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MIDDLEFIELD BANC CORP - Quarter Report: 2006 March (Form 10-Q)

Middlefield Banc Corp. 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20552
FORM 10-Q
     
þ   QUARTERLY REPORT UNDER SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
Commission File Number 33-23094
(MBC LOGO)
Middlefield Banc Corp.
 
(Exact name of registrant as specified in its charter)
     
            Ohio   34-1585111
(State or other jurisdiction of incorporation   (IRS Employer Identification No.)
or organization)    
15985 East High Street, Middlefield, Ohio 44062-9263
(Address of principal executive offices)
(440) 632-1666
(Registrant’s telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or 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 þ       NO o
     
 
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o                 Accelerated filer o                 Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
     
 
  YES o       NO þ
State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicle date:
Class: Common Stock, without par value
Outstanding at May 10, 2006: 1,441,586
 
 

 


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MIDDLEFIELD BANC CORP.
INDEX
     
    Page
    Number
PART I — FINANCIAL INFORMATION
   
Item 1. Financial Statements
   
  3
  4
  5
  6
  7
  10
  17
  18
   
  19
  19
   
  19
  19
  19
  19
   
 EX-31 Certification
 EX-31.1 Certification
 EX-32 Certification
 EX-99.2 Report of Independent Registered Public Accounting

 


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MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
(Unaudited)
                 
    March 31,     December 31  
    2006     2005  
ASSETS
               
Cash and due from banks
  $ 5,729,052     $ 5,294,641  
Interest-bearing deposits in other institutions
    529,619       526,523  
 
           
Cash and cash equivalents
    6,258,671       5,821,164  
 
               
Investment securities available for sale
    55,888,308       57,887,130  
Investment securities held to maturity (estimated market value of $225,429 and $232,967)
    215,819       221,453  
Loans
    235,782,594       234,054,797  
Less allowance for loan losses
    2,887,945       2,841,098  
 
           
Net loans
    232,894,649       231,213,699  
 
               
Premises and equipment
    6,588,122       6,624,776  
Bank-owned life insurance
    6,686,204       5,632,982  
Accrued interest and other assets
    4,045,067       3,812,987  
 
           
 
               
TOTAL ASSETS
  $ 312,576,840     $ 311,214,191  
 
           
 
               
LIABILITIES
               
Deposits:
               
Noninterest-bearing demand
  $ 39,562,323       39,782,375  
Interest-bearing demand
    11,344,064       9,362,399  
Money market
    13,069,480       13,078,829  
Savings
    63,086,115       66,495,057  
Time
    127,205,866       120,730,980  
 
           
Total deposits
    254,267,848       249,449,640  
Short-term borrowings
    4,118,708       6,710,914  
Other borrowings
    25,233,510       26,578,211  
Accrued interest and other liabilities
    1,065,190       1,186,061  
 
           
TOTAL LIABILITIES
    284,685,256       283,924,826  
 
           
 
               
STOCKHOLDERS’ EQUITY
               
Common stock, no par value; 10,000,000 shares authorized, 1,441,355 and 1,434,987 shares issued
    16,203,384       15,976,335  
Retained earnings
    15,460,839       14,959,891  
Accumulated other comprehensive loss
    (747,065 )     (677,088 )
Treasury stock, at cost; 90,694 shares in 2006 and 89,333 shares in 2005
    (3,025,574 )     (2,969,773 )
 
           
TOTAL STOCKHOLDERS’ EQUITY
    27,891,584       27,289,365  
 
           
 
               
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 312,576,840     $ 311,214,191  
 
           
See accompanying unaudited notes to the consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
                 
    Three Months Ended  
    March 31,  
    2006     2005  
INTEREST INCOME
               
Interest and fees on loans
  $ 3,985,618     $ 3,542,916  
Interest-bearing deposits in other institutions
    3,121       1,971  
Federal funds sold
    3,579       9,464  
Investment securities:
               
Taxable interest
    305,970       363,677  
Tax-exempt interest
    245,151       183,452  
Dividends on FHLB stock
    17,197       14,432  
 
           
Total interest income
    4,560,636       4,115,912  
 
           
 
INTEREST EXPENSE
               
Deposits
    1,540,862       1,295,266  
Short-term borrowings
    60,823       18,854  
Other borrowings
    272,974       233,591  
 
           
Total interest expense
    1,874,659       1,547,711  
 
           
 
NET INTEREST INCOME
    2,685,977       2,568,201  
 
Provision for loan losses
    75,000       60,000  
 
           
 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    2,610,977       2,508,201  
 
           
 
NONINTEREST INCOME
               
Service charges on deposit accounts
    412,842       353,473  
Investment securities losses, net
    (5,868 )      
Earnings on bank-owned life insurance
    53,222       50,078  
Other income
    90,130       77,553  
 
           
Total noninterest income
    550,326       481,104  
 
           
 
