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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended June 30, 2012
For the transition period from to
Commission file number: 0-13203
LNB Bancorp, Inc.
(Exact name of the registrant as specified on its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of common shares of the registrant outstanding on August 13, 2012 was 7,944,354.
LNB Bancorp, Inc.
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements
See accompanying notes to consolidated financial statements
(Dollars in thousands except per share amounts)
(1) Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of LNB Bancorp, Inc. (the Corporation) and its primary wholly-owned subsidiary, The Lorain National Bank (the Bank). The consolidated financial statements also include the accounts of North Coast Community Development Corporation, which is a wholly-owned subsidiary of the Bank. All intercompany transactions and balances have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include information or footnote disclosures necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (US GAAP). Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of the Corporation included in the Corporations Annual Report on Form 10-K for the year ended December 31, 2011. However, all adjustments (consisting only of normal recurring accruals) which, in the opinion of the Corporations management (Management), are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the 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 Managements 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 Corporations 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.
The Corporations activities are considered to be a single industry segment for financial reporting purposes. LNB Bancorp, Inc. is a bank holding company engaged in the business of commercial and retail banking, investment management and trust services with operations conducted through its main office and banking centers located throughout Lorain, Erie, Cuyahoga, and Summit counties of Ohio. This market provides the source for substantially all of the Banks deposit, loan and trust activities. The majority of the Banks income is derived from a diverse base of commercial, mortgage and retail lending activities and investments.
Statement of Cash Flows
For purposes of reporting in the Consolidated Statements of Cash Flows, cash and cash equivalents include currency on hand, amounts due from banks, Federal funds sold, and securities purchased under resale agreements. Generally, Federal funds sold and securities purchased under resale agreements are for one day periods.
Securities that are bought and held for the sole purpose of being sold in the near term are deemed trading securities with any related unrealized gains and losses reported in earnings. As of 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,
consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Corporation has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuers financial condition, the Corporation may consider whether the securities are issued by the federal government or its agencies, or U.S. Government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to Management at a point in time.
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether 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 investments amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. If a security is determined to be other-than-temporarily impaired, but the 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.
The Bank is a member of the Federal Home Loan Bank (FHLB) system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The Bank is also a member of and owns stock in the Federal Reserve Bank. The Corporation also owns stock in Bankers Bancshares Inc., an institution that provides correspondent banking services to community banks. Stock in these institutions is classified as restricted stock and is recorded at redemption value which approximates fair value. The Corporation periodically evaluates the restricted stock for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Loans Held For Sale
Held for sale loans are carried at the lower of amortized cost or estimated fair value, determined on an aggregate basis for each type of loan. Net unrealized losses are recognized by charges to income. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in the noninterest income section of the consolidated statement of income.
Loans are reported at the principal amount outstanding, net of unearned income and premiums and discounts. Loans acquired through business combinations are valued at fair market value on or near the date of acquisition. The difference between the principal amount outstanding and the fair market valuation is amortized over the aggregate average life of each class of loan. Unearned income includes deferred fees, net of deferred direct incremental loan origination costs. Unearned income is amortized to interest income, over the contractual life of the loan, using the interest method. Deferred direct loan origination fees and costs are amortized to interest income, over the contractual life of the loan, using the interest method.
Loans are generally placed on nonaccrual status when they are 90 days past due for interest or principal or when the full and timely collection of interest or principal becomes uncertain. When a loan has been placed on nonaccrual status, the accrued and unpaid interest receivable is reversed against interest income. 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 borrowers financial condition and prospects for repayment, including consideration of the borrowers 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
installment loans, and on an individual loan basis for commercial loans that are graded substandard or below. Factors considered by Management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis. If a loan is impaired, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loans existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
Allowance for Loan Losses
The allowance for loan losses is Managements estimate of credit losses inherent in the loan portfolio at the balance sheet date. Managements determination of the allowance, and the resulting provision, is based on judgments and assumptions, including general economic conditions, loan portfolio composition, loan loss experience, Managements evaluation of credit risk relating to pools of loans and individual borrowers, sensitivity analysis and expected loss models, value of underlying collateral, and observations of internal loan review staff or banking regulators.
The provision for loan losses is determined based on Managements evaluation of the loan portfolio and the adequacy of the allowance for loan losses under current economic conditions and such other factors which, in Managements judgment, deserve current recognition. Additional information can be found in Note 6 (Loans and Allowance for Loan Losses).
