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LANDMARK BANCORP INC - Quarter Report: 2013 June (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended June 30, 2013

 

OR

 

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

For the transition period from ________ to ________

 

Commission File Number 0-33203

 

LANDMARK BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   43-1930755
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification Number)

 

701 Poyntz Avenue, Manhattan, Kansas     66502
(Address of principal executive offices)     (Zip code)

 

(785) 565-2000
(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. (Check one):

 

Large accelerated filer ¨      Accelerated filer ¨      Non-accelerated filer ¨      Smaller reporting company  x

(Do not check if a smaller reporting company)

 

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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: as of August 7, 2013, the issuer had outstanding 2,935,833 shares of its common stock, $.01 par value per share.

 

 
 

 

LANDMARK BANCORP, INC.

Form 10-Q Quarterly Report

 

Table of Contents

 

    Page Number
     
PART I
     
Item 1. Financial Statements 2 – 21
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 – 32
Item 3. Quantitative and Qualitative Disclosures about Market Risk 32 – 33
Item 4. Controls and Procedures 34
     
PART II
     
Item 1. Legal Proceedings 35
Item 1A. Risk Factors 35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 3. Defaults Upon Senior Securities 35
Item 4. Mine Safety Disclosures 35
Item 5. Other Information 35
Item 6. Exhibits 35
     
Form 10-Q Signature Page 36

 

1
 

 

ITEM 1. FINANCIAL STATEMENTS

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except per share amounts)  June 30,   December 31, 
   2013   2012 
   (Unaudited)   (Audited) 
Assets          
Cash and cash equivalents  $10,209   $14,920 
Investment securities:          
Available-for-sale, at fair value   238,476    213,300 
Other securities   5,243    5,238 
Loans, net   321,302    315,914 
Loans held for sale, net   8,000    7,163 
Premises and equipment, net   14,635    14,967 
Bank owned life insurance   17,032    16,701 
Goodwill   13,075    13,075 
Other intangible assets, net   2,694    2,394 
Real estate owned   2,321    2,444 
Accrued interest and other assets   8,899    7,951 
Total assets  $641,886   $614,067 
           
Liabilities and Stockholders’ Equity          
Liabilities:          
Deposits:          
Non-interest-bearing demand  $80,935   $75,891 
Money market and NOW   208,083    190,309 
Savings   49,912    45,365 
Time, $100,000 and greater   56,081    59,035 
Time, other   105,203    111,900 
Total deposits   500,214    482,500 
           
Federal Home Loan Bank borrowings   45,808    38,426 
Other borrowings   23,032    21,541 
Accrued interest, taxes, and other liabilities   10,423    8,267 
Total liabilities   579,477    550,734 
           
Commitments and contingencies          
           
Stockholders’ equity:          
Preferred stock, $0.01 par value per share, 200,000 shares authorized; none issued   -    - 
Common stock, $0.01 par value per share, 7,500,000 shares authorized; 2,935,833 and 2,922,275 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively   29    29 
Additional paid-in capital   32,499    32,223 
Retained earnings   29,362    27,623 
Accumulated other comprehensive income   519    3,458 
Total stockholders’ equity   62,409    63,333 
Total liabilities and stockholders’ equity  $641,886   $614,067 

 

See accompanying notes to consolidated financial statements.

 

2
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

 

   Three months ended   Six months ended 
(Dollars in thousands, except per share amounts)  June 30,   June 30, 
   2013   2012   2013   2012 
Interest income:                    
Loans:                    
Taxable  $3,935   $4,204   $7,810   $8,347 
Tax-exempt   57    96    140    191 
Investment securities:                    
Taxable   621    822    1,256    1,524 
Tax-exempt   591    607    1,175    1,198 
Total interest income   5,204    5,729    10,381    11,260 
Interest expense:                    
Deposits   346    575    732    1,167 
Borrowings   412    440    821    887 
Total interest expense   758    1,015    1,553    2,054 
Net interest income   4,446    4,714    8,828    9,206 
Provision for loan losses   300    300    600    600 
Net interest income after provision for loan losses   4,146    4,414    8,228    8,606 
Non-interest income:                    
Fees and service charges   1,405    1,317    2,713    2,491 
Gains on sales of loans, net   879    1,425    1,909    2,629 
Bank owned life insurance   137    139    290    290 
Other   122    147    265    290 
Total non-interest income   2,543    3,028    5,177    5,700 
Investment securities:                    
Net impairment losses   -    -    -    (63)
Gains on sales of investment securities   -    132    -    359 
Investment securities gains, net   -    132    -    296 
Non-interest expense:                    
Compensation and benefits   2,453    2,422    4,906    4,808 
Occupancy and equipment   733    781    1,435    1,483 
Professional fees   257    294    482    567 
Amortization of intangibles   17    215    240    426 
Data processing   245    223    462    418 
Advertising   107    121    214    242 
Federal deposit insurance premiums   123    90    231    182 
Foreclosure and real estate owned expense   18    18    59    29 
Other   910    966    1,715    1,704 
Total non-interest expense   4,863    5,130    9,744    9,859 
Earnings before income taxes   1,826    2,444    3,661    4,743 
Income tax expense   417    626    812    1,198 
Net earnings  $1,409   $1,818   $2,849   $3,545 
Earnings per share:                    
Basic (1)  $0.48   $0.62   $0.97   $1.21 
Diluted (1)  $0.47   $0.62   $0.96   $1.21 
Dividends per share (1)  $0.19   $0.18   $0.38   $0.36 

 

(1) Per share amounts for the periods ended June 30, 2012 have been adjusted to give effect to the 5% stock dividend paid during December 2012.

 

See accompanying notes to consolidated financial statements.

 

3
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three months ended   Six months ended 
(Dollars in thousands)  June 30,   June 30, 
   2013   2012   2013   2012 
                 
Net earnings  $1,409   $1,818   $2,849   $3,545 
Unrealized holding gains on available-for-sale securities for which a portion of an other-than-temporary impairment has been recorded in earnings   -    57    -    94 
Net unrealized holding (losses) gains on all other available-for-sale securities   (4,501)   159    (4,671)   (128)
Less reclassification adjustment for net gains included in earnings   -    (132)   -    (296)
Net unrealized (losses) gains   (4,501)   84    (4,671)   (330)
Income tax (benefit) expense   (1,667)   31    (1,732)   (124)
Total comprehensive (loss) income  $(1,425)  $1,871   $(90)  $3,339 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Six months ended 
(Dollars in thousands)  June 30, 
   2013   2012 
Cash flows from operating activities:          
Net earnings  $2,849   $3,545 
Adjustments to reconcile net earnings to net cash provided by operating activities:          
Provision for loan losses   600    600 
Provision for valuation allowance on real estate owned   26    - 
Amortization of investment security premiums, net   760    590 
Amortization of intangibles   240    426 
Depreciation   464    478 
Bank owned life insurance   (290)   (290)
Stock-based compensation   29    51 
Deferred income taxes   (199)   (110)
Gains on investment securities, net   -    (296)
Gain on sales of real estate owned, net   (10)   (25)
Gains on sales of loans, net   (1,909)   (2,629)
Proceeds from sales of loans held for sale   87,421    104,665 
Origination of loans held for sale   (86,349)   (98,175)
Changes in assets and liabilities:          
Accrued interest and other assets   360    (1,387)
Accrued expenses, taxes, and other liabilities   2,091    (708)
Net cash provided by operating activities   6,083    6,735 
Cash flows from investing activities:          
Net (increase) decrease in loans   (6,052)   20,392 
Maturities and prepayments of investment securities   20,809    20,766 
Purchases of investment securities   (51,419)   (71,894)
Proceeds from sales of investment securities   -    9,855 
Net cash received in bank acquisition   -    3,965 
Proceeds from sales of real estate owned   252    345 
Purchases of premises and equipment, net   (132)   (669)
Net cash used in investing activities   (36,542)   (17,240)
Cash flows from financing activities:          
Net increase in deposits   17,738    44,755 
Federal Home Loan Bank advance borrowings   24,100    42,322 
Federal Home Loan Bank advance repayments   (16,718)   (55,740)
Proceeds from other borrowings   1,491    1,340 
Repayments on other borrowings   -    (7,135)
Proceeds from issuance of common stock under stock option plans   218    5 
Excess tax benefit related to stock option plans   29    1 
Payment of dividends   (1,110)   (1,058)
Net cash provided by financing activities   25,748    24,490 
Net (decrease) increase in cash and cash equivalents   (4,711)   13,985 
Cash and cash equivalents at beginning of period   14,920    17,501 
Cash and cash equivalents at end of period  $10,209   $31,486 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(Unaudited)

 

   Six months ended 
(Dollars in thousands)  June 30, 
   2013   2012 
Supplemental disclosure of cash flow information:          
Cash payments for income taxes  $175   $1,455 
Cash paid for interest   1,601    2,092 
           
Supplemental schedule of noncash investing and financing activities:          
Transfer of loans to real estate owned   145    19 
           
Bank acquisition:          
Fair value of liabilities assumed   -    35,061 
Fair value of assets acquired   -    31,096 

 

See accompanying notes to consolidated financial statements.

 

6
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

 

(Dollars in thousands, except per share amounts)  Common
stock
   Additional
paid-in
capital
   Retained
earnings
   Accumulated other
comprehensive
income
   Total 
                     
Balance at December 31, 2011  $28   $29,313   $26,200   $3,579   $59,120 
Net earnings   -    -    3,545    -    3,545 
Comprehensive loss   -    -    -    (206)   (206)
Dividends paid ($0.36 per share)   -    -    (1,058)   -    (1,058)
Stock-based compensation   -    51    -    -    51 
Exercise of stock options, 361 shares, including excess tax benefit of $1   -    6    -    -    6 
Balance at June 30, 2012  $28   $29,370   $28,687   $3,373   $61,458 
                          
Balance at December 31, 2012  $29   $32,223   $27,623   $3,458   $63,333 
Net earnings   -    -    2,849    -    2,849 
Comprehensive loss   -    -    -    (2,939)   (2,939)
Dividends paid ($0.38 per share)   -    -    (1,110)   -    (1,110)
Stock-based compensation   -    29    -    -    29 
Exercise of stock options, 13,558 shares, including excess tax benefit of $29   -    247    -    -    247 
Balance at June 30, 2013  $29   $32,499   $29,362   $519   $62,409 

 

See accompanying notes to consolidated financial statements.

