|• FORM 10-Q • EXHIBIT 31.1 • EXHIBIT 31.2 • EXHIBIT 32.1 • EXHIBIT 99.1|
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly period ended June 30, 2012
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-24047
GLEN BURNIE BANCORP
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (410) 766-3300
(Former name, former address and former fiscal year if changed from 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 if 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At August 6, 2012, the number of shares outstanding of the registrant’s common stock was 2,730,212.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
GLEN BURNIE BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
See accompanying notes to condensed consolidated financial statements.
GLEN BURNIE BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, Except Per Share Amounts)
See accompanying notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
See accompanying notes to condensed consolidated financial statements.
GLEN BURNIE BANCORP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
See accompanying notes to condensed consolidated financial statements.
GLEN BURNIE BANCORP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying condensed balance sheet as of December 31, 2011, which has been derived from audited financial statements, and the unaudited interim consolidated financial statements were prepared in accordance with instructions for Form 10-Q and Article 10 of Regulation S-X and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in stockholders’ equity, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary for a fair presentation of the unaudited consolidated financial statements have been included in the results of operations for the three and six months ended June 30, 2012 and 2011.
Operating results for the three and six months ended June 30, 2012 is not necessarily indicative of the results that may be expected for the year ending December 31, 2012.
NOTE 2 - EARNINGS PER SHARE
Basic earnings per share of common stock are computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted earnings per share are calculated by including the average dilutive common stock equivalents outstanding during the periods. Dilutive common equivalent shares consist of stock options, calculated using the treasury stock method.
Diluted earnings per share calculations were not required for the three and six months ended June 30, 2012 and 2011, since there were no options outstanding.
NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued several exposure drafts which, if adopted, would significantly alter the Company’s (and all other financial institutions’) method of accounting for, and reporting, its financial assets and some liabilities from a historical cost method to a fair value method of accounting as well as the reported amount of net interest income. Also, the FASB has issued an exposure draft regarding a change in the accounting for leases. Under this exposure draft, the total amount of “lease rights” and total amount of future payments required under all leases would be reflected on the balance sheets of all entities as assets and debt. If the changes under discussion in either of these exposure drafts are adopted, the financial statements of the Company could be materially impacted as to the amounts of recorded assets, liabilities, capital, net interest income, interest expense, depreciation expense, rent expense and net income. The Company has not determined the extent of the possible changes at this time. The exposure drafts are in different stages of review, approval and possible adoption.
In April 2011, the FASB issued ASU No. 2011-02, Receivable (Topic 310), A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. The main objective of the ASU is to clarify a creditor’s evaluation of whether in modifying a loan, it has granted a concession in circumstances that qualify the loan as a Troubled Debt Restructured (TDR) loan. These loans are subject to various accounting and disclosure requirements. The ASU was effective for the first interim or annual period beginning on or after June 15, 2011, and was applied retrospectively to the beginning of the annual period of adoption. Certain disclosures are required for loans considered as TDR loans resulting from the application of the ASU that were not considered TDR under prior guidance. The Company’s compliance with ASU No. 2011-02 did not have a material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The main objective of the ASU is to conform the requirements for measuring fair value and the disclosure information under U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for the disclosure about fair value measurements. Other amendments clarify existing requirements and change particular principles or requirements for measuring fair value or disclosing information about fair value measurements. The ASU was effective for the first interim or annual period beginning on or after December 15, 2011, early application for public entities is not permitted. The Company’s compliance with ASU No. 2011-04 did not have a material impact on the Company’s consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive.
In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary's operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. Early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.
In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has provided the necessary disclosure in the Consolidated Statement of Comprehensive Income.
NOTE 4 – FAIR VALUE
ASC 820-10, formerly SFAS No. 157, defines fair value, establishes a framework for measuring fair value and expands disclosure of fair value measurements.
Fair Value Hierarchy
ASC 820-10 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820-10, these inputs are summarized in the three broad levels listed below:
£ Level 1 – Quoted prices in active markets for identical securities
£ Level 2 – Other significant observable inputs (including quoted prices in active markets for similar securities)
£ Level 3 – Significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments)
In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to ASC 820-10.
The Company’s bond holdings in the investment securities portfolio are the only asset or liability subject to fair value measurements on a recurring basis. No assets are valued under Level 1 inputs at June 30, 2012 or December 31, 2011. The Company has assets measured by fair value measurements on a non-recurring basis during 2012. At June 30, 2012, these assets include 20 loans classified as impaired, which include nonaccrual, past due 90 days or more and still accruing, or troubled debt restructuring, and a homogeneous pool of indirect loans all considered to be impaired loans, which are valued under Level 3 inputs and two properties classified as OREO valued under Level 2 inputs.
The changes in the assets subject to fair value measurements are summarized below by Level:
The estimated fair values of the Company’s financial instruments at June 30, 2012 and December 31, 2011 are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.
Fair values are based on quoted market prices for similar instruments or estimated using discounted cash flows. The discounts used are estimated using comparable market rates for similar types of instruments adjusted to be commensurate with the credit risk, overhead costs and optionality of such instruments.
The fair value of cash and due from banks, federal funds sold, investments in restricted stocks and accrued interest receivable are equal to the carrying amounts. The fair values of investment securities are determined using market quotations. The fair value of loans receivable is estimated using discounted cash flow analysis.
The fair value of non-interest bearing deposits, interest-bearing checking, savings, and money market deposit accounts, securities sold under agreements to repurchase, and accrued interest payable are equal to the carrying amounts. The fair value of fixed-maturity time deposits is estimated using discounted cash flow analysis.
The gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2012 are as follows:
At June 30, 2012, the company owned one pooled trust preferred security issued by Regional Diversified Funding, Senior Notes with a Fitch rating of C. The market for these securities at June 30, 2012 was not active and markets for similar securities were also not active. As a result, the Company had cash flow testing performed as of June 30, 2012 by an unrelated third party in order to measure the possible extent of other-than-temporary-impairment (“OTTI”). This testing assumed future defaults on the currently performing financial institutions of 150 basis points applied annually with a 0% recovery on both current and future defaulting financial institutions. As a result of this testing, no write-down was required in the second quarter of 2012. A write-down of $22,000 was taken on this security in the first quarter of 2011.
Maryland Financial Bank stock was written down $70,000 in the second quarter of 2011 due to a prospectus that offered stock at a discount from par.
Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary-impairment losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain it’s investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
As of June 30, 2012, management had the ability and intent to hold the securities classified as available for sale for a period of time sufficient for a recovery of cost. On June 30, 2012 the Bank held 3 investment securities having continuous unrealized loss positions for more than 12 months. Management has determined that all unrealized losses are either due to increases in market interest rates over the yields available at the time the underlying securities were purchased, current call features that are nearing, and the effect the sub-prime market has had on all mortgage-backed securities. The Bank has no mortgage-backed securities collateralized by sub-prime mortgages. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of credit quality. Except as noted above, as of June 30, 2012, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated income statement.
A rollforward of the cumulative other-than-temporary credit losses recognized in earnings for all debt securities for which a portion of an other-than-temporary loss is recognized in accumulated other comprehensive loss is as follows:
When used in this discussion and elsewhere in this Form 10-Q, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and readers are advised that various factors could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from those anticipated or projected. While it is impossible to identify all such factors, such factors include, but are not limited to, those risks identified in the Company’s periodic reports filed with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K.
The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Glen Burnie Bancorp, a Maryland corporation (the “Company”), through its subsidiary, The Bank of Glen Burnie, a Maryland banking corporation (the “Bank”), operates a commercial bank with eight offices in Anne Arundel County Maryland. The Company had consolidated net income of $656,000 ($0.24 basic and diluted earnings per share) for the second quarter of 2012, compared to the second quarter of 2011 consolidated net income of $758,000 ($0.28 basic and diluted income per share), a 13.46% decrease. Year-to-date net income was $1,386,000 ($0.51 basic and diluted earnings per share), compared to the 2011 consolidated net income of $1,467,000 ($0.54 basic and diluted income per share), a 5.53% decrease. The decreases in net income for the second quarter and year-to-date were primarily due to decreases in income on loans, U.S. Government agency securities, service charges and gains on investment securities. These decreases were partially offset by decreases in other expenses for the respective periods. During the six months ended June 30, 2012, the Bank increased deposits by almost $9.9 million and increased net loans by $16.6 million.
Results Of Operations
Net Interest Income. The Company’s consolidated net interest income prior to provision for credit losses for the three and six months ended June 30, 2012 was $3,098,000 and $6,306,000 respectively, compared to $3,396,000 and $6,743,000 for the same period in 2011, a decrease of $298,000 (8.78%) for the three months and a decrease of $437,000 (6.48%) for the six months.
Interest income for the second quarter decreased from $4,323,000 in 2011 to $3,928,000 in 2012, a 9.14% decrease. Interest income for the six months decreased from $8,609,000 in 2011 to $7,984,000 in 2012, a 7.26% decrease. While the Bank’s net loans increased during these periods, interest income decreased for the three and six month periods due to lower rates earned on U.S. Government agency securities, partially offset by an increase in income on state and municipal securities.
Interest expense for the second quarter decreased from $927,000 in 2011 to $830,000 in 2012, a 10.46% decrease. Interest expense for the six months decreased from $1,866,000 in 2011 to $1,678,000 in 2012, a 10.08% decrease. While total deposits increased during the six months ended June 30, 2012, interest paid on deposit balances for the three and six month periods ended June 30, 2012 decreased due to lower interest rates paid on deposit balances.
Net interest margins on a tax equivalent basis for the three and six months ended June 30, 2012 was 3.86% and 3.95%, compared to 4.36% and 4.40% for the three and six months ended June 30, 2011. The decrease of the net interest margin from the 2011 to 2012 period was primarily due to the decline in the interest rates on loans and U.S. Government Agency securities partially offset by the reduction in interest expense, as noted above.
Provision for Credit Losses. The Company made a provision for credit losses of $0 during the three and six month periods ended June 30, 2012 and $0 and $225,000 for credit losses during the three and six month periods ended June 30, 2011. As of June 30, 2012, the allowance for credit losses equaled 80.59% of non-accrual and past due loans compared to 77.38% at December 31, 2011 and 72.77% at June 30, 2011. During the three and six month periods ended June 30, 2012, the Company recorded net charge-offs of $44,000 and $149,000, compared to net (recoveries) charge-offs of ($43,000) and $30,000 during the corresponding period of the prior year. On an annualized basis, net charge-offs for the 2012 period represent 0.12% of the average loan portfolio.
Other Income. Other income decreased from $489,000 for the three month period ended June 30, 2011, to $422,000 for the corresponding 2012 period, a $67,000 (13.71%) decrease. For the six month period, other income decreased from $1,100,000 at June 30, 2011, to $840,000 for the corresponding 2012 period, a $260,000 (23.64%) decrease. The decrease for the three and six month period was due to a decrease in gains on investment securities and service charges on deposit accounts.
Other Expenses. Other expenses decreased from $2,887,000 for the three month period ended June 30, 2011, to $2,715,000 for the corresponding 2012 period, a $172,000 (5.96%) decrease. Other expenses decreased from $5,698,000 for the six month period ended June 30, 2011, to $5,401,000 for the corresponding 2012 period, a $297,000 (5.22%) decrease. The decrease for the three month period was primarily due to the decrease in impairment on securities and FDIC expenses, partially offset by an increase in salaries. The decrease for the six month period was due to a decrease in FDIC expenses, other real estate owned (OREO) expenses, legal expenses, and the impairment on securities, partially offset by an increase in salaries and employee benefits.
Income Taxes. During the three and six months ended June 30, 2012, the Company recorded income tax expense of $149,000 and $359,000, compared to income tax expense of $240,000 and $453,000 for the same respective periods in 2011. The Company’s effective tax rate for the three and six month period in 2012 was 18.51% and 20.58%, respectively, compared to 24.05% and 23.59% for the prior year period. The decrease in the effective tax rate for the three and six month period was due to an increase in the proportion of tax exempt income included in net interest income.
