XNAS:MBRG Middleburg Financial Corp. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2012
 
or
 
[   ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number:  0-24159
 
MIDDLEBURG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
Virginia
(State or other jurisdiction of
incorporation or organization) 
54-1696103
(I.R.S. Employer
Identification No.)
111 West Washington Street
Middleburg, Virginia
(Address of principal executive offices)
 
20117
(Zip Code)

(703) 777-6327
(Registrant’s telephone number, including area code)

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  R
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  R
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes  £
No  R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.   7,055,290 shares of Common Stock as of July 31, 2012.
 


 
 


MIDDLEBURG FINANCIAL CORPORATION

INDEX
 
Page No.
       
 
       
   
       
   
       
   
       
   
       
   
       
   
       
   
    31 
       
  48 
       
  49 
       
       
 
       
  49 
       
  49 
       
  49 
       
  49 
       
  49 
       
  49 
       
  50 
       
51 
 
 
2


PART I.  FINANCIAL INFORMATION


MIDDLEBURG FINANCIAL CORPORATION
 
 
(In thousands, except for share and per share data)
 
 
 
     (Unaudited)      
     June 30,      December 31,
     2012      2012
ASSETS
         
Cash and due from banks
  $ 5,934     $ 6,163  
Interest-bearing deposits with other institutions
    72,877       45,107  
Total cash and cash equivalents
    78,811       51,270  
Securities available for sale
    314,530       308,242  
Loans held for sale
    67,965       92,514  
Restricted securities, at cost
    7,167       7,117  
Loans receivable, net of allowance for loan losses of $14,969 at June 30, 2012 and $14,623 at December 31, 2011
    670,941       656,770  
Premises and equipment, net
    21,021       21,306  
Goodwill and identified intangibles
    6,103       6,189  
Other real estate owned, net of valuation allowance of $1,982 at June 30, 2012 and $1,522 at December 31, 2011
    13,335       8,535  
Prepaid federal deposit insurance
    3,510       3,993  
Accrued interest receivable and other assets
    35,467       36,924  
          TOTAL ASSETS
  $ 1,218,850     $ 1,192,860  
LIABILITIES
               
Deposits:
               
Non-interest-bearing demand deposits
  $ 154,838     $ 143,398  
Savings and interest-bearing demand deposits
    509,291       460,576  
Time deposits
    311,156       325,895  
        Total deposits
    975,285       929,869  
Securities sold under agreements to repurchase
    33,034       31,686  
Short-term borrowings
    8,393       28,331  
FHLB borrowings
    77,912       82,912  
Subordinated notes
    5,155       5,155  
Accrued interest payable and other liabilities
    7,066       6,894  
Commitments and contingent liabilities
           
          TOTAL LIABILITIES
    1,106,845       1,084,847  
SHAREHOLDERS' EQUITY
               
Common stock ($2.50 par value; 20,000,000 shares authorized, 7,052,554 and 6,996,932 issued and outstanding at June 30, 2012 and December 31, 2011, respectively)
    17,364       17,331  
Capital surplus
    43,616       43,498  
Retained earnings
    43,805       41,157  
Accumulated other comprehensive income
    5,100       3,926  
Total Middleburg Financial Corporation shareholders' equity
    109,885       105,912  
Non-controlling interest in consolidated subsidiary
    2,120       2,101  
TOTAL SHAREHOLDERS' EQUITY
    112,005       108,013  
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
  $ 1,218,850     $ 1,192,860  

See accompanying notes to the consolidated financial statements.

 
3


MIDDLEBURG FINANCIAL CORPORATION
(In thousands, except for per share data)
   
