XNAS:FBMI Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

 
 U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012

[   ]
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:  000-14209

FIRSTBANK CORPORATION
(Exact name of registrant as specified in its charter)
 
Michigan 38-2633910
(State of Incorporation) (I.R.S. Employer Identification No.)
   
311 Woodworth Avenue
Alma, Michigan
48801
(Address of principal executive offices) (Zip Code)
 
Registrant’s telephone number, including area code:  (989) 463-3131

Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.     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 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.
Large accelerated filer ___   Accelerated filer ___  Non-accelerated filer ­­­___   Smaller reporting company _X__
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes           No X  

Common stock outstanding at April 30, 2012: 7,930,346 shares.
 
 
 

 

INDEX


PART I. FINANCIAL INFORMATION  
 
Item 1.
Financial Statements (UNAUDITED)
Page   3

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Page  20

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Page  24

Item 4.
Controls and Procedures
Page  24


PART II.
OTHER INFORMATION

Item 5.
Other Information
Page  25

Item 6.
Exhibits
Page  25


SIGNATURES
Page  26

 
2

 
 
FIRSTBANK CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2012 AND DECEMBER 31, 2011
(Dollars in thousands)
UNAUDITED
 
    March 31     December 31,  
    2012     2011  
ASSETS
           
Cash and due from banks
  $ 26,452     $ 40,151  
Short term investments
    85,863       35,665  
   Total Cash and cash equivalents
    112,315       75,816  
                 
FDIC insured bank time certificates of deposit
    4,164       4,432  
Trading account securities
    2       2  
Securities available for sale
    353,804       342,184  
Federal Home Loan Bank stock
    7,266       7,266  
Loans held for sale
    5,417       349  
Loans, net of allowance for loan losses of $21,220 at March 31, 2012 and $21,019 at December 31, 2011
    961,092       962,890  
Premises and equipment, net
    24,845       25,087  
Goodwill
    35,513       35,513  
Core deposit and other intangibles
    1,302       1,448  
Other real estate owned
    4,022       5,251  
Accrued interest receivable and other assets
    23,809       25,061  
                 
TOTAL ASSETS
  $ 1,533,551     $ 1,485,299  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
LIABILITIES
               
   Deposits:
               
      Non-interest bearing accounts
  $ 220,653     $ 214,904  
      Interest bearing accounts:
               
         Demand
    354,889       340,942  
         Savings
    262,734       241,603  
         Time
    415,026       423,093  
            Total Deposits
    1,253,302       1,220,542  
                 
Securities sold under agreements to repurchase and overnight borrowings
    55,047       46,784  
Federal Home Loan Bank advances
    24,426       19,457  
Subordinated Debentures
    36,084       36,084  
Accrued interest and other liabilities
    7,236       7,055  
    Total Liabilities
    1,376,095       1,329,922  
                 
SHAREHOLDERS’ EQUITY
               
Preferred stock; no par value, 300,000 shares authorized, 33,000 issued
    32,800       32,792  
Common stock; 20,000,000 shares authorized, 7,911,209 shares issued and outstanding (7,892,486 at December 31, 2011)
    115,888       115,734  
Retained earnings
    5,485       3,955  
Accumulated other comprehensive income
    3,283       2,896  
     Total Shareholders’ Equity
    157,456       155,377  
                 
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
  $ 1,533,551     $ 1,485,299  

See notes to consolidated financial statements.

 
3

 
 
FIRSTBANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
MARCH 31, 2012 AND 2011
(Dollars in thousands except per share data)
UNAUDITED
 
    Three Months Ended March 31,  
    2012     2011  
Interest Income:
           
   Interest and fees on loans
  $ 14,568     $ 15,646  
   Securities
               
      Taxable
    1,221       1,011  
      Exempt from Federal Income Tax
    283       293  
   Short term investments
    54       39  
        Total Interest Income
    16,126       16,989  
Interest Expense:
               
   Deposits
    1,892       3,049  
   FHLB advances and other borrowing
    191       281  
   Subordinated Debt
    276       367  
        Total Interest Expense
    2,359       3,697  
        Net Interest Income
    13,767       13,292  
   Provision for loan losses
    2,494       3,011  
   Net Interest Income after provision for loan losses
    11,273       10,281  
Non-interest Income:
               
   Service charges on deposit accounts
    1,058       1,092  
   Gain on sale of mortgage loans
    1,695       568  
   Mortgage servicing, net of amortization
    (94 )     28  
   Gain/(loss) on trading account securities
    1       6  
   Gain/(loss) on securities
    13       (8 )
   Other
    541       359  
        Total Non-interest Income
    3,214       2,045  
Non-interest Expense:
               