Comprehensive Income. In accordance with regulatory requirements, the Company reports comprehensive income in its financial statements. Comprehensive income consists of the Company’s net income, adjusted for unrealized gains and losses on the Bank’s investment portfolio of investment securities. For the second quarter of 2012, comprehensive income, net of tax, totaled $558,000, compared to the June 30, 2011 comprehensive income of $1,833,000. Year-to-date, comprehensive income, net of tax, totaled $1,577,000, as of June 30, 2012, compared to the June 30, 2011 comprehensive income of $3,206,000. The decrease was due to a decrease in net income and a decrease in the net unrealized gains on securities arising during the three and six month periods.
General. The Company’s assets increased to $378,939,000 at June 30, 2012 from $365,260,000 at December 31, 2011, primarily due to an increase in loans, partially offset by a decrease in OREO. The Bank’s net loans totaled $249,353,000 at June 30, 2012, compared to $232,734,000 at December 31, 2011, an increase of $16,619,000 (7.14%), primarily attributable to an increase in indirect lending with lesser increases in purchase money mortgages and commercial mortgages.
The Company’s total investment securities portfolio (investment securities available for sale) totaled $102,510,000 at June 30, 2012, a $357,000 (0.35%) decrease from $102,867,000 at December 31, 2011. The Bank’s cash and due from banks (cash due from banks, interest-bearing deposits in other financial institutions, and federal funds sold), as of June 30, 2012, totaled $7,483,000, a decrease of $2,471,000 (24.83%) from the December 31, 2011 total of $9,954,000. This decrease was used to fund loan growth.
Deposits as of June 30, 2012, totaled $321,798,000, which is an increase of $9,853,000 (3.16%) from $311,945,000 at December 31, 2011. Demand deposits as of June 30, 2012, totaled $78,574,000, which is an increase of $5,235,000 (7.14%) from $73,339,000 at December 31, 2011. NOW accounts as of June 30, 2012, totaled $26,138,000, which is an increase of $2,099,000 (8.73%) from $24,039,000 at December 31, 2011. Money market accounts as of June 30, 2012, totaled $19,423,000, which is an increase of $1,339,000 (7.40%), from $18,084,000 at December 31, 2011. Savings deposits as of June 30, 2012, totaled $65,611,000, which is an increase of $5,547,000 (9.24%) from $60,064,000 at December 31, 2011. Certificates of deposit over $100,000 totaled $29,624,000 on June 30, 2012, which is a decrease of $1,791,000 (5.70%) from $31,415,000 at December 31, 2011. Other time deposits (made up of certificates of deposit less than $100,000 and individual retirement accounts) totaled $102,428,000 on June 30, 2012, which is a $2,576,000 (2.45%) decrease from the $105,004,000 total at December 31, 2011.
Asset Quality. The following tables set forth the amount of the Bank’s current, past due, and non-accrual loans by categories of loans and restructured loans, at the dates indicated.
The following table analyzes the age of past due loans, including both accruing and non-accruing loans, segregated by class of loans as of the three months ended June 30, 2012 and the year ended December 31, 2011.
At June 30, 2012, there was $3,875,000 in loans outstanding, included in the current and 30-89 days past due columns in the above table, as to which known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms. Such loans consist of loans which were not 90 days or more past due but where the borrower is in bankruptcy or has a history of delinquency, or the loan to value ratio is considered excessive due to deterioration of the collateral or other factors.
Non-accrual loans with specific reserves at June 30, 2012 are comprised of:
Commercial loans - Two loans to one borrower totaling $19,000 with $19,000 of specific reserves established.
Commercial Real Estate – Two loans to two borrowers in the amount of $4,097,000, secured by commercial and/or residential properties with a specific reserve of $997,000 established for the loans.
Below is a summary of the recorded investment amount and related allowance for losses of the Bank’s impaired loans at June 30, 2012 and December 31, 2011.
Loans that were restructured by the Bank by categories of loans at June 30, 2012 are as follows:
At June 30, 2012, the Bank has one modified residential loan (done in 2011) in the amount of $1,280,423 which modifications qualify the loan as Troubled Debt Restructuring (TDR). The loan is included in the schedule above of accruing impaired loans. This borrower is in compliance with the modified term and is accruing interest. The Bank has one modified commercial real estate loan (done in 2010) in the amount of $2,817,000 which modifications qualify the loan as Troubled Debt Restructuring (TDR). The loan is included in the schedule above of non-accruing impaired loans. This borrower is not in compliance with the modified term and is not accruing interest.
