XOTC:FETM Fentura Financial Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2012

OR

 

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

For the transition period from                     to                    

Commission file number 000-23550

 

 

Fentura Financial, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Michigan   38-2806518

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employee

Identification No.)

175 N Leroy, P.O. Box 725, Fenton, Michigan 48430

(Address of Principal Executive Offices)

(810) 629-2263

(Registrant’s telephone number)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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.    x  Yes    ¨  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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)    x  Yes    ¨  No

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

 

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: May 1, 2012

Class — Common Stock                Shares Outstanding — 2,403,741

 

 

 


Table of Contents

Fentura Financial, Inc.

Index to Form 10-Q

 

     Page  

Part I — Financial Information

     3   

Item 1 — Consolidated Financial Statements (Unaudited)

     3-31   

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

     32-43   

Item 3 — Quantitative and Qualitative Disclosures about Market Risk

     43-45   

Item 4 — Controls and Procedures

     45   

Part II — Other Information

     46   

Item 1 — Legal Proceedings

     46   

Item 1A — Risk Factors

     46   

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

     46   

Item 3 — Defaults Upon Senior Securities

     46   

Item 4 —Reserved

     46   

Item 5 — Other Information

     46   

Item 6 — Exhibits

     46   

Signatures

     47   

Exhibit Index

     48   

 

2


Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

FENTURA FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(000s omitted except share and per share data)

 

     March 31,     Dec 31,  
     2012     2011  

ASSETS

    

Cash and cash equivalents

   $ 30,476      $ 18,634   

Securities:

    

Securities available for sale

     59,708        58,687   

Securities held to maturity

     2,963        2,963   
  

 

 

   

 

 

 

Total securities

     62,671        61,650   

Loans held for sale

     593        123   

Loans:

    

Commercial

     33,207        33,956   

Commercial real estate

     113,238        118,984   

Residential real estate

     26,845        26,829   

Consumer

     25,397        25,998   
  

 

 

   

 

 

 

Total loans

     198,687        205,767   

Less: Allowance for loan losses

     (7,675     (8,164
  

 

 

   

 

 

 

Net loans

     191,012        197,603   

Bank owned life insurance

     5,967        5,941   

Bank premises and equipment

     10,106        10,202   

Federal Home Loan Bank stock

     661        661   

Accrued interest receivable

     984        1,039   

Other real estate owned

     3,006        1,949   

Other assets

     990        1,059   
  

 

 

   

 

 

 

Total assets

   $ 306,466      $ 298,861   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Deposits:

    

Non-interest bearing

   $ 72,348      $ 62,713   

Interest bearing

     201,306        203,168   
  

 

 

   

 

 

 

Total deposits

     273,654        265,881   

Federal Home Loan Bank advances

     923        923   

Subordinated debentures

     14,000        14,000   

Accrued taxes, interest and other liabilities

     3,719        3,397   
  

 

 

   

 

 

 

Total liabilities

     292,296        284,201   
  

 

 

   

 

 

 

Stockholders’ equity

    

Common stock – no par value, 5,000,000 shares authorized 2,403,741 shares issued and outstanding at March 31, 2012 (2,388,225 at December 31, 2011)

     43,229        43,191   

Accumulated deficit

     (29,293     (28,554

Accumulated other comprehensive income

     234        23   
  

 

 

   

 

 

 

Total stockholders’ equity

     14,170        14,660   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 306,466      $ 298,861   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FENTURA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(000s omitted except share and per share data)

 

     Three Months Ended  
     March 31  
     2012     2011  

Interest income

    

Loans, including fees

   $ 2,757      $ 3,081   

Interest and dividends on securities:

    

Taxable

     320        279   

Tax-exempt

     30        45   

Interest on federal funds sold

     8        9   
  

 

 

   

 

 

 

Total interest income

     3,115        3,414   

Interest expense

    

Deposits

     496        722   

Borrowings

     132        126   
  

 

 

   

 

 

 

Total interest expense

     628        848   
  

 

 

   

 

 

 

Net interest income

     2,487        2,566   

Provision for loan losses

     863        795   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     1,624        1,771   

Non-interest income

    

Service charges on deposit accounts

     239        296   

Trust and investment services income

     219        288   

Gain on sale of mortgage loans

     215        68   

Gain on sale of securities

     18        5   

Other income and fees

     428        502   
  

 

 

   

 

 

 

Total non-interest income

     1,119        1,159   

Non-interest expense

    

Salaries and employee benefits

     1,723        1,673   

Occupancy

     269        284   

Furniture and equipment

     253        292   

Loan and collection

     143        161   

Advertising and promotional

     31        19   

Other operating expenses

     1,187        845   
  

 

 

   

 

 

 

Total non-interest expense

     3,606        3,274   
  

 

 

   

 

 

 

Loss from continuing operations before income tax

     (863     (344

Federal income tax benefit

     (124     (212
  

 

 

   

 

 

 

Net loss from continuing operations

   $ (739   $ (132

Discontinued operations, net of tax

    

Net loss from discontinued operations

     0        (27

Gain from sale of discontinued operations

     0        469   
  

 

 

   

 

 

 

Net income from discontinued operations

     0        442   
  

 

 

   

 

 

 

Net (loss) income

   $ (739   $ 310   
  

 

 

   

 

 

 

Net loss per share from continuing operations

    

Basic and diluted

   $ (0.31   $ (0.06
  

 

 

   

 

 

 

Net income per share from discontinued operations

    

Basic and diluted

   $ 0.00      $ 0.19   
  

 

 

   

 

 

 

Net income (loss) per share

    

Basic and diluted

   $ (0.31   $ 0.13   
  

 

 

   

 

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FENTURA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

(000s omitted except share and per share data)

 

     Three Months Ended  
     March 31,  
     2012     2011  

Common Stock

    

Balance, beginning of period

   $ 43,191      $ 43,036   

Issuance of shares under

    

Director stock purchase plan and dividend reinvestment program (15,516 and 11,842 shares)

     38        26   
  

 

 

   

 

 

 

Balance, end of period

     43,229        43,062   

Accumulated Deficit

    

Balance, beginning of period

     (28,554     (27,042

Net income (loss)

     (739     310   
  

 

 

   

 

 

 

Balance, end of period

     (29,293     (26,732

Accumulated Other Comprehensive Income (Loss)

    

Balance, beginning of period

     23        61   

Change in unrealized gain (loss) on securities, net of tax

     211        (185
  

 

 

   

 

 

 

Balance, end of period

     234        (124
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 14,170      $ 16,206   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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FENTURA FINANCIAL, INC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Three Months Ended  
     March 31,  

(000s omitted)

   2012     2011  

OPERATING ACTIVITIES:

    

Net (loss) income

   $ (739   $ 310   

Adjustments to reconcile net (loss) income to cash Provided by operating activities:

    

Depreciation

     162        183   

Amortization and accretion

     (145     (73

Provision for loan losses

     863        795   

Loans originated for sale

     (12,642     (4,357

Proceeds from the sale of loans

     12,387        4,789   

Gain on sales of loans

     (215     (68

Loss (gain) on other real estate owned

     2        (7

Write downs on other real estate owned

     0        85   

Net gain on sale of securities

     (18     (5

Net earnings from bank owned life insurance

     (26     (35

Net decrease (increase) in interest receivable & other assets

     124        (182

Net increase in interest payable & other liabilities

     322        431   

Net change in discontinued operations operating activities

     0        6,224   
  

 

 

   

 

 

 

Total Adjustments

     814        7,780   
  

 

 

   

 

 

 

Net cash provided by operating activities

     75        8,090   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITES:

    

Proceeds from maturities of securities – AFS

     2,719        1,451   

Proceeds from calls of securities – AFS

     5,150        2,000   

Proceeds from sales of securities – AFS

     9,570        2,024   

Purchases of securities – AFS

     (18,086     (8,116

Origination of loans, net of principal repayments

     4,622        10,588   

Sales of other real estate owned

     47        531   

Acquisition of premises and equipment, net

     (66     (150

Net change in discontinued operations investing activities

     0        95,475   
  

 

 

   

 

 

 

Net cash provided by investing activities

     3,956        103,803   

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase in deposits

     7,773        3,193   

Net decrease in short term borrowings

     0        (217

Net proceeds from stock issuance

     38        26   

Net change in discontinued operations financing activities

     0        (103,965
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     7,811        (100,963
  

 

 

   

 

 

 

Net change in cash and cash equivalents

   $ 11,842      $ 10,930   
  

 

 

   

 

 

 

Cash and cash equivalents – Beginning

   $ 18,634      $ 33,492   
  

 

 

   

 

 

 

Cash and cash equivalents – Ending

   $ 30,476      $ 44,422   
  

 

 

   

 

 

 

Cash paid for:

    

Interest

   $ 507      $ 732   

Income taxes

   $ 9      $ 167   

Non-cash Disclosures:

    

Transfers from loans to other real estate

   $ 1,106      $ 851   

See accompanying notes to consolidated financial statements.

 

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Table of Contents

FENTURA FINANICIAL, INC

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Three Months Ended  
     March 31,  

(000s omitted)

   2012     2011  

Net (loss) income

   $ (739   $ 310   

Other comprehensive income (loss), net of tax:

    

Reclassification adjustment for net gains included in income

     (18     (5

Unrealized holding gains (losses) related to available-for-sale securities arising during period

     229        (180
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     211        (185
  

 

 

   

 

 

 

Comprehensive (loss) income

   $ (528   $ 125   
  

 

 

   

 

 

 

 

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—BASIS OF PRESENTATION

The consolidated financial statements include Fentura Financial, Inc. (the “Corporation”) and its wholly owned subsidiaries Fentura Holdings LLC (“FHLLC”) and The State Bank in Fenton (the “Bank”), Michigan and the other subsidiaries of the Bank. Intercompany transactions and balances are eliminated in consolidation.

As announced at the 2011 Shareholder Meeting, the Corporation had entered into an agreement to sell West Michigan Community Bank to a third-party investor group. The sale closed on January 31, 2011. West Michigan Community Bank is reported as discontinued operations.

Financial statements are presented with discontinued operations sequestered on the balance sheet, statement of operations and statement of cash flows, as applicable. The presentations have been updated for March 31, 2011 to reflect the discontinued operations results to the extent applicable (see Note 9).

During the third quarter of 2011 management decided the Corporation no longer intended to dispose of the residual assets remaining from the sale of West Michigan Community Bank. As a result of the change in intent, amounts and results of operations for the period ended March 31, 2011, as well as balance sheet data as of March 31, 2011 were reclassified to reflect this change in intent.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the year ended December 31, 2011.

Securities: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage- backed securities, where prepayments are anticipated. Gains and losses on sales are based on the amortized cost of the security sold.

 

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Table of Contents

NOTE 1—BASIS OF PRESENTATION (continued)

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

In determining OTTI management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Consumer loans are typically charged off no later than 120 days past due.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segments and is based on the actual loss history experienced by the Corporation. Rolling eight quarter periods of historical charge off experience is considered when calculating the current required level of the allowance for loan losses. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: commercial, commercial real estate, residential mortgage, installment loans and home equity loans.

A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows

 

8


Table of Contents

NOTE 1—BASIS OF PRESENTATION (continued)

 

using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

Troubled debt restructurings: Under certain circumstances, the Corporation will provide borrowers relief through loan restructurings and modifications. A loan restructuring constitutes a troubled debt restructuring (“TDR”) if for economic or legal reasons related to the borrower’s financial difficulties the Corporation grants a concession to the borrower that it would not otherwise consider. Restructured loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. Loans that are reported as TDRs are considered impaired and are measured for impairment as described above.

Other Real Estate Owned and Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance reduces deferred tax assets to the amount expected to be realized.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination including the appeals process. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense.

The liability recorded at December 31, 2011 has been settled with the IRS.

Dividend Restrictions: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Banks to the Corporation or by the Corporation to shareholders. The State Bank has been restricted from dividend payments due to the signing of a Consent Order with the Federal Deposit Insurance Corporation (FDIC). The Holding Company has been placed under restrictions by the Federal Reserve regarding the declaration or payment of any dividends and the receipt of dividends from the subsidiary Bank.

Stock Option Plans: Compensation cost is recognized for stock options, restricted stock awards issued to employees, and stock appreciation rights based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options and stock appreciation rights, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

The Nonemployee Director Stock Option Plan provides for granting options to nonemployee directors to purchase the Corporation’s common stock. The purchase price of the shares is the fair market value at the date of the grant, and there is a three-year vesting period before options may be exercised. Options to acquire no more than 8,131 shares of stock may be granted under the Plan in any calendar year and options to acquire not more than 73,967 shares in the aggregate may be outstanding at any one time. No options were granted in 2012 or 2011.

 

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Table of Contents

NOTE 1—BASIS OF PRESENTATION (continued)

 

The Employee Stock Option Plan grants options to eligible employees to purchase the Corporation’s common stock at a purchase price at or above the fair market value of the stock at the date of the grant. Awards granted under this plan are limited to an aggregate of 86,936 shares. The administrator of the plan is a committee of directors. The administrator has the power to determine the number of options to be granted, the exercise price of the options and other terms of the options, subject to consistency with the terms of the Plan.

The following table summarizes stock option activity:

 

     Number
of

Options
    Weighted
Average
Price
     Weighted
Average
Remaining
Contractual
Life
     Aggregate
Intrinsic
Value
 

Options outstanding at January 1, 2012

     13,786      $ 29.60         

Options forfeited during 2012

     (2,296     21.90         
  

 

 

   

 

 

       

Options outstanding and exercisable at March 31, 2012

     11,490      $ 31.14         1.81       $ 0   
  

 

 

   

 

 

    

 

 

    

 

 

 

 

     Number
of

Options
    Weighted
Average
Price
     Weighted
Average
Remaining
Contractual
Life
     Aggregate
Intrinsic
Value
 

Options outstanding at January 1, 2011

     18,872      $ 29.32         

Options forfeited during 2011

     (5,086     28.57         
  

 

 

   

 

 

       

Options outstanding and exercisable at December 31, 2011

     13,786      $ 29.60         1.73       $ 0   
  

 

 

   

 

 

    

 

 

    

 

 

 

On February 24, 2011, the Corporation’s board of directors granted 25,000 Stock Appreciation Rights (“SARs”) to five executives. The terms of the Stock Appreciation Rights Agreements (the “SAR Agreements”) provide that the SARs will be paid in cash on one or two fixed dates, which are determined as certain performance conditions are met. The conditions include the Corporation’s wholly owned subsidiary, The State Bank, no longer being subject to terms, conditions and restrictions of the consent order dated December 31, 2009 (the “Consent Order”) and the Corporation no longer being subject to terms, conditions and restrictions of the agreement between the Corporation and the Federal Reserve Board, which was effective November 4, 2010 (the “FRB Agreement”). The first payment date under the agreement is the later of February 24, 2014, the date on which the State Bank is no longer subject to the terms, conditions and restrictions of the Consent Order, and the date on which the Corporation is no longer subject to the terms, conditions and restrictions of the FRB Agreement. On the first SAR payment date a participant shall receive an amount equal to the product of the number of stock appreciation rights granted and the excess of the fair market value of one share of the Corporation’s common stock over $2.00. If the first SAR payment date does not occur prior to February 24, 2016, then the SARs shall be cancelled without any payment to the participant. If the first SAR payment date occurs prior to February 24, 2016, then the second SAR payment date shall be February 24, 2016. On the second payment date a participant shall receive an amount equal to the number of stock appreciation rights granted and the excess of the fair market value of one share of the Corporation’s common stock on the second SAR payment date over the value of one share of the Corporation’s common stock on the first SAR payment date. If the fair market value of one share of the Corporation’s common stock on the second SAR payment date does not exceed the fair market value of one share of the Corporation’s common stock on the first SAR payment date, then no payment shall be made to the participant on the second SAR payment date. There were 20,000 SAR’s outstanding at March 31, 2012 as a result of this issuance as 5,000 SAR’s were forfeited during the period ended March 31, 2012 as a result of one of the executive’s departure.

 

10


Table of Contents

NOTE 1—BASIS OF PRESENTATION (continued)

 

On March 13, 2012, the Corporation’s board of directors granted 10,000 Stock Appreciation Rights to a new executive officer. The terms of this Stock Appreciation Rights Agreement is the same as those previously discussed except that the first and second payment dates are March 12, 2015 and March 13, 2017, respectively.

Generally accepted accounting principles require plans settled in cash to be accounted for as liabilities only when the liability is probable and reasonably estimable and to be re-measured at each reporting period. Management has determined that as of March 31, 2012, it is not probable that the performance criteria will be met and as such no liability for the compensatory element of the awards has been recorded in the consolidated financial statements.

Operating Segments While the Corporation’s chief decision-makers monitor the revenue streams of the various Corporation products and services, operations are managed and financial performance is evaluated on a Corporate-wide basis. Accordingly, all of the Corporation’s financial service operations are considered by management to be aggregated in one reportable operating segment.

Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.

NOTE 2—ACCOUNTING STANDARDS UPDATE

ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures,” to converge the fair value measurement guidance in U.S. generally accepted accounting principals and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principals in Topic 820 and requires additional fair value disclosures. ASU 2011-04 was effective for interim and annual periods beginning on or after December 15, 2011 and increased the level of disclosures related to fair value measurements in the Corporation’s consolidated financial statements.

ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate by consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 was effective for interim and annual periods beginning on or after December 15, 2011, and did not have impact on the Corporation’s consolidated financial statements as the Corporation has historically elected to present a separate statement of comprehensive income.

ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 requires that an entity disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The differences in the offsetting requirements in U.S. generally accepted accounting principles (U.S. GAAP) and International Financial Reporting Standards (IFRS) account for a significant difference in the amounts presented in statements of financial position prepared in accordance with U.S. GAAP and in the amounts presented in those statements prepared in accordance with IFRS for certain institutions. Entities

 

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NOTE 2—ACCOUNTING STANDARDS UPDATE (continued)

 

are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The effective date for ASU 2011-11 is January 1, 2013, though the Corporation currently does not hold instruments of this type and does not anticipate any impact to the presentation of its consolidated financial statements.

NOTE 3—SECURITIES

Securities are as follows:

 

      Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized

Losses
    Fair
Value
 
(000s omitted)           
Available for Sale           

March 31, 2012

          

U.S. Government and federal agency

   $ 5,992       $ 4       $ (91   $ 5,905   

Mortgage-backed residential

     15,777         212         (17     15,972   

Collateralized mortgage obligations-agencies

     33,677         513         (33     34,157   

Collateralized mortgage obligations-private label

     1,860         0         (228     1,632   

Equity securities

     2,155         79         (192     2,042   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 59,461       $ 808       $ (561   $ 59,708   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

U.S. Government and federal agency

   $ 6,144       $ 23       $ (2   $ 6,165   

Mortgage-backed residential

     15,625         312         (15     15,922   

Collateralized mortgage obligations-agencies

     31,002         457         (5     31,454   

Collateralized mortgage obligations-private label

     3,725         0         (702     3,023   

Equity securities

     2,155         100         (132     2,123   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 58,651       $ 892       $ (856   $ 58,687   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized

Losses
     Fair
Value
 
(000s omitted)            
Held to Maturity            

March 31, 2012

           

State and municipal

   $ 2,963       $ 72       $ 0       $ 3,035   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,963       $ 72       $ 0       $ 3,035   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

State and municipal

   $ 2,963       $ 90       $ 0       $ 3,053   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,963       $ 90       $ 0       $ 3,053   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE 3—SECURITIES (continued)

 

Contractual maturities of securities at March 31, 2012 were as follows. Securities not due at a single maturity date, mortgage-backed, collateralized mortgage obligations and equity securities are shown separately.

 

     Available for Sale      Held to Maturity  
     Amortized      Fair      Amortized      Fair  
(000s omitted)    Cost      Value      Cost      Value  

U.S. government and federal agency

           

Due in one year or less

   $ 0       $ 0       $ 395       $ 396   

Due from one to five years

     0         0         1,656         1,683   

Due from five to ten years

     3,000         3,004         544         567   

Due after ten years

     2,992         2,901         368         389   

Mortgage backed residential

     15,777         15,972         0         0   

Collateralized mortgage obligations-agencies

     33,677         34,157         0         0   

Collateralized mortgage obligations-private label

     1,860         1,632         0         0   

Equity securities

     2,155         2,042         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 59,461       $ 59,708       $ 2,963       $ 3,035   
  

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012, one holding totaling $1,860,000 in a security issued by Bear Stearns exceeded 10% of stockholders’ equity. At December 31, 2011, two holdings totaling $3,023,000 in securities issued by Wells Fargo and Bear Stearns exceeded 10% of stockholders’ equity. The Corporation sold the Wells Fargo security during the first quarter of 2012.

Sales of available for sale securities, for the three month periods, were as follows:

 

(000s omitted)    March 31, 2012     March 31, 2011  

Proceeds

   $ 9,570      $ 2,024   

Gross gains

     196        5   

Gross losses

     (178     0   

The cost basis used to determine the unrealized gains or losses of securities sold was the amortized cost of the individual investment security as of the trade date.

Securities with unrealized losses are aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position is as follows:

 

      Less than 12 months     12 months or more     Total  

March 31, 2012

   Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
(000s omitted)    Value      Loss     Value      Loss     Value      Loss  

Description of Securities

               

US Government and federal agencies

   $ 2,901       $ (91   $ 0       $ 0      $ 2,901       $ (91

Mortgage-backed residential

     5,151         (17     0         0        5,151         (17

Collateralized mortgage obligations-agencies

     2,622         (13     3,440         (20     6,062         (33

Collateralized mortgage obligations-private label

     0         0        1,632         (228     1,632         (228

Equity securities

     317         (130     396         (62     713         (192
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 10,991       $ (251   $ 5,468       $ (310   $ 16,459       $ (561
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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NOTE 3—SECURITIES (continued)

 

      Less than 12 months     12 months or more     Total  

December 31, 2011

   Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
(000s omitted)    Value      Loss     Value      Loss     Value      Loss  

Description of Securities

               

US government and federal agencies

   $ 0       $ 0      $ 1,498       $ (2   $ 1,498       $ (2

Mortgage-backed residential

     6,766         (15     0         0        6,766         (15

Collateralized mortgage obligations-agencies

     0         0        4,985         (5     4,985         (5

Collateralized mortgage obligations-private label

     0         0        3,023         (702     3,023         (702

Equity securities

     771         (128     1         (4     772         (132
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired

   $ 7,537       $ (143   $ 9,507       $ (713   $ 17,044       $ (856
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

As of March 31, 2012, the Corporation’s security portfolio consisted of 82 securities, 10 of which were in an unrealized loss position. The majority of unrealized losses are related to the Corporation’s collateralized mortgage obligations (CMOs) and equity securities, as discussed below.

Collateralized Mortgage Obligations

The decline in fair value of the Corporation’s private label collateralized mortgage obligation is primarily attributable to the lack of liquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual security. The Standard and Poors rating held on the private label security is A-. The underlying collateral of this CMO is comprised largely of 1-4 family residences. In this security, the Corporation holds the senior tranche and receives payments before other tranches. For the private label security, management completes an analysis to review the recent performance of the mortgage pools underlying the instruments. At March 31, 2012, the private label security has an amortized cost of $1,860,000 and an unrealized loss of $228,000.

The Corporation has been closely monitoring the performance of the CMO and MBS portfolios. Management evaluates items such as payment streams and underlying default rates, and did not recognize a material adverse change in these items. On a quarterly basis, management uses multiple assumptions to project the expected future cash flows of the private label CMO with prepayment speeds, projected default rates and loss severity rates. The cash flows are then discounted using the effective rate on the securities determined at acquisition. Recent historical experience is the base for determining the cash flow assumptions and is adjusted when appropriate after considering characteristics of the underlying loans collateralizing the private label CMO security.

The Corporation has three agency collateralized mortgage obligations with an unrealized loss of $33,000. The decline in value is primarily due to changes in interest rates and other market conditions.

Equity securities

The Corporation’s equity investments with unrealized losses are investments in two non-public bank holding companies in Michigan. These securities receive a multi-faceted review utilizing call report data. Management reviews such performance indicators as earnings, ROE, ROA, non-performing assets, brokered deposits and capital ratios. Management draws conclusions from this information, as well as any published information or trading activity received from the individual institutions, to assist in determining if any unrealized loss is other than temporary impairment.

Additionally management considers the length of time the investments have been at an unrealized loss. At the end of the first quarter, management performed its review and determined that no additional other-than-temporary impairment was necessary on the equity securities in the portfolio.

 

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NOTE 3—SECURITIES (continued)

 

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In evaluating OTTI, management considers the factors presented in Note 1.

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES

Major categories of loans are as follows:

 

(000s omitted)    March 31, 2012     December 31, 2011  

Commercial

   $ 33,207      $ 33,956   

Commercial real estate

     113,238        118,984   

Residential real estate

     26,845        26,829   

Consumer

     25,397        25,998   
  

 

 

   

 

 

 

Total loans

     198,687        205,767   

Less allowance for loan losses

     (7,675     (8,164
  

 

 

   

 

 

 

Net loans

   $ 191,012      $ 197,603   
  

 

 

   

 

 

 

The Corporation originates primarily residential and commercial real estate loans, commercial and installment loans. The Corporation estimates that the majority of their loan portfolio is based in Genesee, Oakland and Livingston counties within southeast Michigan with the remainder of the portfolio distributed throughout Michigan. The ability of the Corporation’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in these areas.

