|• 10-Q • EXHIBIT 31.1 • EXHIBIT 31.2 • EXHIBIT 32.1 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
For the transition period from __________ to __________
Commission file number: 000-31673
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of May 11, 2012, the latest practicable date, there were 19,714,564 shares of the issuer’s Common Stock, without par value, issued and outstanding.
OHIO LEGACY CORP
AS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2012
FIRST QUARTER REPORT
See notes to the consolidated financial statements.
See notes to the consolidated financial statements.
See notes to the consolidated financial statements.
See notes to the consolidated financial statements.
See notes to the consolidated financial statements.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: The consolidated financial statements include Ohio Legacy Corp (“the Company”) and its wholly-owned subsidiary, Premier Bank & Trust, National Association (“Bank”) (formerly known as Ohio Legacy Bank, National Association). Ohio Legacy Corp is approximately 76% owned by Excel Bancorp, LLC, a registered bank holding company. Intercompany transactions and balances are eliminated in consolidation. References to the Company include Ohio Legacy, consolidated with its subsidiary, the Bank.
Ohio Legacy is a bank holding company incorporated on July 1, 1999 under the laws of the State of Ohio. The Bank began operations on October 3, 2000. The Bank provides financial services through its full-service offices in North Canton and St. Clairsville, Ohio. Its primary deposit products are checking, savings and certificate of deposit accounts, and its primary lending products are residential mortgage, commercial and installment loans. Substantially all loans are secured by specific items of collateral including business and consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by residential and commercial real estate. Other financial instruments that potentially represent concentrations of credit risk include deposit accounts in other financial institutions and federal funds sold. On March 23, 2010, the Bank received approval from the Comptroller of the Currency of its application to commence fiduciary powers pursuant to 12 USC 92a. Subsequently, the Bank opted to include “Trust” in its name and announced a name change to Premier Bank & Trust, N.A. effective April 2010. The Bank also began to offer investment brokerage services in April 2010.
These consolidated financial statements are prepared without audit and reflect all adjustments that, in the opinion of management, are necessary to present fairly the financial position of the Company at March 31, 2012, and its results of operations and cash flows for the periods presented. All such adjustments are normal and recurring in nature. The accounting principles used to prepare the consolidated financial statements are in compliance with U.S. GAAP. However, the financial statements were prepared in accordance with the instructions of Form 10-Q and, therefore, do not purport to contain all necessary financial and note disclosures required by U.S. GAAP.
The financial information presented in this report should be read in conjunction with the Company’s Form 10-K for the year ended December 31, 2011, which includes information and disclosures not presented in this report. Reference is made to the accounting policies of the Company described in Note 1 of the Notes to Consolidated Financial Statements. The Company has consistently followed those policies in preparing this Form 10-Q.
Use of Estimates: To prepare financial statements in conformity with U.S. GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, judgments about the other than temporary impairment of securities, fair value of financial instruments, valuation of deferred tax assets and the fair value of assets acquired in settlement of loans are particularly subject to change.
Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications had no impact on reported net income or shareholders’ equity.
Adoption of New Accounting Pronouncements:
No. 2011-04 | Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirement in U.S. GAAP and IFRSs: In May 2011, FASB issued Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirement in U.S. GAAP and IFRSs (ASU 2011-04). The new guidance in this ASU results in common fair value measurement and disclosure requirements in U.S. and international accounting principles. Certain amendments clarify the FASB‘s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. These amendments also enhance disclosure requirements surrounding fair value measurement. Most significantly, an entity will be required to disclose additional information regarding Level 3 fair value measurements including quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements. The new guidance is effective for interim and annual periods beginning on or after December 15, 2011. The effect of adopting this standard did not have a material effect on the Company’s operating results or financial condition, but the additional disclosures are included in Note 6.
No 2011-05 | Presentation of Comprehensive Income: In June 2011, FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (ASU 2011-05): The ASU eliminates the option to report other comprehensive income and its components in the statement of changes in equity. An entity can elect to present the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The ASU does not change the items that must be reported in other comprehensive income, when an item of other comprehensive income must be reclassified to net income, or how earnings per share is calculated or presented. The amendments in this guidance are effective as of the beginning of the fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. The adoption of this amendment changed the presentation of the statement of comprehensive income for the Company to two consecutive statements instead of presented as part of the consolidated statement of shareholders’ equity.
In December 2011, the FASB issued ASU No. 2011-12 Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income that deferred the effective date for amendments to the presentation of reclassifications of items out of accumulated other comprehensive income. The adoption of the new guidance will impact the presentation of the consolidated financial statements.
NOTE 2 – EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is equal to net income (loss) divided by the weighted average number of shares outstanding during the period. Diluted earnings (loss) per share includes the dilutive effect of additional potential common shares that may be issued upon the exercise of stock options and stock warrants. The following table details the calculation of basic and diluted earnings (loss) per share:
The dilutive potential common shares that were excluded from the computation of diluted earnings per share because the effect of their exercise was anti-dilutive were as follows:
NOTE 3 – INVESTMENT SECURITIES
The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
All mortgage-backed securities at both period ends are residential mortgage-backed securities.
No securities were sold during the three months ending March 31, 2012. Proceeds on securities sold during the three months ending March 31, 2011 totaled $4,951,844 and included gross gains of $32,999. No losses were realized on sold securities.
The fair value of debt securities and the carrying amount, if different, at March 31, 2012 by expected maturity are depicted in the following table. Expected maturities may differ from contractual maturities because the loans underlying the mortgage-backed securities generally can be prepaid without penalty.
Securities with unrealized losses for less than one year and one year or more were as follows:
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
As of March 31, 2012, the Company’s security portfolio consisted of 27 securities, one of which was in an unrealized loss position for 12 months or longer.