Credit Quality Information
The following tables represent credit exposures by creditworthiness category for the quarter ending June 30, 2012 and the year ended December 31, 2011. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Bank’s internal creditworthiness is based on experience with similarly graded credits. Loans that trend upward toward higher credit grades typically have less credit risk and loans that migrate downward typically have more credit risk.
The Bank’s internal risk ratings are as follows:
Loans rated 1-4 are considered “Pass” for purposes of the risk rating chart below.
Risk ratings of loans by categories of loans are as follows:
Allowance For Credit Losses. The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. The allowance, based on evaluations of the collectability of loans and prior loan loss experience, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations are performed for each class of loans and take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, value of collateral securing the loans and current economic conditions and trends that may affect the borrowers’ ability to pay. For example, delinquencies in unsecured loans and indirect automobile installment loans will be reserved for at significantly higher ratios than loans secured by real estate. Based on that analysis, the Bank deems its allowance for credit losses in proportion to the total non-accrual loans and past due loans to be sufficient.
Transactions in the allowance for credit losses for the six months ended June 30, 2012 and the year ended December 31, 2011 were as follows:
During 2012, loans to 34 borrowers and related entities totaling approximately $377,000 were determined to be uncollectible and were charged off.
Reserve for Unfunded Commitments. As of June 30, 2012, the Bank had outstanding commitments totaling $26,176,000. These outstanding commitments consisted of letters of credit, undrawn lines of credit, and other loan commitments. The following table shows the Bank’s reserve for unfunded commitments arising from these transactions:
Contractual Obligations and Commitments. No material changes, outside the normal course of business, have been made during the second quarter of 2012.
Market Risk and Interest Rate Sensitivity
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates or equity pricing. The Company’s principal market risk is interest rate risk that arises from its lending, investing and deposit taking activities. The Company’s profitability is dependent on the Bank’s net interest income. Interest rate risk can significantly affect net interest income to the degree that interest bearing liabilities mature or reprice at different intervals than interest earning assets. The Bank’s Asset/Liability and Risk Management Committee oversees the management of interest rate risk. The primary purpose of the committee is to manage the exposure of net interest margins to unexpected changes due to interest rate fluctuations. The Company does not utilize derivative financial or commodity instruments or hedging strategies in its management of interest rate risk. The primary tool used by the committee to monitor interest rate risk is a “gap” report which measures the dollar difference between the amount of interest bearing assets and interest bearing liabilities subject to repricing within a given time period. These efforts affect the loan pricing and deposit rate policies of the Company as well as the asset mix, volume guidelines, and liquidity and capital planning.
The following table sets forth the Company’s interest-rate sensitivity at June 30, 2012.
The foregoing analysis assumes that the Company’s assets and liabilities move with rates at their earliest repricing opportunities based on final maturity. Mortgage backed securities are assumed to mature during the period in which they are estimated to prepay and it is assumed that loans and other securities are not called prior to maturity. Certificates of deposit and IRA accounts are presumed to reprice at maturity. NOW savings accounts are assumed to reprice at within three months although it is the Company’s experience that such accounts may be less sensitive to changes in market rates.
In addition to GAP analysis, the Bank utilizes a simulation model to quantify the effect a hypothetical immediate plus or minus 200 basis point change in rates would have on net interest income and the economic value of equity. The model takes into consideration the effect of call features of investments as well as prepayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of June 30, 2012, the model produced the following sensitivity profile for net interest income and the economic value of equity.
Liquidity and Capital Resources
The Company currently has no business other than that of the Bank and does not currently have any material funding commitments. The Company’s principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends.
The Bank’s principal sources of funds for investments and operations are net income, deposits from its primary market area, principal and interest payments on loans, interest received on investment securities and proceeds from maturing investment securities. Its principal funding commitments are for the origination or purchase of loans and the payment of maturing deposits. Deposits are considered a primary source of funds supporting the Bank’s lending and investment activities.
