XNAS:IBCP Independent Bank Corp (Ionia MI) Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED March 31, 2012

Commission file number   0-7818
 
INDEPENDENT BANK CORPORATION
(Exact name of registrant as specified in its charter)

Michigan
 
38-2032782
(State or jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)
 
230 West Main Street, P.O. Box 491, Ionia, Michigan  48846
(Address of principal executive offices)

(616) 527-5820
(Registrant's telephone number, including area code)
 
NONE
Former name, address and fiscal year, if changed since last report.

     Indicate by check mark whether the registrant (1) has filed all documents and reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     YES x      NO o
 
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   o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or smaller reporting company.
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     YES o      NO x
 
     Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Common stock, no par value
 
8,575,471
Class
 
Outstanding at May 9, 2012
 


 
 

 
 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

INDEX
 
    Number(s)
PART I -
Financial Information
   
Item 1.  
3
   
4
   
5
   
6
   
7
   
8-54
Item 2.  
55-84
Item 3.
 
85
Item 4.
 
85
       
PART II -
Other Information
   
Item 1A
 
86
Item 2.
 
86
Item 3b.
 
86
Item 6.
 
86

Discussions and statements in this report that are not statements of historical fact, including, without limitation, statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan,” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions and other statements that are not historical facts, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; predictions as to our Bank’s ability to maintain certain regulatory capital standards; our expectation that we will have sufficient cash on hand to meet expected obligations during 2012; and descriptions of steps we may take to improve our capital position. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals and, by their nature, are subject to assumptions, risks, and uncertainties.  Although we believe that the expectations, forecasts, and goals reflected in these forward-looking statements are reasonable, actual results could differ materially for a variety of reasons, including, among others:
 
 
·
our ability to successfully raise new equity capital, effect a conversion of our outstanding preferred stock held by the U.S. Treasury into our common stock, and otherwise implement our capital restoration plan;
 
·
the failure of assumptions underlying the establishment of and provisions made to our allowance for loan losses;
 
·
the timing and pace of an economic recovery in Michigan and the United States in general, including regional and local real estate markets;
 
·
the ability of our Bank to remain well-capitalized;
 
·
the failure of assumptions underlying our estimate of probable incurred losses from vehicle service contract payment plan counterparty contingencies, including our assumptions regarding future cancellations of vehicle service contracts, the value to us of collateral that may be available to recover funds due from our counterparties, and our ability to enforce the contractual obligations of our counterparties to pay amounts owing to us;
 
 
1

 
 
·
further adverse developments in the vehicle service contract industry;
 
·
potential limitations on our ability to access and rely on wholesale funding sources;
 
·
the risk that sales of our common stock could trigger a reduction in the amount of net operating loss carryforwards that we may be able to utilize for income tax purposes;
 
·
the continued services of our management team, particularly as we work through our asset quality issues and the implementation of our capital restoration plan;
 
·
implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act or other new legislation, which may have significant effects on us and the financial services industry, the exact nature and extent of which cannot be determined at this time; and
 
·
the risk that our common stock may be delisted from the Nasdaq Global Select Market.

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all inclusive.  The risk factors disclosed in Part I – Item A of our Annual Report on Form 10-K for the year ended December 31, 2011, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risks that our management believes could materially affect the results described by forward-looking statements in this report.  However, those risks may not be the only risks we face.  Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us, that we currently consider to be immaterial, or that develop after the date of this report.  We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.
 
 
2

 
Part I - Item 1.  INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Financial Condition

   
March 31,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
 
Assets
 
(In thousands, except share amounts)
 
Cash and due from banks
  $ 53,690     $ 62,777  
Interest bearing deposits
    299,159       278,331  
Cash and Cash Equivalents
    352,849       341,108  
Trading securities
    69       77  
Securities available for sale
    303,658       157,444  
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
    20,828       20,828  
Loans held for sale, carried at fair value
    40,321       44,801  
Loans
               
Commercial
    649,552       651,155  
Mortgage
    571,251       590,876  
Installment
    210,360       219,559  
Payment plan receivables
    103,544       115,018  
Total Loans
    1,534,707       1,576,608  
Allowance for loan losses
    (56,006 )     (58,884 )
Net Loans
    1,478,701       1,517,724  
Other real estate and repossessed assets
    30,918       34,042  
Property and equipment, net
    63,417       62,548  
Bank-owned life insurance
    49,695       49,271  
Other intangibles
    7,337       7,609  
Capitalized mortgage loan servicing rights
    11,795       11,229  
Prepaid FDIC deposit insurance assessment
    11,788       12,609  
Vehicle service contract counterparty receivables, net
    28,925       29,298  
Accrued income and other assets
    18,977       18,818  
Total Assets
  $ 2,419,278     $ 2,307,406  
Liabilities and Shareholders' Equity
               
