned (“OREO”) and income taxes to be critical as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.

 

The judgments used by management in applying the critical accounting policies discussed below may be affected by a further and prolonged deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in the Company’s investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to further impairment losses.

 

Allowance for Loan and Lease Losses

 

Management continually evaluates the credit quality of the Company’s loan portfolio, and performs a formal review of the adequacy of the ALLL on a quarterly basis.  The ALLL is established through a provision for loan losses charged to earnings and is maintained at a level management considers adequate to absorb estimated probable losses inherent in the loan portfolio as of the evaluation date. Loans, or portions of loans, determined by management to be uncollectible are charged off against the ALLL, while recoveries of amounts previously charged off are credited to the ALLL.

 

Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Various banking regulators, as an integral part of their examination of the Company, also review the ALLL.  Such regulators may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL.  Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio.

 

The ALLL consists of specific and general components.  The specific component relates to loans that are classified as impaired.  For such loans an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors.  The general reserve component of the ALLL is based on pools of unimpaired loans segregated generally by loan segment and risk rating categories of “Pass”, “Special Mention” or “Substandard and Accruing,” and historical loss factors and varied qualitative factor basis point allocations are applied based on the risk profile in each risk rating category to determine the appropriate reserve related to those loans.  Substandard loans on non-accrual status are included in impaired loans if they are above the $100 thousand loan relationship threshold and not considered TDRs.

 

See Note 4 -“Loans” of the consolidated financial statements included in Item 1 hereof for additional information about the ALLL.

 

Securities Valuation

 

Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (Level 1) or quoted prices on similar assets or models using inputs that are observable, either directly or indirectly (Level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if markets are illiquid, valuation techniques are used to determine fair value of any investments that require inputs that are both unobservable and significant to the fair value measurement (Level 3).  For Level 3 inputs, valuation techniques are based on various assumptions, including, but not limited to, cash flows, discount rates, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using Level 3 inputs.  The use of different assumptions could have a positive or negative effect on the consolidated financial condition or results of operations.  See Note 7-“Fair Value Measurements” of the consolidated financial statements included in Item 1 hereof for more information about the Company’s securities valuation techniques.

 

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Table of Contents

 

On a quarterly basis, management evaluates individual investment securities classified as held-to-maturity or available-for-sale having unrealized losses to determine whether or not the security is other-than-temporarily-impaired (“OTTI”). The analysis of OTTI requires the use of various assumptions, including but not limited to, the length of time an investment’s fair value is less than book value, the severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether it is more-likely-than-not that the Company will be required to sell the security prior to recovery of its amortized cost basis. Debt investment securities deemed to be OTTI are written down by the impairment related to the estimated credit loss and the non-credit related impairment loss is recognized in other comprehensive income. The Company did not recognize OTTI charges on investment securities for the three months ended March 31, 2013 and 2012 within the consolidated statements of operations.

 

Other Real Estate Owned

 

Other real estate owned (“OREO”) consists of property acquired by foreclosure, abandonment or conveyance of deed in-lieu of foreclosure. OREO is held for sale and is initially recorded at fair value less cost to sell at the date of acquisition, which establishes a new cost basis. Upon acquisition of the property, any write-down to fair value less estimated selling costs is charged to the ALLL. This determination is made on an individual asset basis.  Subsequent to acquisition, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Fair value is determined through external appraisals, current letters of intent, broker price opinions or executed agreements of sale. Costs relating to the development and improvement of the OREO properties may be capitalized; holding period costs and subsequent changes to the valuation allowance are charged to expense as incurred.

 

Income Taxes

 

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.

 

The Company records an income tax provision or benefit based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities.  Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes.  Management conducts quarterly assessments of all available evidence to determine the amount of deferred tax assets that will more-likely-than-not be realized.  The available evidence used in connection with these assessments includes taxable income in current and prior periods, cumulative losses in prior periods, projected future taxable income, potential tax-planning strategies, and projected future reversals of deferred tax items. Management’s assumptions and estimates take into consideration its interpretation of tax laws and possible outcomes of current and future audits conducted by tax authorities.  These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.

 

In connection with determining the income tax provision or benefit, the Company considers maintaining liabilities for uncertain tax positions and tax strategies that management believes contain an element of uncertainty. Periodically, the Company evaluates each of its tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As of March 31, 2013 and December 31, 2012, the Company did not have any uncertain tax positions or tax strategies and no liability was required to be recorded.

 

New Authoritative Accounting Guidance

 

Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210) - “Disclosures about Offsetting Assets and Liabilities” provides enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Accounting Standards Codification Topic (“ASC”) 210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. The Company adopted ASU No. 2011-11 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2012-02 Intangibles-Goodwill and Other (Topic 350): “Testing Indefinite-Lived Intangible Assets for Impairment” simplifies the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU No. 2012-02 allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the

 

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quantitative impairment test.  An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. The Company adopted ASU 2012-01 on January 1, 2013. The adoption of this new guidance did have not an effect on the operating results or financial position of the Company.

 

ASU No. 2013-01 Balance Sheet (Topic 210): “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” clarifies the scope of transactions that are subject to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11. This update applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-01 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2013-02 Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” improves the transparency of reporting these reclassifications. The new amendments will require an organization to: present either on the face of the statement where income is presented or in the notes to the financial statements the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income; or cross reference to other disclosures currently required under GAAP for other reclassification items to be reclassified directly to income in their entirety in the same reporting period. The amendments apply to all public and private companies that report other comprehensive income. The Company adopted ASU 2013-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

Executive Summary

 

The following overview should be read in conjunction with our MD&A in its entirety.

 

The Company recorded net income of $1.7 million, or $0.11 per diluted common share, for the three months ended March 31, 2013, compared to a net loss of $1.2 million, or $(0.07) per diluted common share for the same three months of 2012. The $2.9 million improvement in earnings was due primarily to a $1.6 million decrease in non-interest expense, a $1.1 million increase in a credit for loan and lease loss expense (primarily due to a recovery of $1.5 million on a commercial loan that was previously charged off), and a $1.0 million increase in non-interest income (primarily due to gains on the sale of securities of $842 thousand). Partially offsetting these factors was an $800 thousand reduction in net interest income.  Return on average assets and return on average equity were 0.18% and 4.69% for the three months ended March 31, 2013, compared to (0.11)% and (2.79)% for three months ended March 31, 2012.  The Company did not pay any dividends during the three months ended March 31, 2013 and 2012.

 

Total assets decreased $38.7 million, or 4.0%, to $929.5 million, at March 31, 2013 from $968.3 million at December 31, 2012. The balance sheet reduction reflected an $82.9 million decrease in cash and cash equivalents, which was due primarily to increases in loans and investment securities, coupled with a decrease in total deposits and a reduction in borrowed funds. Loans, net of deferred loan origination fees and costs, unearned income and the allowance for loan and lease losses, grew $18.3 million, or 3.2%, while available-for-sale investment securities increased $31.5 million, or 17.0%.