 

7
 

 

LANDMARK BANCORP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.Interim Financial Statements

 

The consolidated financial statements of Landmark Bancorp, Inc. (the “Company”) and subsidiary have been prepared in accordance with the instructions to Form 10-Q. To the extent that information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements are contained in or consistent with the consolidated audited financial statements incorporated by reference in the Company’s Form 10-K for the year ended December 31, 2012, such information and footnotes have not been duplicated herein. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of financial statements have been reflected herein. The results of the interim period ended June 30, 2013 are not necessarily indicative of the results expected for the year ending December 31, 2013. The Company evaluates subsequent events and transactions that occur after the balance sheet date up to the date that financial statements are filed for potential recognition or disclosure.

 

2.Goodwill and Other Intangible Assets

 

The Company tests goodwill for impairment annually or more frequently if circumstances warrant. The Company’s annual step one impairment test as of December 31, 2012 concluded that its goodwill was not impaired; however, the Company can make no assurances that future impairment tests will not result in goodwill impairments. The Company concluded there were no triggering events during the first six months of 2013 that required an interim goodwill impairment test.

 

On April 1, 2012, the Company’s subsidiary, Landmark National Bank, assumed approximately $35.0 million in deposits with the acquisition of The Wellsville Bank. The Company identified $24.7 million of core deposits and recorded a core deposit intangible asset of $308,000 as a result of the acquisition. The core deposit intangible asset will be amortized over its estimated useful life of ten years on an accelerated basis. A summary of this and the other intangible assets that continue to be subject to amortization is as follows:

 

(Dollars in thousands)  As of June 30, 2013 
   Gross carrying
amount
   Accumulated
amortization
   Valuation
allowance
   Net carrying
amount
 
Core deposit intangible assets  $4,973   $(4,405)  $-   $568 
Mortgage servicing rights   3,423    (1,297)   -    2,126 
Total other intangible assets  $8,396   $(5,702)  $-   $2,694 

 

(Dollars in thousands)  As of December 31, 2012 
   Gross carrying
amount
   Accumulated
amortization
   Valuation
allowance
   Net carrying
amount
 
Core deposit intangible assets  $4,973   $(4,258)  $-   $715 
Mortgage servicing rights   3,038    (1,147)   (212)   1,679 
Total other intangible assets  $8,011   $(5,405)  $(212)  $2,394 

 

During 2012, the Company recorded a $212,000 valuation allowance against its mortgage servicing rights. During the second quarter of 2013, a rise in mortgage rates increased the estimated fair value of these assets as it became less likely some of the loans the Company services will be refinanced. Based on the increase in estimated fair value, the Company reversed its valuation allowance as of June 30, 2013.

 

8
 

 

Aggregate core deposit and mortgage servicing rights amortization expense, net of the reversal in 2013 of the valuation allowance, was $17,000 and $215,000 for the second quarter of 2013 and 2012, respectively. Aggregate core deposit and mortgage servicing rights amortization expense was $240,000 and $426,000 for the first six months of 2013 and 2012, respectively. The following sets forth estimated amortization expense for other intangible assets for the remainder of 2013 and in successive years ending December 31:

 

(Dollars in thousands)  Amortization 
   expense 
Remainder of 2013  $744 
2014   801 
2015   718 
2016   335 
2017   32 
Thereafter   64 
Total  $2,694 

 

3.Investments

 

A summary of investment securities available-for-sale is as follows:

 

   As of June 30, 2013 
       Gross   Gross     
   Amortized   unrealized   unrealized   Estimated 
(Dollars in thousands)  cost   gains   losses   fair value 
                 
U. S. treasury securities  $500   $-   $(2)  $498 
U. S. federal agency obligations   19,787    23    (498)   19,312 
Municipal obligations, tax exempt   84,528    2,145    (700)   85,973 
Municipal obligations, taxable   51,939    386    (719)   51,606 
Mortgage-backed securities   73,574    416    (668)   73,322 
Common stocks   602    420    -    1,022 
Certificates of deposit   6,743    -    -    6,743 
Total  $237,673   $3,390   $(2,587)  $238,476 

 

   As of December 31, 2012 
       Gross   Gross     
   Amortized   unrealized   unrealized   Estimated 
(Dollars in thousands)  cost   gains   losses   fair value 
                 
U. S. federal agency obligations  $8,804   $50   $(6)  $8,848 
Municipal obligations, tax exempt   73,699    3,618    (31)   77,286 
Municipal obligations, taxable   37,334    818    (10)   38,142 
Mortgage-backed securities   81,113    889    (154)   81,848 
Common stocks   602    301    (1)   902 
Certificates of deposit   6,274    -    -    6,274 
Total  $207,826   $5,676   $(202)  $213,300 

 

9
 

 

Certain of the Company’s investment securities have unrealized losses, or are temporarily impaired. This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date. Securities which are temporarily impaired are shown below, along with the length of the impairment period.

 

       As of June 30, 2013 
(Dollars in thousands)      Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U. S. treasury securities   1   $498   $(2)  $-   $-   $498   $(2)
U. S. federal agency obligations   13    16,350    (498)   -    -    16,350    (498)
Municipal obligations, tax exempt   91    24,908    (668)   1,775    (32)   26,683    (700)
Municipal obligations, taxable   72    29,094    (711)   774    (8)   29,868    (719)
Mortgage-backed securities   40    39,713    (620)   1,778    (48)   41,491    (668)
Total   217   $110,563   $(2,499)  $4,327   $(88)  $114,890   $(2,587)

 

       As of December 31, 2012 
(Dollars in thousands)      Less than 12 months   12 months or longer   Total 
   No. of   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   securities   value   losses   value   losses   value   losses 
U. S. federal agency obligations   2   $2,241   $(6)  $-   $-   $2,241   $(6)
Municipal obligations, tax exempt   16    4,669    (31)   -    -    4,669    (31)
Municipal obligations, taxable   8    2,948    (8)   209    (2)   3,157    (10)
Mortgage-backed securities   24    27,974    (154)   -    -    27,974    (154)
Common stocks   1    21    (1)   -    -    21    (1)
Total   51   $37,853   $(200)  $209   $(2)  $38,062   $(202)

 

The Company performs quarterly reviews of the investment portfolio to determine if investment securities have any declines in fair value which might be considered other-than-temporary. The initial review begins with all securities in an unrealized loss position. The Company’s assessment of other-than-temporary impairment is based on the specific facts and circumstances impacting each individual security. The Company reviews and considers all available information, including expected cash flows, the structure of the security, the credit quality of the underlying assets and the current and anticipated market conditions. Any credit-related impairment on debt securities is realized through a charge to earnings. If an equity security is determined to be other-than-temporarily impaired, the entire impairment is realized through a charge to earnings.

 

The Company’s U.S. treasury securities portfolio consists of securities issued by the U.S. Treasury. The receipt of principal and interest on U.S. treasury securities is guaranteed by the U.S. government, such that the Company believes that its U.S. treasury securities do not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and its belief that it is more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believes that the U.S. treasury securities identified in the tables above are temporarily impaired.

 

The Company’s U.S. federal agency portfolio consists of securities issued by the government-sponsored agencies of Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Bank (“FHLB”). The receipt of principal and interest on U.S. federal agency obligations is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its U.S. federal agency obligations do not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and its belief that it is more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believes that the U.S. federal agency obligations identified in the tables above are temporarily impaired.

 

The Company’s portfolio of municipal obligations consists of both tax-exempt and taxable general obligations securities issued by various municipalities. The Company does not intend to sell and it is more likely than not that the Company will not be required to sell its municipal obligations in an unrealized loss position until the recovery of its cost. Due to the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms and the expectation that they will continue to do so, the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that the municipal obligations identified in the tables above are temporarily impaired.

 

10
 

 

The Company’s mortgage-backed securities portfolio consists of securities underwritten to the standards of and guaranteed by the government-sponsored agencies of FHLMC, FNMA and the Government National Mortgage Association (“GNMA”). The receipt of principal, at par, and interest on mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its mortgage-backed securities do not expose the Company to credit-related losses. Based on these factors, along with the Company’s intent to not sell the securities and the Company’s belief that it is more likely than not that the Company will not be required to sell the securities before recovery of their cost basis, the Company believes that the mortgage-backed securities identified in the tables above are temporarily impaired.

 

It is reasonably possible that the fair values of the Company’s investment securities could decline in the future if the overall economy and/or the financial condition of some of the issuers of these securities deteriorate and/or if the liquidity in markets for these securities declines. As a result, there is a risk that additional other-than-temporary impairments may occur in the future and any such amounts could be material to the Company’s consolidated financial statements. The fair value of the Company’s investment securities may continue to decline from further increases in market interest rates, as the market prices of these investments generally move inversely to market interest rates.

 

Maturities of investment securities at June 30, 2013 are as follows:

 

(Dollars in thousands)  Amortized   Estimated 
   cost   fair value 
Due in less than one year  $14,299   $14,373 
Due after one year but within five years   136,758    136,926 
Due after five years but within ten years   74,429    74,483 
Due after ten years   11,585    11,672 
Common stocks   602    1,022 
Total  $237,673   $238,476 

 

The preceding table includes scheduled principal payments and estimated prepayments, based on observable market inputs, for mortgage-backed securities, where actual maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.

 

Gross realized gains and losses on sales of available-for-sale investment securities are as follows:

 

   Three months ended   Six months ended 
(Dollars in thousands)  June 30,   June 30, 
   2013   2012   2013   2012 
Realized gains  $-   $132   $-   $359 
Realized losses   -    -    -    - 
Total  $-   $132   $-   $359 

 

Other investment securities primarily consist of restricted investments in FHLB and Federal Reserve Bank (“FRB”) stock. The carrying value of the FHLB stock was $3.4 million at June 30, 2013 and December 31, 2012. The carrying value of the FRB stock was $1.8 million at June 30, 2013 and December 31, 2012. These securities are not readily marketable and are required for regulatory purposes and borrowing availability. Since there is no available market value, these securities are carried at cost. Redemption of these investments at par value is at the option of the FHLB or FRB. Also included in other investment securities are other miscellaneous investments in the common stock of various correspondent banks which are held for borrowing purposes and totaled $113,000 at June 30, 2013 and December 31, 2012. The Company assessed the ultimate recoverability of these investments and believes that no impairment has occurred.