   Salaries and employee benefits
    5,670       5,270  
   Occupancy and equipment
    1,361       1,424  
   FDIC insurance premium
    374       543  
   Amortization of intangibles
    145       185  
   Outside professional services
    303       263  
   Advertising and promotions
    364       264  
   Other real estate owned costs
    417       580  
   Other
    2,413       2,233  
        Total Non-interest Expense
    11,047       10,762  
                 
Income before federal income taxes
    3,440       1,564  
Federal income taxes
    1,023       349  
NET INCOME
    2,417     $ 1,215  
                 
Preferred stock dividends and accretion of discount on preferred stock
    420       420  
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
  $ 1,997     $ 795  
                 
COMPREHENSIVE INCOME
               
    Net Income
  $ 2,417     $ 1,215  
    Change in unrealized gain on securities, net of tax and reclassification effects
    387       310  
TOTAL COMPREHENSIVE INCOME
  $ 2,804     $ 1,525  
                 
   Basic Earnings Per Share
  $ 0.25     $ 0.10  
   Diluted Earnings Per Share
  $ 0.25     $ 0.10  
   Dividends Per Share
  $ 0.06     $ 0.01  
 
See notes to consolidated financial statements.
 
 
4

 

FIRSTBANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOW
                FOR THE THREE MONTHS ENDED
               MARCH 31, 2012 AND 2011
                (Dollars in thousands)
                UNAUDITED

    Three months ended March 31,  
   
2012
   
2011
 
OPERATING ACTIVITIES
           
   Net income
  $ 2,417     $ 1,215  
   Adjustments to reconcile net income to net cash provided by operating activities:
               
   Provision for loan losses
    2,494       3,011  
   Depreciation of premises and equipment
    486       542  
   Net amortization of security premiums/discounts
    940       923  
   Loss/(Gain) on trading account securities
    (1 )     (6 )
   Loss/(Gain) on securities transactions
    (13 )     8  
   Amortization and impairment of  intangibles
    145       185  
   Stock option and stock grant compensation expense
    21       33  
   Gain on sale of mortgage loans
    (1,695 )     (568 )
   Proceeds from sales of mortgage loans
    50,560       18,076  
   Loans originated for sale
    (53,933 )     (16,180 )
   Deferred federal income tax expense/(benefit)
    199       160  
   Decrease in accrued interest receivable and other assets
    901       801  
   Increase/(decrease) in accrued interest payable and other liabilities
    180       (183 )
        NET CASH PROVIDED BY OPERATING ACTIVITIES
    2,701       8,017  
                 
INVESTING ACTIVITIES
               
   Proceeds from sale of securities available for sale
    1,765       553  
   Proceeds from maturities of CD’s
    248       4,731  
   Proceeds from maturities and calls of securities available for sale
    31,521       22,390  
   Purchases of securities available for sale
    (45,227 )     (43,723 )
   Proceeds from sale of fixed assets
    1       1  
   Net (increase)/decrease in portfolio loans
    (869 )     12,149  
   Proceeds from sale of other real estate owned
    1,357       917  
   Net purchases of premises and equipment
    (245 )     (573 )
        NET CASH USED IN INVESTING ACTIVITIES
    (11,449 )     (3,555 )
                 
FINANCING ACTIVITIES
               
   Net increase/(decrease) in deposits
    32,760       33,936  
   Increase/(decrease) in securities sold under agreements to repurchase and other short term borrowings
    8,263       1,295  
   Repayment of Federal Home Loan Bank borrowings
    (3,031 )     (15,030 )
   Proceeds from Federal Home Loan Bank borrowings
    8,000       0  
   Cash proceeds from issuance of common stock, net
    142       70  
   Cash dividends-preferred stock
    (413 )     (412 )
   Cash dividends-common stock
    (474 )     (78 )
        NET CASH PROVIDED BY FINANCING ACTIVITIES
    45,247       19,781  
                 
INCREASE IN CASH AND CASH EQUIVALENTS
    36,499       24,243  
   Cash and cash equivalents at beginning of period
    75,816       73,538  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 112,315     $ 97,781  
                 
Supplemental Disclosure
               
   Interest Paid
  $ 2,885     $ 3,665  
   Income Taxes Paid
  $ 1,000     $ 725  
   Non cash transfers of loans to Other Real Estate Owned
  $ 172     $ 836  

See notes to consolidated financial statements.

