XNAS:LNBB LNB Bancorp Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNAS:LNBB (LNB Bancorp Inc): Fair Value Estimate
Premium
XNAS:LNBB (LNB Bancorp Inc): Consider Buying
Premium
XNAS:LNBB (LNB Bancorp Inc): Consider Selling
Premium
XNAS:LNBB (LNB Bancorp Inc): Fair Value Uncertainty
Premium
XNAS:LNBB (LNB Bancorp Inc): Economic Moat
Premium
XNAS:LNBB (LNB Bancorp Inc): Stewardship
Premium
 
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2012

OR

 

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

For the transition period from             to            

Commission file number: 0-13203

 

 

LNB Bancorp, Inc.

(Exact name of the registrant as specified on its charter)

 

 

 

Ohio   34-1406303
(State of Incorporation)   (I.R.S. Employer Identification No.)
457 Broadway, Lorain, Ohio   44052-1769
(Address of principal executive offices)   (Zip Code)

(440) 244-6000

(Registrant’s telephone number, including area code)

Not Applicable

(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):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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 August 13, 2012 was 7,944,354.

 

 

 


Table of Contents

LNB Bancorp, Inc.

Table of Contents

 

Part I — Financial Information

  

Item 1. Financial Statements

  

Consolidated Balance Sheets June 30, 2012 (unaudited) and December 31, 2011

     3   

Consolidated Statements of Income (unaudited) for the three and six months ended June  30, 2012 and June 30, 2011

     4   

Consolidated Statements of Shareholders’ Equity (unaudited) for the six months ended June  30, 2012 and June 30, 2011

     5   

Consolidated Statements of Cash Flows (unaudited) for the six months ended June  30, 2012 and June 30, 2011

     6   

Notes to the Consolidated Financial Statements (unaudited)

     7   

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

     28   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     46   

Item 4. Controls and Procedures

     48   

Part II — Other Information

     48   

Item 1. Legal Proceedings

     48   

Item 1A. Risk Factors

     49   

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

     49   

Item 6. Exhibits

     49   

 

2


Table of Contents

Part I — FINANCIAL INFORMATION

Item 1. Financial Statements.

CONSOLIDATED BALANCE SHEETS

 

     June 30, 2012     December 31, 2011  
     (unaudited)        
     (Dollars in thousands except share amounts)  
ASSETS     

Cash and due from banks (Note 3)

   $ 37,449      $ 34,323   

Federal funds sold and interest bearing deposits in banks

     19,170        6,324   
  

 

 

   

 

 

 

Cash and cash equivalents

     56,619        40,647   

Securities available for sale, at fair value (Note 5)

     228,788        226,012   

Restricted stock

     5,741        5,741   

Loans held for sale

     1,207        3,448   

Loans:

    

Portfolio loans (Note 6)

     867,459        843,088   

Allowance for loan losses (Note 6)

     (17,300     (17,063
  

 

 

   

 

 

 

Net loans

     850,159        826,025   
  

 

 

   

 

 

 

Bank premises and equipment, net

     9,308        8,968   

Other real estate owned

     1,506        1,687   

Bank owned life insurance

     18,202        17,868   

Goodwill, net (Note 4)

     21,582        21,582   

Intangible assets, net (Note 4)

     664        731   

Accrued interest receivable

     3,604        3,550   

Other assets

     10,565        12,163   
  

 

 

   

 

 

 

Total Assets

   $ 1,207,945      $ 1,168,422   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Deposits: (Note 7)

    

Demand and other noninterest-bearing

   $ 143,778      $ 126,713   

Savings, money market and interest-bearing demand

     383,685        359,977   

Time deposits

     496,090        504,390   
  

 

 

   

 

 

 

Total deposits

     1,023,553        991,080   
  

 

 

   

 

 

 

Short-term borrowings (Note 8)

     827        227   

Federal Home Loan Bank advances (Note 9)

     47,495        42,497   

Junior subordinated debentures (Note 10)

     16,238        16,238   

Accrued interest payable

     1,007        1,118   

Accrued expenses and other liabilities

     3,288        3,988   
  

 

 

   

 

 

 

Total Liabilities

     1,092,408        1,055,148   
  

 

 

   

 

 

 

Shareholders’ Equity

    

Preferred stock, Series A Voting, no par value, authorized 150,000 shares, none issued at June 30, 2012 and December 31, 2011.

     —          —     

Preferred stock, Series B, no par value, $1,000 liquidation value, 25,223 shares authorized and issued at June 30, 2012 and December 31, 2011.

     25,223        25,223   

Discount on Series B preferred stock

     (94     (101

Warrant to purchase common stock

     146        146   

Common stock, par value $1 per share, authorized 15,000,000 shares, issued 8,272,548 shares at June 30, 2012 and 8,210,443 at December 31, 2011.

     8,272        8,210   

Additional paid-in capital

     39,689        39,607   

Retained earnings

     46,227        44,080   

Accumulated other comprehensive income

     2,166        2,201   

Treasury shares at cost, 328,194 shares at June 30, 2012 and at December 31, 2011.

     (6,092     (6,092
  

 

 

   

 

 

 

Total Shareholders’ Equity

     115,537        113,274   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 1,207,945      $ 1,168,422   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

3


Table of Contents

Consolidated Statements of Income (unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2012     2011     2012     2011  
     (Dollars in thousands except share and per share amounts)  

Interest and Dividend Income

        

Loans

   $ 10,194      $ 10,523      $ 20,243      $ 21,039   

Securities:

        

U.S. Government agencies and corporations

     1,281        1,612        2,541        3,089   

State and political subdivisions

     291        257        578        513   

Other debt and equity securities

     69        71        141        143   

Federal funds sold and interest on deposits in banks

     10        9        19        23   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and dividend income

     11,845        12,472      $ 23,522        24,807   

Interest Expense

        

Deposits

     1,527        2,204        3,158        4,487   

Federal Home Loan Bank advances

     212        261        427        527   

Short-term borrowings

     —          1        —          2   

Junior subordinated debentures

     173        170        349        341   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,912        2,636        3,934        5,357   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

     9,933        9,836        19,588        19,450   

Provision for Loan Losses (Note 6)

     1,667        3,345        3,567        5,445   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     8,266        6,491        16,021        14,005   

Noninterest Income

        

Investment and trust services

     425        470        815        873   

Deposit service charges

     929        1,000        1,864        1,916   

Other service charges and fees

     804        819        1,552        1,725   

Income from bank owned life insurance

     169        175        334        349   

Other income

     58        41        400        120   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total fees and other income

     2,385        2,505        4,965        4,983   

Securities gains, net

     —          88        —          500   

Gains on sale of loans

     205        238        552        417   

Loss on sale of other assets, net

     (47     (27     (99     (25
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     2,543        2,804        5,418        5,875   

Noninterest Expense

        