 

Total deposits decreased $30.9 million, or 3.6%, to $823.7 million at March 31, 2013 as compared to $854.6 million at December 31, 2012.  During the same period, non-interest-bearing demand deposits decreased $10.3 million, or 7.8%, and interest-bearing deposits decreased $20.6 million, or 2.9%.  The Company repaid $6.2 million in borrowed funds, specifically FHLB advances.

Total shareholders’ equity decreased $0.1 million, from December 31, 2012, as net income of $1.7 million was more than entirely offset by a decrease in accumulated other comprehensive income of $1.8 million.

 

Summary of Performance

 

Net Interest Income

 

Net interest income is the difference between interest revenue, interest and fees on interest-earning assets on the one hand, and interest expense, interest paid to the Company’s depositors and interest paid on external borrowings on the other hand. Net interest income represents the largest component of the Company’s operating income and, as such, is the primary determinant of profitability. Net interest income is impacted by variations in the volume, rate and composition of earning assets and interest-bearing liabilities, changes in general market rates and the level of non-performing assets. The tax-equivalent net interest margin is calculated by dividing tax-equivalent net interest income by average interest-earning assets and is a key measurement used in the banking industry to measure income from earning assets. The Company’s tax-equivalent net interest margin for the three months ended March 31, improved 7 basis points to 3.27% in 2013 from 3.20% in 2012.  Rate spread, the difference between the average yield on interest-earning assets

 

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and the average cost of interest-bearing liabilities shown on a fully tax-equivalent basis, was 3.15% for the three months ended March 31, 2013, an increase of 6 basis points compared to 3.09% for the same period of 2012.

 

Net interest income on a tax equivalent basis was $7.0 million for the first quarter of 2013, a $900 thousand, or 10.8%, decrease from $7.9 million for the first quarter of 2012.  The decrease was primarily due to lower yields on earning assets, coupled with a reduction in average earning assets, which was partially offset by a decrease in average interest-bearing liabilities.

 

Interest income on a tax equivalent basis decreased $1.6 million for the three month period ended March 31, 2013 compared to the same period in 2012. Average earning assets decreased $124.1 million to $861.4 million for the first quarter of 2013, from $985.5 million for the same quarter of 2012, which resulted in a $907 thousand decrease in tax-equivalent interest income due to volume. Accounting for the majority of the decrease was a $75.4 million reduction in average loans. Lower earning asset yields also negatively affected interest income. The tax-equivalent yield on earning assets fell 12 basis points to 4.13% for the three months ended March 31, 2013 from 4.25% for the same three months of 2012, which negatively impacted interest income by $662 thousand. The Company experienced lower yields on both the loan and investment security portfolios. Loan yields were affected by the continued low interest rate environment and increased competition in our market area. With regard to the securities portfolio, sales of higher-risk securities at the end of 2012 were reinvested into lower-risk instruments having lower yields.

 

Average interest-bearing deposits in other banks and federal funds sold decreased by $47.6 million during the quarter ended March 31, 2013 as compared to the same quarter in 2012.  The decrease in the average balance of interest-bearing deposits in other banks and federal funds sold was attributable primarily to a reduction in total deposits.

 

Interest expense for the three months ended March 31, 2013 decreased $716 thousand to $1.9 million from $2.6 million for the same three months of 2012. The reduction in interest expense largely reflected a $128.3 million, or 14.5% , decrease in average interest-bearing liabilities. Average interest-bearing liabilities totaled $758.8 million for the quarter ended March 31, 2013 compared to $887.1 million for the same period in 2012, which resulted in a $757 thousand decrease in interest expense due to volume. Total deposits averaged $95.7 million lower, while average borrowings decreased $32.6 million.  The decrease in average total deposits was due primarily to an $86.6 million, or 21.6%, decrease in total time deposits. The Company did not aggressively compete for time deposits. Longer-term time deposits that matured were repositioned into short-term products, whenever possible. The cost of interest-bearing deposits decreased 13 basis points to 0.63% for the three months ended March 31, 2013 from 0.76% for the same period of 2012. The decrease in the rate on interest-bearing deposits was driven primarily by the pricing decreases that resulted from the Company’s pricing strategy and an overall decrease in market rates.  The cost of borrowed funds increased by 90 basis points to 5.98% for the quarter ended March 31, 2013 as compared 5.08% for the same period in 2012, which resulted from the repayment of maturing FHLB advances that were at lower rates and higher-rate borrowings becoming a larger percentage of total borrowings.

 

Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.  The following table sets forth certain information relating to our consolidated statements of financial condition and consolidated statements of operations for the three month periods ended March 31, 2013 and 2012, and reflects the average yield on assets and average cost of liabilities for the periods indicated.  Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown.  Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields.

 

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Table of Contents

 

 

 

Three months ended March 31,

 

Three months ended March 31,

 

 

 

2013

 

2012

 

 

 

Average

 

 

 

Yield/

 

Average

 

 

 

Yield/

 

(dollars in thousands)

 

Balance

 

Interest

 

Cost

 

Balance

 

Interest

 

Cost

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets (2)(3)

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans-taxable (4)

 

$

573,833

 

$

6,277

 

4.38

%

$

649,062

 

$

7,381

 

4.55

%

Loans-tax free (4)

 

35,169

 

500

 

5.69

%

35,328

 

618

 

7.00

%

Total loans (1)(2)

 

609,002

 

6,777

 

4.45

%

684,390

 

7,999

 

4.68

%

Securities-taxable

 

116,187

 

574

 

1.98

%

118,614

 

919

 

3.10

%

Securities-tax free

 

81,727

 

1,500

 

7.34

%

80,356

 

1,485

 

7.39

%

Total securities (1)(5)

 

197,914

 

2,074

 

4.19

%

198,970

 

2,404

 

4.83

%

Interest-bearing deposits in other banks and federal funds sold

 

54,466

 

39

 

0.29

%

102,114

 

56

 

0.22

%

Total earning assets

 

861,382

 

8,890

 

4.13

%

985,474

 

10,459

 

4.25

%

Non-earning assets

 

100,955

 

 

 

 

 

103,273

 

 

 

 

 

Allowance for loan and lease losses

 

(19,177

)

 

 

 

 

(21,077

)

 

 

 

 

Total assets

 

$

943,160

 

 

 

 

 

$

1,067,670

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

311,587

 

159

 

0.20

%

316,234

 

183

 

0.23

%

Savings deposits

 

84,200

 

26

 

0.12

%

88,696

 

46

 

0.21

%

Time deposits over $100,000

 

144,633

 

317

 

0.88

%

189,065

 

415

 

0.88

%

Other time deposits

 

168,943

 

616

 

1.46

%

211,089

 

888

 

1.68

%

Total interest-bearing deposits

 

709,363

 

1,118

 

0.63

%

805,084

 

1,532

 

0.76

%

Borrowed funds and other interest-bearing liabilities

 

49,429

 

739

 

5.98

%

82,008

 

1,041

 

5.08

%

Total interest-bearing liabilities

 

758,792

 

1,857

 

0.98

%

887,092

 

2,573

 

1.16

%

Demand deposits

 

125,394

 

 

 

 

 

120,944

 

 

 

 

 

Other liabilities

 

22,102

 

 

 

 

 

17,885

 

 

 

 

 

Shareholders’ equity

 

36,872

 

 

 

 

 

41,749

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

943,160

 

 

 

 

 

$

1,067,670

 

 

 

 

 

Net Interest Income/Interest Rate Spread (6)

 

 

 

7,033

 

3.15

%

 

 

7,886

 

3.09

%

Tax equivalent adjustment

 

 

 

(680

)

 

 

 

 

(715

)

 

 

Net interest income as reported

 

 

 

$

6,353

 

 

 

 

 

$

7,171

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Margin (7) 

 

 

 

 

 

3.27

%

 

 

 

 

3.20

%

 


(1)         Interest income is presented on a tax equivalent basis using a 34% rate.

