XNAS:ASBI Ameriana Bancorp 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, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

    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 EXCHANGE ACT

For the transition period from         to        

Commission File Number: 0-18392

 

 

AMERIANA BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

Indiana   35-1782688

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

2118 Bundy Avenue, New Castle, Indiana   47362-1048
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (765) 529-2230

Not Applicable

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

 

 

Indicate by check mark whether the registrant (l) 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.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

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

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

At August 9, 2012, the registrant had 2,988,952 shares of its common stock outstanding.

 

 

 


Table of Contents

AMERIANA BANCORP

Table of Contents

 

              Page No.  
Part I. Financial Information   
 

Item 1.

   Financial Statements (Unaudited)      3   
     Consolidated Condensed Balance Sheets at June 30, 2012 and December 31, 2011      3   
     Consolidated Condensed Statements of Income for the Three and Six Months Ended June 30, 2012 and 2011      4   
     Consolidated Condensed Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011      6   
     Consolidated Condensed Statement of Shareholders’ Equity for the Six Months Ended June 30, 2012      7   
     Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011      8   
     Notes to Consolidated Condensed Financial Statements      9   
 

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      30   
 

Item 3.

   Quantitative and Qualitative Disclosure about Market Risk      43   
 

Item 4.

   Controls and Procedures      43   
Part II. Other Information   
 

Item 1.

   Legal Proceedings      43   
 

Item 1A.

   Risk Factors      43   
 

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      43   
 

Item 3.

   Defaults upon Senior Securities      43   
 

Item 4.

   Mine Safety Disclosures      44   
 

Item 5.

   Other Information      44   
 

Item 6.

   Exhibits      44   

Signatures

  

 

(2)


Table of Contents

PART I - FINANCIAL INFORMATION

ITEM I - FINANCIAL STATEMENTS

Ameriana Bancorp

Consolidated Condensed Balance Sheets

(In thousands, except share data)

 

     June 30,
2012
(Unaudited)
    December 31,
2011
 

Assets

    

Cash on hand and in other institutions

   $ 6,291      $ 6,204   

Interest-bearing demand deposits

     31,420        3,505   
  

 

 

   

 

 

 

Cash and cash equivalents

     37,711        9,709   

Investment securities available for sale

     43,504        43,847   

Loans held for sale

     1,013        252   

Loans, net of allowance for loan losses of $4,103 and $4,132

     303,704        312,509   

Premises and equipment

     14,436        14,650   

Stock in Federal Home Loan Bank

     4,472        4,472   

Goodwill

     656        656   

Cash value of life insurance

     26,639        26,248   

Other real estate owned

     8,468        7,545   

Other assets

     9,325        9,903   
  

 

 

   

 

 

 

Total assets

   $ 449,928      $ 429,791   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 47,715      $ 40,197   

Interest-bearing

     313,411        297,053   
  

 

 

   

 

 

 

Total deposits

     361,126        337,250   

Borrowings

     45,810        49,810   

Drafts payable

     1,375        2,532   

Other liabilities

     6,116        5,694   
  

 

 

   

 

 

 

Total liabilities

     414,427        395,286   
  

 

 

   

 

 

 

Commitments and contingencies Shareholders’ equity

    

Preferred stock - 5,000,000 shares authorized and unissued

     —          —     

Common stock, $1.00 par value
Authorized 15,000,000 shares

Issued – 3,213,952 shares

     3,214        3,214   

Outstanding – 2,988,952 shares

    

Additional paid-in capital

     1,052        1,051   

Retained earnings

     33,609        32,871   

Accumulated other comprehensive income

     624        367   

Treasury stock at cost – 225,000 shares

     (2,998     (2,998
  

 

 

   

 

 

 

Total shareholders’ equity

     35,501        34,505   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 449,928      $ 429,791   
  

 

 

   

 

 

 

See notes to consolidated condensed financial statements

 

(3)


Table of Contents

Ameriana Bancorp

Consolidated Condensed Statements of Income

(In thousands, except per share data)

(Unaudited)

 

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

Interest Income

        

Interest and fees on loans

   $ 4,227      $ 4,440      $ 8,448      $ 8,834   

Interest on mortgage-backed securities

     231        303        475        591   

Interest on investment securities

     46        32        92        70   

Other interest and dividend income

     51        48        99        94   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     4,555        4,823        9,114        9,589   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest Expense

        

Interest on deposits

     627        858        1,281        1,720   

Interest on borrowings

     386        397        774        872   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     1,013        1,255        2,055        2,592   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

     3,542        3,568        7,059        6,997   

Provision for loan losses

     380        255        635        615   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income After Provision for Loan Losses

     3,162        3,313        6,424        6,382   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Income

        

Other fees and service charges

     592        538        1,114        999   

Brokerage and insurance commissions

     380        387        792        773   

Net realized and recognized gains on available-for-sale investment securities

     —          448        89        500   

Gains on sales of loans and servicing rights

     134        87        266        119   

Net loss from sales and write-downs of other real estate owned

     (15     (644     (171     (655

Other real estate owned income

     60        146        140        358   

Increase in cash value of life insurance

     197        214        390        424   

Other

     4        73        12        120   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income

     1,352        1,249        2,632        2,638   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other Expense

        

Salaries and employee benefits

     2,239        2,357        4,521        4,760   

Net occupancy expense

     391        393        809        840   

Furniture and equipment expense

     168        213        371        432   

Legal and professional fees

     162        126        310        289   

FDIC insurance premiums and assessments

     148        152        293        360   

Data processing expense

     192        182        380        384   

Printing and office supplies

     68        62        145        130   

Marketing expense

     81        110        173        198   

Other real estate owned expense

     36        334        181        517   

Other

     450        381        871        801   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     3,935        4,310        8,054        8,711   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income Before Income Taxes

     579        252        1,002        309   

Income tax (benefit)

     126        (18     204        (82
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

   $ 453      $ 270      $ 798      $ 391   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated condensed financial statements

 

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Table of Contents

Ameriana Bancorp

Consolidated Condensed Statements of Income

(In thousands, except per share data)

(Unaudited)

 

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

Basic Earnings Per Share

   $ 0.15       $ 0.09       $ 0.27       $ 0.13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted Earnings Per Share

   $ 0.15       $ 0.09       $ 0.27       $ 0.13   
  

 

 

    

 

 

    

 

 

    

 

 

 

Dividends Declared Per Share

   $ 0.01       $ 0.01       $ 0.02       $ 0.02   
  

 

 

    

 

 

    

 

 

    

 

 

 

See notes to consolidated condensed financial statements

 

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Table of Contents

Ameriana Bancorp

Consolidated Condensed Statements of Comprehensive Income

(In thousands, except per share data)

(Unaudited)

 

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

Net Income

   $ 453       $ 270       $ 798       $ 391   

Unrealized appreciation on available-for-sale securities, net of taxes of $144 and $176 for the three months ended June 30, 2012 and June 30, 2011, respectively, and net of taxes of $163 and $114 for the six months ended June 30, 2012 and June 30, 2011, respectively

     279         342         316         221   

Less: reclassification adjustment for realized gains included in net income, net of taxes of $152 for the three months ended June 30, 2011, and net of taxes of $30 and $170 for the six months ended June 30, 2012 and June 30, 2011, respectively

     —           296         59         330   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income

     279         46         257         (109
  

 

 

    

 

 

    

 

 

    

 

 

 

Comprehensive Income

   $ 732       $ 316       $ 1,055       $ 282   
  

 

 

    

 

 

    

 

 

    

 

 

 

See notes to consolidated condensed financial statements

 

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Table of Contents

Ameriana Bancorp

Consolidated Condensed Statement of Shareholders’ Equity

For the Six Months Ended June 30, 2012

(In thousands, except per share data)

(Unaudited)

 

     Common
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other

Comprehensive
Income
     Treasury
Stock
    Total  

Balance at December 31, 2011

   $ 3,214       $ 1,051       $ 32,871      $ 367       $ (2,998   $ 34,505   

Net Income

     —           —           798        —           —          798   

Other comprehensive income

     —           —           —          257         —          257   

Share-based compensation

     —           1         —          —           —          1   

Dividends declared ($0.02 per share)

     —           —           (60     —           —          (60
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at June 30, 2012

   $ 3,214       $ 1,052       $ 33,609      $ 624       $ (2,998   $ 35,501   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

See notes to consolidated condensed financial statement.

 

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Table of Contents

Ameriana Bancorp

Consolidated Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

 

     Six Months Ended June 30,  
     2012     2011  

Operating Activities

    

Net income

   $ 798      $ 391   

Items not requiring (providing) cash

    

Provision for losses on loans

     635        615   

Depreciation and amortization

     681        630   

Increase in cash value of life insurance

     (390     (424

Gain from sale of available-for-sale securities

     (89     (500

Loss on sale or write-down of other real estate owned

     171        655   

Mortgage loans originated for sale

     (11,020     (4,624

Proceeds from sales of mortgage loans originated for sale

     10,392        4,371   

Gains on sales of mortgage loans and servicing rights

     (266     (119

Decrease in accrued interest payable

     (7     (51

Other adjustments

     914        1,459   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,819        2,403   
  

 

 

   

 

 

 

Investing Activities

    

Purchase of securities

     (7,434     (31,087

Proceeds/principal from the sale of securities

     4,850        27,245   

Principal collected on mortgage-backed securities

     3,225        2,365   

Net change in loans

     6,743        2,773   

Proceeds from sales of other real estate owned

     347        1,979   

Net purchases and construction of premises and equipment

     (278     (228

Proceeds from stock repurchased by Federal Home Loan Bank

     —          629   

Other investing activities

     1        6   
  

 

 

   

 

 

 

Net cash provided by investing activities

     7,454        3,682   
  

 

 

   

 

 

 

Financing Activities

    

Net change in demand and savings deposits

     24,510        17,115   

Net change in brokered certificates of deposit

     —          1,057   

Net change in other certificates of deposit

     (634     (1,985

Decrease in drafts payable

     (1,157     (199

Repayment of long-term borrowings

     (4,000     (6,000

Net change in advances by borrowers for taxes and insurance

     70        (18

Cash dividends paid

     (60     (60
  

 

 

   

 

 

 

Net cash provided by financing activities

     18,729        9,910   
  

 

 

   

 

 

 

Change in Cash and Cash Equivalents

     28,002        15,995   

Cash and Cash Equivalents at Beginning of Year

     9,709        11,747   
  

 

 

   

 

 

 

Cash and Cash Equivalents at End of Quarter

   $ 37,711      $ 27,742   
  

 

 

   

 

 

 

Supplemental information:

    

Interest paid on deposits

   $ 1,284      $ 1,727   

Interest paid on borrowings

   $ 779      $ 917   

Non-cash supplemental information:

    

Transfers from loans to other real estate owned

   $ 1,441      $ 2,385   

See notes to consolidated condensed financial statements.

 

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Table of Contents

AMERIANA BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)

NOTE A — BASIS OF PRESENTATION

The consolidated condensed financial statements include the accounts of Ameriana Bancorp (the “Company”) and its wholly-owned subsidiary Ameriana Bank (the “Bank”). The Bank has two wholly-owned subsidiaries, Ameriana Insurance Agency and Ameriana Financial Services, Inc.

The unaudited interim consolidated condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and disclosures required by generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, the financial statements reflect all adjustments (comprised only of normal recurring adjustments and accruals) necessary to present fairly the Company’s financial position and results of operations and cash flows. The consolidated condensed balance sheet of the Company as of December 31, 2011 has been derived from the audited consolidated balance sheet of the Company as of that date. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected in the full year or for any other period. These statements should be read in conjunction with the consolidated financial statements and related notes which are included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

NOTE B — SHAREHOLDERS’ EQUITY

On June 25, 2012, the Board of Directors declared a quarterly cash dividend of $0.01 per share. This dividend, totaling approximately $30,000, was accrued for payment to shareholders of record on July 6, 2012 and was paid on July 27, 2012.

No stock options were granted or exercised during the second quarter of 2012.

NOTE C — EARNINGS PER SHARE

Earnings per share were computed as follows:

 

    

(In thousands, except share data)

Three Months Ended June 30,

 
     2012      2011  
     Net
Income
     Weighted
Average
Shares
     Per Share
Amount
     Net
Income
     Weighted
Average
Shares
     Per Share
Amount
 

Basic Earnings Per Share: Income available to common shareholders

   $ 453         2,988,952       $ 0.15       $ 270         2,988,952       $ 0.09   
        

 

 

          

 

 

 

Effect of dilutive stock options

     —           —              —           —        
  

 

 

    

 

 

       

 

 

    

 

 

    

Diluted Earnings Per Share: Income available to common shareholders

   $ 453         2,988,952       $ 0.15       $ 270         2,988,952       $ 0.09   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

    

(In thousands, except share data)

Six Months Ended June 30,

 
     2012      2011  
     Net
Income
     Weighted
Average
Shares
     Per Share
Amount
     Net
Income
     Weighted
Average
Shares
     Per Share
Amount
 

Basic Earnings Per Share: Income available to common shareholders

   $ 798         2,988,952       $ 0.27       $ 391         2,988,952       $ 0.13   
        

 

 

          

 

 

 

Effect of dilutive stock options

     —           —              —           —        
  

 

 

    

 

 

       

 

 

    

 

 

    

Diluted Earnings Per Share: Income available to common shareholders

   $ 798         2,988,952       $ 0.27       $ 391         2,988,952       $ 0.13   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Options to purchase 158,482 and 168,892 shares of common stock at exercise prices of $9.25 to $15.56 per share were outstanding at June 30, 2012 and 2011, respectively, but were not included in the computation of diluted earnings per share because the options were anti-dilutive, in that the exercise prices of the options exceeded the market value of the Company’s stock for the periods presented.

NOTE D — INVESTMENT SECURITIES

The following tables provide the composition of investment securities at June 30, 2012 and December 31, 2011 (dollars in thousands):

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Available for sale at June 30, 2012

           

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 38,523       $ 799       $ 5       $ 39,317   

Municipal securities

     2,323         39         —           2,362   

Mutual fund

     1,713         112         —           1,825   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 42,559       $ 950       $ 5       $ 43,504   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair
Value
 

Available for sale at December 31, 2011

           

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 39,280       $ 443       $ 9       $ 39,714   

Municipal securities

     2,322         29         —           2,351   

Mutual fund

     1,689         93         —           1,782   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 43,291       $ 565       $ 9       $ 43,847   
  

 

 

    

 

 

    

 

 

    

 

 

 

The amortized cost and fair value of securities available for sale at June 30, 2012 by contractual maturity are shown below (dollars in thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     Available for Sale  
     Amortized
Cost
     Fair
Value
 

Within one year

   $ —         $ —     

One to five years

     134         136   

Five to ten years

     396         403   

After ten years

     1,793         1,823   
  

 

 

    

 

 

 

Municipal securities

     2,323         2,362   

Ginnie Mae and GSE mortgage-backed pass-through securities

     38,523         39,317   

Mutual fund

     1,713         1,825   
  

 

 

    

 

 

 
   $ 42,559       $ 43,504   
  

 

 

    

 

 

 

Mortgage-backed pass-through securities: The contractual cash flows of those investments are guaranteed by either Ginnie Mae, a U.S. Government agency, or by Fannie Mae and Freddie Mac, U.S. Government-sponsored entities, institutions which the U.S. Government has affirmed its commitment to support. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment.

 

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Table of Contents

Municipal Securities: The municipal securities at June 30, 2012 consisted of non-rated local issue tax increment revenue bonds that were issued during the third quarter of 2011.

Mutual fund: The mutual fund balance at June 30, 2012 consisted of an investment in the CRA Qualified Investment mutual fund, whose portfolio composition is primarily in debt securities with an average credit quality rating of AAA.

Certain investment securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at June 30, 2012 and December 31, 2011 were $5,021,000 and $4,199,000, respectively, which was approximately 11.5% and 9.6%, respectively, of the Company’s investment portfolio at these dates.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011 (dollars in thousands):

 

At June 30, 2012

   Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 4,967       $ 4       $ 54       $ 1       $ 5,021       $ 5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2011

   Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
     Fair Value      Unrealized
Losses
 

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 4,180       $ 8       $ 19       $ 1       $ 4,199       $ 9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities with a total market value of $9,472,000 and $9,369,000 were pledged at June 30, 2012 and December 31, 2011, respectively, to secure a repurchase agreement.

There were no sales of available-for-sale securities during the three-month period ended June 30, 2012, compared to sales resulting in a gross gain of $463,000 and a gross loss of $15,000 for the three-month period ended June 30, 2011, with a net tax expense of $152,000.

A gross gain of $89,000 resulting from sales of available-for-sale securities was realized during the six-month period ended June 30, 2012, with a tax expense of $30,000, compared to a gross gain of $515,000 and a gross loss of $15,000 for the six-month period ended June 30, 2011, with a net tax expense of $170,000.

 

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Table of Contents

NOTE E — LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

 

(Dollars in Thousands)  
     At June 30,      At December 31,  
     2012      2011  

Real estate loans:

     

Commercial

   $ 100,030       $ 100,126   

Residential

     166,023         164,420   

Construction

     15,721         17,980   

Commercial loans and leases

     23,595         30,961   

Municipal loans

     726         740   

Consumer loans

     2,562         2,860   
  

 

 

    

 

 

 

Total loans

     308,657         317,087   
  

 

 

    

 

 

 

Less:

     

Undisbursed loan proceeds

     230         12   

Deferred loan fees, net

     620         434   

Allowance for loan losses

     4,103         4,132   
  

 

 

    

 

 

 
     4,953         4,578   
  

 

 

    

 

 

 

Total loans - net

   $ 303,704       $ 312,509   
  

 

 

    

 

 

 

The risk characteristics of each loan portfolio segment are as follows:

Commercial Real Estate: These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Bank’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. As a general rule, the Bank avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction Real Estate: Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Bank until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, timely completion and sale of the property, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial Loans and Leases: Commercial loans and leases are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

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Table of Contents

Residential and Consumer: With respect to residential loans that are secured by one-to four-family residences and are generally owner occupied, the Bank generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one-to four-family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Municipal: Municipal loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most municipal loans are secured by the full faith and credit of the municipality. The availability of funds for the repayment of these loans may be substantially dependent on the ability of the municipality to collect taxes or other revenue.

Allowance for Loan and Lease Losses Methodology:

Bank policy is designed to ensure that an adequate allowance for loan and lease losses (“ALLL”) will be maintained. Primary responsibility for ensuring that the Bank has processes in place to consistently assess the adequacy of the ALLL rests with the Board. The Board has charged the Chief Credit Officer (“CCO”) with responsibility for establishing the methodology to be used and to assess the adequacy of the ALLL quarterly. The methodology will be reviewed and affirmed by the Loan Review Officer. Quarterly the Board will review recommendations from the CCO to adjust the allowance as appropriate.

The methodology employed by the CCO for each portfolio segment will at a minimum contain the following:

 

  1) Loans will be segmented by type of loan.

 

  2) Loans will be further segmented by risk grades.

 

  3) The required ALLL for types of performing homogeneous loans which do not have a specific reserve will be determined by applying a factor based on historical losses averaged over the twelve quarters prior to the most recent quarter. In those instances, where the Bank’s historical experience is not available, the CCO will develop factors based on industry experience and best practices.

 

  4) All criticized and classified loans will be tested for impairment by applying one of three methodologies:

 

  a. Present value of future cash flows;

 

  b. Fair value of collateral less cost to sell; or

 

  c. The loan’s observable market price

 

  5) All troubled debt restructurings (“TDR”) are considered impaired loans.

 

  6) Loans tested for impairment will be removed from other pools to prevent layering (double-counting).

 

  7) The required ALLL for each group of loans will be added together to determine the total required ALLL for the Bank. The required ALLL will be compared to the current ALLL to determine the required provision to increase the ALLL or credit to decrease the ALLL.

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Bank over the twelve quarters prior to the most recent quarter. Management believes the historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

We also factor in the following qualitative considerations:

 

  1) Changes in policies and procedures;

 

  2) Changes in national, regional and local economic and business conditions;

 

  3) Changes in the composition and size of the portfolio and in the terms of loans;

 

  4) Changes in the experience, ability and depth of lending management and other relevant staff;

 

  5) Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans;

 

  6) Changes in the quality of the Bank’s loan review system;

 

  7) Changes in the value of underlying collateral for collateral-dependent loans;

 

  8) The existence and effect of any concentration of credit, and changes in the level of such concentrations; and

 

  9) The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

 

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Table of Contents

The following table presents the balance and activity in allowance for loan losses as of June 30, 2012 (dollars in thousands):

 

Allowance for Loan Losses

For Three Months Ended June 30, 2012

 

     Commercial
Real Estate
Loans
    Residential
Real Estate
Loans
    Construction
Real Estate
Loans
    Commercial
Loans and
Leases
    Municipal
Loans
     Consumer
Loans
    Total  

Balance at beginning of quarter

   $ 524      $ 1,476      $ 1,066      $ 856        —         $ 110      $ 4,032   

Provision (credit) for losses

     302        7        68        (10     —           13        380   

Charge-offs (1)

     (53     (67     (186     —          —           (18     (324

Recoveries

     —          2        6        1        —           6        15   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of quarter

   $ 773      $ 1,418      $ 954      $ 847      $ —         $ 111      $ 4,103   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

The following table presents the balance and activity in allowance for loan losses and the recorded investment in loans and impairment methods as of June 30, 2012 (dollars in thousands):

 

Allowance for Loan Losses and Recorded Investment in Loans

For Six Months Ended June 30, 2012

 

     Commercial
Real Estate
Loans
    Residential
Real Estate
Loans
    Construction
Real Estate
Loans
    Commercial
Loans and
Leases
    Municipal
Loans
     Consumer
Loans
    Total  

Balance at beginning of year

   $ 584      $ 1,539      $ 1,150      $ 760      $ —         $ 99      $ 4,132   

Provision (credit) for losses

     242        191        (6     174        —           34        635   

Charge-offs (1)

     (53     (317     (196     (89     —           (34     (689

Recoveries

     —          5        6        2        —           12        25   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 773      $ 1,418      $ 954      $ 847      $ —         $ 111      $ 4,103   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Ending allowance balance:

               

Individually evaluated for impairment

   $ 636      $ 470      $ 343      $ 329      $ —         $ 16      $ 1,794   

Collectively evaluated for impairment

     137        948        611        518        —           95        2,309   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 773      $ 1,418      $ 954      $ 847      $ —         $ 111      $ 4,103   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Ending loan balance:

               

Individually evaluated for impairment

   $ 5,910      $ 6,312      $ 4,788      $ 1,428      $ —         $ 59      $ 18,497   

Collectively evaluated for impairment

     94,120        159,711        10,933        22,167        726         2,503        290,160   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 100,030      $ 166,023      $ 15,721      $ 23,595      $ 726       $ 2,562      $ 308,657   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

The following tables present the balance and activity in allowance for loan losses as of June 30, 2011 (dollars in thousands):

 

Allowance for Loan Losses

For Three Months Ended June 30, 2011

 

     Commercial
Real Estate
Loans
    Residential
Real Estate
Loans
    Construction
Real Estate
Loans
    Commercial
Loans and
Leases
     Municipal
Loans
     Consumer
Loans
    Total  

Balance at beginning of quarter

   $ 833      $ 1,741      $ 1,041      $ 723         —         $ 78      $ 4,416   

Provision (credit) for losses

     (159     (22     338        100         —           (2     255   

Charge-offs (1)

     (1     (38     (520     —           —           (11     (570

Recoveries

     1        12        —          1         —           4        18   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 674      $ 1,693      $ 859      $ 824         —         $ 69      $ 4,119   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

Allowance for Loan Losses

For Six Months Ended June 30, 2011

 

     Commercial
Real Estate
Loans
    Residential
Real Estate
Loans
    Construction
Real Estate
Loans
    Commercial
Loans and
Leases
     Municipal
Loans
     Consumer
Loans
    Total  

Balance at beginning of year

   $ 639      $ 1,584      $ 1,254      $ 657         —         $ 78      $ 4,212   

Provision (credit) for losses

     35        273        127        166         —           14        615   

Charge-offs (1)

     (1     (191     (522     —           —           (31     (745

Recoveries

     1        27        —          1         —           8        37   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 674      $ 1,693      $ 859      $ 824         —         $ 69      $ 4,119   
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The following table presents the balance in allowance for loan losses and the recorded investment in loans and impairment methods as of December 31, 2011 (dollars in thousands):

 

Allowance for Loan Losses and Recorded Investment in Loans

For Year Ended December 31, 2011

 

     Commercial
Real Estate
Loans
     Residential
Real Estate
Loans
     Construction
Real Estate
Loans
     Commercial
Loans and
Leases
     Municipal
Loans
     Consumer
Loans
     Total  

Ending allowance balance:

                    

Individually evaluated for impairment

   $ 445       $ 707       $ 435       $ 142       $ —         $ 8       $ 1,737   

Collectively evaluated for impairment

     139         832         715         618         —           91         2,395   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 584       $ 1,539       $ 1,150       $ 760         —         $ 99       $ 4,132   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending loan balance:

                    

Individually evaluated for impairment

   $ 4,891       $ 6,440       $ 3,672       $ 935       $ —         $ 44       $ 15,982   

Collectively evaluated for impairment

     95,235         157,980         14,308         30,026         740         2,816         301,105   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 100,126       $ 164,420       $ 17,980       $ 30,961       $ 740       $ 2,860       $ 317,087   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Policy for Charging Off Loans:

A loan should be charged off at any point in time when it no longer can be considered a bankable asset, meaning collectable within the parameters of policy. The Bank shall not renew any loan, or put a loan on a demand basis, only to defer a problem, nor is it appropriate to attempt long-term recoveries while reporting loans as assets. An unsecured loan generally should be charged off no later than when it is 120 days past due as to principal or interest. For loans in the legal process of foreclosure against collateral of real and/or liquid value, the 120-day rule does not apply. Such charge-offs can be deferred until the foreclosure process progresses to the point where the Bank can adequately determine whether or not any ultimate loss will result. In similar instances where other legal actions will cause extraordinary delays, such as the settlement of an estate, yet collateral of value is realizable, the 120-day period could be extended. When a loan is unsecured or not fully collateralized, the loan should be charged off or written down to the documented collateral value rather than merely being placed on non-accrual status.

All charge-offs and forgiveness of debt greater than $50,000 must be approved by the Loan Committee upon recommendation by the CCO. The Loan Committee consists of the Bank’s Chief Executive Officer, Chief Risk Officer, Chief Credit Officer, Chief Marketing Officer and Loan Review Officer. Charge-offs between $10,000 and $50,000 must be approved by the CCO. Decisions to defer the charge off of a loan must be approved by the CCO.

 

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Table of Contents

Narrative Description of Borrower Rating:

Grade 1 — Highest Quality (Pass)

This loan represents a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has broad access to alternative financial markets. Also included in this category may be loans secured by U.S. government securities, U.S. government agencies, highly rated municipal bonds, insured savings accounts, and insured certificates of deposit drawn on high quality banks.

Grade 2 — Excellent Quality (Pass)

This loan has a sound primary and secondary source of repayment. The borrower has proven access to alternative sources of financing. This loan carries a low level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are strong. Loans secured by high quality traded stocks and lower grade municipal bonds (must still be investment grade).

Grade 3 — Good Quality (Pass)

This loan has a sound primary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the higher quality loans. Real estate loans in this category display advance rates below the suggested maximum, debt coverage well in excess of the suggested level, or are leased beyond the loan term by a “credit” tenant.

Grade 4 — Acceptable Quality (Pass)

The borrower is a reasonable credit risk and demonstrates the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant. All small business loans extended based upon credit scoring should be classified in this category unless deterioration occurs, in which case they should bear one of the below mentioned grades.

Grade 5 - Marginal Quality (Pass)

The borrower is an acceptable credit risk and while it can demonstrate it has the ability to repay the debt from normal business operations, the coverage is not as strong as an Acceptable Quality loan. Weakness in one or more areas are defined. Risk factors would typically include a higher leverage position than desirable, low liquidity, weak or sporadic cash flow, the lack of reasonably current and complete financial information, and/or overall financial trends are erratic.

Grade 6 – Elevated Risk, Management Attention (Watch)

The borrower while at origination is not considered a high risk potential, there are characteristics related to the financial condition, and/or a level of concern regarding either or both the primary and secondary source of repayment, that may preclude this from being a pass credit. These credit facilities are considered “pass” credits but exhibit the potential of developing a more serious weakness in their operation going forward. Usually, a credit in this category will be upgraded or downgraded on further analysis within a short period of time.

Grade 7 — Special Mention

These credit facilities have developing weaknesses that deserve extra attention from the loan officer and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the Bank’s debt in the future. This grade should not be assigned to loans which bear certain peculiar risks normally associated with the type of financing involved, unless circumstances have caused the risk to increase to a level higher than would have been acceptable when the credit was originally approved. Loans where actual, not potential, weaknesses or problems are clearly evident and significant should generally be graded in one of the grade categories below.

Grade 8 — Substandard

Loans and other credit extensions bearing this grade are considered to be inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions which have clearly jeopardized repayment of principal and interest as originally intended. Furthermore, there is the possibility that some future loss will be sustained by the Bank if such weaknesses are not corrected. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.

 

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Table of Contents

Grade 9 — Doubtful

Loans and other credit extensions graded “9” have all the weaknesses inherent in those graded “8,” with the added characteristic that the severity of the weaknesses make collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral. Loans in this classification should be placed in nonaccrual status, with collections applied to principal on the Bank’s books.

Grade 10 — Loss

Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the Bank. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

Loan Portfolio Quality Indicators

At June 30, 2012

 

     Commercial
Real Estate
Loans
     Residential
Real Estate
Loans
     Construction
Real Estate
Loans
     Commercial
Loans and
Leases
     Municipal
Loans
     Consumer
Loans
     Total  

Rating:

                    

Pass (Grades 1-5)

   $ 87,534       $ 159,712       $ 10,755       $ 22,048       $ 726       $ 2,503       $ 283,278   

Watch (Grade 6)

     2,788         —           177         43         —           —           3,008   

Special Mention (Grade 7)

     3,799         —           —           75         —           —           3,874   

Substandard (Grade 8)

     5,261         2,392         2,180         221         —           —           10,054   

Doubtful (Grade 9)