The Bank’s most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, federal funds sold, certificates of deposit with other financial institutions that have an original maturity of three months or less and money market mutual funds. The levels of such assets are dependent on the Bank’s operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows. The Bank’s cash and cash equivalents (cash due from banks, interest-bearing deposits in other financial institutions, and federal funds sold), as of June 30, 2012, totaled $7,483,000, a decrease of $2,471,000 (24.83%) from the December 31, 2011 total of $9,954,000.
As of June 30, 2012, the Bank was permitted to draw on a $39,590,000 line of credit from the FHLB of Atlanta. Borrowings under the line are secured by a floating lien on the Bank’s residential mortgage loans. As of June 30, 2012, there were $20.0 million in long-term convertible advances outstanding with various monthly and quarterly call features and with final maturities through August 2018. There was also $3.0 million in short-term advances outstanding at FHLB Atlanta. In addition, the Bank has two unsecured federal funds lines of credit in the amount of $3.0 million from a commercial bank and a $5.0 million from a financial bank, of which nothing was outstanding as of June 30, 2012.
The Company’s stockholders’ equity increased $1,106,000 (3.55%) during the six months ended June 30, 2012, due mainly to a decrease in other comprehensive gain, net of taxes, and an increase in retained net income from the period. The Company’s accumulated other comprehensive gain (loss), net of taxes (benefits) increased by $191,000 (10.35%) from $1,846,000 at December 31, 2011 to $2,037,000 at June 30, 2012, as a result of an increase in the market value of securities classified as available for sale. Retained earnings increased by $842,000 (4.90%) as the result of the Company’s net income for the six months, partially offset by dividends. Common stock and surplus increased due to dividend reinvestment during the six months of 2012. In addition, $73,550 was transferred within stockholders’ equity in consideration for shares to be issued under the Company’s dividend reinvestment plan in lieu of cash dividends.
The Federal Reserve Board and the FDIC have established guidelines with respect to the maintenance of appropriate levels of capital by bank holding companies and state non-member banks, respectively. The regulations impose two sets of capital adequacy requirements: minimum leverage rules, which require bank holding companies and banks to maintain a specified minimum ratio of capital to total assets, and risk-based capital rules, which require the maintenance of specified minimum ratios of capital to “risk-weighted” assets. At June 30, 2012, the Bank was in full compliance with these guidelines with a Tier 1 leverage ratio of 7.97%, a Tier 1 risk-based capital ratio of 12.58% and a total risk-based capital ratio of 13.83%.
Critical Accounting Policies and Estimates
The Company’s accounting policies are more fully described in its Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. As discussed there, the preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Since future events and their effects cannot be determined with absolute certainty, the determination of estimates requires the exercise of judgment. Management has used the best information available to make the estimations necessary to value the related assets and liabilities based on historical experience and on various assumptions which are believed to be reasonable under the circumstances. Actual results could differ from those estimates, and such differences may be material to the financial statements. The Company reevaluates these variables as facts and circumstances change. Historically, actual results have not differed significantly from the Company’s estimates. The following is a summary of the more judgmental accounting estimates and principles involved in the preparation of the Company’s financial statements, including the identification of the variables most important in the estimation process:
Allowance for Credit Losses. The Bank’s allowance for credit losses is determined based upon estimates that can and do change when the actual events occur, including historical losses as an indicator of future losses, fair market value of collateral, and various general or industry or geographic specific economic events. The use of these estimates and values is inherently subjective and the actual losses could be greater or less than the estimates. For further information regarding the Bank’s allowance for credit losses, see “Allowance for Credit Losses”, above.
Accrued Taxes. Management estimates income tax expense based on the amount it expects to owe various tax authorities. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains a system of disclosure controls and procedures that is designed to provide reasonable assurance that information, which is required to be disclosed by the Company in the reports that it files or submits under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and is accumulated and communicated to management in a timely manner. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated this system of disclosure controls and procedures as of the end of the period covered by this quarterly report, and have concluded that the system is effective. There have been no changes in the Company’s internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.