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Commission File Number: 0-13358
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
At July 31, 2012, 17,199,913 shares of the Registrants Common Stock, $.01 par value, were outstanding.
CITY BANK GROUP, INC.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words may, could, should, would, believe, anticipate, estimate, expect, intend, plan, target, goal, and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements.
Our ability to achieve our financial objectives could be adversely affected by the factors discussed in detail in Part I, Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations and Part II, Item 1A. Risk Factors in this Quarterly Report on Form 10-Q, the following sections of our Annual Report on Form 10-K for the year ended December 31, 2011 (the 2011 Form 10-K): (a) Introductory Note in Part I, Item 1. Business; (b) Risk Factors in Part I, Item 1A., as updated in our subsequent quarterly reports filed on Form 10-Q, and (c) Introduction in Managements Discussion and Analysis of Financial Condition and Results of Operations, in Part II, Item 7 as well as:
However, other factors besides those referenced also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. Capital City Bank Group, Inc. (CCBG or the Company) provides a full range of banking and banking-related services to individual and corporate clients through its subsidiary, Capital City Bank, with banking offices located in Florida, Georgia, and Alabama. The Company is subject to competition from other financial institutions, is subject to regulation by certain government agencies and undergoes periodic examinations by those regulatory authorities.
Basis of Presentation. The consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of CCBG, and its wholly-owned subsidiary, Capital City Bank (CCB or the Bank and together with the Company). All material inter-company transactions and accounts have been eliminated.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six-month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.
The consolidated statement of financial condition at December 31, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
For further information, refer to the consolidated financial statements and footnotes thereto included in the Companys annual report on Form 10-K for the year ended December 31, 2011.
NOTE 2 - INVESTMENT SECURITIES
Investment Portfolio Composition. The amortized cost and related market value of investment securities available-for-sale were as follows:
Securities with an amortized cost of $149.9 million and $102.1 million at June 30, 2012 and December 31, 2011, respectively, were pledged to secure public deposits and for other purposes.
The Bank, as a member of the Federal Home Loan Bank of Atlanta (FHLB), is required to own capital stock in the FHLB based generally upon the balances of residential and commercial real estate loans, and FHLB advances. FHLB stock which is included in other securities is pledged to secure FHLB advances. No ready market exists for this stock, and it has no quoted market value. However, redemption of this stock has historically been at par value.
Maturity Distribution. As of June 30, 2012, the Companys investment securities had the following maturity distribution based on contractual maturities:
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Other Than Temporarily Impaired Securities. The following table summarizes the investment securities with unrealized losses aggregated by major security type and length of time in a continuous unrealized loss position.
Management evaluates securities for other than temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: 1) the length of time and the extent to which the fair value has been less than amortized cost, 2) the financial condition and near-term prospects of the issuer, and 3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in cost. In analyzing an issuers financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by rating agencies have occurred, regulatory issues, and analysts reports.
At June 30, 2012, the Company had securities of $280.8 million with net pre-tax unrealized gains of $1.0 million on these securities, of which $48.9 million have unrealized losses totaling $0.8 million. Approximately $41.2 million of these securities, with an unrealized loss of $0.1 million, have been in a loss position for less than 12 months. Approximately $7.1 million of these securities, with an unrealized loss of approximately $25,000 have been in a loss position for greater than 12 months. These securities are primarily in a loss position because they were acquired when the general level of interest rates was lower than that on June 30, 2012. The Company believes that the losses in these securities are temporary in nature and that the full principal will be collected as anticipated. Because the declines in the market value of these investments are attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold these investments until there is a recovery in fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2012. One preferred bank stock issue for $0.6 million has also been in a loss position for greater than 12 months. The Company continues to closely monitor the fair value of this security as the subject bank continues to experience negative operating trends.
NOTE 3 LOANS, NET
Loan Portfolio Composition. The composition of the loan portfolio was as follows:
Net deferred fees included in loans were $1.6 million at June 30, 2012 and December 31, 2011, respectively.
Loan Portfolio Aging. A loan is defined as a past due loan when one full payment is past due or a contractual maturity is over 30 days past due (DPD).
The following table presents the aging of the recorded investment in past due loans by class of loans:
Nonaccrual Loans. Loans are generally placed on non-accrual status if principal or interest payments become 90 days past due and/or management deems the collectability of the principal and/or interest to be doubtful. Loans are returned to accrual status when the principal and interest amounts contractually due are brought current or when future payments are reasonably assured.
The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days and still on accrual by class of loans:
Impaired Loans. Loans are deemed to be impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due (principal and interest payments), according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
The following table presents loans individually evaluated for impairment by class of loans:
The following table summarizes the average recorded investment and interest income recognized by class of impaired loans:
Troubled Debt Restructurings
(TDRs). TDRs are loans in which the borrower is experiencing financial
difficulty and the Company has granted an economic concession to the borrower
that it would not otherwise consider. In these instances, as part of a work-out
alternative, the Company will defer cash payments required as part of the loan
agreement through either a principal moratorium or extension of the loan term.
The impact of the TDR modifications and defaults are factored into the
allowance for loan losses on a loan-by-loan basis as all TDRs are, by
definition, impaired loans. Thus, specific reserves are established based upon
the results of either a discounted cash flow analysis or the underlying
collateral value, if the loan is deemed to be collateral dependent. In the
limited circumstances that a loan is removed from TDR classification, it is the Companys policy to also remove it from the impaired loan category, but to continue to individually
evaluate loan impairment based on the contractual terms specified by the loan
Loans classified as TDRs during the three and six months ended June 30, 2012 are presented in the table below. The modifications made during the reporting period involved either an extension of the loan term or a principal moratorium and the financial impact of these modifications was not material.
Loans modified as TDRs within the previous 12 months that have subsequently defaulted during the three and six months ended June 30, 2012 are presented in the table below.
Credit Risk Management. The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures designed to maximize loan income within an acceptable level of risk. Management and the Board of Directors review and approve these policies and procedures on a regular basis (at least annually).
Reporting systems have been implemented to monitor loan originations, loan quality, concentrations of credit, loan delinquencies and nonperforming loans and potential problem loans. Management and the Credit Risk Oversight Committee periodically review our lines of business to monitor asset quality trends and the appropriateness of credit policies. In addition, total borrower exposure limits are established and concentration risk is monitored. As part of this process, the overall composition of the portfolio is reviewed to gauge diversification of risk, client concentrations, industry group, loan type, geographic area, or other relevant classifications of loans. Specific segments of the loan portfolio are monitored and reported to the Board on a quarterly basis and have strategic plans in place to supplement Board approved credit policies governing exposure limits and underwriting standards. Detailed below are the categories of loans within the Companys loan portfolio and risk characteristics unique to each.
Commercial, Financial, and Agricultural Loans in this category are primarily made based on identified cash flows of the borrower with consideration given to underlying collateral and personal or other guarantees. Lending policy establishes debt service coverage ratio limits that require a borrowers cash flow to be sufficient to cover principal and interest payments on all new and existing debt. The majority of these loans are secured by the assets being financed or other business assets such as accounts receivable, inventory, or equipment. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines.
Real Estate Construction Loans in this category consist of short-term construction loans, revolving and non-revolving credit lines and construction/perm loans made to individuals and investors to finance the acquisition, development, construction or rehabilitation of real property. These loans are primarily made based on identified cash flows of the borrower or project and generally secured by the property being financed, including 1-4 family residential properties and commercial properties that are either owner-occupied or investment in nature. These properties may include either vacant or improved property. Collateral values are determined based upon third party appraisals and evaluations. Loan to value ratios at origination are governed by established policy guidelines.
Real Estate Commercial Mortgage Loans in this category consists of commercial mortgage loans secured by property that is either owner-occupied or investment in nature. These loans are primarily made based on identified cash flows of the borrower or project with consideration given to underlying real estate collateral and personal guarantees. Lending policy establishes debt service coverage ratios and loan to value ratios specific to the property type. Collateral values are determined based upon third party appraisals and evaluations.
Real Estate Residential Residential mortgage loans held in the Companys loan portfolio are made to borrowers that demonstrate the ability to make scheduled payments with full consideration to underwriting factors such as current income, employment status, current assets, and other financial resources, credit history, and the value of the collateral. Collateral consists of mortgage liens on 1-4 family residential properties. Collateral values are determined based upon third party appraisals and evaluations. The Company does not originate sub-prime loans.
Real Estate Home Equity Home equity loans and lines are made to qualified individuals for legitimate purposes generally secured by senior or junior mortgage liens on owner-occupied 1-4 family homes or vacation homes. Borrower qualifications include favorable credit history combined with supportive income and debt ratio requirements and combined loan to value ratios within established policy guidelines. Collateral values are determined based upon third party appraisals and evaluations.
Consumer Loans This loan portfolio includes personal installment loans, direct and indirect automobile financing, and overdraft lines of credit. The majority of the consumer loan portfolio consists of indirect and direct automobile loans. Lending policy establishes maximum debt to income ratios, minimum credit scores, and includes guidelines for verification of applicants income and receipt of credit reports.
Credit Quality Indicators. As part of the ongoing monitoring of the Companys loan portfolio quality, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment performance, credit documentation, and current economic/market trends, among other factors. Risk ratings are assigned to each loan and revised as needed through established monitoring procedures for individual loan relationships over a predetermined amount and review of smaller balance homogenous loan pools. The Company uses the definitions noted below for categorizing and managing its criticized loans. Loans categorized as Pass do not meet the criteria set forth for the Special Mention, Substandard, or Doubtful categories and are not considered criticized.
Special Mention Loans in this category are presently protected from loss, but weaknesses are apparent which, if not corrected, could cause future problems. Loans in this category may not meet required underwriting criteria and have no mitigating factors. More than the ordinary amount of attention is warranted for these loans.
Substandard Loans in this category exhibit well-defined weaknesses that would typically bring normal repayment into jeopardy. These loans are no longer adequately protected due to well-defined weaknesses that affect the repayment capacity of the borrower. The possibility of loss is much more evident and above average supervision is required for these loans.
Doubtful Loans in this category have all the weaknesses inherent in a loan categorized as Substandard, with the 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 following table presents the risk category of loans by segment:
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents managements best estimate of probable losses within the existing portfolio of loans. Loans are charged-off to the allowance when losses are deemed to be probable and reasonably quantifiable.
The following table details the activity in the allowance for loan losses by portfolio class for the three and six months ended June 30, 2012 and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
The following table details the amount of the allowance for loan losses by portfolio class disaggregated on the basis of the Companys impairment methodology
The Companys recorded investment in loans related to each balance in the allowance for loan losses by portfolio class and disaggregated on the basis of the Companys impairment methodology was as follows:
NOTE 4 - INTANGIBLE ASSETS
The Company had net intangible assets of $85.3 million and $85.5 million at June 30, 2012 and December 31, 2011, respectively. Intangible assets were as follows:
Net Core Deposit Intangibles: As of June 30, 2012 and December 31, 2011, the Company had net core deposit intangibles of $0.1 million and $0.3 million, respectively. Amortization expense for the first six months of 2012 and 2011 was approximately $0.2 million and $0.4 million, respectively. Estimated annual amortization expense for 2012 is $0.3 million. All of our core deposit intangibles will be fully amortized in January 2013.
Goodwill: As of June 30, 2012 and December 31, 2011, the Company had goodwill of $84.8 million.
Goodwill is tested for impairment on an annual basis, or more often if impairment indicators exist. A goodwill impairment test consists of two steps. Step One compares the estimated fair value of the reporting unit to its carrying amount. If the carrying amount exceeds the estimated fair value, Step Two is performed by comparing the fair value of the reporting units implied goodwill to the carrying value of goodwill. If the carrying value of the reporting units goodwill exceeds the estimated fair value, an impairment charge is recorded equal to the excess.
As of June 30, 2012, the book value of the Companys equity exceeded its market capitalization, and as such the Company performed goodwill impairment testing. The Step One test indicated that the carrying amount (including goodwill) of the Companys reporting unit exceeded its estimated fair value. The Step Two test indicated the estimated fair value of our reporting units implied goodwill exceeded its carrying amount. Based on the results of the Step Two analysis, the Company concluded that goodwill was not impaired as of June 30, 2012. The Company will continue to evaluate goodwill for impairment as defined by ASC Topic 350.
Other: As of June 30, 2012 and December 31, 2011, the Company had a customer relationship intangible asset, net of accumulated amortization, of $0.3 million and $0.4 million, respectively. This intangible asset was recorded as a result of the March 2004 acquisition of trust customer relationships. Amortization expense for the first six months of 2012 and 2011 was approximately $96,000. Estimated annual amortization expense is approximately $0.2 million based on use of a 10-year useful life.
NOTE 5 - DEPOSITS
The composition of the Companys interest bearing deposits were as follows:
NOTE 6 - EMPLOYEE BENEFIT PLANS
The Company has a defined benefit pension plan covering substantially all full-time and eligible part-time associates and a Supplemental Executive Retirement Plan (SERP) covering its executive officers.
The components of the net periodic benefit costs for the Companys qualified benefit pension plan were as follows:
NOTE 7 - COMMITMENTS AND CONTINGENCIES
Lending Commitments. The Company is a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of its clients. These financial instruments consist of commitments to extend credit and standby letters of credit.
The Companys maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance sheet instruments. The amounts associated with the Companys off-balance sheet obligations were as follows:
Commitments to extend credit are agreements to lend to a client so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities. In general, management does not anticipate any material losses as a result of participating in these types of transactions. However, any potential losses arising from such transactions are reserved for in the same manner as management reserves for its other credit facilities.
For both on- and off-balance sheet financial instruments, the Company requires collateral to support such instruments when it is deemed necessary. The Company evaluates each clients creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on managements credit evaluation of the counterparty. Collateral held varies, but may include deposits held in financial institutions; U.S. Treasury securities; other marketable securities; real estate; accounts receivable; property, plant and equipment; and inventory.
Contingencies. The Company is a party to lawsuits and claims arising out of the normal course of business. In managements opinion, there are no known pending claims or litigation, the outcome of which would, individually or in the aggregate, have a material effect on the consolidated results of operations, financial position, or cash flows of the Company.
Indemnification Obligation. The Company is a member of the Visa U.S.A. network. Visa U.S.A believes that its member banks are required to indemnify it for potential future settlement of certain litigation (the Covered Litigation) that relates to several antitrust lawsuits challenging the practices of Visa and MasterCard International. In 2008, the Company, as a member of the Visa U.S.A. network, obtained Class B shares of Visa, Inc. upon its initial public offering. Since its initial public offering, Visa, Inc. has funded a litigation reserve for the Covered Litigation resulting in a reduction in the Class B shares held by the Company. During the first quarter of 2011, the Company sold its remaining Class B shares resulting in a $3.2 million pre-tax gain. Associated with this sale, the Company entered into a swap contract with the purchaser of the shares that requires a payment to the counterparty in the event that Visa, Inc. makes subsequent revisions to the conversion ratio for its Class B shares.
In July 2012, Visa and MasterCard International entered into a memorandum of understanding to enter into a settlement agreement to resolve the aforementioned covered litigation matter. Visas share of the claim is to be paid from the litigation reserve account. Subsequent to the memorandum of understanding, Visa increased the litigation reserve by $150 million and revised the conversion ratio for the Class B shares resulting in a $56,000 payment by the Company under the swap contract. The Company does not expect to make any additional payments to the counterparty other than certain fixed charges included in the liability, which are payable until the settlement is finalized.
NOTE 8 FAIR VALUE MEASUREMENTS
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Securities Available for Sale. U.S. Treasury securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, credit information and the bonds terms and conditions, among other things.
The Company reviews the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness to ensure such prices are aligned with traditional pricing matrices. In general, the Company does not purchase securities that have a complicated structure. The Companys entire portfolio consists of traditional investments, nearly all of which are U.S. Treasury obligations, federal agency bullet or mortgage pass-through securities, or general obligation or revenue based municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. From time to time, the Company will validate, on a sample basis, prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.
Fair Value Swap. The Company entered into a stand-alone derivative contract with the purchaser of its Visa Class B shares. The valuation represents an internally developed estimate of the exposure based upon probability-weighted potential Visa litigation losses and related carrying cost obligations required under the contract.
A summary of fair values for assets and liabilities recorded at fair value consisted of the following:
Assets Measured at Fair Value on a Non-Recurring Basis
Certain assets that are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of valuation methodologies used for assets measured on a non-recurring basis.
Impaired Loans. Loans deemed to be impaired are valued based upon the lower of cost or the fair value of the underlying collateral or discounted cash flow analysis. The fair value of collateral is determined by an independent valuation or professional appraisal in conformance with banking regulations. Collateral values are estimated using Level 3 inputs due to the volatility in the real estate market, and the judgment and estimation involved in the real estate appraisal process. The inputs used in performing discounted cash flow analyses are not observable and therefore is considered a Level 3 input. Impaired loans had a carrying value of $103.6 million with a valuation allowance of $9.6 million at June 30, 2012 and $107.8 million and $11.2 million, respectively, at December 31, 2011.
Loans Held for Sale. Loans held for sale were $17.0 million and $21.2 million as of June 30, 2012 and December 31, 2011, respectively. These loans are carried at the lower of cost or fair value and are adjusted to fair value on a non-recurring basis. Fair value is based on observable markets rates for comparable loan products, which is considered a Level 2 fair value measurement.
Other Real Estate Owned. During the first six months of 2012, certain foreclosed assets, upon initial recognition, were measured and reported at fair value through a charge-off to the allowance for possible loan losses based on the fair value of the foreclosed asset. The fair value of the foreclosed asset is determined by an independent valuation or professional appraisal in conformance with banking regulations. The fair value of foreclosed assets is estimated using Level 3 inputs due to the volatility of the real estate market, and judgment and estimation involved in the real estate valuation process. Foreclosed assets measured at fair value upon initial recognition totaled $11.2 million during the six months ended June 30, 2012. The Company disposed of $13.5 million in foreclosed assets and recognized subsequent write-downs totaling $2.2 million for properties that were re-valued during the six months ended June 30, 2012. The carrying value of foreclosed assets was $58.1 million at June 30, 2012.
Assets and Liabilities Disclosed at Fair Value
The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities, for which it is practical to estimate fair value and the following is a description of valuation methodologies used for those assets and liabilities.
Cash and Short-Term Investments The carrying amount of cash and short-term investments is used to approximate fair value, given the short time frame to maturity and as such assets do not present unanticipated credit concerns.
Loans - The loan portfolio is segregated into categories and the fair value of each loan category is calculated using present value techniques based upon projected cash flows and estimated discount rates that reflect the credit and interest rate risks inherent in each loan category. The calculated present values are then reduced by an allocation of the allowance for loan losses against each respective loan category.
Deposits - The fair value of Noninterest Bearing Deposits, NOW Accounts, Money Market Accounts and Savings Accounts are the amounts payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using present value techniques and rates currently offered for deposits of similar remaining maturities.
Subordinated Notes Payable - The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar obligations.
Short-Term and Long-Term Borrowings - The fair value of each note is calculated using present value techniques, based upon projected cash flows and estimated discount rates as well as rates being offered for similar debt.
A summary of estimated fair values of significant financial instruments consisted of the following:
All non-financial instruments were excluded from the above table. The disclosures also do not include certain intangible assets such as client relationships, deposit base intangibles and goodwill. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
NOTE 9 ACCOUNTING STANDARDS UPDATES
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 principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 became effective for the Company on January 1, 2012, and did not have a significant impact on the Companys 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 non-owner changes in stockholders equity be presented in either a single continuous statement of comprehensive income or in two separate but 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 2011-03 became effective for the Company on January 1, 2012, however, certain provisions related to the presentation of reclassification adjustments have been deferred by ASU 2011-12 Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, as further discussed below. In connection with the application of ASU 2011-05, the Companys financial statements now include one continuous statement of comprehensive income.
ASU 2011-08, Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment. ASU 2011-08 amends Topic 350, Intangibles Goodwill and Other, to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 became effective for the Company on January 1, 2012, and did not have a significant impact on the Companys financial statements.
ASU 2011-12 Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to re-deliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 became effective for the Company on January 1, 2012, and did not have a significant impact on the Companys financial statements.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Managements discussion and analysis (MD&A) provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes. The MD&A is divided into subsections entitled Business Overview, Financial Overview, Results of Operations, Financial Condition, Market Risk and Interest Rate Sensitivity, Liquidity and Capital Resources, Off-Balance Sheet Arrangements, and Critical Accounting Policies. The following information should provide a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2012 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and subsidiaries, collectively, are referred to as CCBG, Company, we, us, or our.
In this MD&A, we present an operating efficiency ratio which is not calculated based on accounting principles generally accepted in the United States (GAAP), but that we believe provides important information regarding our results of operations. Our calculation of the operating efficiency ratio is computed by dividing noninterest expense less intangible amortization, by the sum of tax equivalent net interest income and noninterest income. Management uses this non-GAAP measure as part of its assessment of its performance in managing noninterest expenses. We believe that excluding intangible amortization and merger expenses in our calculations better reflect our periodic expenses and is more reflective of normalized operations.
Although we believe the above-mentioned non-GAAP financial measure enhances investors understanding of our business and performance this non-GAAP financial measure should not be considered an alternative to GAAP. In addition, there are material limitations associated with the use of this non-GAAP financial measure such as the risks that readers of our financial statements may disagree as to the appropriateness of items included or excluded in this measure and that our measure may not be directly comparable to other companies that calculate this measure differently. Our management compensates for this limitation by providing a detailed reconciliation between GAAP information and the non-GAAP financial measure as detailed below.
Reconciliation of operating efficiency ratio to efficiency ratio:
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including this MD&A section, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words may, could, should, would, believe, anticipate, estimate, expect, intend, plan, target, goal, and similar expressions are intended to identify forward-looking statements.
All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A. Risk Factors of our 2011 Report on Form 10-K, as updated in our subsequent quarterly reports filed on Form 10-Q, and in our other filings made from time to time with the SEC after the date of this report.
However, other factors besides those listed in our Quarterly Report or in our Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.
We are a bank holding company headquartered in Tallahassee, Florida, and we are the parent of our wholly-owned subsidiary, Capital City Bank (the Bank or CCB). The Bank offers a broad array of products and services through a total of 70 full-service offices located in Florida, Georgia, and Alabama. The Bank offers commercial and retail banking services, as well as trust and asset management, retail securities brokerage and data processing services.
Our profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest received on earning assets, such as loans and securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by the provision for loan losses, operating expenses such as salaries and employee benefits, occupancy and other operating expenses including income taxes, and noninterest income such as service charges on deposit accounts, asset management and trust fees, retail securities brokerage fees, mortgage banking fees, bank card fees, and data processing fees.
A detailed discussion regarding the economic conditions in our markets and our long-term strategic objectives is included as part of the MD&A section of our 2011 Form 10-K.
A summary overview of our financial performance is provided below.
Results of Operations
RESULTS OF OPERATIONS
For the second quarter of 2012, we realized a net loss of $1.7 million, or $0.10 per diluted share, compared to a net loss of $1.2 million, or $0.07 per diluted share for the first quarter of 2012, and net income of $2.1 million, or $0.12 per diluted share, for the second quarter of 2011. For the first six months of 2012, we realized a net loss of $2.9 million, or $0.17 per diluted share, compared to net income of $3.5 million, or $0.20 per diluted share for the same period in 2011.
Compared to the first quarter of 2012, performance reflects lower operating revenues (net interest income plus noninterest income) of $0.3 million and a higher loan loss provision of $0.9 million, partially offset by lower noninterest expense of $0.3 million and income taxes of $0.4 million.
Compared to the second quarter of 2011, the reduction in earnings was due to lower operating revenues of $2.9 million, a higher loan loss provision of $2.2 million, and an increase in noninterest expense of $1.1 million, partially offset by lower income taxes of $2.4 million.
The decrease in earnings for the first half of 2012 is attributable to lower operating revenues of $7.0 million, a higher loan loss provision of $2.9 million, and an increase in noninterest expense of $0.3 million, partially offset by lower income taxes of $3.8 million. Earnings for the first half of 2011 reflect the sale of our Visa Class B shares of stock which resulted in a net pre-tax gain of $2.6 million ($3.2 million pre-tax gain included in noninterest income and recognition of a $0.6 million swap liability included in noninterest expense).
A condensed earnings summary of each major component of our financial performance is provided below:
Net Interest Income
Net interest income represents our single largest source of earnings and is equal to interest income and fees generated by earning assets less interest expense paid on interest bearing liabilities. This information is provided on a taxable equivalent basis to reflect the tax-exempt status of income earned on certain loans and investments, the majority of which are state and local government debt obligations. We provide an analysis of our net interest income including average yields and rates in Table I on page 42.
Tax equivalent net interest income for the second quarter of 2012 was $21.2 million compared to $21.8 million for the first quarter of 2012 and $23.7 million for the second quarter of 2011. For the first six months of 2012, tax equivalent net interest income totaled $43.1 million compared to $47.0 million for the same period of 2011.
The declines of $0.6 million and $2.5 million in tax equivalent net interest income from the first quarter of 2012 and second quarter of 2011, respectively, were due to a reduction in loan income primarily attributable to declining loan balances and continued unfavorable asset repricing, partially offset by a reduction in interest expense and a lower level of foregone interest on loans. The lower interest expense is primarily attributable to certificates of deposit and reflects both lower balances and favorable repricing.
Tax equivalent interest income for the second quarter of 2012 was $22.6 million compared to $23.3 million for the first quarter of 2012 and $25.7 million for the second quarter of 2011. The decrease when compared to both periods is specifically attributable to both the shift in earning asset mix and lower yields. The declining loan portfolio has resulted in the higher yielding earning assets being replaced with lower yielding federal funds or investment securities. Additionally, low yields on new loan and investment production and loan portfolio repricing continue to unfavorably affect net interest income.
Interest expense for the second quarter of 2012 was $1.4 million compared to $1.5 million for the first quarter of 2012 and $2.0 million for the second quarter in 2011. The lower cost of funds when compared to both periods was a result of continued rate reductions on all deposit products except savings accounts. The rate reductions on deposits reflect our response to a historically low interest rate environment and desire to continue our focus on core banking relationships.
The decline in the loan portfolio, coupled with the low rate environment continues to put pressure on our net interest income. The loan portfolio yield has been declining because the average rate on new loans is lower than the loans being paid off and the existing variable rate loans reprice lower. Lowering our cost of funds, to the extent we can, and continuing to shift the mix of our deposits will help to partially mitigate the unfavorable impact of weak loan demand and repricing, although the impact is expected to be minimal.
The net interest margin for the second quarter of 2012 was 3.77%, a decrease of 10 basis points from the first quarter of 2012 and a decline of 44 basis points from the second quarter of 2011. Year-to-date net interest margin of 3.82% declined 35 basis points from the comparable period in 2011. The decrease in the margin for all comparable periods is attributable to the shift in our earning asset mix and unfavorable asset repricing, partially offset by a lower average cost of funds.
As experienced since at least 2010, historically low interest rates, foregone interest, lower loan fees, unfavorable asset repricing without the flexibility to significantly adjust deposit rates, and core deposit growth (which has strengthened our liquidity position, but contributed to an unfavorable shift in our earning asset mix), have all placed pressure on our net interest margin. Our current strategy, as well as our historic strategy, is to not accept greater interest rate risk by reaching further out the curve for yield, particularly given the fact that short term rates are at historical lows. We continue to maintain short duration portfolios on both sides of the balance sheet and believe we are well positioned to respond to changing market conditions. As this strategy in the current environment has unfavorably impacted our net interest margin, over time this strategy has consistently resulted in our net interest margins significantly exceeding those in our peer group comparisons. Given the unfavorable asset repricing and low rate environment, we anticipate continued pressure on the margin for the remainder of 2012.
Provision for Loan Losses
The provision for loan losses for the second quarter of 2012 was $5.7 million compared to $4.8 million in the first quarter of 2012 and $3.5 million for the second quarter of 2011. The increase over both periods was driven by higher loan loss experience and the associated impact on our general reserve needs. For the first six months of 2012, the loan loss provision totaled $10.5 million compared to $7.7 million for the same period in 2011 with the increase primarily attributable to an increase in impaired loans. Net charge-offs for the second quarter of 2012 totaled $7.0 million, or 1.80% (annualized), of average loans compared to $4.6 million, or 1.16%, for the first quarter of 2012 and $6.3 million, or 1.49%, for the second quarter of 2011. For the first half of 2012, net charge-offs totaled $11.6 million, or 1.48% (annualized), of average loans compared to $12.0 million, or 1.41%, for the same period of 2011. At quarter-end, the allowance for loan losses of $29.9 million was 1.93% of outstanding loans (net of overdrafts) and provided coverage of 40% of nonperforming loans compared to 1.98% and 40%, respectively, at March 31, 2012, and 1.91% and 41%, respectively, at December 31, 2011.
Charge-off activity for the respective periods is set forth below:
Noninterest income for the second quarter of 2012 totaled $13.9 million, an increase of $0.3 million, or 2.4%, over the first quarter of 2012 and a decrease of $0.5 million, or 3.8%, from the second quarter of 2011. The increase over the first quarter of 2012 was driven primarily by higher retail brokerage fees of $0.1 million and an increase in other income of $0.2 million, primarily gains from the sale of OREO properties. Compared to the second quarter of 2011, the decrease primarily reflects a $0.9 million reduction in other income attributable to a lower level of gains realized from the sale of OREO properties partially offset by higher mortgage banking fees of $0.3 million and bank card fees of $0.2 million.
For the first six months of 2012, noninterest income totaled $27.5 million, a decrease of $3.3 million, or 10.7%, from the same period of 2011 attributable to the Visa gain realized in the first quarter of 2011. Higher deposit fees, mortgage banking fees, and bank card fees partially offset by lower data processing fees and a reduction in other income, primarily lower gains from the sale of OREO properties, also contributed to the variance.
Noninterest income represented 39.88% of operating revenues (net interest income plus noninterest income) in the second quarter of 2012 compared to 38.64% in the first quarter of 2012 and 38.13% in the second quarter of 2011. For the first six months of 2012, noninterest income represented 39.3% of operating revenues compared to 39.9% for the same period of 2011. The decrease for the first six months of 2012 compared to 2011 is attributable to the gain from the sale of our Visa stock in the 2011. In addition to the Visa gain, this metric has also been impacted by the lower level of net interest income.
The table below reflects the major components of noninterest income.
Significant components of noninterest income are discussed in more detail below.
Service Charges on Deposit Accounts. Deposit service charge fees for the second quarter of 2012 totaled $6.3 million, comparable to both the first quarter of 2012 and second quarter of 2011. For the first six months of 2012, deposit service charge fees totaled $12.6 million, an increase of $330,000, or 2.7%, over the comparable period in 2011 driven by a lower level of overdraft charge-offs.
Data Processing Fees. Fees from data processing services for the second quarter of 2012 totaled $680,000, comparable to the first quarter of 2012. Fees decreased by $84,000, or 11.0%, compared to the second quarter of 2011, attributable to lower processing volume for our state government contract. For the first six months of 2012, fees totaled $1.4 million, a decrease of $383,000, or 22.0%, primarily due to a reduction in the number of banks that we provide processing services to as two of our user banks were acquired and discontinued service in mid 2011.
Retail Brokerage Fees. Fees from the sale of retail investment and insurance products totaled $884,000 for the second quarter of 2012, an increase of $126,000, or 16.6%, over the first quarter of 2012 and a decrease of $55,000, or 5.9%, from the second quarter of 2011. For the first six months of 2012, fees totaled $1.6 million, a $26,000 decrease from the comparable period of 2011. The change for each period reflects fluctuation in trading activity by our clients.
Mortgage Banking Fees. Mortgage banking fees totaled $864,000 for the second quarter of 2012, an increase of $15,000, or 1.8%, over the first quarter of 2012 and $296,000, or 52.1%, over the second quarter of 2011. For the first six months of 2012, fees totaled $1.7 million, an increase of $528,000, or 44.5%, over the same period of 2011. The increase for all respective periods is attributable to increased home purchase activity in our markets and an increase in refinance activity due to the lower rate environment. The mix of refinance and home purchase new loan production for the first half of 2012 was 38% and 62%, respectively, compared to 30% and 70%, respectively, for the same period of 2011.
Asset Management Fees. Fees from asset management activities totaled $1.0 million for the second quarter of 2012, which is comparable to the first quarter of 2012, and a decrease of $60,000, or 5.6%, from the second quarter of 2011. For the first six months of 2012, fees totaled $2.0 million, which is a decrease of $125,000, or 5.8%, from the same period of 2011. The decrease from the second quarter of 2011 reflects fluctuation in asset values for accounts under discretionary management for which fees are based on the account value at quarter-end. The decline in fees for the six month period was driven by both lower asset values for managed accounts as well as a decline in estate management fees. At June 30, 2012, assets under management totaled $668.4 million compared to $660.6 million at December 31, 2011 and $677.1 million at June 30, 2011.
Bank Card Fees. Bank Card Fees (including interchange fees and ATM/debit card fees) totaled $2.8 million for the second quarter of 2012, which is comparable to the first quarter of 2012, and an increase of $226,000, or 8.9%, over the second quarter of 2011. For the first six months of 2012, fees totaled $5.6 million, which represents an increase of $501,000, or 9.9%, over the same period of 2011. The increase over both periods in 2011 reflects higher card utilization as well as growth in active cards due to an increase in the number of deposit accounts.
Other. Other income totaled $1.4 million for the second quarter of 2012, an increase of $151,000, or 12.5%, over the first quarter of 2012, and a decrease of $869,000, or 39.0%, from the second quarter of 2011. The changes compared to both prior periods are attributable to higher or lower gains from the sale of OREO properties. For the first six months of 2012, other income totaled $2.6 million, a decrease of $4.1 million, from the same period of 2011. Compared to the first half of 2011, the decline in other income reflects the $3.2 million gain realized from the sale of our Visa stock as well as a lower level of gains from the sale of OREO properties.
Noninterest expense for the second quarter of 2012 totaled $32.3 million, a decrease of $0.3 million, or 0.9%, from the first quarter of 2012 and an increase of $1.1 million, or 3.6%, over the second quarter of 2011. The decrease compared to the first quarter of 2012 reflects a reduction in compensation expense of $0.7 million partially offset by a $0.4 million increase in the other expense category. The decline in compensation expense was primarily due to lower pension plan and unemployment tax expense. The increase in other expense reflects higher advertising costs and an increase in miscellaneous expense partially offset by lower professional fees. Compared to the second quarter of 2011, the increase was attributable to higher compensation expense of $0.1 million and other expense of $1.1 million. Higher pension plan expense drove the increase in compensation while the other expense category increased due to higher OREO costs, professional fees, and miscellaneous expense.
For the first six months of 2012, noninterest expense totaled $64.9 million, an increase of $0.4 million, or 0.6%, over the same period of 2011 primarily attributable to higher compensation expense of $0.4 million and other expense of $0.2 million partially offset by lower occupancy expense of $0.2 million. The increase in compensation expense reflects higher expense for our pension plan partially offset by lower performance compensation. Higher professional fees and OREO costs partially offset by lower advertising costs, FDIC insurance fees, and intangible amortization drove the increase in the other expense category.
The table below reflects the major components of noninterest expense.
Significant components of noninterest expense are discussed in more detail below.
Compensation. Compensation expense totaled $16.1 million for the second quarter of 2012, a decrease of $726,000, or 4.3%, from the first quarter of 2012 and an increase of $117,000, or 0.7%, over the second quarter of 2011. The decrease compared to the first quarter of 2012 reflects lower salaries of $445,000 and associate benefits of $280,000. The decrease in the salary expense category was primarily due to lower unemployment tax expense as a majority of this liability is paid in the first quarter. Associate benefit expense decreased due to lower pension plan expense. Compared to the second quarter of 2011, the increase was attributable to higher associate benefit expense related to our pension plan reflecting utilization of a lower discount rate in 2012 due to lower long-term bond rates.
For the first six months of 2012, compensation expense totaled $33.0 million, an increase of $383,000, or 1.2%, over the same period of 2011 driven by higher expense for associate benefits partially offset by lower salary expense. The increase in associate benefit expense reflects the aforementioned increase in the expense for our pension plan and the decrease in salaries was due to lower performance compensation.
Occupancy. Occupancy expense (including premises and equipment) totaled $4.5 million for the second quarter of 2012, comparable to the first quarter of 2012 and second quarter of 2011. For the first six months of 2012, occupancy expense totaled $9.0 million, a $198,000, or 2.2%, decrease from the same period in 2011, attributable to lower building maintenance costs.
Other. Other noninterest expense totaled $11.7 million for the second quarter of 2012 compared to $11.3 million for the first quarter of 2012 and $10.6 million for the second quarter of 2011. The $368,000, or 3.3%, increase over the first quarter of 2012 was due to higher advertising costs of $214,000 and miscellaneous expense of $312,000 partially offset by lower professional fees of $137,000. The increase in advertising costs reflects a higher level of promotional activities and the increase in miscellaneous expense was due to severance costs related to the closing of four banking offices and the outsourcing of our items processing function. Professional fees declined due to lower consulting fees and audit costs. The $1.1 million, or 9.9%, increase over the second quarter of 2011 was driven by higher OREO costs of $427,000, professional fees of $274,000, and miscellaneous expense of $309,000. The increase in OREO cost was due to a higher level of valuation adjustments for our OREO portfolio. Higher consulting fees drove the increase in professional fees. The increase in miscellaneous expense reflects the aforementioned severance costs.
For the first six months of 2012, other noninterest expense totaled $22.9 million, an increase of $207,000, or 0.9%, over the same period of 2011 primarily attributable to higher professional fees of $749,000 and OREO expense of $263,000, partially offset by lower advertising expense of $218,000, FDIC insurance fees of $405,000, and intangible amortization expense of $245,000. Professional fees increased due to higher audit fees and consulting fees. OREO expense increased due to higher carrying costs. Advertising expense declined due to improved cost controls over advertising for our free checking account products and a lower level of promotional activity. FDIC insurance fees declined due to a lower premium rate reflective of the revised rate structure implemented in mid-2011. The reduction in intangible amortization expense reflects the full amortization of certain core deposit intangibles from past acquisitions.
Our operating efficiency ratio (expressed as noninterest expense, excluding intangible amortization expense, as a percent of the sum of taxable-equivalent net interest income plus noninterest income) was 90.88% for the second quarter of 2012 compared to 91.73% for the first quarter of 2012 and 81.41% for the second quarter of 2011. For the first six months of 2012, this ratio was 91.31% compared to 82.37% for the comparable period of 2011. Lower noninterest expense drove the decrease in this ratio compared to the first quarter of 2012. The increase in this ratio over both prior periods in 2011 reflects a declining level of net interest income contribution to operating revenues as well as higher noninterest expense. The increase when compared to the first six months of 2011 also reflects the gain on sale of Visa stock realized in 2011. During 2012, we have continued to realize an elevated level of costs related to the management and resolution of nonperforming assets. We continue to review and evaluate opportunities to optimize our operations and reduce operating costs as well as better manage our discretionary expenses.
We realized an income tax benefit of $1.3 million in the second quarter of 2012 compared to a benefit of $1.0 million for the first quarter of 2012 and income tax expense of $1.0 million for the second quarter of 2011. For the first six months of 2012, we realized an income tax benefit of $2.3 million compared to income tax expense of $1.6 million for the same period in 2011. A lower level of book taxable income drove the variance compared to all prior periods.
Average assets totaled approximately $2.624 billion for the second quarter of 2012, a decrease of $12.5 million, or 0.5%, from the first quarter of 2012, and an increase of $114.5 million, or 4.6%, from the fourth quarter of 2011. Average earning assets were $2.263 billion for the second quarter of 2012, a decrease of $5.5 million, or 0.2%, from the first quarter of 2012, and an increase of $116.4 million, or 5.4%, over the fourth quarter of 2011. We discuss these variances in more detail below.
In the second quarter of 2012, our average investment portfolio decreased $18.1 million, or 6.1%, from the first quarter of 2012 and decreased $27.2 million, or 8.8%, from the fourth quarter of 2011. As a percentage of average earning assets, the investment portfolio represented 12.4% in the second quarter of 2012, compared to 13.2% in the prior quarter and 14.3% in the fourth quarter of 2011. The decrease in the average balance of the investment portfolio compared to the prior periods was primarily attributable to declines in U.S. Treasury and mortgage-backed securities, partially offset by increases to municipal bonds and U.S. Agencies. Deposits which require collateralization declined during the comparable periods which allowed for maturing U.S. Treasuries not to be replaced. When appropriate, we will continue to look to deploy a portion of the overnight funds position in the investment portfolio during the remainder of 2012.
The investment portfolio is a significant component of our operations and, as such, it functions as a key element of liquidity and asset/liability management. As of June 30, 2012, all securities are classified as available-for-sale, which offers management full flexibility in managing our liquidity and interest rate sensitivity without adversely impacting our regulatory capital levels. It is neither 36 managements intent nor practice to participate in the trading of investment securities for the purpose of recognizing gains and therefore we do not maintain a trading portfolio. Securities in the available-for-sale portfolio are recorded at fair value with unrealized gains and losses associated with these securities recorded net of tax, in the accumulated other comprehensive income (loss) component of shareowners equity.
At June 30, 2012, the investment portfolio maintained a net pre-tax unrealized gain of $1.0 million compared to $1.3 million and $1.7 million at March 31, 2012 and December 31, 2011, respectively. The decrease in the unrealized gains for both periods resulted from declines in U.S. Treasuries, and to a lesser degree, mortgage backed securities. Yields increased slightly on the short-end of the Treasury curve during both periods, resulting in lower prices.
At quarter end, there were 102 positions with unrealized losses totaling approximately $0.2 million. The positions consisted of Ginnie Mae mortgage-backed securities (GNMA MBS), Small Business Administration (SBA) securities, a Federal Farm Credit Bank bond (FFCB), and municipal bonds. Both the GNMA and SBA securities carry the full faith and credit guarantee of the U.S. Government and float to the prime rate. The FFCB bond remains AAA rated by Moodys, and the municipal bonds carry a minimum rating of AA-. All positions with unrealized losses are not considered impaired, and are expected to mature at par. We also maintain a $0.6 million unrealized loss on a preferred stock investment that maintained a zero book value as of June 30, 2012, March 31, 2012, and December 31, 2011. No additional impairment has been recorded in 2012, but we continue to closely monitor the fair value of this security as the issuer of this security continues to experience negative operating trends.
The average maturity of the total portfolio at June 30, 2012 was 1.53 years compared to 1.41 years and 1.39 years for the March 31, 2012 and December 31, 2011 periods, respectively. The average life of the total portfolio in the second quarter of 2012 extended slightly compared to both periods as Government agency positions with an average life of 2.70 years were added during the quarter.
Average loans declined (a portion of which is attributable to problem loan resolution) by $25.7 million, or 1.6%, from the first quarter of 2012 and $75.9 million, or 4.6%, from the fourth quarter of 2011. Loan balances continued to decline throughout the portfolio, as all loan categories have experienced declines with the reduction primarily in the commercial real estate and residential categories. Our core loan portfolio continues to be impacted by monthly amortization and payoffs that have outpaced our new loan production. New loan production continues to be impacted by weak loan demand attributable to the trend toward consumers and businesses deleveraging, the lack of consumer confidence, and a persistently sluggish economy.
Several new lending programs were introduced during the first half of 2012 to mitigate the impact that consumer and business deleveraging is having on our portfolio. These programs primarily used in our business and commercial real estate lending areas have had a positive impact, as the rate of decline has slowed during the quarter.
The resolution of problem loans (which has the effect of lowering the loan portfolio as loans are either charged off or transferred to other real estate OREO) also contributed to the overall decline. During the second quarter of 2012, loan charge-offs and loans transferred to OREO accounted for $15.9 million, or 70%, of the net reduction in total loans of $22.6 million from the first quarter of 2012. Compared to the fourth quarter of 2011, loan resolution accounted for $25.3 million, or 35%, of the net reduction in loans of $72.4 million. The problem loan resolutions and reductions in portfolio balances previously noted are based on as of balances, not averages.
Efforts to stimulate new loan growth remain ongoing and while we strive to identify opportunities to increase loans outstanding and enhance our loan portfolios overall contribution to earnings, we will only do so by adhering to sound lending principles applied in a prudent and consistent manner. Thus, we will not relax our underwriting standards in order to achieve designated growth goals and, where appropriate, have adjusted our standards to reflect risks inherent in the current economic environment.
Nonperforming assets (nonaccrual loans and OREO) totaled $132.8 million at the end of the second quarter of 2012 compared to $136.8 million at the end of the first quarter of 2012 and $137.6 million at the end of the fourth quarter of 2011. Nonaccrual loans totaled $74.8 million, a decrease of $3.9 million from the first quarter of 2012 and $0.3 million from the fourth quarter of 2011, reflective of loan charge-offs and the migration of loans to OREO, which outpaced gross additions. Gross additions declined for the second straight quarter and represented the lowest quarterly amount thus far in this cycle. The balance of OREO totaled $58.1 million at the end of the second quarter, comparable to the prior quarter and a $4.5 million decrease from the fourth quarter of 2011. We continue to experience progress in our efforts to dispose of OREO by selling properties totaling $13.1 million during the first half of the year. Nonperforming assets represented 5.02% of total assets at June 30, 2012 compared to 5.14% at March 31, 2012 and 5.21% at December 31, 2011.