NONINTEREST EXPENSE
               
Salaries and employee benefits
    994,944       1,016,409  
Occupancy expense
    154,303       134,898  
Equipment expense
    92,213       108,325  
Data processing costs
    178,507       149,000  
Ohio state franchise tax
    90,000       90,000  
Other expense
    525,764       514,583  
 
           
Total noninterest expense
    2,035,731       2,013,215  
 
           
 
Income before income taxes
    1,125,572       976,090  
Income taxes
    308,000       262,000  
 
           
NET INCOME
  $ 817,572     $ 714,090  
 
           
 
               
EARNINGS PER SHARE
               
Basic
  $ 0.61     $ 0.54  
Diluted
    0.60       0.53  
 
               
DIVIDENDS DECLARED PER SHARE
  $ 0.235     $ 0.210  
See accompanying unaudited notes to the consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
                                                 
                    Accumulated                      
                    Other             Total        
    Common     Retained     Comprehensive     Treasury     Stockholders’     Comprehensive  
    Stock     Earnings     Loss     Stock     Equity     Income  
Balance, December 31, 2005
  $ 15,976,335     $ 14,959,891     $ (677,088 )   $ (2,969,773 )   $ 27,289,365          
 
                                               
Net income
            817,572                       817,572     $ 817,572  
Other comprehensive income:
                                               
Unrealized loss on available for sale securities net of tax benefit of $36,048
                    (69,977 )             (69,977 )     (69,977 )
 
                                             
Comprehensive income
                                          $ 747,595  
 
                                             
Common stock issued
    158,880                               158,880          
Purchase of treasury stock
                            (55,801 )     (55,801 )        
Dividend reinvestment plan
    68,169                               68,169          
Cash dividends ($0.235 per share)
            (316,624 )                     (316,624 )        
 
                                     
 
                                               
Balance, March 31, 2006
  $ 16,203,384     $ 15,460,839     $ (747,065 )   $ (3,025,574 )   $ 27,891,584          
 
                                     
See accompanying unaudited notes to the consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
                 
    Three Months Ended  
    March 31,     March 31,  
    2006     2005  
OPERATING ACTIVITIES
               
Net income
  $ 817,572     $ 714,090  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    75,000       60,000  
Investment securities losses, net
    5,868        
Depreciation and amortization
    107,991       110,947  
Amortization of premium and discount on investment securities
    60,799       59,369  
Amortization of deferred loan costs (fees)
    (12,178 )     (34,036 )
Earnings on bank-owned life insurance
    (53,222 )     (50,078 )
Increase in accrued interest receivable
    (217,479 )     (331,811 )
Increase in accrued interest payable
    14,731       97,307  
Other, net
    (93,754 )     (259,086 )
 
           
Net cash provided by operating activities
    705,328       366,702  
 
           
 
               
INVESTING ACTIVITIES
               
Increase in interest-bearing deposits in other institutions, net
          (1,887 )
Investment securities available for sale:
               
Proceeds from repayments and maturities
    1,262,100       2,033,975  
Proceeds from sale of securities
    664,838        
Purchases
    (100,818 )     (2,876,214 )
Investment securities held to maturity:
               
Proceeds from repayments and maturities
    5,643        
Increase in loans, net
    (1,743,772 )     (2,779,677 )
Purchase of Federal Home Loan Bank stock
    (20,400 )     (14,400 )
Purchase of bank-owned life insurance
    (1,000,000 )      
Purchase of premises and equipment
    (71,337 )     (109,805 )
 
           
Net cash used for investing activities
    (1,003,746 )     (3,748,008 )
 
           
 
               
FINANCING ACTIVITIES
               
Net increase in deposits
    4,818,208       9,556,086  
Decrease in short-term borrowings, net
    (2,592,206 )     (617,551 )
Repayment of other borrowings
    (1,344,701 )     (4,724,698 )
Proceeds from other borrowings
          3,000,000  
Purchase of Treasury Stock
    (55,801 )      
Common stock issued
    158,880       127,496  
Proceeds from dividend reinvestment plan
    68,169       67,816  
Cash dividends
    (316,624 )     (278,571 )
 
           
Net cash provided by financing activities
    735,925       7,130,578  
 
           
 
               
Increase in cash and cash equivalents
    437,507       3,749,272  
 
               
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    5,821,164       5,311,776  
 
           
 
               
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 6,258,671     $ 9,061,048  
 
           
 
               
SUPPLEMENTAL INFORMATION
               
Cash paid during the year for:
               
