PINX:ISBA Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended March 31, 2012

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from                     to                     

Commission File Number: 0-18415

 

 

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Michigan   38-2830092
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
identification No.)
401 N. Main St,
Mt. Pleasant, MI
  48858
(Address of principal executive offices)   (Zip code)

(989) 772-9471

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x    Yes  ¨    No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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).

x    Yes  ¨     No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non- accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company”, in Rule 12b-2 of the Exchange Act (Check One).

 

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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, 7,600,622 as of April 24, 2012

 

 

 


Table of Contents

ISABELLA BANK CORPORATION

QUARTERLY REPORT ON FORM 10-Q

Table of Contents

 

PART I

     3   

Item 1

   Interim Condensed Consolidated Financial Statements (Unaudited)      3   

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      37   

Item 3

   Quantitative and Qualitative Disclosures about Market Risk      53   

Item 4

   Controls and Procedures      55   

PART II

     56   

Item 1

   Legal Proceedings      56   

Item 1A

   Risk Factors      56   

Item 2

   Unregistered Sales of Equity Securities and Use of Proceeds      56   

Item 6

   Exhibits      57   

SIGNATURES

     58   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1 – Interim Condensed Consolidated Financial Statements (Unaudited)

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

     March 31,
2012
     December 31
2011
 

ASSETS

     

Cash and cash equivalents

     

Cash and demand deposits due from banks

   $ 17,793       $ 24,514   

Interest bearing balances due from banks

     3,951         4,076   
  

 

 

    

 

 

 

Total cash and cash equivalents

     21,744         28,590   

Certificates of deposit held in other financial institutions

     6,640         8,924   

Trading securities

     4,403         4,710   

Available-for-sale securities (amortized cost of $461,071 in 2012 and $414,614 in 2011)

     471,655         425,120   

Mortgage loans available-for-sale

     3,396         3,205   

Loans

     

Agricultural

     76,681         74,645   

Commercial

     361,325         365,714   

Consumer

     30,459         31,572   

Residential real estate

     274,667         278,360   
  

 

 

    

 

 

 

Total loans

     743,132         750,291   

Less allowance for loan losses

     12,375         12,375   
  

 

 

    

 

 

 

Net loans

     730,757         737,916   

Premises and equipment

     25,054         24,626   

Corporate owned life insurance

     22,246         22,075   

Accrued interest receivable

     6,044         5,848   

Equity securities without readily determinable fair values

     17,220         17,189   

Goodwill and other intangible assets

     46,726         46,792   

Other assets

     13,335         12,930   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 1,369,220       $ 1,337,925   
  

 

 

    

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Deposits

     

Noninterest bearing

   $ 122,862       $ 119,072   

NOW accounts

     170,701         163,653   

Certificates of deposit under $100 and other savings

     460,815         440,123   

Certificates of deposit over $100

     234,748         235,316   
  

 

 

    

 

 

 

Total deposits

     989,126         958,164   

Borrowed funds ($0 in 2012 and $5,242 in 2011 at fair value)

     214,493         216,136   

Accrued interest payable and other liabilities

     8,294         8,842   
  

 

 

    

 

 

 

Total liabilities

     1,211,913         1,183,142   
  

 

 

    

 

 

 

Shareholders’ equity

     

Common stock — no par value

     

15,000,000 shares authorized; issued and outstanding 7,596,772 shares (including 16,686 shares held in a Rabbi Trust) in 2012 and 7,589,226 shares (including 16,585 shares held in the Rabbi Trust) in 2011

     134,868         134,734   

Shares to be issued for deferred compensation obligations

     4,598         4,524   

Retained earnings

     14,755         13,036   

Accumulated other comprehensive income

     3,086         2,489   
  

 

 

    

 

 

 

Total shareholders’ equity

     157,307         154,783   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,369,220       $ 1,337,925   
  

 

 

    

 

 

 

See notes to interim condensed consolidated financial statements.

 

3


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands except per share data)

 

     Common
Stock Shares
Outstanding
    Common
Stock
    Shares to be
Issued for
Deferred
Compensation
Obligations
    Retained
Earnings
    Accumulated
Other
Comprehensive
(Loss) Income
    Totals  

Balance, January 1, 2011

     7,550,074      $ 133,592      $ 4,682      $ 8,596      $ (1,709   $ 145,161   

Comprehensive income

     —          —          —          2,316        1,358        3,674   

Issuance of common stock

     30,531        728        —          —          —          728   

Common stock issued for deferred compensation obligations

     12,037        215        (182     —          —          33   

Share based payment awards under equity compensation plan

     —          —          180        —          —          180   

Common stock purchased for deferred compensation obligations

     —          (164     —          —          —          (164

Common stock repurchased pursuant to publicly announced repurchase plan

     (31,739     (577     —          —          —          (577

Cash dividends ($0.19 per share)

     —          —          —          (1,434     —          (1,434
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, March 31, 2011

     7,560,903      $ 133,794      $ 4,680      $ 9,478      $ (351   $ 147,601   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 1, 2012

     7,589,226      $ 134,734      $ 4,524      $ 13,036      $ 2,489      $ 154,783   

Comprehensive income

     —          —          —          3,234        597        3,831   

Issuance of common stock

     25,998        609        —          —          —          609   

Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations

     —          95        (95     —          —          —     

Share based payment awards under equity compensation plan

     —          —          169        —          —          169   

Common stock purchased for deferred compensation obligations

     —          (144     —          —          —          (144

Common stock repurchased pursuant to publicly announced repurchase plan

     (18,452     (426     —          —          —          (426

Cash dividends ($0.20 per share)

     —          —          —          (1,515     —          (1,515
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, March 31, 2012

     7,596,772      $ 134,868      $ 4,598      $ 14,755      $ 3,086      $ 157,307   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to interim condensed consolidated financial statements.

 

4


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands except per share data)

 

     Three Months Ended
March 31
 
     2012     2011  

Interest income

    

Loans, including fees

   $ 10,940      $ 11,361   

Investment securities

    

Taxable

     1,889        1,513   

Nontaxable

     1,204        1,179   

Trading account securities

     42        51   

Federal funds sold and other

     129        134   
  

 

 

   

 

 

 

Total interest income

     14,204        14,238   

Interest expense

    

Deposits

     2,512        2,785   

Borrowings

     1,192        1,268   
  

 

 

   

 

 

 

Total interest expense

     3,704        4,053   
  

 

 

   

 

 

 

Net interest income

     10,500        10,185   

Provision for loan losses

     461        817   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     10,039        9,368   
  

 

 

   

 

 

 

Noninterest income

    

Service charges and fees

     1,629        1,476   

Gain on sale of mortgage loans

     379        129   

Net loss on trading securities

     (16     (19

Net gain on borrowings measured at fair value

     33        80   

Gain on sale of available-for-sale investment securities

     1,003        —     

Other

     513        282   
  

 

 

   

 

 

 

Total noninterest income

     3,541        1,948   
  

 

 

   

 

 

 

Noninterest expenses

    

Compensation and benefits

     5,301        5,005   

Occupancy

     641        646   

Furniture and equipment

     1,090        1,106   

Available-for-sale impairment loss

    

Total other-than-temporary impairment loss

     486        —     

Portion of loss reported in other comprehensive income

     (204     —     
  

 

 

   

 

 

 

Net available-for-sale impairment loss

     282        —     
  

 

 

   

 

 

 

Other

     2,259        1,830   
  

 

 

   

 

 

 

Total noninterest expenses

     9,573        8,587   
  

 

 

   

 

 

 

Income before federal income tax expense

     4,007        2,729   

Federal income tax expense

     773        413   
  

 

 

   

 

 

 

NET INCOME

   $ 3,234      $ 2,316   
  

 

 

   

 

 

 

Earnings per share

    

Basic

   $ 0.43      $ 0.31   
  

 

 

   

 

 

 

Diluted

   $ 0.41      $ 0.30   
  

 

 

   

 

 

 

Cash dividends per basic share

   $ 0.20      $ 0.19   
  

 

 

   

 

 

 

See notes to interim condensed consolidated financial statements.

 

5


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

 

     Three Months Ended
March 31
 
     2012     2011  

Net income

   $ 3,234      $ 2,316   
  

 

 

   

 

 

 

Unrealized holding gains on available-for-sale securities:

    

Unrealized holding gains arising during the period

     799        1,753   

Reclassification adjustment for net realized gains included in net income

     (1,003     —     

Reclassification adjustment for impairment loss included in net income

     282        —     
  

 

 

   

 

 

 

Net unrealized gains

     78        1,753   

Tax effect

     519        (395
  

 

 

   

 

 

 

Other comprehensive income, net of tax

     597        1,358   
  

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 3,831      $ 3,674   
  

 

 

   

 

 

 

See notes to interim condensed consolidated financial statements.

 

6


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

     Three Months Ended
March 31
 
     2012     2011  

OPERATING ACTIVITIES

    

Net income

   $ 3,234      $ 2,316   

Reconciliation of net income to net cash provided by operations:

    

Provision for loan losses

     461        817   

Impairment of foreclosed assets

     17        10   

Depreciation

     597        647   

Amortization and impairment of originated mortgage servicing rights

     121        89   

Amortization of acquisition intangibles

     66        76   

Net amortization of available-for-sale securities

     528        362   

Available-for-sale security impairment loss

     282        —     

Gain on sale of available-for-sale securities

     (1,003     —     

Net unrealized losses on trading securities

     16        19   

Net gain on sale of mortgage loans

     (379     (129

Net unrealized gains on borrowings measured at fair value

     (33     (80

Increase in cash value of corporate owned life insurance

     (171     (142

Share-based payment awards under equity compensation plan

     169        180   

Origination of loans held for sale

     (25,966     (8,830

Proceeds from loan sales

     26,154        9,889   

Net changes in operating assets and liabilities which provided (used) cash:

    

Trading securities

     291        385   

Accrued interest receivable

     (196     (802

Other assets

     (195     (24

Accrued interest payable and other liabilities

     (548     (323
  

 

 

   

 

 

 

Net cash provided by operating activities

     3,445        4,460   
  

 

 

   

 

 

 

INVESTING ACTIVITIES

    

Net change in certificates of deposit held in other financial institutions

     2,284        1,940   

Activity in available-for-sale securities

    

Sales

     24,241        —     

Maturities and calls

     19,789        15,597   

Purchases

     (90,294     (45,442

Loan principal collections and (originations), net

     6,510        (4,315

Proceeds from sales of foreclosed assets

     328        302   

Purchases of premises and equipment

     (1,025     (239
  

 

 

   

 

 

 

Net cash used in investing activities

     (38,167     (32,157
  

 

 

   

 

 

 

 

7


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)

 

 

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
     Three Months Ended
March 31
 
     2012     2011  

FINANCING ACTIVITIES

    

Acceptances and withdrawals of deposits, net

   $ 30,962      $ 45,908   

Decrease in other borrowed funds

     (1,610     (11,574

Cash dividends paid on common stock

     (1,515     (1,434

Proceeds from issuance of common stock

     609        546   

Common stock repurchased

     (426     (362

Common stock purchased for deferred compensation obligations

     (144     (164
  

 

 

   

 

 

 

Net cash provided by financing activities

     27,876        32,920   
  

 

 

   

 

 

 

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (6,846     5,223   

Cash and cash equivalents at beginning of period

     28,590        18,109   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 21,744      $ 23,332   
  

 

 

   

 

 

 

SUPPLEMENTAL CASH FLOWS INFORMATION:

    

Interest paid

   $ 3,784      $ 4,025   

SUPPLEMENTAL NONCASH INFORMATION:

    

Transfers of loans to foreclosed assets

   $ 188      $ 833   

Common stock issued for deferred compensation obligations

     —          182   

Common stock repurchased from an associated Rabbi Trust

     —          (215

See notes to interim condensed consolidated financial statements.

 

8


Table of Contents

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands except per share amounts)

NOTE 1 – BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In management’s opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report for the year ended December 31, 2011.

The accounting policies are the same as those discussed in Note 1 to the Consolidated Financial Statements included in the Corporation’s annual report for the year ended December 31, 2011.

NOTE 2 – COMPUTATION OF EARNINGS PER SHARE

Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding shares in the Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors (the “Directors Plan”).

Earnings per common share have been computed based on the following:

 

     Three Months Ended
March 31
 
     2012      2011  

Average number of common shares outstanding for basic calculation

     7,594,257         7,557,293   

Average potential effect of shares in the Directors Plan (1)

     199,882         193,128   
  

 

 

    

 

 

 

Average number of common shares outstanding used to calculate diluted earnings per common share

     7,794,139         7,750,421   
  

 

 

    

 

 

 

Net income

   $ 3,234       $ 2,316   
  

 

 

    

 

 

 

Earnings per share

     

Basic

   $ 0.43       $ 0.31   
  

 

 

    

 

 

 

Diluted

   $ 0.41       $ 0.30   
  

 

 

    

 

 

 

 

(1) Exclusive of shares held in the Rabbi Trust

 

9


Table of Contents

NOTE 3 – RECENTLY ADOPTED ACCOUNTING STANDARDS UPDATES

ASU No. 2011-03: “Reconsideration of Effective Control for Repurchase Agreements”

In April 2011, ASU No. 2011-03 amended ASC Topic 310, “Transfers and Servicing” to eliminate from the assessment of effective control, the criteria calling for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed upon terms, even in the event of the transferee’s default. The assessment of effective control should instead focus on the transferor’s contractual rights and obligations. The new authoritative guidance was effective for interim and annual periods beginning on or after December 15, 2011 and did not impact the Corporation’s consolidated financial statements.

ASU No. 2011-04: “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS”

In May 2011, ASU No. 2011-04 amended ASC Topic 820, “Fair Value Measurement” to align fair value measurements and disclosures in U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The ASU changes the wording used to describe the requirements in GAAP for measuring fair value and disclosures about fair value.

The ASU clarifies the application of existing fair value measurements and disclosure requirements related to:

 

   

The application of highest and best use and valuation premise concepts.

 

   

Measuring the fair value of an instrument classified in a reporting entity’s stockholders’ equity.

 

   

Disclosure about fair value measurements within Level 3 of the fair value hierarchy.

The ASU also changes particular principles or requirements for measuring fair value and disclosing information measuring fair value and disclosures related to:

 

   

Measuring the fair value of financial instruments that are managed within a portfolio.

 

   

Application of premiums and discounts in a fair value measurement.

The new authoritative guidance was effective for interim and annual periods beginning on or after December 15, 2011 and did not have a financial impact but increased the level of disclosures related to fair value measurements in the Corporation’s interim condensed consolidated financial statements in 2012.

ASU No. 2011-05: “Presentation of Comprehensive Income”

In June 2011, ASU No. 2011-05 amended ASC Topic 220, “Comprehensive Income” to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. In addition, to increase the prominence of items reported in other comprehensive income, and to facilitate the convergence of GAAP and IFRS, the FASB eliminated the option to present components of other comprehensive income as part of the statement of changes in shareholders’ equity.

The new authoritative guidance was effective for interim and annual periods beginning on or after December 15, 2011 and did not have an impact on Corporation’s consolidated financial statements as the Corporation has historically elected to present a separate statement of comprehensive income.

 

10


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NOTE 4 – TRADING SECURITIES

Trading securities, at fair value, consist of the following investments at:

 

     March 31
2012
     December 31
2011
 

States and political subdivisions

   $ 4,403       $ 4,710   

Included in the net trading losses of $16 during the first three months of 2012 were $13 of net unrealized trading losses on securities that were held in the Corporation’s trading portfolio as of March 31, 2012. Included in the net trading losses of $19 during the first three months of 2011 were $17 of net unrealized trading losses on securities that were held in the Corporation’s trading portfolio as of March 31, 2011.

NOTE 5 – AVAILABLE-FOR-SALE SECURITIES

The amortized cost and fair value of available-for-sale securities, with gross unrealized gains and losses, are as follows at:

 

     March 31, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

Government sponsored enterprises

   $ 2,450       $ 24       $ —         $ 2,474   

States and political subdivisions

     169,341         7,893         348         176,886   

Auction rate money market preferred

     3,200         —           579         2,621   

Preferred stocks

     6,800         —           735         6,065   

Mortgage-backed securities

     154,643         1,976         180         156,439   

Collateralized mortgage obligations

     124,637         2,533         —           127,170   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 461,071       $ 12,426       $ 1,842       $ 471,655   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2011  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

Government sponsored enterprises

   $ 395       $ 2       $ —         $ 397   

States and political subdivisions

     166,832         8,157         51         174,938   

Auction rate money market preferred

     3,200         —           1,151         2,049   

Preferred stocks

     6,800         —           1,767         5,033   

Mortgage-backed securities

     140,842         2,807         47         143,602   

Collateralized mortgage obligations

     96,545         2,556         —           99,101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 414,614       $ 13,522       $ 3,016       $ 425,120   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The amortized cost and fair value of available-for-sale securities by contractual maturity at March 31, 2012 are as follows:

 

                                 Securities
With
Variable
Monthly
Payments

or
Continual
Call
Dates
     Total  
                                   
                                   
     Maturing        
     Due in
One Year
or Less
     After One
Year But
Within
Five Years
     After Five
Years But
Within
Ten Years
     After
Ten Years
       

Government sponsored enterprises

   $ —         $ —         $ 72       $ 2,378       $ —         $ 2,450   

States and political subdivisions

     8,898         35,262         85,647         39,534         —           169,341   

Auction rate money market preferred

     —           —           —           —           3,200         3,200   

Preferred stocks

     —           —           —           —           6,800         6,800   

Mortgage-backed securities

     —           —           —           —           154,643         154,643   

Collateralized mortgage obligations

     —           —           —           —           124,637         124,637   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amortized cost

   $ 8,898       $ 35,262       $ 85,719       $ 41,912       $ 289,280       $ 461,071   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fair value

   $ 8,928       $ 36,518       $ 91,022       $ 42,892       $ 292,295       $ 471,655   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.

As auction rate money market preferreds and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

A summary of the activity related to sales of available-for-sale securities was as follows for the three month period ended March 31, 2012:

 

Proceeds from sales of securities

   $ 24,241   
  

 

 

 

Gross realized gains

   $ 1,003   
  

 

 

 

Applicable income tax expense

   $ 341   
  

 

 

 

There were no sales of available-for-sale securities in the first three months of 2011. The cost basis used to determine the realized gains or losses of securities sold was the amortized cost of the individual investment security as of the trade date.

 

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Information pertaining to available-for-sale securities with gross unrealized losses at March 31, 2012 and December 31, 2011 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

     March 31, 2012  
     Less Than Twelve Months      Over Twelve Months         
     Gross
Unrealized
Losses
     F air
Value
     Gross
Unrealized
Losses
     Fair
Value
     Total
Unrealized
Losses
 

States and political subdivisions

   $ 348       $ 5,783       $ —         $ —         $ 348   

Auction rate money market preferred

     —           —           579         2,621         579   

Preferred stocks

     —           —           735         6,066         735   

Mortgage-backed securities

     180         34,854         —           —           180   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 528       $ 40,637       $ 1,314       $ 8,687       $ 1,842   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Number of securities in an unrealized loss position:

        21            6         27   
     

 

 

       

 

 

    

 

 

 

 

     December 31, 2011  
     Less Than Twelve Months      Over Twelve Months         
     Gross
Unrealized
Losses
     Fair
Value
     Gross
Unrealized
Losses
     Fair
Value
     Total
Unrealized
Losses
 

States and political subdivisions

   $ 51       $ 1,410       $ —         $ —         $ 51   

Auction rate money market preferred

     —           —           1,151         2,049         1,151   

Preferred stocks

     —           —           1,767         5,033         1,767   

Mortgage-backed securities

     47         24,291         —           —           47   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 98       $ 25,701       $ 2,918       $ 7,082       $ 3,016   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Number of securities in an unrealized loss position:

        6            6         12   
     

 

 

       

 

 

    

 

 

 

As of March 31, 2012 and December 31, 2011, management conducted an analysis to determine whether all securities currently in an unrealized loss position should be considered other-than-temporarily-impaired (“OTTI”). Such analyses considered, among other factors, the following criteria:

 

   

Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?

 

   

Is the issuer’s investment credit rating below investment grade?

 

   

Is it probable that the issuer will be unable to pay the amount when due?

 

   

Is it more likely than not that the Corporation will not have to sell the security before recovery of its cost basis?

 

   

Has the duration of the investment been extended?

As of March 31, 2012, the Corporation held an auction rate money market preferred security and preferred stocks which continued to be in an unrealized loss position as a result of the securities’ interest rates, as they are currently lower than the offering rates of securities with similar characteristics. Management has determined that any declines in the fair value of these securities are the result of changes in interest rates and not risks related to the underlying credit quality of the security. Additionally, none of the issuers of these securities are deemed to be below investment grade, management does not intend to sell the securities in an unrealized loss position, and it is more likely than not that the Corporation will not have to sell the securities before recovery of their cost basis.

 

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During the three month period ended March 31, 2012, the Corporation had one state issued student loan auction rate available-for-sale investment security (which is included in states and political subdivisions) that was downgraded by Moody’s from A3 to Caa3. As a result of this downgrade, the Corporation engaged the services of an independent investment valuation firm to estimate the amount of credit losses (if any) related to this particular issue as of March 31, 2012. The evaluation calculated a range of estimated credit losses utilizing two different bifurcation methods: 1) Estimated Cash Flow Method and 2) Credit Yield Analysis Method. The two bifurcation methods were then weighted, with a higher weighting applied to the Estimated Cash Flow Method, to arrive at the estimated credit related impairment of $282 due to a decline in projected cash flows and credit rating downgrade.

A summary of key valuation assumptions used in the aforementioned analysis as of March 31, 2012, follows:

 

     Discounted
Cash Flow Method

Ratings

  

Fitch

   Not Rated

Moody’s

   Caa3

S&P

   A

Seniority

   Senior

Discount rate

   LIBOR + 6.35%
     Credit Yield
Analysis Method

Credit discount rate

   LIBOR + 4.00%

Average observed discounts based on closed transactions

   14.00%

The total other-than-temporary impairment loss recognized in accumulated other comprehensive income as of March 31, 2012 was $204 related to the student loan auction rate security. A roll forward of credit related impairment recognized in earnings on available-for-sale securities in the three months ended March 31, 2012 was as follows:

 

January 1, 2012

   $ —     

Additions to credit losses for which no previous OTTI was recognized

     282   
  

 

 

 
  

 

 

 

March 31, 2012

   $ 282   
  

 

 

 

There were no credit losses recognized in earnings or OTTI impairment losses recognized in accumulated other comprehensive income on available-for-sale securities in the three months ended March 31, 2011.

Based on the Corporation’s analysis using the above criteria, the fact that management has asserted that it does not have the intent to sell these securities in an unrealized loss position, and that it is more likely than not the Corporation will not have to sell the securities before recovery of their cost basis, management does not believe that the values of any other securities are other-than-temporarily impaired as of as of March 31, 2012 or December 31, 2011.

NOTE 6 – LOANS AND ALLOWANCE FOR LOAN LOSSES (ALLL)

The Corporation grants commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, light manufacturing, retail, gaming and tourism, higher education, and general economic conditions of this region. Substantially all of the consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured.

Loans that management has the intent and ability to hold in its portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loans losses, and any deferred fees or costs. Interest income on loans is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.

 

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The accrual of interest on commercial, agricultural, and residential real estate loans is typically discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Consumer loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

For loans that are placed on nonaccrual status or charged off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the allowance for loan losses. The interest on these loans is accounted for on the cash basis, until qualifying for return to accrual status. Loans are returned to accrual status after six months of continuous performance. For impaired loans not classified as nonaccrual, interest income continues to be accrued over the term of the loan based on the principal amount outstanding.

Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, farmland and agricultural production, and state and political subdivisions. Repayment of these loans is often dependent upon the successful operation and management of a business; thus, these loans generally involve greater risk than other types of lending. The Corporation minimizes its risk by limiting the amount of loans to any one borrower to $12,500. Borrowers with credit needs of more than $12,500 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans generally require loan-to-value limits of less than 80%. Depending upon the type of loan, past credit history, and current operating results, the Corporation may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, the Corporation requires annual financial statements, prepares cash flow analyses, and reviews credit reports as deemed necessary.

The Corporation offers adjustable rate mortgages, fixed rate balloon mortgages, construction loans, and fixed rate mortgage loans which typically have amortization periods up to a maximum of 30 years. Fixed rate loans with an amortization of greater than 15 years are generally sold upon origination to the Federal Home Loan Mortgage Corporation. Fixed rate residential real estate loans with an amortization of 15 years or less may be held in the Corporation’s portfolio, held for future sale, or sold upon origination. Factors used in determining when to sell these mortgages include management’s judgment about the direction of interest rates, the Corporation’s need for fixed rate assets in the management of its interest rate sensitivity, and overall loan demand.

Lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 95% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan to value ratios in excess of 80%. Substantially all loans upon origination have a loan to value ratio of less than 80%. Underwriting criteria for residential real estate loans include: evaluation of the borrower’s ability to make monthly payments, the value of the property securing the loan, ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income, all debt servicing does not exceed 36% of income, acceptable credit reports, verification of employment, income, and financial information. Appraisals are performed by independent appraisers and reviewed internally. All mortgage loan requests are reviewed by a mortgage loan committee or through a secondary market automated underwriting system; loans in excess of $400 require the approval of the Corporation’s Internal Loan Committee, Board of Directors, or the Board of Director’s Loan Committee.

Consumer loans include automobile loans, secured and unsecured personal loans, and overdraft protection related loans. Loans are amortized generally for a period of up to 6 years. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when management believes the uncollectibility of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The ALLL is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the net realizable value of the loan’s underlying collateral or the net present value of the projected payment stream and its recorded investment. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding three years. An unallocated component is maintained to cover uncertainties that management believes affect its estimate of probable losses based on qualitative factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

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Table of Contents

A summary of changes in the ALLL and the recorded investment in loans by segments follows:

 

     Allowance for Loan Losses
Three Months Ended March 31, 2012
 
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated     Total  

Allowance for loan losses

            

January 1, 2012

   $ 6,284      $ 1,003      $ 2,980      $ 633      $ 1,475      $ 12,375   

Loans charged off

     (449     —          (115     (91     —          (655

Recoveries

     86        —          41        67        —          194   

Provision for loan losses

     (193     (144     796        16        (14     461   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2012

   $ 5,728      $ 859      $ 3,702      $ 625      $ 1,461      $ 12,375   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Allowance for Loan Losses and Recorded Investment in Loans
As of March 31, 2012
 
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated     Total  

Allowance for loan losses

            

Individually evaluated for impairment

   $ 2,232      $ 531      $ 1,287      $ —        $ —        $ 4,050   

Collectively evaluated for impairment

     3,496        328        2,415        625        1,461        8,325   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 5,728      $ 859      $ 3,702      $ 625      $ 1,461      $ 12,375   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans

            

Individually evaluated for impairment

   $ 17,350      $ 3,095      $ 8,214      $ 95        $ 28,754   

Collectively evaluated for impairment

     343,975        73,586        266,453        30,364          714,378   
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

Total

   $ 361,325      $ 76,681      $ 274,667      $ 30,459        $ 743,132   
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

 

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Table of Contents
     Allowance for Loan Losses
Three Months Ended March 31, 2011
 
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated     Total  

Allowance for loan losses

            

January 1, 2011

   $ 6,048      $ 1,033      $ 3,198      $ 605      $ 1,489      $ 12,373   

Loans charged off

     (655     —          (323     (145     —          (1,123

Recoveries

     137        —          74        103        —          314   

Provision for loan losses

     716        (257     473        59        (174     817   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2011

   $ 6,246      $ 776      $ 3,422      $ 622      $ 1,315      $ 12,381   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Allowance for Loan Losses and Recorded Investment in Loans
As of December 31, 2011
 
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated     Total  

Allowance for loan losses

            

Individually evaluated for impairment

   $ 2,152      $ 822      $ 1,146      $ —        $ —        $ 4,120   

Collectively evaluated for impairment

     4,132        181        1,834        633        1,475        8,255   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 6,284      $ 1,003      $ 2,980      $ 633      $ 1,475      $ 12,375   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans

            

Individually evaluated for impairment

   $ 14,097      $ 3,384      $ 7,664      $ 105        $ 25,250   

Collectively evaluated for impairment

     351,617        71,261        270,696        31,467          725,041   
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

Total

   $ 365,714      $ 74,645      $ 278,360      $ 31,572        $ 750,291   
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

 

 

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The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit ratings as of:

 

     March 31, 2012  
     Commercial      Agricultural  
     Real Estate      Other      Total      Real Estate      Other      Total  

Rating

                 

2 - High quality

   $ 9,938       $ 16,472       $ 26,410       $ 2,465       $ 1,739       $ 4,204   

3 - High satisfactory

     95,563         26,385         121,948         14,972         5,569         20,541   

4 - Low satisfactory

     114,175         53,308         167,483         24,918         17,678         42,596   

5 - Special mention

     15,318         2,136         17,454         1,763         1,200         2,963   

6 - Substandard

     19,692         3,717         23,409         1,874         4,027         5,901   

7 - Vulnerable

     1,802         101         1,903         —           —           —     

8 - Doubtful

     2,681         37         2,718         190         286         476   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 259,169       $ 102,156       $ 361,325       $ 46,182       $ 30,499       $ 76,681   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Commercial      Agricultural  
     Real Estate      Other      Total      Real Estate      Other      Total  

Rating

                 

2 - High quality

   $ 11,113       $ 11,013       $ 22,126       $ 3,583       $ 1,390       $ 4,973   

3 - High satisfactory

     90,064         29,972         120,036         11,154         5,186         16,340   

4 - Low satisfactory

     118,611         57,572         176,183         24,253         15,750         40,003   

5 - Special mention

     15,482         4,200         19,682         3,863         2,907         6,770   

6 - Substandard

     19,017         4,819         23,836         1,640         4,314         5,954   

7 - Vulnerable

     187         —           187         —           —           —     

8 - Doubtful

     3,621         43         3,664         190         415         605   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 258,095       $ 107,619       $ 365,714       $ 44,683       $ 29,962       $ 74,645   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Internally assigned risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned risk ratings for commercial and agricultural loans are as follows:

 

1. EXCELLENT – Substantially Risk Free

Credit has strong financial condition and solid earnings history, characterized by:

 

   

High liquidity, strong cash flow, low leverage.

 

   

Unquestioned ability to meet all obligations when due.

 

   

Experienced management, with management succession in place.

 

   

Secured by cash.

 

2. HIGH QUALITY – Limited Risk

Credit with sound financial condition and has a positive trend in earnings supplemented by:

 

   

Favorable liquidity and leverage ratios.

 

   

Ability to meet all obligations when due.

 

   

Management with successful track record.

 

   

Steady and satisfactory earnings history.

 

   

If loan is secured, collateral is of high quality and readily marketable.

 

   

Access to alternative financing.

 

   

Well defined primary and secondary source of repayment.

 

   

If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

 

3. HIGH SATISFACTORY – Reasonable Risk

Credit with satisfactory financial condition and further characterized by:

 

   

Working capital adequate to support operations.

 

   

Cash flow sufficient to pay debts as scheduled.

 

   

Management experience and depth appear favorable.

 

   

Loan performing according to terms.

 

   

If loan is secured, collateral is acceptable and loan is fully protected.

 

4. LOW SATISFACTORY – Acceptable Risk

Credit with bankable risks, although some signs of weaknesses are shown:

 

   

Would include most start-up businesses.

 

   

Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.

 

   

Management’s abilities are apparent, yet unproven.

 

   

Weakness in primary source of repayment with adequate secondary source of repayment.

 

   

Loan structure generally in accordance with policy.

 

   

If secured, loan collateral coverage is marginal.

 

   

Adequate cash flow to service debt, but coverage is low.

 

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Table of Contents

To be classified as less than satisfactory, only one of the following criteria must be met.

 

5. SPECIAL MENTION – Criticized

Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:

 

   

Downward trend in sales, profit levels, and margins.

 

   

Impaired working capital position.

 

   

Cash flow is strained in order to meet debt repayment.

 

   

Loan delinquency (30-60 days) and overdrafts may occur.

 

   

Shrinking equity cushion.

 

   

Diminishing primary source of repayment and questionable secondary source.

 

   

Management abilities are questionable.

 

   

Weak industry conditions.

 

   

Litigation pending against the borrower.

 

   

Collateral or guaranty offers limited protection.

 

   

Negative debt service coverage, however the credit is well collateralized and payments are current.

 

6. SUBSTANDARD – Classified

Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that the Corporation will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:

 

   

Sustained losses have severely eroded the equity and cash flow.

 

   

Deteriorating liquidity.

 

   

Serious management problems or internal fraud.

 

   

Original repayment terms liberalized.

 

   

Likelihood of bankruptcy.

 

   

Inability to access other funding sources.

 

   

Reliance on secondary source of repayment.

 

   

Litigation filed against borrower.

 

   

Collateral provides little or no value.

 

   

Requires excessive attention of the loan officer.

 

   

Borrower is uncooperative with loan officer.

 

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Table of Contents
7. VULNERABLE – Classified

Credit is considered “Substandard” and warrants placing on nonaccrual. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:

 

   

Insufficient cash flow to service debt.

 

   

Minimal or no payments being received.

 

   

Limited options available to avoid the collection process.

 

   

Transition status, expect action will take place to collect loan without immediate progress being made.

 

8. DOUBTFUL – Workout

Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:

 

   

Normal operations are severely diminished or have ceased.

 

   

Seriously impaired cash flow.

 

   

Original repayment terms materially altered.

 

   

Secondary source of repayment is inadequate.

 

   

Survivability as a “going concern” is impossible.

 

   

Collection process has begun.

 

   

Bankruptcy petition has been filed.

 

   

Judgments have been filed.

 

   

Portion of the loan balance has been charged-off.

 

9. LOSS – Charge off

Credits are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:

 

   

Liquidation or reorganization under bankruptcy, with poor prospects of collection.

 

   

Fraudulently overstated assets and/or earnings.

 

   

Collateral has marginal or no value.

 

   

Debtor cannot be located.

 

   

Over 120 days delinquent.

 

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Table of Contents

The Corporation’s primary credit quality indicators for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the Corporation’s past due and current loans as of:

 

     March 31, 2012  
     Accruing Interest
and Past Due:
            Total
Past Due
and
Nonaccrual
               
     30-89
Days
     90 Days
or More
     Nonaccrual         Current      Total  

Commercial

                 

Commercial real estate

   $ 1,350       $ 189       $ 4,661       $ 6,200       $ 252,969       $ 259,169   

Commercial other

     448         —           101         549         101,607         102,156   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     1,798         189         4,762         6,749         354,576         361,325   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Agricultural

                 

Agricultural real estate

     302         99         189         590         45,592         46,182   

Agricultural other

     186         —           286         472         30,027         30,499   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total agricultural

     488         99         475         1,062         75,619         76,681   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential real estate

                 

Senior liens

     2,538         35         1,130         3,703         212,442         216,145   

Junior liens

     103         38         85         226         19,557         19,783   

Home equity lines of credit

     133         —           199         332         38,407         38,739   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total residential real estate

     2,774         73         1,414         4,261         270,406         274,667   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer

                 

Secured

     76         —           —           76         25,345         25,421   

Unsecured

     22         —           —           22         5,016         5,038   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer

     98         —           —           98         30,361         30,459   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,158       $ 361       $ 6,651       $ 12,170       $ 730,962       $ 743,132   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Accruing Interest
and Past Due:
            Total
Past  Due

and
Nonaccrual
               
     30-89
Days
     90 Days
or More
     Nonaccrual         Current      Total  

Commercial

                 

Commercial real estate

   $ 1,721       $ 364       $ 4,176       $ 6,261       $ 251,834       $ 258,095   

Commercial other

     426         3         25         454         107,165         107,619   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     2,147         367         4,201         6,715         358,999         365,714   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Agricultural

                 

Agricultural real estate

     —           99         189         288         44,395         44,683   

Agricultural other

     2         —           415         417         29,545         29,962   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total agricultural

     2         99         604         705         73,940         74,645   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential real estate

                 

Senior liens

     3,004         124         1,292         4,420         213,181         217,601   

Junior liens

     235         40         94         369         20,877         21,246   

Home equity lines of credit

     185         125         198         508         39,005         39,513   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total residential real estate

     3,424         289         1,584         5,297         273,063         278,360   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer

                 

Secured

     158         5         —           163         26,011         26,174   

Unsecured

     23         —           —           23         5,375         5,398   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer

     181         5         —           186         31,386         31,572   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 5,754       $ 760       $ 6,389       $ 12,903       $ 737,388       $ 750,291   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Impaired Loans

Loans may be classified as impaired if they meet one or more of the following criteria:

 

  1. There has been a chargeoff of its principal balance (in whole or in part);

 

  2. The loan has been classified as a Troubled Debt Restructuring (TDR); or

 

  3. The loan is in nonaccrual status.

Impairment is measured on a loan by loan basis for commercial, commercial real estate, agricultural, or agricultural real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.

Interest income is recognized on impaired loans in nonaccrual status on the cash basis, but only after all principal has been collected. For impaired loans not in nonaccrual status, interest income is recognized daily as earned according to the terms of the loan agreement.

The following is a summary of information pertaining to impaired loans as of:

 

     March 31, 2012      December 31, 2011  
     Outstanding
Balance
     Unpaid
Principal
Balance
     Valuation
Allowance
     Outstanding
Balance
     Unpaid
Principal
Balance
     Valuation
Allowance
 

Impaired loans with a valuation allowance

              

Commercial real estate

   $ 6,759       $ 6,969       $ 1,941       $ 5,014       $ 5,142       $ 1,881   

Commercial other

     714         714         291         734         734         271   

Agricultural other

     2,243         2,243         531         2,689         2,689         822   

Residential real estate senior liens

     7,830         9,165         1,253         7,271         8,827         1,111   

Residential real estate junior liens

     185         251         34         195         260         35   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans with a valuation allowance

   $ 17,731       $ 19,342       $ 4,050       $ 15,903       $ 17,652       $ 4,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans without a valuation allowance

              

Commercial real estate

   $ 7,632       $ 10,521          $ 7,984       $ 10,570      

Commercial other

     2,245         2,339            365         460      

Agricultural real estate

     190         190            190         190      

Agricultural other

     662         782            505         625      

Home equity lines of credit

     199         499            198         498      

Consumer secured

     95         104            105         114      
  

 

 

    

 

 

       

 

 

    

 

 

    

Total impaired loans without a valuation allowance

   $ 11,023       $ 14,435          $ 9,347       $ 12,457      
  

 

 

    

 

 

       

 

 

    

 

 

    

Impaired loans

              

Commercial

   $ 17,350       $ 20,543       $ 2,232       $ 14,097       $ 16,906       $ 2,152   

Agricultural

     3,095         3,215         531         3,384         3,504         822   

Residential real estate

     8,214         9,915         1,287         7,664         9,585         1,146   

Consumer

     95         104         —           105         114         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 28,754       $ 33,777       $ 4,050       $ 25,250       $ 30,109       $ 4,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Three Months Ended  
     March 31, 2012      March 31, 2011  
     Average
Outstanding
Balance
     Interest
Income
Recognized
     Average
Outstanding
Balance
     Interest
Income
Recognized
 

Impaired loans with a valuation allowance

           

Commercial real estate

   $ 5,887       $ 98       $ 2,091       $ 24   

Commercial other

     724         12         9         —     

Agricultural other

     2,466         37         2,196         33   

Residential real estate senior liens

     7,550         83         4,427         36   

Residential real estate junior liens

     190         2         170         1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans with a valuation allowance

   $ 16,817       $ 232       $ 8,893       $ 94   
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans without a valuation allowance

           

Commercial real estate

   $ 7,808       $ 67       $ 2,676       $ 33   

Commercial other

     1,305         31         981         60   

Agricultural real estate

     190         —           95         —     

Agricultural other

     584         4         —           —     

Residential real estate senior liens

     1         —           537         6   

Home equity lines of credit

     199         4         1         —     

Consumer secured

     100         2         47         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans without a valuation allowance

   $ 10,187       $ 108       $ 4,337       $ 101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans

           

Commercial

   $ 15,724       $ 208       $ 5,757       $ 117   

Agricultural

     3,240         41         2,291         33   

Residential real estate

     7,940         89         5,135         43   

Consumer

     100         2         47         2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 27,004       $ 340       $ 13,230       $ 195   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Corporation had pledged to advance $359 in connection with impaired loans, which include TDR’s, as of March 31, 2012.

 

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Table of Contents

Troubled Debt Restructurings

Loan modifications are considered to be TDR’s when a concession has been granted to a borrower who is experiencing financial difficulties.

Typical concessions granted include, but are not limited to:

 

  1. Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.

 

  2. Extending the amortization period beyond typical lending guidelines for debt with similar risk characteristics.

 

  3. Forbearance of principal.

 

  4. Forbearance of accrued interest.

To determine if a borrower is experiencing financial difficulties, the Corporation considers if:

 

  1. The borrower is currently in default on any of their debt.

 

  2. It is likely that the borrower would default on any of their debt if the concession was not granted.

 

  3. The borrower’s cash flow was sufficient to service all of their debt if the concession was not granted.

 

  4. The borrower has declared, or is in the process of declaring, bankruptcy.

 

  5. The borrower is unlikely to continue as a going concern (if the entity is a business).

The following is a summary of information pertaining to TDR’s for the three month period ended March 31, 2012:

 

     Number
of
Loans
     Pre-
Modification
Recorded

Investment
     Post-
Modification
Recorded

Investment
 

Commercial other

     21       $ 4,586       $ 4,586   

Agricultural other

     6         561         561   

Residential real estate senior liens

     5         721         721   
  

 

 

    

 

 

    

 

 

 

Total

     32       $ 5,868       $ 5,868   
  

 

 

    

 

 

    

 

 

 

The following tables summarize concessions granted by the Corporation to borrowers in financial difficulties in the three month period ended March 31, 2012:

 

     Below Market
Interest Rate
     Below Market
Interest Rate
and
Extension of
Amortization Period
 
     Number
of
Loans
     Pre-
Modification
Recorded
Investment
     Number
of
Loans
     Pre-
Modification
Recorded
Investment
 

Commercial other

     21       $ 4,586         —         $ —     

Agricultural other

     6         561         —           —     

Residential real estate senior liens

     —           —           5         721   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     27       $ 5,147         5       $ 721   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Corporation did not restructure any loans through the forbearance of principal or accrued interest in the three month period ended March 31, 2012.

 

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Table of Contents

Based on the Corporation’s historical loss experience, losses associated with TDR’s are not significantly different than other impaired loans within the same loan segment. As such, TDR’s, including TDR’s that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.

The following is a summary of loans that defaulted in the first three months of 2012, which were modified within 12 months prior to the default date.

 

     Number
of
Loans
     Pre-
Default
Recorded
Investment
     Charge Off
Recorded
Upon
Default
     Post-
Default
Recorded
Investment
 

Commercial other

     1       $ 82       $ 42       $ 40   

Residential real estate senior liens

     1         47         43         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2       $ 129       $ 85       $ 44   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Corporation had no loans that defaulted during the first three months of 2011, which were modified within 12 months prior to the default date.

The following is a summary of TDR loan balances as of:

 

     March 31
2012
     December 31
2011
 

Troubled debt restructurings

   $ 23,102       $ 18,756   

NOTE 7 – EQUITY SECURITIES WITHOUT READILY DETERMINABLE FAIR VALUES

Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and investments in nonconsolidated entities accounted for under the equity method of accounting.

Equity securities without readily determinable fair values consist of the following as of:

 

     March 31
2012
     December 31
2011
 

Federal Home Loan Bank Stock

   $ 7,380       $ 7,380   

Investment in Corporate Settlement Solutions

     6,642         6,611   

Federal Reserve Bank Stock

     1,879         1,879   

Investment in Valley Financial Corporation

     1,000         1,000   

Other

     319         319   
  

 

 

    

 

 

 

Total

   $ 17,220       $ 17,189   
  

 

 

    

 

 

 

NOTE 8 – BORROWED FUNDS

Borrowed funds consist of the following obligations as of:

 

     March 31, 2012     December 31, 2011  
     Amount      Rate     Amount      Rate  

Federal Home Loan Bank advances

   $ 142,000         2.61   $ 142,242         3.16

Securities sold under agreements to repurchase without stated maturity dates

     55,791         0.20     57,198         0.25

Securities sold under agreements to repurchase with stated maturity dates

     16,702         3.51     16,696         3.51
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 214,493         2.05   $ 216,136         2.42
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

The Federal Home Loan Bank (FHLB) advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans and certain mortgage-backed securities and collateralized mortgage obligations. Advances are also secured by FHLB stock owned by the Corporation. The Corporation had the ability to borrow up to an additional $121,701 based on assets currently pledged as collateral as of March 31, 2012. During the first quarter of 2012, management reduced funding costs by modifying the terms of $60,000 of FHLB advances.

The following table lists the maturity and weighted average interest rates of FHLB advances as of:

 

     March 31
2012
    December 31
2011
 
     Amount         Rate        Amount         Rate   

Fixed rate advances due 2012

   $ 7,000         4.31   $ 17,000         2.97

One year putable advances due 2012

     15,000         4.10     15,000         4.10

Fixed rate advances due 2013

     —           —          5,242         4.14

One year putable advances due 2013

     —           —          5,000         3.15

Fixed rate advances due 2014

     —           —          25,000         3.16

Fixed rate advances due 2015

     30,000         1.32     45,000         3.30

Fixed rate advances due 2016

     10,000         2.15     10,000         2.15

Fixed rate advances due 2017

     40,000         2.15     20,000         2.56

Fixed rate advances due 2018

     20,000         2.86     —           —     

Fixed rate advances due 2019

     20,000         3.73     —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 142,000         2.61   $ 142,242         3.16
  

 

 

    

 

 

   

 

 

    

 

 

 

Securities sold under agreements to repurchase are classified as secured borrowings. Securities sold under agreements to repurchase without stated maturity dates generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $108,202 and $99,869 at March 31, 2012 and December 31, 2011, respectively. Such securities remain under the control of the Corporation. The Corporation may be required to provide additional collateral based on the fair value of underlying securities.

The following table provides a summary of short term borrowings for the three month periods ended March 31:

 

     2012     2011  
     Maximum
Month-End
Balance
     Quarter
to Date
Average
Balance
     Weighted Average
Interest Rate
During the Period
    Maximum
Month-End
Balance
     Quarter
to Date
Average
Balance
     Weighted Average
Interest Rate
During the Period
 

Securities sold under agreements to repurchase without stated maturity dates

   $ 56,923       $ 56,172         0.23   $ 41,406       $ 41,036         0.25

Federal funds purchased

     —           71         0.48     3,600         1,206         0.50

 

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Table of Contents

The Corporation had pledged certificates of deposit held in other financial institutions, trading securities, available-for-sale securities, and 1-4 family residential real estate loans in the following amounts at:

 

     March 31
2012
     December 31
2011
 

Pledged to secure borrowed funds

   $ 322,370       $ 292,092   

Pledged to secure repurchase agreements

     108,202         99,869   

Pledged for public deposits and for other purposes necessary or required by law

     25,302         26,761   
  

 

 

    

 

 

 

Total

   $ 455,874       $ 418,722   
  

 

 

    

 

 

 

The Corporation had no investment securities that are restricted to be pledged for specific purposes.

NOTE 9 – OTHER NONINTEREST EXPENSES

A summary of expenses included in other noninterest expenses are as follows for the three month periods ended March 31:

 

     2012      2011  

Marketing and community relations

     494         223   

FDIC insurance premiums

     215         334   

Directors fees

     210         211   

Audit and SOX compliance fees

     176         156   

Education and travel

     127         105   

Consulting fees

     187         33   

Printing and supplies

     109         100   

Postage and freight

     101         100   

Foreclosed asset and collection

     97         100   

Amortization of deposit premium

     66         76   

Legal fees

     62         62   

All other

     415         330   
  

 

 

    

 

 

 

Total

   $ 2,259       $ 1,830   
  

 

 

    

 

 

 

NOTE 10 – FEDERAL INCOME TAXES

The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the three month periods ended March 31:

 

     2012     2011  

Income taxes at 34% statutory rate

   $ 1,362      $ 928   

Effect of nontaxable income

    

Interest income on tax exempt municipal bonds

     (391     (383

Earnings on corporate owned life insurance

     (58     (48

Other

     (151     (94
  

 

 

   

 

 

 

Total effect of nontaxable income

     (600     (525

Effect of nondeductible expenses

     11        10   
  

 

 

   

 

 

 

Federal income tax expense

   $ 773      $ 413   
  

 

 

   

 

 

 

 

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Table of Contents

Included in other comprehensive income for the three month periods ended March 31, 2012 and 2011 are changes in unrealized holding gains, related to auction rate money market preferreds and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

A summary of other comprehensive income (loss) follows for the three month periods ended March 31:

 

     2012  
     Auction Rate
Money Market
Preferreds and
Preferred Stocks
     All Other
Available-for-Sale
Securities
    Total  

Unrealized gains (losses) arising during the period

   $ 1,604       $ (805   $ 799   

Reclassification adjustment for net realized gains included in net income

     —           (1,003     (1,003

Reclassification adjustment for impairment loss included in net income

     —           282        282   
  

 

 

    

 

 

   

 

 

 

Net unrealized gains (losses)

     1,604         (1,526     78   

Tax effect

     —           519        519   
  

 

 

    

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

   $ 1,604       $ (1,007   $ 597   
  

 

 

    

 

 

   

 

 

 
     2011  
     Auction Rate
Money Market
Preferreds and
Preferred Stocks
     All Other
Available-for-Sale
Securities
    Total  

Unrealized gains arising during the period

   $ 595       $ 1,158      $ 1,753   

Reclassification adjustment for net realized gains included in net income

     —           —          —     

Reclassification adjustment for impairment loss included in net income

     —           —          —     
  

 

 

    

 

 

   

 

 

 

Net unrealized gains

     595         1,158        1,753   

Tax effect

     —           (395     (395
  

 

 

    

 

 

   

 

 

 

Other comprehensive income, net of tax

   $ 595       $ 763      $ 1,358   
  

 

 

    

 

 

   

 

 

 

 

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NOTE 11 – DEFINED BENEFIT PENSION PLAN

The Corporation has a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007. As a result of the curtailment, future salary increases are no longer considered and plan benefits are based on years of service and the employees’ five highest consecutive years of compensation out of the last ten years of service through March 1, 2007. The Corporation made a $135 contribution to the pension plan during the three month period ended March 31, 2012 and made no contributions to the plan in the three month period ended March 31, 2011. The Corporation does not anticipate any further contributions during 2012.

Following are the components of net periodic benefit cost for the three month period ended March 31:

 

      2012     2011  

Interest cost on projected benefit obligation

   $ 118      $ 127   

Expected return on plan assets

     (127     (131

Amortization of unrecognized actuarial net loss

     73        38   
  

 

 

   

 

 

 

Net periodic benefit cost

   $ 64      $ 34   
  

 

 

   

 

 

 

NOTE 12 – FAIR VALUE

Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.

Cash and demand deposits due from banks: The carrying amounts of cash and short term investments, including Federal funds sold, approximate fair values. As such, the Corporation classifies cash and demand deposits due from banks as Level 1.

Certificates of deposit held in other financial institutions: Interest bearing balances held in unaffiliated financial institutions include certificates of deposit and other short term interest bearing balances that mature within 3 years. Fair value is determined using prices for similar assets with similar characteristics. As such, the Corporation classifies certificates of deposits held in other financial institutions as Level 2.

Investment securities: Investment securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. Level 2 securities include bonds issued by government sponsored enterprises, states and political subdivisions, mortgage-backed securities, collateralized mortgage obligations issued by government sponsored enterprises, and auction rate money market preferred securities. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, management compares the values provided to alternative pricing sources.

Due to the limited trading activity of certain auction rate money market preferred securities and preferred stocks the Corporation measured these securities using Level 3 inputs as of March 31, 2011. As the markets for these securities normalized and established regular trading patterns, the Corporation measured preferred stocks with fair values of $5,033 utilizing Level 1 inputs and auction rate money market preferred securities with fair values of $2,049 utilizing Level 2 inputs as of December 31, 2011 and continued to measure at these levels as of March 31, 2012.

The table below represents the activity in auction rate money market preferred available-for-sale investment securities measured with Level 3 inputs on a recurring basis for the three months ended March 31, 2011:

 

Level 3 inputs - January 1

   $ 2,865   

Net unrealized losses on available-for-sale investment securities

     (62
  

 

 

 

Level 3 inputs - March 31

   $ 2,803   
  

 

 

 

 

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The table below represents the activity in preferred stock available-for-sale investment securities measured with Level 3 inputs on a recurring basis for the three months ended March 31, 2011:

 

Level 3 inputs - January 1

   $ 6,936   

Net unrealized gains on available-for-sale investment securities

     657   
  

 

 

 

Level 3 inputs - March 31

   $ 7,593   
  

 

 

 

Mortgage loans available-for-sale: Mortgage loans available-for-sale are carried at the lower of cost or fair value. The fair value of mortgage loans available-for-sale are based on what price secondary markets are currently offering for portfolios with similar characteristics. As such, the Corporation classifies loans subjected to nonrecurring fair value adjustments as Level 2.

Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated.

The Corporation does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, management measures the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

The Corporation reviews the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, management utilizes independent appraisals, broker price opinions, or internal evaluations. These valuations are reviewed to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to carry and sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. The Corporation uses these valuations to determine if any charge offs or specific reserves are necessary. The Corporation may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.

Impaired loans where an allowance is established based on the net realizable value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraisal value, the Corporation records the loan as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of collateral is further impaired below the appraised value, the Corporation records the impaired loans as nonrecurring Level 3.

 

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The table below lists the quantitative information about impaired loans measured utilizing Level 3 fair value measurements as of March 31, 2012:

 

Valuation Techniques

   Fair Value     

Unobservable
Input

   Range
      Duration of cash flows    10 years

Discounted cash flow

   $ 6,726      

Reduction in interest rate

from original loan terms

   3.00%
           

Discount applied to

collateral appraisal:

    
      Real Estate    20% - 30%
      Equipment    50%

Discounted appraisal value

   $ 17,978       Livestock    50%
      Cash crop inventory    50%
      Other inventory    75%
      Accounts receivable    75%
      Estimated liquidation costs    10%

Accrued interest: The carrying amounts of accrued interest approximate fair value. As such, the Corporation classifies accrued interest as Level 1.

Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Goodwill is typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of goodwill is more likely than not to be impaired, management performs a cash flow valuation to determine the extent of the potential impairment. Acquisition intangibles are tested for impairment with a cash flow valuation. This valuation method requires a significant degree of management judgment. In the event the projected undiscounted net operating cash flows for these intangible assets are less than the carrying value, the asset is recorded at fair value as determined by the valuation model. If the testing resulted in impairment, the Corporation would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2012 and 2011 there were no impairments recorded on goodwill and other acquisition intangibles.

Equity securities without readily determinable fair values: The Corporation has investments in equity securities without readily determinable fair values as well as investments in joint ventures. The assets are individually reviewed for impairment on an annual basis, or more frequently if an indication of impairment exists, by comparing the carrying value to the estimated fair value. The lack of an independent source to validate fair value estimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. The Corporation classifies nonmarketable equity securities and its investments in joint ventures subjected to nonrecurring fair value adjustments as Level 3. During 2012 and 2011, there were no impairments recorded on equity securities without readily determinable fair values.

Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral and as such, the Corporation classifies foreclosed assets as a nonrecurring Level 2. When management determines that the net realizable value of the collateral is further impaired below the appraised value but there is no observable market price, the Corporation records the foreclosed asset as nonrecurring Level 3.

Originated mortgage servicing rights: Originated mortgage servicing rights are subject to impairment testing. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and a discount rate determined by management, is used for impairment testing. If the valuation model reflects a value less than the carrying value, originated mortgage servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Corporation classifies loan servicing rights subject to nonrecurring fair value adjustments as Level 2.

 

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Deposits: Demand, savings, and money market deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts), and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their recorded carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, certificates of deposit are classified as Level 2.

Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short- term borrowings maturing within ninety days approximate their fair values. The fair values of the Corporation’s other borrowed funds are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing arrangements.

The Corporation elected to measure a portion of borrowed funds at fair value as of December 31, 2011. These borrowings were recorded at fair value on a recurring basis, with the fair value measurement estimated using discounted cash flow analysis based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements. Changes in the fair value of these borrowings are included in noninterest income. As such, the Corporation classifies other borrowed funds as Level 2.

The activity in borrowings which the Corporation has elected to carry at fair value was as follows for the three months ended March 31:

 

     2012     2011  

Borrowings carried at fair value - beginning of year

   $ 5,242      $ 10,423   

Paydowns and maturities

     (5,209     —     

Net unrealized change in fair value

     (33     (80
  

 

 

   

 

 

 

Borrowings carried at fair value - March 31

   $ —        $ 10,343   
  

 

 

   

 

 

 

Unpaid principal balance - March 31

   $ —        $ 10,000   
  

 

 

   

 

 

 

Commitments to extend credit, standby letters of credit and undisbursed loans: Fair values for off balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties’ credit standings. The Corporation does not charge fees for lending commitments; thus it is not practicable to estimate the fair value of these instruments.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Corporation believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.

 

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Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis

Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, the Corporation uses present value techniques and other valuation methods to estimate the fair values of its financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.

The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis on the Corporation’s consolidated balance sheets are as follows as of:

 

     March 31, 2012  
     Carrying
Value
    Estimated
Fair Value
    (Level 1)      (Level 2)     (Level 3)  

ASSETS

           

Cash and demand deposits due from banks

   $ 21,744      $ 21,744      $ 21,744       $ —        $ —     

Certificates of deposit held in other financial institutions

     6,640        6,674        —           6,674        —     

Mortgage loans available-for-sale

     3,396        3,396        —           3,396        —     

Total loans

     743,132        757,635        —           728,881        28,754   

Less allowance for loan losses

     (12,375     (12,375     —           (8,325     (4,050
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Net loans

     730,757        745,260        —           720,556        24,704   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Accrued interest receivable

     6,044        6,044        6,044         —          —     

Equity securities without readily determinable fair values (1)

     17,220        17,220        —           —          —     

Originated mortgage servicing rights

     2,438        2,438        —           2,438        —     

LIABILITIES

           

Deposits without stated maturities

     510,561        510,561        510,561         —          —     

Deposits with stated maturities

     478,565        491,910        —           491,910        —     

Borrowed funds

     214,493        220,395        —           220,395        —     

Accrued interest payable

     887        887        887         —          —     

 

(1) Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy.

 

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     December 31, 2011  
     Carrying
Value
    Estimated
Fair Value
 

ASSETS

    

Cash and demand deposits due from banks

   $ 28,590      $ 28,590   

Certificates of deposit held in other financial institutions

     8,924        8,977   

Mortgage loans available-for-sale

     3,205        3,252   

Total loans

     750,291        769,177   

Less allowance for loan losses

     (12,375     (12,375
  

 

 

   

 

 

 

Net loans

     737,916        756,802   
  

 

 

   

 

 

 

Accrued interest receivable

     5,848        5,848   

Equity securities without readily determinable fair values

     17,189        17,189   

Originated mortgage servicing rights

     2,374        2,374   

LIABILITIES

    

Deposits without stated maturities

     476,627        476,627   

Deposits with stated maturities

     481,537        499,644   

Borrowed funds

     210,894        222,538   

Accrued interest payable

     967        967   

Financial Instruments Recorded at Fair Value

The table below presents the recorded amount of assets and liabilities measured at fair value on:

 

    March 31, 2012     December 31, 2011  

Description

  Total     (Level 1)     (Level 2)     (Level 3)     Total     (Level 1)     (Level 2)     (Level 3)  

Recurring items

               

Trading securities

               

States and political subdivisions

  $ 4,403      $ —        $ 4,403      $ —        $ 4,710      $ —        $ 4,710      $ —     

Available-for-sale investment securities

               

Government sponsored enterprises

    2,474        —          2,474        —          397        —          397        —     

States and political subdivisions

    176,886        —          176,886        —          174,938        —          174,938        —     

Auction rate money market preferred

    2,621        —          2,621          2,049        —          2,049        —     

Preferred stocks

    6,065        6,065        —