Salaries and employee benefits

     3,894        4,072        8,005        8,163   

Furniture and equipment

     877        798        1,709        1,478   

Net occupancy

     554        588        1,133        1,200   

Professional fees

     564        445        1,059        931   

Marketing and public relations

     395        275        642        546   

Supplies, postage and freight

     265        289        508        561   

Telecommunications

     172        169        345        384   

Ohio franchise tax

     307        298        623        596   

FDIC assessments

     394        399        786        973   

Other real estate owned

     175        207        307        797   

Electronic banking expenses

     323        223        561        432   

Loan and collection expense

     308        310        657        752   

Other expense

     819        449        1,256        898   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

     9,047        8,522        17,591        17,711   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     1,762        773        3,848        2,169   

Income tax expense

     324        61        905        327   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

   $ 1,438      $ 712      $ 2,943      $ 1,842   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of taxes:

        

Changes in unrealized securities’ holding gain (loss) net of taxes

     357        751        (35     1,221   

Minimum pension liability adjustment, net of taxes during the period

     —          —          —          —     

Less: reclassification adjustments for securities’ gains realized in net income, net of taxes

   $ —        $ 59      $ —        $ 333   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss, net of taxes

     357        692        (35     888   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 1,795      $ 2,730      $ 2,908      $ 2,730   
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends and accretion on preferred stock

     318        318        637        637   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Available to Common Shareholders

   $ 1,120      $ 394      $ 2,306      $ 1,205   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income Per Common Share (Note 2)

        

Basic

   $ 0.14      $ 0.05      $ 0.29      $ 0.15   

Diluted

     0.14        0.05        0.29        0.15   

Dividends declared

     0.01        0.01        0.02        0.02   

Average Common Shares Outstanding

        

Basic

     7,944,354        7,884,749        7,934,458        7,878,119   

Diluted

     7,950,528        7,884,934        7,938,383        7,878,224   

See accompanying notes to consolidated financial statements

 

4


Table of Contents

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

 

     Preferred
Stock
(net of
discount)
     Warrant  to
Purchase

Common
Stock
     Common
Stock
     Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Total  
     (Dollars in thousands except share and per share amounts)  

Balance, January 1, 2011

   $ 25,107       $ 146       $ 8,173       $ 39,455      $ 40,668      $ 2,007      $ (6,092   $ 109,464   

Net Income

                1,842            1,842   

Common dividends declared, $.02 per share

                (159         (159

Preferred dividends and accretion of discount

     7                 (637         (630

Net unrealized gains and losses on securities

                  888          888   

Share-based compensation

              92              92   

Restricted shares granted (40,000 shares)

     —           —           40         (40     —          —          —          —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 25,114       $ 146       $ 8,213       $ 39,507      $ 41,714      $ 2,895      $ (6,092   $ 111,497   

Balance, January 1, 2012

   $ 25,122       $ 146       $ 8,210       $ 39,607      $ 44,080      $ 2,201      $ (6,092   $ 113,274   

Net Income

                2,943            2,943   

Common dividends declared, $.02 per share

                (159         (159

Preferred dividends and accretion of discount

     7                 (637         (630

Net unrealized gains and losses on securities

                  (35       (35

Share-based compensation

              144              144   

Restricted shares granted (62,105 shares)

     —           —           62         (62     —          —          —          —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

   $ 25,129       $ 146       $ 8,272       $ 39,689      $ 46,227      $ 2,166      $ (6,092   $ 115,537   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

5


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

     Six Months Ended  
     June 30, 2012     June 30, 2011  
     (Dollars in thousands)  

Operating Activities

    

Net income

   $ 2,943      $ 1,842   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     3,567        5,445   

Depreciation and amortization

     559        636   

Amortization of premiums and discounts

     805        675   

Amortization of intangibles

     29        67   

Amortization of loan servicing rights

     181        26   

Amortization of deferred loan fees

     (501     (140

Federal deferred income tax expense

     197        637   

Securities gains, net

     —          (500

Share-based compensation expense

     144        92   

Loans originated for sale

     (34,330     (35,116

Proceeds from sales of loan originations

     37,123        39,330   

Net gain from loan sales

     (552     (417

Net (gain) or loss on sale of other assets

     99        25   

Net (increase) decrease in accrued interest receivable and other assets

     863        (1,339

Net decrease in accrued interest payable, taxes and other liabilities

     (610     (560
  

 

 

   

 

 

 

Net cash provided by operating activities

     10,517        10,703   
  

 

 

   

 

 

 

Investing Activities

    

Proceeds from sales of available-for-sale securities

     —          24,664   

Proceeds from maturities of available-for-sale securities

     75,498        23,826   

Purchase of available-for-sale securities

     (79,132     (56,621

Net (increase) decrease in loans made to customers

     (27,688     (23,843

Proceeds from the sale of other real estate owned

     594        2,837   

Purchase of bank premises and equipment

     (1,099     (197
  

 

 

   

 

 

 

Net cash used in investing activities

     (31,827     (29,334

Financing Activities

    

Net increase in demand and other noninterest-bearing

     17,065        14,734   

Net increase in savings, money market and interest-bearing demand

     23,708        19,135   

Net decrease in certificates of deposit

     (8,300     (30,358

Net increase (decrease) in short-term borrowings

     600        (175

Proceeds from Federal Home Loan Bank advances

     20,000        15,000   

Payment of Federal Home Loan Bank advances

     (15,002     (15,003

Dividends paid

     (789     (789
  

 

 

   

 

 

 

Net cash provided by financing activities

     37,282        2,544   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     15,972        (16,087

Cash and cash equivalents, January 1

     40,647        48,568   
  

 

 

   

 

 

 

Cash and cash equivalents, June 30

   $ 56,619      $ 32,481   
  

 

 

   

 

 

 

Supplemental cash flow information

    

Interest paid

   $ 5,992      $ 5,412   

Income taxes paid

     770        610   

Transfer of loans to other real estate owned

     677        2,295   

See accompanying notes to consolidated financial statements

 

6


Table of Contents

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 Corporation’s 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 Corporation’s management (“Management”), are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the six month period ended June 30, 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 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 Management’s estimates and assumptions include the allowance for loan losses, the valuation of goodwill, the realization of deferred tax assets, fair values of certain securities, mortgage servicing rights, net periodic pension expense, and accrued pension costs recognized in the Corporation’s consolidated financial statements. Estimates that are more susceptible to change in the near term include the allowance for loan losses and the fair value of certain assets and liabilities.

Segment Information

The Corporation’s 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 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 Bank’s deposit, loan and trust activities. The majority of the Bank’s 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

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 June 30, 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 June 30, 2012 and December 31, 2011, the Corporation 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.

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,

 

7


Table of Contents

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 issuer’s 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 issuer’s 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 the Corporation 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 the Corporation decides to sell or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. 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 Corporation 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.

Restricted Stock

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

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. Placement of an account on nonaccrual status includes a reversal of all previously accrued but uncollected interest against interest income. When doubt exists as to the collectability of the principal portion of the loan, payments received must be applied to principal to the extent necessary to eliminate such doubt.