The Company’s mortgage-backed securities portfolio includes one non-agency security with a fair value of $191,318 which represents an unrealized loss of approximately $34,231 at March 31, 2012; the estimated fair value has been less than its amortized cost for twelve months or more. This non-agency mortgage-backed security was rated Caa1 by Moody’s on April 21, 2011 and BBB- on July 12, 2011 by Standard & Poor’s rating services. This security is senior to several subordinate classes of securities that together are collateralized by a pool of residential mortgages. No losses incurred on the mortgages in the pool have been assigned to the senior classes. Although the borrowers are not required to make principal payments during the initial 10 year period, 77% of the original principal has been repaid as of March 31, 2012. There are no negative amortization loans in the pool and none of the loans are subprime, Alt A or similar type of high-default product. Based on these factors, as of March 31, 2012, the Company believes there is no OTTI and does not have the intent to sell this security and it is likely that it will not be required to sell the security before its anticipated recovery.
NOTE 4 – LOANS
Loans, by collateral type, were as follows at March 31, 2012 and December 31, 2011:
Residential real estate loans pledged as collateral for advances and to support available borrowing capacity at the Federal Home Loan Bank totaled approximately $24,090,000 at March 31, 2012 and $24,475,000 at December 31, 2011. Commercial and multi-family real estate pledged to the FHLB as of March 31, 2012 and December 31, 2011 totaled $25,707,000 and $23,827,000, respectively. Commercial and home equity loans pledged as collateral at the Federal Reserve Bank of Cleveland for available discount window borrowing at March 31, 2012 and December 31, 2011 totaled $18,752,000 and $16,553,000, respectively.
Allowance for Loan and Lease Losses: The allowance for loan and lease losses (“ALLL”) is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Management utilizes past due information as a credit quality indicator across the loan portfolio. The past due information is the primary credit quality indicator within both the 1-4 family residential real estate loan portfolio (including first liens, home equity loans, and construction loans in the 1-4 family real estate class) and consumer loans.
The primary credit quality indicator for commercial and commercial real estate loans (including non-owner occupied, owner occupied, multi-family real estate, 1-4 family rental property, and construction and development loans not included in the residential real estate class) is based on an internal grading system. Credit grades are monitored regularly by the respective loan officer and independently by credit administration, and adjustments are made when appropriate. The frequency of loan review with respect to credit grades is dependent upon the size and grade of the loan. See below for a description of credit quality indicators.
Commercial and commercial real estate loans that are graded “doubtful” are shown as nonperforming and management generally charges these loans down to their fair value by taking a partial charge-off or recording a specific allocation of the allowance. Loans classified as “doubtful” have all the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Any commercial loan graded “loss” is immediately charged-off.
When collection of principal and interest is in doubt or a loan is 90-days past due, the loan is placed on non-accrual status and is specifically reviewed for impairment. Impairment is measured based on one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) at the observable market price of the loan; or (3) the fair value of the collateral less estimated disposal costs. Individually impaired loans include all nonaccrual and restructured loans. U.S. generally accepted accounting principles (“GAAP”) require a specific allocation to be established as a component of the allowance for loan losses for certain loans when it is probable that all amounts due pursuant to the contractual terms of the loans will not be collected, and the recorded investment exceeds fair value.
For all loan classes, the Bank will initiate a charge-off or a partial charge-off based on the status of the loan. If the loan is not fully collateralized and is in the process of collection, the Bank will charge off the amount of the uncollectable account balance as a loss. The designated workout officer is generally responsible for calculating and recommending the charge-off amount. All charge-offs must be approved by the Credit Committee whose members consist of the Chief Credit Officer, the Chief Executive Officer, the Chief Operating Officer and the Senior Lending Officer.
Charge offs are recorded when consumer loans are 120 days past due and real estate loans are 180 days past due. This may be extended if management believes that the risk of loss is minimal, and the Bank is in the process of collection with a reasonable prospect of full collection. Management conducts reviews of impaired loans regularly and assesses the requirement for specific allocations or charge-offs. When a loss has not been confirmed and payments are current, a specific allocation is generally recorded. Charge-offs (either full or partial) are recognized when loss is confirmed (for example, upon receipt of a current appraisal) and is generally based on the amount that the loan balance exceeds the estimated net realizable value of the collateral. For unsecured loans, the full balance is charged-off at the time the loan is deemed impaired. The Company did not revise its charge-off policy during periods presented.
Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired and assigned a probable loss amount. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless the loan is on nonaccrual status. The Company then divides the remaining loans by risk into four grades: pass, special mention, substandard, and doubtful. Loans with a pass grade are divided into ten separate categories. Total charge-offs for a specified time period, currently three years, are divided into the same categories and used as a starting point to estimate credit losses in each category. Other subjective factors, such as industry conditions, local economic trends and similar items are assigned a numeric value by category and are also applied to the balances in the pass grade. Historic loss percentages are applied separately to the special mention and substandard pools of loans based on actual charge-offs for each pool in total regardless of the category. The amount and timing of full or partial charge-offs is important since charge-offs are factored into the calculation of the three-year historical loan loss experience rates used to estimate the adequacy of the allowance for loan losses. Failure to record charge-offs in a timely manner could result in lower historical loss rates and potentially understate the estimate of the amount of incurred losses within the portfolio and distort coverage ratios such as the allowance for loan losses to nonaccrual loans used by management to evaluate the adequacy of the allowance for loan losses.
A description of each class of the loan portfolio, along with the risk characteristics of each class, is included below:
Residential real estate: The Company defines residential real estate loans as first mortgages on individuals’ primary residence. Credit approval for residential real estate loans requires demonstration of sufficient income to repay the principal and interest and the real estate taxes and insurance, stability of employment, an established credit record and an appropriately appraised value of the real estate securing the loan that generally requires that the residential real estate loan amount be no more than 85% of the purchase price or the appraised value of the real estate securing the loan, whichever is less, unless private mortgage insurance is obtained by the borrower. Loans made for the Bank’s portfolio are generally adjustable rate, fully amortized mortgages. The rates used are generally fully-indexed rates and are not priced using low introductory “teaser” rates.
Home equity loans: These loans are either lines of credit or closed-end loans secured by second mortgages. The maximum amount of a home equity line of credit is generally limited to 95% (with acceptable credit scores) of the appraised value of the property less the balance of the first mortgage.
One to Four Family Rental Property: These loans are secured by residential real estate rental properties. The principal source of repayment generally is dependent upon satisfactory occupancy of the building by tenants.
Multi-family Real Estate: These loans consist of residential rental properties and generally consist of buildings with rental units for five or more families. The principal source of repayment generally is dependent upon satisfactory occupancy of the building by tenants.
Consumer Loans: The Company originates direct consumer loans, primarily automobile loans, personal lines of credit, and unsecured consumer loans in its primary market areas. Credit approval for consumer loans requires income sufficient to repay principal and interest due, stability of employment, an established credit record and sufficient collateral for secured loans. Consumer loans typically have shorter terms and lower balances with higher yields as compared to real estate mortgage loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances.
Commercial Loans: Commercial loans are made for a wide variety of general corporate purposes, including financing for industrial and commercial properties, financing for equipment, inventories and accounts receivable. The term of each commercial loan varies by its purpose. Repayment terms are structured such that commercial loans will be repaid within the economic useful life of the underlying asset. The commercial loan portfolio includes loans to a wide variety of corporations and businesses across many industrial classifications in the areas where the Bank operates.
Loans Secured by Trust Assets: These loans are secured by cash or marketable securities and have substantially less credit risk than other types of loans.
Commercial Real Estate: Commercial real estate loans (“CRE loans”) include mortgage loans to developers and owners of commercial real estate. The collateral for these CRE loans is the underlying commercial real estate. The Bank generally requires that the CRE loan amount be no more than 90% of the purchase price or 80% of the appraised value of the commercial real estate securing the CRE loan, whichever is less. The Bank evaluates commercial real estate based on whether the property is owner occupied or non-owner occupied. Non-owner occupied CRE loans typically exhibit higher risk.
Construction and development: Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. If the estimate of construction cost proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project having a value insufficient to assure full repayment, should the borrower default. In the event a default on a construction loan occurs and foreclosure follows, the Bank must take control of the project and attempt either to arrange for completion of construction or to dispose of the unfinished project. Additional risk exists with respect to loans made to developers who do not have a buyer for the property, as the developer may lack funds to pay the loan if the property is not sold upon completion. Generally the Bank attempts to reduce such risks on loans to developers by requiring personal guarantees and reviewing current personal financial statements and tax returns.
Activity in the allowance for loan loss by portfolio class for the three months ending March 31, 2012 was as follows:
Activity in the allowance for loan loss by portfolio class for the three months ending March 31, 2011 was as follows:
The unpaid principal balance of loans reflects the borrowers’ principal balance and is not reduced by partial charge-offs previously recorded by the Company. For nonaccrual loans, the recorded investment in loans is reduced by the full amount of payments received from the borrower, whereas the unpaid principal balance will continue to reflect an allocation of the borrower’s payment between principal and interest. Generally accepted accounting principles define the recorded investment in loans as the sum of unpaid principal balance, accrued interest receivable, and deferred fees and costs minus partial charge-offs. Because accrued interest receivable, deferred fees and deferred costs are not material, the recorded investment in loans presented in the accompanying tables does not include these balances.
The following tables present the balance in the allowance for loan losses and the recorded investment of loans by portfolio class and based on impairment method.
The following tables present loans individually evaluated for impairment by loan class as of March 31, 2012 and December 31, 2011 and for the three months ended March 31, 2012 and March 31, 2011:
The following tables present the aging of the recorded investment in loans by loan class:
The following tables present the aging of the recorded investment in nonaccrual and loans past due over 90 days still on accrual by loan class:
Troubled Debt Restructurings:
Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDRs”) and classified as impaired. TDRs are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The Company has allocated $33,178 of specific reserves as of March 31, 2012 and $100,746 of specific reserves as of December 31, 2011 to customers whose loan terms have been modified in TDRs. The Company has committed to lend additional amounts totaling up to $6,000 as of March 31, 2012 and $6,000 as of December 31, 2011 to customers with outstanding loans that are classified as TDRs. All loans classified as TDRs were also classified as impaired loans as of March 31, 2012 and December 31, 2011.
There were no TDRs completed during the three months ending March 31, 2012 or the three months ending March 31, 2011.
There were no troubled Debt Restructurings outstanding as of March 31, 2011.
The troubled debt restructurings described above did not increase the allowance for loan losses or result in charge offs during the period ending March 31, 2012 and March 31, 2011, respectively.
The Home Equity modification related to a change in payment through the re-amortization of the remaining balance and an increase in the interest rate.
The modifications of the Commercial class generally relate to maturity date extensions as well as rate and payment modifications. The payment modifications adjusted the remaining amortization of the outstanding loan balance. Generally, interest rates are either maintained at the same rate or increased for modifications in the Commercial class. The advance of funds “post-modification” related to equipment purchases.
The modifications of the Non-Owner Occupied Commercial Real Estate class related to a restructuring of payment, interest rate, term and amortization. For each loan, the interest rate was either increased or was unchanged. The loan term was left unchanged or shortened. The amortization period was lengthened up to 7 years with the loan-to-value of each loan remaining within Bank credit policy limits. The increase in balances “post-modification” related to the advance of new funds to pay delinquent real estate taxes.
The Owner-Occupied Commercial Real Estate modifications were the result of matching the expiration date of the real estate holding company debt with the debt of the operating entity.
A loan is typically considered to be in payment default once it is eleven days contractually past due under the modified terms. As of March 31, 2012, there was one commercial loan identified as a TDR with a principal balance of approximately $7,000 for which a payment default occurred during the prior twelve months following the modification.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the company’s internal underwriting policy.
No loans were modified during the three months ending March 31, 2012 that had a significant payment delay and did not meet the definition of a troubled debt restructuring.
Credit Quality Indicators:
The Company classifies all non-homogeneous loans such as commercial and commercial real estate loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk into four non-classified categories (i.e. passing grade loans) and three categories of classified loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are included in groups of homogeneous loans. Loans not analyzed as part of homogeneous groups include commercial, commercial real estate, multi-family real estate, construction and development loans. Homogeneous groups of loans are not typically risk rated unless the loan is placed on nonaccrual status. A loan may also be separated from the homogeneous pool and individually risk rated due to recurrent delinquency problems, typically 60 to 89 days past due. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the current principal balance of residential and consumer loans based on payment activity:
NOTE 5 – ASSETS ACQUIRED IN SETTLEMENT OF LOANS
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. Expenditures that improve the fair value of the property are capitalized. The Company makes periodic reassessments of the value of assets held in this category and record valuation adjustments or write-downs as the reassessments dictate.
Assets acquired in settlement of loans were as follows:
The interest in the limited liability company was obtained through a U.S. Bankruptcy Code 363 sale. The limited liability company was formed by the lead bank for the banks participating in the project financing to acquire title to the real estate, conduct the operation of the facility, and market the real estate and the operations of the business for sale. The carrying value of its interest is based upon the estimated fair value of the real estate less costs to sell.
Direct write-downs of assets acquired in settlement of loans totaled $30,450 and $0 for the three months ended March 31, 2012 and 2011, respectively.
NOTE 6 – FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 – Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial asset:
Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
Certificate of Deposit in Financial Institution: The fair value of certificates of deposit maintained with financial institutions is based upon discounted cash analyses, using interest rates currently offered for similar time deposits resulting in a Level 2 classification.
Securities: The fair values for securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using matrix pricing, which is a mathematical technique used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2).
Loans Held For Sale: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan resulting in Level 2 classification.
Loans: Fair values of loans, excluding loans held for sale, are estimated as follows: Fair values for loans are estimated using discounted cash flow analyses, using interest rates currently offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Federal Bank Stock: It is not practical to determine the fair value of federal bank stock due to restrictions placed on its transferability.
Assets Acquired in Settlement of Loans: Assets acquired in settlement of loans are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. The fair value of assets acquired in settlement of loans is generally based on real estate appraisals. Appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
Annual appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. For commercial impaired loans and other real estate owned, if the carrying value is less than $250,000, the Company may obtain a property evaluation by an independent company instead of an appraisal. The Company uses an independent third party appraisal management company for the management of appraisal ordering and review. The appraisal management company reviews the assumptions and approaches, utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics and provides a written review report to the Company. Appraised values or evaluation values are always discounted by at least ten percent for selling costs to arrive at fair value. In some cases, and when justified through appropriate documentation, additional discounting is reflected to allow for changing market conditions, property condition or increasing vacancy.
Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
Short-term Borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.
Other Borrowings: The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
Accrued Interest Receivable/Payable: The carrying amounts of accrued interest approximate fair value and its classification is correlated to the underlying financial instrument.
Off-balance Sheet Instruments: Fair values for off-balance sheet commitments are nominal and are not material.
Assets measured at fair value on a recurring basis are summarized in the following tables:
Level 3 securities are priced by a third party vendor and consist of non-rated municipal bonds of a single issuer. The vendor uses internal quality ratings that are a proprietary, internal data management tool to group municipal securities into sectors by perceived credit quality and correlation to the overall municipal market. Data gathered can be categorized as indicative data (terms and conditions data) and market data which are inputs used in price generation. Market data is comprised of various inputs needed to generate or adjust the variables required by the vendors pricing system. Examples of these market inputs are trades, bid price or spread, two-sided markets, quotes, benchmark curves including but not limited to Treasury benchmarks and LIBOR and swap curves, market data feeds such as MSRB, new issues, financial statements, discount rate, capital rates, and trustee reports. They rely on the expertise and judgment of its pricing analysts to gather and identify relevant information to use in formulating pricing opinions.
The Company’s policy is to recognize transfers into or out of a level as of the end of the reporting period. There were no transfers between Level 1 and Level 2 securities during the three months ended March 31, 2012 or March 31, 2011.
The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2012:
The following table summarizes changes in unrealized gains and losses recorded in earnings for the three months ended March 31 for Level 3 assets and liabilities that are still held at March 31.
The table below summarizes changes in unrealized gains and losses recorded in earnings for the three months ended March 31 for Level 3 assets and liabilities that are still held at March 31.
Assets measured at fair value on a non-recurring basis are summarized in the following table:
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $711,917 with a specific allocation of the allowance for loan losses of $125,917 at March 31, 2012. Provisions for loan losses as a result of charge-offs or write-downs to the fair value of collateral were $77,406 for the three months ended March 31, 2012.
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $1,639,944, with a specific allocation of the allowance for loan losses of $119,080 at December 31, 2011. Provisions for loan losses as a result of charge-offs or write-downs to the fair value of collateral were $628,530 in 2011, of which $118,895 was provided for during the three months ended March 31, 2011.
Assets acquired in settlement of loans, measured at fair value less costs to sell, had a carrying value of $1,864,552 at March 31, 2012. Gross write downs totaling $30,450 were recorded on assets acquired in settlement of loans during the three months ended March 31, 2012. Gross write downs totaling $192,882 were recorded on assets acquired in settlement of loans during 2011, of which $0 was provided for during the three months ended March 31, 2011.
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2012:
The carrying values and estimated fair values of financial assets and liabilities were as follows:
NOTE 7 – STOCK BASED COMPENSATION
Shareholders adopted the Ohio Legacy Corp 2010 Cash and Equity Incentive Plan in May 2010. The Plan permits the grant of share-based awards for a maximum of 2,000,000 shares of common stock. The Plan provides for awards of options, restricted stock, stock appreciation rights, and other stock-based awards to employees, directors and consultants. Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant. Options awards have vesting periods as determined by the Compensation Committee of the Board of Directors. All options currently outstanding have an original vesting period of five years.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. (Employee and management options are tracked separately.) The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.
The following table depicts the activity under this Plan:
The weighted average remaining contractual life of the options outstanding at March 31, 2012 was 8.28 years. The intrinsic value of options outstanding was $0. At March 31, 2012, there were 265,250 options that were exercisable. All nonvested outstanding options are expected to vest.
The compensation cost yet to be recognized for stock options that have been awarded but not vested is as follows:
NOTE 8 – REGULATORY MATTERS
Banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Prompt corrective action regulations provide five classifications: (i) well capitalized; (ii) adequately capitalized; (iii) undercapitalized; (iv) significantly undercapitalized; and (v) critically undercapitalized, although these terms are not used to represent overall financial condition. Failure to meet capital requirements can initiate regulatory action.
On September 9, 2011, the Bank’s primary regulator, the Office of the Comptroller of the Currency (“OCC”), terminated the Consent Order entered into during February 2009 since the Bank demonstrated full compliance with all terms of the Consent Order, and the continued existence of the Consent Order was no longer required. As a result, the Bank is considered well-capitalized under the risk-based capital regulations governing the banking industry and is no longer classified by the OCC as a “troubled” institution.
Actual and required capital amounts (in thousands) and ratios are presented below at March 31, 2012 and December 31, 2011:
NOTE 9 – INCOME TAXES
A valuation allowance of $4,612,697 was recorded to reduce the carrying amount of the Company’s net deferred tax assets to zero due primarily to losses sustained in prior years. As a result, income tax benefits related to net operating losses are not typically recorded. A portion of the change in the valuation allowance in each period is attributable to other comprehensive income.
Internal Revenue Code section 382 places a limitation on the amount of taxable income that can be offset by net operating loss carryforwards after a change in control (generally greater than 50% change in ownership) of a loss corporation. Accordingly, utilization of net operating loss carryforwards may be subject to an annual limitation regarding their utilization against future taxable income upon change in control.
At February 19, 2010, a Stock Purchase Agreement between Ohio Legacy Corp and Excel Bancorp resulted in a section 382 limitation against pre-transaction Ohio Legacy Corp net operating loss carryforwards. The Company reduced the deferred tax asset related to net operating loss carryforwards and the valuation allowance by $1,039,000 at December 31, 2010. At December 31, 2011, the Company further reduced the deferred tax asset related to net operating loss carryforwards and the valuation allowance by an additional $377,000 as a result of changes in the realizable amount of such net operating loss.
At December 31, 2011, after consideration of the reduction to pre-transaction net operating losses due to the section 382 limitation, the Company had net operating loss carryforwards of approximately $8,026,000 that will expire as follows: $1,257,000 on December 31, 2027, $132,000 on December 31, 2028, $1,532,000 on December 31, 2029, and $5,105,000 on December 31, 2030. In addition, the Company had approximately $76,000 of alternative minimum tax credits that may be carried forward indefinitely.
At December 31, 2011 and 2010, the Company had no unrecognized tax benefits recorded. The Company does not expect the amount of unrecognized tax benefits to change significantly within the next twelve months.
Item 2. Management’s Discussion and Analysis.
In the following section, management presents an analysis of Ohio Legacy Corp's financial condition as of March 31, 2012, and results of operations as of and for the three months ended March 31, 2012 and 2011. This discussion is provided to give shareholders a more comprehensive review of the issues facing management than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and the accompanying notes included in this Form 10-Q and the Company’s annual report on Form 10-K for the year ended December 31, 2011.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, includes “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act which can be identified by the use of forward-looking terminology, such as “may”, “might”, “could”, “would”, “believe”, “expect”, “intend”, “plan”, “seek”, “anticipate”, “estimate”, “project” or “continue” or the negative version of such terms or comparable terminology. All statements other than statements of historical fact included in this Form 10-Q, including statements regarding our outlook, financial position, results of operation, liquidity, capital resources and interest rate sensitivity are forward-looking statements.
The Private Securities Litigation Reform Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the forward-looking statements. We desire to take advantage of the “safe harbor” provisions of that Act.
Forward-looking statements speak only as of the date on which they are made and, except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date on which the statement is made.
Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results to be materially different from any future results expressed or implied by such forward-looking statements. Although we believe the assumptions, judgments and expectations reflected in such forward-looking statements are reasonable, we can give no assurance such assumptions, judgments and expectations will prove to have been correct. Important factors that could cause actual results to differ materially from those in the forward-looking statements included in this Form 10-Q include, but are not limited to:
OVERVIEW OF STRATEGIC DEVELOPMENTS
Following the recapitalization of the Company in February 2010, the Company’s management has focused on a number of initiatives including the following:
o The Consent Order was removed by the OCC on September 9, 2011, reflecting improvements in the management of problem loans.
In October 2011, Premier Bank & Trust completed the sale of two branch offices located in Wooster, Ohio, to The Commercial and Savings Bank of Millersburg, Ohio (“CSB”), a wholly owned subsidiary of CSB Bancorp, Inc., under an agreement (the “Agreement”) entered into during June 2011. Under the terms of the Agreement, CSB purchased approximately $9 million in loans, net of an allocation of the Allowance for Loan and Lease Losses totaling $600,000, real estate, fixtures and equipment associated with the branch locations, and deposits and other liabilities of $75 million. CSB paid a premium of $3.5 million, or 5% of the average amount of assumed deposits during the ten day period prior to and the day of closing less a fixed stated amount of $166,000. In addition to the loans, real estate, and fixed assets sold to CSB, the transaction was funded with approximately $42 million in cash and $19 million in borrowings from the Federal Home Loan Bank. This transaction positions the Company to focus on our core market of Stark County, Ohio, and provides future expansion potential. The impact of the branch sale is evident when comparing the first quarter results of 2012 compared to the same quarter of 2011 particularly for deposit related noninterest income and overhead expenses.
The following key factors summarize the Company’s financial condition at March 31, 2012 compared to December 31, 2011:
The following key factors summarize our results of operations for the three months ended March 31, 2012:
The following forward-looking statements describe our near term outlook:
CRITICAL ACCOUNTING POLICIES
The preparation of consolidated financial statements and related disclosures in accordance with U.S. generally accepted accounting principles requires us to make judgments, assumptions and estimates at a specific point in time that affect the amounts reported in the accompanying consolidated financial statements and related notes. In preparing these financial statements, we have utilized available information including our past history, industry standards and the current economic environment, among other factors, in forming our estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by management in formulating our estimates inherent in these financial statements may not materialize. Application of the critical accounting policies described below involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact the comparability of our results of operation to similar businesses.
Allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and recoveries and decreased by charge-offs. We estimate the allowance balance by considering the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged off. Loan losses are charged against the allowance when we believe the loan balance cannot be collected.
We consider various factors, including portfolio risk, economic environment and loan delinquencies, when determining the level of the provision for loan losses. We monitor loan quality monthly and engage an independent third party each quarter to help monitor and confirm our loan grading conclusions.
Valuation allowance for deferred tax assets. Another critical accounting policy relates to valuation of the deferred tax asset for net operating losses. Net operating loss carryforwards of approximately $8,026,000 will expire as follows: $1,257,000 on December 31, 2027, $132,000 on December 31, 2028, $1,532,000 on December 31, 2029, and $5,105,000 on December 31, 2030. A valuation allowance has been recorded for the related deferred tax asset for these carryforwards and other net deferred tax assets recorded by the Company to reduce the carrying amount of these assets to zero. Additional information is included in Note 9 to the consolidated financial statements.
FINANCIAL CONDITION – March 31, 2012 compared to December 31, 2011
Assets. At March 31, 2012, total assets increased to $158.8 million, up $12.2 million from $146.6 million at December 31, 2011. The asset increase was principally due to an increase in deposits of $8.9 million.
Cash and Cash Equivalents. Cash and cash equivalents increased to $24.1 million at March 31, 2012, up $4.0 million from year-end 2011. The increase in cash and cash equivalents was due to an increase in deposits that was not otherwise invested in loans or securities.
Securities. Total securities available for sale had an estimated fair value of $12.5 million at March 31, 2012, compared to $10.7 million at year-end 2011. There were no sales of securities during the first quarter of 2012. The net unrealized gain on the securities portfolio was $446,401 at March 31, 2012 compared to a net unrealized gain of $452,816 at December 31, 2011.
Loans and Asset Quality. Total loans, net of the allowance for loan loss and deferred loan fees, increased $5.1 million to $113.4 million. Loans classified by management as special mention, substandard, doubtful and not deemed impaired represented 3.6% of total loans at March 31, 2012, compared to 5.0% at December 31, 2011. Impaired loans on nonaccrual status represented 1.3% of total loans at March 31, 2012, and totaled $1,558,394, up $223,096 from year-end 2011. Improving asset quality continues to be a prime objective for management. Outstanding loan balances are expected to increase over the remainder of the year through business development efforts. However expected loan growth may be constrained by continued economic weakness in the markets served by the Company and competitive pressure.
Allowance for loan losses. The balance of the allowance for loan loss at March 31, 2012, was $2,419,047 compared to $2,484,478 at year-end 2011. For the three months ending March 31, 2012, the allowance for loan loss was reduced by a negative loan loss provision of $7,557. Recoveries on loans previously charged-off totaled $12,695 and loans charged off totaled $70,569. The amount of the allowance for loan loss is based on a combination of actual experiential factors such as historical losses for each category of loans, information about specific borrowers, and other factors, including delinquencies, general economic conditions and the outlook for specific industries, which are more subjective in nature.
The reduction to the allowance is directionally consistent with the trends in the criticized loan portfolio. Criticized loans decreased as a result of loan risk upgrades on specific loans and principal reductions from payments. Another contributing factor was a decrease in the historical loss percentages. These loss rates are regularly updated to reflect the most recent three years of loss experience. Reductions to the estimate of incurred losses in the loan portfolio for lower loss rates and loan risk upgrades during the first quarter of 2012 were partly offset by the amount of the allowance required to support growth in loan balances since year-end 2011.
The general allowance allocated to loans not criticized by management totaled 1.73% of non-criticized loans at March 31, 2012, compared to 1.75% at year-end 2011. As a percentage of total loans, the allowance decreased to 2.09% at March 31, 2012, compared to 2.24% at year-end 2011. The allowance for loan loss as a percentage of loans not individually identified as impaired and that excludes the amount of the allowance specifically allocated to impaired loans totaled 2.06% at March 31, 2012, compared to 2.22% at year-end 2011. Specific allocations of the allowance for impaired loans increased to $125,918 at March 31, 2012 compared to $119,080 at year-end 2011.
Assets acquired in settlement of loans. These assets include other real estate owned (“OREO”) and an interest in a limited liability company acquired during 2010 that owns the real estate and operations of an indoor water park and resort obtained through a U.S. Bankruptcy Code 363 sale. The limited liability company was formed by the lead bank for the banks participating in the project financing to acquire title to the real estate, conduct the operation of the facility, and market the real estate and the operations of the business for sale. The carrying value of its interest is approximately $1.3 million and is based upon the estimated fair value of the real estate less costs to sell.
Other real estate owned consisted of eight properties and totaled approximately $635,000 at March 31, 2012 compared to nine properties with a carrying value of $757,000 at year-end 2011. One property was sold for a gain of $3,609, and no properties were transferred to OREO during the first quarter of 2012.
Deposits. Total deposits increased $8.9 million to $112.8 million compared to year-end 2011. Time deposits included $17.8 million in deposits acquired from financial institutions subscribing to a national time deposit rate listing service. These deposits had a weighted average rate of 0.52% with an average remaining maturity of 214 days. This funding source is less expensive than rates paid in the retail deposit market, but there is no opportunity to cross-sell other products and services to these depositors. It has also allowed the Bank to extend the maturity term of its deposits since retail depositors have migrated into money market funds as customers tend to be unwilling to lengthen deposit maturities given low interest rates. It has also partially replaced deposits sold through the branch sale during the fourth quarter of 2011.
Federal Home Loan Bank Advances. Federal Home Loan Bank advances totaling $19 million were used as a funding source following the sale of two branches during the fourth quarter of 2012.
Accrued interest payable and other liabilities. Other liabilities increased $2.8 million to $3.7 million due to the purchase of a security prior to the end of March 2012 that did not settle until April.
Shareholders’ Equity. Shareholders’ Equity decreased $172,000 to $18.4 million at March 31, 2012. The decrease was due to the operating loss of approximately $215,000 incurred for the three months of 2012 which was partially offset by stock-based compensation costs, a noncash expense, of approximately $49,000. Accumulated other comprehensive income decreased by approximately $6,000.
RESULTS OF OPERATIONS – THREE MONTHS ENDED MARCH 31, 2012
The net loss for the three months ending March 31, 2012, totaled $214,974 or a loss of $0.01 per diluted share compared to a net loss of $468,567, or $0.02 per diluted share during the first quarter of 2011. Average diluted shares outstanding were unchanged at 19,714,564 shares for the first quarter of 2012 compared to the same quarter of 2011.
The following table sets forth information relating to the average balance sheet and reflects the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. These yields and costs are derived by dividing income or expense, on an annualized basis, by the average balances of interest-earning assets or interest-bearing liabilities for the periods presented.
Net interest income. For the three months ending March 31, 2012, net interest income was $1,282,956, up $34,963 from same period in 2011 while average total interest earning assets were down $12.3 million. Loans and liquid assets used to fund deposits sold during the third quarter of 2011 reduced the balance of earning assets. The yield on earning assets declined 0.14% to 3.94% for the first quarter of 2012 from 4.08% for the comparable period of 2011. The yield on interest-bearing liabilities declined 0.52% to 0.60% for the first quarter of 2012 from 1.12% for the same period in 2011. The net interest margin increased to 3.50% from 2.88%.
Interest Income. Total interest income for the first quarter of 2012 was $1.4 million, down from $1.6 million for the first quarter of 2011. Interest-bearing assets continue to reprice downward as low interest rates prevailed during the quarter and originations of interest earning assets are booked at lower rates contributing to lower interest income levels.
Interest expense. Interest on deposits declined $182,000 to $144,000 for the first quarter of 2012 compared to the same period in 2011. The average yield on interest-bearing deposits dropped 0.39% to 0.68%. Interest expense related to other borrowings including Federal Home Loan Bank advances declined by $17,000. During the fourth quarter of 2011, the Company took loan advances totaling $19 million from the Federal Home Loan Bank to assist in the funding of the branch deposit sale. Of this amount, $13 million is short term debt with a comparatively low cost that contributed to the reduction in the average rate paid on other borrowings to 0.27% during the first quarter of 2012 compared to 2.11% for the same period of 2011. Management expects that it will be difficult to achieve further reductions to the cost its core deposits since the current cost is already priced at historically low rates.
Provision for Loan Loss. A negative loan loss provision totaling $7,557 was recorded during the first quarter of 2012, compared to provision expense of $23,772 for the same quarter last year; negative loan loss provisions provide a positive contribution to net income. The provision for loan loss will fluctuate based on management’s evaluation of the credit within the loan portfolio, changes in credit loss experience factors, and incurred losses in the loan portfolio during the period. See also the discussion above for the Allowance for Loan Losses.
Noninterest income. Noninterest income decreased $69,523 to $282,831 for the first quarter of 2012 compared to $352,354 for the same quarter of 2011. The decrease was the result of a reduction in service charges and other fees due to the sale of branch deposits during the fourth quarter of 2011.
Service charges and other fees declined $84,612, to $68,582 for the first quarter of 2012 compared to the same period of 2011. This decline resulted from the sale of deposit accounts during the fourth quarter of 2012. Those accounts generated approximately $90,000 in service charges and other fees during the first quarter of 2011.
The Bank’s trust department and brokerage business generated $216,386 in gross fees during the first quarter of 2012, up from $165,838 for the comparative quarter of 2011. These services, newly introduced during the second quarter of 2010, provided asset management expertise for $114 million in assets as of March 31, 2012.
No securities were sold during the first quarter of 2012. Gains realized on the sale of securities during the first quarter of 2011 totaled $32,999. These sales were intended to reduce the price sensitivity of the investment portfolio in a period of rising rates.
Gains on sale of loans decreased $3,954 to $22,793 for the first quarter of 2012 compared to the same quarter of 2011.
Losses recorded on the other real estate owned during the first quarter of 2012 totaled $26,841, an improvement from a loss of $35,299 recorded during the first quarter of 2011. One property was sold for a gain during the first quarter of 2012. Direct write-downs in the value of OREO totaled $30,450 for two properties in the first quarter of 2012 and $0 for the comparative quarter of 2011.
Other income declined $8,301 to $1,911 for the first quarter of 2012 compared to the same quarter last year. The decline was principally due to the absence of rental income from leased office space located at one of the sold branch offices.
Noninterest expense. Noninterest expense decreased $272,201 to $1,772,941 for the first quarter of 2012 compared to $2,045,142 for the first quarter of 2011. Lower expenses were principally the result of the reduction in overhead associated with the branch offices sold during the fourth quarter of 2012. The significant changes are detailed below.
Salaries and benefits decreased $89,040 to $956,510 for the first quarter of 2012 compared to $1,045,550 for the same period of 2011. Salaries and benefits costs associated with recently sold branches totaled approximately $87,000 for the first quarter of 2011.
Occupancy and equipment costs decreased $57,307 to $188,529 for the first quarter of 2012. Costs associated with recently sold branches during the first quarter of 2011 totaled approximately $62,000. Occupancy and equipment costs associated with the recently opened St. Clairsville branch totaled approximately $24,000.
Professional fees, including legal, accounting and other consulting expense, decreased $18,931 to $115,720 for the first quarter of 2012 principally due to a reduction in costs for audit and regulatory examination costs.
Franchise tax increased $7,000 to $60,800 for the first quarter of 2012. Ohio franchise tax for financial institutions for the current year is based on the Bank’s net worth on the last day of the prior calendar year end; higher capital levels at year-end 2011 compared to year-end 2010 resulted in higher costs for 2012.
Data processing charges include costs for internet banking, core systems data processing and courier charges. This expense category decreased $39,441 to $140,554. This cost is principally driven by the costs associated with core processing and is largely driven by transaction volumes. Costs for the first quarter of 2012 also included approximately $6,000 in expenses associated with the core processing conversion that was completed in April 2012.
Marketing costs were down $6,030 for the first quarter of 2012 to $16,918. This reduction is attributed to the difference in the timing when costs are incurred. General marketing costs for 2012 are expected to be similar to the costs incurred in 2011.
Deposit insurance and deposit related expenses decreased $40,271 to $72,938 for the first quarter of 2012 compared to the same period in 2011. FDIC insurance expense decreased $33,727. Both the change in the methodology in FDIC assessments implemented April 1, 2011 and the reduction in total assessment base due to lower average total assets contributed to the decrease.
Other expenses decreased $25,593 during the first quarter of 2012 compared to the same period in 2011. Other real estate owned expenses decreased $12,074, insurance expense decreased $10,671, directors’ fees decreased $4,750 and employee-related expense accounts decreased $4,027. Offsetting these savings was an increase to loan-related expenses increased of $6,737.
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE SHEET ARRANGEMENTS
At March 31, 2012, the Company had no active unconsolidated, related special purpose entities, nor did the Company engage in derivatives and hedging contracts, such as interest rate swaps, that may expose the Company to liabilities greater than the amounts recorded on the consolidated balance sheet. The investment policy prohibits engaging in derivatives contracts for speculative trading purposes; however, the Company may pursue certain contracts, such as interest rate swaps, to execute a sound and defensive interest rate risk management policy.
Liquidity refers to our ability to fund loan demand and customers’ deposit withdrawal needs and to meet other commitments and contingencies. The purpose of liquidity management is to ensure sufficient cash flow to meet all of our financial commitments and to capitalize on opportunities for business expansion in the context of managing the Company’s interest rate risk exposure. This ability depends on our financial strength, asset quality and the types of deposit and loan instruments we offer to our customers.
Our principal sources of funds are deposits, loan and security repayments, maturities and sales of securities, borrowings from the FHLB and capital transactions. Alternative sources of funds include repurchase agreements and brokered certificates of deposit and the sale of loans. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan and security prepayments are more influenced by interest rates, general economic conditions and competition. We maintain investments in liquid assets based upon our assessment of our need for funds, our expected deposit flows, yields available on short-term liquid assets and the objectives of our asset/liability management program.
We have implemented a liquidity contingency funding plan that identifies liquidity thresholds and red flags that may provide evidence of an impending liquidity crisis. Additionally, the liquidity contingency plan details specific actions to be taken by management and the Board of Directors and identifies sources of emergency liquidity, both asset and liability-based, should we encounter a liquidity crisis. We actively monitor our liquidity position and analyze various scenarios that could impact our ability to access emergency funding in conjunction with our asset/liability and interest rate risk management activities.
The Consolidated Statement of Cash Flows provides details on sources and uses of cash for the three months ended March 31. Cash and cash equivalents increased $4.1 million to $24.1 million at March 31, 2012 since year-end 2011.
Total shareholders’ equity was $18.4 million at March 31, 2012, a decrease of $172,000 from the prior year-end balance. The decrease in equity was primarily due to the net loss of approximately $215,000 incurred by the Company for the first quarter of 2012. Stock-based compensation expense of approximately $49,000 increased equity as this noncash expense is recorded as an increase to capital. Unrealized net gains in the investment portfolio declined by approximately $6,000 since year-end also reducing shareholders’ equity.
The Bank is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. Failure to meet capital requirements can initiate regulatory action. At March 31, 2012, the Bank was well capitalized under the provisions of prompt corrective action. See Note 8 for more information regarding the regulatory capital requirements for the Bank and the Bank’s capital ratios as of March 31, 2012.
The payment of dividends by the Bank to the Company and by the Company to shareholders is subject to restrictions by regulatory agencies. These restrictions generally limit dividends to the sum of the current year’s earnings and the prior two years’ retained earnings, as defined. In addition, dividends may not reduce capital levels below the minimum regulatory requirements as described above. The Bank cannot declare dividends without prior approval from the Comptroller of the Currency in 2012.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable for Smaller Reporting Companies.
Item 4T. Controls and Procedures
As of March 31, 2012 an evaluation was conducted under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in the Company’s internal control over financial reporting that occurred during the Company’s first fiscal quarter ended March 31, 2012, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
There are no matters required to be reported under this item.
Item 1A. Risk Factors
Not applicable for Smaller Reporting Companies.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 3. Defaults upon Senior Securities.
There are no matters required to be reported under this item.
Item 4. (Removed and Reserved)
Item 5. Other Information.
There are no matters required to be reported under this item.
Item 6. Exhibits.
INDEX TO EXHIBITS
The following exhibits are included in this Report on Form 10-Q or are incorporated herein by reference as noted in the following table:
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: May 15, 2012