Activity in the allowance for loan losses, by classification, for the three month periods ended March 31, 2012 and 2011 are as follows:

 

(000s omitted)    Commercial     Commercial
Real
Estate
    Residential
Real
Estate
    Installment
Loans
    Home
Equity
    Unallocated     Total  

Allowance for loan losses

              

Balance January 1, 2012

   $ 891      $ 5,759      $ 476      $ 215      $ 482      $ 341      $ 8,164   

Provision for loan losses

     181        1,068        74        (36     (87     (337     863   

Loans charged off

     (551     (680     (60     (10     (104     0        (1,405

Loan recoveries

     13        29        1        6        4        0        53   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2012

   $ 534      $ 6,176      $ 491      $ 175      $ 295      $ 4      $ 7,675   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(000s omitted)    Commercial     Commercial
Real
Estate
    Residential
Real
Estate
    Installment
Loans
    Home
Equity
    Unallocated     Total  

Allowance for loan losses

              

Balance January 1, 2011

   $ 871        9,155      $ 411      $ 233      $ 508      $ 46      $ 11,224   

Provision for loan losses

     (158     888        (4     (17     148        (62     795   

Loans charged off

     (2     (3,031     (11     (32     (98     0        (3,174

Loan recoveries

     6        124        1        6        15        18        170   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2011

   $ 717      $ 7,136      $ 397      $ 190      $ 573      $ 2      $ 9,015   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method at:

 

(000s omitted)

March 31, 2012

   Commercial      Commercial
Real
Estate
     Residential
Real
Estate
     Installment
Loans
     Home
Equity
     Unallocated      Total  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 191       $ 3,011       $ 296       $ 54       $ 97       $ 0       $ 3,649   

Collectively evaluated for impairment

     343         3,165         195         121         198         4         4,026   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 534       $ 6,176       $ 491       $ 175       $ 295       $ 4       $ 7,675   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 2,842         24,007       $ 1,109       $ 101       $ 470       $ 0       $ 28,529   

Loans collectively evaluated for impairment

     30,365         89,231         25,736         5,866         18,960         0         170,158   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

     33,207         113,238         26,845         5,967         19,430         0         198,687   

Accrued interest receivable

     273         167         85         38         53         0         616   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total recorded investment in loans

   $ 33,480       $ 113,405       $ 26,930       $ 6,005       $ 19,483       $ 0       $ 199,303   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(000s omitted)

December 31, 2011

  Commercial     Commercial
Real
Estate
    Residential
Real
Estate
    Installment
Loans
    Home
Equity
    Unallocated     Total  

Allowance for loan losses:

             

Ending allowance balance attributable to loans:

             

Individually evaluated for impairment

  $ 714      $ 2,907      $ 201      $ 60      $ 275      $ 0      $ 4,157   

Collectively evaluated for impairment

    177        2,852        275        155        207        341        4,007   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

  $ 891      $ 5,759      $ 476      $ 215      $ 482      $ 341      $ 8,164   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

             

Loans individually evaluated for impairment

  $ 3,823      $ 24,797      $ 844      $ 133      $ 494      $ 0      $ 30,091   

Loans collectively evaluated for impairment

    30,133        94,187        25,985        6,270        19,101        0        175,676   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending loans balance

  $ 33,956      $ 118,984      $ 26,829      $ 6,403      $ 19,595      $ 0      $ 205,767   

Accrued interest receivable

    143        341        75        47        61        0        667   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recorded investment in loans

  $ 34,099      $ 119,325      $ 26,904      $ 6,450      $ 19,656      $ 0      $ 206,434   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

The following tables present loans individually evaluated for impairment by class of loans as of:

 

(000s omitted)

March 31, 2012

   Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
for Loan
Losses
Allocated
 

With no related allowances recorded:

        

Commercial

   $ 2,849       $ 1,612       $ 0   

Commercial real estate

     12,714         9,203         0   

Residential real estate

     289         253         0   

Consumer

        

Installment Loans

     13         10         0   

Home Equity

     326         279         0   

With an allowance recorded:

        

Commercial

     717         705         191   

Commercial real estate

     17,966         15,467         3,011   

Residential real estate

     1,077         856         296   

Consumer

        

Installment loans

     91         91         54   

Home equity

     191         191         97   
  

 

 

    

 

 

    

 

 

 

Total

   $ 36,233       $ 28,667       $ 3,649   
  

 

 

    

 

 

    

 

 

 

 

(000s omitted)

December 31, 2011

   Unpaid
Principal
Balance
     Recorded
Investment
     Allowance
for Loan
Losses
Allocated
 

With no related allowances recorded:

        

Commercial

   $ 2,280       $ 2,116       $ 0   

Commercial real estate

     16,275         11,302         0   

Residential real estate

     279         168         0   

Consumer

        

Installment Loans

     13         13         0   

Home Equity

     119         119         0   

With an allowance recorded:

        

Commercial

     1,903         1,715         714   

Commercial real estate

     15,814         13,532         2,907   

Residential real estate

     894         675         201   

Consumer

        

Installment loans

     121         121         60   

Home equity

     377         379         275   
  

 

 

    

 

 

    

 

 

 

Total

   $ 38,705       $ 30,140       $ 4,157   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

The following table presents the average recorded investment and interest income recognized on loans individually evaluated for impairment by class of loans for the period ended:

 

     March 31, 2012      March 31, 2011  
(000s omitted)   

Average
Recorded

Investment

    

Interest

Income

Recognized

    

Average
Recorded

Investment

    

Interest

Income

Recognized

 

With no related allowances recorded:

           

Commercial

   $ 1,864       $ 7       $ 971       $ 11   

Commercial real estate

     10,253         40         9,003         39   

Residential real estate

     211         4         226         0   

Consumer

           

Installment Loans

     12         0         127         1   

Home Equity

     199         2         242         2   

With an allowance recorded:

           

Commercial

     1,210         11         446         9   

Commercial real estate

     14,500         50         19,697         123   

Residential real estate

     766         12         699         6   

Consumer

           

Installment loans

     106         1         104         2   

Home equity

     285         2         460         3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 29,406       $ 129       $ 31,975       $ 196   
  

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans at:

 

March 31, 2012

(000s omitted)

   Nonaccrual      Loans Past Due
Over 90 Days Still
Accruing
 

Commercial

   $ 2,186       $ 0   

Commercial real estate

     11,174         0   

Residential real estate

     237         0   

Home Equity

     168         0   

Installment loans

     6         0   
  

 

 

    

 

 

 

Total

   $ 13,771       $ 0   
  

 

 

    

 

 

 

 

December 31, 2011

(000s omitted)

   Nonaccrual      Loans Past Due
Over 90 Days Still
Accruing (1)
 

Commercial

   $ 2,837       $ 449   

Commercial real estate

     13,918         0   

Residential real estate

     241         0   

Home Equity

     88         39   

Installment loans

     13         0   
  

 

 

    

 

 

 

Total

   $ 17,097       $ 488   
  

 

 

    

 

 

 

(1)-Includes accrued interest receivable of $6

 

18


Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

The following table presents the aging of the recorded investment in past due loans by class of loans at:

 

(000s omitted)

March 31, 2012

   30-59 Days Past
Due
     60-89 Days Past
Due
     Greater than 90
Days Past Due
     Total Past
Due
 

Commercial

   $ 1,049       $ 0       $ 2,249       $ 3,298   

Commercial real estate

     453         0         8,360         8,813   

Residential real estate

     99         95         196         390   

Installment loans

     0         230         6         236   

Home Equity

     7         0         6         13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,608       $ 325       $ 10,817       $ 12,750   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(000s omitted)

December 31, 2011

   30-59 Days Past
Due
     60-89 Days Past
Due
     Greater than 90
Days Past Due (1)
     Total Past
Due
 

Commercial

   $ 431       $ 14       $ 2,741       $ 3,186   

Commercial real estate:

     2,796         0         10,750         13,546   

Residential real estate

     0         0         198         198   

Installment loans

     3         1         51         55   

Home Equity

     73         0         85         158   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,303       $ 15       $ 13,825       $ 17,143   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes interest receivable of $15.

Modifications:

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan or lease, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial real estate loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Residential real estate loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs through a reduction of interest rate and/or extension of the maturity date. Installment loans modified in a TDR are primarily comprised of loans where the Corporation has lowered monthly payments by extending the term.

Loans modified in a TDR are typically already on non-accrual status and partial charge-offs have in some cases been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan.

The Corporation has identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance for loan losses methodology. Upon identifying these loans as TDRs, the Corporation classified them as impaired. The Corporation’s recorded investment in TDRs at March 31, 2012 is $16,182,000, with a specific valuation allowance of $2,376,000. This is compared to $15,005,000, with a specific valuation allowance of $2,289,000, at December 31, 2011. This specific valuation allowance is an allocated portion of the total allowance for loan losses. The Corporation has no additional amounts committed to these customers.

 

19


Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

The following presents by class, information related to loans modified in a TDR during the period ended March 31, 2012.