 

11
 

 

4.Loans and Allowance for Loan Losses

 

Loans consisted of the following as of:

 

   June 30,   December 31, 
(Dollars in thousands)  2013   2012 
         
One-to-four family residential real estate  $92,869   $88,454 
Construction and land   23,043    23,435 
Commercial real estate   96,142    88,790 
Commercial loans   62,302    64,570 
Agriculture loans   32,602    31,935 
Municipal loans   6,293    9,857 
Consumer loans   12,765    13,417 
Total gross loans   326,016    320,458 
Net deferred loan costs and loans in process   191    37 
Allowance for loan losses   (4,905)   (4,581)
Loans, net  $321,302   $315,914 

 

12
 

 

The following tables provide information on the Company’s allowance for loan losses by loan class and allowance methodology:

 

   Three and six months ended June 30, 2013 
(Dollars in thousands) 

One-to-four

family

residential
real estate

  

Construction

and land

  

Commercial

real estate

  

Commercial

loans

  

Agriculture

loans

  

Municipal

loans

  

Consumer

loans

   Total 
                                 
Allowance for loan losses:                                        
Balance at March 31, 2013  $578   $1,134   $1,608   $615   $507   $101   $91   $4,634 
Charge-offs   (20)   (53)   -    (1)   -    -    (55)   (129)
Recoveries   -    80    -    16    -    -    4    100 
Net charge-offs   (20)   27    -    15    -    -    (51)   (29)
Provision for loan losses   19    95    271    (47)   (153)   (4)   119    300 
Balance at June 30, 2013   577    1,256    1,879    583    354    97    159    4,905 
                                         
Balance at December 31, 2012  $714   $1,214   $1,313   $707   $367   $107   $159   $4,581 
Charge-offs   (43)   (53)   -    (200)   -    -    (102)   (398)
Recoveries   8    82    -    17    -    -    15    122 
Net charge-offs   (35)   29    -    (183)   -    -    (87)   (276)
Provision for loan losses   (102)   13    566    59    (13)   (10)   87    600 
Balance at June 30, 2013   577    1,256    1,879    583    354    97    159    4,905 
                                         
Allowance for loan losses:                                        
Individually evaluated for loss   32    281    8    44    -    65    -    430 
Collectively evaluated for loss   545    975    1,871    539    354    32    159    4,475 
Total   577    1,256    1,879    583    354    97    159    4,905 
                                         
Loan balances:                                        
Individually evaluated for loss   750    8,377    3,106    261    -    772    7    13,273 
Collectively evaluated for loss   92,119    14,666    93,036    62,041    32,602    5,521    12,758    312,743 
Total  $92,869   $23,043   $96,142   $62,302   $32,602   $6,293   $12,765   $326,016 

 

   Three and six months ended June 30, 2012 
(Dollars in thousands) 

One-to-four

family

residential

real estate

  

Construction

and land

  

Commercial

real estate

  

Commercial

loans

  

Agriculture

loans

  

Municipal

loans

  

Consumer

loans

   Total 
                                 
Allowance for loan losses:                                        
Balance at March 31, 2012  $691   $1,062   $1,897   $728   $408   $135   $93   $5,014 
Charge-offs   (15)   -    -    (10)   -    -    (33)   (58)
Recoveries   3    2    -    1    -    -    10    16 
Net charge-offs   (12)   2    -    (9)   -    -    (23)   (42)
Provision for loan losses   29    722    (412)   (67)   (6)   (23)   57    300 
Balance at June 30, 2012   708    1,786    1,485    652    402    112    127    5,272 
                                         
Balance at December 31, 2011   560    928    1,791    745    433    130    120    4,707 
Charge-offs   (15)   -    -    (10)   -    -    (77)   (102)
Recoveries   5    3    -    5    38    -    16    67 
Net charge-offs   (10)   3    -    (5)   38    -    (61)   (35)
Provision for loan losses   158    855    (306)   (88)   (69)   (18)   68    600 
Balance at June 30, 2012   708    1,786    1,485    652    402    112    127    5,272 
                                         
Allowance for loan losses:                                        
Individually evaluated for loss   45    10    -    27    -    65    18    165 
Collectively evaluated for loss   663    1,776    1,485    625    402    47    109    5,107 
Total   708    1,786    1,485    652    402    112    127    5,272 
                                         
Loan balances:                                        
Individually evaluated for loss   833    25    -    281    5    784    35    1,963 
Collectively evaluated for loss   81,760    22,856    88,020    55,786    35,219    9,475    14,124    307,240 
Total  $82,593   $22,881   $88,020   $56,067   $35,224   $10,259   $14,159   $309,203 

 

13
 

 

The Company’s key credit quality indicator is a loan’s performance status, defined as accruing or non-accruing. Performing loans are considered to have a lower risk of loss. Non-accrual loans are those which the Company believes have a higher risk of loss. Loans are placed on non-accrual or are charged off at an earlier date if collection of principal or interest is considered doubtful. The accrual of interest on non-performing loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. There were no loans 90 days delinquent and accruing interest at June 30, 2013 or December 31, 2012. The following tables present information on the Company’s past due and non-accrual loans by loan class:

 

(Dollars in thousands)  As of June 30, 2013 
  

30-59 days

delinquent

and

accruing

  

60-89 days

delinquent

and

accruing

  

90 days or

more

delinquent

and accruing

  

Total past

due loans

accruing

  

Non-accrual

loans

   Total 
                         
One-to-four family residential real estate  $462   $1,096   $-   $1,558   $742   $2,300 
Construction and land   -    -    -    -    2,171    2,171 
Commercial real estate   -    277    -    277    2,828    3,105 
Commercial loans   53    53    -    106    261    367 
Agriculture loans   8    -    -    8    -    8 
Municipal loans   -    -    -    -    131    131 
Consumer loans   109    69    -    178    7    185 
Total  $632   $1,495   $-   $2,127   $6,140   $8,267 
                               
Percent of gross loans   0.19%   0.46%   0.00%   0.65%   1.88%   2.54%

 

(Dollars in thousands)  As of December 31, 2012 
  

30-59 days

delinquent

and

accruing

  

60-89 days

delinquent

and

accruing

  

90 days or

more

delinquent

and accruing

  

Total past

due loans

accruing

  

Non-accrual

loans

   Total 
                         
One-to-four family residential real estate  $282   $1,362   $-   $1,644   $731   $2,375 
Construction and land   18    -    -    18    3,915    3,933 
Commercial real estate   166    82    -    248    2,833    3,081 
Commercial loans   62    17    -    79    1,475    1,554 
Agriculture loans   -    -    -    -    5    5 
Municipal loans   -    -    -    -    131    131 
Consumer loans   142    65    -    207    18    225 
Total  $670   $1,526   $-   $2,196   $9,108   $11,304 
                               
Percent of gross loans   0.21%   0.48%   0.00%   0.69%   2.84%   3.53%

 

14
 

 

The Company’s impaired loans decreased from $14.5 million at December 31, 2012 to $13.3 million at June 30, 2013. The difference between the unpaid contractual principal and the impaired loan balance is a result of charge-offs recorded against impaired loans. The difference in the Company’s non-accrual loan balances and impaired loan balances at June 30, 2013 and December 31, 2012, was related to troubled debt restructurings (“TDR”) that are current and accruing interest, but still classified as impaired. The following tables present information on impaired loans:

 

(Dollars in thousands)  As of June 30, 2013 
  

Unpaid

contractual

principal

  

Impaired
loan balance

  

Impaired

loans

without an

allowance

  

Impaired

loans with

an

allowance

  

Related

allowance

recorded

  

Year-to-date

average loan

balance

  

Year-to-date

interest

income

recognized

 
                             
One-to-four family residential real estate  $1,040   $750   $603   $147   $32   $772   $- 
Construction and land   10,111    8,377    6,244    2,133    281    8,225    122 
Commercial real estate   3,106    3,106    3,041    65    8    3,179    9 
Commercial loans   261    261    33    228    44    265    - 
Agriculture loans   -    -    -    -    -    -    - 
Municipal loans   772    772    641    131    65    772    10 
Consumer loans   7    7    7    -    -    7    - 
Total impaired loans  $15,297   $13,273   $10,569   $2,704   $430   $13,220   $141 

 

(Dollars in thousands)  As of December 31, 2012 
  

Unpaid

contractual

principal

  

Impaired
loan balance

  

Impaired

loans

without an

allowance

  

Impaired

loans with

an

allowance

  

Related

allowance

recorded

  

Year-to-date

average loan

balance

  

Year-to-date

interest

income

recognized

 
                             
One-to-four family residential real estate  $1,029   $739   $57   $682   $165   $767   $19 
Construction and land   10,425    8,691    6,334    2,357    388    9,211    302 
Commercial real estate   2,833    2,833    2,833    -    -    3,352    - 
Commercial loans   1,475    1,475    395    1,080    268    1,621    3 
Agriculture loans   5    5    5    -    -    8    - 
Municipal loans   772    772    641    131    65    779    20 
Consumer loans   18    18    3    15    15    20    - 
Total impaired loans  $16,557   $14,533   $10,268   $4,265   $901   $15,758   $344 

 

At June 30, 2013, the Company had eight loan relationships consisting of twelve outstanding loans that were classified as TDRs compared to eight relationships consisting of thirteen outstanding loans at December 31, 2012. During the first six months of 2013, the Company classified a $278,000 commercial real estate loan as a TDR after modifying the loan payments to interest only in order to allow the borrower additional time to liquidate the properties securing the loan. Since the loan was adequately secured, no impairment was recorded against the principal as of June 30, 2013. During 2012, the Company classified a commercial loan relationship consisting of two commercial loans as a TDR after agreeing to extend the maturity of the loans while the borrower liquidated the business assets securing the loans. The loans were repaid in the first quarter of 2013 and resulted in a net charge-off of $6,000.

 

The Company evaluates each TDR individually and returns the loan to accrual status when a payment history is established after the restructuring and future payments are reasonably assured. There were no loans as of June 30, 2013 that had been modified as TDRs and then subsequently defaulted. At June 30, 2013 and December 31, 2012, there was $13,000 and $15,000, respectively, of commitments to lend additional funds to a land loan classified as a TDR. As of June 30, 2013, the Company had $281,000 of allowance recorded against loans classified as TDRs compared to $521,000 recorded at December 31, 2012.

 

15
 

 

The following table presents information on loans that are classified as TDRs:

 

(Dollars in thousands)                
   As of June 30, 2013   As of December 31, 2012 
   Number of
loans
   Loan balance   Number of
loans
   Loan balance 
                 
One-to-four family residential real estate   2   $460    2   $493 
Construction and land   7    6,839    7    7,077 
Commercial real estate   1    278    -    - 
Commerical loans   -    -    2    196 
Municipal loans   2    641    2    641 
Total troubled debt restructurings   12   $8,218    13   $8,407 

 

The Company services one-to-four family residential real estate loans for others with outstanding principal balances of $295.5 million and $263.5 million at June 30, 2013 and December 31, 2012, respectively. Gross service fee income related to such loans was $178,000 and $131,000 for the quarters ended June 30, 2013 and 2012, respectively, and is included in fees and service charges in the consolidated statements of earnings. Gross service fee income for the six months ended June 30, 2013 and 2012 was $347,000 and $250,000, respectively.

