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POTOMAC BANCSHARES INC - Quarter Report: 2011 September (Form 10-Q)

potomac_10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________________
 
FORM 10-Q
 
(Mark one)
 
XXX       QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the quarterly period ended September 30, 2011
     
    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 0-24958
 
POTOMAC BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
West Virginia   55-0732247
(State or Other Jurisdiction of   (I.R.S. Employer  
Incorporation or Organization)   Identification No.)

111 East Washington Street    
PO Box 906, Charles Town WV   25414-0906
(Address of Principal Executive Offices)   (Zip Code)
     
Registrant's telephone number, including area code   304-725-8431

Indicate by check mark whether the registrant: (l) 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      XX          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      XX          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 definition of “accelerated filer”, “large 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 
XX 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
                         
Yes                  No      XX   
 
APPLICABLE ONLY TO CORPORATE REGISTRANTS
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
3,390,178 as of November 14, 2011
 

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
September 30, 2011
 
    INDEX    
         
PART I.   FINANCIAL INFORMATION       PAGE
         
Item 1.       Financial Statements.    
         
    Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010 (Audited)   3
     
    Consolidated Statements of Operations (Unaudited) for the Three Months Ended September 30, 2011    
           and 2010 and for the Nine Months ended September 30, 2011 and 2010   4
         
    Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Nine Months    
           Ended September 30, 2011 and 2010   5
         
    Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended    
           September 30, 2011 and 2010   6
         
    Notes to Consolidated Financial Statements (Unaudited)   7 - 26
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.   26 - 32
         
Item 4.   Controls and Procedures.   32
         
Part II.   OTHER INFORMATION    
         
Item 1.   Legal Proceedings.   32
         
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds.   33
         
Item 4.   (Removed and Reserved).   33
         
Item 5.   Other Information.   33
         
Item 6.   Exhibits.   33
         
Signatures   34

FORWARD-LOOKING STATEMENTS
 
     The Private Securities Litigation Reform Act of 1995 evidences Congress’ determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. “Forward-looking statements” are easily identified by the use of words such as “could,” “anticipate,” “estimate,” “believe,” “confident,” and similar words that refer to a future outlook. To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the company’s actual results and experiences to differ materially from the anticipated results or other expectations expressed in the company’s forward-looking statements.
 
     The risks and uncertainties that may affect the operations, performance, development and results of the company’s business include, but are not limited to, the growth of the economy, unemployment, pricing in the real estate market, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, the current economic environment posing significant challenges and affecting our financial condition and results of operations, the possibility of future FDIC assessments, Congressional legislation and similar matters (including changes as a result of rules and regulations adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act). The downgrade of U.S. government securities by one of the credit rating agencies could have a material adverse effect on the company’s operations, earnings and financial condition. We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by unanticipated future events. Actual results, accordingly, may differ materially from management expectations.
 
2
 

 

PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
($ in thousands, except per share data)
(Unaudited)
 
    September 30,         December 31,  
        2011     2010  
Assets:                
       Cash and due from banks   $      1 705     $      2 185  
       Interest-bearing deposits in other financial institutions     15 563       7 995  
       Federal funds sold     725       2 725  
       Securities available for sale, at fair value     45 543       42 690  
       Loans held for sale     - -       76  
       Loans, net of allowance for loan losses of $5,263 and                
              $5,012, respectively     202 108       214 238  
       Premises and equipment, net     8 003       8 270  
       Other real estate owned, net of valuation allowance of                
              $2,165 and $95, respectively     6 151       6 563  
       Accrued interest receivable     888       960  
       Bank owned life insurance     6 872       6 397  
       Federal Home Loan Bank of Pittsburgh stock     822       765  
       Other assets     5 365       4 745  
                 
    Total Assets
  $      293 745     $      297 609  
                 
Liabilities and Stockholders’ Equity:                
Liabilities:                
       Deposits                
              Noninterest-bearing   $ 29 721     $ 26 695  
              Interest-bearing     227 976       230 727  
    Total Deposits     257 697       257 422  
       Securities sold under agreements to repurchase     5 239       7 382  
       Federal Home Loan Bank advances     1 823       2 717  
       Accrued interest payable     245       361  
       Other liabilities     3 016       2 951  
    Total Liabilities
  $ 268 020     $ 270 833  
                 
Stockholders’ Equity:                
       Common stock, $1 per share par value; 5,000,000 shares                
              authorized; 3,671,691 shares issued and outstanding   $ 3 672     $ 3 672  
       Surplus     3 943       3 932  
       Undivided profits     22 286       23 725  
       Accumulated other comprehensive (loss), net     (1 310 )     (1 687 )
    $ 28 591     $ 29 642  
                 
    Less cost of shares acquired for the treasury, 281,513 shares     2 866       2 866  
                 
    Total Stockholders’ Equity   $ 25 725     $ 26 776  
                 
    Total Liabilities and Stockholders’ Equity   $ 293 745     $ 297 609  
                 
See Notes to Consolidated Financial Statements.
 
3
 

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands, except per share data)
(Unaudited)
 
    For the Three Months     For the Nine Months  
    Ended September 30     Ended September 30  
    2011     2010     2011     2010  
Interest and Dividend Income:                                                
       Interest and fees on loans   $      2 929     $      3 226     $      8 801     $      9 772  
       Interest on securities available for sale - taxable     167       176       527       588  
       Interest on securities available for sale – nontaxable     62       50       171       148  
       Interest on federal funds sold     - -       1       1       3  
       Other interest and dividends     4       6       24       13  
              Total Interest and Dividend Income     3 162       3 459       9 524     10 524  
                               
Interest Expense:                                
       Interest on deposits     606       957       2 259       3 058  
       Interest on securities sold under agreements to repurchase     19       23       54       63  
       Federal Home Loan Bank advances     9       13       30       74  
              Total Interest Expense     634       993       2 343       3 195  
                                 
              Net Interest Income     2 528       2 466       7 181       7 329  
                                 
Provision for Loan Losses     2 128       213       2 727       984  
              Net Interest Income after                                
                     Provision for Loan Losses     400       2 253       4 454       6 345  
                                 
Noninterest Income:                                
       Trust and financial services     225       199       677       636  
       Service charges on deposit accounts     485       480       1 394       1 394  
       Visa/MC Fees     198       172       567       501  
       Cash surrender value of life insurance     59       58       175       176  
       Other operating income     87       113       289       318  
              Total Noninterest Income     1 054       1 022       3 102       3 025  
                                 
Noninterest Expenses:                                
       Salaries and employee benefits     1 249       1 177       3 732       3 579  
       Net occupancy expense of premises     153       161       476       495  
       Furniture and equipment expenses     250       162       660       599  
       Advertising and public relations     47       39       103       91  
       Accounting, auditing and compliance     68       48       148       114  
       Computer services and online banking     86       62       232       111  
       Loss (gain) on sale of other real estate     266       (25 )     336       (167 )
       FDIC assessment     98       142       356       416  
       Legal Fees     13       46       42       103  
       Postage     43       38       122       106  
       Printing, stationery and supplies     47       34       146       136  
       Communications     46       46       139       138  
       Foreclosed property expense     46       182       427       501  
       Write down of OREO property     1 848       - -       2 133       17  
       ATM and check card expenses     92       78       245       213  
       Other operating expenses     322       316       1 001       882  
              Total Noninterest Expenses     4 674       2 506       10 298       7 334  
              (Loss) Income before Income Tax (Benefit) Expense     (3 220 )     769       (2 742 )     2 036  
Income Tax (Benefit) Expense     (1 418 )     241       (1 370 )     648  
                                 
              Net (Loss) Income   $ (1 802 )   $ 528     $ (1 372 )   $ 1 388  
                                 
(Loss) Earnings Per Share, basic and diluted   $ (.53 )   $ .16     $ (.40 )   $ .41  
                                 
See Notes to Consolidated Financial Statements.                                