Interest on deposits and borrowings
  $ 1,859,928     $ 1,450,404  
Income taxes
    50,000       50,000  
See accompanying notes to unaudited consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 — BASIS OF PRESENTATION
The consolidated financial statements of Middlefield Banc Corp. (“Middlefield”) includes its wholly owned subsidiary, The Middlefield Banking Company (the “Bank”). All significant inter-company items have been eliminated.
The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10-Q and Article 10 of Regulation S-X. In Management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that Middlefield considers necessary to fairly state Middlefield’s financial position and the results of operations and cash flows. The balance sheet at December 31, 2005, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U. S. generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with Middlefield’s Form 10-K (File No. 33-23094). The results of Middlefield’s operations for any interim period are not necessarily indicative of the results of Middlefield’s operations for any other interim period or for a full fiscal year.
NOTE 2 – STOCK-BASED COMPENSATION
The Company maintains a stock option plan for key officers, employees, and non-employee directors. Had compensation expense for the stock option plans been recognized in accordance with the fair value accounting provisions of FAS No. 123, Accounting for Stock-Based Compensation, net income applicable to common stock, basic, and diluted net income per common share would have been as follows:
         
    Three Months Ended March 31,  
    2005  
Net income, as reported:
  $ 714,090  
 
       
Less proforma expense related to stock options
    12,750  
 
     
Proforma net income
  $ 701,340  
 
     
 
       
Basic net income per common share:
       
As reported
  $ 0.54  
Pro forma
    0.53  
Diluted net income per common share:
       
As reported
  $ 0.53  
Pro forma
    0.52  
For purposes of computing pro forma results, the Company estimated the fair values of stock options using the Black-Scholes option-pricing model. The model requires the use of subjective assumptions that can materially affect fair value estimates. Therefore, the pro forma results are estimates of results of operations as if compensation expense had been recognized for the stock option plans.
As of March 31, 2006, there was no unrecognized compensation cost related to unvested share-based compensation awards granted.

 


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Stock option activity during the three months ended March 31, 2006 is as follows:
                 
            Weighted-  
            average  
            Exercise  
    2006     Price  
Outstanding, January 1
    72,247     $ 28.13  
Granted
           
Exercised
    (2,058 )     25.52  
Forfeited
           
 
             
 
               
Outstanding, March 31
    70,189     $ 28.28  
 
             
NOTE 3 — EARNINGS PER SHARE
Middlefield provides dual presentation of Basic and Diluted earnings per share. Basic earnings per share utilize net income as reported as the numerator and the actual average shares outstanding as the denominator. Diluted earnings per share include any dilutive effects of options, warrants, and convertible securities.
There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income (Unaudited) will be used as the numerator. The following tables set forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.
                 
    For the Three  
    Months Ended  
    March 31,  
    2006     2005  
Weighted average common shares outstanding
    1,436,812       1,419,133  
 
               
Average treasury stock shares
    (89,348 )     (89,333 )
 
           
 
               
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
    1,347,464       1,329,800  
 
               
Additional common stock equivalents (stock options) used to calculate diluted earnings per share
    21,467       7,157  
 
           
 
               
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
    1,368,931       1,336,957  
 
           

 


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NOTE 4 – COMPREHENSIVE INCOME
The components of comprehensive income consist exclusively of unrealized gains and losses on available for sale securities. For the three months ended March 31, 2006, this activity is shown under the heading Comprehensive Income as presented in the Consolidated Statement of Changes in Stockholders’ Equity (Unaudited). For the three months ended March 31, 2005, comprehensive income totaled $747,595.
The following shows the components and activity of comprehensive income during the periods ended March 31, 2006 and 2005 (net of the income tax effect):
                 
    For the Three Months  
    Ended March 31,  
    2006     2005  
Unrealized holding losses arising during the period on securities held
  $ (66,104 )   $ (394,882 )
 
               
Reclassification adjustment for gains included in net income
    (3,873 )      
 
           
 
               
Net change in unrealized losses during the period
    (69,977 )     (394,882 )
 
               
Unrealized holding (losses) gains, beginning of period
    (677,088 )     (28,683 )
 
           
 
               
Unrealized holding losses, end of period
  $ (747,065 )   $ (423,565 )
 
           
 
               
Net income
  $ 817,572     $ 714,090  
Other comprehensive income, net of tax:
               
Unrealized holding losses arising during the period
    (69,977 )     (394,882 )
 
           
 
               
Comprehensive income
  $ 747,595     $ 319,208  
 
           
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
     When used in this Form 10-Q, or in future filings with the Securities and Exchange Commission, in press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases “will likely result”, “are expected to”, “will continue”, “is anticipated”, “estimate”, “project”, or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the Corporation’s actual results to be materially different from those indicated. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the market areas the Corporation conducts business, which could materially impact credit quality trends, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the market areas the Corporation conducts business, and competition, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The Corporation wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Corporation undertakes no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 