While in nonaccrual status, some or all of the cash interest payments may be treated as interest income on a cash basis as long as the remaining principal (after charge-off of identified losses, if any) is deemed to be fully collectible. The determination as to the ultimate collectability must be supported by a current, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s historical repayment performance and other relevant factors. 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 of principal and interest 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

 

8


Table of Contents

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 loan’s 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 Management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. Management’s determination of the allowance, and the resulting provision, is based on judgments and assumptions, including general economic conditions, loan portfolio composition, loan loss experience, Management’s 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 Management’s evaluation of the loan portfolio and the adequacy of the allowance for loan losses under current economic conditions and such other factors which, in Management’s judgment, deserve current recognition. Additional information can be found in Note 6 (Loans and Allowance for Loan Losses).

Servicing

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 tested at least annually for impairment or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Corporation tests for 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.

Other Real Estate Owned

Other real estate owned (OREO) 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.

 

9


Table of Contents

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 Corporation’s 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.

Income Taxes

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

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 Corporation’s available-for-sale securities (after applicable income tax expense) totaling $3,984 and $4,019 at June 30, 2012 and December 31, 2011, respectively, and the minimum pension liability adjustment (after applicable income tax benefit) totaling $1,818 for both June 30, 2012 and December 31, 2011 are included in accumulated other comprehensive income.

Preferred Stock

The Corporation is authorized to issue up to 1,000,000 shares of Voting Preferred Stock, no par value. As of June 30, 2011, the Corporation had authorized 150,000 Series A Voting Preferred Shares. No Series A Voting Preferred Shares have been issued.

As of June 30, 2012 and December 31, 2011, 25,223 shares of the Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”) were issued and outstanding. 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 Corporation’s sale of $25.2 million of its Series B Preferred Stock to United States Department of Treasury (Treasury) in conjunction with the Capital Purchase Program on December 12, 2008. The Corporation also issued a warrant to purchase 561,343 of its common shares at an exercise price of $6.74.

As part of the Treasury’s strategy for winding down its remaining investment in the Troubled Asset Relief Program (TARP), particularly in community banks, the Treasury conducted various public auctions of TARP preferred stock in 2012.

On June 13, 2012, the Corporation and the bank entered into an underwriting agreement (the “Underwriting Agreement”) with the Treasury and Merrill Lynch, Pierce, Fenner & Smith Incorporated and Sandler O’Neill & Partners, L.P. as representatives of the several underwriters named therein (the “Underwriters”) providing for the offer and sale by Treasury of 25,223 shares of the Company’s Series B preferred stock. Under the terms of the Underwriting Agreement, the Underwriters agreed to purchase the Series B preferred stock from Treasury at a price of $856.1325 per share, and to sell the Series B Preferred Stock to the public through a modified dutch auction at an initial public offering price of $869.17 per share. The Corporation did not receive any of the proceeds from the offering. The offering closed on June 19, 2012.

 

10


Table of Contents

Subsequent Event

On July 2, 2012, the Corporation entered into a Warrant Repurchase Agreement to purchase 561,343 shares of common stock of the Corporation that was issued to the United States Department of the Treasury in connection with the Corporation’s participation in the Troubled Asset Relief Program Capital Purchase Program. The Warrant was repurchased at a mutually agreed upon price of $860. Settlement of the repurchase of the Warrant occurred on July 18, 2012. Following settlement of the TARP Warrant, the Treasury has no remaining investment in the Corporation.

New Accounting Pronouncements

ASC Topic 220: Comprehensive Income: Presentation of Comprehensive Income. On June 16, 2011, the FASB issued Accounting Standards Update (ASU) 2011-05. This ASU is intended to increase the prominence of other comprehensive income in financial statements. The new guidance does not change whether items are reported in net income or in other comprehensive income or whether and when items of other comprehensive income are reclassified to net income. ASU 2011-05 eliminates the option in current U.S. generally accepted accounting principles that permits the presentation of other comprehensive income in the statement of changes in equity. The new guidance in the ASU requires that an entity report comprehensive income in either a single continuous statement that presents the components of net income or a separate but consecutive statement. The new guidance is to be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this pronouncement did not have a material impact on the Corporation’s financial statements.

Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment. On September 15, 2011 the FASB issued an accounting standards update (ASU) to simplify testing of goodwill for impairment. The changes will reduce complexity and costs by allowing an entity (public or nonpublic) to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. Specifically, an entity will have the option of first assessing qualitative factors (events and circumstances) to determine whether it is more likely than not (meaning a likelihood of more than fifty percent) that the fair value of a reporting unit is less than its carrying amount. The amendments are effective for annual and interim goodwill impairment testing performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Corporation early adopted the ASU for the year ended December 31, 2011 and concluded that a full impairment test was not required. Refer to Note 4, Goodwill and Intangible Assets, for additional information.

FASB ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This amendment was issued as result of an effort to develop common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). While ASU 2011-04 is largely consistent with existing fair value measurement principles under U.S. GAAP, it expands the disclosure requirements for fair value measurements and clarifies the existing guidance or wording changes to align with IRFS No. 13. Many of the requirements for the amendments in ASU 2011-04 do not result in a change in the application of the requirements in ASC 820. ASU 2011-04 was effective for the Corporation on a prospective basis beginning in the quarter ended March 31, 2012. The adoption of this pronouncement did not have a material impact on the Corporation’s financial statements

Reclassification

Certain amounts appearing in the prior year’s financial statements have been reclassified to conform to the current period’s financial statements.

 

11


Table of Contents

(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:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2012      2011      2012      2011  
     (Dollars in thousands except per share amounts)  

Weighted average shares outstanding used in Basic Earnings per Common Share

     7,944,354         7,884,749         7,934,458         7,878,119   

Dilutive effect of incentive stock options and warrants

     6,174         185         3,925         105   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding used in Diluted Earnings Per Common Share

     7,950,528         7,884,934         7,938,383         7,878,224   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 1,438       $ 712       $ 2,943       $ 1,842   

Dividends and accretion on preferred stock

     318         318         637         637   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income Available to Common Shareholders

   $ 1,120       $ 394       $ 2,306       $ 1,205   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic Earnings Per Common Share

   $ 0.14       $ 0.05       $ 0.29       $ 0.15   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted Earnings Per Common Share

   $ 0.14       $ 0.05       $ 0.29       $ 0.15   
  

 

 

    

 

 

    

 

 

    

 

 

 

Options to purchase 232,000 common shares and common stock warrants for 561,343 shares were considered in computing diluted earnings per common share for the three and six month periods ended June 30, 2012. Stock options for 6,174 and 3,925 common shares were considered dilutive and the remaining stock options and the stock warrants were antidilutive for the three and six month periods ended June 30, 2012. Stock options to purchase 197,000 common shares and common stock warrants of 561,343 were considered in computing diluted earnings per common share for the three and six month periods ended June 30, 2011. Stock options to purchase 2,500 common shares were considered dilutive and the remaining stock options and stock warrants were antidilutive for the three and six month periods ended June 30, 2011.