 
5

 
 
FIRSTBANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2012
UNAUDITED

NOTE 1- FINANCIAL STATEMENTS

The accompanying unaudited financial information presented is for Firstbank Corporation (“Corporation”) and its wholly owned subsidiaries:  Firstbank - Alma, Firstbank (Mt. Pleasant), Firstbank - West Branch (including its wholly owned subsidiary; 1st Title, Inc., and its 48% ownership in 1st Investors Title, LLC, Keystone Community Bank, Firstbank – West Michigan and its wholly owned subsidiary Accord Financial Services, Inc., collectively the “Banks”, FBMI Risk Management Services, Inc., a company that provides insurance coverage to only affiliates of Firstbank Corporation, and Austin Mortgage Company, a company that holds certain performing and non-performing residential mortgage loans originated prior to the acquisition of ICNB Financial Corporation, and beginning in the second quarter of 2009 certain non-performing loans transferred from affiliate banks. All of the subsidiaries listed above are fully owned except 1st Investors Title, LLC, in which we have a 48% minority interest. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month periods ended March 31, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The balance sheet at December 31, 2011, has been derived from the audited financial statements at that date. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the year ended December 31, 2011.

Newly Adopted Accounting Standards

Effect of Newly Issued but not yet Effective Accounting Standards
 
NOTE 2 - INVESTMENTS

The following table presents information about our investment portfolio, showing the gross unrealized gains and losses within each segment of the portfolio. Unrealized gains and losses are included in other comprehensive income. Unrealized losses have been analyzed and determined to be temporary in nature. The unrealized losses are related to changes in the interest rate environment compared with rates at the time the securities were purchased.

(Dollars in Thousands)
 
Amortized Cost
   
Unrealized Gains
   
Unrealized Losses
   
Carrying Value
 
March 31, 2012
                       
Securities available for sale
                       
U.S. governmental agency
  $ 134,833     $ 1,255     $ (55 )   $ 136,033  
States and political subdivisions
    83,207       1,497       (51 )     84,653  
Mortgage backed securities
    69,763       1,457       (7 )     71,213  
Collateralized mortgage obligations
    59,389       881       (20 )     60,250  
Equity and other securities
    1,622       33       0       1,655  
  Total securities available for sale
  $ 348,814     $ 5,123     $ (133 )   $ 353,804  
                                 
December 31, 2011
                               
Securities available for sale
                               
U.S. governmental agency
  $ 132,534     $ 1,325     $ (25 )   $ 133,834  
States and political subdivisions
    76,574       1,238       (23 )     77,789  
Mortgage backed securities
    70,059       1,080       (87 )     71,052  
Collateralized mortgage obligations
    57,006       854       (15 )     57,845  
Equity and other securities
    1,606       58       0       1,664  
  Total securities available for sale
  $ 337,779     $ 4,555     $ (150 )   $ 342,184  

 
6

 
 
Securities with unrealized losses at March 31, 2012 and year end 2011 not recognized in income are as follows:

(In Thousands of Dollars)
 
Less than 12 Months
   
12 Months or More
   
Total
 
 
Description of Securities
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
 Value
   
Unrealized
Loss
 
March 31, 2012
                                   
US governmental agency
  $ 11,253     $ (55 )   $ 0     $ 0     $ 11,253     $ (55 )
States and political subdivisions
    7,437       (46 )     978       (5 )     8,415       (51 )
Mortgage backed securities
    2,725       (7 )     0       0       2,725       (7 )
Collateralized mortgage obligations
    2,204       (7 )     4,077       (13 )     6,281       (20 )
Total temporarily impaired
  $ 23,619     $ (115 )   $ 5,055     $ (18 )   $ 28,674     $ (133 )
                                                 
December 31, 2011
                                               
US governmental agencies
  $ 17,974     $ (25 )   $ 0     $ 0     $ 17,974     $ (25 )
States and political subdivisions
    5,987       (23 )     0       0       5,987       (23 )
Mortgage backed securities
    18,091       (87 )     0       0       18,091       (87 )
Collateralized mortgage obligations
    5,703       (11 )     887       (4 )     6,590       (15 )
Total temporarily impaired
  $ 47,755     $ (146 )   $ 887     $ (4 )   $ 48,642     $ (150 )

Unrealized losses on securities shown in the previous tables have not been recognized into income because management has the intent and ability to hold these securities for the foreseeable future. The decline in market value is due to changes in interest rates for debt securities and considered normal market fluctuations for equity securities. Management has also reviewed the issuers’ bond ratings, noting they are of high credit quality.

Trading account securities are marked to market with the change in value reported on the income statement. Gains and losses on available for sale securities are recognized if the security is either deemed to be other than temporarily impaired, or the security is sold. The following table shows gross gains and losses on investment securities for the three months ended March 31 of 2012 and 2011.