4
 

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND 2010
($ in thousands, except share and per share data)
(Unaudited)
 
                                Accumulated                  
                                Other                  
    Common         Undivided     Treasury     Comprehensive      Comprehensive          
    Stock   Surplus   Profits     Stock     (Loss)     Income     Total  
Balances, December 31, 2009    $   3 672    $   3 898    $      21 931      $    (2 866 )    $    (1 063 )             $    25 572  
                                                     
       Comprehensive income                                                    
              Net income     - -     - -     1 388       - -       - -     $    1 388       1 388  
              Other comprehensive income:                                                    
                     unrealized holding losses                                                    
                     arising during the period                                                    
                     (net of tax, $2)     - -     - -     - -       - -       (3 )     (3 )     (3 )
       Total comprehensive income                                       $ 1 385          
                                                     
       Stock-based compensation expense     - -     25     - -       - -       - -               25  
                                                     
Balances, September 30, 2010   $ 3 672   $ 3 923   $ 23 319     $ (2 866 )   $ (1 066 )           $ 26 982  
                                                     
Balances, December 31, 2010   $ 3 672   $ 3 932   $ 23 725     $ (2 866 )   $ (1 687 )           $ 26 776  
                                                     
       Comprehensive loss                                                    
              Net loss     - -     - -     (1 372 )     - -       - -     $ (1 372 )     (1 372 )
              Other comprehensive income:                                                    
                     unrealized holding gains                                                    
                     arising during the period                                                    
                     (net of tax, $194)     - -     - -     - -       - -       377       377       377  
       Total comprehensive loss                                       $ ( 995 )        
                                                     
       Stock-based compensation expense     - -     11     - -       - -       - -               11  
                                                     
       Cash dividends ($.02 per share)     - -     - -     (67 )     - -       - -               (67 )
                                                     
Balances, September 30, 2011   $ 3 672   $ 3 943   $ 22 286     $ (2 866 )   $ (1 310 )           $ 25 725  
                                                     
See Notes to Consolidated Financial Statements.
 
5
 

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)
(Unaudited)
 
    For the Nine Months Ended  
    September 30     September 30  
    2011     2010  
CASH FLOWS FROM OPERATING ACTIVITIES                        
       Net (loss) income   $           (1 372 )   $      1 388  
       Adjustments to reconcile net (loss) income to net cash provided by                
              operating activities:                
                     Provision for loan losses     2 727       984  
                     Depreciation     361       419  
                     Write down of other real estate     2 133       17  
                     Discount accretion and premium amortization on securities, net     212       145  
                     Loss (gain) on sale of other real estate     336       (167 )
                     Loss on disposal of fixed assets     - -       5  
                     Stock compensation expense     11       25  
                     Proceeds from sale of loans     686       1 826  
                     Origination of loans for sale     (610 )     (2 341 )
                     Changes in assets and liabilities:                
                            Decrease (increase) in accrued interest receivable     72       (58 )
                            (Increase) decrease in other assets     (1 346 )     345  
                            Decrease in accrued interest payable     (116 )     (19 )
                            Increase in other liabilities     65       439  
                                   Net cash provided by operating activities   $ 3 159     $ 3 008  
                 
CASH FLOWS FROM INVESTING ACTIVITIES                
       Proceeds from maturity of securities available for sale   $ 5 110     $ 1 000  
       Proceeds from call of securities available for sale     23 000       22 545  
       Purchase of securities available for sale     (30 604 )     (26 885 )
       Net decrease in loans     5 422       6 937  
       Purchases of premises and equipment     (94 )     (71 )
       Proceeds from sale of other real estate     1 924       2 413  
                                   Net cash provided by investing activities   $ 4 758     $ 5 939  
                 
CASH FLOWS FROM FINANCING ACTIVITIES                
       Net increase (decrease) in noninterest-bearing deposits   $ 3 026     $ (2 685 )
       Net decrease in interest-bearing deposits     (2 751 )     (3 207 )
       Net (repayment) purchase of securities sold under agreements to repurchase     (2 143 )     978  
       Net repayment of Federal Home Loan Bank advances     (894 )     (843 )
       Cash dividends     (67 )     - -  
                                   Net cash used in financing activities   $ (2 829 )   $ (5 757 )
                 
                                   Increase in cash and cash equivalents   $ 5 088     $ 3 190  
                 
CASH AND CASH EQUIVALENTS                
       Beginning     12 905       12 623  
       Ending   $ 17 993     $ 15 813  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                
       Cash payments for:                
              Interest   $ 2 459     $ 3 214  
              Income tax payments   $ - -     $ 621  
                 
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING                
       AND FINANCING ACTIVITIES                
       Unrealized gain (loss) on securities available for sale   $ 571     $ (5 )
       Loans transferred to other real estate owned   $ 3 981     $ 2 977  
       Loans made on sale of other real estate   $ 142     $ 695  
                 
See Notes to Consolidated Financial Statements.
 
6
 

 

POTOMAC BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1. In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 2011 and December 31, 2010, and the results of operations for the three months and nine months ended September 30, 2011 and 2010, and cash flows and statements of changes in stockholders’ equity for the nine months ended September 30, 2011 and 2010. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 2010. The results of operations for the three month and nine month periods ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.
 
          The consolidated financial statements of Potomac Bancshares, Inc. (the “company”) and its wholly-owned subsidiary, Bank of Charles Town (the “bank”), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation.
 
  Certain reclassifications have been made to prior period amounts to conform to the current year presentation.
 
  In preparing these financial statements, the company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.
 
2. Stock-Based Compensation
 
  The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003, which authorized up to 183,600 shares of common stock to be used in the granting of incentive options to employees and directors. On April 24, 2007, the stockholders approved an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first and only stock incentive plan adopted by the company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Employee options granted under the plan are subject to a five year vesting schedule. Director options immediately vest.
 
  Incremental stock-based compensation expense recognized for the nine month periods ending September 30, 2011 and 2010 was $11 thousand and $25 thousand, respectively.
 
  Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first nine months of 2011 and 2010.
 
  Stock option plan activity for the nine months ended September 30, 2011 is summarized below:
 
            Weighted      
            Average      
      Weighted   Remaining      
      Average   Contractual   Aggregate
      Exercise   Life   Intrinsic
  Shares       Price       (in years)       Value
Options outstanding, January 1, 2011 120 974   $      14.76          
Granted - -     - -          
Exercised - -     - -          
Canceled or expired - -     - -          
Options outstanding, September 30, 2011 120 974     14.76   4   $      - -
Options exercisable, September 30, 2011 116 896     14.73   4   $ - -
                   
         
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2011. The aggregate intrinsic values change based on changes in the market value of the company’s stock.
 
As of September 30, 2011 there was $4 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining requisite service period.
 
7
 

 

3. Securities
 
          The amortized cost and fair value of securities available for sale as of September 30, 2011 and December 31, 2010 (in thousands) are as follows:
 
  September 30, 2011
        Gross   Gross      
  Amortized   Unrealized   Unrealized   Fair
  Cost   Gains   (Losses)   Value
Obligations of U. S. Government                        
       sponsored agencies $      37 573   $      469   $      (1 )   $      38 041
State and municipal obligations   6 454     255     - -       6 709
Equity securities   1 099     - -     (306 )     793
  $ 45 126   $ 724   $ (307 )   $ 45 543
 
  December 31, 2010
        Gross   Gross      
  Amortized   Unrealized   Unrealized   Fair
  Cost       Gains       (Losses)       Value
Obligations of U. S. Government                        
       sponsored agencies $ 36 207   $ 241   $          (160 )   $ 36 288
State and municipal obligations   5 537     71     (84 )     5 524
Equity securities   1 100     - -     (222 )     878
  $ 42 844   $ 312   $ (466 )   $ 42 690
                         
         
The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. There is one debt security in the consolidated portfolio that has a loss at September 30, 2011. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at September 30, 2011 and no impairment has been recognized.
 
There are three equity security investments in the company’s portfolio with losses at September 30, 2011. The company considers these investments to be temporarily impaired at September 30, 2011 and is recognizing no impairment. These are community bank stock related holdings.
 
U.S. Government sponsored agencies include the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation debt securities with a fair value of $22.4 million as of September 30, 2011 and $11.7 million as of December 31, 2010
 
The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of September 30, 2011 and December 31, 2010 (in thousands).
 