(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 $1,099 on June 30, 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. Goodwill is assessed using the Bank as the reporting unit. The Corporation considers several methodologies in determining the fair value of the reporting unit, including the discounted estimated future net cash flows, price to tangible book value, and core deposit premium values. Primary reliance is placed on the discounted estimated future net cash flow approach. The key assumptions used to determine the fair value of the Corporation subsidiary include: (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 Corporation’s average cost of capital adjusted for the risk associated with its operations. A variance in these assumptions could have a significant effect on the determination of goodwill impairment. 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 Corporation’s 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:

 

     June 30, 2012      December 31, 2011  
     (Dollars in thousands)  

Core deposit intangibles

   $ 1,367       $ 1,367   

Less: accumulated amortization

     703         636   
  

 

 

    

 

 

 

Carrying value of core deposit intangibles

   $ 664       $ 731   
  

 

 

    

 

 

 

 

12


Table of Contents

(5) Securities

The amortized cost, gross unrealized gains and losses and fair values of securities available for sale at June 30, 2012 and December 31, 2011 is as follows:

 

     At June 30, 2012  
     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available for sale:

          

U.S. Government agencies and corporations

   $ 52,908       $ 215       $ (1   $ 53,122   

Mortgage backed securities

     114,294         3,355         (278     117,371   

Collateralized mortgage obligations

     25,959         582         —          26,541   

State and political subdivisions

     29,591         2,164         (1     31,754   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Securities

   $ 222,752       $ 6,316       $ (280   $ 228,788   
  

 

 

    

 

 

    

 

 

   

 

 

 
     At December 31, 2011  
     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 
     (Dollars in thousands)  

Securities available for sale:

          

U.S. Government agencies and corporations

   $ 56,762       $ 120       $ (1   $ 56,881   

Mortgage backed securities

     103,624         3,705         (292     107,037   

Collateralized mortgage obligations

     29,537         700         —          30,237   

State and political subdivisions

     30,000         1,901         (44     31,857   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Securities

   $ 219,923       $ 6,426       $ (337   $ 226,012   
  

 

 

    

 

 

    

 

 

   

 

 

 

The carrying value of securities pledged to secure trust deposits, public deposits, line of credit, and for other purposes required by law amounted to $173,757 and $137,388 at June 30, 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.

 

     At June 30, 2012  
     (Dollars in thousands)  
     Amortized
Cost
     Fair
Value
 

Securities available for sale:

     

Due in one year or less

   $ 34,404       $ 34,523   

Due from one year to five years

     30,229         30,959   

Due from five years to ten years

     10,087         11,084   

Due after ten years

     7,779         8,310   

Mortgage backed securities and collateralized mortgage obligations

     140,253         143,912   
  

 

 

    

 

 

 
   $ 222,752       $ 228,788   
  

 

 

    

 

 

 

Realized gains and losses related to securities available-for-sale at June 30, 2012 and 2011 is as follows:

 

     2012      2011  
     (Dollars in thousands)  

Gross realized gains

   $ —         $ 500   

Gross realized losses

     —           —     
  

 

 

    

 

 

 

Net Securities Gains

   $ —         $ 500   
  

 

 

    

 

 

 

Proceeds from the sale of available for sale securities

   $ —         $ 24,664   
  

 

 

    

 

 

 

The following is a summary of securities that had unrealized losses at June 30, 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 June 30, 2012 there were 7 securities with unrealized losses totaling $280 and at December 31,

 

13


Table of Contents

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.

 

     At June 30, 2012  
     Less than 12 months     12 months or longer      Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 
     (Dollars in thousands)  

U.S. Government agencies and corporations

   $ 9,999       $ (1   $ —         $ —         $ 9,999       $ (1

Mortgage backed securities

     25,827         (278     —           —           25,827         (278

State and political subdivisions

     403         (1     —           —           403         (1
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 36,229       $ (280   $ —         $ —         $ 36,229       $ (280
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

     At December 31, 2011  
     Less than 12 months     12 months or longer      Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 
     (Dollars in thousands)  

U.S. Government agencies and corporations

   $ 9,999       $ (1   $ —         $ —         $ 9,999       $ (1

Mortgage backed securities

     25,606         (292     —           —           25,606         (292

State and political subdivisions

     3,669         (44     —           —           3,669         (44
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 39,274       $ (337   $ —         $ —         $ 39,274       $ (337
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

(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 Management’s 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 for unidentified problem loans 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. The methodology applies to the Corporation’s total loan portfolio including the performing portion of commercial and commercial real estate loans, real estate, and all types of other loans. The loss factors are applied accordingly on a portfolio basis. Loss factors are based on the Corporation’s 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 Corporation’s 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.

 

14


Table of Contents

Activity in the loan balances and the allowance for loan losses by segment at June 30, 2012 and June 30, 2011 are summarized as follows:

 

Six Months Ended June 30, 2012

                                          
     Commercial
Real Estate
    Commercial     Residential
Real Estate
    Home
Equity Loans
    Indirect     Consumer     Total  
                 (Dollars in thousands)                    

Allowance for loan losses:

            

Balance, beginning of period

   $ 10,714      $ 1,409      $ 1,331      $ 2,289      $ 891      $ 429      $ 17,063   

Losses charged off

     (1,319     (165     (975     (555     (577     (106     (3,697

Recoveries

     30        20        83        15        190        29        367   

Provision charged to expense

     1,971        (424     1,277        397        481        (135     3,567   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 11,396      $ 840      $ 1,716      $ 2,146      $ 985      $ 217      $ 17,300   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2012

                                          
     Commercial
Real Estate
    Commercial     Residential
Real Estate
    Home
Equity Loans
    Indirect     Consumer     Total  
                 (Dollars in thousands)                    

Allowance for loan losses:

            

Balance, beginning of period

   $ 11,651      $ 585      $ 1,574      $ 2,298      $ 807      $ 200      $ 17,115   

Losses charged off

     (340     (165     (508     (152     (399     (57     (1,621

Recoveries

     10        3        16        11        87        12        139   

Provision charged to expense

     75        417        634        (11     490        62        1,667   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 11,396      $ 840      $ 1,716      $ 2,146      $ 985      $ 217      $ 17,300   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of June 30, 2012

                                          

Ending allowance balance attributable to loans:

              

Individually evaluated for impairment

   $ 3,181      $ 80      $ 37      $ —        $ —        $ —        $ 3,298   

Collectively evaluated for impairment

     8,215        760        1,679        2,146        985        217        14,002   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 11,396      $ 840      $ 1,716      $ 2,146      $ 985      $ 217      $ 17,300   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

              

Individually evaluated for impairment

   $ 28,102      $ 306      $ 1,161      $ —        $ —        $ —        $ 29,569   

Collectively evaluated for impairment

     370,149        79,155        63,673        126,568        184,892        13,453        837,890   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending loans balance

   $ 398,251      $ 79,461      $ 64,834      $ 126,568      $ 184,892      $ 13,453      $ 867,459   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2011

                                          
     Commercial
Real Estate
    Commercial     Residential
Real Estate
    Home
Equity Loans
    Indirect     Consumer     Total  
                 (Dollars in thousands)                    

Allowance for loan losses:

            

Balance, beginning of period

   $ 11,127      $ 1,317      $ 805      $ 1,512      $ 904      $ 471      $ 16,136   

Losses charged off

     (2,092     (224     (1,026     (686     (338     (245     (4,611

Recoveries

     216        35        10        2        72        46        381   

Provision charged to expense

     2,430        54        1,460        1,063        283        155        5,445   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 11,681      $ 1,182      $ 1,249      $ 1,891      $ 921      $ 427      $ 17,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2011