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.
Split-Dollar Life Insurance
The Corporation recognizes a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to certain employees extending to post-retirement periods. Based on the present value of expected future cash flows, the liability is recognized based on the substantive agreement with the employee.
Investment and Trust Services Assets and Income
Property held by the Corporation in fiduciary or agency capacity for its customers is not included in the Corporations financial statements as such items are not assets of the Corporation. Income from the Investment and Trust Services Division is reported on an accrual basis.
The Corporation and its wholly-owned subsidiary file an annual consolidated Federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be removed or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when necessary to reduce deferred tax assets to amounts which are deemed more likely than not to be realized.
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale and changes in the funded status of the pension plan, which are also recognized as separate components of shareholders equity.
Unrealized gains on the Corporations available-for-sale securities (after applicable income tax expense) totaling $3,984 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.
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 Corporations 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 Corporations 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 Treasurys 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 ONeill & 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 Companys 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.
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 Corporations 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 Corporations 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 Corporations financial statements
Certain amounts appearing in the prior years financial statements have been reclassified to conform to the current periods financial statements.
(2) Earnings Per Share
Basic earnings per share are computed by dividing income available to common shareholders by the weighted average number of shares outstanding during the year. Diluted earnings per share is computed based on the weighted average number of shares outstanding plus the effects of dilutive stock options and warrants outstanding during the year. Basic and diluted earnings per share are calculated as follows:
Options 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 Corporations 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 Corporations customer base or a material negative change in the relationship with significant customers.
Core deposit intangibles are amortized over their estimated useful life of 10 years. A summary of core deposit intangible assets follows:
The amortized cost, gross unrealized gains and losses and fair values of securities available for sale at June 30, 2012 and December 31, 2011 is as follows:
The carrying value of securities pledged to secure trust deposits, public deposits, line of credit, and for other purposes required by law amounted to $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.
Realized gains and losses related to securities available-for-sale at June 30, 2012 and 2011 is as follows:
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,
2011, the Corporation held 10 securities with unrealized losses totaling $337. Factors that are temporary in nature may result in securities being valued at less than amortized cost. For example, when the current levels of interest rates offered on securities are higher compared to the coupon interest rates on the securities held by the Corporation or when impairment is not due to credit deterioration, securities will be valued at less than amortized cost. The Corporation has the ability and the intent to hold these securities until their value recovers.
(6) Loans and Allowance for Loan Losses
The allowance for loan losses is maintained by the Corporation at a level considered by Management to be adequate to cover probable credit losses inherent in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of Management, to maintain the allowance for loan losses at an adequate level. While Managements periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur. Loan losses are charged off against the allowance when Management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.
The allowance is comprised of a general allowance 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 Corporations 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 Corporations historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectability of the loan portfolio. These other factors include but are not limited to: changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices; changes in national and local economic and business conditions, including the condition of various market segments; changes in the nature and volume of the portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the volume and severity of past due and classified loans, the volume of nonaccrual loans, troubled debt restructurings and other loan modifications; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of external factors, such as legal and regulatory requirements, on the level of estimated credit losses in the Corporations current portfolio. Specific allowances are established for all impaired loans when Management has determined that, due to identified significant conditions, it is probable that a loss will be incurred.
Activity in the loan balances and the allowance for loan losses by segment at June 30, 2012 and June 30, 2011 are summarized as follows:
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:
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:
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:
Nonaccrual loans at June 30, 2012 were $34,993 compared to $34,471 at December 31, 2011.
Troubled Debt Restructuring
A restructuring of a debt constitutes a troubled debt restructuring if the creditor, for economic or legal reasons related to the debtors financial difficulties, grants a concession to the debtor that it would not otherwise consider. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. The Corporation adheres to ASC 310-40, Troubled Debt Restructurings by Creditors, to determine whether a troubled debt 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
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:
Credit Risk Grading
Sound credit systems, practices and procedures such as credit risk grading systems; effective credit review and examination processes; effective loan monitoring, problem identification, and resolution processes; and a conservative loss recognition process and charge-off policy are integral to Managements proper assessment of the adequacy of the allowance. Many factors are considered when grades are assigned to individual loans such as current and historic delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. Commercial, commercial real estate and residential construction loans are assigned internal credit risk grades. The loans internal credit risk grade is reviewed on at least an annual basis and more frequently if needed based on specific borrower circumstances. Credit quality indicators used in Managements periodic analysis of the adequacy of the allowance include the Corporations internal credit risk grades which are described below and are included in the table below for June 30, 2012 and December 31, 2011:
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 Corporations internal credit risk grades as indicated above.