Deposits
               
Non-interest bearing
  $ 519,819     $ 497,718  
Savings and interest-bearing checking
    1,093,799       1,019,603  
Retail time
    524,694       526,525  
Brokered time
    46,000       42,279  
Total Deposits
    2,184,312       2,086,125  
Other borrowings
    33,039       33,387  
Subordinated debentures
    50,175       50,175  
Vehicle service contract counterparty payables
    6,813       6,633  
Accrued expenses and other liabilities
    39,907       28,459  
Total Liabilities
    2,314,246       2,204,779  
Shareholders' Equity
               
Convertible preferred stock, no par value, 200,000 shares authorized; 74,426 shares issued and outstanding at March 31, 2012 and December 31, 2011; liquidation preference: $82,024 at  March 31, 2012 and $81,023 at December 31, 2011
    80,913       79,857  
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding:  8,546,342 shares at March 31, 2012 and 8,491,526 shares at December 31, 2011
    248,995       248,950  
Accumulated deficit
    (211,811 )     (214,259 )
Accumulated other comprehensive loss
    (13,065 )     (11,921 )
Total Shareholders' Equity
    105,032       102,627  
Total Liabilities and Shareholders' Equity
  $ 2,419,278     $ 2,307,406  

See notes to interim condensed consolidated financial statements (unaudited)
 
 
3

 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
 
   
Three Months Ended
 
   
March 31,
   
March 31,
 
   
2012
   
2011
 
   
(unaudited)
 
   
(In thousands, except per share amounts)
 
Interest Income
           
Interest and fees on loans
  $ 24,346     $ 29,484  
Interest on securities
               
Taxable
    658       467  
Tax-exempt
    296       332  
Other investments
    396       435  
Total Interest Income
    25,696       30,718  
Interest Expense
               
Deposits
    2,424       4,945  
Other borrowings
    1,172       1,323  
Total Interest Expense
    3,596       6,268  
Net Interest Income
    22,100       24,450  
Provision for loan losses
    5,131       10,702  
Net Interest Income After Provision for Loan Losses
    16,969       13,748  
Non-interest Income
               
Service charges on deposit accounts
    4,201       4,282  
Interchange income
    2,322       2,168  
Net gains (losses) on assets
               
Mortgage loans
    3,860       1,935  
Securities
    684       213  
Other than temporary impairment loss on securities
               
Total impairment loss
    (177 )     (469 )
Loss recognized in other comprehensive loss
    -       327  
Net impairment loss recognized in earnings
    (177 )     (142 )
Mortgage loan servicing
    736       896  
Title insurance fees
    508       473  
(Increase) decrease in fair value of U.S. Treasury warrant
    (154 )     354  
Other
    2,604       2,532  
Total Non-interest Income
    14,584       12,711  
Non-interest Expense
               
Compensation and employee benefits
    12,482       12,349  
Loan and collection
    2,890       3,867  
Occupancy, net
    2,716       3,101  
Data processing
    2,339       2,310  
Furniture, fixtures and equipment
    1,294       1,418  
Net losses on other real estate and repossessed assets
    987       1,406  
Legal and professional
    897       778  
Communications
    875       948  
FDIC deposit insurance
    857       1,235  
Credit card and bank service fees
    651       1,047  
Advertising
    556       554  
Vehicle service contract counterparty contingencies
    471       2,346  
Provision for loss reimbursement on sold loans
    432       406  
Cost (recoveries) related to unfunded lending commitments
    (47 )     95  
Other
    649       2,008  
Total Non-interest Expense
    28,049       33,868  
Income (Loss) Before Income Tax
    3,504       (7,409 )
Income tax expense (benefit)
    -       (8 )
Net Income (Loss)
  $ 3,504     $ (7,401 )
Preferred stock dividends and discount accretion
    1,056       1,008  
Net Income (Loss) Applicable to Common Stock
  $ 2,448     $ (8,409 )
Net Income (Loss) Per Common Share
               
Basic
  $ .29     $ (1.06 )
Diluted
    .07       (1.06 )
Dividends Per Common Share
               
Declared
  $ .00     $ .00  
Paid
    .00       .00  
 
See notes to interim condensed consolidated financial statements (unaudited)
 
 
4

 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income (Loss)
 
   
Three months ended March 31,
 
   
2012
   
2011
 
   
(unaudited)
 
   
(In thousands)
 
Net income (loss)
  $ 3,504     $ (7,401 )
Other comprehensive income (loss), before tax
               
Unrealized losses on available for sale securities
               
Unrealized gain (loss) arising during period
    (860 )     321  
Change in unrealized losses for which a portion of other than temporary impairment has been recognized in earnings
    129       (327 )
Reclassification adjustments for (gains) losses included in earnings
    (692 )     (140 )
Unrealized losses on available for sale securities, net
    (1,423 )     (146 )
                 