                                          
                 (Dollars in thousands)                    

Allowance for loan losses:

            

Balance, beginning of period

   $ 12,003      $ 1,151      $ 926      $ 1,940      $ 902      $ 393      $ 17,315   

Losses charged off

     (1,862     (224     (753     (341     (143     (176     (3,499

Recoveries

     114        4        6        1        47        18        190   

Provision charged to expense

     1,426        251        1,070        291        115        192        3,345   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 11,681      $ 1,182      $ 1,249      $ 1,891      $ 921      $ 427      $ 17,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of June 30, 2011

                                          

Ending allowance balance attributable to loans:

              

Individually evaluated for impairment

   $ 5,602      $ 166      $ 302      $ —        $ —        $ —        $ 6,070   

Collectively evaluated for impairment

     6,079        1,016        947        1,891        921        427        11,281   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending allowance balance

   $ 11,681      $ 1,182      $ 1,249      $ 1,891      $ 921      $ 427      $ 17,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

              

Individually evaluated for impairment

   $ 35,349      $ 771      $ 2,126      $ —        $ —        $ —        $ 38,246   

Collectively evaluated for impairment

     351,542        71,908        66,711        130,143        158,885        12,877        792,066   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total ending loans balance

   $ 386,891      $ 72,679      $ 68,837      $ 130,143      $ 158,885      $ 12,877      $ 830,312   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

15


Table of Contents

Delinquencies

Delinquencies are a sign of weakness in credit quality. Lending staff at the Corporation monitor the financial performance and delinquency of borrowers in its portfolios. Lenders are responsible for managing delinquencies by following up with borrowers and arranging for payments. The Corporation determines if a commercial or commercial real estate loan is delinquent based on the number of days past due according to the contractual terms of the loan. For residential, home equity and consumer loans, the Corporation considers the borrower delinquent if the borrower is in arrears by two or more monthly payments. The following procedure is followed in managing delinquent accounts:

 

   

15-30 days past due- a collection notice is sent reminding the borrower of past due status and the urgency of bringing the account current.

 

   

45 days past due- a default letter is sent declaring the loan in default and advising the borrower that legal action will be necessary if the account is not brought current immediately.

 

   

60 days past due- an “attorney letter” accelerating the loan is sent advising the borrower that legal proceeding to collect the debt will begin immediately.

Management monitors delinquencies and potential problem loans on a recurring basis. At June 30, 2012 there was $27,158 in total past due loans or 3.13% of total loans compared to $31,315 or 3.71% of total loans at December 31, 2011. A table showing total loan delinquencies as of June 30, 2012 and December 31, 2011 by loan segment is as follows:

 

Age Analysis of Past Due Loans

as of June 30, 2012

                    
(Dollars in thousands)    30-59 Days
Past Due
     60-89 Days
Past Due
     Greater
than

90  Days
     Total Past
Due
     Current      Total Loans      Recorded
Investment >
90 Days and
Accruing
 

Commercial real estate

   $ 701       $ 425       $ 16,435       $ 17,561       $ 380,690       $ 398,251       $ —     

Commercial

     404         123         491         1,018         78,443         79,461         —     

Residential real estate

     506         608         3,579         4,693         60,141         64,834         —     

Home equity loans

     1,342         272         1,386         3,000         123,568         126,568         —     

Indirect

     518         96         5         619         184,273         184,892      

Consumer

     60         163         44         267         13,186         13,453         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,531       $ 1,687       $ 21,940       $ 27,158       $ 840,301       $ 867,459       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Age Analysis of Past Due Loans

as of December 31, 2011

                                                
(Dollars in thousands)    30-59 Days
Past Due
     60-89 Days
Past Due
     Greater
than

90  Days
     Total Past
Due
     Current      Total
Loans
     Recorded
Investment >
90 Days and
Accruing
 

Commercial real estate

   $ 290       $ 804       $ 19,023       $ 20,117       $ 361,735       $ 381,852       $ —     

Commercial

     54         249         805         1,108         75,462         76,570         —     

Residential real estate

     545         1,172         3,554         5,271         59,253         64,524         —     

Home equity loans

     1,942         181         1,666         3,789         123,169         126,958         —     

Indirect

     664         71         124         859         179,230         180,089      

Consumer

     131         12         28         171         12,924         13,095         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,626       $ 2,489       $ 25,200       $ 31,315       $ 811,773       $ 843,088       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

16


Table of Contents

Impaired Loans

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 the periods reported. Information regarding impaired loans as of June 30, 2012 and June 30, 2011 is as follows:

 

     At June 30, 2012      Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average Recorded
Balance
     Average Recorded
Balance
 
(Dollars in thousands)                                   

With no related allowance recorded:

              

Commercial real estate

   $ 8,241       $ 12,981       $ —         $ 9,121       $ 9,758   

Commercial

     171         171         —           208         177   

Residential real estate

     1,089         2,138         —           1,353         1,184   

Home equity loans

     —           —           —           —           —     

Indirect

     —           —           —           —           —     

Consumer

     —           —           —           —           —     

With allowance recorded:

              

Commercial real estate

     19,861         21,465         3,181         19,600         19,511   

Commercial

     135         135         80         313         269   

Residential real estate

     72         72         37         72         72   

Home equity loans

     —           —           —           —           —     

Indirect

     —           —           —           —           —     

Consumer

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 29,569       $ 36,962       $ 3,298       $ 30,667       $ 30,971   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     At December 31, 2011      Three Months Ended
June 30, 2011
     Six Months Ended
June 30, 2011
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average Recorded
Balance
     Average Recorded
Balance
 
(Dollars in thousands)                                   

With no related allowance recorded:

              

Commercial real estate

   $ 12,585       $ 20,138       $ —         $ 10,575       $ 9,609   

Commercial

     386         386         —           368         484   

Residential real estate

     1,069         1,897         —           1,771         2,491   

Home equity loans

     —           —           —           —           —     

Indirect

     —           —           —           —           —     

Consumer

     —           —           —           —           —     

With allowance recorded:

              

Commercial real estate

     19,161         19,823         3,747         26,667         28,307   

Commercial

     319         794         148         531         837   

Residential real estate

     72         72         37         662         1,041   

Home equity loans

     —           —           —           —           —     

Indirect

     —           —           —           —           —     

Consumer

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 33,592       $ 43,110       $ 3,932       $ 40,574       $ 42,769   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Nonaccrual loans at June 30, 2012 were $34,993 compared to $34,471 at December 31, 2011.