(2)         Loans are stated net of unearned income.

(3)         Non-accrual loans are included in loans within earning assets.

(4)         Loan fees included in interest income are not significant.

(5)         The yields for securities that are classified as available-for-sale are based on the average historical amortized cost.

(6)         Interest rate spread represents the difference between the average yield on interest-earning assets and the cost of interest-bearing liabilities and is presented on a tax-equivalent basis.

(7)         Net interest income as a percentage of total average interest earning assets.

 

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Table of Contents

 

The following table shows the effect of changes in volume and interest rates on net interest income.  The variance in interest income or expense due to the combination of rate and volume has been allocated proportionately.

 

 

 

March 31,

 

 

 

2013 vs. 2012

 

 

 

Increase (Decrease)

 

 

 

 

 

Due to

 

 

 

 

 

Due to

 

Change in

 

Total

 

(in thousands)

 

Volume

 

Rate

 

Change

 

Interest Income:

 

 

 

 

 

 

 

Loans - taxable

 

$

(831

)

$

(273

)

$

(1,104

)

Loans - tax free

 

(3

)

(115

)

(118

)

Total loans

 

(834

)

(388

)

(1,222

)

Securities - taxable

 

(18

)

(327

)

(345

)

Securities - tax free

 

25

 

(10

)

15

 

Total securities

 

7

 

(337

)

(330

)

Interest-bearing deposits in other banks and federal funds sold

 

(31

)

14

 

(17

)

Total interest income

 

(858

)

(711

)

(1,569

)

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

(3

)

(21

)

(24

)

Savings deposits

 

(2

)

(18

)

(20

)

Time deposits over $100,000

 

(97

)

(1

)

(98

)

Other time deposits

 

(163

)

(109

)

(272

)

Total interest-bearing deposits

 

(265

)

(149

)

(414

)

Borrowed funds and other interest-bearing liabilities

 

(464

)

162

 

(302

)

Total interest expense

 

(729

)

13

 

(716

)

Net interest income

 

$

(129

)

$

(724

)

$

(853

)

 

Provision for Loan and Lease Losses

 

Management closely monitors the loan portfolio and the adequacy of the ALLL considering underlying borrower financial performance and collateral values and associated credit risks.  Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management used in making its evaluation of the ALLL. The provision for loan and lease losses is an expense charged against net interest income to provide for estimated losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL.

 

The Company recorded a credit for loan and lease losses of $1.2 million for the three month period ended March 31, 2013, compared to a credit of $136 thousand for the three months ended March 31, 2012.  The credit was directly attributable to a recovery of $1.5 million on a commercial loan that was previously charged-off.

 

Non-interest Income

 

For the three months ended March 31, 2013, non-interest income totaled $2.5 million, an increase of $1.0 million, from $1.5 million for the three months ended March 31, 2012. The 66.7% improvement resulted primarily from an increase in net gains from the sale of securities during the quarter. Net gains on the sale of securities amounted to $842 thousand for the first quarter of 2013, compared to $8 thousand for the same quarter of 2012. Also favorably affecting non-interest income was an increase of $392 thousand in other income, which resulted primarily from the settlement of an insurance claim. Partially offsetting these increases was a $133 thousand decrease in the gains on sale of residential mortgage loans held for sale.

 

Non-interest Expense

 

Non-interest expense totaled $8.3 million for the three month period ended March 31, 2013, compared to $9.9 million for the same period in 2012.  The $1.6 million, or 16.2%, decrease was due primarily to reductions in professional fees and salaries and employee benefits. Professional fees declined $967 thousand, or 63.7%, as the Company continued to reduce its reliance on outside consultants.

 

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Salaries and employee benefits decreased $318 thousand, or 8.7%, as a result of a reduction in force and voluntary separation program that was implemented in the fourth quarter of 2012.

 

In addition to the decrease in professional fees, legal fees for the three months ended March 31, 2013 declined $109 thousand compared to the same three months of 2012. Legal and professional fees are expected to continue to decline to more normalized levels for the remainder of 2013, reflecting reduced activity related to outstanding litigation, as well as less reliance on outside advisors and consultants.

 

Provision for Income Taxes

 

The Company did not record a provision or benefit for income taxes for the quarters ended March 31, 2013 and 2012.  In future periods, the Company anticipates that it will have a minimal tax provision or benefit until such time as it is able to reverse the deferred tax asset valuation allowance that it recorded in 2009.

 

FINANCIAL CONDITION

 

Assets

 

Total assets were $929.5 million at March 31, 2013, a decrease of $38.8 million, or 4.0%, from $968.3 million at December 31, 2012.

 

Cash and Cash Equivalents

 

Cash and cash equivalents decreased $82.9 million, or 71.9% during the three months ended March 31, 2013 to $32.3 million.  The decrease resulted primarily from a $30.9 million decrease in total deposits, coupled with increases in cash used for loans and purchases of loans and securities of $18.3 million and $31.5 million, respectively. The Company did not pay any dividends during the quarter ended March 31, 2013 as it suspended paying dividends to conserve capital and comply with regulatory requirements.

 

Securities

 

The Company’s investment securities portfolio provides a source of liquidity needed to meet expected loan demand and provides a source of interest income to increase our profitability. Additionally, the Company utilizes the investment securities portfolio to meet pledging requirements. Investment securities are classified as held-to-maturity and carried at amortized cost when the Company has the positive intent and ability to hold them to maturity.  Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with unrealized holding gains and losses reported as a component of shareholders’ equity in accumulated comprehensive income, net of tax.  The Company determines the appropriate classification of investment securities at the time of purchase. The decision to purchase or sell investment securities is based upon the current assessment of long- and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components. Investment securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost. Federal Reserve Bank stock is included in other assets.

 

At March 31, 2013, the Company’s investment portfolio was comprised principally of taxable and tax-exempt obligations of state and political subdivisions and obligations of U.S. government-sponsored agencies, including residential mortgage-backed securities and collateralized mortgage obligations (“CMOs”). There were two security issuers, St. Clair County, IL School District and the Commonwealth of Massachusetts, whose aggregate carrying values exceeded 10.0% of Shareholders’ equity as of March 31, 2013. The aggregate carrying values of the securities of these issuers were $4.2 million and $4.1 million, respectively.