Unaudited
 
Unaudited
   
For the Three Months
 
For the Six Months
   
Ended June 30,
 
Ended June 30,
     
2012
 
2011
 
2012
 
2011
INTEREST AND DIVIDEND INCOME
               
Interest and fees on loans
 
$
9,616
   
$
9,731
   
$
19,547
   
$
19,466
 
Interest and dividends on securities available for sale
               
Taxable
 
1,704
   
1,751
   
3,439
   
3,150
 
Tax-exempt
 
596
   
604
   
1,203
   
1,165
 
Dividends
 
45
   
36
   
89
   
72
 
Interest on deposits in banks and federal funds sold
 
25
   
33
   
49
   
60
 
Total interest and dividend income
 
11,986
   
12,155
   
24,327
   
23,913
 
INTEREST EXPENSE
               
Interest on deposits
 
1,846
   
2,332
   
3,739
   
4,640
 
Interest on securities sold under agreements to repurchase
 
84
   
69
   
167
   
125
 
Interest on short-term borrowings
 
89
   
53
   
237
   
116
 
Interest on FHLB borrowings and other debt
 
287
   
306
   
584
   
602
 
Total interest expense
 
2,306
   
2,760
   
4,727
   
5,483
 
NET INTEREST INCOME
 
9,680
   
9,395
   
19,600
   
18,430
 
Provision for loan losses
 
730
   
1,087
   
1,522
   
1,541
 
NET INTEREST INCOME AFTER PROVISION
               
FOR LOAN LOSSES
 
8,950
   
8,308
   
18,078
   
16,889
 
NONINTEREST INCOME
               
Service charges on deposit accounts
 
538
   
526
   
1,068
   
1,015
 
Trust services income
 
979
   
983
   
1,900
   
1,850
 
Gains on loans held for sale
 
5,053
   
3,938
   
8,822
   
6,785
 
Gains on securities available for sale, net
 
148
   
87
   
288
   
122
 
Total other-than-temporary impairment losses
 
(36
)
 
   
(46
)
 
(17
)
Portion of loss recognized in other comprehensive income
 
36
   
   
46
   
16
 
Net impairment losses
 
   
   
   
(1
)
Commissions on investment sales
 
125
   
185
   
272
   
365
 
Fees on mortgages held for sale
 
64
   
87
   
106
   
241
 
Other service charges, commissions and fees
 
121
   
134
   
271
   
249
 
Bank-owned life insurance
 
123
   
139
   
245
   
262
 
Other operating income (loss)
 
(2
)
 
(55
)
 
12
   
105
 
Total noninterest income
 
7,149
   
6,024
   
12,984
   
10,993
 
NONINTEREST EXPENSE
               
Salaries and employees' benefits
 
7,506
   
7,813
   
14,863
   
15,129
 
Net occupancy and equipment expense
 
1,755
   
1,640
   
3,533
   
3,316
 
Advertising
 
447
   
285
   
747
   
441
 
Computer operations
 
394
   
343
   
779
   
708
 
Other real estate owned
 
874
   
606
   
1,160
   
950
 
Other taxes
 
205
   
205
   
408
   
402
 
Federal deposit insurance expense
 
261
   
358
   
519
   
765
 
Other operating expenses
 
1,869
   
1,703
   
4,616
   
3,478
 
Total noninterest expense
 
13,311
   
12,953
   
26,625
   
25,189
 
Income before income taxes
 
2,788
   
1,379
   
4,437
   
2,693
 
Income tax expense
 
598
   
301
   
1,014
   
618
 
NET INCOME
 
2,190
   
1,078
   
3,423
   
2,075
 
Net (income) loss attributable to noncontrolling interest
 
(421
)
 
121
   
(72
)
 
351
 
Net income attributable to Middleburg Financial Corporation
 
$
1,769
   
$
1,199
   
$
3,351
   
$
2,426
 
Earnings per share:
               
Basic
 
$
0.25
   
$
0.17
   
$
0.48
   
$
0.35
 
Diluted
 
$
0.25
   
$
0.17
   
$
0.48
   
$
0.35
 
Dividends per common share
 
$
0.05
   
$
0.05
   
$
0.10
   
$
0.10
 

See accompanying notes to the consolidated financial statements.

 
4


MIDDLEBURG FINANCIAL CORPORATION
(In thousands)
   
Unaudited
 
Unaudited
   
For the Three Months
 
For the Six Months
   
Ended June 30,
 
Ended June 30,
   
2012
 
2011
 
2012
 
2011
                 
Net income
  $ 2,190     $ 1,078     $ 3,423     $ 2,075  
Other comprehensive income, net of tax:
                               
Unrealized holding gains arising during the period (net of tax of $389, $1,828, $748 and $2,093 respectively for the periods presented)
    756       3,549       1,451       4,063  
Reclassification adjustment for gains included in net income  (net of tax of $50, $30, $98, and $42 respectively for the periods presented)
    (98 )     (57 )     (190 )     (80 )
Unrealized losses on securities for which other-than-temporary impairment has been recognized in earnings (net of tax)
                      1  
Unrealized (loss) on interest rate swap  (net of tax of $72, $54, $45, and $33 respectively for the periods presented)
    (140 )     (104 )     (87 )     (64 )
Total other comprehensive income
    518       3,388       1,174       3,920  
Total comprehensive income
    2,708       4,466       4,597       5,995  
Comprehensive (income) loss attributable to non-controlling interest
    (421 )     121       (72 )     351  
Comprehensive income attributable to Middleburg Financial Corporation
  $ 2,287     $ 4,587     $ 4,525     $ 6,346  

See accompanying notes to the consolidated financial statements.