 

(000s omitted)    Number
of
Loans
     Pre-Modification
Recorded  Investment
     Post-Modification
Recorded  Investment
 

Commercial real estate

     5       $ 2,565       $ 2,565   

Residential real estate

     2         191         191   

Home equity

     1         38         38   
  

 

 

    

 

 

    

 

 

 

Total

     8       $ 2,794       $ 2,794   
  

 

 

    

 

 

    

 

 

 

The following presents information on TDRs for which there was a payment default during the period ended March 31, 2012 (i.e. 30 days or more past due following a modification) that had been modified during the 12-month period prior to the default.

 

(000s omitted)    Loans with payment defaults  
     Number of
Contracts
     Recorded Investment
(as of period end) (1)
 

Commercial

     4       $ 1,295   

Commercial real estate

     7         1,554   

Installment loans

     1         6   
  

 

 

    

 

 

 

Total

     12       $ 2,855   
  

 

 

    

 

 

 

 

(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date, if any. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

Based on the Corporation’s historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs are analyzed in the same manner as other impaired loans within their respective loan segment.

The following presents by portfolio loan class, the type of modification made in a TDR from January 1, 2012 through March 31, 2012:

 

     Loans modified through reduction of interest rate  
(000s omitted)    Number of Loans      Recorded Investment
(as of period end) (1)
 

Commercial real estate

     3       $ 2,264   

Residential real estate

     1         104   

Home equity

     1         38   
  

 

 

    

 

 

 

Total

     5       $ 2,406   
  

 

 

    

 

 

 

 

(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date, if any. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

 

     Loans modified through extension of term  
(000s omitted)    Number of Loans      Recorded Investment
(as of period end) (1)
 

Commercial real estate

     2       $ 301   

Residential real estate

     1         87   
  

 

 

    

 

 

 

Total

     3       $ 388   
  

 

 

    

 

 

 

 

(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date, if any. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

 

20


Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

Credit Quality Indicators:

The Corporation categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debts such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Corporation uses the following definitions for classified risk ratings:

Prime. Loans classified as prime are well seasoned borrowers displaying strong financial condition, consistently superior earning performance, and access to a range of financing alternatives. The borrower’s trends and outlook, as well as those of its industry are positive.

Pass. Loans classified as pass have a moderate to average risk to established borrowers that display sound financial condition and operating results. The capacity to service debt is stable and demonstrated at a level consistent with or above the industry norms. Borrower and industry trends and outlook are considered good.

Watch. Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The Corporation does not classify loans as doubtful. Loans that approach this status are charged-off.

Based on the most recent analysis performed, the recorded investment by risk category of loans by class of loans is as follows:

 

(000s omitted)

March 31, 2012

   Prime      Pass      Watch      Substandard      Total  

Commercial

   $ 5,160       $ 24,057       $ 1,948       $ 2,315       $ 33,480   

Commercial real estate

     396         80,856         8,499         23,654         113,405   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,556       $ 104,913       $ 10,447       $ 25,969       $ 146,885   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

(000s omitted)

December 31, 2011

   Prime      Pass      Watch      Substandard      Total  

Commercial

   $ 3,411       $ 25,006       $ 1,850       $ 3,832       $ 34,099   

Commercial real estate:

     0         79,909         14,583         24,833         119,325   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,411       $ 104,915       $ 16,433       $ 28,665       $ 153,424   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of:

 

21


Table of Contents

NOTE 4—LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

 

(000s omitted)

March 31, 2012

   Home Equity      Installment      Residential
Real Estate
     Total  

Performing

   $ 19,098       $ 5,819       $ 25,821       $ 50,738   

Non-performing

     385         186         1,109         1,680   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 19,483       $ 6,005       $ 26,930       $ 52,418   
  

 

 

    

 

 

    

 

 

    

 

 

 

(000s omitted)

December 31, 2011

   Home Equity      Installment      Residential
Real Estate
     Total  

Performing

   $ 19,162       $ 6,317       $ 26,060       $ 51,539   

Non-performing

     494         133         844         1,471   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 19,656       $ 6,450       $ 26,904       $ 53,010   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 5—FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values.

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as 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.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Securities Available for Sale:

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The remaining fair values of securities (Level 3 inputs) are based on the reporting entity’s own assumptions and basic knowledge of market conditions and individual investment performance. The Corporation reviews the performance of the securities that comprise level 3 on a quarterly basis.

Impaired Loans:

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

22


Table of Contents

NOTE 5—FAIR VALUE (continued)

 

Other Real Estate Owned:

Non-recurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sale and income data available, which results in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below:

 

     Fair Value Measurements Using  

(000s omitted)

March 31, 2012

   Total      Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Available for sale securities

           

US Government and federal agency

   $ 5,905       $ 0       $ 5,905       $ 0   

Mortgage-backed residential

     15,972         0         15,972         0   

Collateralized mortgage obligations-agencies

     34,157         0         34,157         0   

Collateralized mortgage obligations-private label

     1,632         0         1,632         0   

Equity securities

     2,042         0         1,050         992   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 59,708       $ 0       $ 58,716       $ 992   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Fair Value Measurements Using  

(000s omitted)

December 31, 2011

   Total      Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Available for sale securities

           

US Government and federal agency

   $ 6,165       $ 0       $ 6,165       $ 0   

Mortgage-backed residential

     15,922         0         15,922         0   

Collateralized mortgage obligations-agencies

     31,454         0         31,454         0   

Collateralized mortgage obligations-private label

     3,023         0         3,023         0   

Equity securities

     2,123         0         1,051         1,072   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 58,687       $ 0       $ 57,615       $ 1,072   
  

 

 

    

 

 

    

 

 

    

 

 

 

The table below presents a reconciliation including the respective income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

23


Table of Contents

NOTE 5—FAIR VALUE (continued)

 

      Equity Securities  
(000s omitted)    2012     2011  

Beginning balance, January 1,

   $ 1,072      $ 1,147   

Included in other comprehensive income (loss)

     (80     13   
  

 

 

   

 

 

 

Ending balance, March 31,

   $ 992      $ 1,160   
  

 

 

   

 

 

 

Assets Measured on a Non-Recurring Basis

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

 

(000s omitted)    Total      Significant
Unobservable

Inputs
(Level 3)
 

At March 31, 2012

     

Impaired loans

     

Commercial

   $ 512       $ 512   

Commercial real estate

     8,809         8,809   

Residential real estate

     667         667   

Installment

     32         32   

Home equity

     88         88   
  

 

 

    

 

 

 

Total impaired loans

   $ 10,108       $ 10,108   
  

 

 

    

 

 

 
(000s omitted)    Total      Significant
Unobservable

Inputs
(Level 3)
 

At December 31, 2011

     

Impaired loans

     

Commercial

   $ 997       $ 997   

Commercial real estate

     8,526         8,526   

Residential real estate

     474         474   

Installment

     55         55   

Home equity

     102         102   
  

 

 

    

 

 

 

Total impaired loans

   $ 10,154       $ 10,154   
  

 

 

    

 

 

 

Other real estate owned

     

Commercial real estate

   $ 301       $ 301   
  

 

 

    

 

 

 

Total other real estate owned

   $ 301       $ 301   
  

 

 

    

 

 

 

The following represent impairment charges recognized during the period:

At March 31, 2012, impaired loans, which were measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal amount of $12,697,000 with a valuation allowance of $2,589,000. This is compared to December 31, 2011 when the principal amount of impaired loans was $13,868,000 with a valuation allowance of $3,714,000.

 

24


Table of Contents

NOTE 5—FAIR VALUE (continued)

 

Other real estate owned which is measured at the lower of carrying value or fair value less costs to sell, had a net carrying amount of $3,006,000, of which none were at fair value at March 31, 2012, as there were no write-downs during the first quarter of 2012. At December 31, 2011, other real estate owned had a net carrying amount of $1,949,000, of which $301,000 was at fair value, which resulted from write downs totaling $24,000.

Quantitative information about Level 3 fair value measurements is as follows:

 

     Fair Value at
March 31, 2012
     Valuation Technique(s)    Unobservable Input    Range
(Weighted
Average)
 

Equity Securities (1)

   $ 992       Market Average    Price to book multiple
of peer group
     (67.29 %) 

Impaired Loans

   $ 10,108            
  

 

 

          
      Appraisal Value-

Real estate

   Discount applied to
appraisal
    

 

10-40

(19.69


%) 

      Appraisal Value-
Accounts receivable
   Discount applied to
appraisal
    

 

25-100

(33.59


%) 

      Appraisal Value-
Vehicles/equipment
   Discount applied to
appraisal
    

 

20-80

(73.78


%) 

Total level 3 assets

   $ 11,100            
  

 

 

          

 

(1) 

Reasonable modifications made to the price to book multiple are not expected to have a significant impact to the value of the securities.

 

25


Table of Contents

NOTE 5—FAIR VALUE (continued)

 

The estimated fair values of financial instruments that are not reported at fair value in their entirety in the Corporation’s consolidated balance sheets, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value were as follows:

 

     March 31, 2012      December 31, 2011  
(000s omitted)    Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Assets:

           

Level 1 inputs:

           

Cash and cash equivalents

   $ 30,476       $ 30,476       $ 18,634       $ 18,634   

FHLB Stock

     661         NA         661         NA   

Accrued interest receivable

     984         984         1,039         1,039   

Level 2 inputs:

           

Securities—held to maturity

     2,963         3,035         2,963         3,053   

Loans held for sale

     593         593         123         123   

Performing loans

     188,579         173,446         192,378         178,864   

Level 3 inputs:

           

Impaired loans

     10,108         10,108         10,154         10,154   

Liabilities:

           

Level 1 inputs:

           

Deposits-non-maturing

   $ 189,705       $ 186,579       $ 180,051       $ 178,305   

Accrued interest payable

     1,692         1,692         1,572         1,572   

Level 2 inputs:

           

Deposits-with stated maturity

     83,949         83,016         85,830         84,815   

FHLB advance

     923         1,163         923         1,180   

Subordinated debentures

     14,000         12,647         14,000         12,612   

The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:

Cash and cash equivalents

The carrying amounts reported in the consolidated balance sheets for cash and short-term instruments approximate their fair values.

Securities—held to maturity

Fair values for securities held to maturity are based on similar information previously presented for securities available for sale.

Loans held for sale

The fair values of these loans are determined in the aggregate on the basis of existing forward commitments or fair values attributable to similar loans.

Performing loans

For variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value for other loans is estimated using discounted cash flow analysis.

FHLB Stock

It was not practical to determine the fair value of FHLB stock and therefore the FHLB stock is not included under a specific value methodology.

 

26


Table of Contents

NOTE 5—FAIR VALUE (continued)

 

Accrued interest

The carrying amount of accrued interest approximates its fair value.

Off-balance-sheet instruments

The fair value of off-balance sheet items is not considered material.

Deposits

The fair values disclosed for non-maturing deposits are by definition equal to the amount payable on demand at the reporting date. Fair values for deposits with a stated maturity are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar deposits.

FHLB advance

Rates currently available for FHLB advances with similar terms and remaining maturities are used to estimate the fair value of the existing obligation.

Subordinated debentures

The estimated fair value of the existing subordinated debentures is calculated by comparing a current market rate for the instrument compared to the book rate. The difference between these rates computes the fair value.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on management’s judgments regarding future expected loss experience, current economic conditions, risk characteristics and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

NOTE 6—INCOME TAXES

The provision (benefit) for federal income taxes is computed by applying the statutory federal income tax rate to income (loss) before income taxes as reported in the consolidated financial statements after deducting non-taxable items, principally income on bank-owned life insurance, and deducting credits related to certain investments.

A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position for the Corporation at March 31, 2012 and December 31, 2011. The Corporation’s evaluation of taxable events, losses in recent years and the continuing struggles of the Michigan economy led management to conclude that it was more likely than not that the benefit would not be realized. As a result, the Corporation maintained a full valuation allowance at March 31, 2012 and December 31, 2011.

An income tax benefit associated with continuing operations in the amount of $124,000 and $242,000 was recorded for the periods ending March 31, 2012 and 2011, respectively. In 2011, the benefit recorded considered the results of current period adjustments to other comprehensive income and discontinued operations. Generally, the calculation for income tax expense (benefit) does not consider the tax effects of changes in other comprehensive income or loss, which is a component of shareholders’ equity on the balance sheet. However, an exception is provided in certain circumstances when there is a pre-tax loss from continuing operations and income from other categories such as other comprehensive

 

27


Table of Contents

NOTE 6—INCOME TAXES (continued)

 

income or discontinued operations. In such case, pre-tax income from other categories is included in the tax expense (benefit) calculation for the current period. For the first quarter of 2012, the income tax benefit was related to the reversal of excess taxes accrued during the fourth quarter of 2011 in relation to estimates of a tax audit.

There were no unrecognized tax benefits at March 31, 2012 or December 31, 2011, and the Corporation does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months. The Corporation and its subsidiaries are subject to U.S federal income taxes as well as income tax of the state of Michigan. The Corporation is no longer subject to examination by taxing authorities for years before 2009.

NOTE 7—EARNINGS PER COMMON SHARE

The factors in the earnings per share computation follow:

 

     Three Months Ended  
(000s omitted except share and per share data)    March 31,  
   2012     2011  

Basic

    

Net (loss) income

   $ (739   $ 310   
  

 

 

   

 

 

 

Weighted average common shares outstanding

     2,388,893        2,309,912   
  

 

 

   

 

 

 

Basic (loss) income per common share

   $ (0.31   $ 0.13   
  

 

 

   

 

 

 

Diluted

    

Net (loss) income

   $ (739   $ 310   
  

 

 

   

 

 

 

Weighted average common shares outstanding for basic earnings per common share

     2,388,893        2,309,912   

Add: Dilutive effects of assumed exercises of stock options

     0        0   
  

 

 

   

 

 

 

Average shares and dilutive potential common shares

     2,388,893        2,309,912   
  

 

 

   

 

 

 

Diluted income per common share

   $ (0.31   $ 0.13   
  

 

 

   

 

 

 

The factors in the earnings per share of continuing operations follow:

 

     Three Months Ended  
(000s omitted except share and per share data)    March 31,  
   2012     2011  

Basic

    

Net loss of continuing operations

   $ (739   $ (132
  

 

 

   

 

 

 

Weighted average common shares outstanding

     2,388,893        2,309,912   
  

 

 

   

 

 

 

Basic loss per common share from continuing operations

   $ (0.31   $ (0.06
  

 

 

   

 

 

 

Diluted

    

Net loss of continuing operations

   $ (739   $ (132
  

 

 

   

 

 

 

Weighted average common shares outstanding for basic earnings per common share

     2,388,893        2,309,912   

Add: Dilutive effects of assumed exercises of stock options

     0        0   
  

 

 

   

 

 

 

Average shares and dilutive potential common shares

     2,388,893        2,309,912   
  

 

 

   

 

 

 

Diluted loss per common share from continuing operations

   $ (0.31   $ (0.06
  

 

 

   

 

 

 

 

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Table of Contents

NOTE 7—EARNINGS PER COMMON SHARE (continued)

 

Stock options of 11,490 and 16,634 shares of common stock outstanding at March 31, 2012 and March 31, 2011, respectively were not considered in computing diluted earnings per common share for 2012 and 2011, because they were anti-dilutive.

NOTE 8—COMMITMENTS AND CONTINGENCIES

There are various contingent liabilities that are not reflected in the financial statements including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, there are no matters which are expected to have a material effect on the Corporation’s consolidated financial condition or results of operations.

NOTE 9—DISCONTINUED OPERATIONS

On April 28, 2010, at the Annual Shareholder Meeting, a formal announcement was made regarding the signing of a definitive agreement to sell West Michigan Community Bank (“WMCB”). The transaction was consummated on January 31, 2011, and the Corporation received $10,500,000 from the sale of West Michigan Community Bank (a 10% premium to book). As a condition of the sale, the Corporation assumed certain non-performing assets of West Michigan Community Bank which totaled $9,900,000. The assets were housed in a newly formed real estate holding company subsidiary of the Corporation, FHLLC. In addition, The State Bank assumed $2,900,000 of watch rated credits.

As of July 1, 2011, due to a change in management’s intent, the remaining balances of the assets described above and previously classified as discontinued operations were reclassified to continuing operations; therefore there are no assets or liabilities presented at December 31, 2011 or March 31, 2012. Corresponding amounts also were reclassified for all periods presented.

A condensed statement of income of discontinued operations is presented for the three months ended March 31, 2011. Due to the sale of West Michigan Community Bank at January 31, 2011, only one month of income and expense is presented for West Michigan Community Bank.

CONDENSED STATEMENT OF INCOME OF DISCONTINUED OPERATIONS

(000s omitted)

 

     Three Months Ended
March 31, 2011
 
     Assumed Loans
and Other Real
Estate
    WMCB     Total  

Interest income

   $ (63   $ 515      $ 452   

Interest expense

     0        129        129   
  

 

 

   

 

 

   

 

 

 

Net interest income

     (63     386        323   

Provision for loan losses

     0        (50     (50
  

 

 

   

 

 

   

 

 

 

Net interest income (loss) after provision for loan losses

     (63     436        373   

Non-interest income

     36        121        157   

Non-interest expense

     105        415        520   
  

 

 

   

 

 

   

 

 

 

Income (loss) before federal income tax

     (132     142        10   
  

 

 

   

 

 

   

 

 

 

Federal income tax expense

     0        37        37   

Gain on sale of subsidiary

     0        469        469   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (132   $ 574      $ 442   
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

NOTE 9—DISCONTINUED OPERATIONS (continued)

 

In connection with the sale of West Michigan Community Bank, the Corporation recognized a gross gain of $711,000. Net of tax the net gain amounted to $469,000.