Unrealized losses on derivative instruments
               
Unrealized loss arising during period
    (51 )     (23 )
Reclassification adjustment for expense recognized in earnings
    185       202  
Reclassfication adjustment for accretion on settled derivatives
    145       222  
Unrealized gains on derivative instruments
    279       401  
Other comprehensive income (loss), before tax
    (1,144 )     255  
Income tax expense related to components of other comprehesive income (loss)
    -       -  
Other comprehensive income (loss)
    (1,144 )     255  
Comprehensive income (loss)
  $ 2,360     $ (7,146 )
 
See notes to interim condensed consolidated financial statements (unaudited)
 
 
5

 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
 
   
Three months ended March 31,
 
   
2012
   
2011
 
   
(unaudited - In thousands)
 
Net Income (Loss)
  $ 3,504     $ (7,401 )
Adjustments to Reconcile Net Income (Loss) to Net Cash from Operating Activities
               
Proceeds from sales of loans held for sale
    116,422       122,838  
Disbursements for loans held for sale
    (108,082 )     (91,156 )
Provision for loan losses
    5,131       10,702  
Deferred loan fees
    (97 )     (28 )
Depreciation, amortization of intangible assets and premiums and accretion of discounts on securities and loans
    (1,313 )     (3,736 )
Net gains on sales of mortgage loans
    (3,860 )     (1,935 )
Net gains on securities
    (684 )     (213 )
Securities impairment recognized in earnings
    177       142  
Net losses on other real estate and repossessed assets
    987       1,406  
Vehicle service contract counterparty contingencies
    471       2,346  
Share based compensation
    45       153  
(Increase) decrease in accrued income and other assets
    (934 )     1,821  
Increase (decrease) in accrued expenses and other liabilities
    1,576       (188 )
Total Adjustments
    9,839       42,152  
Net Cash from Operating Activities
    13,343       34,751  
Cash Flow from (used in) Investing Activities
               
Proceeds from the sale of securities available for sale
    9,206       12,399  
Proceeds from the maturity of securities available for sale
    545       295  
Principal payments received on securities available for sale
    4,261       1,228  
Purchases of securities available for sale
    (150,607 )     (62,894 )
Net decrease in portfolio loans (loans originated, net of principal payments)
    34,293       63,644  
Proceeds from the collection of vehicle service contract counterparty receivables
    210       544  
Proceeds from the sale of other real estate and repossessed assets
    5,298       4,519  
Capital expenditures
    (2,827 )     (757 )
Net Cash from (used in) Investing Activities
    (99,621 )     18,978  
Cash Flow from (used in) Financing Activities
               
Net increase (decrease) in total deposits
    98,187       (28,871 )
Net increase (decrease) in other borrowings
    6       (6 )
Proceeds from Federal Home Loan Bank advances
    12,000       4,000  
Payments of Federal Home Loan Bank advances
    (12,354 )     (29,011 )
Net increase in vehicle service contract counterparty payables
    180       1,929  
Proceeds from issuance of common stock
    -       846  
Net Cash from (used in) Financing Activities
    98,019       (51,113 )
Net Increase in Cash and Cash Equivalents
    11,741       2,616  
Cash and Cash Equivalents at Beginning of Period
    341,108       385,374  
Cash and Cash Equivalents at End of Period
  $ 352,849     $ 387,990  
Cash paid during the period for
               
Interest
  $ 3,034     $ 5,806  
Income taxes
    131       20  
Transfers to other real estate and repossessed assets
    3,161       4,025  
Transfer of payment plan receivables to vehicle service contract counterparty receivables
    368       6,312  
Purchase of securities available for sale not yet settled     10,817       -  

See notes to interim condensed consolidated financial statements (unaudited)
 
 
6

 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders' Equity

   
Three months ended
 
   
March 31
 
   
2012
   
2011
 
   
(unaudited)
 
   
(In thousands)
 
Balance at beginning of period
  $ 102,627     $ 119,085  
Net income (loss)
    3,504       (7,401 )
Issuance of common stock
    -       846  
Share based compensation
    45       153  
Net change in accumulated other comprehensive loss, net of related tax effect
    (1,144 )     255  
Balance at end of period
  $ 105,032     $ 112,938  

See notes to interim condensed consolidated financial statements (unaudited)
 
 
7

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. 
Preparation of Financial Statements

The interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading.  The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes for the year ended December 31, 2011 included in our Annual Report on Form 10-K.

In our opinion, the accompanying unaudited condensed consolidated financial statements contain all the adjustments necessary to present fairly our consolidated financial condition as of March 31, 2012 and December 31, 2011, and the results of operations for the three-month periods ended March 31, 2012 and 2011.  The results of operations for the three-month periods ended March 31, 2012, are not necessarily indicative of the results to be expected for the full year.  Certain reclassifications have been made in the prior period financial statements to conform to the current period presentation.  Our critical accounting policies include the assessment for other than temporary impairment (“OTTI”) on investment securities,  the determination of the allowance for loan losses, the determination of vehicle service contract counterparty contingencies, the valuation of originated mortgage loan servicing rights and the valuation of deferred tax assets.  Refer to our 2011 Annual Report on Form 10-K for a disclosure of our accounting policies.

2. 
New Accounting Standards

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, “Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. This ASU amended guidance that will result in common fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards (“IFRS”). Under the amended guidance, entities are required to expand disclosure for fair value instruments categorized within Level 3 of the fair value hierarchy to include (1) the valuation processes used; and (2) a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs for recurring fair value measurements and the interrelationships between those unobservable inputs, if any. They are also required to disclose the categorization by level of the fair value hierarchy for items that are not measured at fair value in the Consolidated Statement of Financial Condition but for which the fair value is required to be disclosed (e.g. portfolio loans). This amended guidance became effective for us at January 1, 2012.  The effect of adopting this standard did not have a material impact on our consolidated operating results or financial condition, but the additional disclosures are included in notes #12 and #13.
 
 
8

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

In June 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05”. This ASU amended guidance on the presentation requirements for comprehensive income. The amended guidance requires an entity to present total comprehensive income, the components of net income and the components of other comprehensive income on the face of the financial statements, either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amended guidance did not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This amended guidance became effective for us at January 1, 2012 and was applied retrospectively.  The effect of adopting this standard did not have a material impact on our consolidated operating results or financial condition, but we have included separate Condensed Consolidated Statements of Comprehensive Income (Loss) immediately following our Condensed Consolidated Statements of Operations in our Condensed Consolidated Financial Statements.

3. 
Securities

Securities available for sale consist of the following:

   
Amortized
   
Unrealized
       
   
Cost
   
Gains
   
Losses
   
Fair Value
 
   
(In thousands)
 
March 31, 2012
                       
U.S. agency
  $ 97,511     $ 32     $ 1,479     $ 96,064  
U.S. agency residential mortgage-backed
    161,735       640       221       162,154  
Private label residential mortgage-backed
    10,528       -       2,497       8,031  
Obligations of states and political subdivisions
    34,152       464       202       34,414  
Trust preferred
    4,734       -       1,739       2,995  
Total
  $ 308,660     $ 1,136     $ 6,138     $ 303,658  
                                 
                                 
December 31, 2011
                               
U.S. agency
  $ 24,980     $ 58     $ 21     $ 25,017  
U.S. agency residential mortgage-backed
    93,415       1,007       216       94,206  
Private label residential mortgage-backed
    11,066       -       2,798       8,268  
Obligations of states and political subdivisions
    26,865       510       58       27,317  
Trust preferred
    4,697       -       2,061       2,636  
Total
  $ 161,023     $ 1,575     $ 5,154     $ 157,444  

 
9

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Our investments’ gross unrealized losses and fair values aggregated by investment type and length of time that individual securities have been at a continuous unrealized loss position follows:
 
   
Less Than Twelve Months
   
Twelve Months or More
   
Total
 
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair Value
   
Losses
   
Fair Value
   
Losses
   
Fair Value
   
Losses
 
   
(In thousands)
 
                                     
March 31, 2012
                                   
U.S. agency
  $ 78,629     $ 1,479     $ -     $ -     $ 78,629     $ 1,479  
U.S. agency residential mortgage-backed
    72,387       221       -       -       72,387       221  
Private label residential mortgage-backed
    -       -       8,028       2,497       8,028       2,497  
Obligations of states and political subdivisions
    7,971       202       -       -       7,971       202  
Trust preferred
    -       -       2,995       1,739       2,995       1,739  
Total
  $ 158,987     $ 1,902     $ 11,023     $ 4,236     $ 170,010     $ 6,138  
                                                 
December 31, 2011
                                               
U.S. agency
  $ 9,974     $ 21     $ -     $ -     $ 9,974     $ 21  
U.S. agency residential mortgage-backed
    42,500       216       -       -       42,500       216  
Private label residential mortgage-backed
    163       90       8,102       2,708       8,265       2,798  
Obligations of states and political subdivisions
    -       -       1,729       58       1,729       58  
Trust preferred
    591       1,218       2,045       843       2,636       2,061  
Total
  $ 53,228     $ 1,545     $ 11,876     $ 3,609     $ 65,104     $ 5,154  
 
Our portfolio of available-for-sale securities is reviewed quarterly for impairment in value. In performing this review management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income or loss.

U.S. Agency and U.S. Agency residential mortgage-backed securities — at March 31, 2012 we had 11 U.S. Agency and 19 U.S. Agency residential mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates during the first quarter of 2012 and widening discount margins. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Private label residential mortgage backed securities — at March 31, 2012 we had eight securities whose fair value is less than amortized cost.  Two of the issues are rated by a major rating agency as investment grade while four are below investment grade and two are split rated.  Six of these bonds have impairment in excess of 10% and all of these holdings have been impaired for more than 12 months.
 
 
10

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The unrealized losses are largely attributable to credit spread widening on these securities since their acquisition. The underlying loans within these securities include Jumbo (76%) and Alt A (24%) at March 31, 2012.

   
March 31, 2012
   
December 31, 2011
 
         
Net
         
Net
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Gain (Loss)
   
Value
   
Gain (Loss)
 
   
(In thousands)
 
                         
Private label residential mortgage-backed
                       
Jumbo
  $ 6,074     $ (1,846 )   $ 6,454     $ (1,937 )
Alt-A
    1,957       (651 )     1,814       (861 )
 
Seven of the private label residential mortgage-backed transactions have geographic concentrations in California, ranging from 22% to 58% of the collateral pool. Typical exposure levels to California (median exposure is 47%) are consistent with overall market collateral characteristics. Three transactions have modest exposure to Florida, ranging from 5% to 7% and one transaction has modest exposure to Nevada (5%). The underlying collateral pools do not have meaningful exposure to Arizona, Michigan or Ohio. None of the issues involve subprime mortgage collateral. Thus the impact of this market segment is only indirect, in that it has impacted liquidity and pricing in general for private label residential mortgage-backed securities. The majority of transactions are backed by fully amortizing loans. However, six transactions have concentrations in loans that pay interest only for a specified period of time and will fully amortize thereafter ranging from 31% to 94% (at origination date). The structure of the residential mortgage securities portfolio provides protection to credit losses. The portfolio primarily consists of senior securities as demonstrated by the following: super senior (21%), senior (45%), senior support (24%) and mezzanine (10%). The mezzanine class is from a seasoned transaction (91 months) with a significant level of subordination (8.39%). Except for the additional discussion below relating to other than temporary impairment, each private label residential mortgage-backed security has sufficient credit enhancement via subordination to reasonably assure full realization of book value. This assertion is based on a transaction level review of the portfolio.

Individual security reviews include: external credit ratings, forecasted weighted average life, recent prepayment speeds, underwriting characteristics of the underlying collateral, the structure of the securitization and the credit performance of the underlying collateral. The review of underwriting characteristics considers: average loan size, type of loan (fixed or ARM), vintage, rate, FICO, loan-to-value, scheduled amortization, occupancy, purpose, geographic mix and loan documentation. The review of the securitization structure focuses on the priority of cash flows to the bond, the priority of the bond relative to the realization of credit losses and the level of subordination available to absorb credit losses. The review of credit performance includes: current period as well as cumulative realized losses; the level of severe payment problems, which includes other real estate (ORE), foreclosures, bankruptcy and 90 day delinquencies; and the level of less severe payment problems, which consists of 30 and 60 day delinquencies.

All of these securities are receiving some principal and interest payments. Most of these transactions are passthrough structures, receiving pro rata principal and interest payments from a dedicated collateral pool for loans that are performing. The nonreceipt of interest cash flows is not expected and thus not presently considered in our discounted cash flow methodology discussed below.
 
 
11

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

In addition to the review discussed above, all private label residential mortgage-backed securities are reviewed for OTTI utilizing a cash flow projection. The cash flow analysis forecasted cash flow from the underlying loans in each transaction and then applied these cash flows to the bonds in the securitization. The cash flows from the underlying loans considered contractual payment terms (scheduled amortization), prepayments, defaults and severity of loss given default. The analysis used dynamic assumptions for prepayments, defaults and loss severity. Near term prepayment assumptions were based on recently observed prepayment rates. More weight was given to longer term historic performance (12 months). In some cases, recently observed prepayment rates are lower than historic norms due to the absence of new jumbo loan issuances. This loan market is heavily dependent upon securitization for funding, and new securitization transactions have been minimal. Our model projections anticipate that prepayment rates gradually revert to historical levels. For seasoned ARM transactions, normalized prepayment rates range from 10% to 18% CPR which is at the lower end of historically observed speeds for seasoned ARM collateral. For fixed rate collateral (one transaction), the prepayment speeds are projected to rise modestly.

Default assumptions are largely based on the volume of existing real-estate owned, pending foreclosures and severe delinquencies. Other considerations include the quality of loan underwriting, recent default experience, realized loss performance and the volume of less severe delinquencies. Default levels generally are projected to remain elevated or increase for a period of time sufficient to address the level of distressed loans in the transaction. Our projections expect defaults to then decline, generally beginning in year three. Current loss severity assumptions are based on recent observations when meaningful data is available. Loss severity is expected to remain elevated for the next three years as recent housing data remains weak. Severity is expected to decline beginning in year four as the back log of foreclosure and distressed sales clear the market. Except for three securities discussed in further detail below (all three are currently below investment grade), our cash flow analysis forecasts complete recovery of our cost basis for each reviewed security.

At March 31, 2012 three below investment grade private label residential mortgage-backed securities with fair values of $3.6 million, $1.7 million and $0.1 million, respectively and unrealized losses of $1.2 million, $0.3 million and $0.03 million, respectively (amortized cost of $4.8 million, $2.0 million and $0.1 million, respectively) had losses that were considered other than temporary.

The underlying loans in the first transaction are 30 year fixed rate jumbos with an average FICO of 744 and an average loan-to-value ratio of 72%. The loans backing this transaction were originated in 2007 and this is our only security backed by 2007 vintage loans. We believe that this vintage is a key differentiating factor between this security and the others in our portfolio that do not have unrealized losses that are considered OTTI. The bond is a senior security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated $0.560 million of credit related OTTI as of March 31, 2012 and was recognized in our Condensed Consolidated Statements of Operations ($0.085 million and $0.052 million of this amount was recognized in our Condensed Consolidated Statements of Operations during the three months ended March 31, 2012 and 2011, respectively while the balance was recognized in other periods). The remaining unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.
 
 
12

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The underlying loans in the second transaction are 30 year hybrid ARM Alt-A with an average FICO of 717 and an average loan-to-value ratio of 78%. The loans backing this transaction were originated in 2005.  The bond is a super senior security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated $0.457 million of credit related OTTI as of March 31, 2012 and was recognized in our Condensed Consolidated Statements of Operations ($0.032 million and zero of this amount was recognized in our Condensed Consolidated Statements of Operations during the three months ended March 31, 2012 and 2011, respectively while the balance was recognized in other periods).  The remaining unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.

The underlying loans in the third transaction are 30 year hybrid ARM jumbos with an average FICO of 738 and an average loan-to-value ratio of 57%. The loans backing this transaction were originated in 2005. The bond is a senior support security that is receiving principal and interest payments similar to principal reductions in the underlying collateral. The cash flow analysis described above calculated credit related OTTI of $0.380 million as of March 31, 2012 and was recognized in our Condensed Consolidated Statements of Operations ($0.060 million and $0.090 million of this amount was recognized in our Condensed Consolidated Statements of Operations during the three months ended March 31, 2012 and 2011, respectively while the balance was recognized in other periods). The remaining unrealized loss was attributed to other factors and is reflected in other comprehensive income (loss) during those same periods.

As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no other declines discussed above are deemed to be other than temporary.

Obligations of states and political subdivisions — at March 31, 2012 we had 11 municipal securities whose fair value is less than amortized cost. The unrealized losses are largely attributed to increases in interest rates and widening of market spreads.  Eight of the impaired securities are rated by a major rating agency as investment grade.  The non rated securities have a periodic internal credit review according to established procedures. As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

Trust preferred securities — at March 31, 2012 we had four securities whose fair value is less than amortized cost. All of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities over the past several years has suffered from significant credit spread widening fueled by uncertainty regarding potential losses of financial companies, the absence of a liquid functioning secondary market and potential supply concerns from financial companies issuing new debt to recapitalize themselves.

One of the four securities is rated by two major rating agencies as investment grade, while one is split rated (this security is rated as investment grade by one major rating agency and below investment grade by another) and the other two are non-rated. The non-rated issues are relatively small banks and were never rated. The issuers of these non-rated trust preferred securities, which had a total amortized cost of $2.8 million and total fair value of $1.5 million as of March 31, 2012, continue to have satisfactory credit metrics and one continues to make interest payments.  The other non-rated issue began deferring dividend payments in the third quarter of 2011 apparently due to an increase in non-performing assets.  Nevertheless, this issuer continues to have satisfactory capital measures and interim profitability.
 
 
13

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

The following table breaks out our trust preferred securities in further detail as of March 31, 2012 and December 31, 2011:

   
March 31, 2012
   
December 31, 2011
 
         
Net
         
Net
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Gain (Loss)
   
Value
   
Gain (Loss)
 
   
(In thousands)
 
                         
Trust preferred securities
                       
Rated issues
  $ 1,447     $ (444 )   $ 1,405     $ (484 )
Unrated issues - no OTTI
    1,548       (1,295 )     1,231       (1,577 )
 
As management does not intend to liquidate these securities and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines are deemed to be other than temporary.

During the three month periods ended March 31, 2012 and 2011 we recorded in earnings OTTI charges on securities available for sale of $0.177 million and $0.142 million, respectively (see discussion above).

A roll forward of credit losses recognized in earnings on securities available for sale for the three month periods ending March 31, follows:
 
   
2012
   
2011
 
   
(In thousands)
 
Balance at beginning of year
  $ 1,470     $ 710  
Additions to credit losses on securities for which no previous OTTI was recognized
    -       -  
Increases to credit losses on securities for which OTTI was
               
previously recognized
    177       142  
Total
  $ 1,647     $ 852  

The amortized cost and fair value of securities available for sale at March 31, 2012, by contractual maturity, follow. The actual maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

   
Amortized
   
Fair
 
   
Cost
   
Value
 
   
(In thousands)
 
Maturing within one year
  $ 1,360     $ 1,374  
Maturing after one year but within five years
    6,722       6,934  
Maturing after five years but within ten years
    25,349       25,470  
Maturing after ten years
    102,966       99,695  
      136,397       133,473  
U.S. agency residential mortgage-backed
    161,735       162,154  
Private label residential mortgage-backed
    10,528       8,031  
Total
  $ 308,660     $ 303,658  

 
14

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)

Gains and losses realized on the sale of securities available for sale are determined using the specific identification method and are recognized on a trade-date basis.  A summary of proceeds from the sale of securities available for sale and gains and losses for the three month periods ending March 31, follows:

         
Realized
       
   
Proceeds
   
Gains
   
Losses(1)
 
   
(In thousands)
 
2012
  $ 9,206     $ 692     $ -  
2011
    12,399       185       45  
 

(1)
Losses in 2012 and 2011 exclude $0.177 million and $0.142 million, respectively of credit related OTTI recognized in earnings.

During 2012 and 2011 our trading securities consisted of various preferred stocks. During the first three months of 2012 and 2011 we recognized gains (losses) on trading securities of  $(0.008) million and $0.073 million, respectively, that are included in net gains (losses) on securities in the Condensed Consolidated Statements of Operations.  Both of these amounts, relate to gains (losses)  recognized on trading securities still held at each respective period end.

4. 
Loans

Our assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions and other pertinent factors.
 
An analysis of the allowance for loan losses by portfolio segment for the three months ended March 31, follows:
 
                     
Payment
             
                     
Plan
             
   
Commercial
   
Mortgage
   
Installment
   
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
2012
                                   
Balance at beginning of period
  $ 18,183     $ 22,885     $ 6,146     $ 197     $ 11,473     $ 58,884  
Additions (deductions)
                                               
Provision for loan losses
    1,496       4,235       289       30       (919 )     5,131  
Recoveries credited to allowance
    1,006       548       326       -       -       1,880  
Loans charged against the allowance
    (4,244 )     (4,397 )     (1,227 )     (21 )     -       (9,889 )
Balance at end of period
  $ 16,441     $ 23,271     $ 5,534     $ 206     $ 10,554     $ 56,006  
                                                 
2011
                                               
Balance at beginning of period
  $ 23,836     $ 22,642     $ 6,769     $ 389     $ 14,279     $ 67,915  
Additions (deductions)
                                               
Provision for loan losses
    4,710       5,369       1,235       8       (620 )     10,702  
Recoveries credited to allowance
    219       355       359       2       -       935  
Loans charged against the allowance
    (7,486 )     (4,595 )     (1,644 )     (66 )     -       (13,791 )
Balance at end of period
  $ 21,279     $ 23,771     $ 6,719     $ 333     $ 13,659     $ 65,761  

 
15

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Allowance for loan losses and recorded investment in loans by portfolio segment follows:

                     
Payment
             
                     
Plan
             
   
Commercial
   
Mortgage
   
Installment
   
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
March 31, 2012
                                   
Allowance for loan losses:
                                   
Individually evaluated for impairment
  $ 9,285     $ 11,002     $ 1,736     $ -     $ -     $ 22,023  
Collectively evaluated for impairment
    7,156       12,269       3,798       206       10,554       33,983  
Total ending allowance balance
  $ 16,441     $ 23,271     $ 5,534     $ 206     $ 10,554     $ 56,006  
                                                 
Loans
                                               
Individually evaluated for impairment
  $ 58,760     $ 91,894     $ 7,737     $ -             $ 158,391  
Collectively evaluated for impairment
    592,760       481,970       203,466       103,544               1,381,740  
Total loans recorded investment
    651,520       573,864       211,203       103,544               1,540,131  
Accrued interest included in recorded investment
    1,968       2,613       843       -               5,424  
Total loans
  $ 649,552     $ 571,251     $ 210,360     $ 103,544             $ 1,534,707  
                                                 
December 31, 2011
                                               
Allowance for loan losses:
                                               
Individually evaluated for impairment
  $ 10,252     $ 10,285     $ 1,762     $ -     $ -     $ 22,299  
Collectively evaluated for impairment
    7,931       12,600       4,384       197       11,473       36,585  
Total ending allowance balance
  $ 18,183     $ 22,885     $ 6,146     $ 197     $ 11,473     $ 58,884  
                                                 
Loans
                                               
Individually evaluated for impairment
  $ 58,674     $ 93,702     $ 7,554     $ -             $ 159,930  
Collectively evaluated for impairment
    594,665       499,919       212,907       115,018               1,422,509  
Total loans recorded investment
    653,339       593,621       220,461       115,018               1,582,439  
Accrued interest included in recorded investment
    2,184       2,745       902       -               5,831  
Total loans
  $ 651,155     $ 590,876     $ 219,559     $ 115,018             $ 1,576,608  

 
16

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
Loans on non-accrual status and past due more than 90 days (“Non-performing Loans”) follow:

   
90+ and
         
Total Non-
 
   
Still
   
Non-
   
Performing
 
   
Accruing
   
Accrual
   
Loans
 
   
(In thousands)
 
March 31, 2012
                 
Commercial
                 
Income producing - real estate
  $ -     $ 11,000     $ 11,000  
Land, land development and construction - real estate
    -       5,578       5,578  
Commercial and industrial
    261       7,759       8,020  
Mortgage
                       
1-4 family
    -       14,321       14,321  
Resort lending
    -       7,828       7,828  
Home equity line of credit - 1st lien
    -       665       665  
Home equity line of credit - 2nd lien
    -       730       730  
Installment
                       
Home equity installment - 1st lien
    -       1,226       1,226  
Home equity installment - 2nd lien
    -       935       935  
Loans not secured by real estate
    -       951       951  
Other
    -       1       1  
Payment plan receivables
                       
Full refund
    -       225       225  
Partial refund
    -       244       244  
Other
    -       12       12  
Total recorded investment
  $ 261     $ 51,475     $ 51,736  
Accrued interest included in recorded investment
  $ 3     $ -     $ 3  
December 31, 2011
                       
Commercial
                       
Income producing - real estate
  $ 490     $ 13,788     $ 14,278  
Land, land development and
                       
construction - real estate
    43       6,990       7,033  
Commercial and industrial
    -       7,984       7,984  
Mortgage
                       
1-4 family
    54       15,929       15,983  
Resort lending
    -       8,819       8,819  
Home equity line of credit - 1st lien
    -       523       523  
Home equity line of credit - 2nd lien
    -       889       889  
Installment
                       
Home equity installment - 1st lien
    -       1,542       1,542  
Home equity installment - 2nd lien
    -       1,023       1,023  
Loans not secured by real estate
    -       880       880  
Other
    -       4       4  
Payment plan receivables
                       
Full refund
    -       491       491  
Partial refund
    -       424       424  
Other
    -       23       23  
Total recorded investment
  $ 587     $ 59,309     $ 59,896  
Accrued interest included in recorded investment
  $ 13     $ -     $ 13  

 
17


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
An aging analysis of loans by class follows:
 
   
Loans Past Due
   
Loans not
   
Total
 
   
30-59 days
   
60-89 days
   
90+ days
   
Total
   
Past Due
   
Loans
 
   
(In thousands)
 
March 31, 2012
                                   
Commercial
                                   
Income producing - real estate
  $ 1,098     $ 2,681     $ 4,170     $ 7,949     $ 269,429     $ 277,378  
Land, land development and construction - real estate
    864       265       1,713       2,842       46,969       49,811  
Commercial and industrial
    3,756       1,819       4,094       9,669       314,662       324,331  
Mortgage
                                               
1-4 family
    2,674       1,609       14,321       18,604       287,737       306,341  
Resort lending
    1,337       1,157       7,828       10,322       177,770       188,092  
Home equity line of credit - 1st lien
    120       6       665       791       24,264       25,055  
Home equity line of credit - 2nd lien
    359       248       730       1,337       53,039       54,376  
Installment
                                               
Home equity installment - 1st lien
    385       92       1,226       1,703       40,101       41,804  
Home equity installment - 2nd lien
    536       172       935       1,643       49,544       51,187  
Loans not secured by real estate
    1,084       296       951       2,331       112,852       115,183  
Other
    13       2       1       16       3,013       3,029  
Payment plan receivables
                                               
Full refund
    2,222       540       225       2,987       90,921       93,908  
Partial refund
    238       80       244       562       8,456       9,018  
Other
    15       3       12       30       588       618  
Total recorded investment
  $ 14,701     $ 8,970     $ 37,115     $ 60,786     $ 1,479,345     $ 1,540,131  
Accrued interest included in recorded investment
  $ 127     $ 118     $ 3     $ 248     $ 5,176     $ 5,424  
                                                 
December 31, 2011
                                               
Commercial
                                               
Income producing - real estate
  $ 1,701     $ 937     $ 6,408     $ 9,046     $ 264,620     $ 273,666  
Land, land development and construction - real estate
    487       66       2,720       3,273       51,453       54,726  
Commercial and industrial
    1,861       1,132       3,516       6,509       318,438       324,947  
Mortgage
                                               
1-4 family
    3,507       1,418       15,983       20,908       294,771       315,679  
Resort lending
    2,129       932       8,819       11,880       184,943       196,823  
Home equity line of credit - 1st lien
    96       196       523       815       24,705       25,520  
Home equity line of credit - 2nd lien
    506       159       889       1,554       54,045       55,599  
Installment
                                               
Home equity installment - 1st lien
    757       264       1,542       2,563       41,239       43,802  
Home equity installment - 2nd lien
    676       365       1,023       2,064       51,224       53,288  
Loans not secured by real estate
    1,173       463       880       2,516       117,661       120,177  
Other
    36       10       4       50       3,144       3,194  
Payment plan receivables