 

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The following table sets forth the carrying value of available-for-sale securities, which are carried at fair value, and held-to-maturity securities, which are carried at amortized cost, at the dates indicated:

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Available-for-sale

 

 

 

 

 

Obligations of U.S. government agencies

 

$

1,870

 

$

1,891

 

Obligation of state and political subdivisions

 

102,709

 

103,501

 

Collateralized mortgage obligations

 

 

 

 

 

Government-sponsored agency

 

16,408

 

9,103

 

Residential mortgage-backed securities

 

 

 

 

 

Government-sponsored agency

 

94,453

 

69,456

 

Corporate debt securities

 

415

 

410

 

Equity securities

 

994

 

1,000

 

Total securities available-for-sale

 

$

216,849

 

$

185,361

 

 

 

 

 

 

 

Held-to-maturity

 

 

 

 

 

Obligations of state and political subdivisions

 

$

2,225

 

$

2,198

 

 

The Company sold three of its holdings of residential mortgage pools that were guaranteed by the Government National Mortgage Association with an aggregate carrying value of $16.3 million during the three months ended March 31, 2013. Net gains of $842 thousand were realized upon the sale and are included in non-interest income.

 

During the three months ended March 31, 2013, the Company purchased securities totaling $53.9 million. Specifically, purchases included $8.9 million CMOs and $45.1 million of residential mortgage-backed securities of government-sponsored agencies.

 

The following table sets forth the maturities of available-for-sale and held-to-maturity securities, based on book value, at March 31, 2013 and the weighted average yields of such securities calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security.

 

 

 

March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

Mortgage-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Backed

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collateralized

 

 

 

 

 

 

 

Within

 

> 1 – 5

 

6 - 10

 

Over

 

Mortgage

 

No Fixed

 

 

 

(dollars in thousands)

 

One Year

 

Years

 

Years

 

10 Years

 

Obligations

 

Maturity

 

Total

 

Available-for-sale securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Obligations of U.S. government agencies

 

$

 

$

 

$

1,870

 

$

 

$

 

$

 

$

1,870

 

Yield

 

 

 

 

 

4.22

%

 

 

 

 

 

 

4.22

%

Obligations of state and political subdivisions (1)

 

 

984

 

31,873

 

69,852

 

 

 

102,709

 

Yield

 

 

 

6.33

%

5.09

%

7.37

%

 

 

 

 

6.65

%

Corporate debt securities

 

 

 

 

415

 

 

 

415

 

Yield

 

 

 

 

 

 

 

0.96

%

 

 

 

 

0.96

%

CMOs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Government sponsored agencies

 

 

 

 

 

16,408

 

 

16,408

 

Yield

 

 

 

 

 

 

 

 

 

2.38

%

 

 

2.38

%

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Government sponsored agencies

 

 

 

 

 

94,453

 

 

94,453

 

Yield

 

 

 

 

 

 

 

 

 

1.90

%

 

 

1.90

%

Equity securities

 

 

 

 

 

 

994

 

994

 

Yield

 

 

 

 

 

 

 

 

 

 

 

3.39

%

3.39

%

Total available-for-sale maturities

 

$

 

$

984

 

$

33,743

 

$

70,267

 

$

110,861

 

$

994

 

$

216,849

 

Weighted yield

 

0.00

%

6.33

%

5.04

%

7.33

%

1.97

%

3.39

%

4.21

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Held-to-maturity securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Obligations of state and political subdivisions

 

$

 

$

 

$

2,225

 

$

 

$

 

$

 

$

2,225

 

Yield

 

 

 

7.40

%

 

 

 

7.40

%

Total held-to-maturity securities

 

$

 

$

 

$

2,225

 

$

 

$

 

$

 

$

2,225

 

Weighted yield

 

0.00

%

0.00

%

7.40

%

0.00

%

0.00

%

0.00

%

7.40

%

 


(1) Yields on tax-exempt state and municipal securities, inlcuded in this category, are presented on a tax-equivalent basis using a 34% federal income tax rate.

 

The majority of the Company’s securities portfolio is comprised of obligations of states and political subdivisions, residential mortgage-backed securities, including home equity conversion mortgages, and collateralized mortgage obligations. The Company held 71 securities that were in an unrealized loss position at March 31, 2013. Substantially all of the unrealized losses relate to debt securities.

 

To determine whether a security’s impairment is other-than-temporary, management considers factors that include:

 

·                  the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility;

 

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·                  the severity and duration of the decline;

·                  the Company’s ability and intent to hold investments until they recover in value, as well as the likelihood of such a recovery in the near term;

·                  the Company’s intent to sell security investments, or if it is more likely than not that the Company will be required to sell such securities before recovery of their individual amortized cost basis less any current-period credit loss.

 

For debt securities which the Company does not intend to sell or does not expect it will be required to sell, the primary consideration in determining whether impairment is other-than-temporary is whether or not the Company expects to receive all contractual cash flows.

 

Based on its evaluation at March 31, 2013, management has determined that the decreases in estimated fair value of the securities it holds in its portfolio are temporary.  See Note 6 — “Securities” of the consolidated financial statements included in Item 1 hereof for more information about this evaluation.

 

Investments in FHLB and FRB stock, which have limited marketability, are carried at cost of $6.4 million and $7.3 million at March 31, 2013 and December 31, 2012, respectively.  FRB stock of $1.3 million is included in Other Assets at March 31, 2013 and December 31, 2012.  Management noted no indicators of impairment for the FHLB of Pittsburgh and FRB of Philadelphia at March 31, 2013.

 

Loans

 

The Company experienced an increase in loan demand during the 2013 first quarter. Net loans increased $18.3 million, or 3.2%, to $597.7 million at March 31, 2013 from $579.4 million as of December 31, 2012.  Net loans represented 64.3% of total assets at March 31, 2013, compared to 59.8% at December 31, 2012.  Historically, commercial lending activities have represented a significant portion of the Company’s loan activities.  This includes commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans.  Furthermore, from a collateral standpoint, a majority of the Company’s loan portfolio consisted of loans secured by real estate.  Real estate secured loans, which include commercial real estate, construction, land acquisition and development, residential real estate and home equity loans, increased by $12.6 million, or 3.2% to $400.8 million at March 31, 2013, from $388.2 million at December 31, 2012.  The increase was concentrated in residential and commercial mortgages, partially offset by a decrease in construction, land acquisition and development loans. Real estate secured loans as a percentage of total gross loans have increased from 59.3% at December 31, 2012 to 65.1% of the loan portfolio at March 31, 2013.

 

Loans secured by commercial real estate increased $16.6 million, or 7.2%, from $231.8 million at December 31, 2012 to $248.4 million at March 31, 2013.  Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages.  The increase in commercial real estate loans was attributable to new loan originations and commercial construction, land acquisition and development loans converting to commercial mortgages upon completion of construction.  Accordingly, construction, land acquisition and development loans decreased $10.2 million, or 31.4%, during the quarter from $32.5 million at December 31, 2012 to $22.3 million at March 31, 2013.