 

The Company had a mortgage repurchase reserve of $418,000 at June 30, 2013 and December 31, 2012, which represents the Company’s best estimate of probable losses that the Company has incurred related to the repurchase obligation of one-to-four family residential real estate loans previously sold or to reimburse investors for credit losses incurred on loans previously sold where a breach of the contractual representations and warranties occurred. Because the level of mortgage repurchase losses depends upon economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, mortgage repurchase losses are difficult to estimate and require considerable judgment. The Company did not make any provisions or charge any losses against the reserve during the first six months of 2013.

 

5.Earnings per Share

 

Basic earnings per share has been computed based upon the weighted average number of common shares outstanding during each period. Diluted earnings per share includes the effect of all potential common shares outstanding during each period. The shares used in the calculation of basic and diluted earnings per share are shown below:

 

   Three months ended   Six months ended 
(Dollars in thousands, except per share amounts)  June 30,   June 30, 
   2013   2012   2013   2012 
Net earnings  $1,409   $1,818   $2,849   $3,545 
                     
Weighted average common shares outstanding - basic (1)   2,926,032    2,922,217    2,924,385    2,922,092 
Assumed exercise of stock options (1)   60,506    29,556    53,662    18,341 
Weighted average common shares outstanding - diluted (1)   2,986,538    2,951,773    2,978,047    2,940,433 
Net earnings per share (1):                    
Basic  $0.48   $0.62   $0.97   $1.21 
Diluted  $0.47   $0.62   $0.96   $1.21 

 

(1) Share and per share values for the period ended June 30, 2012 have been adjusted to give effect to the 5% stock dividend paid during December 2012.

 

The diluted earnings per share computations for the three and six months ended June 30, 2013 include all unexercised stock options, while the diluted earnings per share computations for the three and six months ended June 30, 2012 exclude unexercised stock options of 2,553 and 152,192, respectively, because their inclusion would have been anti-dilutive to earnings per share.

 

16
 

 

6.Fair Value of Financial Instruments and Fair Value Measurements

 

The Company follows the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820 “Fair Value Measurements and Disclosures,” which defines fair value, establishes a framework for measuring fair value and expands the disclosures about fair value measurements. ASC Topic 820-10-55 requires the use of a hierarchy of fair value techniques based upon whether the inputs to those fair values reflect assumptions other market participants would use based upon market data obtained from independent sources or reflect the Company’s own assumptions of market participant valuation. The Company applies FASB ASC 820 to certain nonfinancial assets and liabilities, which include foreclosed real estate, long-lived assets, goodwill, mortgage servicing rights and core deposit premium, which are recorded at fair value only upon impairment. The fair value hierarchy is as follows:

 

• Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

• Level 2: Quoted prices for similar assets in active markets or quoted prices that contain observable inputs such as yield curves, volatilities, prepayment speeds and other inputs derived from market data.

• Level 3: Quoted prices in markets that are not active or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

 

Fair value estimates of the Company’s financial instruments as of June 30, 2013 and December 31, 2012, including methods and assumptions utilized, are set forth below:

 

(Dollars in thousands)  As of June 30,   As of December 31, 
   2013   2012 
   Carrying   Estimated   Carrying   Estimated 
   amount   fair value   amount   fair value 
Financial assets:                    
Cash and cash equivalents  $10,209   $10,209   $14,920   $14,920 
Investment securities:                    
Available-for-sale   238,476    238,476    213,300    213,300 
Other securities   5,243    5,243    5,238    5,238 
Loans, net   321,302    323,656    315,914    317,335 
Loans held for sale, net   8,000    8,000    7,163    7,179 
Mortgage servicing rights   2,126    2,749    1,679    1,859 
Derivative financial instruments   240    240    334    334 
Accrued interest receivable   2,540    2,540    2,589    2,589 
                     
Financial liabilities:                    
Non-maturity deposits  $338,930   $338,930   $311,565   $311,565 
Time deposits   161,284    161,453    170,935    171,961 
FHLB borrowings   45,808    48,218    38,426    42,904 
Other borrowings   23,032    20,615    21,541    19,273 
Derivative financial instruments   43    43    28    28 
Accrued interest payable   362    362    410    410 

 

Methods and Assumptions Utilized

 

The carrying amount of cash and cash equivalents is considered to approximate fair value.

 

The Company’s investment securities classified as available-for-sale include U.S. treasury securities, U.S. federal agency securities, municipal obligations, mortgage-backed securities, certificates of deposits and common stocks. Quoted exchange prices are available for the Company’s common stock investments, which are classified as Level 1. U.S. treasury securities are priced based on the active trading prices in U.S. treasury bills, bonds and notes and are classified as Level 1. U.S. federal agency securities and mortgage-backed obligations are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace and are classified as Level 2. Municipal securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against U.S. treasury rates based on credit rating. These model and matrix measurements are classified as Level 2 in the fair value hierarchy. The Company’s investments in FDIC-insured, fixed-rate certificates of deposits are valued using a net present value model that discounts the future cash flows at the current market rates and are classified as Level 2.

 

17
 

 

The Company’s other investment securities primarily include investments in FHLB and FRB stock, which are held for regulatory purposes. These investments generally have restrictions on the sale and/or liquidation of stock and the carrying value is approximately equal to fair value. Fair value measurements for these securities are classified as Level 3 based on the restrictions on sale and/or liquidation and related credit risk.

 

The estimated fair value of the Company’s loan portfolio is based on the segregation of loans by collateral type, interest terms, and maturities. The fair value is estimated based on discounting scheduled and estimated cash flows through maturity using an appropriate risk-adjusted yield curve to approximate current interest rates for each category. No adjustment was made to the interest rates for changes in credit risk of performing loans where there were no known credit concerns. Management segregates loans in appropriate risk categories. Management believes that the risk factor embedded in the interest rates along with the allowance for loan losses applicable to the performing loan portfolio results in a fair valuation of such loans. The fair values of impaired loans are generally based on market prices for similar assets determined through independent appraisals or discounted values of independent appraisals and brokers’ opinions of value. This method of estimating fair value is classified as Level 3 and does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.

 

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, determined on an aggregate basis. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2.

 

The Company measures its mortgage servicing rights at the lower of amortized cost or fair value. Periodic impairment assessments are performed based on fair value estimates at the reporting date. The fair value of mortgage servicing rights is estimated based on a valuation model which calculates the present value of estimated future cash flows associated with servicing the underlying loans. The model incorporates assumptions that market participants use in estimating future net servicing income, including estimated prepayment speeds, market discount rates, cost to service, and other servicing income, including late fees. The fair value measurements are classified as Level 3.

 

The carrying amount of accrued interest receivable and payable is considered to approximate fair value and is classified as Level 3.

 

The estimated fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, money market accounts, and NOW accounts, is equal to the amount payable on demand. The fair value of interest-bearing time deposits is based on the discounted value of contractual cash flows of such deposits. The discount rate is tied to the FHLB yield curve plus an appropriate servicing spread. Fair value measurements based on discounted cash flows are classified as Level 3. These fair values do not incorporate the value of core deposit intangibles which may be associated with the deposit base.

 

The fair value of advances from the FHLB and other borrowings is estimated using current yield curves for similar borrowings adjusted for the Company’s current credit spread, if applicable, and classified as Level 2.

 

The Company’s derivative financial instruments consist of interest rate lock commitments and corresponding forward sales contracts on mortgage loans held for sale. The fair values of these derivatives are based on quoted prices for similar loans in the secondary market. The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sales of loans in the consolidated statements of earnings.

 

The Company also includes interest rate swaps in derivative financial instruments. The fair values of these derivatives are based on valuation models that utilize readily observable market inputs. These instruments are classified as Level 2. The amounts are included in other assets or other liabilities on the consolidated balance sheets.

 

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Off-Balance Sheet Financial Instruments

 

The fair value of letters of credit and commitments to extend credit is based on the fees currently charged to enter into similar agreements. The aggregate of these fees is not material.

 

Transfers

 

The Company did not transfer any assets or liabilities among levels during the six months ended June 30, 2013 or during the year ended December 31, 2012.

 

Limitations

 

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.

 

Valuation Methods for Instruments Measured at Fair Value on a Recurring Basis

 

The following table represents the Company’s financial instruments that are measured at fair value on a recurring basis at June 30, 2013 and December 31, 2012, allocated to the appropriate fair value hierarchy:

 

(Dollars in thousands)      As of June 30, 2013 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                    
Available-for-sale securities                    
U. S. treasury securities  $498   $498   $-   $- 
U. S. federal agency obligations   19,312    -    19,312    - 
Municipal obligations, tax exempt   85,973    -    85,973    - 
Municipal obligations, taxable   51,606    -    51,606    - 
Mortgage-backed securities   73,322    -    73,322    - 
Common stocks   1,022    1,022    -    - 
Certificates of deposit   6,743    -    6,743    - 
Derivative financial instruments   240    -    240    - 
Liabilities:                    
Derivative financial instruments  $43   $-   $43   $- 

 

(Dollars in thousands)      As of December 31, 2012 
       Fair value hierarchy 
   Total   Level 1   Level 2   Level 3 
Assets:                    
Available-for-sale securities                    
U. S. federal agency obligations  $8,848   $-   $8,848   $- 
Municipal obligations, tax exempt   77,286    -    77,286    - 
Municipal obligations, taxable   38,142    -    38,142    - 
Mortgage-backed securities   81,848    -    81,848    - 
Common stocks   902    902    -    - 
Certificates of deposit   6,274    -    6,274    - 
Derivative financial instruments   334    -    334    - 
Liabilities:                    
Derivative financial instruments  $28   $-   $28   $- 

 

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Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other-than-temporary impairments. Other-than-temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other-than-temporary results in a write-down of that security’s cost basis.

