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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended March 31, 2012
For the transition period from to
Commission file number: 0-13203
LNB Bancorp, Inc.
(Exact name of the registrant as specified on its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of common shares of the registrant outstanding on May 4, 2012 was 7,944,354.
LNB Bancorp, Inc.
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements
See accompanying notes to consolidated financial statements
(Dollars in thousands except per share amounts)
(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of LNB Bancorp, Inc. (the Corporation) and its primary wholly-owned subsidiary, The Lorain National Bank (the Bank). The consolidated financial statements also include the accounts of North Coast Community Development Corporation, which is a wholly-owned subsidiary of the Bank. All intercompany transactions and balances have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include information or footnote disclosures necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (US GAAP). Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of the Corporation included in the Corporations Annual Report on Form 10-K for the year ended December 31, 2011. However, all adjustments (consisting only of normal recurring accruals) which, in the opinion of the Corporations management (Management), are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the three month period ended March 31 2012, are not necessarily indicative of the results which may be expected for a full year.
Use of Estimates
LNB Bancorp Inc. prepares its financial statements in conformity with generally accepted accounting principles (GAAP), which requires the Corporations management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates. Areas involving the use of managements estimates and assumptions include the allowance for loan losses, the valuation of goodwill, the realization of deferred tax assets and fair values of financial instruments.
The Corporations activities are considered to be a single industry segment for financial reporting purposes. LNB Bancorp, Inc. is a bank holding company engaged in the business of commercial and retail banking, investment management and trust services, title insurance, and insurance with operations conducted through its main office and banking centers located throughout Lorain, Erie, Cuyahoga, and Summit counties of Ohio. This market provides the source for substantially all of the Banks deposit and loan and trust activities. The majority of the Banks income is derived from a diverse base of commercial, mortgage and retail lending activities and investments.
Statement of Cash Flows
For purposes of reporting in the Consolidated Statements of Cash Flows, cash and cash equivalents include currency on hand, amounts due from banks, Federal funds sold, and securities purchased under resale agreements. Generally, Federal funds sold and securities purchased under resale agreements are for one day periods.
Securities that are bought and held for the sole purpose of being sold in the near term are deemed trading securities with any related unrealized gains and losses reported in earnings. As of March 31, 2012 and December 31, 2011, the Corporation did not hold any trading securities. Securities that the Corporation has a positive intent and ability to hold to maturity are classified as held to maturity. As of March 31, 2012 and December 31, 2011, LNB Bancorp, Inc. did not hold any securities classified as held to maturity. Securities that are not classified as trading or held to maturity are classified as available for sale. Securities classified as available for sale are carried at their fair value with unrealized gains and losses, net of tax, included as a component of accumulated other comprehensive income. Interest and dividends on securities, including amortization of premiums and accretion of discounts using the effective interest method over the period to maturity or call, are included in interest income. Gains and losses on sales of securities are determined on the specific identification method.
Management evaluates securities for other-than-temporary impairment (OTTI) on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. When evaluating investment securities consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by
macroeconomic conditions and whether the Corporation 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. In analyzing an issuers financial condition, the Corporation may consider whether the securities are issued by the federal government or its agencies, or U.S. Government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers financial condition. 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. 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, the OTTI shall be recognized in earnings equal to the entire difference between the investments amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. If a security is determined to be other-than-temporarily impaired, but the entity does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.
The Bank is a member of the Federal Home Loan Bank (FHLB) system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The Bank is also a member of and owns stock in the Federal Reserve Bank. The Corporation also owns stock in Bankers Bancshares Inc., an institution that provides correspondent banking services to community banks. Stock in these institutions is classified as restricted stock and is recorded at redemption value which approximates fair value. The Corporation periodically evaluates the restricted stock for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Loans Held For Sale
Held for sale loans are carried at the lower of amortized cost or estimated fair value, determined on an aggregate basis for each type of loan. Net unrealized losses are recognized by charges to income. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in the noninterest income section of the consolidated statement of income.
Loans are reported at the principal amount outstanding, net of unearned income and premiums and discounts. Loans acquired through business combinations are valued at fair market value on or near the date of acquisition. The difference between the principal amount outstanding and the fair market valuation is amortized over the aggregate average life of each class of loan. Unearned income includes deferred fees, net of deferred direct incremental loan origination costs. Unearned income is amortized to interest income, over the contractual life of the loan, using the interest method. Deferred direct loan origination fees and costs are amortized to interest income, over the contractual life of the loan, using the interest method.
Loans are generally placed on nonaccrual status when they are 90 days past due for interest or principal or when the full and timely collection of interest or principal becomes uncertain. When a loan has been placed on nonaccrual status, the accrued and unpaid interest receivable is reversed against interest income. Generally, a loan is returned to accrual status when all delinquent interest and principal becomes current under the terms of the loan agreement and when the collectability is no longer doubtful.
A loan is impaired when full payment under the original loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as real estate mortgages and installment loans, and on an individual loan basis for commercial loans that are graded substandard or below. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loans existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
Allowance for Loan Losses
The allowance for loan losses is managements estimate of credit losses inherent in the loan portfolio at the balance sheet date. Managements determination of the allowance, and the resulting provision, is based on judgments and assumptions, including general economic conditions, loan portfolio composition, loan loss experience, managements evaluation of credit risk relating to pools of loans and individual borrowers, sensitivity analysis and expected loss models, value of underlying collateral, and observations of internal loan review staff or banking regulators.
The provision for loan losses is determined based on Managements evaluation of the loan portfolio and the adequacy of the allowance for loan losses under current economic conditions and such other factors which, in managements judgment, deserve current recognition.
Servicing assets are recognized as separate assets when rights are acquired through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment on a quarterly basis based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed generally on the straight-line method over the estimated useful lives of the assets. Upon the sale or other disposition of assets, the cost and related accumulated depreciation are retired and the resulting gain or loss is recognized. Maintenance and repairs are charged to expense as incurred, while renewals and improvements are capitalized. Software costs related to externally developed systems are capitalized at cost less accumulated amortization. Amortization is computed on the straight-line method over the estimated useful life.
Goodwill and Core Deposit Intangibles
Intangible assets arise from acquisitions and include goodwill and core deposit intangibles. Goodwill is the excess of purchase price over the fair value of identified net assets in acquisitions. Core deposit intangibles represent the value of depositor relationships purchased. Goodwill is evaluated at least annually for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Corporation evaluates goodwill impairment annually as of November 30th of each year. Core deposit intangible assets are amortized using the straight-line method over ten years and are subject to annual impairment testing.
To simplify the process of testing goodwill for impairment for both public and nonpublic entities, on September 15, 2011 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2011-08, Intangibles Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 gives an entity the option to first assess qualitative factors to determine whether it is more likely than not (a likelihood of more than 50%) that the fair value if a reporting unit less than its carrying amount (impairment). If the entity finds after the qualitative assessment that it is more likely than not (impairment indicators) that the fair value of a reporting unit is less than its carrying amount, the entity is then required to perform a full impairment test. Prior to the update entities were required to test goodwill for impairment on at least an annual basis. The Corporation tested for goodwill impairment in 2010 and 2009 with no impairment losses recognized. The Corporation early-adopted the ASU in 2011.
Other Real Estate Owned
Other real estate (ORE) is comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure, and loans classified as in-substance foreclosure. Other real estate owned is recorded at the lower of the recorded investment in the loan at the time of acquisition or the fair value of the underlying property collateral, less estimated selling costs. Any write-down in the carrying value of a property at the time of acquisition is charged to the allowance for loan losses. Any subsequent write-downs to reflect current fair market value, as well as gains and losses on disposition and revenues and expenses incurred in maintaining such properties, are treated as period costs. Other real estate owned also includes bank premises formerly but no longer used for banking. Banking premises are transferred at the lower of carrying value or estimated fair value, less estimated selling costs.
Split-Dollar Life Insurance
The Corporation recognizes a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to certain employees extending to post-retirement periods. Based on the present value of expected future cash flows, the liability is recognized based on the substantive agreement with the employee.
Investment and Trust Services Assets and Income
Property held by the Corporation in fiduciary or agency capacity for its customers is not included in the Corporations financial statements as such items are not assets of the Corporation. Income from the Investment and Trust Services Division is reported on an accrual basis.
The Corporation and its wholly-owned subsidiary file an annual consolidated Federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be removed or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when necessary to reduce deferred tax assets to amounts which are deemed more likely than not to be realized.
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale and changes in the funded status of the pension plan, which are also recognized as separate components of shareholders equity.
Unrealized gains on the Corporations available-for-sale securities (after applicable income tax expense) totaling $3,627 and $4,019 at March 31, 2012 and December 31, 2011, respectively, and the minimum pension liability adjustment (after applicable income tax benefit) totaling $1,818 for both March 31, 2012 and December 31, 2011 are included in accumulated other comprehensive income.
In June 2011, the FASB issued ASU 2011-05, which provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income, along with a total for other comprehensive income, and a total amount for comprehensive income. This update is effective on a retrospective basis for the quarter ended March 31, 2012. In compliance with the ASU, the Corporation reported comprehensive income in a single continuous statement with all of the components required by ASU 2011-05. The adoption of this guidance did not have an impact on the consolidated financial statements of the Corporation.
The Corporation is authorized to issue up to 1,000,000 shares of Voting Preferred Stock, no par value. As of March 31, 2012, the Corporation had authorized 150,000 Series A Voting Preferred Shares. No Series A Voting Preferred Shares have been issued.
As of March 31, 2012 and December 31, 2011, 25,223 shares of the Corporations Fixed Rate Cumulative Perpetual Preferred Stock, Series B (Series B preferred stock) have been issued. The Board of Directors of the Corporation is authorized to provide for the issuance of one or more series of Voting Preferred Stock and establish the dividend rate, dividend dates, whether dividends are cumulative, liquidation prices, redemption rights and prices, sinking fund requirements, conversion rights, and restrictions on the issuance of any series of Voting Preferred Stock. The Voting Preferred Stock may be issued with conversion rights to common stock and may rank prior to the common stock in dividends, liquidation preferences, or both. In connection with the Corporations sale of $25.2 million of its Series B preferred stock to the U.S. Treasury in conjunction with the TARP Capital Purchase Program, the Corporation also issued to the U.S. Treasury a warrant to purchase 561,343 of its common shares at an exercise price of $6.74.
Certain amounts appearing in the prior years financial statements have been reclassified to conform to the current periods financial statements.
(2) Earnings Per Share
Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of shares outstanding during the year. Diluted earnings per share is computed based on the weighted average number of shares outstanding plus the effects of dilutive stock options and warrants outstanding during the year. Basic and diluted earnings per share are calculated as follows:
Options for an aggregate of 232,000 common shares and a common stock warrant for 561,343 shares were considered in computing diluted earnings per common share for the three month period ended March 31, 2012. As of March 31, 2012, stock options of 37,500 were considered dilutive and the remaining stock options and stock warrants were antidilutive. Options for an aggregate of 197,000 common shares and a common stock warrant for 561,343 shares were considered in computing diluted earnings per common share for the three month period ended March 31, 2011. As of March 31, 2011, stock options of 2,500 were considered dilutive and the remaining stock options and stock warrants were considered antidilutive.
(3) Cash and Due from Banks
Federal Reserve Board regulations require the Bank to maintain reserve balances on deposits with the Federal Reserve Bank of Cleveland. The required ending reserve balance was $1,349 on March 31, 2012 and $690 on December 31, 2011.
(4) Goodwill and Intangible Assets
The Corporation has goodwill of $21,582 primarily from an acquisition completed in 2007. The Corporation assesses goodwill for impairment annually and more frequently in certain circumstances. In September 2011, FASB issued an update on the testing of goodwill for impairment under ASC Topic 350, Intangibles Goodwill and Other. ASC 350 requires a corporation to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. The overall objective of the update is to simplify how entities, both public and private, test goodwill for impairment. Simplification has resulted in an entity having the option to first assess qualitative factors to determine whether the existence or circumstances lead to a determination that it is more likely than not (that is, a likelihood of more than fifty percent) that the fair value of a reporting unit is less than its carrying amount. For 2011, the Corporation determined the Bank was one reporting unit and assessed the following qualitative factors to determine if there is likelihood that goodwill is impaired: (a) industry and market considerations such as a deterioration in the environment in which the Corporation operates; (b) overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods; (c) events affecting a reporting unit such as a change in the composition or carrying amount of the Corporations assets unit; (d) share priceconsidered in both absolute terms and relative to peers; (e) non-performing loans and allowance for loans losses; and (f) bank capital analysis. Based upon this assessment the Corporation determined that there is no likelihood of goodwill impairment. Therefore, no impairment charge was recognized as of December 31, 2011.
The Corporation tested for impairment in 2010 and 2009 and no impairment was recognized. Methodologies used in determining the fair value of the reporting unit for these years included discounted estimated future net cash flows, price to tangible book value and core deposit premium values. Primary reliance was placed on the discounted estimated future net cash flow approach. The key assumptions used to determine the fair value of the Corporation subsidiary included: (a) cash flow period of 5 years; (b) capitalization rate of 10.0%: and (c) a discount rate of 13.0%, which is based on the Corporations average cost of capital adjusted for the risk associated with its operations. The Corporation cannot predict the occurrences of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions in response to economic and competitive conditions, the effect of the economic environment on the Corporations customer base or a material negative change in the relationship with significant customers.
Core deposit intangibles are amortized over their estimated useful life of 10 years. A summary of core deposit intangible assets follows:
The amortized cost, gross unrealized gains and losses and fair values of securities available for sale at March 31, 2012 and December 31, 2011 are as follows:
The carrying value of securities pledged to secure trust deposits, public deposits, line of credit, and for other purposes required by law amounted to $144,582 and $137,388 at March 31, 2012 and December 31, 2011 respectively.
The amortized cost and fair value of the debt securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. U.S. Government agencies and corporations include callable and bullet agency issues and agency-backed mortgage backed securities. Mortgage backed securities and collateralized mortgage obligations are not due at a single maturity date and are shown separately.
Realized gains and losses related to securities available-for-sale sold during the three-month periods ended March 31, 2012 and 2011 are as follows:
The following is a summary of securities that had unrealized losses at March 31, 2012 and December 31, 2011. The information is presented for securities that have been in an unrealized loss position for less than 12 months and for more than 12 months. At March 31, 2012 there were 15 securities with unrealized losses totaling $614 and at December 31, 2011, the Corporation held 10 securities with unrealized losses totaling $337. Factors that are temporary in nature may result in securities being valued at less than amortized cost. For example, when the current levels of interest rates offered on securities are higher compared to the coupon interest rates on the securities held by the Corporation or when impairment is not due to credit deterioration, securities will be valued at less than amortized cost. The Corporation has the ability and the intent to hold these securities until their value recovers.
(6) Loans and Allowance for Loan Losses
The allowance for loan losses is maintained by the Corporation at a level considered by Management to be adequate to cover probable credit losses inherent in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of Management, to maintain the allowance for loan losses at an adequate level. While managements periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.
The allowance is comprised of a general allowance and a specific allowance for identified problem loans. The general allowance is determined by applying estimated loss factors to the credit exposures from outstanding loans. For residential real estate, installment and other loans, loss factors are applied on a portfolio basis. Loss factors are based on the Corporations historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectability of the loan portfolio. These other factors include but are not limited to: changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices; changes in national and local economic and business conditions, including the condition of various market segments; changes in the nature and volume of the portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the volume and severity of past due and classified loans, the volume of nonaccrual loans, troubled debt restructurings and other loan modifications; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of external factors, such as legal and regulatory requirements, on the level of estimated credit losses in the Corporations current portfolio. Specific allowances are established for all impaired loans when management has determined that, due to identified significant conditions, it is probable that a loss will be incurred.
Activity in the loan balances and the allowance for loan losses by segment for the three months ended March 31, 2012 and 2011 are summarized as follows:
Management monitors delinquency and potential commercial problem loans. Bank-wide delinquency at March 31, 2012 was 3.8% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.6% and 0.2% of total loans at March 31, 2012, respectively. Bank-wide delinquency at December 31, 2011 was 3.7% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.4% and 0.3% of total loans at December 31, 2011, respectively. Information regarding delinquent loans as of March 31, 2012 and December 31, 2011 is as follows:
Age Analysis of Past Due Loans
as of March 31, 2012
Age Analysis of Past Due Loans
as of December 31, 2011
A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. Residential mortgage, installment and other consumer loans are evaluated collectively for impairment. Individual commercial loans are evaluated for impairment. Impaired loans are written down by the establishment of a specific allowance where necessary. Interest income recognized on impaired loans while considered impaired was immaterial for all periods. Information regarding impaired loans is as follows:
Nonaccrual loans at March 31, 2012 were $36,870, compared to $34,471 at December 31, 2011. Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
Troubled Debt Restructuring
A restructuring of a debt constitutes a troubled debt restructuring (TDR) if the creditor, for economic or legal reasons related to the debtors financial difficulties, grants a concession to the debtor that it would not otherwise consider. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. The Corporation adheres to ASC 310-40, Troubled Debt Restructurings by Creditors, to determine whether a troubled debt restructuring applies in a particular instance. Included in loans individually evaluated for impairment as of March 31, 2012 are loans with a recorded investment of $3,041, the terms of which were modified in troubled debt restructurings and considered nonaccrual. The Corporation has allocated reserves of $466 for the nonaccrual TDR loans at March 31, 2012. As of December 31, 2011, included in loans individually evaluated for impairment were loans with a recorded investment of $3,099, the terms of which were modified in troubled debt restructurings and considered nonaccrual. The Corporation allocated reserves of $307 for the nonaccrual TDR loans at December 31, 2011. There are no commitments to lend additional amounts to borrowers with loans that are classified as troubled debt restructurings at March 31, 2012 and December 31, 2011. At March 31, 2012 and December 31, 2011 the borrowers had made timely payments of principal and interest on those loans per the modified agreements. Information regarding TDR loans for the year ended March 31, 2012 and December 31, 2011 is as follows:
There were no loans modified in a TDR from during the three months ended March 31, 2012 that subsequently defaulted (i.e., 60 days or more past due following a modification).
A modification of a loan constitutes a 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, 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 may be requested. Commercial mortgage and construction 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. Construction loans modified in a TDR may also involve extending the interest-only payment period. Land
loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years and changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.
Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already 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 allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loans effective interest rate. Management exercises significant judgment in developing these estimates.
Credit Risk Grading
Sound credit systems, practices and procedures such as credit risk grading systems; effective credit review and examination processes; effective loan monitoring, problem identification, and resolution processes; and a conservative loss recognition process and charge-off policy are integral to managements proper assessment of the adequacy of the allowance. Many factors are considered when grades are assigned to individual loans such as current and historic delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. Commercial, commercial real estate and residential construction loans are assigned internal credit risk grades. The loans internal credit risk grade is reviewed on at least an annual basis and more frequently if needed based on specific borrower circumstances. Credit quality indicators used in managements periodic analysis of the adequacy of the allowance include the Corporations internal credit risk grades which are described below and are included in the table below for March 31, 2012 and December 31, 2011:
Grades 1 -5: defined as Pass credits loans which are protected by the borrowers current net worth and paying capacity or by the value of the underlying collateral. Pass credits are current or have not displayed a significant past due history.
Grade 6: defined as Special Mention credits loans where a potential weakness or risk exists, which could cause a more serious problem if not monitored. Loans listed for special mention generally demonstrate a history of repeated delinquencies, which may indicate a deterioration of the repayment abilities of the borrower.
Grade 7: defined as Substandard credits loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.
Grade 8: defined as Doubtful credits loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable.
Grade 9: defined as Loss credits loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.
For the residential real estate segment, the Corporation monitors credit quality using a combination of the delinquency status of the loan and/or the Corporations internal credit risk grades as indicated above.
The following table presents the recorded investment of commercial real estate, commercial and residential real estate loans by internal credit risk grade and the recorded investment in residential real estate, home equity, indirect and consumer loans based on delinquency status as of March 31, 2012 and December 31, 2011:
The Corporation adheres to underwriting standards consistent with its Loan Policy for indirect and consumer loans. Final approval of a consumer credit depends on the repayment ability of the borrower. Repayment ability generally requires the determination of the borrowers capacity to meet current and proposed debt service requirements. A borrowers repayment ability is monitored based on delinquency, generally for time periods of 30 to 59 days past due, 60 to 89 days past due and greater than 90 days past due. This information is provided in the above past due loans table.
Deposit balances at March 31, 2012 and December 31, 2011 are summarized as follows:
The aggregate amount of certificates of deposit in denominations of $100,000 or more amounted to $248,414 and $241,217 at March 31, 2012 and December 31, 2011, respectively.
The contractual maturities of certificates of deposits for each of the next five years and thereafter are as follows:
(8) Short-Term Borrowings
The Corporation has a line of credit for advances and discounts with the Federal Reserve Bank of Cleveland. The amount of this line of credit varies on a monthly basis. The line is equal to 50% of the balances of qualified home equity lines of credit that are pledged as collateral. At March 31, 2012, the Bank had pledged approximately $86,319 in qualifying home equity lines of credit, resulting in an available line of credit of approximately $43,159. No amounts were outstanding at March 31, 2012 or December 31, 2011. The Corporation also has a $4,000 line of credit with an unaffiliated financial institution. The balance of this line of credit was $0 as of March 31, 2012 and December 31, 2011.
Short-term borrowings include securities sold under repurchase agreements and Federal funds purchased from correspondent banks. Securities sold under repurchase agreements at March 31, 2012 and December 31, 2011 were $894 and $227, respectively. The interest rate paid on these borrowings was 0.15% at March 31, 2012 and December 31, 2011. No Federal Funds were purchased as of March 31, 2012 and December 31, 2011.
(9) Federal Home Loan Bank Advances
Federal Home Loan Bank advances amounted to $47,496 and $42,497 at March 31, 2012 and December 31, 2011, respectively. All advances are bullet maturities with no call features. At March 31, 2012, collateral pledged for FHLB advances consisted of qualified multi-family and residential real estate mortgage loans and investment securities of $73,512 and $29,592, respectively. The maximum borrowing capacity of the Bank at March 31, 2012 was $59,966 with unused collateral borrowing capacity of $10,942. The Bank maintains a $40,000 cash management line of credit (CMA) with the FHLB. No amounts were outstanding for the CMA line of credit as of March 31, 2012 and December 31, 2011.
Maturities of FHLB advances outstanding at March 31, 2012 and December 31, 2011 are as follows.
(10) Trust Preferred Securities
In May 2007, LNB Trust I (Trust I) and LNB Trust II (Trust II) each sold $10.0 million of preferred securities to outside investors and invested the proceeds in junior subordinated debentures issued by the Corporation. The Corporations obligations under the transaction documents, taken together, have the effect of providing a full guarantee by the Corporation, on a subordinated basis, of the payment obligation of the Trusts.
The subordinated notes mature in 2037. Trust I bears a floating interest rate (current three-month LIBOR plus 148 basis points). Trust II bears a fixed rate of 6.64% through June 15, 2017, and then becomes a floating interest rate (current three-month LIBOR plus 148 basis points). Interest on the notes is payable quarterly. The interest rates in effect as of the last determination date in 2012 were 1.95% and 6.64% for Trust I and Trust II, respectively. At March 31, 2012 and December 31, 2011, accrued interest payable for Trust I was $7 and $7 and for Trust II was $23 and $24, respectively.
The subordinated notes are redeemable in whole or in part, without penalty, at the Corporations option on or after June 15, 2012 and mature on June 15, 2037. The notes are junior in right of payment to the prior payment in full of all senior indebtedness of the Corporation, whether outstanding at the date of the indenture governing the notes or thereafter incurred. At March 31, 2012, the balance of the subordinated notes payable to Trust I and Trust II was $8,119 each.
(11) Commitments, Credit Risk, and Contingencies
In the normal course of business, the Bank enters into commitments that involve off-balance sheet risk to meet the financing needs of its customers. These instruments are currently limited to commitments to extend credit and standby letters of credit. Commitments to extend credit involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. Interest rate risk on commitments to extend credit results from the possibility that interest rates may have moved unfavorably from the position of the Bank since the time the commitment was made.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates of 30 to 120 days or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Bank evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on Managements evaluation of the applicants credit. Collateral held is generally single-family residential real estate and commercial real estate. Substantially all of the obligations to extend credit are variable rate. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Payments under standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.
A summary of the contractual amount of commitments at March 31, 2012 and December 31, 2011 follows:
(12) Estimated Fair Value of Financial Instruments
The Corporation discloses estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Corporations financial instruments. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Estimates of fair value are made at a specific point in time, based on relevant market information and information about the financial instrument. 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.
Estimates of fair value are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Corporation has a substantial Investment and Trust Services Division that contributes net fee income annually. The Investment and Trust Services Division is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial instruments include property, plant and equipment, goodwill and deferred tax liabilities. In addition, it is not practicable for the Corporation to estimate the tax ramifications related to the realization of the unrealized gains and losses and they have not been reflected in any of the estimates of fair value. The impact of these tax ramifications can have a significant effect on estimates of fair value.
The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Corporations financial instruments as of March 31, 2012 and December 31, 2011. This table excludes financial instruments for which the carrying value approximates fair value. For short-term financial assets such as cash and due from banks, Federal funds sold, interest bearing deposits in other banks, loans held for sale and accrued interest receivable, the carrying amount is a reasonable estimate of fair value due to the relatively short time between origination of the instrument and its expected realization. For financial liabilities such as demand, savings and money market accounts, short-term borrowings and accrued interest payable, the carrying value is a reasonable estimate of fair value due to these products having no stated maturity.
The fair value of financial assets and liabilities is categorized in three levels. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. These levels are:
Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities, but in all cases are corroborated by external data, which may include third-party pricing services.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporations assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The following information pertains to assets measured by fair value on a recurring basis (in thousands):
Fair value measurements of U.S. Government agencies and mortgage backed securities use pricing models that vary and may consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Fair value of debt securities such as obligations of state and political may be determined by matrix pricing. Matrix pricing is a mathematical technique that is used to value debt securities without relying exclusively on quoted prices for specific securities, but rather by relying on the securities relationship to other benchmark quoted prices.
There were no transfers between Levels 1 and 2 of the fair value hierarchy during the three months ended March 31, 2012. For the available for sale securities, the Corporation obtains fair value measurements from an independent third party service and or from independent brokers.
The following tables present the balances of assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2012 and December 31, 2011:
Impaired and nonaccrual loans: Fair value adjustments for these items typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair market value of the collateral. The Corporation measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The vast majority of collateral is real estate. The value of the collateral is determined based on internal estimates as well as third party appraisals or non-binding broker quotes. These measurements were classified as Level 3.
Other Real Estate: Other real estate includes foreclosed assets and properties securing residential and commercial loans. Foreclosed assets are adjusted to fair value less costs to sell upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at lower of carry value or fair value less costs to sell. Fair value is generally based upon internal estimates and third party appraisals or non-binding broker quotes and, accordingly, considered a Level 3 classification.
(13) Share-Based Compensation
A broad-based stock incentive plan, the 2006 Stock Incentive Plan, was adopted by the Corporations shareholders on April 18, 2006. Awards granted under this Plan as of December 31, 2011 were stock options granted in 2007, 2008, 2009 and 2012 and long-term restricted shares issued in 2010, 2011 and 2012. In addition, the Corporation has nonqualified stock option agreements outside of the 2006 Stock Incentive Plan. Grants under the nonqualified stock option agreements were made from 2005 to 2007.
The expense recorded for stock options was $1 and $0 for the first three months of 2012 and 2011, respectively. The maximum option term is ten years and the options generally vest over three years as follows: one-third after one year from the grant date, two-thirds after two years and completely after three years.
The fair value of options granted was determined using the following weighted-average assumptions as of grant date:
The weighted-average fair value of options granted in 2012 was $5.39.
Options outstanding at March 31, 2012 were as follows:
A summary of the status of stock options at March 31, 2012 and March 31, 2011 and changes during the three months then ended is presented in the table below:
There were no options exercised during the first three months of 2012, therefore the total intrinsic value of options exercised was $0. The total intrinsic value of all options outstanding at March 31, 2012 was $58.
A summary of the status of nonvested stock options at March 31, 2012 is presented in the table below:
In 2012, the Corporation issued 62,105 shares of long-term restricted stock. The market price of the Corporations common shares on the date of grant of the long-term restricted shares was $5.39 per share. In 2011, the Corporation issued 40,000 shares of long-term restricted stock, 2,500 of which were forfeited by the recipients due to employee terminations. The market price of the Corporations common shares on the date of grant of the long-term restricted shares was $5.28 per share. In 2010, the Corporation issued 86,852 long-term restricted shares at a weighted average market price of $4.42 per share. Shares of long-term restricted stock generally vest in two equal installments on the second and third anniversaries of the date of grant, or upon the earlier death or disability of the recipient or a qualified change of control of the Corporation. The expense recorded for long-term restricted stock for the three months ended March 31, 2012 and 2011 was $66 and $44, respectively.
The market price of the Corporations common shares at the date of grant is used to estimate the fair value of restricted stock awards. A summary of the status of restricted shares at March 31, 2012 is presented in the table below:
Stock Appreciation Rights (SARs)
In 2006, the Corporation issued an aggregate of 30,000 SARS at $19.00 per share, 15,500 of which have expired due to employee terminations. The SARS vest over three years as follows: one-third after one year from the grant date, two-thirds after two years and completely after three years. Any unexercised portion of the SARS shall expire at the end of the stated term which is specified at the date of grant and shall not exceed ten years. The SARS issued in 2006 will expire in January 2016. The expense recorded for SARS for the three months ended March 31, 2012 and March 31, 2011 was $2 and $0, respectively.
The following commentary presents a discussion and analysis of the Corporations financial condition and results of operations by its management (Management). This Managements Discussion and Analysis (MD&A) section discusses the financial condition and results of operations of the Corporation for the three months ended March 31, 2012. This MD&A should be read in conjunction with the financial information contained in the Corporations Form 10-K for the fiscal year ended December 31, 2011 and in the accompanying consolidated financial statements and notes contained in this Form 10-Q. The objective of this financial review is to enhance the readers understanding of the accompanying tables and charts, the consolidated financial statements, notes to the financial statements and financial statistics appearing elsewhere in the report. Where applicable, this discussion also reflects Managements insights as to known events and trends that have or may reasonably be expected to have a material effect on the Corporations operations and financial condition.
The Corporation is a bank holding company headquartered in Lorain, Ohio, deriving substantially all of its revenue from the Bank. The Corporation provides a range of products and services to commercial customers and the community, and currently operates 20 banking centers throughout Lorain, Erie, Cuyahoga and Summit counties in Ohio.
Net income was $1,505 for the first quarter of 2012 in comparison to $1,130 for the first quarter of 2011. Net income available to common shareholders was $1,186 or $0.15 per diluted common share. This compares to net income available to common shareholders of $811 or $0.10 per diluted common share for the first quarter of 2011.
For the first quarter 2012, net interest income totaled $9,655 compared to $9,614 for the first quarter of 2011. Net interest income on a fully taxable equivalent (FTE) basis for the first quarter of 2012 was $9,810, a 0.7% increase compared with $9,739 for the first quarter of 2011. The net interest margin FTE, determined by dividing tax equivalent net interest income by average earning assets, was 3.61% for the three months ended March 31, 2012 compared to 3.63% for the three months ended March 31, 2011. This decrease is mainly attributable to the lower interest rate environment which continues to reduce the Corporations yield on its investment portfolio and as a result, negatively impacts the net interest margin.
The provision for loan losses was $1,900 for the quarter ended March 31, 2012 compared to $2,100 for March 31, 2011.
Noninterest income, which is traditionally weak in the first quarter, totaled $2,875 compared to $3,071 for the first quarter of 2011. Other fees, which include ATM fees and merchant/debit card fees, declined year over year as well as investment and trust services income. Service charges on deposits for the first quarter of 2012 marginally increased $19 despite new federal regulations impacting certain bank overdraft fees and charges. No sales of securities were recorded in the first quarter of 2012 compared to a gain of $412 recorded for the first quarter of 2011. Gains on the sale of loans increased $168, or 93.8%, compared to the first quarter of 2011.
Noninterest expense was $8,544 for the first quarter of 2012, compared to $9,189 for the first quarter of 2011, a decrease of $645, or 7.0%. The decline in expenses related to credit administration and other real estate owned accounted for $551 of this decrease. The efficiency ratio, which is the measure of cost to generate revenue, decreased from 71.73% in the first quarter of 2011 to 67.36% in the first quarter of 2012.
During the first quarter of 2012, loan demand increased as total portfolio loans ended the quarter at $862,220, a 2.3% increase compared to $843,088 at December 31, 2011. Total assets for the first quarter ended at $1,199,094 compared to $1,168,422 at the end of 2011. Total deposits grew to $1,016,166 at the end of the first quarter of 2012, up from $991,080 at December 31, 2011. The growth in deposits came in the form of core deposits which improved liquidity while reducing costs.
The Corporation is continuing its efforts to reduce the level of problem loans and their associated costs. The Corporations non-performing loans totaled $36,870, or 4.28% of total loans, a slight increase from $34,471, or 4.09% of total loans at December 31, 2011.
The allowance for possible loan losses was $17,115 at March 31, 2012 compared to $17,063 at December 31, 2011 equaling 1.98% of total loans compared to 2.02% at December 31, 2011. Annualized net charge-offs to average loans for the quarter ending March 31, 2012 was 0.87% compared to actual net charge-offs to average loans of 1.14% for the year ended December 31, 2011.
Table 1: Condensed Consolidated Average Balance Sheets
Interest, Rate, and Rate/ Volume differentials are stated on a Fully-Tax Equivalent (FTE) Basis.
Table 1 presents the condensed average balance sheets for the three months ended March 31, 2012 and 2011. Rates are computed on a tax equivalent basis. Nonaccrual loans and loans held for sale are included in the average loan balances.
Results of Operations
Three Months Ended March 31, 2012 versus Three Months Ended March 31, 2011 Net Interest Income Comparison
Net interest income is the difference between interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Net interest income is the Corporations principal source of revenue, accounting for 77.1% of the Corporations revenues for the three months ended March 31, 2012. The amount of net interest income is affected by changes in the volume and mix of earning assets and interest-bearing liabilities, the level of rates earned or paid on those assets and liabilities and the amount of loan fees earned. The Corporation reviews net interest income on a fully taxable equivalent (FTE) basis, which presents interest income with an adjustment for tax-exempt interest income on an equivalent pre-tax basis assuming a 34% statutory Federal tax rate. These rates may differ from the Corporations actual effective tax rate. The net interest margin is net interest income as a percentage of average earning assets.
Net interest income was $9,655 for the first quarter of 2012 compared to $9,614 during the same quarter of 2011. Adjusting for tax-exempt income, net interest income FTE for the first quarter of 2012 and 2011 was $9,810 and $9,739, respectively. The net interest margin FTE, determined by dividing tax equivalent net interest income by average earning assets, was 3.61% for the three months ended March 31, 2012 compared to 3.63% for the three months ended March 31, 2011.
Average earning assets for the first quarter of 2012 were $1,093,618, an increase of $4,538 or 0.4% compared to the same quarter of last year at $1,089,080. The yield on average earning assets reflected a favorable change in the mix of earning assets. The yield on average assets totaled 4.35% in the first quarter of 2012 compared to 4.64% for the same period a year ago. The yield on average loans during the first quarter of 2012 was 4.71%, which was 45 basis points lower than the yield on average loans during the first quarter of 2011 of 5.16%. Interest income from securities was $1,672 (FTE) for the three months ended March 31, 2012, compared to $1,846 during the first quarter of 2011. The yield on average securities was 3.02% and 3.34% for these periods, respectively.
The cost of interest-bearing liabilities was 0.87% during the first quarter of 2012 compared to 1.19% during the same period in 2011. This decrease is primarily due to an improved deposit mix with noninterest bearing accounts of $124,732, increasing 7.5% when compared to the same period a year ago. Total average interest-bearing liabilities for the quarter ended March 31, 2012 increased $2,912, or 0.3%, compared to March 31, 2011. Average core deposits for the quarter ended March 31, 2012 increased $7,381, or 0.7%, compared to the same period of 2011. The average cost of trust preferred securities was 4.34% for the first quarter of 2012, compared to 4.24% for the first quarter of 2011. One half of the Corporations outstanding trust preferred securities accrues dividends at a fixed rate of 6.64% and the other half accrues dividends at LIBOR plus 1.48% which was 1.95% as of March 31, 2012.
Net interest income may also be analyzed by comparing the volume and rate components of interest income and interest expense. Table 2 is an analysis of the changes in interest income and expense between the quarters ended March 31, 2012 and March 31, 2011. The table is presented on a fully tax-equivalent basis.
Table 2: Rate/Volume Analysis of Net Interest Income (FTE)