  September 30, 2011
  Less than 12 months   More than 12 months   Total
        Gross         Gross           Gross
        Unrealized         Unrealized           Unrealized
  Fair Value       Losses       Fair Value       Losses       Fair Value       Losses
Obligations of U.S. Government                                          
       sponsored agencies $     999   $            (1 )   $     - -   $          - -     $     999     $         (1 )
State and municipal obligations   - -     - -       - -     - -       - -       - -  
Equity securities   - -     - -       793     (306 )     793       (306 )
       Total $ 999   $ (1 )   $ 793   $ (306 )   $ 1 792     $ (307 )
                                           
8
 

 

3.          Securities (Continued)
 
  December 31, 2010
  Less than 12 months   More than 12 months   Total
        Gross         Gross         Gross
        Unrealized         Unrealized         Unrealized
  Fair Value   Losses   Fair Value   Losses   Fair Value   Losses
Obligations of U.S. Government                                                            
       sponsored agencies $     9 899   $         (147 )   $     1 108   $           (13 )   $     11 007   $          (160 )
State and municipal obligations   1 912     (84 )     - -     - -       1 912     (84 )
Equity securities   878     (222 )     - -     - -       878     (222 )
       Total $ 12 689   $ (453 )   $ 1 108   $ (13 )   $ 13 797   $ (466 )
                                         
  The company’s investment in Federal Home Loan Bank (FHLB) stock totaled $822 thousand at September 30, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess capital stock on a regular basis, the company does not consider this investment to be other-than-temporarily impaired at September 30, 2011 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.
 
          At September 30, 2011 and December 31, 2010, securities with carrying values of approximately $11.9 million and $24 million, respectively, were pledged to secure municipal deposits, securities sold under agreements to repurchase, other borrowings, and for other purposes as required or permitted by law.
 
4. Loans
 
          The loan portfolio, stated at face amount, is composed of the following:
 
  September 30,   December 31,
  2011   2010
  (in thousands)
Commercial – non real estate          
       Commercial and industrial $     7 579       $     7 920
Commercial real estate          
       Owner occupied   61 823     67 517
       Non-owner occupied   13 734     12 098
Construction          
       Residential   3 805     5 922
       Commercial   17 885     18 252
Real Estate          
       Farmland   635     792
Residential          
       Revolving open end   5 039     5 975
       1 to 4 family – first liens   79 254     82 691
       1 to 4 family – junior liens   7 853     8 871
       5 or more family   3 110     1 976
Consumer loans          
       Titled vehicles   2 998     3 713
       Deposit accounts   748     737
       All other consumer loans   2 782     2 350
All other loans   126     436
              Total loans   207 371     219 250
                     Less: allowance for loan losses   5 263     5 012
 
  $ 202 108   $ 214 238
           
9
 

 

4. Loans (Continued)
           
  The FHLB of Pittsburgh has a blanket lien on all the company’s loans except those loans specifically pledged to the Federal Reserve and removed from the FHLB lien. Currently, the FHLB lien is securing an advance to the company in the amount of $1.8 million and letters of credit issued on behalf of a customer of the company in the amount of $11 million.
 
5. Allowance for Loan Losses
 
  The following is a summary of transactions (in thousands) in the allowance for loan losses:

        September 30,       December 31,       September 30,
    2011   2010   2010
Balance at beginning of period   $            5 012     $            5 718     $            5 718  
                         
       Provision charged to operating expense     2 727       1 599       984  
       Recoveries added to the allowance     138       321       182  
       Loan losses charged to the allowance     (2 614 )     (2 626 )     (2 012 )
                         
Balance at end of period   $ 5 263     $ 5 012     $ 4 872  
 

Allowance for Loan Losses – By Segment
September 30, 2011
(in thousands)
 
                    Commercial                           All              
        Farmland       Commercial       Real Estate       Construction       Consumer       Residential       Other       Unallocated       Total
Beginning balance   $      166     $      239     $      859     $      2 022     $      20     $     1 691     $      1     $ 14   $     5 012  
       Charge-offs     - -       (20 )     (59 )     (1 123 )     (119 )     (1 293 )     - -       - -     (2 614 )
       Recoveries     - -       18       6       5       100       9       - -       - -     138  
       Provision     (149 )     (85 )     273       247       70       2 328       (1 )     44     2 727  
                                                                       
Ending balance   $ 17     $ 152     $ 1 079     $ 1 151     $ 71     $ 2 735     $ 0     $ 58   $ 5 263  
                                                                       
Individually evaluated                                                                      
       for impairment   $ - -     $ 143     $ 840     $ 718     $ 4     $ 379     $ - -     $ - -   $ 2 084  
Collectively evaluated                                                                      
       for impairment     17       9       239       433       67       2 356       0       58     3 179  
    $ 17     $ 152     $ 1 079     $ 1 151     $ 71     $ 2 735     $ 0     $ 58   $ 5 263  
                                                                       
Financing receivables:                                                                      
Ending balance   $ 635     $ 7 579     $ 75 557     $ 21 690     $ 6 528     $ 95 256     $ 126     $ - -   $ 207 371  
                                                                       
Ending balance:                                                                      
Individually evaluated                                                                      
       for impairment   $ - -     $ 143     $ 9 827     $ 5 603     $ 75     $ 3 623     $ - -     $ - -   $ 19 271  
Collectively evaluated                                                                      
       for impairment     635       7 436       65 730       16 087       6 453       91 633       126       - -     188 100  
Total   $ 635     $ 7 579     $ 75 557     $ 21 690     $ 6 528     $ 95 256     $ 126     $ - -   $ 207 371  
 

10
 

 

5.        Allowance for Loan Losses (Continued)
 
Allowance for Loan Losses – By Segment
December 31, 2010
(in thousands)
 
                Commercial                     All            
        Farmland       Commercial       Real Estate       Construction       Consumer       Residential       Other       Unallocated       Total
Ending balance   $ 166   $ 239   $ 859   $ 2 022   $ 20   $ 1 691   $     1   $ 14   $     5 012
                                                       
Individually evaluated                                                      
       for impairment   $ 161   $ 217   $ 528   $ 1 812   $ - -   $ 429   $ - -   $ - -   $ 3 147
Collectively evaluated                                                      
       for impairment     5     22     331     210     20     1 262     1     14     1 865
    $ 166   $ 239   $ 859   $ 2 022   $ 20   $ 1 691   $ 1   $ 14   $ 5 012
                                                       
Financing receivables:                                                      
Ending balance   $ 792   $ 7 920   $ 79 615   $ 24 174   $ 6 800   $ 99 513   $ 436   $ - -   $ 219 250
                                                       
Ending balance:                                                      
Individually evaluated                                                      
       for impairment   $ 539   $ 367   $ 9 398   $ 11 484   $ - -   $ 2 874   $ - -   $ - -   $ 24 662
Collectively evaluated                                                      
       for impairment     253     7 553     70 217     12 690     6 800     96 639     436     - -     194 588
Total   $ 792   $ 7 920   $ 79 615   $ 24 174   $ 6 800   $ 99 513   $ 436   $ - -   $ 219 250
 

Credit Quality Information – By Class
September 30, 2011
(in thousands)
 
          Special   Sub-            
Internal Risk Rating Grades         Pass       Mention       Standard       Doubtful       Loss
Commercial – non real estate                              
       Commercial and industrial   $     7 198   $     238   $     69   $     74   $     - -
Commercial real estate                              
       Owner occupied     39 723     12 979     6 855     2 266     - -
       Non-owner occupied     12 760     333     585     56     - -
Construction                              
       Residential     1 906     1 000     242     657     - -
       Commercial     11 204     2 181     2 622     1 878     - -
Real estate                              
       Farmland     635     - -     - -     - -     - -
Consumer                              
       Titled vehicles     N/A     N/A     N/A     N/A     N/A
       Deposit accounts     N/A     N/A     N/A     N/A     N/A
       All other     N/A     25     N/A     N/A     N/A
Residential                              
       Revolving open end     N/A     1 279     277     N/A     N/A
       1-4 family – first liens     N/A     4 096     1 523     333     - -
       1-4 family – junior liens     N/A     308     - -     - -     - -
       5 or more family     N/A     300     - -     - -     - -
                               
Totals   $ 73 426   $ 22 739   $ 12 173   $ 5 264   $ - -
 

As a matter of practice, we do not risk rate consumer or residential mortgage loans. Any of these loans listed in the risk rating table above are associated with commercial loans that have been risk rated as per our policy. When a loan is designated as a loss, it will usually be cleared from the loan portfolio within 90 days.
 
11
 

 

5.       Allowance for Loan Losses (Continued)
 
Credit Quality Information – By Class
September 30, 2011
(in thousands)
 
Non Risk Rated Loans         Performing       Nonperforming
Consumer – non real estate            
       Titled vehicles   $     2 992   $ 6
       Deposit accounts     748     - -
       All other     2 752     5
Residential            
       Revolving open end     3 453     30
       1-4 family – first liens     72 393     909
       1-4 Family – junior liens     7 545     - -
       5 or more family     2 810     - -
All other     126     - -
       Totals   $ 92 819   $ 950
 

Credit Quality Information – By Class
December 31, 2010
(in thousands)
 
          Special   Sub-            
Internal Risk Rating Grades         Pass       Mention       Standard       Doubtful       Loss
Commercial – non real estate                              
       Commercial and industrial   $     7 371   $     180   $     95   $     106   $     166
Commercial real estate                              
       Owner occupied     53 078     5 041     3 829     5 375     194
       Non-owner occupied     11 470     628     - -     - -     - -
Construction                              
       Residential     282     489     4 005     1 095     51
       Commercial     10 348     2 789     3 575     1 363     - -
Real estate                              
       Farmland     253     - -     - -     539     - -
Consumer                              
       Titled vehicles     N/A     N/A     N/A     N/A     N/A
       Deposit accounts     N/A     N/A     N/A     N/A     N/A
       All other     N/A     N/A     N/A     N/A     N/A
Residential                              
       Revolving open end     N/A     N/A     N/A     N/A     N/A
       1-4 family – first liens     N/A     3 234     956     1 434     242
       1-4 family – junior liens     N/A     187     42     175     25
       5 or more family     N/A     308     - -     - -     - -
Totals   $ 82 802   $ 12 856   $ 12 502   $ 10 087   $ 678
 

As a matter of practice, we do not risk rate consumer or residential mortgage loans. Any of these loans listed in the risk rating table above are associated with commercial loans that have been risk rated as per our policy. Once a loan is designated as a loss, it will usually be cleared from the loan portfolio within 90 days. The majority of the loss loans above are in process of foreclosure and will be transferred to other real estate owned (including possible charge-offs) when foreclosures are completed.
 
Credit Quality Information – By Class (Continued)
December 31, 2010
(in thousands)
 
Non Risk Rated Loans         Performing       Nonperforming
Consumer – non real estate            
       Titled vehicles   $     3 705   $ 8
       Deposit accounts     737     - -
       All other     2 345     7
Residential            
       Revolving open end     5 962     13
       1-4 family – first liens     75 901     1 101
       1-4 Family – junior liens     8 442     - -
       5 or more family     1 668     - -
All other     436     - -
Totals   $ 99 196   $ 1 129
 

12
 

 

5.       Allowance for Loan Losses (Continued)
 
Impaired Loans – By Class
September 30, 2011
(in thousands)
 
With no related allowance:                                
                      Average   Interest
    Unpaid   Recorded   Related   Recorded   Income
        Principal       Investment       Allowance       Investment       Recognized
Commercial – non real estate                              
       Commercial and industrial   $     - -   $     - -   $     N/A   $     82   $     - -
Commercial real estate                              
       Owner occupied     1 550     1 542     N/A     3 522     41
       Non-owner occupied     - -     - -     N/A     15     - -
Construction                              
       Residential     792     778     N/A     989     11
       Commercial     3 127     3 077     N/A     2 962     98
Real estate                              
       Farmland     - -     - -     N/A     - -     - -
Residential                              
       Revolving open end     277     277     N/A     115     12
       1 to 4 family –first liens     450     419     N/A     1 282     - -
       1 to 4 family – junior liens     - -     - -     N/A     229     - -
       5 or more family     - -     - -     N/A     - -     - -
Consumer                              
       Titled vehicles     - -     - -     N/A     - -     - -
       Deposit accounts     - -     - -     N/A     - -     - -
       All other consumer     - -     - -     N/A     - -     - -
All other     - -     - -     N/A     4     - -
    $ 6 196   $ 6 093   $ N/A   $ 9 200   $ 162
  
With an allowance recorded:                                
                      Average   Interest
    Unpaid   Recorded   Related   Recorded   Income
        Principal       Investment       Allowance       Investment       Recognized
Commercial – non real estate                              
       Commercial and industrial   $     144   $     143   $     143   $     176   $     3
Commercial real estate                              
       Owner occupied     7 703     7 644     751     5 326     253
       Non-owner occupied     647     641     89     163     3
Construction                              
       Residential     - -     - -     - -     1 638     - -
       Commercial     1 764     1 748     718     3 199     66
Real estate                              
       Farmland     - -     - -     - -     216     - -
Residential                              
       Revolving open end     - -     - -     - -     76     - -
       1 to 4 family – first liens     2 243     2 234     343     2 085     55
       1 to 4 family – junior liens     696     693     36     174     15
       5 or more family     - -     - -     - -     - -     - -
Consumer                              
       Titled vehicles     - -     - -     - -     - -     - -
       Deposit accounts     - -     - -     - -     - -     - -
       All other consumer     76     75     4     15     2
All other     - -     - -     - -     - -     - -
    $ 13 273   $ 13 178   $ 2 084   $ 13 068   $ 397
                               
Totals:                              
Commercial – non real estate   $ 144   $ 143   $ 143   $ 258   $ 3
Commercial real estate     9 900     9 827     840     9 026     297
Construction     5 683     5 603     718     8 788     175
Real estate –farmland     - -     - -     - -     216     - -
Residential     3 666     3 623     379     3 961     82
Consumer     76     75     4     19     2
All other     - -     - -     - -     - -     - -
    $ 19 469   $ 19 271   $ 2 084   $ 22 268   $ 559
 

13
 

 

5.       Allowance for Loan Losses (Continued)
 
Impaired Loans – By Class
December 31, 2010
(in thousands)
 
With no related allowance:                              
                    Average   Interest
  Unpaid   Recorded   Related   Recorded   Income
  Principal       Investment       Allowance       Investment       Recognized
Commercial – non real estate                            
       Commercial and industrial $ 117   $ 95   $ N/A   $ 53   $ - -
Commercial real estate                            
       Owner occupied   4 206     4 256     N/A     3 591     158
       Non-owner occupied   75     - -     N/A     15     - -
Construction                            
       Residential   1 188     1 183     N/A     1 769     52
       Commercial   2 641     2 631     N/A     3 655     112
Real estate                            
       Farmland   - -     - -     N/A     - -     - -
Residential                            
       Revolving open end   - -     - -     N/A     - -     - -
       1 to 4 family – first liens   1 259     1 242     N/A     1 351     15
       1 to 4 family – junior liens   175     175     N/A     142     3
       5 or more family   - -     - -     N/A     - -     - -
Consumer                            
       Titled vehicles   - -     - -     N/A     - -     - -
       Deposit accounts   - -     - -     N/A     - -     - -
       All other consumer   - -     - -     N/A     - -     - -
All other   - -     - -     N/A     - -     - -
  $      9 661   $      9 582   $    N/A   $    10 576   $    340
                               
With an allowance recorded:                              
                    Average   Interest
  Unpaid   Recorded   Related   Recorded   Income
  Principal       Investment       Allowance       Investment       Recognized
Commercial – non real estate                            
       Commercial and industrial $ 274   $ 272   $ 217   $ 355   $ 6
Commercial real estate                            
       Owner occupied   5 201     5 142     528     4 972     272
       Non-owner occupied   - -     - -     - -     - -     - -
Construction                            
       Residential   2 786     2 767     600     3 910     175
       Commercial   4 924     4 903     1 212     3 242     216
Real estate                            
       Farmland   549     539     161     547     - -
Residential                            
       Revolving open end   - -     - -     - -     - -     - -
       1 to 4 family – first liens   1 412     1 390     362     1 186     56
       1 to 4 family – junior liens   71     67     67     220     - -
       5 or more family   - -     - -     - -     - -     - -
Consumer                            
       Titled vehicles   - -     - -     - -     - -     - -
       Deposit accounts   - -     - -     - -     - -     - -
       All other consumer   - -     - -     - -     4     - -
All other   - -     - -     - -     - -     - -
  $      15 217   $  15 080   $ 3 147   $    14 436   $ 725
 
Totals:                            
Commercial – non real estate $ 391   $ 367   $ 217   $ 408   $ 6
Commercial real estate   9 482     9 398     528     8 578     430
Construction   11 539     11 484     1 812     12 576     555
Real estate – farmland   549     539     161     547     - -
Residential   2 917     2 874     429     2 899     74
Consumer   - -     - -     - -     4     - -
All other   - -     - -     - -     - -     - -
  $ 24 878   $ 24 662   $ 3 147   $ 25 012   $ 1 065
 

14
 

 