 

Valuation Methods for Instruments Measured at Fair Value on a Nonrecurring Basis

 

The Company does not value its loan portfolio at fair value, however adjustments are recorded on certain loans to reflect the impaired value on the underlying collateral. Collateral values are reviewed on a loan-by-loan basis through independent appraisals. Appraised values may be discounted based on management’s historical knowledge, changes in market conditions and/or management’s expertise and knowledge of the client and the client’s business. Because many of these inputs are unobservable, the valuations are classified as Level 3. The carrying value of the Company’s impaired loans was $13.3 million at June 30, 2013 and $14.5 million at December 31, 2012, with allocated allowances of $430,000 and $901,000, respectively.

 

The Company measures the fair value of its goodwill based on the Company’s market capitalization with appropriate control premiums and valuation multiples, as compared to recent similar financial industry acquisition multiples, to estimate the fair value of the Company’s single reporting unit. The fair value measurements are classified as Level 3. Core deposit intangibles are recognized at the time core deposits are acquired, using valuation techniques which calculate the present value of the estimated net cost savings relative to the Company’s alternative costs of funds over the expected remaining economic life of the deposits. Subsequent evaluations are made when facts or circumstances indicate potential impairment may have occurred. The models incorporate market discount rates, estimated average core deposit lives and alternative funding rates. The fair value measurements are classified as Level 3.

 

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, determined on an aggregate basis. The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2.

 

Real estate owned includes assets acquired through, or in lieu of, foreclosure and land previously acquired for expansion. Real estate owned is initially recorded at the fair value of the collateral less estimated selling costs. Subsequent valuations are updated periodically and are based upon independent appraisals, third party price opinions or internal pricing models and are classified as Level 3.

 

The following table represents the Company’s financial instruments that are measured at fair value on a non-recurring basis as of June 30, 2013 and December 31, 2012 allocated to the appropriate fair value hierarchy:

 

(Dollars in thousands)                    
       As of June 30, 2013     
       Fair value hierarchy   Total gains 
   Total   Level 1   Level 2   Level 3   / (losses) 
Assets:                         
Impaired loans  $12,843   $-   $-   $12,843   $54 
Loans held for sale, net   8,000    -    8,000    -    - 
Mortgage servicing rights   2,749    -    -    2,749    212 
Real estate owned, net  $2,321   $-   $-   $2,321   $(26)

 

       As of December 31, 2012     
       Fair value hierarchy   Total gains 
   Total   Level 1   Level 2   Level 3   / (losses) 
Assets:                         
Impaired loans  $13,632   $-   $-   $13,632   $(758)
Loans held for sale, net   7,179    -    7,179    -    - 
Mortgage servicing rights   1,859    -    -    1,859    (212)
Real estate owned, net  $2,444   $-   $-   $2,444   $(175)

  

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8.            Impact of Recent Accounting Pronouncements

 

In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments require an entity to present, either in the income statement or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety, an entity is required to cross-reference to other disclosures that provide additional detail about those amounts. This ASU became effective for annual and interim periods beginning January 1, 2013. Adoption of ASU 2013-02 did not have a significant impact on the Company’s consolidated financial statements.

 

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists. To eliminate diversity in practice, ASU 2013-11 provides explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU is effective for annual and interim periods beginning after December 15, 2013. Adoption of ASU 2013-11 is not expected to have a significant impact on the Company’s consolidated financial statements.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview. Landmark Bancorp, Inc. is a one-bank holding company incorporated under the laws of the State of Delaware and is engaged in the banking business through its wholly-owned subsidiary, Landmark National Bank. Landmark Bancorp is listed on the Nasdaq Global Market under the symbol “LARK”. Landmark National Bank is dedicated to providing quality financial and banking services to its local communities. Our overall strategy includes continuing a tradition of quality assets while growing our commercial and commercial real estate loan portfolios. We are committed to developing relationships with our borrowers and providing a total banking service.

 

Landmark National Bank is principally engaged in the business of attracting deposits from the general public and using such deposits, together with borrowings and other funds, to originate one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans. Although not our primary business function, we also invest in certain investment and mortgage-related securities using deposits and other borrowings as funding sources.

 

Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by non-interest income, such as service charges, loan fees and gains from the sale of newly originated loans and gains or losses on investments. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, advertising, federal deposit insurance costs, data processing expenses and provision for loan losses.

 

We are significantly impacted by prevailing economic conditions including federal monetary and fiscal policies and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and interest rate pricing competition from other lending institutions.

 

Our business consists of ownership of Landmark National Bank, with its main office in Manhattan, Kansas and twenty one branch offices across the state of Kansas as of June 30, 2013.

 

Critical Accounting Policies. Critical accounting policies are those which are both most important to the portrayal of our financial condition and results of operations, and require our management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to the allowance for loan losses, valuation of real estate owned, valuation of investment securities and accounting for income taxes, all of which involve significant judgment by our management. Information about our critical accounting policies is included under Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2012.

 

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Summary of Results. During the second quarter of 2013, we recorded net earnings of $1.4 million, which was a decline from the $1.8 million of net earnings in the second quarter of 2012. In the first six months of 2013, our net earnings were $2.8 million, a decline from the $3.5 million of net earnings recorded in the same period of 2012. The decline from our 2012 record net earnings was primarily driven by a decline in gains on sales of loans, as one-to-four family residential mortgage loan originations volumes declined in the 2013 periods. Our net interest income also declined as low interest rates over the past year continued to decrease our net interest margin. Further, gains on sale of investment securities contributed to higher net earnings in 2012, with no such gains occurring in the comparable periods of 2013.

 

The following table summarizes earnings and key performance measures for the periods presented.

 

(Dollars in thousands, except per share amounts)  Three months ended June 30,   Six months ended June 30, 
   2013   2012   2013   2012 
Net earnings:                    
Net earnings  $1,409   $1,818   $2,849   $3,545 
Basic earnings per share (1)  $0.48   $0.62   $0.97   $1.21 
Diluted earnings per share (1)  $0.47   $0.62   $0.96   $1.21 
Earnings ratios:                    
Return on average assets (2)   0.88%   1.12%   0.90%   1.14%
Return on average equity (2)   8.79%   12.00%   8.98%   11.81%
Equity to total assets   9.72%   9.31%   9.72%   9.31%
Net interest margin (2) (3)   3.34%   3.51%   3.36%   3.57%
Dividend payout ratio   40.43%   29.23%   39.58%   29.92%

 

(1) Per share values for the periods ended June 30, 2012 have been adjusted to give effect to the 5% stock dividend paid during December 2012.

(2) Ratios have been annualized and are not necessarily indicative of the results for the entire year.

(3) Net interest margin is presented on a fully tax equivalent basis, using a 34% federal tax rate.

 

Interest Income. Interest income for the quarter ended June 30, 2013 decreased $525,000 to $5.2 million, a decrease of 9.2% as compared to the same period of 2012. Interest income on loans decreased $308,000, or 7.2%, to $4.0 million for the quarter ended June 30, 2013, due to lower tax equivalent yields earned on loans. Our average tax equivalent yield on loans decreased to 4.99% in the second quarter of 2013 from 5.53% in the same period of 2012. Partially offsetting the lower tax equivalent yields was an increase in our average loan balances, which increased to $323.4 million from $316.4 million over the same periods. Interest income on investment securities decreased $217,000, or 15.2%, to $1.2 million for the second quarter of 2013, as compared to the same period of 2012. The decrease in interest income on investment securities was due to a decline in the tax equivalent yield on our investment portfolio from 2.72% during the second quarter of 2012 to 2.48% during the second quarter of 2013. The yield on our investment securities declined as the current interest rate environment resulted in the purchase of lower yielding investment securities with funds from the maturities, prepayments and sales of higher yielding investment securities. Also contributing to the decline in interest income on investment securities was lower average balances of investment securities, which decreased from $254.1 million during the second quarter of 2012 to $241.7 million during the second quarter of 2013.

 

Interest income for the six months ended June 30, 2013 decreased $879,000 to $10.4 million, a decrease of 7.8% as compared to the same period of 2012. Interest income on loans decreased $588,000, or 6.9%, to $8.0 million for the first six months of 2013, due to lower tax equivalent yields earned on loans. Our average tax equivalent yield on loans decreased to 5.01% in the first six months of 2013 from 5.50% in the same period of 2012. Partially offsetting the lower tax equivalent yields was an increase in our average loan balances, which increased to $322.6 million from $315.5 million over the same periods. Interest income on investment securities decreased $291,000, or 10.7%, to $2.4 million for the six months ending June 30, 2013, as compared to the same period of 2012. The decrease in interest income on investment securities was due to a decline in the tax equivalent yield on our investment portfolio from 2.89% during the first half of 2012 to 2.61% during the same period of 2013. Partially offsetting the lower yield on investment securities was higher average balances of investment securities, which increased from $229.7 million during the first six months of 2012 to $231.0 million during the first half of 2013, resulting in part from our purchases of additional investment securities with excess liquidity and in part from our acquisition of The Wellsville Bank, which was completed in the second quarter of 2012.

 

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Interest Expense. Interest expense during the quarter ended June 30, 2013 decreased $257,000, or 25.3%, to $758,000 as compared to the same period of 2012. For the second quarter of 2013, interest expense on interest-bearing deposits decreased $229,000, or 39.8%, to $346,000 as a result of lower rates paid on our certificates of deposit, money market, NOW and savings accounts and lower average balances. Our total cost of deposits declined from 0.52% during the second quarter of 2012 to 0.33% during the same period of 2013 as we were able to reprice our deposits lower in the current low rate environment. Our average interest-bearing deposit balances decreased from $441.7 million for the second quarter of 2012 to $425.9 million for the second quarter of 2013 due lower average balances of certificates of deposits. For the second quarter of 2013, interest expense on borrowings decreased $28,000, or 6.4%, to $412,000 due to a lower average rate on our borrowings. Our average cost of borrowings decreased from 3.02% in the second quarter of 2012 to 2.69% in the same period of 2013. Partially offsetting the lower cost of borrowings was an increase in our average outstanding borrowings from $58.6 million in the second quarter of 2012 to $61.5 million in the same period of 2013.

 

Interest expense during the six months ended June 30, 2013 decreased $501,000, or 24.4%, to $1.6 million as compared to the same period of 2012. For the first half of 2013, interest expense on interest-bearing deposits decreased $435,000, or 37.3%, to $732,000 as a result of lower rates paid on our certificates of deposit, money market, NOW and savings accounts. Our total cost of deposits declined from 0.56% during the first six months of 2012 to 0.35% during the same period of 2013 as we were able to reprice our deposits lower in the current low rate environment. Our average interest-bearing deposit balances increased from $422.1 million for the first six months of 2012 to $425.0 million for the first six months of 2013 due to both our organic growth and our acquisition of The Wellsville Bank. The deposit growth occurred in our money market, NOW and savings accounts, while our certificates of deposit balances declined. For the first half of 2013, interest expense on borrowings decreased $66,000, or 7.4%, to $821,000 due primarily to a lower average rate on our borrowings. Our average cost of borrowings decreased from 2.96% in the first half of 2012 to 2.77% in the same period of 2013. Also contributing to the decline in interest expense on borrowings was a slight decrease in our average outstanding borrowings decreased from $60.2 million in the first six months of 2012 to $59.7 million in the same period of 2013.

 

Net Interest Income. Net interest income decreased $268,000, or 5.7%, for the second quarter of 2013 to $4.4 million compared to the same period of 2012. The lower net interest income resulted from a decline in our net interest margin, on a tax equivalent basis, to 3.34% during the second quarter of 2013 compared to 3.51% during the same period of 2012. Net interest margin declined as we were unable to lower the costs of our interest-bearing liabilities to the extent necessary to offset the decline in our yields on assets in this low rate environment. Also contributing to lower net interest income was a decline in our average interest-earning assets from $580.3 million in the second quarter of 2012 to $573.0 million in the second quarter of 2013.

 

Net interest income decreased $378,000, or 4.1%, for the six months of 2013 to $8.8 million compared to the same period of 2012. The lower net interest income resulted from a decline in our net interest margin, on a tax equivalent basis, to 3.36% during the first half of 2013 compared to 3.57% during the same period of 2012. Net interest margin declined as we were unable to lower the costs of our interest-bearing liabilities to the extent necessary to offset the decline in our yields on assets in this low rate environment. Partially offsetting the lower net interest margin was an increase in average interest-earning assets from $557.5 million during the first six months of 2012 to $569.2 million during the same period of 2013, primarily as a result of the acquisition of The Wellsville Bank.

 

See the Average Assets/Liabilities and Rate/Volume tables at the end of Item 2 “Management’s Discussion and Analysis of Financial Condition” for additional details on asset yields, liability rates and net interest margin.

 

Provision for Loan Losses. We maintain, and our Board of Directors monitors, an allowance for losses on loans. The allowance is established based upon management's periodic evaluation of known and inherent risks in the loan portfolio, review of significant individual loans and collateral, review of delinquent loans, past loss experience, adverse situations that may affect the borrowers’ ability to repay, current and expected market conditions, and other factors management deems important. Determining the appropriate level of reserves involves a high degree of management judgment and is based upon historical and projected losses in the loan portfolio and the collateral value of specifically identified problem loans. Additionally, allowance policies are subject to periodic review and revision in response to a number of factors, including current market conditions, actual loss experience and management’s expectations.

 

We recorded $300,000 of provision for loan losses during the second quarters of both 2013 and 2012. We recorded net loan charge-offs of $29,000 during the second quarter of 2013 compared to net loan charge-offs of $42,000 during the same period of 2012.

 

Our provision for loan losses totaled $600,000 of during the first six months of both 2013 and 2012. We recorded net loan charge-offs of $276,000 during the first six months of 2013 compared to net loan charge-offs of $35,000 during the same period of 2012. The increase in charge-offs in the six months ended June 30, 2013 was principally associated with liquidating the assets securing a previously identified and impaired $1.1 million commercial loan relationship, which was fully reserved as of December 31, 2012.

 

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For further discussion of the allowance for loan losses, refer to the “Asset Quality and Distribution” section.

 

Non-interest Income. Total non-interest income decreased $485,000, or 16.0%, to $2.5 million in the second quarter of 2013 compared to the same period of 2012. The decline in non-interest income was the result of a $546,000 decrease in gains on sales of loans as the volume of loans sold in the secondary market was lower in the second quarter of 2013 compared to a year earlier. In addition, an increase in mortgage rates caused us to record a $325,000 valuation allowance against our loans held for sale as of June 30, 2013, recognized in gains on sales of loans, as the estimated fair value of these loans declined. The valuation allowance will be reversed as the loans are sold for their full principal amount in the third quarter. Further increases in mortgage rates may further reduce our gains on sales of loans in future periods as the origination volumes associated with refinancing slows. Partially offsetting the decline in gains on sales of loans was an $88,000 increase in fees and service charges as a result of additional fees and service charges received on our deposit accounts and service fee income on one-to-four family residential real estate loans serviced for others.

 

Total non-interest income decreased $523,000, or 9.2%, to $5.2 million in the first six months of 2013 compared to the same period of 2012. The decrease in non-interest income was the result of a $720,000 decrease in gains on sales of loans due to lower volumes of loans sold in the secondary market and a $325,000 valuation allowance recorded against our loans held for sale as of June 30, 2013 recognized in gains on sales of loans,. Partially offsetting the decline in gains on sales of loans, was a $222,000 increase in fees and service charges as a result of additional fees and service charges received on our deposit accounts and service fee income on one-to-four family residential real estate loans serviced for others.

 

Investment Securities Gains, Net. During the second quarter of 2012, we recognized $132,000 in gains on sales of investment securities as a result of selling approximately $2.5 million of mortgage-backed investment securities, as we capitalized on what we believed to be premium pricing that existed in the markets for these types of securities at the time. No such gains or losses were realized during the second quarter of 2013.

 

During the first six months of 2012, we recognized $359,000 in gains on sales of investment securities as a result of selling approximately $8.0 million of mortgage-backed investment securities. Partially offsetting the gains on sales of investment securities was a credit-related, other-than-temporary impairment loss of $63,000 recognized during the first quarter of 2012 on one of our investments in pooled trust preferred securities. We sold our portfolio of pooled trust preferred investment securities during the fourth quarter of 2012. No such gains or losses were realized during the first six months of 2013.

 

Non-interest Expense. Non-interest expense decreased $267,000, or 5.2%, to $4.9 million for the second quarter of 2013 compared to a year earlier. The decrease in non-interest expense was primarily the result of a $198,000 decline in amortization expense, which was impacted by the reversal in 2013 of a $212,000 valuation allowance against our mortgage servicing rights as an increase in mortgage rates increased the estimated fair value of these assets.

 

Non-interest expense decreased $115,000, or 1.2%, to $9.7 million for the first six months of 2013 compared to a year earlier. The decrease in non-interest expense was primarily the result of a $186,000 decline in amortization expense which was impacted by the reversal in 2013 of a $212,000 valuation allowance against our mortgage servicing rights. Partially offsetting the lower amortization expense were increases of $98,000 in compensation and benefits, $49,000 in federal deposit insurance premiums and $44,000 in data processing primarily as a result of our acquisition of The Wellsville Bank.

 

Income Tax Expense. During the second quarter of 2013, we recorded income tax expense of $417,000, compared to $626,000 during the same period of 2012. Our effective tax rate decreased from 25.6% in the second quarter of 2012 to 22.8% in the second quarter of 2013 as a result of lower earnings before income taxes, while tax-exempt income remained stable between the periods.

 

During the first six months of 2013, we recorded income tax expense of $812,000, compared to $1.2 million during the same period of 2012. Our effective tax rate decreased from 25.3% in the first half of 2012 to 22.2% in the same period of 2013 as a result of lower earnings before income taxes, while tax-exempt income remained stable between the periods.

 

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Financial Condition. Despite measured improvement in certain metrics, general economic conditions in the United States, including difficult credit markets, depressed residential and commercial real estate values, generally depressed consumer confidence, heightened unemployment and decreased consumer spending continue to affect our asset quality and performance. Even though the geographic markets in which the Company operates have been impacted by these economic conditions in recent years, the effect has not been as severe as those experienced in some areas of the United States. In addition, our loan portfolio is diversified across various types of loans and collateral throughout the markets in which we operate. Despite a few lingering problem loans that management is working to resolve, our asset quality has generally improved over the past few years. Outside of identified problem assets, management believes that it continues to have a high quality asset base and solid core earnings, and anticipates that its efforts to run a high quality financial institution with a sound asset base will continue to create a strong foundation for continued growth and profitability in the future.

 

Asset Quality and Distribution. Our primary investing activities are the origination of commercial real estate, commercial and consumer loans and the purchase of investment and mortgage-backed securities. Total assets increased to $641.9 million at June 30, 2013, compared to $614.1 million at December 31, 2012. Net loans, excluding loans held for sale, increased to $321.3 million at June 30, 2013 from $315.9 million at December 31, 2012. The $5.4 million increase in loans was primarily the result higher outstanding balances of commercial real estate, one-to-four family residential real estate and agriculture loans. Partially offsetting those increases were lower balances in our commercial, municipal, consumer and construction and land loans. The decline in these loan balances is the result of multiple factors, including reduced loan demand from our customers, seasonal factors and early payoffs. Generally, we originate fixed-rate, residential mortgage loans with maturities in excess of ten years for sale in the secondary market. These loans are typically sold soon after the loan closing. We also retain some of our newly originated one-to-four family residential real estate loans that meet internal criteria as well as secondary market qualifications. We typically only retain loans with maturities of 15 years or less. While we do not intend to significantly increase our one-to-four family residential real estate loan portfolio, we are currently slowing the normal runoff of the portfolio by retaining some of the new loan originations to offset weak commercial loan demand; however, most of the new loan originations will still be sold. We do not originate and warehouse these fixed-rate residential loans for resale in order to speculate on interest rates.

 

The allowance for loan losses is established through a provision for loan losses based on our evaluation of the risk inherent in the loan portfolio and changes in the nature and volume of our loan activity. This evaluation, which includes a review of all loans with respect to which full collectability may not be reasonably assured, considers the fair value of the underlying collateral, economic conditions, historical loan loss experience, level of classified loans and other factors that warrant recognition in providing for an appropriate allowance for loan losses. At June 30, 2013, our allowance for loan losses totaled $4.9 million, or 1.50% of gross loans outstanding, as compared to $4.6 million, or 1.43% of gross loans outstanding, at December 31, 2012.