   
As of March 31,
 
(In Thousands of Dollars)
 
2012
   
2011
 
Trading Account Securities Gains/Losses
  $ 1     $ 6  
                 
Available for Sale Securities
               
  Gross realized gains
    13       0  
  Gross realized losses
    0       (8 )
  Net realized gains (losses)
  $ 13     $ (8 )

The carrying value of securities at March 31, 2012, by stated maturity, is shown below. Actual maturities may differ from stated maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
(In Thousands of Dollars)
 
Carrying Value
 
Due in one year or less
  $ 29,098  
Due after one year through five years
    178,884  
Due after five years through ten years
    66,797  
Due after ten years
    77,370  
   Total debt securities
    352,149  
         
Equity securities
    1,655  
   Total securities
  $ 353,804  

At March 31, 2012 and 2011, securities with carrying values approximating $53,971,000 and $49,958,000 were pledged to secure public trust deposits, securities sold under agreements to repurchase, and for such other purposes as required or permitted by law.

Federal Home Loan Bank stock is carried at cost, which approximates fair value.

 
7

 
 
NOTE 3 - LOANS

The following information provides a description of how loan grades are determined for our Commercial and Industrial and Commercial Real Estate Segments. In general, for Commercial and Industrial, and Commercial Real Estate Segments, the probability of loss increases with each rate change from the Grade 1 Excellent down through the Grade 9 Doubtful classes. For Consumer and Residential Mortgage segments, the probability of loss increases as loans move down from current to greater than 60 days past due, nonaccrual.

Grade 1 Excellent – Characteristics of loans in this category include: the loan is generally secured by cash or readily marketable securities; the borrower provides annual audited financials with interim financials reviewed quarterly; the loan has no delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; management of the company has over 15 years of experience; lines of credit have not and are not expected to be utilized; financial statements demonstrate consistently strong profits; and the company has little competition and excellent growth prospects.

Grade 2 Quality – Characteristics of loans in this category include: high net worth borrowers with excellent cash flow and a high degree of liquidity; the borrower generally has annual audited financial statements; there has been one or fewer delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; the company’s management has over ten years of experience; lines of credit have had nominal use over the preceding 12 months; financial statements demonstrate consistent profitability; and the company is in an excellent competitive position.

Grade 3 Good – Loans in this category are very strong, but may lack some of the net worth and/or cash flow characteristics of the previous rating. Characteristics of loans in this category include: annual reviewed financial statements and compiled quarterly financial statements, there has only been one or fewer delinquencies over 15 days in the past year, the company’s management has solid integrity, the company’s management is capable and has over five years of experience, lines of credit have regular usage with no balance in the last 60 days, financial statements demonstrate consistent but nominal profits, and the company has good a solid market share.

Grade 4 Acceptable – Characteristics of loans in this category include: annual compiled financial statements with quarterly information available or CPA prepared tax returns, there are only two or fewer delinquencies over 15 days of which only one is over 30 days in the past year, the company’s management has average business experience of over three years, lines of credit have regular use but have no current balance or a significant reduction in balance in the last 30 days, the company has been profitable in two of the preceding three years, and the company is competitive in its market and is maintaining its market share.

Loans graded as one through four are considered as Pass loans and are shown as one class of loans in our credit quality table.

Grade 5 Watch - This rating is used for loans which have shown some sign of weakness, but have not degraded to the point of requiring an impairment review. Characteristics of loans in this rating include: annual management prepared financial statements; delinquencies not exceeding three times over 30 days or one time over 60 days in the past year; weakening financial statements but profitable in two of the last three years; and a declining market share in a competitive market. These loans merit monitoring by management to assure that if circumstances deteriorate further actions are taken to protect the bank’s position.

Grade 6 Special Mention - This rating is used for loans which are included on a watch list and have degraded to a point where additional supervision is required; however, the bank remains confident in the full collection of all principal and interest. These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: repeat delinquency; longer term negative trends in financial results; continuing deterioration of cash flows; concerns regarding the liquidity of guarantors; and other negative business trends.

Grade 7 Substandard - This rating is for loans for which a lender is actively working with the borrower to resolve issues and the full repayment of the loan is questionable. The loan is inadequately protected by current sound worth of the borrower, paying capacity of the guarantor, or pledged collateral. Loans in this grade have well defined weaknesses that jeopardize the full collectability of the loan and a distinct possibility of loss exits.  These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: persistent delinquency; poor financial results of the business; negative cash flow; the ability of guarantor(s) to provide support for the loan is questionable.
 
 
8

 
 
Grade 8 Impaired Nonaccrual - This rating is for loans which are considered impaired and classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as substandard grade 7 above, with the added characteristic that, based upon currently known facts, the weaknesses make collection of all principal and interest due according to contractual terms unlikely. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.

Grade 9 Doubtful Nonaccrual- This rating is for loans which are considered impaired and are classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as impaired nonaccrual grade 8 above, with the added characteristic that the weaknesses make full collection through payment or liquidation of the collateral, based on currently known facts, highly questionable or improbable. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.