 

Residential real estate loans totaled $98.3 million at March 31, 2013, an increase of $8.1 million, or 8.9%, from $90.2 million at December 31, 2012.  The components of residential real estate loans include fixed and variable rate mortgage loans.  Home equity lines of credit (“HELOCs”) are not included in this category but are included in consumer loans. The Company primarily underwrites fixed-rate purchase and refinance of residential mortgage loans for sale in the secondary market to reduce interest rate risk and provide funding for additional loans. However, starting in the third quarter of 2012, the Company began holding 15- and 20-year mortgages in the loan portfolio rather than selling these loans in order to provide additional interest income based on underlying yields.

 

Commercial and industrial loans increased $2.1 million, or 1.9%, during the quarter from $110.1 million at December 31, 2012 to $112.2 at March 31, 2013.  Commercial and industrial loans consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities.

 

Consumer loans decreased $0.4 million during the quarter from $109.8 million at December 31, 2012 to $109.4 million at March 31, 2012.  The decrease was attributable to loan pay downs exceeding new loan originations.

 

Loans to states and political subdivisions totaled $25.3 million at March 31, 2013, an increase of $1.9 million, or 8.1%, from $23.4 million at December 31, 2012.  The increase was attributable to new loan originations.

 

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Details regarding the loan portfolio are as follows:

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Residential real estate

 

$

98,273

 

$

90,228

 

Commercial real estate

 

248,455

 

231,835

 

Construction, land acquisition and development

 

22,363

 

32,502

 

Commercial and industrial

 

112,176

 

110,073

 

Consumer

 

109,378

 

109,783

 

State and political subdivisions

 

25,278

 

23,354

 

Total loans, gross

 

615,923

 

$

597,775

 

Unearned discount

 

(89

)

(103

)

Net deferred loan fees and costs

 

321

 

260

 

Allowance for loan and lease losses

 

(18,473

)

(18,536

)

Loans, net

 

$

597,682

 

$

579,396

 

 

At March 31, 2013 and December 31, 2012, the Company’s loan portfolio was concentrated in the following industries:

 

 

 

March 31, 2013

 

December 31, 2012

 

(in thousands)

 

Amount

 

% of Gross
Loans

 

Amount

 

% of Gross
Loans

 

Shopping centers/complexes

 

$

20,845

 

3.38

%

$

21,068

 

3.52

%

Land subdivision

 

17,400

 

2.83

%

17,658

 

2.95

%

Hotels

 

13,438

 

2.18

%

13,596

 

2.27

%

Solid waste landfills

 

13,034

 

2.12

%

13,233

 

2.21

%

Office complexes/units

 

10,244

 

1.66

%

9,801

 

1.64

%

Automobile dealers

 

9,626

 

1.56

%

10,607

 

1.77

%

Supermarkets

 

8,511

 

1.38

%

6,348

 

1.06

%

 

Asset Quality

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan losses charged to earnings.

 

The Company manages credit risk through the efforts of loan officers, the loan review function, and the Loan Quality and the ALLL management committees, as well as oversight from the Board of Directors, along with the application of policies and procedures designed to foster sound underwriting and credit monitoring practices.  The Company continually evaluates this process to ensure it is reacting to problems in the loan portfolio in a timely manner, although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond the Company’s control.

 

Under the Company’s risk rating system, loans rated pass/watch, special mention, substandard, doubtful, or loss are reviewed regularly as part of the Company’s risk management practices. The Company’s Loan Quality Committee, which consists of key members of senior management and credit administration, meets monthly or more often as necessary to review individual problem credits and workout strategies and reports to the Board of Directors.

 

A loan is considered impaired when it is probable that the Bank will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement.  For purposes of the Company’s analysis, loans that are identified as troubled debt restructurings (“TDRs”), loans rated substandard and non-accrual, and loans that are identified as doubtful or loss are considered impaired.  Impaired loans are analyzed individually to quantify the impairment.  The Company utilizes the fair value of collateral method for collateral dependent loans. A loan is considered to be collateral dependent when repayment of the loan is expected to be provided through the liquidation of the collateral held.  For impaired loans that are secured by real estate, external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be

 

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updated.  Should a current appraisal not be available at the time of impairment analysis, other sources of valuation such as current letters of intent, broker price opinions or executed agreements of sale may be used.  For non-collateral dependent loans, the Company measures impairment based on the present value of expected future cash flows, net of disposal costs, discounted at the loan’s original effective interest rate.

 

Loans to borrowers that are experiencing financial difficulty that are modified and result in the Company granting concessions to the borrower are classified as TDRs and are considered to be impaired.  Concessions granted under a troubled debt restructuring generally involve an extension of a loan’s stated maturity date, a reduction of the stated interest rate, payment modifications, or a combination of these modifications.  Non-accrual TDRs are returned to accrual status if principal and interest payments, under the modified terms, are brought current, are performing under the modified terms for six consecutive months, and management believes that collection of the remaining interest and principal is probable.

 

Non-performing loans are monitored on an ongoing basis as part of the Company’s loan review process.  Additionally, work-out efforts continue and are actively monitored for non-performing loans and OREO through the Loan Quality Committee.   Potential loss on non-performing assets is generally evaluated by comparing the outstanding loan balance to the fair market value of the pledged collateral.

 

Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This generally occurs when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. The Company determines delinquency status based on the number of days since the date of the borrower’s last required contractual loan payment.  When the interest accrual is discontinued, all unpaid interest income is reversed and charged back against current earnings.  Any cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts.  Any excess is treated as a recovery of lost interest.  A non-accrual loan is returned to accrual status when the loan is current as to principal and interest payments, is performing according to contractual terms for six consecutive months and future payments are reasonably assured.

 

Management actively manages impaired loans in an effort to reduce loan balances by working with customers to develop strategies to resolve borrower difficulties, through sale or liquidation of collateral, foreclosure, and other appropriate means.  Real estate values appear to have stabilized. However, further real estate devaluations or weakening in economic conditions in our market area could negatively impact asset quality, causing an increase in the provision for loan and lease losses.

 

Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell.  For the Company’s calculations on real estate secured loans, a factor of 10% is generally utilized to estimate costs to sell, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process.  If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, either the entire loan is written off or the difference between the fair value and the principal balance is charged off.  For impaired loans for which the value of the collateral less costs to sell exceeds the loan value, the impairment is considered to be zero.