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CHANGES IN FINANCIAL CONDITION
General. The Company’s total assets increased by $1.4 million or .44% from December 31, 2005 to $312.6 million at March 31, 2006. Cash and cash equivalents, loans receivable, bank owned life insurance and accrued interest and other assets increased $438,000, $1.7 million, $1.1 million and $232,000, respectively. The increase in total assets reflects a corresponding increase in total liabilities of $760,000 or .27% and an increase in stockholders’ equity of $602,000 or 2.2%. The increase in total liabilities was primarily the result of increases in deposits of $4.8 million, partially offset by decreases to short-term borrowing, other borrowing and accrued interest and other liabilities of $2.6 million, $1.4 million, and $121,000, respectively. The increase in stockholders’ equity was the result of increases in retained earnings and common stock of $501,000 and $227,000, respectively. These increase were partially offset by decreases in comprehensive loss and treasury stock of $70,000, and $56,000, respectively.
Cash on hand and due from banks. Cash on hand and due from banks represent cash equivalents. Cash equivalents increased a combined $438,000 or 7.5% to $6.3 million at March 31, 2006 from $5.8 million at December 31, 2005. Deposits from customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, purchase of bank-owned life insurance, security purchases and repayments of borrowed funds. The increase for the quarter ended March 31, 2006 can principally be attributed to increases in deposits.
Securities.Securities available for sale decreased by $2.0 million or 3.5% to $55.9 million at March 31, 2006 from $57.9 million at December 31, 2005. During the quarter ended March 31, 2006 the Company recorded purchases of available for sale securities of $101,000, consisting of purchases municipal bonds. Offsetting the purchases of securities were repayments and maturities of securities of $1.3 million along with security sales of $700,000 during the three months ended March 31, 2006. In addition, the securities portfolio decreased approximately $106,000 due to decreases in the market value. These fair value adjustments represent temporary fluctuations resulting from changes in market rates in relation to average yields in the available for sale portfolio. If securities are held to their respective maturity dates, no fair value gain or loss is realized.
Loans receivable. The loans receivable category consists primarily of single family mortgage loans used to purchase or refinance personal residences located within the Company’s market area and commercial real estate loans used to finance properties that are used in the borrowers businesses or to finance investor-owned rental properties, and to a lesser extent commercial and consumer loans. Loans receivable increased $1.7 million or .7% to $235.8 million at March 31, 2006 from $234.1 million at December 31, 2005. Included in this increase were increases in commercial loans of $1.1 million or 1.6% and mortgage loans of $1.0 million or .8%, as well as decreases in home equity loans of $336,000 and consumer loans of $266,000 during the three months ended March 31, 2006.
Non-performing loans. Non-performing loans included non-accrual loans, renegotiated loans, loans 90 days or more past due, other real estate loans, and repossessed assets. A loan is classified as non-accrual when, in the opinion of management, there are serious doubts about collectibility of interest and principal. At the time the accrual of interest is discontinued, future income is recognized only when cash is received. Renegotiated loans are those loans which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deterioration of the borrower. Non-performing loans amounted to $2.1 million or 0.87% and $1.7 million or 0.73% of total loans at March 31, 2006 and December 31, 2005, respectively. The level of non-performing loans remains relatively high in comparison to the bank’s historical levels, however, one large commercial credit constitutes the bulk of the dollar total. Senior credit personnel remain committed to resolving the issue within an expedient timeframe. Our expectations are for nominal losses, should there be any.
Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds totaling $254.3 million or 89.7% of the Company’s total funding sources at March 31, 2006. Total deposits increased $4.8 million or 1.9% to $254.3 million at March 31, 2006 from $249.4 million at December 31, 2005. The increase in deposits is primarily related to the growth of certificates of deposits that totaled $127.2 million at March 31, 2006 an increase of $6.5 million or 5.4% for the year. Interest-bearing demand accounts increased $2.0 million, or 21.2 %, while noninterest-bearing demand deposit and money market accounts decreased $220,000, or .6%, and $10,000, or .1, respectively, during the three months ended March 31, 2006.
Borrowed funds. The Company utilizes short and long-term borrowings as another source of funding used for asset growth and liquidity needs. These borrowings primarily include FHLB advances and repurchase agreements. Borrowed funds decreased $3.9 million or 11.8% to $29.4 million at March 31, 2006 from $33.3 million at December 31, 2005. FHLB advances decreased $1.3 million or 5.1% while short-term borrowings decreased $2.6 million or 38.6%. The decrease in FHLB advances is a result of the increase in the Company’s deposits.
Stockholders’ equity. Stockholders’ equity increased $602,000 or 2.2% to $27.9 million at March 31, 2006 from $27.3 million at December 31, 2005. The increase in stockholders’ equity was the result of increases in common stock and retained earnings of $227,000 and $501,000, respectively offset by an increase in accumulated other comprehensive loss of $70,000. The increase in common stock was due in part to activity of the dividend reinvestment program of $175,000 along with purchases of stock options totaling $52,000 for the quarter. The increase in stock due to the dividend reinvestment program was made up of optional cash payments totaling $107,000 along with $68,000 of reinvested dividends. The increase of accumulated other comprehensive loss was the result of a decrease in the mark to market of the Company’s