Restructured Loans
Impaired Restructured and Accruing - Loans where the borrower is experiencing financial difficulty and the bank has granted a concession to the borrower. A concession may be: a reduction in the contractual interest rate below current market rates for loans of similar quality, a lengthening of the accrual time frame beyond normal market terms, a forgiveness of a portion of the outstanding principal, or acceptance of collateral in lieu of payment for a portion of the loan balance. If the loan is in accrual status at the time of the restructuring, the borrower has the ability to make the payments under the restructured terms, and the restructuring does not forgive principal, the loan remains on an accrual status under the new terms. However, if there is a forgiveness of debt or partial charge off, the loan will generally be graded as impaired nonaccrual (Grade 8) with any accrued interest reversed against interest income. If a loan is in nonaccrual status at the time of a restructuring, it will remain in nonaccrual status (Grade 8) at the time of restructuring. All non-accruing restructured loans remain in nonaccrual status until the borrower has demonstrated the ability to make the payments under the restructured terms by making a minimum of six months of payments. If the borrower makes the six months of payments without becoming past due 30 days or more, the loan may be returned to accrual status. The determination of the need for an allowance for loan loss adjustment is based on a factor relating to historical losses multiplied times the balance of the loan for residential mortgages, or a collateral impairment review for commercial loans, and a net present value adjustment relating to a change in interest rate and other terms, if applicable.

Impaired Restructured and Accruing loans are graded seven or better based on the above definitions. If  a restructured loan is graded as eight or nine, it is reported as Impaired Nonaccrual, or Doubtful Nonaccrual, respectively.

For commercial loans graded eight and nine and consumer and residential mortgage loans reported in nonaccrual, interest income is generally not recognized until the loan improves and is returned to accrual status. In some cases, if the loan is well secured and the borrower’s ability to support the loan payments has improved, such as in the case of a restructured nonaccrual loan, interest income may be recognized on a cash basis while the loan is in nonaccrual status.

For Consumer and Residential Mortgage Loan Segments, loans are classified by risk based on current delinquency and nonaccrual status. These segments of loans will contain a separate class for restructured loans, if they exist.

The following credit quality indicators provide a system for distribution of our loan portfolio in a manner consistent with the previously described loan grading system and for use in the determination of our loan loss allowance. This presentation differs somewhat by loan category from classification of loans presented elsewhere in our regulatory reports and within this report. These variations primarily relate to how real estate loans are analyzed internally to determine the adequacy of the loan loss allowance, versus how we are required to report real estate loans for regulatory purposes.

 
9

 
 
Credit Quality Indicators:
 
Loans at period end were as follows:

(In Thousands of Dollars)
 
March 31,
 2012
   
December 31,
2011
 
Commercial & Industrial
           
  Pass loans
  $ 127,829     $ 122,812  
  Watch loans
    16,713       19,542  
  Special mention loans
    5,613       7,878  
  Substandard loans
    3,557       2,928  
  Impaired restructured and accruing loans
    2,432       3,562  
  Impaired nonaccrual loans
    1,581       1,771  
  Doubtful nonaccrual loans
    0       0  
Total Commercial & Industrial
    157,725       158,493  
                 
Commercial Real Estate
               
  Pass loans
  $ 371,789     $ 373,320  
  Watch loans
    58,073       56,571  
  Special mention loans
    20,536       21,155  
  Substandard loans
    6,207       5,686  
  Impaired restructured and accruing loans
    11,220       10,652  
  Impaired nonaccrual loans
    13,767       15,336  
  Doubtful nonaccrual loans
    0       0  
Total Commercial Real Estate
    481,592       482,720  
                 
First lien residential mortgage loans
               
  Performing loans
  $ 201,545     $ 199,117  
  Loans > 60 days past due
    1,435       2,203  
  Impaired restructured and accruing loans
    4,207       4,425  
  Nonaccrual loans
    5,807       5,374  
Total First lien residential mortgage loans
    212,994       211,119  
                 
Junior lien residential mortgage loans
               
  Performing loans
  $ 63,500     $ 66,169  
  Loans > 60 days past due
    193       328  
  Impaired restructured and accruing loans
    360       278  
  Nonaccrual loans
    250       278  
Total Junior lien residential mortgage loans
    64,303       67,053  
                 
Consumer Loans
               
  Performing loans
  $ 65,103     $ 64,075  
  Loans > 60 days past due
    110       239  
  Impaired restructured and accruing loans
    107       0  
  Nonaccrual loans
    378       210  
Total Consumer Loans
    65,698       64,524  
                 
Total Loans
  $ 982,312     $ 983,909  

Allowance for Loan Losses

The allowance for loan losses is determined based on management’s estimate of probable losses incurred within the loan portfolio as of the balance sheet date. We determine the amount of the allowance for loan losses based on periodic evaluation of the loan portfolios and other relevant factors. This evaluation is inherently subjective and requires material estimates, which are subject to change. Factors that are considered in the evaluation of individual, and pools of loans, include: historical loss experience; likelihood of default; liquidation value of a loan’s underlying collateral; timing and amounts of expected future cash flows; and our exposure to loss in the event of default. We further estimate the impact of qualitative factors that may cause future losses to differ from historical experience. Such factors include: changes in credit quality, macro economic impacts on our customers, and changes in underwriting standards.