5.       Allowance for Loan Losses (Continued)
 
Modifications
As of September 30, 2011
(in thousands except number of contracts)
 
    For the Three Months Ended   For the Nine Months Ended
    September 30, 2011   September 30, 2011
          Pre-   Post-         Pre-   Post-
          Modification   Modification         Modification   Modification
    Number   Outstanding   Outstanding   Number   Outstanding   Outstanding
    Of   Recorded   Recorded   Of   Recorded   Recorded
        Contracts       Investment       Investment       Contracts       Investment       Investment
Troubled Debt Restructurings                                    
                                     
Commercial – non real estate                                    
       Commercial and industrial     - -   $ - -   $  - -     - -   $ - -   $ - -
Commercial real estate                                    
       Owner Occupied     3     431     431     3     431     431
       Non owner occupied     - -     - -     - -     - -     - -     - -
Construction                                    
       Residential     - -     - -     - -     - -     - -     - -
       Commercial     1     27     27     6     329     329
Real Estate                                    
       Farmland     - -     - -     - -     - -     - -     - -
Residential                                    
       Revolving open end 1 to 4 family     - -     - -     - -     - -     - -     - -
       1 to 4 family – first liens     3     153     170     16     1 580     1 694
       1 to 4 family – junior liens     11     415     415     20     705     705
       5 or more family     - -     - -     - -     - -     - -     - -
Consumer                                    
       Titled Vehicles     - -     - -     - -     - -     - -     - -
       Deposit Accounts     - -     - -     - -     - -     - -     - -
       All other consumer     2     56     56     3     77     77
                                     
All Other     - -     - -     - -     - -     - -     - -
                                     
Totals     20   $ 1 082   $ 1 099     48   $ 3 122   $ 3 236
 

As of September 30, 2011 there are two troubled debt restructurings that are thirty or more days past due and one loan that was in non-accrual status before being modified and will be put back on accrual status when they make six timely payments.
 
15
 

 

    For the Three Months   For the Nine Months
    Ended September 30,2011   Ended September 30,2011
    Number   Outstanding   Number   Outstanding
    Of   Recorded   Of   Recorded
        Contracts       Investment            Contracts       Investment
Troubled Debt Restructurings                        
That Subsequently Defaulted                        
                         
Commercial – non real estate                        
       Commercial and industrial     - -   $  - -     - -   $ - -
Commercial real estate                        
       Owner Occupied     - -     - -     - -     - -
       Non owner occupied     - -     - -     - -     - -
Construction                        
       Residential     - -     - -     - -     - -
       Commercial     - -     - -     - -     - -
Real Estate                 - -     - -
       Farmland     - -     - -     - -     - -
Residential                        
       Revolving open end 1 to 4 family     - -     - -     - -     - -
       1 to 4 family – first liens     1     127     1     127
       1 to 4 family – junior liens     3     104     3     104
       5 or more family     - -     - -     - -     - -
Consumer                        
       Titled Vehicles     - -     - -     - -     - -
       Deposit Accounts     - -     - -     - -     - -
       All other consumer     - -     - -     - -     - -
All Other     - -     - -     - -     - -
Totals     4   $ 231     4   $ 231
 

16
 

 

5. Allowance for Loan Losses (Continued)
           
  Recorded reserves for impaired loans total $2.1 million compared to total nonaccrual loans of $2.8 million. These loans are kept under constant scrutiny by the loan officers and credit administration.
 
Nonaccrual and Past Due Loans – By Class
September 30, 2011
(in thousands)
 
                                               
    30-59   60-89   90 Days                     90 Days      
    Days   Days   or more   Total       Total   Past Due   Non
       Past Due      Past Due      Past Due      Past Due      Current      Loans      Accruing      Accrual
Commercial – non real estate                                                
       Commercial and industrial   $     61   $     - -   $      - -   $     61   $     7 518   $     7 579   $     - -   $      - -
Commercial real estate                                                
       Owner Occupied     - -     112     537     649     61 174     61 823     116     420
       Non owner occupied     1 014     333     253     1 600     12 134     13 734     - -     253
Construction                                                
       Residential     - -     - -     272     272     3 533     3 805     - -     272
       Commercial     1 478     99     478     2 055     15 830     17 885     - -     524
Real Estate                                                
       Farmland     - -     - -     - -     - -     635     635     - -     - -
Residential                                                
       Revolving open end     - -     - -     - -     - -     5 039     5 039     - -     31
       1 to 4 family – first liens     1 101     41     976     2 118     77 136     79 254     252     1 329
       1 to 4 family – junior liens     116     - -     40     156     7 697     7 853     40     - -
       5 or more family     - -     - -     - -     - -     3 110     3 110     - -     - -
Consumer                                                
       Titled Vehicles     21     - -     2     23     2 975     2 998     2     5
       Deposit Accounts     - -     - -     - -     - -     748     748     - -     - -
       All other consumer     31     - -     29     60     2 722     2 782     25     5
All Other     - -     - -     - -     - -     126     126     - -     - -
Totals   $ 3 822   $ 585   $ 2 587   $ 6 994   $ 200 377   $ 207 371   $ 435   $ 2 839
                                                 
Percentage to Total Loans     1.84%     0.28%     1.25%     3.37%     96.63%           0.21%     1.37%
 

Nonaccrual and Past Due Loans – By Class
December 31, 2010
(in thousands)
 
                                               
    30-59   60-89   90 Days                     90 Days      
    Days   Days   or more   Total       Total   Past Due   Non
       Past Due      Past Due      Past Due      Past Due      Current      Loans      Accruing      Accrual
Commercial – non real estate                                                
       Commercial and industrial   $     80   $     92   $     2   $     174   $     7 746   $     7 920   $     - -   $     97
Commercial real estate                                                
       Owner Occupied     612     - -     - -     612     66 905     67 517     - -     - -
       Non owner occupied     194     - -     - -     194     11 904     12 098     - -     - -
Construction                                                
       Residential     238     - -     - -     238     5 684     5 922     - -     - -
       Commercial     115     - -     285     400     17 852     18 252     - -     405
Real Estate                                                
       Farmland     - -     - -     539     539     253     792     - -     539
Residential                                                
       Revolving open end     - -     - -     - -     - -     5 975     5 975     - -     38
       1 to 4 family – first liens     2 269     416     881     3 566     79 125     82 691     - -     1 099
       1 to 4 family – junior liens     135     19     - -     154     8 717     8 871     - -     42
       5 or more family     - -     - -     - -     - -     1 976     1 976     - -     - -
Consumer                                                
       Titled Vehicles     37     2     - -     39     4 310     4 349     - -     8
       Deposit Accounts     11     - -     - -     11     774     785     - -     - -
       All other consumer     3     - -     5     8     1 658     1 666     - -     5
All Other     - -     - -     - -     - -     436     436     - -     - -
Totals   $ 3 694   $ 529   $ 1 712   $ 5 935   $ 213 315   $ 219 250   $ - -   $ 2 233
 
Percentage to Total Loans     1.69%     0.24%     0.78%     2.71%     97.29%           - -%     1.02%
 

17
 

 

5. Allowance for Loan Losses (Continued)
           
  The past due policy of the bank is to report all classes of loans past due in the following categories:
   
 
  • 30 to 59 days past due (principal or interest)
  • 60 to 89 days past due (principal or interest)
  • 90 days or more past due (principal or interest)
  • Nonaccrual status.
   
6. Employee Benefit Plans
           
  Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below:

    Pension Benefits   Other Postretirement Benefits
    Three Months Ended   Three Months Ended
    September 30,   September 30,   September 30,   September 30,
        2011       2010       2011       2010
    (in thousands)   (in thousands)
Components of Net Periodic Benefit Cost                            
       Service cost   $ - -     $ - -     $ 3   $ 3
       Interest cost     100       104       9     8
       Expected return on plan assets                   (119 )                   (115 )     - -     - -
       Amortization of net obligation at transition     - -       - -       4     4
       Recognized net actuarial loss     38       24       - -     - -
                             
Net periodic benefit cost   $ 19     $ 13     $ 16   $ 15
 

    Pension Benefits   Other Postretirement Benefits
    Nine Months Ended   Nine Months Ended
    September 30,   September 30,   September 30,   September 30,
        2011       2010       2011       2010
    (in thousands)   (in thousands)
Components of Net Periodic Benefit Cost                            
       Service cost   $ - -     $ - -     $ 10   $ 9
       Interest cost     301       309       27     26
       Expected return on plan assets                   (356 )                   (345 )     - -     - -
       Amortization of net obligation at transition     - -       - -       13     12
       Recognized net actuarial loss     112       72       - -     - -
                             
Net periodic benefit cost   $ 57     $ 36     $ 50   $ 47
 

Employer Contribution
 
The company anticipates the 2011 contribution for the pension plan will approximate $10 thousand and has made this payment as of September 30, 2011. The company has made payments of $14 thousand for the other postretirement benefit plans for the first nine months of 2011 and anticipates remaining payments for 2011 to total $6 thousand.
 