 

Loans past due 30-89 days and still accruing interest totaled $2.1 million, or 0.65% of gross loans at June 30, 2013 compared to $2.2 million, or 0.69% of gross loans, at December 31, 2012. At June 30, 2013, $6.1 million in loans were on non-accrual status, or 1.88% of gross loans, compared to a balance of $9.1 million, or 2.84% of gross loans, at December 31, 2012. Non-accrual loans consist of loans 90 or more days past due and certain impaired loans. The decrease in non-accrual loans was principally associated with two loans. During the second quarter, a $1.5 million land loan was returned to accrual status after a payment history was established based on the terms of the TDR that occurred in 2012. Also reducing our non-accrual loan balances was the pay down of a $1.1 million commercial loan with proceeds from the liquidation of the borrower’s assets in the first quarter of 2013. The remaining loan balance of $192,000 was charged off during the first quarter of 2013. There were no loans 90 days delinquent and still accruing interest at June 30, 2013 or December 31, 2012. Our impaired loans totaled $13.3 million at June 30, 2013 compared to $14.5 million at December 31, 2012. The difference in the Company’s non-accrual loan balances and impaired loan balances at June 30, 2013 was related to troubled debt restructurings that are current but still classified as impaired. We recorded net loan charge-offs of $276,000 during the first six months of 2013 compared to net loan charge-offs of $35,000 during the same period of 2012. The increase in charge-offs in the six months ended June 30, 2013 was principally associated with liquidating the assets securing a previously identified and impaired $1.1 million commercial loan relationship, which was fully reserved as of December 31, 2012.

 

At June 30, 2013, the Company had eight loan relationships consisting of twelve outstanding loans that were classified as TDRs compared to eight relationships consisting of thirteen outstanding loans at December 31, 2012. During the first six months of 2013, the Company classified a $278,000 commercial real estate loan as a TDR after modifying the loan payments to interest only in order to allow the borrower additional time to liquidate the properties securing the loan. Since the loan was adequately secured, no impairment was recorded against the principal as of June 30, 2013.

 

26
 

 

During 2012, the Company classified a commercial loan relationship consisting of two commercial loans as a TDR after agreeing to extend the maturity of the loans while the borrower liquidated the business assets securing the loans. The loans were repaid in the first quarter of 2013 and resulted in a net charge-off of $6,000.

 

As part of our credit risk management, we continue to manage the loan portfolio to identify problem loans and have placed additional emphasis on commercial real estate and construction and land relationships. We are working to resolve the remaining problem credits or move the non-performing credits out of the loan portfolio. At June 30, 2013, we had $2.3 million of real estate owned compared to $2.4 million at December 31, 2012. Real estate owned primarily consists of a residential subdivision development we took possession of after the development slowed and the borrower was unable to comply with the contractual terms of the loan, a commercial real estate building resulting from a loan settlement, land previously acquired by Landmark National Bank for expansion and a few residential real estate properties. During the second quarter of 2013, the Company agreed to sell the residential subdivision development and the land previously acquired for expansion. The book value of these two properties totaled $999,000 at June 30, 2013 and the transactions closed in July 2013. The book values at June 30, 2013 reflected the net sale prices. The Company is currently marketing all of the other properties in real estate owned.

 

Many financial institutions, including us, experienced a general increase in non-performing assets during recent years, as even well-established business borrowers developed cash flow, profitability and other business-related problems as a result of economic conditions. While we believe that our allowance for loan losses at June 30, 2013 and December 31, 2012 was appropriate, there can be no assurances that loan losses will not exceed the estimated amounts. We believe that we use the best information available to determine the allowance for loan losses; however, unforeseen market conditions could result in adjustment to the allowance for loan losses. In addition, net earnings could be significantly affected if circumstances differ substantially from the assumptions used in establishing the allowance for loan losses. Deterioration in the local economy or real estate values may create additional problem loans for us and require further adjustment to our allowance for loan losses.

 

Liability Distribution. Our primary ongoing sources of funds are deposits, FHLB borrowings, proceeds from principal and interest payments on loans and investment securities and proceeds from the sale of mortgage loans and investment securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates and economic conditions. We experienced a $17.7 million increase in total deposits during the first six months of 2013, to $500.2 million at June 30, 2013, from $482.5 million at December 31, 2012. The growth occurred in our non-interest-bearing demand, money market and NOW and savings accounts, while our time deposit balances declined. Total borrowings increased $8.8 million to $68.8 million at June 30, 2013, from $60.0 million at December 31, 2012. The increase was primarily the result of an increase in borrowings on our FHLB line of credit.

 

Non-interest-bearing deposits at June 30, 2013 were $80.9 million, or 16.2% of deposits, compared to $75.9 million, or 15.7%, at December 31, 2012. Money market and NOW deposit accounts were 41.6% of our deposit portfolio and totaled $208.1 million at June 30, 2013, compared to $190.3 million, or 39.5%, at December 31, 2012. Savings accounts increased to $49.9 million, or 10.0% of deposits, at June 30, 2013, from $45.4 million, or 9.4%, at December 31, 2012. Certificates of deposit decreased to $161.3 million, or 32.2% of deposits, at June 30, 2013, from $170.9 million, or 35.4%, at December 31, 2012.

 

Certificates of deposit at June 30, 2013, which are scheduled to mature in one year or less, totaled $100.7 million. Historically, maturing deposits have generally remained with our bank and we believe that a significant portion of the deposits maturing in one year or less will remain with us upon maturity.

 

Cash Flows. During the six months ended June 30, 2013, our cash and cash equivalents decreased by $4.7 million. Our operating activities provided net cash of $6.1 million during the first six months of 2013. Our investing activities used net cash of $36.6 million during the first six months of 2013 as we purchased investment securities with our excess liquidity and our outstanding loan balances increased. Financing activities provided net cash of $25.7 million during the first half of 2013 as a result of increased deposits and borrowings on our FHLB line of credit.

 

Liquidity. Our most liquid assets are cash and cash equivalents and investment securities available for sale. The levels of these assets are dependent on the operating, financing, lending and investing activities during any given period. These liquid assets totaled $248.7 million at June 30, 2013 and $228.2 million at December 31, 2012. During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments, we increase our liquid assets by investing in short-term, high-grade investments.

 

27
 

 

Liquidity management is both a daily and long-term function of our strategy. Excess funds are generally invested in short-term investments. In the event we require funds beyond our ability to generate them internally, additional funds are generally available through the use of FHLB advances, a line of credit with the FHLB, other borrowings or through sales of investment securities. At June 30, 2013, we had outstanding FHLB advances of $35.7 million and $10.1 million of borrowings against our line of credit with the FHLB. At June 30, 2013, we had collateral pledged to the FHLB that would allow us to borrow an additional $16.7 million, subject to FHLB credit requirements and policies. At June 30, 2013, we had no borrowings through the Federal Reserve discount window, while our borrowing capacity was $14.9 million. We also have various other fed funds agreements, both secured and unsecured, with correspondent banks totaling approximately $50.0 million under which we had no outstanding borrowings at June 30, 2013. We had other borrowings of $23.0 million at June 30, 2013, which included $16.5 million of subordinated debentures and $6.5 million in repurchase agreements. The Company has a $7.5 million line of credit from an unrelated financial institution maturing on November 5, 2013, with an interest rate that adjusts daily based on the prime rate plus 0.25%, but not less than 4.00%. This line of credit has covenants specific to capital and other financial ratios, which the Company was in compliance with at June 30, 2013. There was no outstanding balance on the line of credit at June 30, 2013.

 

Off Balance Sheet Arrangements. As a provider of financial services, we routinely issue financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by us generally to guarantee the payment or performance obligation of a customer to a third party. While these standby letters of credit represent a potential outlay by us, a significant amount of the commitments may expire without being drawn upon. We have recourse against the customer for any amount the customer is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by us. Most of the standby letters of credit are secured, and in the event of nonperformance by the customers, we have the right to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The contract amount of these standby letters of credit, which represents the maximum potential future payments guaranteed by us, was $1.8 million at June 30, 2013.

 

At June 30, 2013, we had outstanding loan commitments, excluding standby letters of credit, of $63.3 million. We anticipate that sufficient funds will be available to meet current loan commitments. These commitments consist of unfunded lines of credit and commitments to finance real estate loans.

 

Capital. Current regulatory capital regulations require financial institutions (including banks and bank holding companies) to meet certain regulatory capital requirements. Institutions are required to have minimum leverage capital equal to 4% of total average assets and total qualifying capital equal to 8% of total risk weighted assets in order to be considered “adequately capitalized.” As of June 30, 2013 and December 31, 2012, both the Company and Landmark National Bank were rated “well capitalized,” which is the highest rating available under the regulatory capital regulations framework for prompt corrective action. Management believes that as of June 30, 2013, the Company and Landmark National Bank met all capital adequacy requirements to which we are subject.

 

The following is a comparison of the Company’s regulatory capital to minimum capital requirements at June 30, 2013 and December 31, 2012:

 

                   To be well-capitalized 
                   under prompt 
(Dollars in thousands)      For capital   corrective 
   Actual   adequacy purposes   action provisions 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of June 30, 2013                              
Leverage  $64,615    10.29%  $25,124    4.00%  $31,405    5.00%
Tier 1 Capital  $64,615    16.73%  $15,449    4.00%  $23,174    6.00%
Total Risk Based Capital  $69,634    18.03%  $30,898    8.00%  $38,623    10.00%
                               
As of December 31, 2012                              
Leverage  $61,839    10.09%  $24,504    4.00%  $30,631    5.00%
Tier 1 Capital  $61,839    16.39%  $15,092    4.00%  $22,638    6.00%
Total Risk Based Capital  $67,273    17.83%  $30,184    8.00%  $37,731    10.00%

 

28
 

 

The following is a comparison of Landmark National Bank’s regulatory capital to minimum capital requirements at June 30, 2013 and December 31, 2012:

 

                   To be well-capitalized 
                   under prompt 
(Dollars in thousands)      For capital   corrective 
   Actual   adequacy purposes   action provisions 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of June 30, 2013                              
Leverage  $63,071    10.07%  $25,046    4.00%  $31,308    5.00%
Tier 1 Capital  $63,071    16.40%  $15,386    4.00%  $23,079    6.00%
Total Risk Based Capital  $67,881    17.65%  $30,771    8.00%  $38,464    10.00%
                               
As of December 31, 2012                              
Leverage  $60,463    9.90%  $24,433    4.00%  $30,541    5.00%
Tier 1 Capital  $60,463    16.09%  $15,029    4.00%  $22,543    6.00%
Total Risk Based Capital  $65,124    17.33%  $30,057    8.00%  $37,571    10.00%

 

Dividends. During the quarter ended June 30, 2013, we paid a quarterly cash dividend of $0.19 per share to our stockholders.

 

The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. As described above, Landmark National Bank exceeded its minimum capital requirements under applicable guidelines as of June 30, 2013. The National Bank Act imposes limitations on the amount of dividends that a national bank may pay without prior regulatory approval. Generally, the amount is limited to the bank's current year's net earnings plus the adjusted retained earnings for the two preceding years. As of June 30, 2013, approximately $4.7 million was available to be paid as dividends to the Company by Landmark National Bank without prior regulatory approval.