NOTE 10—REGULATORY MATTERS

The Corporation (on a consolidated basis) and its Bank subsidiaries are subject to various regulatory capital requirements administered by the federal and state regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Corporation. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items that are calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As of March 31, 2012 and December 31, 2011, the most recent notifications from the Federal Deposit Insurance Corporation categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action.

In January 2010, The State Bank entered into a Consent Order with federal and state banking regulators containing provisions to foster improvement in The State Bank’s earnings, reduce nonperforming loan levels, increase capital, and require revisions to various policies. The Consent Order requires The State Bank to maintain a Tier 1 capital to average asset ratio of a minimum of 8.0%. It also requires The State Bank to maintain a total capital to risk weighted asset ratio of 12.0%. At March 31, 2012, The State Bank had a Tier 1 capital to average assets ratio of 7.9% and a total capital to risk-weighted assets ratio of 12.6%. The State Bank is not in compliance with the Consent Order requirements, and therefore cannot be considered well capitalized.

The Consent Orders restrict the Bank from issuing or renewing brokered deposits. The Consent Orders also restrict dividend payments from The State Bank to the Corporation. The Corporation, the Board of Directors and management continue to work on plans to come into compliance with the Consent Orders. At March 31, 2012 actions included the injection of $250,000 of capital into The State Bank resulting from the sale of non-performing assets from the subsidiary of the Corporation. While below the compliance level required by the Orders, the Bank maintains capital levels that would be considered well capitalized by regular prompt corrective action regulatory standards. Non-compliance with Consent Order requirements may cause bank to be subject to further enforcement actions by the FDIC.

Effective in November 2010, the Corporation received a notice from The Federal Reserve which defined restrictions being placed upon the Corporation. The restrictions include the declaration or payment of any dividends, the receipt of dividends from subsidiary banks, the repayment of any principal or interest on subordinated debentures or Trust Preferred securities, restrictions on debt, any changes in Executive or Senior Management or change in the role of Senior Management. In addition, the notice provided an expectation that the Corporation “maintain sufficient capital” levels.

At December 31, 2011 the total capital to risk weighted assets for the Corporation was at 10.1%, which is above the 8% threshold required to be considered adequately capitalized. The ratios for the Corporation are not reported at March 31, 2012, as the total assets of the Corporation were below the $500,000,000 threshold of reporting requirements. The Corporation continues to be required to obtain written approval prior to payments of any dividends or for any increase or decrease to outstanding debt.

 

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Table of Contents

NOTE 10—REGULATORY MATTERS (continued)

 

The Corporation’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies.

 

(000s omitted)         Actual         

For Capital

Adequacy

Purposes

        

Regulatory

Agreement

Requirements

 
        Amount           Ratio          Amount      Ratio          Amount      Ratio  

As of March 31, 2012

                           

Total Capital

                           

(to Risk Weighted Assets)

                           

The State Bank

          26,058            12.6          16,580         8.0          24,871         12.0

Tier 1 Capital

                           

(to Risk Weighted Assets)

                           

The State Bank

        23,386            11.4           8,290         4.0           NA         NA   

Tier 1 Capital

                           

(to Average Assets)

                           

The State Bank

        23,386            7.9           11,905         4.0           23,810         8.0   

 

(000s omitted)    Actual    

For Capital

Adequacy

Purposes

   

Regulatory

Agreement

Requirements

 
   Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of December 31, 2011

               

Total Capital

               

(to Risk Weighted Assets)

               

Consolidated

   $ 22,263         10.1   $ 27,646         8.0     NA         NA   

The State Bank

     26,448         12.3        17,166         8.0      $ 25,749         12.0

Tier 1 Capital

               

(to Risk Weighted Assets)

               

Consolidated

     19,515         8.8        8,823         4.0        NA         NA   

The State Bank

     23,700         11.0        8,583         4.0        NA         NA   

Tier 1 Capital

               

(to Average Assets)

               

Consolidated

     19,515         6.5        11,981         4.0        NA         NA   

The State Bank

     23,700         8.1        11,654         4.0        23,307         8.0   

 

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Table of Contents

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

Certain of the Corporation’s accounting policies are important to the portrayal of the Corporation’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances, which could affect these judgments, include, but are not limited to, changes in interest rates, in the performance of the economy or in the financial condition of borrowers.

Results of Operations

As indicated in the statement of operations, the loss from continuing operations for the first three months ended March 31, 2012 was ($739,000) compared to ($132,000) for the same period in 2011. Net interest income in the first quarter of 2012 was $79,000 below net interest income for the same quarter in 2011. The first quarter of 2012 provision for loan losses increased $68,000 compared to the first quarter of 2011. Management feels the allowance for loan losses is appropriate and such allowance has decreased $489,000 when comparing the balance as of March 31, 2012 to the balance as of December 31, 2011. Non interest income for the first quarter of 2012 was $40,000 below non interest income for the same quarter in 2011. Non interest expense for the first quarter of 2012 was $332,000 higher than for the same quarter in 2011. These variances from period to period are detailed over the next several pages.

The banking industry uses standard performance indicators to help evaluate a banking institution’s performance. Return on average assets is one of these indicators. For the three months ended March 31, 2012, the Corporation’s return on average assets (annualized) was (0.97%) compared to 0.09% for the same period in 2011. For the three months ended March 31, 2012, the Corporation’s return on average equity (annualized) was (19.5%) compared to 1.86% for the same period in 2011. The net loss per share, basic and diluted, was ($0.31) in the first quarter of 2012 compared to $0.13 net income per share basic and diluted for the same period in 2011.

Net Interest Income

Net interest income and average balances and yields on major categories of interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2012 and 2011 are summarized in Table 2.

Table 1 below displays the effects of changing rates and volumes on our net interest income for the three month period ended March 31, 2012 compared to the three month period ended March 31, 2011. The information displayed is with respect to the effects on interest income and interest expense attributable to changes in volume and rate.

As indicated in Table 1, during the three months ended March 31, 2012, net interest income decreased compared to the same period in 2011. While the volume of loans increased over the past year, the loan yield decreased. This is due to the repricing of fixed rate loans to current market rates as they renew along with new volume of loans being booked at current rates which are lower than rates for the same periods in prior years. These changes resulted in a decrease in loan yield when comparing March 31, 2012 to March 31, 2011. Mitigating the decrease in interest income, deposit rates and volumes decreased year over year. The deposit interest rate reduction was achieved by a reduction of offering rates on time deposits, which assisted in discouraging high rate instruments from renewing, with some funds exiting, thus reducing interest bearing liability costs. In addition, a shift of deposits from interest bearing to non-interest bearing assisted in improving the net interest margin.

 

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Table of Contents

Table 1

 

    

THREE MONTHS ENDED

MARCH 31,

 
     2012 COMPARED TO 2011  
     INCREASE (DECREASE)  
(000s omitted)    DUE TO  
         YIELD/        
   VOLUME     RATE     TOTAL  

Taxable securities

   $ 81      $ (40   $ 41   

Tax-exempt securities (1)

     (21     (2     (23

Federal funds sold

     (5     4        (1

Total loans (1)

     (40     (249     (289

Loans held for sale

     1        (1     0   
  

 

 

   

 

 

   

 

 

 

Total earning assets

     16        (288     (272

Interest bearing demand deposits

     0        0        0   

Savings deposits

     0        (1     (1

Time CD’s $100,000 and over

     (83     (87     (170

Other time deposits

     (30     (25     (55

Other borrowings

     (4     10        6   
  

 

 

   

 

 

   

 

 

 

Total interest bearing liabilities

     (117     (103     (220
  

 

 

   

 

 

   

 

 

 

Net Interest Income

   $ 133      $ (185   $ (52
  

 

 

   

 

 

   

 

 

 

 

(1) Presented on a fully taxable equivalent basis using a federal income tax rate of 34%.

As indicated in Table 2, for the three months ended March 31, 2012, the Corporation’s net interest margin as a percentage of average assets (with consideration of full tax equivalency) was 3.86% compared with 3.76% for the same period in 2011. The increase in net interest margin is the result of the downward re-pricing on interest bearing assets which was offset by the decreases in rates paid on interest bearing liabilities when comparing the three month period ended March 31, 2012 to the three month period ended March 31, 2011.

Average earning assets decreased 2.8% or $7,467,000 comparing the first three months of 2012 to the same time period in 2011. Loans, the highest yielding component of earning assets, represented 77.0% of earning assets in 2012 compared to 73.7% in 2011. Average interest bearing liabilities decreased 7.1% or $16,759,000 comparing the first three months of 2012 to the same time period in 2011. Non-interest bearing deposits amounted to 25.4% of average earning assets in the first three months of 2012 compared with 21.3% in the same time period of 2011.

Management reviews economic forecasts and statistics on a monthly basis. Accordingly, the Corporation will continue to strategically manage the balance sheet structure in an effort to optimize net interest income. The Corporation expects to continue to selectively seek out new loan opportunities while continuing to maintain sound credit quality.

Management continually monitors the Corporation’s balance sheet in an effort to insulate net interest income from significant swings caused by interest rate volatility. If market rates change in 2012, corresponding changes in funding costs will be considered to avoid the potential negative impact on net interest income. The Corporation’s policies in this regard are further discussed in the section titled “Interest Rate Sensitivity Management.”

 

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Table of Contents

Table 2 Average Balance and Rates

 

     THREE MONTHS ENDED MARCH 31,  
     2012     2011  
(000s omitted)(Annualized)    AVERAGE     INCOME/      YIELD/     AVERAGE     INCOME/      YIELD/  
   BALANCE     EXPENSE      RATE     BALANCE     EXPENSE      RATE  

ASSETS

              

Securities:

              

U.S. Treasury and government Agencies

   $ 53,763      $ 309         2.31   $ 40,279      $ 267         2.67

State and Political (1)

     2,963        45         6.11     4,350        68         6.29

Other

     2,780        11         1.59     2,804        12         1.72
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total Securities

     59,506        365         2.47     47,433        347         2.94

Fed Funds Sold

     0        8         0.00     22,741        9         0.16

Loans:

              

Commercial

     147,871        2,051         5.58     148,538        2,310         6.05

Tax Free (1)

     1,535        26         6.81     2,001        32         6.43

Real Estate-Mortgage

     26,093        320         4.93     19,393        299         6.12

Consumer

     25,873        360         5.60     28,350        405         5.75
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total loans

     201,372        2,757         5.51     198,282        3,046         6.12
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Loans Held for Sale

     748        8         4.30     637        8         5.05
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

TOTAL EARNING ASSETS

   $ 261,626      $ 3,138         4.82   $ 269,093      $ 3,410         5.00
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Cash Due from Banks

     28,522             17,934        

Allowance for Loan Losses

     (7,687          (10,129     

Assets of discontinued operations

     0             46,045        

All Other Assets

     20,831             26,595        
  

 

 

        

 

 

      

TOTAL ASSETS

   $ 303,292           $ 349,538        
  

 

 

        

 

 

      

LIABILITIES & STOCKHOLDERS’ EQUITY:

              

Deposits:

              

Interest Bearing – DDA

   $ 48,862      $ 14         0.12   $ 48,157      $ 14         0.12

Savings Deposits

     67,980        15         0.09     68,004        16         0.09

Time CD’s $100,000 and Over

     36,258        264         2.93     46,224        434         3.78

Other Time CD’s

     50,296        203         1.62     57,339        258         1.81
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total Interest Bearing Deposits

     203,396        496         0.98     219,724        722         1.32

Other Borrowings

     14,923        132         3.56     15,354        126         3.30
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

INTEREST BEARING LIABILITIES

   $ 218,319        628         1.16   $ 235,078        848         1.45
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Non-Interest bearing – DDA

     66,508             57,342        

Liabilities of discontinued operations

     0             37,422        

All Other Liabilities

     3,596             3,040        

Stockholders’ Equity

     14,869             16,656        
  

 

 

        

 

 

      

TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY

   $ 303,292           $ 349,538        
  

 

 

        

 

 

      

Net Interest Rate Spread

          3.66          3.60
       

 

 

        

 

 

 

Net Interest Income /Margin

     $ 2,510         3.86     $ 2,562         3.76
    

 

 

    

 

 

     

 

 

    

 

 

 

 

(1) Presented on a fully taxable equivalent basis using a federal income tax rate of 34%.

 

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Table of Contents

Allowance and Provision For Loan Losses

The Corporation maintains formal policies and procedures to control and monitor credit risk. Management believes the allowance for loan losses is appropriate to provide for probable incurred losses in the loan portfolio. While the Corporation’s loan portfolio has no significant concentrations in any one industry or any exposure in foreign loans, the loan portfolio has a concentration connected with commercial real estate loans. Specific strategies have been implemented to reduce the concentration levels and limit exposure to this type of lending in the future. The Michigan economy, employment levels and other economic conditions in the Corporation’s local markets may have a significant impact on the level of credit losses. Management continues to identify and devote attention to credits that are not performing as agreed. Of course, deterioration of economic conditions could have an impact on the Corporation’s credit quality, which could impact the need for greater provision for loan losses and the level of the allowance for loan losses as a percentage of gross loans. Non-performing loans are discussed further in the section titled “Non-Performing Assets.”

The allowance for loan losses reflects management’s judgment as to the level considered appropriate to absorb probable losses in the loan portfolio. The Corporation’s methodology in determining the appropriateness of the allowance is based on ongoing quarterly assessments and relies on several key elements, which include specific allowances for identified problem loans and a formula-based risk-allocated allowance for the remainder of the portfolio. This includes a review of individual loans, size, and composition of the loan portfolio, historical loss experience, current economic conditions, financial condition of borrowers, the level and composition of non-performing loans, portfolio trends, estimated net charge-offs and other pertinent factors. While management consider the allowance for loan losses to be appropriate based on information currently available, future adjustments to the allowance may be necessary due to changes in economic conditions, delinquencies, or loss rates. Although portions of the allowance have been allocated to various portfolio segments, the allowance is general in nature and is available for the portfolio in its entirety.

The provision for loan losses remains high as a result of continued weaknesses in the national and local economies, elevated amounts of non-performing loans and elevated charge-off levels over the past two years. Rolling eight quarter periods of historical charge off experience is considered when calculating the current required level of the allowance for loan losses. The amount of the allowance for loan losses specifically allocated to impaired loans decreased by $508,000 during the quarter as a result of charge offs incurred on loans for which specific allocations were previously recorded.

At March 31, 2012, the allowance was $7,675,000, or 3.86% of total loans compared to $8,164,000, or 3.97%, at December 31, 2011, a decrease of $489,000 during the first three months of 2012. Non performing loan levels, discussed below, decreased during the period while net charge-offs decreased to $1,352,000 during the first three months of 2012 compared to $3,004,000 during the first three months of 2011. A majority of the charge-offs relate to loans for which specific allocations were recorded at December 31, 2011.

Table 3 below summarizes loan losses and recoveries for the first three months of 2012 and 2011. During the first three months of 2012, the Corporation experienced net charge-offs of $1,352,000 or 0.68% of gross loans compared with net charge-offs of $3,004,000 or 1.53% of gross loans in the first three months of 2011. The provision for loan loss was $863,000 in the first three months of 2012 and $795,000 for the same time period in 2011. Continuing declines in appraised values of properties in Michigan, along with additional loans migrating to watch status due to economic conditions, have contributed to the ongoing elevated level of provision for loan losses. The application of historical loss rates to the current portfolio has the potential to be a lagging indicator and management evaluates whether these allocations should be adjusted. While there are indications that asset quality is improving, the use of historical loss rates in estimating the required level of allowance for loan losses continues to require high levels of provision for estimated future loan losses.

 

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Table of Contents

Table 3 Analysis of the Allowance for Loan Losses

 

(000s omitted)    Commercial     Commercial
Real
Estate
    Residential
Real
Estate
    Installment
Loans
    Home
Equity
    Unallocated     Total  

Balance January 1, 2012

              

Allowance for loan losses

   $ 891      $ 5,759      $ 476      $ 215      $ 482      $ 341      $ 8,164   

Provision for loan losses

     181        1,068        74        (36     (87     (337     863   

Loans charged off

     (551     (680     (60     (10     (104     0        (1,405

Loan recoveries

     13        29        1        6        4        0        53   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance March 31, 2012

   $ 534      $ 6,176      $ 491      $ 175      $ 295      $ 4      $ 7,675   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs to gross loans

     1.62     0.57     0.22     0.06     0.51       0.68

 

(000s omitted)    Commercial     Commercial
Real
Estate
    Residential
Real
Estate
    Installment
Loans
    Home
Equity
    Unallocated     Total  

Balance January 1, 2011

              

Allowance for loan losses

   $ 871      $ 9,155      $ 411      $ 233      $ 508      $ 46      $