 

The following table reflects non-performing loans (including non-performing TDRs) OREO and performing TDRs at March 31, 2013 and December 31, 2012:

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Non-accrual loans

 

$

8,832

 

$

9,652

 

Loans past due 90 days or more and still accruing

 

 

57

 

Total Non-Performing Loans

 

8,832

 

9,709

 

Other Real Estate Owned

 

3,910

 

3,983

 

Total Non-Performing Loans and OREO

 

$

12,742

 

$

13,692

 

 

 

 

 

 

 

Performing TDRs

 

$

6,817

 

$

7,517

 

 

 

 

 

 

 

Non-performing loans as a percentage of gross loans

 

1.43

%

1.62

%

 

Management continued to manage problem credits through heightened work-out efforts on non-performing loans and disposing of its holdings of foreclosed properties. The Company’s asset quality continued to improve during the first quarter of 2013. Total non-

 

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performing loans and OREO decreased $950 thousand, or 6.9%, to $12.7 million at March 31, 2013 from $13.7 million at December 31, 2012.  The Company’s ratio of non-performing loans to total gross loans improved to 1.43% at March 31, 2013 from 1.62% at December 31, 2012.  Despite the improvement, the percentage remains elevated and further deterioration in economic conditions could lead to additional increases in impaired loans.

 

The average balance of impaired loans was $16.4 million and $23.2 million for the three months ended March 31, 2013 and 2012, respectively.  The Company recorded $104 thousand and $85 thousand of interest income on impaired loans for the three months ended March 31, 2013 and 2012, respectively.

 

Changes in non-performing loans for the period indicated is as follows:

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Balance at January 1,

 

$

9,709

 

$

19,913

 

Newly placed on non-accrual

 

624

 

941

 

Loans past due 90 days or more and still accruing

 

(57

)

142

 

Transferred to OREO

 

 

(239

)

Returned to performing status

 

(73

)

 

Additional charge-offs

 

(546

)

(188

)

Loan payments

 

(825

)

(1,487

)

Balance at March 31,

 

$

8,832

 

$

19,082

 

 

The additional interest income that would have been earned on non-accrual and restructured loans for the quarter ended on March 31, 2013 and 2012 in accordance with their original terms approximated $200 thousand and $405 thousand, respectively.

 

The following table outlines delinquency within the Company’s loan portfolio.

 

 

 

March 31,
2013

 

December 31,
2012

 

Accruing: 30-59 days

 

0.42

%

0.44

%

60-89 days

 

0.09

%

0.06

%

90 + days

 

0.00

%

0.01

%

Non-Accrual

 

1.43

%

1.62

%

Total Delinquencies

 

1.94

%

2.13

%

 

The decrease in total delinquencies as a percentage of gross loans at March 31, 2013 was primarily due to the more rigorous collections of non-performing loans.   In its evaluation for the ALLL, management considers a variety of qualitative factors including changes in the volume and severity of delinquencies.

 

Allowance for Loan and Lease Losses

 

The ALLL represents management’s estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and is maintained at a level that is based on management’s evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.

 

In its evaluation, management considers qualitative and environmental factors, including, but not limited to:

 

·                  Changes in national, local, and business economic conditions and developments, including the condition of various market segments;

·                  Changes in the nature and volume of the Company’s loan portfolio;

·                  Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results;

·                  Changes in the experience, ability and depth of the Company’s management and staff;

·                  Changes in the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors;

 

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·                  Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications;

·                  The existence and effect of any concentrations of credit and changes in the level of such concentrations;

·                  The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s current loan portfolio; and

·                  Analysis of its customers’ credit quality, including knowledge of their operating environment and financial condition.

 

Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur.  Management monitors the loan portfolio on an ongoing basis with emphasis on weakness in both the real estate market and the economy in general and its effect on repayment.  Adjustments to the ALLL are made based on management’s assessment of the factors noted above.

 

For purposes of its analysis, all loan relationships with an aggregate balance greater than $100 thousand that are rated substandard and non-accrual, identified as doubtful or loss, and all TDRs are considered impaired and are analyzed individually to determine the amount of impairment.  Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired.  The Company utilizes the fair value of collateral method for collateral-dependent loans and TDRs for which repayment depends on the sale of collateral. For non-collateral dependent loans and TDRs, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. With regard to collateral-dependent loans, appraisals are received at least annually to ensure that impairment measurements reflect current market conditions.  Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used.  Only downward adjustments are made based on these supporting values.  Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process.  Sales costs are periodically revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed.

 

The Company’s ALLL consists of both specific and general components.  At March 31, 2013, the ALLL that related to impaired loans that are individually evaluated for impairment, the guidance for which is provided by ASC 310 “Impairment of a Loan” (“ASC 310”), was $518 thousand, or 2.8%, of the total ALLL.  A general allocation of $17.9 million was calculated for loans analyzed collectively under ASC 450 “Contingencies” (“ASC 450”), which represented 97.2% of the total ALLL of $18.5 million.  The ratio of the ALLL to total loans at March 31, 2013 and December 31, 2012 was 3.00% and 3.10%, respectively, based on total loans of $615.9 million and $597.8 million, respectively.  The decrease in the ratio of the ALLL to total loans primarily reflects and improvement in asset quality.  See “Asset Quality” for further information.

 

The following table presents an allocation of the ALLL and percent of loans in each category at March 31, 2013 and December 31, 2012:

 

Allocation of the Allowance for Loan Losses

 

 

 

March 31, 2013

 

December 31, 2012

 

(in thousands)

 

Amount

 

Percentage
of Loans in
Each
Category to
Total Loans

 

Amount

 

Percentage
of Loans in
Each
Category to
Total Loans

 

Residential real estate

 

$

1,884

 

15.96

%

$

1,764

 

15.09

%

Commercial real estate

 

8,882

 

40.34

%

8,062

 

38.78

%

Construction, land acquisition and development

 

1,676

 

3.63

%

2,162

 

5.44

%

Commercial and industrial

 

3,605

 

18.21

%

4,167

 

18.41

%

Consumer

 

1,739

 

17.76

%

1,708

 

18.37

%

State and political subdivision

 

687

 

4.10

%

673

 

3.91

%

Total

 

$

18,473

 

100.00

%

$

18,536

 

100.00

%

 

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Table of Contents

 

The following table presents an analysis of ALLL for the three months ended March 31, 2013 and 2012.

 

 

 

For the three months ended March 31,

 

(in thousands)

 

2013

 

2012

 

Balance at beginning of period

 

18,536

 

$

20,834

 

 

 

 

 

 

 

Credit for loan losses

 

(1,224

)

(136

)

 

 

 

 

 

 

Charge-offs:

 

 

 

 

 

Residential real estate

 

(159

)

(312

)

Commercial real estate

 

(48

)

(154

)

Construction land acquisition and development

 

(110

)

 

Commercial and industrial

 

(45

)

(49

)

Consumer

 

(194

)

(79

)

State and political subdivisions

 

 

 

Total charge-offs

 

(556

)

(594

)

 

 

 

 

 

 

Recoveries:

 

 

 

 

 

Residential real estate

 

8

 

19

 

Commercial real estate

 

45

 

317

 

Construction land acquisition and development

 

5

 

21

 

Commercial & industrial

 

1,516

 

125

 

Consumer

 

143

 

78

 

State and political subdivisions

 

 

 

Total recoveries

 

1,717

 

560

 

 

 

 

 

 

 

Net recoveries (charge-offs)

 

1,161

 

(34

)

Balance at end of period

 

$

18,473

 

$

20,664

 

 

 

 

 

 

 

Net (recoveries) charge-offs during the period as a percentage of average loans outstanding during the period

 

(0.19

)%

0.00

%

 

 

 

 

 

 

Allowance for loan and lease losses as a percentage of gross loans at March 31

 

3.00

%

3.00

%

 

Other Real Estate Owned

 

OREO totaled $3.9 million at March 31, 2013, which was a decrease of $73 thousand, from $4.0 million at December 31, 2012.  At March 31, 2013, OREO consisted of 20 properties as compared to 22 properties at December 31, 2012.  Five of the properties held in OREO at March 31, 2013 totaled $2.4 million and represented 61.5% of the total.  Included in OREO at March 31, 2013 were three properties totaling $331 thousand, or 8.5%, of OREO, located outside of the Company’s general market area.  Additionally, $2.6 million, or 65.0%, of OREO is in the Pocono region located within the Company’s primary market area that was severely impacted by the weakened economic environment.

 

The Company is actively marketing these properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors.  The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value.  A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process.  This market value is updated on an annual basis or more frequently if new valuation information is available.  Further deterioration in the real estate market could result in additional losses on these properties.

 

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The following schedule reflects the roll forward of OREO:

 

 

 

March 31,

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Balance, beginning of period

 

$

3,983

 

$

6,958

 

Additions

 

 

239

 

Recoveries / (write-downs)

 

 

26

 

Carrying value of OREO sold

 

(73

)

(1,097

)

Balance, end of period

 

$

3,910

 

$

6,126

 

 

The following schedule reflects a breakdown of OREO for the periods reviewed:

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Land / Lots

 

$

2,856

 

$

2,929

 

Commercial Real Estate

 

1,054

 

1,054

 

Total Other Real Estate Owned

 

$

3,910

 

$

3,983

 

 

The Company did not foreclose on any properties during the three months ended March 31, 2013. There was one property foreclosed upon during the three months ended March 31, 2012.  The expenses related to maintaining OREO and the subsequent write-down of the values related to declines in value since foreclosure amounted to $218 thousand for the three months ended March 31, 2013, compared to $178 thousand for the same period in 2012. There were two properties with an aggregate carrying value of $73 thousand that were sold during the three months ended March 31, 2013. The Company sold four properties with an aggregate carrying value of $1.1 million during the three months ended March 31, 2012. Net gains on the sale of foreclosed properties were $13 thousand and $9 thousand, respectively for the three months ended March 31, 2013 and 2012.

 

Liabilities

 

Total liabilities were $892.7 million at March 31, 2013, a decrease of $38.6 million, or 4.2%, from $931.3 million at December 31, 2012. Deposit liabilities decreased $30.9 million, or 3.6%, to $823.7 million at March 31, 2013 compared to $854.6 million at December 31, 2012.  During the same period, non-interest-bearing demand deposits decreased by $10.3 million, or 7.8%, while interest-bearing deposits decreased $20.6 million, or 2.9%.   The Company continued to pursue the pricing strategy it implemented in 2011 to reduce its cost of funds and to concentrate deposit growth on short-term maturities.  The Company continued to reposition maturing longer-term time deposits into short-term products, whenever possible, and allowed the residual to run-off.  Borrowed funds decreased by $6.2 million, or 11.5%, during the first three months of 2013 to $47.7 million from $53.9 million at December 31, 2012.

 

Equity

 

Total shareholders’ equity decreased $107 thousand to $36.8 million at March 31, 2013 from $36.9 million at December 31, 2012.  Net income of $1.7 million was more than entirely offset by a $1.8 million reduction in accumulated other comprehensive income.  The decrease in accumulated other comprehensive income was primarily attributed to a decline in the fair value of securities held in the available-for-sale portfolio.  Book value per common share was $2.23 at March 31, 2013 compared to $2.24 at December 31, 2012.

 

Liquidity

 

The term liquidity refers to the ability of the Company to generate sufficient amounts of cash to meet its cash flow needs.  Liquidity is required to fulfill the borrowing needs of the Company’s credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments.  The Company’s liquidity position is impacted by several factors, which include, among others, loan origination volumes, loan and investment maturity structure and cash flows, deposit demand and certificate of deposit maturity structure and retention. Management monitors the Company’s liquidity position and fluctuations daily,

 

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so that the Company can adapt accordingly to market influences and balance sheet trends. Management also forecasts liquidity needs and develops strategies to ensure adequate liquidity at all times.

 

The Company’s statements of cash flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents, cash and due from banks and interest-bearing deposits in other banks, are the Company’s most liquid assets.  At March 31, 2013, cash and cash equivalents totaled $32.3 million, a decrease of $82.9 million compared to $115.3 million at December 31, 2012. Cash outlays for investing and financing activities used $49.3 million and $37.1 million, respectively, of cash and cash equivalents during the three months ended March 31, 2013. These outflows more than entirely offset the net cash inflow from operating activities of $3.4 million.

 

Interest Rate Risk

 

Our consolidated statements of financial position have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering the changes in fair value of certain investments due to changes in interest rates.  Generally, the fair value of financial investments such as loans and securities fluctuates inversely with changes in interest rates.  As a result, increases in interest rates could result in decreases in the fair value of our interest-earning assets and could adversely affect our results of operation if such assets were sold, or, in the case of securities classified as available-for-sale, could lead to decreases in our shareholders’ equity, if such securities were retained.

 

We manage the mix of interest-earning assets and interest-bearing liabilities on a continuous basis to maximize return and adjust our exposure to interest rate risk.  This report quantifies the potential changes in net interest income and net portfolio value should interest rates go up or down (shocked) 200 basis points, assuming the yield curves of the rate shocks will be parallel to each other.  All changes in income and value are measured as percentage changes from the projected net interest income and net portfolio value at the base interest rate scenario.  The base interest rate scenario assumes interest rates at March 31, 2013. Various estimates regarding prepayment assumptions are made at each level of rate shock.  However, prepayment penalty income is excluded from this analysis.  Actual results could differ significantly from these estimates.

 

Earnings at Risk

 

Earnings-at-risk simulation measures the change in net interest income and net income should interest rates rise and fall.  The simulation recognizes that not all assets and liabilities re-price equally and simultaneously with market rates (i.e., savings rate).  ALCO generally looks at “earnings at risk” to determine income changes from a base case scenario under an increase and decrease of 200 basis points in the interest rate simulation model. However, given the current interest rate environment, characterized by short-term rates already at or near zero, a decrease of 100 basis points was used.

 

Economic Value at Risk

 

Earnings-at-risk simulation measures the short-term risk in the balance sheet.  Economic value (or portfolio equity) at risk measures the long-term risk by finding the net present value of the future cash flows from the Company’s existing assets and liabilities.  ALCO examines this ratio regularly utilizing a rate shock of +/- 200 basis points in the interest rate simulation model. Similar to the Earnings at Risk calculation, a decrease of 100 basis points was used in this calculation. Management recognizes that, in some instances, this ratio may contradict the “earnings at risk” ratio.