 

     June 30, 2012     December 31, 2011  
     (Dollars in thousands)  

Commercial real estate

   $ 22,456      $ 21,512   

Commercial

     644        1,072   

Residential real estate

     6,724        6,551   

Home equity loans

     4,252        4,365   

Indirect

     530        711   

Consumer

     387        260   
  

 

 

   

 

 

 

Total Nonaccrual Loans

   $ 34,993      $ 34,471   
  

 

 

   

 

 

 

Percentage of nonaccrual loans to portfolio loans

     4.03     4.09

Percentage of nonaccrual loans to total assets

     2.90     2.95

Troubled Debt Restructuring

A restructuring of a debt constitutes a troubled debt restructuring if the creditor, for economic or legal reasons related to the debtor’s 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 structuring applies in a particular instance. As of June 30, 2012, the Corporation had five loans that were classified as troubled debt restructurings which totaled $2,972. As of December 31, 2011, the Corporation had

 

17


Table of Contents

five loans that were classified as a troubled debt restructuring in the amount of $3,099. The Corporation has allocated $455 and $307 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2012 and December 31, 2011, respectively. There are no commitments to lend additional amounts to borrowers with loans that are classified as troubled debt restructurings at June 30, 2012 and December 31, 2011.

Information regarding TDR loans for the three and six months end June 30, 2012 is as follows:

 

     For the Six Months Ended
June 30, 2012
     For the Three Months Ended
June 30, 2012
 
     (Dollars in thousands)      (Dollars in thousands)  
     Number of
Contracts
     Post-Modification
Outstanding
Recorded Investment
     Number of
Contracts
     Post-Modification
Outstanding
Recorded Investment
 

Troubled Debt Restructurings

           

Commercial Real Estate

     5       $ 2,972         —         $ —     
     

 

 

       

 

 

 

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 Management’s 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 loan’s 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 Management’s periodic analysis of the adequacy of the allowance include the Corporation’s internal credit risk grades which are described below and are included in the table below for June 30, 2012 and December 31, 2011:

 

   

Grades 1 -5: defined as “Pass” credits — loans which are protected by the borrower’s 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 residential, home equity, indirect and consumer loan segments, the Corporation monitors credit quality using a combination of the delinquency status of the loan and/or the Corporation’s internal credit risk grades as indicated above.

 

18


Table of Contents

The following table presents the recorded investment of commercial, commercial real estate and residential construction loans by internal credit risk grade and the recorded investment in residential, home equity, indirect and consumer loans based on delinquency status as of June 30, 2012 and December 31, 2011:

 

     Commercial
Real Estate
     Commercial      Residential
Real Estate*
     Home Equity
Loans
     Indirect      Consumer      Total  
Commercial Credit Exposure    June 30, 2012  
     (Dollars in thousands)  

Loans graded by internal credit risk grade:

                    

Grade 1-Minimal

   $ —         $ 110       $ —         $ —         $ —         $ —         $ 110   

Grade 2-Modest

     —           —           —           —           —           —           —     

Grade 3-Better than average

     1,566         13         —           —           —           —           1,579   

Grade 4-Average

     38,195         4,837         232         —           —           —           43,264   

Grade 5-Acceptable

     319,260         70,231         4,681         —           —           —           394,172   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Pass Credits

     359,021         75,191         4,913         —           —           —           439,125   

Grade 6-Special mention

     5,789         3,642         46         —           —           —           9,477   

Grade 7-Substandard

     32,676         628         1,533         —           —           —           34,837   

Grade 8-Doubtful

     765         —           —           —           —           —           765   

Grade 9-Loss

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans internally credit risk graded

     398,251         79,461         6,492         —           —           —           484,204   

Loans not monitored by internal risk grade:

                    

Current loans not internally risk graded

     —           —           55,181         123,568         184,273         13,186         376,208   

30-59 days past due loans not internally risk graded

     —           —           506         1,342         518         60         2,426   

60-89 days past due loans not internally risk graded

     —           —           608         272         96         163         1,139   

90+ days past due loans not internally risk graded

     —           —           2,047         1,386         5         44         3,482   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans not internally credit risk graded

     —           —           58,342         126,568         184,892         13,453         383,255   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans internally and not internally credit risk graded

   $ 398,251       $ 79,461       $ 64,834       $ 126,568       $ 184,892       $ 13,453       $ 867,459   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Commercial
Real Estate
     Commercial      Residential
Real Estate*
     Home Equity
Loans
     Indirect      Consumer      Total  
Commercial Credit Exposure    December 31, 2011  
     (Dollars in thousands)  

Loans graded by internal credit risk grade:

                    

Grade 1-Minimal

   $ —         $ 3,157       $ —         $ —         $ —         $ —         $ 3,157   

Grade 2-Modest

     —           —           —           —           —           —           —     

Grade 3-Better than average

     1,602         19         —           —           —           —           1,621   

Grade 4-Average

     44,527         5,322         237         —           —           —           50,086   

Grade 5-Acceptable

     278,458         63,880         4,835         —           —           —           347,173   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Pass Credits

     324,587         72,378         5,072         —           —           —           402,037   

Grade 6-Special mention

     16,390         2,947         157         —           —           —           19,494   

Grade 7-Substandard

     40,875         1,245         1,830         —           —           —           43,950   

Grade 8-Doubtful

     —           —           —           —           —           —           —     

Grade 9-Loss

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans internally credit risk graded

     381,852         76,570         7,059         —           —           —           465,481   

Loans not monitored by internal risk grade:

                    

Current loans not internally risk graded

     —           —           53,276         123,169         179,230         12,924         368,599   

30-59 days past due loans not internally risk graded

     —           —           545         1,942         664         131         3,282   

60-89 days past due loans not internally risk graded

     —           —           1,172         181         71         12         1,436   

90+ days past due loans not internally risk graded

     —           —           2,472         1,666         124         28         4,290   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans not internally credit risk graded

     —           —           57,465         126,958         180,089         13,095         377,607   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans internally and not internally credit risk graded

   $ 381,852       $ 76,570       $ 64,524       $ 126,958       $ 180,089       $ 13,095       $ 843,088   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Residential loans include conventional 1-4 family residential property loans and conventional 1-4 family residential property loans used to finance the cost of construction when upon completion of construction the loan converts into a permanent mortgage.

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 borrower’s capacity to meet current and proposed debt service requirements. A borrower’s 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 delinquent loan table. Additionally, a good indicator of repayment ability is a borrower’s credit history. A borrower’s credit history is evaluated though the use of credit reports and/or an automated underwriting system. A borrower’s credit score is an indication of a person’s creditworthiness that is used to access the likelihood that a borrower will repay their debts. A credit score is generally based upon a person’s past credit history and is a number between 300 and 850—the higher the number, the more creditworthy the person is deemed to be.

 

19


Table of Contents

(7) Deposits

Deposit balances at June 30, 2012 and December 31, 2011 are summarized as follows:

 

     June 30, 2012      December 31, 2011  
     (Dollars in thousands)  

Demand and other noninterest-bearing

   $ 143,778       $ 126,713   

Interest checking

     165,176         151,894   

Savings

     111,742         102,440   

Money market accounts

     106,767         105,643   

Consumer time deposits

     411,265         424,870   

Public time deposits

     84,825         79,520   
  

 

 

    

 

 

 

Total deposits

   $ 1,023,553       $ 991,080   
  

 

 

    

 

 

 

The aggregate amount of certificates of deposit in denominations of $100,000 or more amounted to $252,197 and $241,217 at June 30, 2012 and December 31, 2011, respectively.