The company’s defined benefit pension plan was frozen as of October 31, 2009. Benefits of all existing participants stopped accruing and no new participants could be admitted to the plan after that date.
 
18
 

 

7. Weighted Average Number of Shares Outstanding and Earnings Per Share
           
  The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of potential diluted common stock. Potential diluted common stock had no effect on the three months and nine months ended September 30, 2011 and September 30, 2010 earnings per share.

    Three Months Ended   Three Months Ended
    September 30, 2011   September 30, 2010
        Average Shares       Per Share Amount       Average Shares       Per Share Amount
Basic earnings per share   3 390 178   $                        (.53 )   3 390 178   $ .16
Effect of dilutive securities:                      
       Stock options   - -           - -      
                       
Diluted earnings per share   3 390 178   $ (.53 )   3 390 178   $ .16
             
    Nine Months Ended   Nine Months Ended
    September 30, 2011   September 30, 2010
    Average Shares   Per Share Amount   Average Shares   Per Share Amount
Basic earnings per share   3 390 178   $ (.40 )   3 390 178   $ .41
Effect of dilutive securities:                      
       Stock options   - -           - -      
                       
Diluted earnings per share   3 390 178   $ (.40 )   3 390 178   $ .41
                       
 
For the three months and nine months ended September 30, 2011, stock options representing 120,974 average shares, and for the three months and nine months ended September 30, 2010, stock options representing 126,224 average shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.
           
8. Recent Accounting Pronouncements
 
  In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
 
  In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into an entity’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, were required for periods beginning on or after December 15, 2010. The company has included the required disclosures in its consolidated financial statements.
 
19
 

 

8. Recent Accounting Pronouncements (continued)
           
  The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The company complied with this Rule beginning with the filing of the June 30, 2011 Form 10-Q.
 
  In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
 
  In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The company has adopted ASU 2011-02 and included the required disclosures in its consolidated financial statements.
 
  In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.
 
20
 

 

8. Recent Accounting Pronouncements (continued)
           
  In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.
 
  In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.
 
  In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.” The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification. The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act. The Release was effective as of August 12, 2011. The adoption of the release did not have a material impact on the company’s consolidated financial statements.
 
21
 

 

9. Fair Value Measurements
 
          Determination of Fair Value
 
  The company uses fair value measurements to record fair value adjustments for certain assets and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
  The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
 
  Fair Value Hierarchy
 
  In accordance with this guidance, the company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
 
  Level 1—Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
 
  Level 2—Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
 
  Level 3—Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques.
 
  A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
 
  The following methods and assumptions were used by the company in estimating fair value disclosures for financial instruments:
 
  Cash and Short-Term Investments
 
  The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.
 
  Securities
 
 
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). Certain of the equity securities with inactive markets utilize Level 3 which may include judgement or estimation.
 
22
 

 

9. Fair Value Measurements (Continued)
 
          Loans
 
  For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.
 
  FHLB Stock
 
  The carrying amounts of FHLB stock approximate fair value based on redemption provisions of the FHLB.
 
  Bank Owned Life Insurance (BOLI)
 
  The carrying amounts of BOLI approximate fair value.
 
  Deposit Liabilities
 
  The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity fixed rate certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
 
  Short-Term Borrowings
 
  The carrying amounts of borrowings under repurchase agreements and federal funds purchased approximate fair value.
 
  FHLB Advances
 
  The fair values of the company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.
 
  Accrued Interest
 
  The carrying amounts of accrued interest approximate fair value.
 
  Off-Balance Sheet Financial Instruments
 
  At September 30, 2011 and December 31, 2010, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.
 
23
 

 

9. Fair Value Measurements (Continued)
 
          The carrying amounts and estimated fair values of the company’s financial instruments are as follows:

      September 30, 2011   December 31, 2010
      Carrying   Fair   Carrying   Fair
          Amount       Value       Amount       Value
      (in thousands)   (in thousands)
Financial assets:                        
       Cash   $     17 268   $     17 268   $     10 180   $     10 180
  Federal funds sold     725     725     2 725     2 725
  Securities available for sale     45 543     45 543     42 690     42 690
  Loans, net     202 108     201 864     214 238     212 200
  Loans held for sale     - -     - -     76     76
  FHLB stock     822     822     765     765
  BOLI     6 872     6 872     6 397     6 397
  Accrued interest receivable     888     888     960     960
                         
Financial liabilities:                        
  Deposits   $ 257 697   $ 258 612   $ 257 422   $ 258 240
  Securities sold under                        
         agreements to repurchase     5 239     5 239     7 382     7 382
  FHLB advances     1 823     1 839     2 717     2 734
  Accrued interest payable     245     245     361     361

Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010:
 
          Fair Value Measurements at September 30, 2011 Using
          Quoted Prices            
          in Active   Significant      
          Markets for   Other   Significant
    Balance as of   Identical   Observable   Unobservable
    September 30   Assets   Inputs   Inputs
Description         2011       (Level 1)       (Level 2)       (Level 3)
Available for sale debt securities                        
       U.S. Government sponsored                        
              agency securities   $     38 041   $     - -   $     38 041   $     - -
       State and municipal securities     6 709     - -     6 709     - -
                         
Total available for sale debt securities     44 750     - -     44 750     - -
                         
Available for sale equity securities                        
       Financial services industry     793     - -     135     658
                         
Total available for sale securities   $ 45 543   $ - -   $     44 885   $ 658
                         
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9. Fair Value Measurements (Continued)
           
          Fair Value Measurements at December 31, 2010 Using
          Quoted Prices            
          in Active   Significant      
          Markets for   Other   Significant
    Balance as of   Identical   Observable   Unobservable
    December 31   Assets   Inputs   Inputs
Description         2010       (Level 1)       (Level 2)       (Level 3)
Available for sale debt securities                        
       U.S. Government sponsored                        
              agency securities   $     36 288   $     - -   $     36 288   $     - -
       State and municipal securities     5 524     - -     5 524     - -
                         
Total available for sale debt securities     41 812     - -     41 812     - -
                         
Available for sale equity securities                        
       Financial services industry     878     - -     878     - -
                         
Total available for sale securities   $ 42 690   $ - -   $ 42 690   $ - -
                         
          Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)
 
    Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
    (in thousands)
                     
       
Available for Sale Equity Securities
Beginning Balance January 1, 2011   $     - -                              
                         
       Transfers into Level 3     834                  
       Transfers out of Level 3     - -                  
       Total losses (unrealized)                        
              included in other                        
                     comprehensive income     (176 )                
                         
       Ending Balance September 30, 2011   $      658                  
                         
          Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
   
  Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
   
  The following describes the valuation techniques used by the company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
   
  Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended September 30, 2011 and December 31, 2010. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of operations.
   
  Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is likely that some amounts due according to the contractual terms of the loan agreement may not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered (Level 3). The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.
 
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9. Fair Value Measurements (Continued)
 
          Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal outside of the company or comparative market analysis using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, or property is in the process of being appraised then the fair value is considered Level 3.
 
  The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of September 30, 2011 and December 31, 2010.

          Carrying Value at September 30, 2011
          Quoted Prices            
          In Active   Significant      
          Markets for   Other   Significant
          Identical   Observable   Unobservable
    Balance as of   Assets   Input   Input
Description         September 30, 2011       (Level 1)       (Level 2)       (Level 3)
Assets                        
       Impaired loans with a                        
              valuation allowance   $     11 094   $      - -   $     5 034   $     6 060
                         
       OREO     6 151     - -     5 355     796
             
          Carrying Value at December 31, 2010
          Quoted Prices            
          In Active   Significant      
          Markets for   Other   Significant
          Identical   Observable   Unobservable
    Balance as of   Assets   Input   Input
Description     December 31, 2010   (Level 1)   (Level 2)   (Level 3)
Assets                        
       Loans held for sale   $ 76         $ 76      
       Impaired loans with a                        
              valuation allowance     11 933     - -     10 593     1 340
                         
       OREO     6 563     - -     6 563     - -

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
          CRITICAL ACCOUNTING POLICIES
   
  General
   
  The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

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Allowance for Loan Losses
 
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) losses be accrued based on the differences between the value of collateral and the loan balance.
 
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as loss, doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for environmental factors such as economic, concentration, and growth trends. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects that margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
FINANCIAL OVERVIEW
 
The quarter ended September 30, 2011 has produced little, if any, clarity to the economic outlook. The local economy has remained relatively unchanged. The housing market and unemployment continue to be a drag on the local economy. Management has counteracted the reductions in loan income by reducing expenses wherever possible, and continuing to reduce interest expense on deposits. There have been no significant adverse effects on deposit balances.
 
Management continues to pursue potential loan relationships and is vigilantly marketing our current inventory of foreclosed properties. It is management’s opinion that one of the key elements to improving our situation and that of the local economy is to reduce this housing inventory currently owned by financial institutions. We expect economic growth to be slow and do not expect the real estate market to return to pre-recession levels.
 
The net loss for the quarter of $1.8 million and a net loss year to date of $1.3 million are primarily due to two charges posted in this quarter. First, we reduced the value of our foreclosed property assets by some $1.85 million upon obtaining updated appraisals on foreclosed property carried on our balance sheet. We evaluate these assets on an ongoing basis especially in a “declining real estate market” which our area continues to experience. About two thirds of the write-down involves residential lot developments foreclosed upon and charged down in 2009. These properties have continued to lose value due to very weak demand by consumers for new housing and little demand from builders for lots. A surplus of foreclosed properties on the market continues to keep prices low, so until new and existing housing values reach some sort of price equilibrium, there will be little demand for both lots and new construction.
 
A second charge of $2.1 million involves additions to our loan loss reserve as businesses and consumers continue to struggle because of the sluggish economy. In conjunction with our ongoing loan review process, an analysis of both primary and secondary sources of repayment including an assessment of the current value of collateral is performed. Again, most of the collateral that secures our loans is real estate and those values are down significantly.
 
Total assets have decreased $3.9 million or 1.3% from the December 31, 2010 total of $297.6 million to $293.7 million at September 30, 2011. Net loans have decreased approximately $12.1 million from the December 31, 2010 total of $214.2 million to $202.1 million at September 30, 2011 due to minimal loan demand, the pay down of existing loans, loan charge-offs and the transfer of loans to OREO. Other real estate, net of valuation allowance, has decreased $412 thousand. With the decrease in loans, excess funds have been invested in securities, and overnight funds at the Federal Reserve.
 
Total deposits have increased $275 thousand or .1% at September 30, 2011 compared to December 31, 2010. Interest-bearing deposits have decreased 1.2% during the first three quarters of 2011, with non-interest bearing deposits increasing 11.3%.
 
The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.42% at September 30, 2011 compared to 9.36% at December 31, 2010. This capital ratio is within the regulatory guidelines for “well capitalized”.
 
The debate in Congress regarding the national debt ceiling, federal budget deficit concerns and overall weakness in the economy recently resulted in a downgrade of U.S. government securities by Standard and Poor’s, one of the three major credit rating agencies. This downgrade and the possible future downgrade by one or both of the other two major ratings agencies could create uncertainty in the U.S. and global financial markets. These actions could cause other events which, directly or indirectly, may adversely affect the company’s operations, earnings and financial condition.
 
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The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Management monitors the loan portfolio on a continual basis with procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Written reports are prepared on a monthly basis for all loans including commercial loans graded below a certain level for management review and are reported to the Board of Directors on a quarterly basis. In addition, a subcommittee of the board of directors meets monthly to review all classified assets. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.
 
  September 30,   December 31,   September 30,
  2011      2010      2010
Balance at beginning of period $        5 012   $        5 718   $        5 718
Charge-offs:                
       Commercial, financial and agricultural   20     313     294
       Real estate – construction   1 123     775     555
       Real estate – mortgage   1 352     1 245     949
       Consumer   119     293     214
              Total charge-offs   2 614     2 626     2 012
Recoveries:                
       Commercial, financial and agricultural   18     25     - -
       Real estate – construction   5     - -     - -
       Real estate – mortgage   15     95     20
       Consumer   100     201     162
              Total recoveries   138     321     182
Net charge-offs   2 476     2 305     1 830
Provision charged to operations   2 727     1 599     984
Balance at end of period $ 5 263   $ 5 012   $ 4 872
                 
Ratio of net charge-offs (annualized) during the period                
       to average loans outstanding during the period   1.56%     1.01%     1.07%
                 

As a result of the regular loan reviews by management, the allowance for loan losses increased when comparing data as of September 30, 2011 to September 30, 2010. Many of the loans foreclosed upon or currently in nonaccrual status are related to the real estate industry. In comparing data for the loan loss reserve for the September 30, 2011 quarter end to December 31, 2010 information, the reserve has increased in relation to a continued weak economy. Management continues to review these assets on a regular basis.
 
Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more and in the process of collection. Interest income generally is recognized on specific impaired loans unless the likelihood of further loss is expected. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. The majority of the current non-accrual loans as shown in the chart below are in the process of collection. Following is a table showing the risk elements in the loan portfolio with amounts in thousands.
 
  September 30,   December 31,   September 30,
  2011      2010      2010
Nonperforming Assets                
       Nonaccrual loans (1) $        2 839   $        2 233   $        2 134
       Foreclosed properties   6 151     6 563     6 363
              Total nonperforming assets $ 8 990   $ 8 796   $ 8 497
                 
       Performing troubled debt restructures (2) $ 3 083   $ - -   $ - -
                 
       Loans past due 90 days accruing interest $ 435   $ - -   $ 99
       Allowance for loan losses to period end loans   2.54%     2.29%     2.19%
       Nonperforming assets to period end loans and                
              foreclosed properties, net   4.21%     3.90%     3.71%
                 
       Performing troubled debt restructures to period end loans   1.51%     - -%     - -%
                 

(1)         Currently there is 1 TDR in non-performing assets with a balance of $50K.
(2)   Within this amount are two TDR’s with balances totaling $155k and both are 30 or more days past due.
 
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The details of the income statements for the three month and nine month periods ended September 30, 2011 and 2010 are highlighted below.
 
Ø Year to date net loss in 2011 is $1.37 million compared to net income of $1.39 million in 2010. Quarterly net loss is $1.8 million in 2011 compared to net income of $528 thousand for the same quarter of 2010. The loan portfolio has decreased as the result of foreclosures and normal run off. Decline in property values have further affected the net income as other real estate write downs have been charged against income. In addition there were net gains on sale of other real estate in 2010 compared to net losses in 2011.
 
Ø The primary driver of both the year to date loss and quarterly loss are attributable to increases in the loan loss provision and write downs of OREO property. The year to date provision for loan loss has increased $1.7 million over the same period in 2010. The quarterly provision increased $1.9 million over the same quarter in 2010. Likewise, the write down of OREO property had a year to date increase of $2.1 million and a quarterly increase of $1.8 million. Both of these figures represent comparisons to the same time period in 2010.
 
Ø At September 30, 2011, year to date total interest and dividend income is down 9.5% compared to September 30, 2010. A comparison of quarterly interest and dividend income provides a reduction of 8.6%. In each scenario the reasons for the decrease in income are the same. Loan yields are down slightly over the past year and the loan portfolio has decreased. As of September 30 there are also $2.8 million in loans on nonaccrual status. As of September 30, 2011 loans are down 5.4% compared to December 31, 2010.
 
Ø At September 30, 2011, year to date interest expense was 26.7% below 2010 expense for the same time period. The quarterly results show a 36.2% drop in interest expense as compared to the same quarter in 2010. The decrease in expense is primarily due to a reduction in interest rates on deposit accounts as part of a planned strategy.
 
Ø Net interest margin at September 30, 2011 is 3.54%. This is down from the net interest margin of 3.56% for the same period in 2010. During the first nine months of 2011, the overall average rate on loans dropped to 5.56% at September 30, 2011 compared to 5.71% for the same period in 2010. During this same period the overall average rate being paid on deposits decreased to 1.29% from 1.72% at September 30, 2010.
 
Noninterest income increased 2.5% for the nine months ended September 30, 2011 compared to September 30, 2010 and increased 3.13% for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. Some significant income items are listed here.
 
Ø Visa and Mastercard fees have increased 13.2% on a year to date basis compared to the same period in 2010. The increase is due to an overall increase in consumer spending and the likelihood that consumers continue to get more comfortable with using credit/debit cards versus cash.
 
Ø Quarterly comparisons show a 13.1% increase in income from fiduciary activities and a 15.1% increase in fees from Visa and Mastercard. These results are in comparison to the quarter ended September 30, 2010.
 
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Year to date total noninterest expense increased about 40.4% for the nine months ended September 30, 2011 compared to the same period in 2010. The quarterly result was an increase of 86.5% over the September 2010 quarter. Excluding write downs and losses from sales of other real estate, noninterest expense was up 4.6% and 1.1% for the nine and three month periods, respectively. Some details of the remaining accounts are listed below.
 
Ø Furniture and equipment expense increased 10.2% over September 30, 2010. The quarterly comparisons show an increase of 54.3% over the September 2010 quarter. The primary reason for the increase is maintenance expense related to our core banking software.
 
Ø Advertising and public relations expense increased 13.2% compared to the same period in 2010. The expense is 20.5% greater than the September 2010 quarter.
 
Ø Accounting, audit and compliance fees are up 29.8% over September 30, 2010. These same fees show an increase of 41.7% as compared to the September 30, 2010 quarter. The increase is due to auditing services provided by an outside vendor to help assess our loan portfolio.
 
Ø ATM and check card expenses have increased 15% in the first nine months of 2011 compared to the same time period in 2010. The increase jumps to 18% when compared to the quarter ended September 30, 2010. The increase is due to the purchase of card stock (which generally occurs on a bi-annual basis) as well as an increase in the number of cards being reissued because of fraud, damage or loss by the customer.
 
Ø Postage expense has increased 15.1% over September 30, 2010. The quarterly results show increases of 13.2% over the quarter ended September 30, 2010. The increase is primarily related to postage costs related to promotional materials and customer notifications. In the third quarter we expensed the postage costs for the shipment of the 140th anniversary calendars and mailings to notify customers of our privacy policy and changes in our fees on deposit accounts. Two of these three items are one time expenses not in the normal course of business.
 
Ø 2011 year to date other operating expenses have increased 13.5% compared to the same period in 2010. The significant contributing factors include trust investing outsource, other professional fees, other taxes, training and study, and credit reports and investigation.
 
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LIQUIDITY
 
Liquidity is a measure of the Bank’s ability to respond to sudden changes in funding needs or funding sources. Examples of sudden changes could involve a sudden increase in loan demand, a funding need, or it might involve a large decrease in deposited funds, a funding source. The role of cash management is to manage assets and liabilities so that the Bank can respond to such fluctuations in sources and uses of cash. Management spends much of its time assessing our liquidity position.
 
Management is informed of the liquidity information via reports and committee discussion. The president is provided a weekly “dashboard” report of our liquidity information. The Asset/Liability Committee reviews and discusses our liquidity position on a quarterly basis. The committee has set a benchmark minimum liquidity ratio of 15%. Management has recently implemented on a strategy to free up some pledged assets for liquidity purposes.
 
Public funds are required to have collateral pledged against their balances above the FDIC insurance limits. Generally the bank has pledged securities or obtained letters of credit from the Federal Home Loan Bank of Pittsburgh to cover public funds. Two additional strategies to cover these funds are now being used. In the case of public funds in the form of CDs, the bank is utilizing the CDARS network to insure their funds. We are also using the Insured Cash Sweep (ICS) product to secure public funds. Both of the programs provide complete coverage through FDIC insurance. Most importantly, the securities that had been pledged against the public funds can be used as a source of cash if the need would arise. The securities are effectively converted from a non liquid asset to a liquid asset.
 
Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2011.
 
     Operating Activities. The company’s net income usually provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions such as depreciation expense that reduces net income but does not require a cash outlay. During 2011, the net loss as adjusted has provided cash of $3.1 million. Interest income earned on loans and investment securities is the company’s major income source.
 
     Investing Activities. Customer core deposits and company noncore funding provide the funds used to invest in loans and investment securities. In addition, the principal portion of loan payments, loan payoffs and maturity of investment securities provide cash flow. Purchases of bank premises and equipment are an investing activity. We have taken advantage of our noncore funding capabilities since deposit growth is not always sufficient. The net amount of cash provided by investing activities in 2011 is $4.8 million.
 
     Financing Activities. Customer core deposits and company noncore funding provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends to shareholders, purchase of shares of the company’s common stock for the treasury and repayment of any noncore funding. The net amount of cash used in financing activities in 2011 is $2.8 million.
 
At September 30, 2011, cash and due from banks, interest-bearing deposits in financial institutions, securities purchased under agreements to resell, federal funds sold and loans and securities maturing within one year were $41.5 million.
 
Noncore funding capabilities, including borrowing, provide additional liquidity. The subsidiary bank maintains a federal funds line with one financial institution and is a member of the Federal Home Loan Bank of Pittsburgh. In March 2010, the subsidiary bank modified a $3 million borrowing amortizing over three years from the Federal Home Loan Bank. In July 2009 the subsidiary bank secured a credit line with the Federal Reserve discount window. At September 30, 2011, the subsidiary bank has total credit available through these institutions of approximately $35.7 million.
 
ANALYSIS OF CAPITAL
 
     The adequacy of the company’s capital is reviewed by management on an ongoing basis in terms of the size, composition, and quality of the company’s asset and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.
 
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     The Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. All capital ratios are within the regulatory guidelines for a “well capitalized institution as noted below.
 
  September 30, 2011 (000’s)
            Minimum    
            Capital    
  Actual       Requirement    
  Amount      Ratio      Amount      Ratio
Total capital to risk weighted assets $       27 656   13.09%   $       16 903   8.00%
Tier 1 capital to risk weighted assets $ 24 983   11.82%   $ 8 451   4.00%
Tier 1 capital to average assets $ 24 983   8.42%   $ 11 886   4.00%
 
  December 31, 2010 (000’s)
            Minimum    
            Capital    
  Actual       Requirement    
  Amount      Ratio      Amount      Ratio
Total capital to risk weighted assets $       30 798   14.24%   $       17 306   8.00%
Tier 1 capital to risk weighted assets $ 28 065   12.97%   $ 8 653   4.00%
Tier 1 capital to average assets $ 28 065   9.36%   $ 11 992   4.00%
 
Item 4. Controls and Procedures
 
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
 
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings.
 
There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance.
 
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
            (c) Total Number    
            of Shares    
    (a) Total       Purchased as   (d) Maximum Number
    Number of   (b) Average   Part of Publicly   of Shares that May
    Shares   Price Paid   Announced   Yet be Purchased
Period       Purchased       Per Share       Programs       Under the Program
July 1 through                
       July 31   NONE   - -   283 553   62 515
August 1 through                
       August 31   NONE   - -   283 553   62 515
September 1 through                
       September 30   NONE   - -   283 553   62 515

On February 12, 2002, the company’s Board of Directors originally authorized the repurchase program. The program authorized the repurchase of up to 10% of the company’s stock over the next twelve months. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent. The program has been extended on annual basis at Potomac’s reorganization meeting.
 
Item 4. (Removed and Reserved)
 
Item 5. Other Information
 
      (b)        There have been no changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors since the registrant last provided disclosure in response to Item 7(d)(2)(ii)(G) of Schedule 14A.
 
Item 6. Exhibits
 
                     31.1        Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
       
  31.2   Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002)
       
  32   Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002)
       
  101.INS   XBRL Instance Document. **
       
  101.SCH   XBRL Taxonomy Extension Schema. **
       
  101.CAL   XBRL Taxonomy Extension Calculation Linkbase. **
       
  101.LAB   XBRL Taxonomy Extension Label Linkbase. **
       
  101.PRE   XBRL Taxonomy Extension Presentation Linkbase. **
       
  101.DEF   XBRL Taxonomy Definition Linkbase. **
       
  **   Furnished, not filed, herewith
 
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SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
    POTOMAC BANCSHARES, INC.
       
Date:  November 14, 2011   /s/ Robert F. Baronner, Jr.
    Robert F. Baronner, Jr.
    President & CEO
   
Date:  November 14, 2011   /s/ Dean Cognetti
    Dean Cognetti
    Sr. Vice President and Interim Chief Financial Officer
 
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