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:
The Corporation adheres to underwriting standards consistent with its Loan Policy for indirect and consumer loans. Final approval of a consumer credit depends on the repayment ability of the borrower. Repayment ability generally requires the determination of the borrowers capacity to meet current and proposed debt service requirements. A borrowers repayment ability is monitored based on delinquency, generally for time periods of 30 to 59 days past due, 60 to 89 days past due and greater than 90 days past due. This information is provided in the above delinquent loan table. Additionally, a good indicator of repayment ability is a borrowers credit history. A borrowers credit history is evaluated though the use of credit reports and/or an automated underwriting system. A borrowers credit score is an indication of a persons creditworthiness that is used to access the likelihood that a borrower will repay their debts. A credit score is generally based upon a persons past credit history and is a number between 300 and 850the higher the number, the more creditworthy the person is deemed to be.
Deposit balances at June 30, 2012 and December 31, 2011 are summarized as follows:
The aggregate amount of certificates of deposit in denominations of $100,000 or more amounted to $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:
(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.
Maturities of FHLB advances outstanding at June 30, 2012 and December 31, 2011 are as follows.
(10) Trust Preferred Securities
In May 2007, LNB Trust I (Trust I) and LNB Trust II (Trust II) each sold $10,000 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 Corporations obligations under the transaction documents, taken together, have the effect of providing a full guarantee by the Corporation, on a subordinated basis, of the payment obligation of the Trusts.
The subordinated notes mature in 2037. Trust I bears a floating interest rate (current three-month LIBOR plus 148 basis points). Trust II bears a fixed rate of 6.64% through June 15, 2017, and then becomes a floating interest rate (current three-month LIBOR plus 148 basis points). Interest on the notes is payable quarterly. The interest rates in effect as of the last determination date in 2012 were 1.95% and 6.64% for Trust I and Trust II, respectively. At 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 Corporations option on or after June 15, 2012 and mature on June 15, 2037. The notes are junior in right of payment to the prior payment in full of all Senior Indebtedness of the Corporation, whether outstanding at the date of the indenture governing the notes or thereafter incurred. At 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 Banks exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. The Bank uses the same credit policies in making commitments as it does for on-balance sheet instruments. Interest rate risk on commitments to extend credit results from the possibility that interest rates may have moved unfavorably from the position of the Bank since the time the commitment was made.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates of 30 to 120 days or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
The Bank evaluates each customers credit worthiness on a case-by-case basis. The amount of collateral obtained by the Bank upon extension of credit is based on Managements evaluation of the applicants credit. Collateral held is generally single-family residential real estate and commercial real estate. Substantially all of the obligations to extend credit are variable rate. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Payments under standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party.
A summary of the contractual amount of commitments at June 30, 2012 and December 31, 2011 are as follows:
(12) Estimated Fair Value of Financial Instruments
The Corporation discloses estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Corporations financial instruments.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Estimates of fair value are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Estimates of fair value are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Corporation has a substantial Investment and Trust Services Division that
contributes net fee income annually. The Investment and Trust Services Division is not considered a financial instrument and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial instruments include property, plant and equipment, goodwill and deferred tax liabilities. In addition, it is not practicable for the Corporation to estimate the tax ramifications related to the realization of the unrealized gains and losses and they have not been reflected in any of the estimates of fair value. The impact of these tax ramifications can have a significant effect on estimates of fair value.
The estimated fair values of the Corporations financial instruments at June 30, 2012 and December 31, 2011 are summarized as follows:
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:
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporations assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The following information pertains to assets measured by fair value on a recurring basis (in thousands):
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:
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.
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. Managements 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 Corporations 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.
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:
The weighted-average fair value of options granted in 2012 was $5.39.
Options outstanding at June 30, 2012 were as follows:
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:
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:
In the first quarter of 2012, the Corporation issued 62,105 shares of long-term restricted stock. The market price of the Corporations common shares on the date of grant of the long-term restricted 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 Corporations 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 Corporations common shares at the date of grant is used to estimate the fair value of restricted stock awards. A summary of the status of restricted shares at June 30, 2012 is presented in the table below: