PINX:ISBA Isabella Bank Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 2012

or

 

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

For the transition period from                 to

Commission File Number: 0-18415

 

 

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, 7,617,345 as of July 23, 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      39   

Item 3

  Quantitative and Qualitative Disclosures about Market Risk      58   

Item 4

  Controls and Procedures      58   

PART II

       59   

Item 1

  Legal Proceedings      59   

Item 1A

  Risk Factors      59   

Item 2

  Unregistered Sales of Equity Securities and Use of Proceeds      59   

Item 6

  Exhibits      60   

SIGNATURES

     61   

 

2


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1 – Interim Condensed Consolidated Financial Statements (Unaudited)

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

     June 30,
2012
     December 31
2011
 

ASSETS

     

Cash and cash equivalents

     

Cash and demand deposits due from banks

   $ 19,492       $ 24,514   

Interest bearing balances due from banks

     759         4,076   
  

 

 

    

 

 

 

Total cash and cash equivalents

     20,251         28,590   

Certificates of deposit held in other financial institutions

     6,880         8,924   

Trading securities

     1,998         4,710   

Available-for-sale securities (amortized cost of $464,931 in 2012 and $414,614 in 2011)

     476,935         425,120   

Mortgage loans available-for-sale

     2,347         3,205   

Loans

     

Agricultural

     81,222         74,645   

Commercial

     368,371         365,714   

Consumer

     31,357         31,572   

Residential real estate

     274,002         278,360   
  

 

 

    

 

 

 

Total loans

     754,952         750,291   

Less allowance for loan losses

     12,318         12,375   
  

 

 

    

 

 

 

Net loans

     742,634         737,916   

Premises and equipment

     24,729         24,626   

Corporate owned life insurance

     22,423         22,075   

Accrued interest receivable

     5,217         5,848   

Equity securities without readily determinable fair values

     17,708         17,189   

Goodwill and other intangible assets

     46,659         46,792   

Other assets

     13,715         12,930   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 1,381,496       $ 1,337,925   
  

 

 

    

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Deposits

     

Noninterest bearing

   $ 124,230       $ 119,072   

NOW accounts

     163,000         163,653   

Certificates of deposit under $100 and other savings

     450,159         440,123   

Certificates of deposit over $100

     241,439         235,316   
  

 

 

    

 

 

 

Total deposits

     978,828         958,164   

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

     234,132         216,136   

Accrued interest payable and other liabilities

     8,681         8,842   
  

 

 

    

 

 

 

Total liabilities

     1,221,641         1,183,142   
  

 

 

    

 

 

 

Shareholders’ equity

     

Common stock — no par value

     

15,000,000 shares authorized; issued and outstanding 7,602,545 shares (including 19,990 shares held in the Rabbi Trust) in 2012 and 7,589,226 shares (including 16,585 shares held in the Rabbi Trust) in 2011

     134,931         134,734   

Shares to be issued for deferred compensation obligations

     4,724         4,524   

Retained earnings

     16,240         13,036   

Accumulated other comprehensive income

     3,960         2,489   
  

 

 

    

 

 

 

Total shareholders’ equity

     159,855         154,783   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,381,496       $ 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

     —          —          —          4,988        3,722        8,710   

Issuance of common stock

     61,218        1,346        —          —          —          1,346   

Common stock issued for deferred compensation obligations

     14,842        266        (254     —          —          12   

Share based payment awards under equity compensation plan

     —          —          307        —          —          307   

Common stock purchased for deferred compensation obligations

     —          (227     —          —          —          (227

Common stock repurchased pursuant to publicly announced repurchase plan

     (50,458     (914     —          —          —          (914

Cash dividends ($0.38 per share)

     —          —          —          (2,881     —          (2,881
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

     7,575,676      $ 134,063      $ 4,735      $ 10,703      $ 2,013      $ 151,514   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, January 1, 2012

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

Comprehensive income

     —          —          —          6,238        1,471        7,709   

Issuance of common stock

     54,900        1,322        —          —          —          1,322   

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

     —          95        (95     —          —          —     

Share based payment awards under equity compensation plan

     —          —          295        —          —          295   

Common stock purchased for deferred compensation obligations

     —          (225     —          —          —          (225

Common stock repurchased pursuant to publicly announced repurchase plan

     (41,581     (995     —          —          —          (995

Cash dividends ($0.40 per share)

     —          —          —          (3,034     —          (3,034
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2012

     7,602,545      $ 134,931      $ 4,724      $ 16,240      $ 3,960      $ 159,855   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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
June 30
    Six Months Ended
June 30
 
     2012     2011     2012     2011  

Interest income

        

Loans, including fees

   $ 10,849      $ 11,464      $ 21,789      $ 22,825   

Investment securities

        

Taxable

     1,988        1,836        3,877        3,349   

Nontaxable

     1,216        1,189        2,420        2,368   

Trading account securities

     22        47        64        98   

Federal funds sold and other

     113        133        242        267   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     14,188        14,669        28,392        28,907   

Interest expense

        

Deposits

     2,368        2,776        4,880        5,561   

Borrowings

     1,061        1,325        2,253        2,593   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     3,429        4,101        7,133        8,154   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     10,759        10,568        21,259        20,753   

Provision for loan losses

     439        603        900        1,420   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     10,320        9,965        20,359        19,333   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest income

        

Service charges and fees

     1,628        1,617        3,257        3,093   

Gain on sale of mortgage loans

     279        53        658        182   

Net loss on trading securities

     (16     (8     (32     (27

Net gain on borrowings measured at fair value

     —          37        33        117   

Gain on sale of available-for-sale investment securities

     —          —          1,003        —     

Other

     653        279        1,166        561   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     2,544        1,978        6,085        3,926   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expenses

        

Compensation and benefits

     5,232        4,746        10,533        9,751   

Occupancy

     599        613        1,240        1,259   

Furniture and equipment

     1,170        1,127        2,260        2,233   

Other

     2,187        2,293        4,446        4,123   
  

 

 

   

 

 

   

 

 

   

 

 

 

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        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expenses

     9,188        8,779        18,761        17,366   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before federal income tax expense

     3,676        3,164        7,683        5,893   

Federal income tax expense

     672        492        1,445        905   
  

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 3,004      $ 2,672      $ 6,238      $ 4,988   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share

        

Basic

   $ 0.40      $ 0.35      $ 0.82      $ 0.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.39      $ 0.34      $ 0.80      $ 0.64   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends per basic share

   $ 0.20      $ 0.19      $ 0.40      $ 0.38   
  

 

 

   

 

 

   

 

 

   

 

 

 

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
June 30
    Six Months Ended
June 30
 
     2012     2011     2012     2011  

Net income

   $  3,004      $ 2,672      $ 6,238      $ 4,988   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized holding gains on available-for-sale securities:

        

Unrealized holding gains arising during the period

     1,420        3,576        2,219        5,329   

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

     1,420        3,576        1,498        5,329   

Tax effect

     (546     (1,212     (27     (1,607
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     874        2,364        1,471        3,722   
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 3,878      $ 5,036      $ 7,709      $ 8,710   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to interim condensed consolidated financial statements.

 

6


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

     Six Months Ended
June 30
 
     2012     2011  

OPERATING ACTIVITIES

    

Net income

   $ 6,238      $ 4,988   

Reconciliation of net income to net cash provided by operations:

    

Provision for loan losses

     900        1,420   

Impairment of foreclosed assets

     17        35   

Depreciation

     1,195        1,282   

Amortization and impairment of originated mortgage servicing rights

     287        193   

Amortization of acquisition intangibles

     133        152   

Net amortization of available-for-sale securities

     1,076        693   

Available-for-sale security impairment loss

     282        —     

Gain on sale of available-for-sale securities

     (1,003     —     

Net unrealized losses on trading securities

     32        27   

Net gain on sale of mortgage loans

     (658     (182

Net unrealized gains on borrowings measured at fair value

     (33     (117

Increase in cash value of corporate owned life insurance

     (348     (287

Share-based payment awards under equity compensation plan

     295        307   

Origination of loans held for sale

     (46,386     (17,247

Proceeds from loan sales

     47,902        17,847   

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

    

Trading securities

     2,680        900   

Accrued interest receivable

     631        (123

Other assets

     (1,132     653   

Accrued interest payable and other liabilities

     (161     684   
  

 

 

   

 

 

 

Net cash provided by operating activities

     11,947        11,225   
  

 

 

   

 

 

 

INVESTING ACTIVITIES

    

Net change in certificates of deposit held in other financial institutions

     2,044        4,934   

Activity in available-for-sale securities

    

Sales

     24,241        —     

Maturities and calls

     37,922        33,799   

Purchases

     (112,835     (78,664

Loan principal originations, net

     (6,768     (13,462

Proceeds from sales of foreclosed assets

     647        859   

Purchases of premises and equipment

     (1,298     (884
  

 

 

   

 

 

 

Net cash used in investing activities

     (56,047     (53,418
  

 

 

   

 

 

 

 

7


Table of Contents

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)

 

 

     Six Months Ended
June 30
 
     2012     2011  

FINANCING ACTIVITIES

    

Acceptances and withdrawals of deposits, net

     20,664      $ 46,860   

Increase in other borrowed funds

     18,029        1,680   

Cash dividends paid on common stock

     (3,034     (2,881

Proceeds from issuance of common stock

     1,322        1,092   

Common stock repurchased

     (995     (648

Common stock purchased for deferred compensation obligations

     (225     (227
  

 

 

   

 

 

 

Net cash provided by financing activities

     35,761        45,876   
  

 

 

   

 

 

 

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

     (8,339     3,683   

Cash and cash equivalents at beginning of period

     28,590        18,109   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 20,251      $ 21,792   
  

 

 

   

 

 

 

SUPPLEMENTAL CASH FLOWS INFORMATION:

    

Interest paid

   $ 7,291      $ 8,156   

Federal income taxes paid

     836        365   

SUPPLEMENTAL NONCASH INFORMATION:

    

Transfers of loans to foreclosed assets

   $ 1,150      $ 1,057   

Common stock issued for deferred compensation obligations

     —          254   

Common stock repurchased from the Rabbi Trust

     —          (266

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

As used in these Notes as well as in the Management’s Discussion & Analysis of Financial Condition & Results of Operations, references to “Isabella,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.

The acronyms and abbreviations identified below are used in the Notes to Interim Condensed Consolidated Financial Statements as well as in the Management’s Discussion and Analysis of Financial Condition and Results of Operations. You may find it helpful to refer back to this page as you read this report.

 

AFS: Available-for-sale

   IFRS: International Financial Reporting Standards

ALLL: Allowance for loan and lease losses

   IRR: Interest Rate Risk

ASC: FASB Accounting Standards Codification

   JOBS Act: Jumpstart our Business Startups Act

ASU: FASB Accounting Standards Update

   LIBOR: London Interbank Offered Rate

ATM: Automated Teller Machine

   Moody’s: Moody’s Investors Service, Inc

Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors

  

N/A: Not applicable

N/M: Not meaningful

Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

  

OCI: Other comprehensive income (loss)

OMSR: Originated mortgage servicing rights

FASB: Financial Accounting Standards Board

   OTTI: Other-than-temporary impairment

FDIC: Federal Deposit Insurance Corporation

   PBO: Projected Benefit Obligation

FFIEC: Federal Financial Institutions Council

FRB: Board of Governors of the Federal
Reserve System

  

Rabbi Trust: A trust established to fund
    the Directors Plan

SEC: U.S. Securities & Exchange Commission

FHLB: Federal Home Loan Bank

  

SOX: Sarbanes-Oxley Act of 2002

Freddie Mac: Federal Home Loan Mortgage Corporation

  

TDR: Troubled debt restructuring

FTE: Fully taxable equivalent

  

XBRL: eXtensible Business Reporting Language

GAAP: U.S. generally accepted accounting principles

  

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP 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 GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 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 our annual report for the year ended December 31, 2011.

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

 

9


Table of Contents

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 relate solely to outstanding shares in the Directors Plan.

 

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

 

     Three Months Ended
June 30
     Six Months Ended
June 30
 
     2012      2011      2012      2011  

Average number of common shares outstanding for basic calculation

     7,592,668         7,570,752         7,593,462         7,564,060   

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

     203,603         194,964         201,743         194,051   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

     7,796,271         7,765,716         7,795,205         7,758,111   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 3,004       $ 2,672       $ 6,238       $ 4,988   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share

           

Basic

   $ 0.40       $ 0.35       $ 0.82       $ 0.66   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.39       $ 0.34       $ 0.80       $ 0.64   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Exclusive of shares held in the Rabbi Trust

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 our 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 GAAP and 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.

 

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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 our 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 our consolidated financial statements as we have historically elected to present a separate statement of comprehensive income.

NOTE 4 – TRADING SECURITIES

 

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

 

     June 30
2012
     December 31
2011
 

States and political subdivisions

   $ 1,998       $ 4,710   

Included in the net trading losses of $32 during the first six months of 2012 were $10 of net unrealized trading losses on securities that were held in our trading portfolio as of June 30, 2012. Included in the net trading losses of $27 during the first six months of 2011 were $32 of net unrealized trading losses on securities that were held in the trading portfolio as of June 30, 2011.

 

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NOTE 5 – AVAILABLE-FOR-SALE SECURITIES

 

The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:

 

     June 30, 2012  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

Government sponsored enterprises

   $ 2,197       $ 34       $ —         $ 2,231   

States and political subdivisions

     170,958         8,243         547         178,654   

Auction rate money market preferred

     3,200         —           626         2,574   

Preferred stocks

     6,800         —           873         5,927   

Mortgage-backed securities

     161,521         2,991         15         164,497   

Collateralized mortgage obligations

     120,255         2,844         47         123,052   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 464,931       $ 14,112       $ 2,108       $ 476,935   
  

 

 

    

 

 

    

 

 

    

 

 

 
     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   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

The amortized cost and fair value of AFS securities by contractual maturity at June 30, 2012 are as follows:

 

    

 

 

Maturing

     Securities
With
Variable
Monthly
Payments

or
Continual
Call

Dates
     Total  
     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       $ 2,125       $ —         $ 2,197   

States and political subdivisions

     7,573         34,073         85,055         44,257         —           170,958   

Auction rate money market preferred

     —           —           —           —           3,200         3,200   

Preferred stocks

     —           —           —           —           6,800         6,800   

Mortgage-backed securities

     —           —           —           —           161,521         161,521   

Collateralized mortgage obligations

     —           —           —           —           120,255         120,255   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total amortized cost

   $ 7,573       $ 34,073       $ 85,127       $ 46,382       $ 291,776       $ 464,931   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fair value

   $ 7,589       $ 35,243       $ 90,845       $ 47,208       $ 296,050       $ 476,935   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

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As auction rate money market preferred 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 AFS securities was as follows for the six month period ended June 30, 2012:

 

Proceeds from sales of securities

   $ 24,241   
  

 

 

 

Gross realized gains

   $ 1,003   
  

 

 

 

Applicable income tax expense

   $ 341   
  

 

 

 

There were no sales of AFS securities in the first six 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.

 

Information pertaining to AFS securities with gross unrealized losses at June 30, 2012 and December 31, 2011 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

     June 30, 2012  
     Less Than Twelve Months      Over Twelve Months      Total
Unrealized
Losses
 
     Gross
Unrealized
Losses
     Fair
Value
     Gross
Unrealized
Losses
     Fair
Value
    

States and political subdivisions

   $ 55       $ 6,768       $ 492       $ 2,482       $ 547   

Auction rate money market preferred

     —           —           626         2,574         626   

Preferred stocks

     —           —           873         5,927         873   

Mortgage-backed securities

     15         15,283         —           —           15   

Collateralized mortgage obligations

     47         4,686         —           —           47   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 117       $ 26,737       $ 1,991       $ 10,983       $ 2,108   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Number of securities in an unrealized loss position:

        24            8         32   
     

 

 

       

 

 

    

 

 

 
     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 June 30, 2012 and December 31, 2011, we conducted an analysis to determine whether any securities currently in an unrealized loss position should be other-than-temporarily impaired. 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?

 

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

 

   

Has the duration of the investment been extended?

As of June 30, 2012, we 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. We 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, we do not intend to sell the securities in an unrealized loss position, and it is more likely than not that we will not have to sell the securities before recovery of their cost basis.

During the three month period ended March 31, 2012, we had one state issued student loan auction rate AFS 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, we 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 methods were then weighted, with a higher weighting applied to the Estimated Cash Flow Method, to determine the estimated credit related impairment. As a result of this analysis we, recognized an OTTI of $282 in the first quarter of 2012.

 

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%

To test for additional impairment of this security during the three months ended June 30, 2012, we obtained another investment valuation (from the same firm engaged to perform the March 31, 2012 valuation) as of June 30, 2012. Based on the results of this valuation, no additional OTTI was observed as of June 30, 2012.

A rollforward of credit related impairment recognized in earnings on available-for-sale securities in the three and six months ended June 30, 2012 was as follows:

 

     Three Months
Ended
June 30, 2012
     Six Months
Ended
June 30, 2012
 

Balance at beginning of period

   $ 282       $ —     

Additions to credit losses for which no previous OTTI was recognized

     —           282   
  

 

 

    

 

 

 

June 30, 2012

   $ 282       $ 282   
  

 

 

    

 

 

 

 

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There were no credit losses recognized in on available-for-sale securities during 2011.

Based on our analysis using the above criteria, the fact that we have asserted that we do not have the intent to sell these securities in an unrealized loss position, and that it is more likely than not that we will not have to sell the securities before recovery of their cost basis, we do not believe that the values of any other securities are other-than-temporarily impaired as of as of June 30, 2012 or December 31, 2011.

NOTE 6 – LOANS AND ALLOWANCE FOR LOAN LOSSES

We grant 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 we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, 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.

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 typically 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. We minimize our 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, we 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, we require annual financial statements, prepare cash flow analyses, and review credit reports as deemed necessary.

We offer 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 Freddie Mac. Fixed rate residential real estate loans with an amortization of 15 years or less may be held in our portfolio, held for future sale, or sold upon origination. We consider the direction of interest rates, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell loans to Freddie Mac.

 

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Table of Contents

Our 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 our mortgage loan committee or through a secondary market automated underwriting system; loans in excess of $400 require the approval of our Internal Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

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 we believe 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 and is based upon a 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 our recorded investment. Historical loss allocations were calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding four years. An unallocated component is maintained to cover uncertainties that we believe affect our 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.

 

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

 

     Allowance for Loan Losses
Three Months Ended June 30, 2012
 
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated      Total  

Allowance for loan losses

             

April 1, 2012

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

Loans charged off

     (237     —          (238     (146     —           (621

Recoveries

     42        —          20        63        —           125   

Provision for loan losses

     475        (426     185        125        80         439   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

June 30, 2012

   $ 6,008      $ 433      $ 3,669      $ 667      $ 1,541       $ 12,318   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents
      Allowance for Loan Losses
Six Months Ended June 30, 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

     (686     —          (353     (237     —           (1,276

Recoveries

     128        —          61        130        —           319   

Provision for loan losses

     282        (570     981        141        66         900   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

June 30, 2012

   $ 6,008      $ 433      $ 3,669      $ 667      $ 1,541       $ 12,318   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

     Allowance for Loan Losses and Recorded Investment in Loans
As of June 30, 2012
 
     Commercial      Agricultural      Residential
Real Estate
     Consumer      Unallocated      Total  

Allowance for loan losses

                 

Individually evaluated for impairment

   $ 2,115       $ 133       $ 1,308       $ —         $ —         $ 3,556   

Collectively evaluated for impairment

     3,893         300         2,361         667         1,541         8,762   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,008       $ 433       $ 3,669       $ 667       $ 1,541       $ 12,318   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans

                 

Individually evaluated for impairment

     15,271         2,955         8,248         82            26,556   

Collectively evaluated for impairment

     353,100         78,267         265,754         31,275            728,396   
  

 

 

    

 

 

    

 

 

    

 

 

       

 

 

 

Total

   $ 368,371       $ 81,222       $ 274,002       $ 31,357          $ 754,952   
  

 

 

    

 

 

    

 

 

    

 

 

       

 

 

 

 

     Allowance for Loan Losses  
     Three Months Ended June 30, 2011  
     Commercial     Agricultural     Residential
Real Estate
    Consumer     Unallocated      Total  

Allowance for loan losses

             

April 1, 2011

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

Loans charged off

     (214     (1     (555     (139     —           (909

Recoveries

     209        —          29        65        —           303   

Provision for loan losses

     497        (11     (11     112        16         603   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

June 30, 2011

   $ 6,738      $ 764      $ 2,885      $ 660      $ 1,331       $ 12,378   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Allowance for Loan Losses  
     Six Months Ended June 30, 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

     (869     (1     (878     (284     —          (2,032

Recoveries

     346        —          103        168        —          617   

Provision for loan losses

     1,213        (268     462        171        (158     1,420   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

June 30, 2011

   $ 6,738      $ 764      $ 2,885      $ 660      $ 1,331      $ 12,378   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     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   
  

 

 

    

 

 

    

 

 

    

 

 

       

 

 

 

 

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

 

     June 30, 2012  
     Commercial      Agricultural  
     Real Estate      Other      Total      Real Estate      Other      Total  

Rating

                 

2 – High quality

   $ 27,077       $ 14,143       $ 41,220       $ 2,578       $ 2,199       $ 4,777   

3 – High satisfactory

     81,883         28,314         110,197         15,964         8,273         24,237   

4 – Low satisfactory

     124,323         51,092         175,415         25,173         19,382         44,555   

5 – Special mention

     12,303         2,691         14,994         1,088         3,022         4,110   

6 – Substandard

     17,658         5,196         22,854         1,704         1,363         3,067   

7 – Vulnerable

     2,556         92         2,648         —           —           —     

8 – Doubtful

     1,019         24         1,043         190         286         476   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 266,819       $ 101,552       $ 368,371       $ 46,697       $ 34,525       $ 81,222   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

18


Table of Contents
     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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

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Table of Contents
   

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.

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 we 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

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

 

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

Commercial

                 

Commercial real estate

   $ 3,505       $ 309       $ 3,818       $ 7,632       $ 259,186       $ 266,818   

Commercial other

     411         50         199         660         100,893         101,553   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     3,916         359         4,017         8,292         360,079         368,371   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Agricultural

                 

Agricultural real estate

     206         —           356         562         46,135         46,697   

Agricultural other

     319         —           286         605         33,920         34,525   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total agricultural

     525         —           642         1,167         80,055         81,222   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential real estate

                 

Senior liens

     2,463         346         876         3,685         212,392         216,077   

Junior liens

     239         33         65         337         18,293         18,630   

Home equity lines of credit

     284         —           190         474         38,821         39,295   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total residential real estate

     2,986         379         1,131         4,496         269,506         274,002   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer

                 

Secured

     145         1         —           146         26,290         26,436   

Unsecured

     33         —           —           33         4,888         4,921   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer

     178         1         —           179         31,178         31,357   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,605       $ 739       $ 5,790       $ 14,134       $ 740,818       $ 754,952   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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 and for the periods ended:

 

     June 30, 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

   $ 6,128       $ 6,408       $ 1,893       $ 5,014       $ 5,142       $ 1,881   

Commercial other

     944         944         222         734         734         271   

Agricultural other

     2,046         2,046         133         2,689         2,689         822   

Residential real estate senior liens

     7,894         9,077         1,278         7,271         8,827         1,111   

Residential real estate junior liens

     164         268         30         195         260         35   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans with a valuation allowance

   $ 17,176       $ 18,743       $ 3,556       $ 15,903       $ 17,652       $ 4,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans without a valuation allowance

                 

Commercial real estate

   $ 5,946       $ 6,628          $ 7,984       $ 10,570      

Commercial other

     2,253         2,294            365         460      

Agricultural real estate

     357         357            190         190      

Agricultural other

     552         672            505         625      

Home equity lines of credit

     190         490            198         498      

Consumer secured

     82         95            105         114      
  

 

 

    

 

 

       

 

 

    

 

 

    

Total impaired loans without a valuation allowance

   $ 9,380       $ 10,536          $ 9,347       $ 12,457      
  

 

 

    

 

 

       

 

 

    

 

 

    

Impaired loans

                 

Commercial

   $ 15,271       $ 16,274       $ 2,115       $ 14,097       $ 16,906       $ 2,152   

Agricultural

     2,955         3,075         133         3,384         3,504         822   

Residential real estate

     8,248         9,835         1,308         7,664         9,585         1,146   

Consumer

     82         95         —           105         114         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 26,556       $ 29,279       $ 3,556       $ 25,250       $ 30,109       $ 4,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     Average
Outstanding
Balance
     Interest
Income
Recognized
     Average
Outstanding
Balance
     Interest
Income
Recognized
 

Impaired loans with a valuation allowance

           

Commercial real estate

   $ 6,444       $ 83       $ 6,165       $ 181   

Commercial other

     829         16         777         28   

Agricultural other

     2,145         36         2,306         73   

Residential real estate senior liens

     7,862         92         7,706         175   

Residential real estate junior liens

     175         2         183         4   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans with a valuation allowance

   $ 17,455       $ 229       $ 17,137       $ 461   
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans without a valuation allowance

           

Commercial real estate

   $ 6,789       $ 112       $ 7,299       $ 179   

Commercial other

     2,249         34         1,777         65   

Agricultural real estate

     274         —           232         —     

Agricultural other

     607         3         595         7   

Home equity lines of credit

     195         4         197         8   

Consumer secured

     89         1         95         3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans without a valuation allowance

   $ 10,203       $ 154       $ 10,195       $ 262   
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans

           

Commercial

   $ 16,311       $ 245       $ 16,018       $ 453   

Agricultural

     3,026         39         3,133         80   

Residential real estate

     8,232         98         8,086         187   

Consumer

     89         1         95         3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

   $ 27,658       $ 383       $ 27,332       $ 723   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Three Months Ended
June 30, 2011
    Six Months Ended
June 30, 2011
 
     Average
Outstanding
Balance
     Interest
Income
Recognized
    Average
Outstanding
Balance
     Interest
Income
Recognized
 

Impaired loans with a valuation allowance

          

Commercial real estate

   $ 2,570       $ 96      $ 3,490       $ 120   

Commercial other

     —           —          9         —     

Agricultural other

     1,776         9        1,776         42   

Residential real estate senior liens

     4,980         70        4,845         106   

Residential real estate junior liens

     184         3        186         4   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total impaired loans with a valuation allowance

   $ 9,510       $ 178      $ 10,306       $ 272   
  

 

 

    

 

 

   

 

 

    

 

 

 

Impaired loans without a valuation allowance

          

Commercial real estate

   $ 4,085       $ 69      $ 3,151       $ 102   

Commercial other

     1,780         28        968         88   

Agricultural real estate

     190         —          95         (1

Agricultural other

     641         39        641         39   

Residential real estate senior liens

     337         (6     201         —     

Home equity lines of credit

     1         —          —           —     

Consumer secured

     36         1        38         3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total impaired loans without a valuation allowance

   $ 7,070       $ 131      $ 5,094       $ 231   
  

 

 

    

 

 

   

 

 

    

 

 

 

Impaired loans

          

Commercial

   $ 8,435       $ 193      $ 7,618       $ 310   

Agricultural

     2,607         48        2,512         80   

Residential real estate

     5,502         67        5,232         110   

Consumer

     36         1        38         3   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total impaired loans

   $ 16,580       $ 309      $ 15,400       $ 503   
  

 

 

    

 

 

   

 

 

    

 

 

 

Impaired loans, which include TDRs, had $290 of unfunded commitments under lines of credit as of June 30, 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, we consider 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 and six month periods ended June 30, 2012:

 

     Loans Restructured in the Three Month      Loans Restructured in the Six Month  
     Period ended June 30, 2012      Period ended June 30, 2012  
     Number
of
Loans
     Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
     Number
of
Loans
     Pre-
Modification
Recorded
Investment
     Post-
Modification
Recorded
Investment
 

Commercial other

     5       $ 305       $ 305       $ 26       $ 4,891       $ 4,891   

Agricultural other

     —           —           —           6         561         561   

Residential real estate senior liens

     7         684         684         12         1,405         1,405   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 12       $ 989       $ 989       $ 44       $ 6,857       $ 6,857   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Loans Restructured in the Three Month      Loans Restructured in the Six Month  
     Period Ended June 30, 2012      Period Ended June 30, 2012  
            Below Market
Interest Rate
and
Extension of
Amortization Period
     Below Market
Interest Rate
     Below Market
Interest Rate
and
Extension of
Amortization Period
 
             
                        
     Below Market           
     Interest Rate           
            Pre-             Pre-             Pre-             Pre-  
     Number      Modification      Number      Modification      Number      Modification      Number      Modification  
     of      Recorded      of      Recorded      of      Recorded      of      Recorded  
     Loans      Investment      Loans      Investment      Loans      Investment      Loans      Investment  

Commercial other

     3       $ 160         2       $ 145         24       $ 4,746         2       $ 145   

Agricultural other

     —           —           —           —           6         561         —           —     

Residential real estate senior liens

     4         324         3         360         4         324         8         1,081   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     7       $ 484         5       $ 505         34       $ 5,631         10       $ 1,226   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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We did not restructure any loans through the forbearance of principal or accrued interest in the three or six month periods ended June 30, 2012.

Based on our 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.

 

Following is a summary of loans that defaulted in the three and six month periods ended June 30, 2012, which were modified within 12 months prior to the default date:

 

     Three Months Ended June 30, 2012      Six Months Ended June 30, 2012  
            Pre-             Post-             Pre-             Post-  
     Number      Default      Charge Off      Default      Number      Default      Charge Off      Default  
     of      Recorded      Recorded      Recorded      of      Recorded      Recorded      Recorded  
     Loans      Investment      Upon Default      Investment      Loans      Investment      Upon Default      Investment  

Commercial other

     2       $ 50       $ 25       $ 25         3       $ 132       $ 67       $ 65   

Residential real estate senior liens

     —           —           —           —           1         47         43         4   

Consumer secured

     1         8         8         —           1         8         8         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     3       $ 58       $ 33       $ 25         5       $ 187       $ 118       $ 69   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We had no loans that defaulted during the first six 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:

 

     June 30      December 31  
     2012      2011  

Troubled debt restructurings

   $ 22,543       $ 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:

 

     June 30      December 31  
     2012      2011  

Federal Home Loan Bank Stock

   $ 7,700       $ 7,380   

Investment in Corporate Settlement Solutions

     6,810         6,611   

Federal Reserve Bank Stock

     1,879         1,879   

Investment in Valley Financial Corporation

     1,000         1,000   

Other

     319         319   
  

 

 

    

 

 

 

Total

   $ 17,708       $ 17,189   
  

 

 

    

 

 

 

 

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NOTE 8 – BORROWED FUNDS

 

Borrowed funds consist of the following obligations as of:

 

     June 30, 2012     December 31, 2011  
     Amount      Rate     Amount      Rate  

Federal Home Loan Bank advances

   $ 154,000         2.18   $ 142,242         3.16

Securities sold under agreements to repurchase without stated maturity dates

     53,824         0.20     57,198         0.25

Securities sold under agreements to repurchase with stated maturity dates

     16,708         3.51     16,696         3.51

Federal funds purchased

     9,600         0.50     —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 234,132         1.75   $ 216,136         2.42
  

 

 

    

 

 

   

 

 

    

 

 

 

The 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 our holdings of FHLB stock. We had the ability to borrow up to an additional $100,781 based on assets currently pledged as collateral as of June 30, 2012. During the first quarter of 2012, we 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:

 

     June 30     December 31  
     2012     2011  
     Amount      Rate     Amount      Rate  

Fixed rate advances due 2012

   $ 2,000         4.90   $ 17,000         2.97

One year putable fixed rate advances due 2012

     5,000         3.48     15,000         4.10

Variable rate advances due 2012

     5,000         0.50     —           —     

Fixed rate advances due 2013

     —           —          5,242         4.14

One year putable fixed rate advances due 2013

     —           —          5,000         3.15

Fixed rate advances due 2014

     —           —          25,000         3.16

Fixed rate advances due 2015

     42,000         1.12     45,000         3.30

Fixed rate advances due 2016

     10,000         2.15