Our historical loss experience is determined based on actual losses incurred over the previous twelve quarters. We utilize a method of averaging these losses whereby we place a heavier emphasis on more recent experience. Our model provides a 50% weighting on the most recent four quarters, 30% weighting on the middle four quarters, and 20% weighting on the oldest four quarters.

 
10

 
 
The loan portfolio is segmented into five loan types: commercial and industrial loans; commercial real estate loans; consumer loans; residential mortgages – first liens; and residential mortgage – junior liens. These segments are further grouped by credit quality classifications.

The segments comprising commercial and industrial loans and commercial real estate loans are classified based on the loan grading system described above. We group loans rated as one through four together into one class of Pass loans. Commercial and industrial and commercial real estate loans graded as Pass and Watch are assigned a unique pooled loss rate based on historical losses incurred over the prior three years as described above. We adjust the calculated historical loss rate up or down based on current developments, that in management’s judgment are not reflected in the historical losses of the company. The current outstanding balance for each of these classes of loans is then multiplied by the adjusted historical loss rate to determine the amount of allowance for loan losses to reserve on that pool of loans.

Loans graded special mention use a shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. That calculated historical loss rate is multiplied by a probability factor to determine a loss rate to be applied to this class of loans. The probability factor is determined from an analysis of the migration of special mention loans to more severe risk classes over the preceding 12 month period.

Loans graded as substandard use the shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. The calculated historical loss rate, without adjustment for migration, is then multiplied times the outstanding balance of substandard loans to determine the amount of allowance for loan losses to provide for this class of loans.

Loans graded as impaired nonaccrual, impaired doubtful, and impaired restructured and accruing are individually analyzed for loan losses. An allocated reserve is established within the allowance for loan losses for the difference between the carrying value of the loan and its determined collectable value. To determine the collectable value of the loan, the present value of expected cash flows, the collateral value, or some combination of the two is used. The allocated reserve is established as the difference between the carrying value of the loan and the collectable value.

For consumer and residential loan segments, loans that are current, or less than 60 days past due are assigned a unique historical loss rate as described above for commercial Pass and Watch loans. For loans that are more than 60 days past due including nonaccrual loans, a loss rate is determined based on charge offs within the last 12 months, divided by the sum of the average balance of loans 60 days or more past due and nonaccrual loans. These loss rates are multiplied by the outstanding balances in each unique loan segment at the end of the reporting period to determine the amount of allowance for loan loss.

For restructured loans where the bank has granted a rate concession, an additional amount is added to the loan loss reserve that represents the difference in the present value of the cash flows between the original terms and the new terms of the modified loan, using the original interest rate of the loan as a discount rate. Any change in the present value of the loan due to passage of time is reflected as an adjustment to provision for loan loss expense.

After each of the steps outlined above is completed, the results are aggregated and compared with the existing balance of the allowance for loan losses. If the aggregation is greater than the balance, the allowance for loan losses is increased through a charge to earnings on the provision for loan losses line. If the resulting aggregation is below the current balance of the allowance for loan losses, management will determine, based upon the number, potential impact, and uncertainty of the estimates contained within the process whether the unallocated reserve is excessive. If in management’s judgment the unallocated reserve exceeds a level deemed prudent given the inherent uncertainty of these issues, a reversal of the provision for loan losses may be recorded.
 
 
11

 

Allowance for credit losses and recorded investment in financing receivables:

(In Thousands of Dollars)
                                         
 
Three months ending March 31, 2012
 
Commercial and Industrial
   
Commercial Real Estate
   
First Lien Residential Mortgages
   
Junior Lien Residential Mortgages
   
Consumer Loans
   
 
Unallocated
   
 
Total
 
Allowance for Credit Losses:
                                         
Beginning balance
  $ 2,485     $ 11,534     $ 5,393     $ 505     $ 931     $ 171     $ 21,019  
Provision for loan losses
    3       1,525       707       221       165       (127 )     2,494  
Loans charged off
    (129 )     (1,340 )     (583 )     (194 )     (249 )     0       (2,495 )
Recoveries
    10       48       46       0       98        0       202  
Ending balance
  $ 2,369     $ 11,767     $ 5,563     $ 532     $ 945     $ 44     $ 21,220  
                                                         
Ending balance: individually evaluated for impairment
  $ 253     $ 3,399     $ 0     $ 0     $ 0     $ 0     $ 3,652  
                                                         
Ending balance: collectively evaluated for impairment
  $ 2,116     $ 8,368     $ 5,563     $ 532     $ 945     $ 44     $ 17,569  
                                                         
Financing Receivables:
                                                       
Ending balance
  $ 157,725     $ 481,592     $ 212,994     $ 64,303     $ 65,698     $ 0     $ 982,312  
                                                         
Ending balance: individually evaluated for impairment
  $ 4,013     $ 24,979     $ 0     $ 0     $ 0     $ 0     $ 28,992  
                                                         
Ending balance: collectively evaluated for impairment
  $ 154,433     $ 455,892     $ 212,994     $ 64,303     $ 65,698     $ 0     $ 953,320  
                                                         
Three months ending March 31, 2011
                                                       
Allowance for Credit Losses:
                                                       
Beginning balance
  $ 3,024     $ 12,375     $ 3,960     $ 774     $ 1,162     $ 136     $ 21,431  
Provision for loan losses
    386       1,813       519       105       24       164       3,011  
Loans charged off
    (760 )     (1,555 )     (461 )     (331 )     (181 )     0       (3,288 )
Recoveries
    112       4       4       0       73        0       193  
Ending balance
  $ 2,762     $ 12,637     $ 4,022     $ 548     $ 1,078     $ 300     $ 21,347  
                                                         
Ending balance: individually evaluated for impairment
  $ 313     $ 4,354     $ 0     $ 0     $ 0     $ 0     $ 4,667  
                                                         
Ending balance: collectively evaluated for impairment
  $ 2,449     $ 8,283     $ 4,022     $ 548     $ 1,078     $ 300     $ 16,680  
                                                         
Financing Receivables:
                                                       
Ending balance
  $ 161,261     $ 503,727     $ 201,048     $ 73,548     $ 75,980     $ 0     $ 1,015,564  
                                                         
Ending balance: individually evaluated for impairment
  $ 1,044     $ 24,825     $ 0     $ 0     $ 0     $ 0     $ 25,869  
                                                         
Ending balance: collectively evaluated for impairment
  $ 160,217     $ 478,902     $ 201,048     $ 73,548     $ 75,980     $ 0     $ 989,695  

 
12

 
 
Age Analysis of Past Due Loans excluding nonaccrual loans:

(In thousands of dollars)
                                         
At March 31, 2012
 
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days
or More
Past Due
   
Total
Past Due
   
Current
   
Total Financing Receivables
   
Recorded Investment > 90 days and accruing
 
Commercial and Industrial
  $ 480     $ 75     $ 529     $ 1,084     $ 155,781     $ 157,725     $ 530  
Commercial Real Estate
    1,106       1,049       67       2,222       464,882       481,592       67  
Residential Mortgages 1st Liens
    654       1,001       562       2,217       204,970       212,994       573  
Residential Mortgages Junior Liens
    441       37       27       505       63,548       64,303       27  
Consumer
    328       110       0       438       63,882       65,698       0  
  Total
  $ 3,009     $ 2,272     $ 1,185     $ 6,466     $ 953,063     $ 982,312     $ 1,197  
                                                         
At December 31, 2011
                                                       
Commercial and Industrial
  $ 1,039     $ 94     $ 0     $ 1,133     $ 157,360     $ 158,493     $ 0  
Commercial Real Estate
    4,313       500       0       4,813       477,907       482,720       0  
Residential Mortgages 1st Liens
    973       1,875       328       3,176       208,221       211,397       328  
Residential Mortgages Junior Liens
    561       255       73       889       65,886       66,775       73  
Consumer
    848       221       18       1,087       63,437       64,524       18  
  Total
  $ 7,734     $ 2,945     $ 419     $ 11,098     $ 972,811     $ 983,909     $ 419  

 
13

 
 
Impaired loans were as follows:

(In Thousands of Dollars)
                 
March 31, 2012
 
Recorded Investment
   
Unpaid Principal Balance
   
Related
Allowance
   
Average
Recorded Investment
   
Interest Income Recognized
 
Period end loans with no allocated allowance for loan losses
                             
   Commercial and Industrial
  $ 3,504     $ 3,504       0     $ 3,931     $ 72  
   Commercial Real Estate
    11,393       11,392       0       11,667       318  
   Residential Mortgages 1st Liens
    10,014       10,014       0       10,047       123  
   Residential Mortgages Junior Liens
    610       610       0       444       3  
   Consumer
    485       485       0       348       8  
     Total
  $ 26,006     $ 26,005     $ 0     $ 26,437     $ 524  
                                         