 

Additionally, our ability to pay dividends is limited by the subordinated debentures that are held by two business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock.

 

29
 

 

Average Assets/Liabilities. The following tables reflects the tax equivalent yields earned on average interest-earning assets and costs of average interest-bearing liabilities for the periods indicated (derived by dividing income or expense by the monthly average balance of assets or liabilities, respectively) as well as “net interest margin” (which reflects the effect of the net earnings balance) for the periods shown:

 

   Three months ended   Three months ended 
   June 30, 2013   June 30, 2012 
   Average
balance
   Interest   Average
yield/rate
   Average
balance
   Interest   Average
yield/rate
 
   (Dollars in thousands) 
Assets                              
Interest-earning assets:                              
Interest-bearing deposits at banks  $7,881   $10    0.51%  $9,901   $9    0.37%
Investment securities (1)   241,671    1,496    2.48%   254,059    1,720    2.72%
Loans receivable, net (2)   323,446    4,021    4.99%   316,377    4,348    5.53%
Total interest-earning assets   572,998    5,527    3.87%   580,337    6,077    4.21%
Non-interest-earning assets   68,385              71,219           
Total  $641,383             $651,556           
                               
Liabilities and Stockholders' Equity                              
Interest-bearing liabilities:                              
Money market and NOW accounts  $211,733   $41    0.08%  $211,737   $85    0.16%
Savings accounts   49,946    4    0.03%   46,348    8    0.07%
Certificates of deposit   164,194    301    0.74%   183,621    482    1.06%
Total deposits   425,873    346    0.33%   441,706    575    0.52%
FHLB advances and other borrowings   61,543    412    2.69%   58,604    440    3.02%
Total interest-bearing liabilities   487,416    758    0.62%   500,310    1,015    0.82%
Non-interest-bearing liabilities   89,706              90,308           
Stockholders' equity   64,261              60,938           
Total  $641,383             $651,556           
                               
Interest rate spread (3)             3.25%             3.39%
Net interest margin (4)       $4,769    3.34%       $5,062    3.51%
Tax equivalent interest - imputed        323              348      
Net interest income       $4,446             $4,714      
                               
Ratio of average interest-earning assets to average interest-bearing liabilities             117.6%             116.0%

 

 

(1)Income on tax exempt securities is presented on a fully tax equivalent basis, using a 34% federal tax rate.
(2)Includes loans classified as non-accrual. Income on tax exempt loans is presented on a fully tax equivalent basis, using a 34% federal tax rate.
(3)Interest rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(4)Net interest margin represents annualized, tax-equivalent net interest income divided by average interest-earning assets.

 

30
 

 

   Six months ended   Six months ended 
   June 30, 2013   June 30, 2012 
   Average
balance
   Interest   Average
yield/rate
   Average
balance
   Interest   Average
yield/rate
 
   (Dollars in thousands) 
Assets                              
Interest-earning assets:                              
Interest-bearing deposits at banks  $15,606   $20    0.26%  $12,245   $11    0.18%
Investment securities (1)   231,019    2,996    2.61%   229,746    3,303    2.89%
Loans receivable, net (2)   322,562    8,020    5.01%   315,477    8,633    5.50%
Total interest-earning assets   569,187    11,036    3.91%   557,468    11,947    4.31%
Non-interest-earning assets   67,806              69,199           
Total  $636,993             $626,667           
                               
Liabilities and Stockholders' Equity                              
Interest-bearing liabilities:                              
Money market and NOW accounts  $209,619   $88    0.08%  $199,582   $173    0.17%
Savings accounts   48,815    8    0.03%   42,723    18    0.08%
Certificates of deposit   166,571    636    0.77%   179,803    976    1.09%
 Total deposits   425,005    732    0.35%   422,108    1,167    0.56%
 FHLB advances and other borrowings   59,702    821    2.77%   60,163    887    2.96%
Total interest-bearing liabilities   484,707    1,553    0.65%   482,271    2,054    0.86%
Non-interest-bearing liabilities   88,343              84,040           
Stockholders' equity   63,943              60,356           
Total  $636,993             $626,667           
                               
Interest rate spread (3)             3.26%             3.45%
Net interest margin (4)       $9,483    3.36%       $9,893    3.57%
Tax equivalent interest - imputed        655              687      
Net interest income       $8,828             $9,206      
                               
Ratio of average interest-earning assets  to average interest-bearing liabilities             117.4%             115.6%

 

(1)Income on tax exempt securities is presented on a fully tax equivalent basis, using a 34% federal tax rate.
(2)Includes loans classified as non-accrual. Income on tax exempt loans is presented on a fully tax equivalent basis, using a 34% federal tax rate.
(3)Interest rate spread represents the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities.
(4)Net interest margin represents annualized, tax-equivalent net interest income divided by average interest-earning assets.

 

31
 

 

Rate/Volume Table. The following table describes the extent to which changes in tax equivalent interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities affected the Company’s interest income and expense for periods indicated. The table distinguishes between (i) changes attributable to rate (changes in rate multiplied by prior volume), (ii) changes attributable to volume (changes in volume multiplied by prior rate), and (iii) net change (the sum of the previous columns). The net changes attributable to the combined effect of volume and rate that cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

 

   Three months ended June 30,   Six months ended June 30, 
   2013 vs 2012   2013 vs 2012 
   Increase/(decrease) attributable to   Increase/(decrease) attributable to 
   Volume   Rate   Net   Volume   Rate   Net 
   (Dollars in thousands)   (Dollars in thousands) 
Interest income:                              
Interest-bearing deposits at banks  $(1)  $2   $1   $3   $6   $9 
Investment securities   (80)   (144)   (224)   19    (326)   (307)
Loans   97    (424)   (327)   207    (820)   (613)
Total   16    (566)   (550)   229    (1,140)   (911)
Interest expense:                              
Deposits   (20)   (209)   (229)   8    (443)   (435)
Other borrowings   24    (52)   (28)   (7)   (59)   (66)
Total   4    (261)   (257)   1    (502)   (501)
Net interest income  $12   $(305)  $(293)  $228   $(638)  $(410)

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Our assets and liabilities are principally financial in nature and the resulting net interest income thereon is subject to changes in market interest rates and the mix of various assets and liabilities. Interest rates in the financial markets affect our decision on pricing our assets and liabilities, which impacts net interest income, a significant cash flow source for us. As a result, a substantial portion of our risk management activities relates to managing interest rate risk.

 

Our Asset/Liability Management Committee monitors the interest rate sensitivity of our balance sheet using earnings simulation models. We have set policy limits of interest rate risk to be assumed in the normal course of business and monitor such limits through our simulation process.

 

We have been successful in meeting the interest rate sensitivity objectives set forth in our policy. Simulation models are prepared to determine the impact on net interest income for the coming twelve months, including one using rates at June 30, 2013, and forecasting volumes for the twelve-month projection. This position is then subjected to a shift in interest rates of 100 and 200 basis points with an impact to our net interest income on a one-year horizon as follows:

 

   Dollar change in net   Percent change in 
Scenario  interest income ($000’s)   net interest income 
200 basis point rising  $446    6.6%
100 basis point rising  $270    3.5%
 100 basis point falling  $(941)   (5.7)%
 200 basis point falling   NM    NM 

 

The 200 basis point falling scenario is considered to be not meaningful (“NM”) in the current low rate environment.

 

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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

 

Forward-Looking Statements

This document (including information incorporated by reference) contains, and future oral and written statements by us and our management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to our financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of our management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and we undertake no obligation to update any statement in light of new information or future events.

 

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on operations and future prospects by us and our subsidiaries include, but are not limited to, the following:

 

·The strength of the United States economy in general and the strength of the local economies in which we conduct our operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of our assets.
·The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters (including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules and regulations promulgated thereunder, as well as rules recently adopted by the federal bank regulatory agencies to implement Basel III) and the effects of increases in FDIC premiums.
·The effects of changes in interest rates (including the effects of changes in the rate of prepayments of our assets) and the policies of the Board of Governors of the Federal Reserve System.
·Our ability to compete with other financial institutions as effectively as we currently intend due to increases in competitive pressures in the financial services sector.
·Our inability to obtain new customers and to retain existing customers.
·The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.
·Technological changes implemented by us and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to us and our customers.
·Our ability to develop and maintain secure and reliable electronic systems.
·Our ability to retain key executives and employees and the difficulty that we may experience in replacing key executives and employees in an effective manner.
·Consumer spending and saving habits which may change in a manner that affects our business adversely.
·Our ability to successfully integrate acquired businesses and future growth.
·The costs, effects and outcomes of existing or future litigation.
·Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.
·The economic impact of past and any future terrorist attacks, acts of war or threats thereof, and the response of the United States to any such threats and attacks.
·Our ability to effectively manage our credit risk.
·Our ability to forecast probable loan losses and maintain an adequate allowance for loan losses.
·The effects of declines in the value of our investment portfolio.
·Our ability to raise additional capital if needed.
·The effects of declines in real estate markets.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning us and our business, including other factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission, including the “Risk Factors” section in our Form 10-K.

 

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ITEM 4. CONTROLS AND PROCEDURES

 

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2013. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2013.

 

There were no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2013 that materially affected or were likely to materially affect the Company’s internal control over financial reporting.

 

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LANDMARK BANCORP, INC. AND SUBSIDIARY

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

There are no material pending legal proceedings to which the Company or its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1A. “Risk Factors,” in the Company's 2012 Annual Report on Form 10-K.

 

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

 

Exhibit 31.1   Certificate of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
Exhibit 31.2   Certificate of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
Exhibit 32.1   Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2   Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 101   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Earnings for the three and six months ended June 30, 2013 and June 30, 2012; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and June 30, 2012; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and June 30, 2012; (v) Consolidated Statements of Stockholders’ Equity for the three and six months ended June 30, 2013 and June 30, 2012; and (vi) Notes to Consolidated Financial Statements*

 

* As provided in Rule 406T of Regulation S-T, this information shall not be deemed filed for purposes of Sections 11 and 12 of the Securities Act of 1933, as amended, and Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability under those sections.

 

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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.

 

    LANDMARK BANCORP, INC.
     
Date: August 8, 2013   /s/ Patrick L. Alexander
    Patrick L. Alexander
    Chairman and Chief Executive Officer
     
Date: August 8, 2013   /s/ Mark A. Herpich
    Mark A. Herpich
    Vice President, Secretary, Treasurer and Chief Financial Officer

 

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