 

The following table illustrates the simulated impact of a 200 basis point upward or 100 basis point downward movement in interest rates on net interest income and the change in economic value.  This analysis assumed that interest-earning asset and interest-bearing liability levels at March 31, 2013 remained constant.  The impact of the rate movements were developed by simulating the effect of an immediate rate shock from the March 31, 2013 levels.

 

 

 

RATES + 200

 

RATES – 100

 

Earnings at risk:

 

 

 

 

 

Percent change in net interest income

 

3.7

%

-0.4

%

 

 

 

 

 

 

Economic value at risk:

 

 

 

 

 

Percent change in economic value of equity

 

-15.7

%

4.4

%

 

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Off-Balance Sheet Arrangements

 

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with U.S. GAAP, are not recorded in our consolidated financial statements or are recorded in amounts that differ from the notional amounts.  These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk.  Such transactions are used for general corporate purposes and for customer needs.  Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital.  Customer transactions are used to manage customers’ requests for funding.

 

For the three months ended March 31, 2013, the Company did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition.

 

Item 3 — Quantitative and Qualitative Disclosures about Market Risk

 

There have been no material changes in the company’s exposure to market risk during the first three months of 2013.  For discussion of the Company’s exposure to market risk, refer to Item 7A, Quantitative and Qualitative Disclosure about Market Risk, contained in the Company’s Form 10-K for the year ended December 31, 2012.

 

Item 4 — Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure controls and procedures were effective as of March 31, 2013.

 

There were no changes made to the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II  Other Information

 

Item 1 — Legal Proceedings.

 

On August 8, 2011, the Company announced that it had received document subpoenas from the SEC.  The information requested generally relates to disclosure and financial reporting by the Company and the restatement of the Company’s financial statements for the year ended December 31, 2009, and the quarters ended March 31, 2010 and June 30, 2010.  The Company is presently cooperating with the SEC in this matter.

 

On May 24, 2012, a putative shareholder by the name of Lori Gray filed a complaint in the Court of Common Pleas in Lackawanna County against certain present and former directors of the Company (including all of the current directors except Steven R. Tokach and Thomas J. Melone) and Demetrius & Company, LLC (“Demetrius”) alleging, inter alia, breach of fiduciary duty, abuse of control, corporate waste, unjust enrichment and, in the case of Demetrius, professional negligence, negligent misrepresentation, breach of contract and aiding and abetting breach of fiduciary duty.  The Company has been named as a nominal defendant.   On April 4, 2013, the plaintiff filed a motion to amend the complaint to add claims of professional negligence and aiding and abetting the breach of fiduciary duty against a new defendant, as well as new allegations relating to all claims.  The defendants responded in opposition to the motion on May 1, 2013. The Board had appointed a special litigation committee in January 2012 to investigate the matters raised in the Gray complaint.  The special litigation committee has retained independent counsel to assist with its investigation.  This matter is in a preliminary stage and the Company cannot determine the outcome or potential range of loss at this time.

 

On September 5, 2012, Fidelity and Deposit Company of Maryland (“F&D”) filed an action against the Company and its subsidiary, First National Community Bank, as well as several current and former officers and directors of the Company, in the United States District Court for the Middle District of Pennsylvania. F&D has asserted a claim for the rescission of a directors’ and officers’ insurance policy and a bond that it had issued to the Company. On November 9, 2012, the Company and the Bank answered the claim and asserted counterclaims. The Company and the other defendants are defending the claims, specifically all parties have filed pre-discovery motions. The motions have been fully briefed and the parties are awaiting the Judge’s rulings on the motions. At this time, the Company cannot reasonably determine the outcome or potential range of loss.

 

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The Company has been subject to tax audits and is also a party to routine litigation involving various aspects of its business, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business, none of which is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

The Company is also a party to routine litigation involving various aspects of its business none of which is expected to have a material adverse impact on the consolidated financial condition, results of operations or liquidity of the Company.

 

Item 1A — Risk Factors.

 

Management of the Company does not believe there have been any material changes in the risk factors that were previously disclosed in the Company’s Form 10-K for the year ending December 31, 2012.

 

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3 - Defaults upon Senior Securities.

 

None.

 

Item 4 — Mine Safety Disclosures.

 

Not applicable.

 

Item 5 - Other Information.

 

None.

 

Item 6 — Exhibits.

 

The following exhibits are filed herewith or incorporated by reference.

 

EXHIBIT 3.1

 

Amended and Restated Articles of Incorporation dated May 19, 2010 — filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K on May 19, 2010, is hereby incorporated by reference.

 

 

 

EXHIBIT 3.2

 

Amended and Restated Bylaws — filed as Exhibit 3.2 to the Company’s Annual Report on Form 10-K as filed on March 28, 2013, is hereby incorporated by reference.

 

 

 

EXHIBIT 4.1

 

Form of Common Stock Certificate — filed as Exhibit 4.1 to the Company’s Form 10-K for the year ended December 31, 2009, as filed on March 16, 2010, is hereby incorporated by reference.

 

 

 

EXHIBIT 4.2

 

Form of Subordinated Note — filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K dated August 28, 2009, is hereby incorporated by reference.

 

 

 

EXHIBIT 31.1*

 

Certification of Chief Executive Officer

 

 

 

EXHIBIT 31.2*

 

Certification of Chief Financial Officer

 

 

 

EXHIBIT 32.1**

 

Section 1350 Certification —Chief Executive Officer and Chief Financial Officer

 

 

 

EXHIBIT 101.INS

 

XBRL INSTANCE DOCUMENT

 

 

 

EXHIBIT 101.SCH

 

XBRL TAXONOMY EXTENSION SCHEMA

 

 

 

EXHIBIT 101.CAL

 

XBRL TAXONOMY EXTENSION CALCULATION LINKBASE

 

 

 

EXHIBIT 101.DEF

 

XBRL TAXONOMY EXTENSION DEFINITION LINKBASE

 

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EXHIBIT 101.LAB

 

XBRL TAXONOMY EXTENSION LABEL LINKBASE

 

 

 

EXHIBIT 101.PRE

 

XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Registrant:  FIRST NATIONAL COMMUNITY BANCORP, INC.

 

Date: May 14, 2013

By:

/s/ Steven R. Tokach

 

Steven R. Tokach

 

President and Chief Executive Officer

 

 

 

 

 

 

Date: May 14, 2013

By:

/s/ James M. Bone, Jr.

 

James M. Bone, Jr., CPA

 

Executive Vice President and Chief Financial Officer

 

Principal Financial Officer

 

 

 

 

 

 

Date: May 14, 2013

By:

/s/ Stephanie A. Westington

 

Stephanie A. Westington, CPA

 

Senior Vice President and Controller

 

Principal Accounting Officer

 

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