 
5


Middleburg Financial Corporation
For the Six Months Ended June 30, 2012 and 2011
(In Thousands, Except Share Data)
(Unaudited)
 
             
   
Middleburg Financial Corporation Shareholders
       
   
Common Stock
 
Capital Surplus
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interest
 
Total
Balances - December 31, 2010
  $ 17,314     $ 43,058     $ 37,593     $ (1,012 )   $ 3,040     $ 99,993  
Net income (loss)
                    2,426               (351 )     2,075  
Other comprehensive income, net of tax
                            3,920               3,920  
Cash dividends declared
                    (697 )                     (697 )
Vesting of restricted stock awards (7,922 shares)
    19       (19 )                              
Cancellation of restricted stock (946 shares)
    (2 )     (12 )                             (14 )
Distributions to non-controlling interest
                                    (592 )     (592 )
Share-based compensation
            123                               123  
Balances - June 30, 2011
  $ 17,331     $ 43,150     $ 39,322     $ 2,908     $ 2,097     $ 104,808  
                                                 
Balances - December 31, 2011
  $ 17,331     $ 43,498     $ 41,157     $ 3,926     $ 2,101     $ 108,013  
Net income
                    3,351               72       3,423  
Other comprehensive income, net of tax
                            1,174               1,174  
Cash dividends declared
                    (703 )                     (703 )
Vesting of restricted stock awards (12,432 shares)
    33       (33 )                              
Cancellation of restricted stock (2,736 shares)
          (43 )                             (43 )
Distributions to non-controlling interest
                                    (53 )     (53 )
Share-based compensation
            194                               194  
Balances - June 30, 2012
  $ 17,364     $ 43,616     $ 43,805     $ 5,100     $ 2,120     $ 112,005  

 See accompanying notes to the consolidated financial statements.

 
6


MIDDLEBURG FINANCIAL CORPORATION
(In Thousands)
   
Unaudited
   
For the six months ended
   
June 30, 2012
 
June 30, 2011
Cash Flows From Operating Activities
       
Net income
  $ 3,423     $ 2,075  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    957       930  
Equity in (undistributed earnings) of affiliate
    (4 )     (20 )
Provision for loan losses
    1,522       1,541  
Net (gain) on securities available for sale
    (288 )     (122 )
Other than temporary impairment loss
          1  
Net loss on disposal of assets
    7       39  
Premium amortization on securities, net
    1,790       1,344  
Origination of loans held for sale
    (444,613 )     (289,532 )
Proceeds from sales of loans held for sale
    477,984       306,989  
Net (gains) on mortgages held for sale
    (8,822 )     (6,785 )
Share-based compensation
    194       123  
Net loss on sale of other real estate owned
    24       233  
Valuation adjustment on other real estate owned
    460       350  
Decrease in prepaid FDIC insurance
    483       700  
Changes in assets and liabilities:
               
Decrease (increase) in other assets
    622       (767 )
Increase in other liabilities
    172       86  
Net cash provided by operating activities
  $ 33,911     $ 17,185  
Cash Flows from Investing Activities
               
Proceeds from maturity, principal paydowns and calls of securities available for sale
  $ 41,046     $ 27,868  
Proceeds from sale of securities available for sale
    15,986       15,860  
Purchase of securities available for sale
    (62,912 )     (80,266 )
Purchase of restricted stock
    (50 )     (636 )
Purchases of bank premises and equipment
    (534 )     (694 )
Net (increase) in loans
    (21,805 )     (20,530 )
Proceeds from sale of other real estate owned
    829       1,108  
Net cash (used in) investing activities
  $ (27,440 )   $ (57,233 )

See Accompanying Notes to Consolidated Financial Statements.

 
7



MIDDLEBURG FINANCIAL CORPORATION
Consolidated Statements of Cash Flows
(Continued)
(In Thousands)
   
For the three months ended
   
June 30, 2012
 
June 30, 2011
Cash Flows from Financing Activities
       
Net increase in non-interest-bearing and interest-bearing demand deposits and savings accounts
  $ 60,155     $ 24,503  
Net (decrease) increase in certificates of deposit
    (14,739 )     (6,324 )
Increase in securities sold under agreements
               
to repurchase
    1,348       9,648  
Proceeds from short-term borrowings
    58,882       39,749  
Payments on short-term borrowings
    (78,820 )     (47,377 )
Proceeds from FHLB borrowings
    62,912       40,000  
Payments on FHLB borrowings
    (67,912 )     (25,000 )
Distributions to non-controlling interest
    (53 )     (592 )
Payment of dividends on common stock
    (703 )     (697 )
Net cash provided by financing activities
  $ 21,070     $ 33,910  
Increase (decrease) in cash and and cash equivalents
    27,541       (6,138 )
Cash and Cash Equivalents
               
Beginning
    51,270       64,724  
Ending
  $ 78,811     $ 58,586  
Supplemental Disclosures of Cash Flow Information
               
Cash payments for:
               
Interest
  $ 4,893     $ 5,418  
Income taxes
  $ 850     $ 100  
Supplemental Disclosure of Non-cash Transactions
               
Unrealized gain on securities available for sale
  $ 1,910     $ 6,033  
Change in market value of interest rate swap
  $ (131 )   $ (97 )
Transfer of loans to other real estate owned
  $ 6,261     $ 625  
Loans originated from sale of other real estate owned
  $ 149     $ 533  

See accompanying notes to the consolidated financial statements.