The maturity distribution of certificates of deposit as of June 30, 2012 follows:

 

June 30, 2012  
(Dollars in thousands)  
2013    $ 236,598   
2014      187,672   
2015      34,411   
2016      23,157   
2017      14,252   
  

 

 

 
Total    $ 496,090   
  

 

 

 

(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 June 30, 2012, the Bank had pledged approximately $100,863 in qualifying home equity lines of credit, resulting in an available line of credit of approximately $50,432. No amounts were outstanding at June 30, 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 June 30, 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 June 30, 2012 and December 31, 2011 were $827 and $227, respectively. The interest rate paid on these borrowings was 0.25% at June 30, 2012 and December 31, 2011. No Federal Funds were purchased as of June 30, 2012 and December 31, 2011.

(9) Federal Home Loan Bank Advances

Federal Home Loan Bank advances amounted to $47,521 and $42,497 at June 30, 2012 and December 31, 2011, respectively. All advances are bullet maturities with no call features. At June 30, 2012, collateral pledged for FHLB advances consisted of qualified multi-family and residential real estate mortgage loans and investment securities of $78,529 and 27,152, respectively. The maximum borrowing capacity of the Bank at June 30, 2012 was $66,755 with unused collateral borrowing capacity of $17,734. The Bank maintains a $40,000 cash management line of credit (CMA) with the FHLB. The amount outstanding was $0 for the CMA line of credit as of June 30, 2012 and December 31, 2011.

 

20


Table of Contents

Maturities of FHLB advances outstanding at June 30, 2012 and December 31, 2011 are as follows.

 

     June 30, 2012      December 31, 2011  
     (Dollars in thousands)  

Maturity January 2012, fixed rate 2.37%

   $ —         $ 15,000   

Maturities January 2014 through August 2014, with fixed rates ranging from 2.06% to 3.55%

     14,995         15,027   

Maturities January 2015 and July 2015, with fixed rates ranging from 0.80% to 4.76%

     32,500         12,470   
  

 

 

    

 

 

 

Total FHLB advances

   $ 47,495       $ 42,497   
  

 

 

    

 

 

 

(10) Trust Preferred Securities

In May 2007, LNB Trust I (“Trust I”) and LNB Trust II (“Trust II”) each sold $10,000 of preferred securities to outside investors and invested the proceeds in junior subordinated debentures issued by the Corporation. The Corporation used the proceeds from the debentures to fund the cash portion of its acquisition of Morgan Bancorp, Inc. Trust I and Trust II are wholly-owned unconsolidated subsidiaries of the Corporation. The Corporation’s 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 June 30, 2012 and December 31, 2011, accrued interest payable for Trust I was $7 and $7 and for Trust II was $22 and $24, respectively.

The subordinated notes are redeemable in whole or in part, without penalty, at the Corporation’s 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 June 30, 2012, the balance of the subordinated notes payable to Trust I and Trust II were each $8,116.

(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 Bank’s 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 customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on Management’s evaluation of the applicant’s 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.

 

21


Table of Contents

A summary of the contractual amount of commitments at June 30, 2012 and December 31, 2011 are as follows:

 

     June 30, 2012      December 31, 2011  
     (Dollars in thousands)  

Commitments to extend credit

   $ 78,859       $ 92,128   

Home equity lines of credit

     75,279         78,410   

Standby letters of credit

     8,335         8,145   
  

 

 

    

 

 

 

Total

   $ 162,473       $ 178,683   
  

 

 

    

 

 

 

(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 Corporation’s 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:

 

   

The carrying value of cash and due from banks, Federal funds sold, short-term investments, interest-bearing deposits in other banks and accrued interest receivable and other financial assets is a reasonable estimate of fair value due to the short-term nature of the asset.

 

   

The fair value of investment securities is based on quoted market prices, where available. If quoted market prices are not available, fair value is estimated using the quoted market prices of comparable instruments.

 

   

For variable rate loans with interest rates that may be adjusted on a quarterly, or more frequent basis, the carrying amount is a reasonable estimate of fair value. The fair value of other types of loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

 

   

The carrying value approximates the fair value for bank owned life insurance.

 

   

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, money market, checking and interest-bearing checking, is equal to the amount payable on demand as of the balance sheet date, for each year presented. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. For variable rate certificates of deposit, the carrying amount is a reasonable estimate of fair value.

 

   

Securities sold under repurchase agreements, other short-term borrowings, accrued interest payable and other financial liabilities approximate fair value due to the short-term nature of the liability.

 

   

The fair value of Federal Home Loan Bank advances is estimated by discounting future cash flows using current FHLB rates for the remaining term to maturity.

 

   

The fair value of junior subordinated debentures is based on the discounted value of contractual cash flows using rates currently offered for similar maturities.

 

   

The fair value of commitments to extend credit approximates the fees charged to make these commitments; since rates and fees of the commitment contracts approximates those currently charged to originate similar commitments. The carrying amount and fair value of off-balance sheet instruments is not significant as of June 30, 2012 and December 31, 2011.

Limitations

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

 

22


Table of Contents

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 estimated fair values of the Corporation’s financial instruments at June 30, 2012 and December 31, 2011 are summarized as follows:

 

     June 30, 2012      December 31, 2011  
     Carrying
Value
     Estimated Fair
Value
     Carrying
Value
     Estimated Fair
Value
 
            (Dollars in thousands)         

Financial assets

           

Cash and due from banks, Federal funds sold and interest bearing deposits in other banks

   $ 56,619       $ 56,619       $ 40,647       $ 40,647   

Securities

     228,788         228,788         226,012         226,012   

Portfolio loans, net

     850,159         848,393         826,025         825,662   

Loans held for sale

     1,207         1,207         3,448         3,448   

Accrued interest receivable

     3,604         3,604         3,550         3,550   

Financial liabilities

           

Deposits:

           

Demand, savings and money market

   $ 527,463         527,463         486,690         486,690   

Certificates of deposit

     496,090         500,265         504,390         509,449   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total deposits

     1,023,553         1,027,728         991,080         996,139   
  

 

 

    

 

 

    

 

 

    

 

 

 

Short-term borrowings

     827         827         227         227   

Federal Home Loan Bank advances

     47,495         48,671         42,497         43,824   

Junior subordinated debentures

     16,238         16,645         16,238         16,130   

Accrued interest payable

     1,007         1,007         1,118         1,118   

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 1 —Valuations based on quoted prices in active markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

   

Level 2 —Valuations of assets and liabilities traded in less active dealer or broker markets. Valuations include quoted prices for similar assets and liabilities traded in the same market; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Valuations may be obtained from, or corroborated by, third-party pricing services.