 


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securities available for sale portfolio. The increase in treasury stock was the result of the purchase of 1,361 shares of common stock at a price of $41.00 a share.
RESULTS OF OPERATIONS
General. The Company recorded net income of $818,000 for the three months ended March 31, 2006, as compared to net income of $714,000 for the same period in the prior year. The $103,000 or 14.5% increase in net income for the three months ended March 31, 2006, as compared to the three months ended March 31, 2005, was primarily attributable to an increase in net interest income and non-interest income of $118,000 and $69,000, respectively. These items were partially offset by increases in non-interest expense of $23,000 a net change in the provision for loan losses of $15,000 and an increase in provisions for income taxes of $46,000.
Net interest income. Net interest income, the primary source of revenue growth for the Company, is defined as the difference between income on earning assets and the cost of funds supporting those assets. The level of interest rates and changes in the amount and composition of interest earning assets and liabilities affect the Company’s net interest income. Net interest income increased $118,000 or 4.6% to $2.7 million for the three months ended March 31, 2006, compared to $2.6 million for the same period in the prior year. This increase in net interest income can be attributed to an increase in interest income of $445,000 partially offset by an increase in interest expense $327,000. The net interest margin remained the same during the first quarter of 2006 even with the increase in interest rates. This change in interest rates resulted in a growth in the cost of funds of 37 basis points to 3.07% for the quarter ended March 31, 2006, compared to 2.70% for the same period in the prior year. This increase in the cost of funds negatively impacted net interest income but was offset by an increase in the yield on interest earning assets of 34 basis points to 6.49% for the quarter ended March 31, 2005, compared to 6.15% for the same period in the prior year.
Interest income. Interest income increased $445,000 or 10.8% to $4.6 million for the three months ended March 31, 2006, compared to $4.1 million for the same period in the prior year. This increase can be attributed to interest and fees on loans which was $443,000 higher than the same period in 2005.
Interest and fees on loans increased $443,000 or 12.5 to $4.0 million for the quarter ended March 31, 2006, compared to $3.5 million for the same period in the prior year. This increase was attributable to a increase in the average balance of loans receivable of $16.8 million or 7.7% to $233.7 million for the three months ended March 31, 2006, as compared to $216.9 million for the same period in the prior year.
Interest earned on securities increased slightly by $4,000 or .7% to $551,000 for the three months ended March 31, 2006, compared to $547,000 for the same period in the prior year. This increase in earnings was the result of an increase in market rate as the average balance remained unchanged.
Interest expense. Interest expense increased $327,000 or 21.1% to $1.9 million for the three months ended March 31, 2006, compared to $1.6 million for the same period in the prior year. This increase in interest expense can be primarily attributed to increases in interest incurred on deposits and borrowed funds of $246,000 and $81,000 million, respectively.
Interest incurred on deposits increased $246,000 or 19.0% to $1.5 million for the three months ended March 31, 2006, compared to $1.3 million for the same period in the prior year. This increase was primarily attributable to an increase in the average balance of deposits of $4.3 million to $212.2 million for the three months ended March 31, 2006 from $207.9 million for the same period in the prior year.
Interest incurred on borrowed funds increased $81,000 or 32.2% to $334,000 for the three months ended March 31, 2006, compared to $252,000 million for the same period in the prior year. This increase was primarily attributable to an increase in the average balance of borrowed funds of $10.9 million or 44.0% to $35.6 million for the three months ended March 31, 2006, compared to $24.7 million for the same period in the prior year.
Provision for loan losses. The provision for loan losses for the quarter ended March 31, 2006 is the result of normal operations for the quarter. In determining the appropriate level of allowance for loan losses, management considers historical loss experience, the financial condition of borrowers, economic conditions (particularly as they relate to markets where the Company originates loans), the status of non-performing assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio. The Company’s total allowance for losses on loans at March 31, 2006 and December 31, 2005 amounted to $2.9 million or 1.23% and $2.8 million or 1.21%, respectively, of the Company’s total loan portfolio. The Company’s allowance for losses on loans as a percentage of non-performing loans was 121.4% and 165.9% at March 31, 2006 and December 31, 2005, respectively.
Non-interest income. Non-interest income increased $69,000 or 14.4% to $550,000 for the three months ended March 31, 2006, compared to $481,000 for the same period in the prior year. This increase can be attributed primarily to increases in fees and service charges and other income of $59,000 and $13,000, respectively. Partially offsetting these increases was a increase in losses on investment securities of $6,000.