 
8



Note 1.  
General

In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at June 30, 2012 and December 31, 2011, the results of operations and comprehensive income for the three and six months ended June 30, 2012 and 2011, and changes in shareholders’ equity and cash flows for the six months ended June 30, 2012 and 2011, in accordance with accounting principles generally accepted in the United States of America.  The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”) of Middleburg Financial Corporation (the “Company”).  The results of operations for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year.

In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued.  Management has concluded there were no additional material subsequent events to be disclosed.

Certain amounts in the 2011 consolidated financial statements have been reclassified to conform to the 2012 presentation.  Commissions paid on the origination of mortgages held for sale and commissions paid on investments sales have been netted against the related revenue amounts for these sources of revenue for both 2012 and 2011.  Management considers the net presentation to more accurately reflect the net contribution to consolidated net income of the mortgage and wealth management segments.

Note 2.  
Stock–Based Compensation Plan

As of June 30, 2012, the Company sponsored one stock-based compensation plan (the 2006 Equity Compensation Plan), which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards and stock units.  The 2006 Equity Compensation Plan was approved by the Company’s shareholders at the Annual Meeting held on April 26, 2006 and has succeeded the Company’s 1997 Stock Incentive Plan.  Under the plan, the Company may grant stock-based compensation to its directors, officers, employees and other persons the Company determines have contributed to the profits or growth of the Company.  The Company may grant awards of up to 255,000 shares of common stock under the 2006 Equity Compensation Plan.

The Company recognized $194,000 for stock-based compensation expenses for the six months ended June 30, 2012.

The following table summarizes stock options awarded under the 2006 Equity Compensation Plan and remaining un-exercised options under the 1997 Stock Incentive Plan at the end of the reporting period.


 
June 30, 2012
 
Shares
 
Weighted
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
Outstanding at beginning of year
160,171
 
$
20.40
     
Granted
 
     
Exercised
 
     
Forfeited
(78,000 )
(23.64
)
   
Outstanding at end of period
82,171
 
$
(17.32
)
 
$
 

As of the end of the reporting period, 79,671 options were vested and exercisable representing 22,000 shares issued under the original 1997 plan and 57,671 vested options under the 2006 Plan.  As of June 30, 2012 no outstanding options were unvested from the original 1997 plan and 2,500 outstanding options were not vested under the 2006 plan.  At June 30, 2012 the weighted average exercise price of these stock options was greater than the average market price during the period.  The weighted average remaining contractual term for options outstanding and exercisable at June 30, 2012 was  5.1 years.  As of June 30,

 
9


2012 there was $2,000 of total unrecognized compensation expense related to stock option awards under the 2006 Equity Compensation Plan.

The following table summarizes restricted stock awarded under the 2006 Equity Compensation Plan at the end of the reportable period.


 
June 30, 2012
 
Shares
 
Weighted
Average
Grant-Date
Fair Value
 
Aggregate
Intrinsic
Value
Outstanding at beginning of year
86,220
 
$
14.79
     
Granted
49,475
 
16.86
     
Vested
(12,432 )
(13.28
)
   
Forfeited
(2,808 )
(14.59
)
   
Non-vested at end of period
120,455
 
$
15.66
   
$
2,047,735
 

The weighted average remaining contractual term for non-vested restricted stock at June 30, 2012 was 4.4 years.  As of June 30, 2012, there was approximately $1,591,000 of total unrecognized compensation expense related to non-vested restricted stock awards under the 2006 Equity Compensation Plan.