Period end loans with allocated allowance for loan losses
                                       
   Commercial and Industrial
  $ 257     $ 509     $ 253     $ 615     $ 13  
   Commercial Real Estate
    10,190       13,587       3,399       12,118       51  
   Residential Mortgages 1st Liens
    0       0       0       0       0  
   Residential Mortgages Junior Liens
    0       0       0       0       0  
   Consumer
    0       0       0       0       0  
     Total
  $ 10,447     $ 14,096     $ 3,652     $ 12,733     $ 64  
                                         
Total
                                       
   Commercial and Industrial
  $ 3,761     $ 4,013     $ 253     $ 4,546     $ 85  
   Commercial Real Estate
    21,583       24,979       3,399       23,785       369  
   Residential Mortgages 1st Liens
    10,014       10,014       0       10,047       123  
   Residential Mortgages Junior Liens
    610       610       0       444       3  
   Consumer
    485       485       0       348       8  
     Total
  $ 36,453     $ 40,101     $ 3,652     $ 39,170     $ 588  
                                         
December 31, 2011
                                       
Period end loans with no allocated allowance for loan losses
                                       
   Commercial and Industrial
  $ 4,358     $ 5,846       0     $ 2,073     $ 116  
   Commercial Real Estate
    11,940       16,987       0       12,444       452  
   Residential Mortgages 1st Liens
    10,079       11,120       0       9,223       219  
   Residential Mortgages Junior Liens
    278       331       0       459       2  
   Consumer
    210       249       0       192       0  
     Total
  $ 26,865     $ 34,533     $ 0     $ 24,391     $ 789  
                                         
Period end loans with allocated allowance for loan losses
                                       
   Commercial and Industrial
  $ 720     $ 998     $ 253     $ 722     $ 0  
   Commercial Real Estate
    10,423       15,225       3,622       9,003       28  
   Residential Mortgages 1st Liens
    0       0       0       0       0  
   Residential Mortgages Junior Liens
    0       0       0       0       0  
   Consumer
    0       0       0       0       0  
     Total
  $ 11,143     $ 16,223     $ 3,875     $ 9,725     $ 28  
                                         
Total
                                       
   Commercial and Industrial
  $ 5,078     $ 6,844     $ 253     $ 2,795     $ 116  
   Commercial Real Estate
    22,363       32,212       3,622       21,447       480  
   Residential Mortgages 1st Liens
    10,079       11,120       0       9,223       219  
   Residential Mortgages Junior Liens
    278       331       0       459       2  
   Consumer
    210       249       0       192       0  
     Total
  $ 38,008     $ 50,756     $ 3,875     $ 34,116     $ 817  

 
14

 
 
Loan Modifications as of the period ending:

(In thousands of dollars)
 
Troubled Debt Restructurings
   
Troubled Debt Restructurings that Subsequently Defaulted
 
   
 
Number of contracts
   
Pre-modification outstanding recorded investment
   
Post-modification outstanding recorded investment
   
 
Number of contracts
   
 
Recorded investment
 
March 31, 2012
                             
Commercial and industrial
    5     $ 787     $ 782       0     $ 0  
Commercial real estate
    8       1,985       1,983       4       1,047  
Residential 1st liens
    4       377       377       6       561  
Residential junior liens
    2       103       103       0       0  
Consumer
    2       107       107       0       0  
   Total
    21     $ 3,359     $ 3,352       10     $ 1,608  
                                         
March 31, 2011
                                       
Commercial and industrial
    2     $ 95     $ 99       1     $ 150  
Commercial real estate
    4       354       354       1       995  
Residential 1st liens
    3       330       351       2       136  
Residential junior liens
    0       0       0       0       0  
Consumer
    0       0       0       0       0  
   Total
    9     $ 779     $ 804       4     $ 1,281  

Financing Receivables on Nonaccrual Status were as follows:

(In Thousands of Dollars)
 
March 31,
 2012
   
December 31,
 2011
 
Nonaccrual loans at period end
           
  Commercial and Industrial
  $ 1,580     $ 1,771  
  Commercial Real Estate
    13,760       15,336  
  Residential Mortgages 1st Liens
    5,807       5,374  
  Residential Mortgages Junior Liens
    250       278  
  Consumer
    378       210  
Total nonaccrual loans
  $ 21,775     $ 22,969  

 
15

 
 
NOTE 4 – FAIR VALUE

Carrying amount and estimated fair values of financial instruments were as follows:

March 31, 2012
(In Thousands of Dollars)
 
Carrying
Amount
   
Estimated
Fair Value
   
Quoted Prices in Active Markets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
                               
Financial Assets:
                             
     Cash and cash equivalents
  $ 112,315     $ 112,315     $ 112,315       -       -  
      FDIC insured bank certificates of deposit
    4,164       4,164       4,164       -       -  
     Trading account securities
    2       2       2       -       -  
     Securities available for sale
    353,804       353,804       67       337,109       16,628  
     Federal Home Loan Bank stock
    7,266       7,266       -       -