 


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Fees and service charges increased $59,000 or 16.8% to $413,000 for the three months ended March 31, 2006, compared to $353,000 for the same period in the prior year. The increase to fees generated from checking accounts is a result of the continued growth in fees from overdraft services.
Non-interest expense. Non-interest expense increased $23,000 or 1.1% to $2.0 million for the three months ended March 31, 2006, from $2.0 million for the same period in the prior year. This increase was the result of increases in occupancy, data processing and other expenses of $19,000, $30,000 and $11,000, respectively. The leading factor in the increased expenses was data processing costs associated with an expanded base of products per customer, as well as the introduction during 2005 of the company’s image based item processing system. Also contributing were the cost of certain maintenance contracts, seasonal utility costs, and depreciation.
Provision for income taxes. The Company recognized $308,000 in income tax expense, which reflected an effective tax rate of 27.4% for the three months, ended March 31, 2006, as compared to $262,000 with an effective tax rate of 26.8% for the respective 2005 period.
CRITICAL ACCOUNTING ESTIMATES
The Company’s critical accounting estimates involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of March 31, 2006, have remained unchanged from December 31, 2005.
Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include non-accrual loans and exclude the allowance for loan losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis utilizing a federal tax rate of 34%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.
                                                 
    For the Three Months Ended March 31,  
    2006     2005  
                    (4)                     (4)  
    Average             Average     Average             Average  
    Balance     Interest (1)     Yield/Cost     Balance     Interest (1)     Yield/Cost  
    (Dollars in thousands)                         (Dollars in thousands)                      
Interest-earning assets:
                                               
Loans receivable
    233,710     $ 3,986       6.92 %     216,918     $ 3,543       6.62 %
Investments securities
    57,509       551       4.78 %     57,529       547       4.52 %
Interest-bearing deposits with other banks
    1,805       24       5.39 %     3,294       26       3.20 %
 
                                   
Total interest-earning assets
    293,024       4,561       6.49 %     277,741       4,116       6.15 %
 
                                           
Noninterest-earning assets
    17,132                       16,672                  
 
                                           
Total assets
  $ 310,156                     $ 294,413                  
 
                                           
Interest-bearing liabilities:
                                               
Interest — bearing demand deposits
  $ 10,287       29       1.14 %   $ 9,850       16       0.66 %
Money market deposits
    13,286       78       2.38 %     15,899       72       1.84 %
Savings deposits
    62,048       245       1.60 %     73,873       273       1.50 %
Certificates of deposit
    126,607       1,189       3.81 %     108,271       938       3.51 %
Borrowings
    35,567       334       3.81 %     24,692       249       4.09 %
 
                                   
Total interest-bearing liabilities
    247,795       1,875       3.07 %     232,585       1,548       2.70 %
 
                                       
Noninterest-bearing liabilities
                                               
Other liabilities
    34,640                       38,374                  
Stockholders’ equity
    27,721                       23,454                  
Total liabilities and stockholders’ equity
  $ 310,156                     $ 294,413                  
 
                                           
Net interest income
          $ 2,686                     $ 2,568          
 
                                           
Interest rate spread (2)
                    3.42 %                     3.45 %
Net yield on interest-earning assets (3)
                    3.89 %                     3.89 %
Ratio of average interest-earning assets to average interest-bearing liabilities
                    118.25 %                     119.41 %
 
(1)   Interest income and expense are for the period that banking operations were in effect.

 


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(2)   Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
 
(3)   Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.
 
(4)   Average yields are computed using annualized interest income and expense for the periods.
Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the quarters ended March 31, 2006 and 2005, in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on securities reflects the changes in interest income on a fully tax equivalent basis.
                         
    2006 versus 2005  
    Increase (decrease) due to  
    Volume     Rate     Total  
    (Dollars in thousands)  
Interest-earning assets:
                       
Loans receivable
    1,112       -669       443  
Investments securities
    -1       5       4  
Interest-bearing deposits with other banks
    -48       46       -2  
 
                 
Total interest-earning assets
    1,063       -618       445  
 
                       
Interest-bearing liabilities:
                       
Interest — bearing demand deposits
    3       10       13  
Money market deposits
    -48       54       6  
Savings deposits
    -177       149       -28  
Certificates of deposit
    644       -393       251  
Borrowings
    445       -360       85  
 
                 
Total interest-bearing liabilities
    867       -540       327  
 
                       
Net interest income
  $ 196       ($78 )   $ 118  
 
                 
LIQUIDITY
Management’s objective in managing liquidity is maintaining the ability to continue meeting the cash flow needs of its customers, such as borrowings or deposit withdrawals, as well as its own financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, and the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the Federal Home Loan Bank of Cincinnati, Ohio and the adjustment of interest rates to obtain depositors. Management feels that it has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.
For the three months ended March 31, 2006, the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment, the provision for loan losses, net amortization of securities and net changes in other assets and liabilities. Cash and cash equivalents increased as a result of the purchasing of government agency securities. For a more detailed illustration of sources and uses of cash, refer to the condensed consolidated statements of cash flows.
INFLATION
Substantially all of the Company’s assets and liabilities relate to banking activities and are monetary in nature. The consolidated financial statements and related financial data are presented in accordance with U.S. GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, with the exception of securities available for sale, impaired loans and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause

 


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purchasing power loss.
Management’s opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do effect each other, but do not always move in correlation with each other. The Company’s ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company’s performance.
REGULATORY MATTERS
The Company is subject to the regulatory requirements of The Federal Reserve System as a one-bank holding company. The affiliate bank is subject to regulations of the Federal Deposit Insurance Corporation (FDIC) and the State of Ohio, Division of Financial Institutions.
REGULATORY CAPITAL REQUIREMENTS
The Company is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the Banks’ operations.
The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion and plans for capital restoration are required.
The minimum requirements are:
                         
    Total   Tier 1   TIER 1
    Capital to   Capital to   Capital to
    Risk-Weighted   Risk-Weighted   Average
    Assets   Assets   Assets
Well capitalized
    10.00 %     6.00 %     5.00 %
Adequately capitalized
    8.00 %     4.00 %     4.00 %
Undercapitalized
    6.00 %     3.00 %     3.00 %
The following table illustrates the Company’s risk-weighted capital ratios at March 31, 2006:
         
    March 31,  
(in thousands)   2006  
Risk-Weighted Capital Ratios
       
 
       
Tier 1 Capital
  $ 28,610  
Total risk-based capital
  $ 31,294  
Risk-weighted assets
  $ 215,008  
Average total assets
  $ 309,261  

 


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    March 31,
    2006
Tier 1 capital to average assets
    9.22 %
Tier 1 risk-based capital ratio
    13.31 %
Total risk-based capital ratio
    14.55 %
Item 3 Quantitative and Qualitative Disclosures about Market Risk
ASSET AND LIABILITY MANAGEMENT
The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing and maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in strong asset/liability management in order to insulate the Company from material and prolonged increases in interest rates. As a result of this policy, the Company emphasizes a larger, more diversified portfolio of residential mortgage loans in the form of mortgage-backed securities. Mortgage-backed securities generally increase the quality of the Company’s assets by virtue of the insurance or guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company.
The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of four outside directors, the President and Chief Executive Officer, Executive/Vice President/ Chief Operating Officer, Senior Vice President/Chief Financial Officer and Senior Vice President/Commercial Lending. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies, which were implemented by the Company over the past few years. These strategies have included: (i) an emphasis on the investment in adjustable-rate and shorter duration mortgage-backed securities; (ii) an emphasis on the origination of single-family residential adjustable-rate mortgages (ARMs), residential construction loans and commercial real estate loans, which generally have adjustable or floating interest rates and/or shorter maturities than traditional single-family residential loans, and consumer loans, which generally have shorter terms and higher interest rates than mortgage loans; (iii) increase the duration of the liability base of the Company by extending the maturities of savings deposits, borrowed funds and repurchase agreements.
The Company has established the following guidelines for assessing interest rate risk:
Net interest income simulation. Given a 200 basis point parallel and gradual increase or decrease in market interest rates, net interest income may not change by more than 10% for a one-year period.
Portfolio equity simulation. Portfolio equity is the net present value of the Company’s existing assets and liabilities. Given a 200 basis point immediate and permanent increase or decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity.
The following table presents the simulated impact of a 200 basis point upward and a 200 basis point downward shift of market interest rates on net interest income and the change in portfolio equity. This analysis was done assuming that the interest-earning asset and interest-bearing liability levels at March 31, 2006 remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over a one-year period from the March 31, 2006 levels for net interest income. The impact of market rate movements was developed by simulating the effects of an immediate and permanent change in rates at March 31, 2006 for portfolio equity:
                 
    Increase   Decrease
    +200   -200
    BP   BP
Net interest income — increase (decrease)
    5.7 %     (6.7 )%
 
Portfolio equity — increase (decrease)
    (3.1 )%     .85 %

 


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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by Middlefield in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in internal controls. There were no significant changes in the Registrant’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings
     None
Item 1A. Risk Factors
For information regarding factors that could affect the Corporation’s results of operations, financial condition and liquidity, see the risk factors discussion provided under Part 1, Item 1A on Form 10-K for the fiscal year ended December 31, 2005. See also, “Forward-Looking Statements” included in Part 1, Item 2 of this Quarterly Report on Form 10-Q. There have been no material changes in risk factors since December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases of equity securities by the issuer.
The following table summarizes the treasury stock purchased by the issuer during the first quarter of 2006:
                                 
                    Total Number of     Maximum Number of  
                    Shares Purchased as     Shares that May Yet  
    Total Number of     Average Price Paid     Part of Publicly     Be Purchased Under  
Date   Shares Purchased     Per Share     Announced Program     the Program  
March 30, 2006
    1,361     $ 41.00              
 
                           
 
                               
TOTAL
    1,361     $ 41.00              
Item 3. Defaults upon senior securities
     None

 


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Item 4. Submission of matters to a vote of security holders
     None
Item 5. Other information
     None
Item 6. Exhibits
  (a)   The following exhibits are included in this Report or incorporated herein by reference:
         
Exhibit        
Number   Description   Location
3.1
  Second Amended and Restated Articles of Incorporation of Middlefield Banc Corp.   File herewith
 
       
3.2
  Regulations of Middlefield Banc Corp.   Incorporated by reference to Exhibit 3.2 to the registration statement on Form 10 filed on April 17, 2001
 
       
4
  Specimen Stock Certificate   Incorporated by reference to Exhibit 4 to the registration statement on Form 10 filed on April 17, 2001
 
       
10.1
  *1999 Stock Option Plan of Middlefield Banc Corp.   Incorporated by reference to Exhibit 10.1 to the registration statement on Form 10 filed on April 17, 2001
 
       
10.2
  *                     2003 Amended and Restated Severance Agreement of President and Chief Executive Officer   File herewith
 
       
10.3
  *                     2003 Amended and Restated severance Agreement of Severance Agreement of Executive Vice President   File herewith
 
       
10.4
  *Severance Agreement of designated executive officers   Incorporated by reference to Exhibit 10.3 of the registration statement on Form 10 filed on April 17, 2001 (executive officers Teresa M. Hetrick, Jack L. Lester, Nancy C. Snow, and Donald L. Stacy have entered into this form of severance agreement)
 
       
10.5
  Federal Home Loan Bank of Cincinnati Agreement for Advances and Security Agreement dated September 14, 2000   Incorporated by reference to Exhibit 10.4 to the registration statement on Form 10 filed April 17, 2001
 
       
10.6
  *Director Retirement Agreement with Richard T. Coyne   Incorporated by reference to Exhibit 10.6 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.7
  *Director Retirement Agreement with Frances H. Frank   Incorporated by reference to Exhibit 10.7 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.8
  *Director Retirement Agreement with Thomas C. Halstead   Incorporated by reference to Exhibit 10.8 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.9
  *Director Retirement Agreement with George F. Hasman   Incorporated by reference to Exhibit 10.9 to the December 31, 2001Form 10-K filed on March 28, 2002

 


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Exhibit        
Number   Description   Location
10.10
  *Director Retirement Agreement with Donald D. Hunter   Incorporated by reference to Exhibit 10.10 to the December 31, 2001 Form 10-K filed on March 28, 2002
 
       
10.11
  *Director Retirement Agreement with Martin S. Paul   Incorporated by reference to Exhibit 10.11 to the December 31, 2001 Form 10-K filed on March 28, 2002
 
       
10.12
  *Director Retirement Agreement with Donald E. Villers   Incorporated by reference to Exhibit 10.12 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.13
  *DBO Agreement with Donald L. Stacy   Incorporated by reference to Exhibit 10.13 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.14
  *DBO Agreement with Jay P. Giles   Incorporated by reference to Exhibit 10.14 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.15
  *DBO Agreement with Alfred F. Thompson, Jr.   Incorporated by reference to Exhibit 10.15 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.16
  *DBO Agreement with Nancy C. Snow   Incorporated by reference to Exhibit 10.16 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.17
  *DBO Agreement with Teresa M. Hetrick   Incorporated by reference to Exhibit 10.17 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.18
  *DBO Agreement with Jack L. Lester   Incorporated by reference to Exhibit 10.18 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.19
  *DBO Agreement with James R. Heslop, II   Incorporated by reference to Exhibit 10.19 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.20
  *DBO Agreement with Thomas G. Caldwell   Incorporated by reference to Exhibit 10.20 to the December 31, 2001Form 10-K filed on March 28, 2002
 
       
10.21
  *Form of Indemnification Agreement with directors of Middlefield Banc Corp. and executive officers of Middlefield Banc Corp. and The Middlefield Banking Company   Incorporated by reference to Exhibit 99.1 to the registration statement on Form 10, Amendment No. 1, filed on June 14, 2001
 
       
10.22
  *Annual Incentive Plan Summary   Incorporated by reference to the summary description of the annual incentive plan included as Exhibit 10.22 to the Form 8-K Current Report filed December 16,2005
 
       
 
31.1
  Section 302 Certification   filed herewith
 
       
31.2
  Section 302 Certification   filed herewith
 
       
32
  Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   filed herewith

 


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned and hereunto duly authorized.
         
 
MIDDLEFIELD BANC CORP.
 
 
Date: May 10, 2006  By:   /s/ Thomas G. Caldwell    
    Thomas G. Caldwell   
    President and Chief Executive Officer   
 
     
Date: May 10, 2006  By:   /s/ Donald L. Stacy    
    Donald L. Stacy   
    Principal Financial and Accounting Officer