Note 3.  
Securities

Amortized costs and fair values of securities available for sale at June 30, 2012 are summarized as follows:


 
June 30, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In Thousands)
Available for Sale
             
U.S. government agencies
$
8,764
   
$
374
   
$
   
$
9,138
 
Obligations of states and
             
political subdivisions
69,061
   
3,546
   
(4
)
 
72,603
 
Mortgage-backed securities:
             
Agency
168,363
   
5,728
   
(281
)
 
173,810
 
Non-agency
49,246
   
383
   
(534
)
 
49,095
 
Corporate preferred stock
68
   
   
(14
)
 
54
 
Corporate securities
10,611
   
8
   
(900
)
 
9,719
 
Trust-preferred securities
244
   
   
(133
)
 
111
 
Total
$
306,357
   
$
10,039
   
$
(1,866
)
 
$
314,530
 

Amortized costs and fair values of securities available for sale at December 31, 2011 are summarized as follows:

 
10



   
December 31, 2011
   
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
   
(In Thousands)
Available for Sale
               
U.S. government agencies
 
$
9,068
   
$
293
   
$
(18
)
 
$
9,343
 
Obligations of states and
               
political subdivisions
 
65,090
   
2,503
   
(51
)
 
67,542
 
Mortgage-backed securities:
               
Agency
 
181,797
   
5,482
   
(209
)
 
187,070
 
Non-agency
 
34,847
   
157
   
(1,002
)
 
34,002
 
Corporate preferred stock
 
68
   
   
(28
)
 
40
 
Corporate securities
 
10,612
   
5
   
(641
)
 
9,976
 
Trust-preferred securities
 
497
   
   
(228
)
 
269
 
Total
 
$
301,979
   
$
8,440
   
$
(2,177
)
 
$
308,242
 

The amortized cost and fair value of securities available for sale as of June 30, 2012, by contractual maturity are shown below.  Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties.  Therefore, these securities are not included in the maturity categories in the following maturity summary.


   
June 30, 2012
   
Amortized
Cost
 
Fair
Value
   
(In thousands)
Due in one year or less
 
$
4,013
   
$
4,040
 
Due after one year through
       
five years
 
18,524
   
18,547
 
Due after five years through
       
ten years
 
34,031
   
35,696
 
Due after ten years
 
31,868
   
33,177
 
Mortgage-backed securities
 
217,609
   
222,905
 
Corporate preferred stock
 
68
   
54
 
Trust preferred securities
 
244
   
111
 
Total
 
$
306,357
   
$
314,530
 

Proceeds from the sale of securities during the six months ended June 30, 2012 were $16.0 million and net gains of $288,000 were realized on those sales.  The tax expense applicable to the net realized gains amounted to $98,000.  Additionally, no loss on securities with other than temporary impairment was recognized during the six months ended June 30, 2012.

The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $148.3 million at June 30, 2012.

At June 30, 2012, investments in an unrealized loss position that were temporarily impaired are as follows:

 
11



   
June 30, 2012
       
(In thousands)
   
   
Less than Twelve Months
 
Twelve Months or Greater
 
Total
   
Fair Value
 
Gross
Unrealized Losses
 
Fair Value
 
Gross
Unrealized Losses
 
Fair Value
 
Gross
Unrealized Losses
U.S. government agencies
 
$
375
   
$
   
$
25
   
$
   
$
400
   
$
 
Obligations of states and
                       
political subdivisions
 
1,937
   
(4
)
 
   
   
1,937
   
(4
)
Mortgage backed securities:
                       
Agency
 
18,601
   
(281
)
 
   
   
18,601
   
(281
)
Non-agency
 
18,007
   
(264
)
 
8,374
   
(270
)
 
26,381
   
(534
)
Corporate preferred stock
 
   
   
25
   
(14
)
 
25
   
(14
)
Corporate securities
 
3,164
   
(336
)
 
6,407
   
(564
)
 
9,571
   
(900
)
Trust-preferred securities
 
   
   
111
   
(133
)
 
111
   
(133
)
Total
 
$
42,084
   
$
(885
)
 
$
14,942
   
$
(981
)
 
$
57,026
   
$
(1,866
)

At December 31, 2011, investments in an unrealized loss position that were temporarily impaired are as follows:


   
December 31, 2011
       
(In thousands)
   
   
Less than Twelve Months
 
Twelve Months or Greater
 
Total
   
Fair Value
 
Gross
Unrealized Losses
 
Fair Value
 
Gross
Unrealized Losses
 
Fair Value
 
Gross
Unrealized Losses
U.S. government agencies
 
$
2,045
   
$
(18
)
 
$
26
   
$
   
$
2,071
   
$
(18
)
Obligations of states and
                       
political subdivisions
 
43
   
   
2,243
   
(51
)
 
2,286
   
(51
)
Mortgage backed securities:
                       
Agency
 
22,768
   
(209
)
 
   
   
22,768
   
(209
)
Non-agency
 
15,345
   
(465
)
 
5,989
   
(537
)
 
21,334
   
(1,002
)
Corporate preferred stock
 
   
   
11
   
(28
)
 
11
   
(28
)
Corporate securities
 
7,775
   
(227
)
 
2,057
   
(414
)
 
9,832
   
(641
)
Trust-preferred securities
 
   
   
269
   
(228
)
 
269
   
(228
)
Total
 
$
47,976
   
$
(2,634
)
 
$
10,595
   
$
(1,258
)
 
$
58,571
   
$
(2,177
)

A total of 51 securities have been identified by the Company as temporarily impaired at June 30, 2012.  Of the 51 securities, 50 are investment grade and 1 is speculative grade.  Agency, non-agency mortgage-backed securities, and corporate debt securities make up the majority of temporarily impaired securities at June 30, 2012.  The speculative grade security is an asset backed security that is collateralized by trust preferred issuances of financial institutions.  Market prices change daily and are affected by conditions beyond the control of the Company.  Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered.  No such sales are anticipated or required as of June 30, 2012.  Investment decisions reflect the strategic asset/liability objectives of the Company.  

Trust preferred securities

As of June 30, 2012, the company holds one trust preferred security in its portfolio, Trust Preferred IV.  This security was evaluated within the scope of ASC 320 Investments – Debt and Equity Securities for potential impairment. The Company reviewed currently available information in estimating the future cash flows of this security to determine whether there has

 
12


been favorable or adverse changes in estimated cash flows from the cash flows previously projected.  The Company considers the structure and term of the pool and the financial condition of the underlying issuers.  Specifically, the evaluation incorporates factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes.  Current estimates of cash flows are based on the most recent trustee report, announcements of deferrals or defaults, expected future default rates and other relevant market information.  

The trust preferred security in the Company’s portfolio has a floating rate coupon. In performing the present value analysis of expected cash flows, we incorporate expected deferral and default rates. The deferral/default assumptions for this pooled trust preferred security was developed by reviewing the underlying collateral or issuing banks. The present value of expected future cash flows is discounted at the effective purchase yield, which in the case of the floating rate securities is equal to the credit spread at time of purchase plus the current 3-month LIBOR rate.    We then compare the present value to the current book value for purposes of determining if there is an other-than-temporary impairment (“OTTI”).  The discount rate used to determine OTTI is the effective purchase yield or the credit spread at the time of purchase plus the 3-month LIBOR rate.

The Company reviewed the list of issuers underlying the trust preferred security as of June 30, 2012, and ranked each bank in order of expectations for future defaults and deferrals. We reviewed data on each bank such as earnings, capital ratios, credit metrics and loan loss reserves. We then assigned a default rate to each ranking, then the default rates were applied to each bank that was performing as of the reporting date.  Finally, we summed the defaults and divided by the total remaining performing collateral in each pool. For Trust Preferred IV, the expected default rate was 50 basis points.

In connection with the preparation of the financial statements included in this Form 10-Q and using the evaluation procedures described above, the Company concluded that there were no securities with other-than-temporary impairment within its portfolio as of June 30, 2012.  Accordingly, during the six months ended June 30, 2012, no credit related impairment losses were recognized by the Company compared to $1,000 recognized for the six months ended June 30, 2011.

The Company previously held trust preferred securities in its portfolio that were identified as other-than-temporarily impaired.  These securities were sold during the quarter ended June 30, 2012 with a recognized net loss of approximately $142,000.  Additionally, these securities incurred cumulative OTTI credit losses recognized in prior period earnings of approximately $2.4 million through December 31, 2011.  No additional write-downs were necessary prior to the sale of the securities during the second quarter of 2012.

The following table provides further information on the Company’s trust preferred security that is not considered other-than-temporarily impaired as of June 30, 2012 (in thousands):
 

Security
 
Tranche Level
 
Current
Moody's Rating
 
Par Value
 
Book Value
 
Fair Value
 
Cumulative
Other
Comprehensive Loss
 
Institutions Performing
 
(1)
Excess Subord.
 
Deferrals/ Defaults
 
Expected
Default Rate
 
Expected Recovery
 
Lag Years
Trust Preferred IV
 
Mez
 
Ca
 
$244
 
$244
 
$111
 
$133
 
4
 
19.71%
 
27.10%
 
0.50%
 
15%
 
2
           
$244
 
$244
 
$111
 
$133
                       
(1)  Excess subordination.  See explanation in text below table.

The preceding table presents data on the excess subordination existing in the trust preferred issuance included in the Company’s investment portfolio.  Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are senior to the class owned by the Company. Negative excess subordination indicates that there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to the classes owned by the Company.
 
The credit deferral/default assumptions utilized in the Company’s OTTI analysis methodology and included in the above table considers specific collateral underlying each trust preferred security.
 
At June 30, 2012, the Company concluded that no adverse change in cash flows occurred during the quarter and did not consider any portfolio securities to be other-than-temporarily impaired.  Based on this analysis and because the Company does not intend to sell securities prior to maturity and it is more likely than not the Company will not be required to sell any securities before recovery of amortized cost basis, which may be at maturity; and, for debt securities related to corporate securities, determined that there was no other adverse change in the cash flows as viewed by a market participant, the Company does not consider the investments in these assets to be other than temporarily impaired at June 30, 2012.  However, there is a risk that the Company’s continuing reviews could result in recognition of other-than-temporary impairment charges in the future.

 
13



Note 4.  
Loan Portfolio

The Company segregates its loan portfolio into three primary loan segments:  Real Estate Loans, Commercial Loans, and Consumer Loans.  Real estate loans are further segregated into the following classes: construction loans, loans secured by farmland, loans secured by 1-4 family residential real estate, and other real estate loans.  Other real estate loans include commercial real estate loans.  The consolidated loan portfolio was composed of the following on the dates indicated:


   
June 30, 2012
 
December 31, 2011
   
Outstanding
Balance
   
Percent of
Total Portfolio
 
Outstanding
Balance
   
Percent of
Total Portfolio
   
(In Thousands)
       
(In Thousands)
     
Real estate loans:
                   
Construction
  $ 49,390       7.2 %   $ 42,208       6.3 %
Secured by farmland
    9,450       1.4 %     10,047       1.5 %
Secured by 1-4 family residential
    252,775       36.9 %     236,760       35.3 %
Other real estate loans
    263,124       38.4 %     275,428       41.0 %
Commercial loans
    98,681       14.4 %     94,427       14.1 %
Consumer loans
    12,490       1.8 %     12,523       1.8 %
      685,910       100.0 %     671,393       100.0 %
Less allowance for loan losses
    14,969               14,623          
Net loans
  $ 670,941             $ 656,770          


Loans presented in the table above exclude loans held for sale.  The Company had $68.0 million and $92.5 million in mortgages held for sale at June 30, 2012 and December 31, 2011, respectively.

The following table presents a contractual aging of the recorded investment in past due loans by class of loans as of June 30, 2012 and December 31, 2011.


   
June 30, 2012
             
(In thousands)
       
   
30-59 Days
Past Due
   
60-89 Days
Past Due
 
90 Days
Or Greater
 
Total Past
Due
 
Current
 
Total
Loans
Real estate loans:
                         
Construction
  $ 143     $ 1,914     $ 1,972     $ 4,029     $ 45,361     $ 49,390  
Secured by farmland
                            9,450       9,450  
Secured by 1-4 family residential
    805       1,661       3,131       5,597       247,178       252,775  
Other real estate loans
    371       1,061       6,439       7,871       255,253       263,124  
Commercial loans
    355             1,987       2,342       96,339       98,681  
Consumer loans
    119             51       170       12,320       12,490  
Total
  $ 1,793     $ 4,636     $ 13,580     $ 20,009     $ 665,901     $ 685,910  


 
14



   
December 31, 2011
           
(In thousands)
       
   
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days
Or Greater
 
Total Past
Due
 
Current
 
Total
Loans
Real estate loans:
                       
Construction
 
$
696
   
$
   
$
3,285
   
$
3,981
   
$
38,227
   
$
42,208
 
Secured by farmland
 
415
   
   
   
415
   
9,632
   
10,047
 
Secured by 1-4 family residential
 
2,036
   
1,721
   
7,639
   
11,396
   
225,364
   
236,760
 
Other real estate loans
 
6,079
   
1,736
   
1,466
   
9,281
   
266,147
   
275,428
 
Commercial loans
 
1,751
   
121
   
315
   
2,187
   
92,240
   
94,427
 
Consumer loans
 
23
   
   
   
23
   
12,500
   
12,523
 
Total
 
$
11,000
   
$
3,578
   
$
12,705
   
$
27,283
   
$
644,110
   
$
671,393
 

The following table presents the recorded investment in nonaccrual loans and loans past due 90 days or more and still accruing by class of loans as of June 30, 2012 and December 31, 2011:


   
June 30, 2012
 
December 31, 2011
   
Nonaccrual
 
Past due 90
days or more
and still accruing
 
Nonaccrual
 
Past due 90
days or more
and still accruing
   
(In Thousands)
Real estate loans:
               
Construction
 
$
1,954
   
$
94
   
$
3,804
   
$
86
 
Secured by 1-4 family residential
 
7,939
   
441
   
11,839
   
1,097
 
Other real estate loans
 
6,929
   
739
   
7,567
   
 
Commercial loans
 
1,980
   
46
   
2,136
   
50
 
Consumer loans
 
   
51
   
   
 
Total
 
$
18,802
   
$
1,371
   
$
25,346
   
$
1,233
 


If interest on non-accrual loans had been accrued, such income would have approximated $553,000 for the six months ended June 30, 2012 and $1.5 million for the year ended December 31, 2011.

The Company utilizes an internal asset classification system as a means of measuring and monitoring credit risk in the loan portfolio.  Under the Company’s classification system, problem and potential problem loans are classified as “Special Mention”, “Substandard”, “Doubtful” and “Loss”.
 
Special Mention:  Loans classified as special mention have potential weaknesses that deserve management’s close attention.  If left uncorrected, the potential weaknesses may result in the deterioration of the repayment prospects for the credit.

Substandard:  Loans classified as substandard have a well-defined weakness that jeopardizes the liquidation of the debt.  Either the paying capacity of the borrower or the value of the collateral may be inadequate to protect the Company from potential losses.

Doubtful:  Loans classified as doubtful have a very high possibility of loss.  However, because of important and reasonably specific pending factors, classification as a loss is deferred until a more exact status can be determined.

Loss: Loans are classified as loss when they are deemed uncollectable and are charged off immediately.

The following tables present a summary of loan classifications by class of loan as of June 30, 2012 and December 31, 2011:
 
 
15




 
June 30, 2012
         
(In Thousands)
       
 
Real Estate
Construction
 
Real Estate
Secured by
Farmland
 
Real Estate
Secured by 1-4
Family Residential
 
Other Real
Estate Loans
 
Commercial
 
Consumer
 
Total
Pass
$
27,570
   
$
8,640
   
$
227,475
   
$
221,577
   
$
92,571
   
$
12,125
   
$
589,958
 
Special Mention
15,818
   
199
   
10,917
   
24,623
   
3,135
   
78
   
54,770
 
Substandard
6,002
   
611
   
12,895
   
16,666
   
2,833
   
287
   
39,294
 
Doubtful
   
   
1,488
   
258
   
142
   
   
1,888
 
Loss
   
   
   
   
   
   
 
Ending Balance
$
49,390
   
$
9,450
   
$
252,775
   
$
263,124
   
$
98,681
   
$
12,490
   
$
685,910
 

 
December 31, 2011
         
(In thousands)
       
 
Real Estate
Construction
 
Real Estate
Secured by
Farmland
 
Real Estate
Secured by 1-4
Family Residential
 
Other Real
Estate Loans
 
Commercial
 
Consumer
 
Total
Pass
$
22,250
   
$
9,235
   
$
207,332
   
$
239,156
   
$
87,731
   
$
12,448
   
$
578,152
 
Special Mention
5,764
   
199
   
10,773
   
23,434
   
4,127
   
61
   
44,358
 
Substandard
13,163
   
613
   
17,062
   
12,592
   
2,374
   
14
   
45,818
 
Doubtful
1,031
   
   
1,593
   
246
   
195
   
   
3,065
 
Loss
   
   
   
   
   
   
 
Ending Balance
$
42,208
   
$
10,047
   
$
236,760
   
$
275,428
   
$
94,427
   
$
12,523
   
$
671,393
 
  
The following table presents loans identified as impaired by class of loan as of and for the six months ended June 30, 2012:

 
16



   
June 30, 2012
         
(In thousands)
   
   
Recorded
Investment
   
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
                     
Real estate loans:
                     
Construction
  $ 1,617     $ 2,168     $     $ 2,041     $  
Secured by farmland
                             
Secured by 1-4 family residential
    2,374       2,764             2,075       18  
Other real estate loans
    4,578       4,947             4,550       113  
Commercial loans
    1,789       1,789             1,770        
Consumer loans
                             
Total with no related allowance
    10,358       11,668             10,436       131  
                                         
With an allowance recorded:
                                       
Real estate loans:
                                       
Construction
    337       368       126       339        
Secured by farmland
                             
Secured by 1-4 family residential
    6,858       7,731       2,398       7,065       17  
Other real estate loans
    5,145       5,188       1,049       5,188       51  
Commercial loans
    438       459       325       446       14  
Consumer loans
                             
Total with a related allowance
    12,778       13,746       3,898       13,038       82  
Total
  $ 23,136     $ 25,414     $ 3,898     $ 23,474     $ 213  
 
The following table presents loans identified as impaired by class of loan as of and for the year ended December 31, 2011:

 
17



   
December 31, 2011
         
(In thousands)
   
   
Recorded
Investment
   
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With no related allowance recorded:
                     
Real estate loans:
                     
Construction
  $ 2,992     $ 3,652     $     $ 3,948     $  
Secured by farmland
                               
Secured by 1-4 family residential
    3,978       4,656             4,424       7  
Other real estate loans
    4,732       4,775             5,729       95  
Commercial loans
    1,751       1,751             1,735        
Consumer loans
                             
Total with no related allowance
    13,453       14,834             15,836       102  
                                         
With an allowance recorded:
                                       
Real estate loans:
                                       
Construction
    812       842       328       812        
Secured by farmland