 

   

Level 3 —Assets and liabilities with valuations that include methodologies and assumptions that may not be readily observable, including option pricing models, discounted cash flow models, yield curves and similar techniques. 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 Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

 

23


Table of Contents

The following information pertains to assets measured by fair value on a recurring basis (in thousands):

 

Description

  Fair Value as of
June 30, 2012
    Quoted Prices in Active
Markets for Identical
Assets (Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable  Inputs
(Level 3)
 
(Dollars in thousands)                        

Securities available for sale:

       

U.S. Government agencies and corporations

  $ 53,122      $ —        $ 53,122      $ —     

Mortgage backed securities

    117,371        —          117,371        —     

Collateralized mortgage obligations

    26,541        —          26,541        —     

State and political subdivisions

    31,754        —          31,754        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 228,788      $ —        $ 228,788      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

Description

  Fair Value as of
December 31, 2011
    Quoted Prices in  Active
Markets for Identical
Assets (Level 1)
    Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable  Inputs
(Level 3)
 
(Dollars in thousands)                        

Securities available for sale:

       

U.S. Government agencies and corporations

  $ 56,881      $ —        $ 56,881      $ —     

Mortgage backed securities

    107,037        —          107,037        —     

Collateralized mortgage obligations

    30,237        —          30,237        —     

State and political subdivisions

    31,857        —          31,857        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 226,012      $ —        $ 226,012      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

 

There were no transfers between Levels 1 and 2 of the fair value hierarchy during the three and six months ended June 30, 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 June 30, 2012 and December 31, 2011:

 

June 30, 2012

  Quoted Market
Prices in Active
Markets (Level 1)
    Internal Models with
Significant Observable
Market Parameters
(Level 2)
    Internal Models with
Significant Unobservable
Market Parameters
(Level 3)
    Total  
(Dollars in thousands)                        

Impaired and nonaccrual loans

  $ —        $ —        $ 29,569      $ 29,569   

Other real estate

    —          —          1,506        1,506   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value on a nonrecurring basis

  $ —        $ —        $ 31,075      $ 31,075   
 

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

  Quoted Market
Prices in Active
Markets (Level 1)
    Internal Models with
Significant Observable
Market Parameters
(Level 2)
    Internal Models with
Significant Unobservable
Market Parameters
(Level 3)
    Total  
(Dollars in thousands)                        

Impaired and nonaccrual loans

  $ —        $ —        $ 33,592      $ 33,592   

Other real estate

    —          —          1,687        1,687   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total assets at fair value on a nonrecurring basis

  $ —        $ —        $ 35,279      $ 35,279   
 

 

 

   

 

 

   

 

 

   

 

 

 

The Corporation has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. The fair value of collateral-dependent impaired loans and other real estate owned is determined through the use of an independent third-party appraisal (Level 3 input), once a loan is identified as impaired or the Corporation takes ownership of a property. The Corporation maintains a disciplined approach of obtaining updated independent third-party appraisals relating to such loans or property on at least an annual basis, at which time the determination of fair value is updated as necessary to reflect the appraisal. In addition, Management reviews the fair value of those collateral-dependent impaired loans in amounts that it considers to be material ($250,000 or greater) on a monthly basis and makes necessary adjustments to the fair value based on individual facts and circumstances, which review may include obtaining new third-party appraisals.

 

24


Table of Contents

Mortgage Servicing Rights (MSR). The Corporation carries its mortgage servicing rights at lower of cost or fair value, and therefore, can be subject to fair value measurements on a nonrecurring basis. Since sales of mortgage servicing rights occur in private transactions and the precise terms and conditions of the sales are typically not readily available (Level 3), there is a limited market to refer to in determining the fair value of mortgage servicing rights. As such the Corporation utilizes a third party vendor to perform a valuation on the mortgage servicing rights to estimate the fair value. The Corporation reviews the estimated fair values and assumptions used by the third party vendor on a quarterly basis.

Impaired Loans. Impaired loans valued using Level 3 inputs consist of non-homogeneous loans that are considered impaired. The Corporation estimates the fair value of these loans based on the estimated realizable values of available collateral, which is typically based on current independent third-party appraisals.

Other Real Estate Owned. Other real estate owned (“OREO”) is measured and reported at fair value when the current book value exceeds the estimated fair value of the property. Management’s determination of the fair value for these loans uses a market approach representing the estimated net proceeds to be received from the sale of the property based on observable market prices and market value provided by independent, licensed or certified appraisers (Level 3 Inputs).

(13) Share-Based Compensation

A broad-based stock option incentive plan, the 2006 Stock Incentive Plan, was originally adopted by the Corporation’s shareholders on April 18, 2006 and an amended and restated version of the plan was adopted by shareholders effective May 2, 2012. As of June 30, 2012, outstanding awards granted under this Plan consisted of stock options granted in 2007, 2008 and 2009 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 have been made from 2005 to 2007.

Stock Options

The expense recorded for stock options was $1 and $0 for the first six months of June 30, 2012 and June 30, 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:

 

     2012  

Risk free interest rate

     1.27

Dividend yield

     3.38

Volatility

     33.00

The weighted-average fair value of options granted in 2012 was $5.39.

Options outstanding at June 30, 2012 were as follows:

 

     Outstanding      Exercisable  
     Number      Weighted
Average
Remaining
Contractual Life
(Years)
     Number      Weighted
Average Exercise
Price
 

Range of Exercise Prices

           

$5.34-$5.39

     37,500         9.41         2,500       $ 5.34   

$14.47-$15.34

     82,000         5.60         82,000         14.47   

$15.35-$16.50

     52,500         4.71         52,500         15.78   

$16.51-$19.10

     30,000         3.59         30,000         19.10   

$19.11-$19.17

     30,000         2.59         30,000         19.17   
  

 

 

       

 

 

    

Outstanding at end of period

     232,000         5.37         197,000       $ 16.12   
  

 

 

       

 

 

    

 

25


Table of Contents

A summary of the status of stock options at June 30, 2012 and June 30, 2011 and changes during the six months then ended is presented in the table below:

 

     2012      2011  
     Options      Weighted
Average Exercise
Price per Share
     Options      Weighted
Average Exercise
Price per Share
 

Outstanding at beginning of period

     197,000       $ 16.12         197,000       $ 16.12   

Granted

     35,000         5.39         —           —     

Forfeited or expired

     —           —           —           —     

Exercised

     —           —           —           —     

Stock dividend or split

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Outstanding at end of period

     232,000       $ 14.50         197,000       $ 16.12   
  

 

 

    

 

 

    

 

 

    

 

 

 

Exercisable at end of period

     197,000       $ 16.12         196,167       $ 16.17   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no options exercised during the first six months of 2012, therefore the total intrinsic value of options exercised was $0. The total intrinsic value of all options outstanding for the first six months of 2012 was $0.

A summary of the status of nonvested stock options at June 30, 2012 is presented in the table below:

 

     Nonvested Shares      Weighted Average
Exercise Price per
share
 

Nonvested at January 1, 2012

     833       $ 5.34   

Granted

     35,000         5.39   

Vested

     833         5.34   

Forfeited or expired

     —           —     
  

 

 

    

 

 

 

Nonvested at March 31, 2012

     35,000       $ 5.39   
  

 

 

    

 

 

 

Restricted Shares

In the first quarter of 2012, the Corporation issued 62,105 shares of long-term restricted stock. The market price of the Corporation’s common shares on the date of grant of the long-term restricted stock 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 Corporation’s common shares on the date of grant of the long-term restricted shares was $5.28 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 six months ended June 30, 2012 and 2011 was $144 and $92, respectively.

The market price of the Corporation’s 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 June 30, 2012 is presented in the table below: