XNAS:IBCP Independent Bank Corp (Ionia MI) Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 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
 
8,773,629
Class
 
Outstanding at August 9, 2012
 


 
 

 

INDEPENDENT BANK CORPORATION AND SUBSIDIARIES


   
Number(s)
 
PART I -
Financial Information
 
Item 1.
3
 
4
 
5
 
6
 
7
 
8-61
Item 2.
62-94
Item 3.
95
Item 4.
95
     
PART II -
Other Information
 
Item 1A
96
Item 2.
96
Item 3b.
96
Item 6.
96

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 convertible 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

   
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(unaudited)
 
Assets
 
(In thousands, except share amounts)
 
Cash and due from banks
  $ 60,838     $ 62,777  
Interest bearing deposits
    358,920       278,331  
Cash and Cash Equivalents
    419,758       341,108  
Trading securities
    86       77  
Securities available for sale
    247,047       157,444  
Federal Home Loan Bank and Federal Reserve Bank stock, at cost
    20,494       20,828  
Loans held for sale, carried at fair value
    43,386       44,801  
Loans held for sale relating to branch sale, carried at lower of cost or fair value
    53,180       -  
Loans
               
Commercial
    612,044       651,155  
Mortgage
    547,210       590,876  
Installment
    199,190       219,559  
Payment plan receivables
    98,946       115,018  
Total Loans
    1,457,390       1,576,608  
Allowance for loan losses
    (51,346     (58,884 )
Net Loans
    1,406,044       1,517,724  
Other real estate and repossessed assets
    29,504       34,042  
Property and equipment, net
    50,802       62,548  
Bank-owned life insurance
    50,094       49,271  
Other intangibles
    7,065       7,609  
Capitalized mortgage loan servicing rights
    10,651       11,229  
Prepaid FDIC deposit insurance assessment
    11,008       12,609  
Vehicle service contract counterparty receivables, net
    28,879       29,298  
Fixed assets held for sale relating to branch sale
    8,491       -  
Accrued income and other assets
    16,976       18,818  
Total Assets
  $ 2,403,465     $ 2,307,406  
Liabilities and Shareholders' Equity
               
Deposits
               
Non-interest bearing
  $ 471,718     $ 497,718  
Savings and interest-bearing checking
    852,214       1,019,603  
Retail time
    392,544       526,525  
Brokered time
    48,860       42,279  
Total Deposits
    1,765,336       2,086,125  
Deposits held for sale relating to branch sale
    417,521       -  
Other borrowings
    17,929       33,387  
Subordinated debentures
    50,175       50,175  
Vehicle service contract counterparty payables
    7,118       6,633  
Accrued expenses and other liabilities
    32,214       28,459  
Total Liabilities
    2,290,293       2,204,779  
Shareholders' Equity
               
Convertible preferred stock, no par value, 200,000 shares authorized; 74,426 shares issued and outstanding at June 30, 2012 and December 31, 2011; liquidation preference: $83,061 at  June 30, 2012 and $81,023 at December 31, 2011
    82,004       79,857  
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 8,749,220 shares at June 30, 2012 and 8,491,526 shares at December 31, 2011
    249,751       248,950  
Accumulated deficit
    (208,569     (214,259 )
Accumulated other comprehensive loss
    (10,014     (11,921 )
Total Shareholders' Equity
    113,172       102,627  
Total Liabilities and Shareholders' Equity
  $ 2,403,465     $ 2,307,406  
 
See notes to interim condensed consolidated financial statements (unaudited)

 
3


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
 
   
(In thousands)
 
Interest Income
                       
Interest and fees on loans
  $ 23,696     $ 28,102     $ 48,042     $ 57,586  
Interest on securities
                               
Taxable
    933       344       1,591       811  
Tax-exempt
    244       298       540       630  
Other investments
    382       383       778       818  
Total Interest Income
    25,255       29,127       50,951       59,845  
Interest Expense
                               
Deposits
    2,305       4,511       4,729       9,456  
Other borrowings
    1,120       1,232       2,292       2,555  
Total Interest Expense
    3,425       5,743       7,021       12,011  
Net Interest Income
    21,830       23,384       43,930       47,834  
Provision for loan losses
    1,056       4,156       6,187       14,858  
Net Interest Income After Provision for Loan Losses
    20,774       19,228       37,743       32,976  
Non-interest Income
                               
Service charges on deposit accounts
    4,552       4,784       8,753       9,066  
Interchange income
    2,407       2,308       4,729       4,476  
Net gains (losses) on assets
                               
Mortgage loans
    3,579       1,793       7,439       3,728  
Securities
    169       115       853       328  
Other than temporary impairment loss on securities
                               
Total impairment loss
    (85     327       (262     (142 )
Loss recognized in other comprehensive loss
    -       (327     -       -  
Net impairment loss recognized in earnings
    (85     -       (262     (142 )
Mortgage loan servicing
    (1,088     (126     (352     770  
Title insurance fees
    489       318       997       791  
(Increase) decrease in fair value of U.S. Treasury warrant
    (25     642       (179     996  
Other
    3,044       2,622       5,648       5,154  
Total Non-interest Income
    13,042       12,456       27,626       25,167  
Non-interest Expense
                               
Compensation and employee benefits
    13,506       13,029       25,988       25,378  
Loan and collection
    2,407       3,580       5,297       7,447  
Occupancy, net
    2,490       2,663       5,206       5,764  
Data processing
    2,450       2,415       4,789       4,725  
Furniture, fixtures and equipment
    1,307       1,502       2,601       2,920  
Legal and professional
    1,268       801       2,165       1,579  
Communications
    826       889       1,701       1,837  
FDIC deposit insurance
    816       652       1,673       1,887  
Net losses on other real estate and repossessed assets
    633       777       1,620       2,183  
Credit card and bank service fees
    624       1,013       1,275       2,060  
Advertising
    639       670       1,195       1,224  
Vehicle service contract counterparty contingencies
    326       1,311       797       3,657  
Provision for loss reimbursement on sold loans
    126       363       558       769  
Costs (recoveries) related to unfunded lending commitments
    (12     89       (59     184  
Other
    2,077       2,151       2,726       4,159  
Total Non-interest Expense
    29,483       31,905       57,532       65,773  
Income (Loss) Before Income Tax
    4,333       (221     7,837       (7,630 )
Income tax benefit
    -       (258     -       (266 )
Net Income (Loss)
  $ 4,333     $ 37     $ 7,837     $ (7,364 )
Convertible preferred stock dividends and discount accretion
    1,092       1,051       2,148       2,059  
Net Income (Loss) Applicable to Common Stock
  $ 3,241     $ (1,014     5,689     $ (9,423 )
Net Income (Loss) Per Common Share
                               
Basic
  $ .38     $ (.12 )   $ .66     $ (1.16 )
Diluted
    .11       (.12 )     .19       (1.16 )
Dividends Per Common Share
                               
Declared
  $ .00     $ .00     $ .00     $ .00  
Paid
    .00       .00       .00       .00  

See notes to interim condensed consolidated financial statements (unaudited)

 
4


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(unaudited)
   
(unaudited)
 
   
(In thousands)
   
(In thousands)
 
Net income (loss)
  $ 4,333     $ 37     $ 7,837     $ (7,364 )
Other comprehensive income (loss), before tax
                               
Unrealized losses on available for sale securities
                               
Unrealized gain (loss) arising during period
    2,756       394       1,896       715  
Change in unrealized losses for which a portion of other than temporary impairment has been recognized in earnings
    204       738       333       411  
Reclassification adjustments for (gains) losses included in earnings
    (151 )     (64 )     (843 )     (204 )
Unrealized losses on available for sale securities, net
    2,809       1,068       1,386       922  
                                 
Unrealized losses on derivative instruments
                               
Unrealized loss arising during period
    (24 )     (240 )     (75 )     (263 )
Reclassification adjustment for expense recognized in earnings
    120       201       305       403  
Reclassfication adjustment for accretion on settled derivatives
    146       147       291       369  
Unrealized gains on derivative instruments
    242       108       521       509  
Other comprehensive income (loss), before tax
    3,051       1,176       1,907       1,431  
Income tax expense related to components of other comprehesive   income (loss)
    -       501       -       501  
Other comprehensive income
    3,051       675       1,907       930  
Comprehensive income (loss)
  $ 7,384     $ 712     $ 9,744     $ (6,434 )

See notes to interim condensed consolidated financial statements (unaudited)

 
5


INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

   
Six months ended June 30,
 
   
2012
   
2011
 
   
(unaudited - In thousands)
 
Net Income (Loss)
  $ 7,837     $ (7,364 )
Adjustments to Reconcile Net Income (Loss) to Net Cash from Operating Activities
               
Proceeds from sales of loans held for sale
    246,587       187,558  
Disbursements for loans held for sale
    (237,733     (160,040 )
Provision for loan losses
    6,187       14,858  
Deferred loan fees
    (404 )     (214 )
Depreciation, amortization of intangible assets and premiums and accretion of discounts on securities and loans
    (2,351 )     (6,442 )
Net gains on sales of mortgage loans
    (7,439 )     (3,728 )
Net gains on securities
    (853 )     (328 )
Securities impairment recognized in earnings
    262       142  
Net losses on other real estate and repossessed assets
    1,620       2,183  
Vehicle service contract counterparty contingencies
    797       3,657  
Share based compensation
    304       455  
Decrease in accrued income and other assets
    3,288       4,346  
Increase in accrued expenses and other liabilities
    4,262       2,632  
Total Adjustments
    14,527       45,079  
Net Cash from Operating Activities
    22,364       37,715  
Cash Flow from (used in) Investing Activities
               
Proceeds from the sale of securities available for sale
    18,999       70,322  
Proceeds from the maturity or call of securities available for sale
    60,728       295  
Principal payments received on securities available for sale
    11,220       3,872  
Purchases of securities available for sale
    (179,262 )     (83,906 )
Redemption of Federal Home Loan Bank stock
    -       2,397  
Redemption of Federal Reserve Bank stock
    334       228  
Net decrease in portfolio loans (loans originated, net of principal payments)
    53,220       108,369  
Proceeds from the collection of vehicle service contract counterparty receivables
    396       671  
Proceeds from the sale of other real estate and repossessed assets
    8,912       10,084  
Capital expenditures
    (3,257 )     (1,554 )
Net Cash from (used in) Investing Activities
    (28,710 )     110,778  
Cash Flow from (used in) Financing Activities
               
Net increase (decrease) in total deposits
    99,472       (187,153 )
Net increase (decrease) in other borrowings
    9       (8 )
Proceeds from Federal Home Loan Bank advances
    12,000       7,000  
Payments of Federal Home Loan Bank advances
    (27,467 )     (37,115 )
Net increase in vehicle service contract counterparty payables
    485       2,858  
Proceeds from issuance of common stock
    497       1,335  
Net Cash from (used in) Financing Activities
    84,996       (213,083 )
Net Increase (Decrease) in Cash and Cash Equivalents
    78,650       (64,590 )
Cash and Cash Equivalents at Beginning of Period
    341,108       385,374  
Cash and Cash Equivalents at End of Period
  $ 419,758     $ 320,784  
Cash paid during the period for
               
Interest
  $ 5,914     $ 11,361  
Income taxes
    186       26  
Transfers to other real estate and repossessed assets
    5,994       10,462  
Transfer of payment plan receivables to vehicle service contract counterparty receivables
    849       8,010  
Transfers to loans held for sale
    54,127       -  
Transfers to fixed assets held for sale
    11,065       -  
Transfers to deposits held for sale
    420,261       -  

See notes to interim condensed consolidated financial statements (unaudited)

 
6

 
INDEPENDENT BANK CORPORATION AND SUBSIDIARIES

   
Six months ended
 
   
June 30,
 
   
2012
   
2011
 
   
(unaudited)
 
   
(In thousands)
 
Balance at beginning of period
  $ 102,627     $ 119,085  
Net income (loss)
    7,837       (7,364 )
Issuance of common stock
    497       1,335  
Share based compensation
    304       455  
Net change in accumulated other comprehensive loss, net of related tax effect
    1,907       930  
Balance at end of period
  $ 113,172     $ 114,441  

See notes to interim condensed consolidated financial statements (unaudited)

 
7


(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 June 30, 2012 and December 31, 2011, and the results of operations for the three and six-month periods ended June 30, 2012 and 2011.  The results of operations for the three and six-month periods ended June 30, 2012, are not necessarily indicative of the results to be expected for the full year.  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 2011-05, “Comprehensive Income (Topic 220)”. 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)
 
June 30, 2012
                       
U.S. agency
  $ 38,039     $ 124     $ 20     $ 38,143  
U.S. agency residential mortgage-backed
    156,231       994       61       157,164  
Private label residential mortgage-backed
    9,887       -       2,208       7,679  
Obligations of states and political subdivisions
    40,383       643       62       40,964  
Trust preferred
    4,700       -       1,603       3,097  
Total
  $ 249,240     $ 1,761     $ 3,954     $ 247,047  
                                 
                                 
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)
 
                                     
June 30, 2012
                                   
U.S. agency
  $ 7,507     $ 20     $ -     $ -     $ 7,507     $ 20  
U.S. agency residential mortgage-backed
    30,497       44       10,097       17       40,594       61  
Private label residential mortgage-backed
    -       -       7,677       2,208       7,677       2,208  
Obligations of states and political subdivisions
    8,202       62       -       -       8,202       62  
Trust preferred
    -       -       3,097       1,603       3,097       1,603  
Total
  $ 46,206     $ 126     $ 20,871     $ 3,828     $ 67,077     $ 3,954  
                                                 
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 June 30, 2012 we had two U.S. Agency and eight U.S. Agency residential mortgage-backed securities whose fair market value is less than amortized cost. The unrealized losses on U.S. Agency residential mortgage-backed securities are largely attributed to 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 June 30, 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 (75%) and Alt A (25%) at June 30, 2012.

   
June 30, 2012
   
December 31, 2011
 
         
Net
         
Net
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Gain (Loss)
   
Value
   
Gain (Loss)
 
   
(In thousands)
 
                         
Private label residential mortgage-backed
                       
Jumbo
  $ 5,738     $ (1,602 )   $ 6,454     $ (1,937 )
Alt-A
    1,941       (606 )     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 (22%), senior (43%), senior support (25%) and mezzanine (10%). The mezzanine class is from a seasoned transaction (94 months) with a significant level of subordination (8.60%). 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 forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization. The cash flows from the underlying loans considers contractual payment terms (scheduled amortization), prepayments, defaults and severity of loss given default. The analysis uses dynamic assumptions for prepayments, defaults and loss severity. Near term prepayment assumptions are based on recently observed prepayment rates. More weight is 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 June 30, 2012 three below investment grade private label residential mortgage-backed securities with fair values of $3.3 million, $1.7 million and $0.1 million, respectively and unrealized losses of $1.0 million, $0.3 million and $0.03 million, respectively (amortized cost of $4.3 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 $0.645 million of cumulative credit related OTTI as of June 30, 2012 on this security.   $0.085 million and zero of this credit related OTTI was recognized in our Condensed Consolidated Statements of Operations during the three months ended June 30, 2012 and 2011, respectively and $0.170 million and $0.052 million of this credit related OTTI was recognized during the six months ended June 30, 2012 and 2011, respectively, with the balance being recognized in previous periods.  The remaining non-credit related 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 cumulative credit related OTTI as of June 30, 2012 on this security.   There was no credit related OTTI recognized in our Condensed Consolidated Statements of Operations during the three months ended June 30, 2012 and 2011 while $0.032 million and zero of this credit related OTTI was recognized during the six months ended June 30, 2012 and 2011, respectively, with the balance being recognized in previous periods.  The remaining non-credit related 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 $0.380 million of cumulative credit related OTTI as of June 30, 2012 on this security.   There was no credit related OTTI recognized in our Condensed Consolidated Statements of Operations during the three months ended June 30, 2012 and 2011, while $0.060 million and $0.090 million of this credit related OTTI was recognized during the six months ended June 30, 2012 and 2011, respectively, with the balance being recognized in previous periods.  The remaining non-credit related 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 June 30, 2012 we had nine municipal securities whose fair value is less than amortized cost. The unrealized losses are largely attributed to widening of market spreads.  Seven 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 June 30, 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.

 
13


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

One of the four securities is rated by two major rating agencies as investment grade, while one is rated one grade below investment grade by two major rating agencies 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 June 30, 2012, continue to have satisfactory credit metrics and one continues to make interest payments.  One 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.

The following table breaks out our trust preferred securities in further detail as of June 30, 2012 and December 31, 2011:

   
June 30, 2012
   
December 31, 2011
 
         
Net
         
Net
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Gain (Loss)
   
Value
   
Gain (Loss)
 
   
(In thousands)
 
                         
Trust preferred securities
                       
Rated issues
  $ 1,564     $ (329 )   $ 1,405     $ (484 )
Unrated issues - no OTTI
    1,533       (1,274 )     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.

We recorded credit related OTTI charges in earnings on securities available for sale of $0.085 million and zero during the three month periods ended June 30, 2012 and 2011, respectively and $0.262 million and $0.142 million during the six month periods ended June 30, 2012 and 2011, respectively (see discussion above).

A roll forward of credit losses recognized in earnings on securities available for sale for the three and six month periods ending June 30, follows:

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
Balance at beginning of period
  $ 1,647     $ 852     $ 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
    85       -       262       142  
Balance at end of period
  $ 1,732     $ 852     $ 1,732     $ 852  

 
14

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

The amortized cost and fair value of securities available for sale at June 30, 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
  $ 1,323     $ 1,341  
Maturing after one year but within five years
    6,491       6,711  
Maturing after five years but within ten years
    15,318       15,531  
Maturing after ten years
    59,990       58,621  
      83,122       82,204  
U.S. agency residential mortgage-backed
    156,231       157,164  
Private label residential mortgage-backed
    9,887       7,679  
Total
  $ 249,240     $ 247,047  
 
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 six month periods ending June 30, follows:

         
Realized
       
   
Proceeds
   
Gains
   
Losses(1)
 
   
(In thousands)
 
2012
  $ 18,999     $ 843     $ -  
2011
    70,322       279       75  
 

(1)
Losses in 2012 and 2011 exclude $0.262 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 six months of 2012 and 2011 we recognized gains on trading securities of $0.010 million and $0.124 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  recognized on trading securities still held at each respective period end.

 
15


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

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 June 30, follows:
 
                     
Payment
             
                     
Plan
             
   
Commercial
   
Mortgage
   
Installment
   
Receivables
   
Unallocated
   
Total
 
   
(In thousands)
 
2012
                                   
Balance at beginning of period
  $ 16,441     $ 23,271     $ 5,534     $ 206     $ 10,554     $ 56,006  
Additions (deductions)
                                               
Provision for loan losses
    1,194       570       229       (7 )     (930 )     1,056  
Recoveries credited to allowance
    390       572       389       -       -       1,351  
Loans charged against the allowance
    (2,379 )     (2,950 )     (953 )     (4 )     -       (6,286 )
Reclassification to loans held for sale
    (170 )     (192 )     (218 )     -       (201 )     (781 )
Balance at end of period
  $ 15,476     $ 21,271     $ 4,981     $ 195     $ 9,423     $ 51,346  
                                                 
2011
                                               
Balance at beginning of period
  $ 21,279     $ 23,771     $ 6,719     $ 333     $ 13,659     $ 65,761  
Additions (deductions)
                                               
Provision for loan losses
    1,333       2,964       446       37       (624 )     4,156  
Recoveries credited to allowance
    512       385       348       2       -       1,247  
Loans charged against the allowance
    (5,427 )     (3,968 )     (1,224 )     (26 )     -       (10,645 )
Balance at end of period
  $ 17,697     $ 23,152     $ 6,289     $ 346     $ 13,035     $ 60,519  

 
16

 
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
 
An analysis of the allowance for loan losses by portfolio segment for the six months ended June 30, 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
    2,690       4,805       518       23       (1,849 )     6,187  
Recoveries credited to allowance
    1,396       1,120       715       -       -       3,231  
Loans charged against the allowance
    (6,623 )     (7,347 )     (2,180 )     (25 )     -       (16,175 )
Reclassification to loans held for sale
    (170 )     (192 )     (218 )     -       (201 )     (781 )
Balance at end of period
  $ 15,476     $ 21,271     $ 4,981     $ 195     $ 9,423     $ 51,346  
                                                 
2011
                                               
Balance at beginning of period
  $ 23,836     $ 22,642     $ 6,769     $ 389     $ 14,279     $ 67,915  
Additions (deductions)
                                               
Provision for loan losses
    6,043       8,333       1,681       45       (1,244 )     14,858  
Recoveries credited to allowance
    731       740       707       4       -       2,182  
Loans charged against the allowance
    (12,913 )     (8,563 )     (2,868 )     (92 )     -       (24,436 )
Balance at end of period
  $ 17,697     $ 23,152     $ 6,289     $ 346     $ 13,035     $ 60,519  

 
17

 
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)
 
June 30, 2012
                                   
Allowance for loan losses:
                                   
Individually evaluated for impairment
  $ 9,855     $ 10,201     $ 1,674     $ -     $ -     $ 21,730  
Collectively evaluated for impairment
    5,621       11,070       3,307       195       9,423       29,616  
Total ending allowance balance
  $ 15,476     $ 21,271     $ 4,981     $ 195     $ 9,423     $ 51,346  
                                                 
Loans
                                               
Individually evaluated for impairment
  $ 66,703     $ 91,494     $ 7,717     $ -             $ 165,914  
Collectively evaluated for impairment
    547,014       458,274       192,249       98,946               1,296,483  
Total loans recorded investment
    613,717       549,768       199,966       98,946               1,462,397  
Accrued interest included in recorded investment
    1,673       2,558       776       -               5,007  
Total loans
  $ 612,044     $ 547,210     $ 199,190     $ 98,946             $ 1,457,390  
                                                 
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  

 
18

 
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)
 
June 30, 2012
                 
Commercial
                 
Income producing - real estate
  $ 280     $ 8,277     $ 8,557  
Land, land development and construction - real estate
    125       4,804       4,929  
Commercial and industrial
    338       8,932       9,270  
Mortgage
                       
1-4 family
    -       11,593       11,593  
Resort lending
    -       6,475       6,475  
Home equity line of credit - 1st lien
    -       592       592  
Home equity line of credit - 2nd lien
    -       690       690  
Installment
                       
Home equity installment - 1st lien
    -       1,079       1,079  
Home equity installment - 2nd lien
    -       710       710  
Loans not secured by real estate
    -       883       883  
Other
    -       1       1  
Payment plan receivables
                       
Full refund
    -       126       126  
Partial refund
    -       137       137  
Other
    -       15       15  
Total recorded investment
  $ 743     $ 44,314     $ 45,057  
Accrued interest included in recorded investment
  $ 4     $ -     $ 4  
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