     648         3,919         2,609         1,208         —           59         8,443   

Loss (Grade 10)

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 100,030       $ 166,023       $ 15,721       $ 23,595       $ 726       $ 2,562       $ 308,657   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loan Portfolio Quality Indicators

At December 31, 2011

 

     Commercial
Real Estate
Loans
     Residential
Real Estate
Loans
     Construction
Real Estate
Loans
     Commercial
Loans and
Leases
     Municipal
Loans
     Consumer
Loans
     Total  

Rating:

                    

Pass (Grades 1-5)

   $ 82,701       $ 156,783       $ 12,204       $ 28,513       $ 740       $ 2,860       $ 283,801   

Watch (Grade 6)

     7,257         1,100         2,210         1,200         —           —           11,767   

Special Mention (Grade 7)

     5,037         90         135         318         —           —           5,580   

Substandard (Grade 8)

     5,131         1,940         —           286         —           —           7,357   

Doubtful (Grade 9)

     —           4,507         3,431         644         —           —           8,582   

Loss (Grade 10)

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 100,126       $ 164,420       $ 17,980       $ 30,961       $ 740       $ 2,860       $ 317,087   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For all loan classes, the entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

 

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Table of Contents

The following tables present the Company’s loan portfolio aging analysis as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

Loan Portfolio Aging Analysis

At June 30, 2012

 

     30-59 Days
Past Due (A)
     60-89 Days
Past Due
     Greater than
90 Days
     Total Past
Due
     Current      Total Loans
Receivable
     Total Loans
> 90 days &
Accruing
 

Real estate loans:

                    

Commercial

   $ 297       $ —         $ 443       $ 740       $ 99,290       $ 100,030       $ —     

Residential

     3,226         289         2,779         6,294         159,729         166,023         198   

Construction

     2,321         149         —           2,470         13,251         15,721         —     

Commercial loans and leases

     260         123         733         1,116         22,479         23,595         —     

Municipal loans

     —           —           —           —           726         726         —     

Consumer loans

     14         —           —           14         2,548         2,562         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,118       $ 561       $ 3,955       $ 10,634       $ 298,023       $ 308,657       $ 198   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(A) Includes $3,974,000 in loans classified as nonaccrual that are less than 30 days past due, of which $2,186,000 are construction loans, $1,276,000 are residential real estate loans, $238,000 are commercial loans, $266,000 are commercial real estate loans and $8,000 are consumer loans.

Loan Portfolio Aging Analysis

At December 31, 2011

 

     30-59 Days
Past Due (A)
     60-89 Days
Past Due
     Greater than
90 Days
     Total Past
Due
     Current      Total Loans
Receivable
     Total Loans
> 90 days &
Accruing
 

Real estate loans:

                    

Commercial

   $ —         $ —         $ —         $ —         $ 100,126       $ 100,126       $ —     

Residential

     1,204         417         4,398         6,019         158,401         164,420         243   

Construction

     4,908         —           1,126         6,034         11,946         17,980         —     

Commercial loans and leases

     434         554         219         1,207         29,754         30,961         —     

Municipal loans

     —           —           —           —           740         740         —     

Consumer loans

     8         2         9         19         2,841         2,860         9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,554       $ 973       $ 5,752       $ 13,279       $ 303,808       $ 317,087       $ 252   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(A) Includes $3,049,000 in loans classified as nonaccrual that are less than 30 days past due, of which $2,306,000 are construction loans, $425,000 are commercial loans, and $318,000 are residential real estate loans.
(B) Includes a $27,000 residential real estate loan 68 days delinquent that is classified as non-accrual.

Impaired Loans: For all loan classes, a loan is designated as impaired when, based on current information or events, it is probable that the Bank will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with insignificant delays not exceeding 90 days outstanding are not considered impaired. Certain non-accrual and substantially delinquent loans may be considered to be impaired. Generally, loans are placed on non-accrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and non-accrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.

For all loan classes, when interest accrual is discontinued all unpaid accrued interest is reversed when considered uncollectible. When a loan is in a non-accrual status, all cash payments of interest are applied to loan principal. Should the loan be reinstated to accrual status, all cash payments of interest received while in non-accrual status will be taken into income over the remaining life of the loan using the level yield accounting method.

 

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Table of Contents

The following table presents impaired loans as of June 30, 2012 (dollars in thousands):

 

Impaired Loans

At June 30, 2012

 

                      Three Months Ended
June 30, 2012
    Six Months Ended
June 30, 2012
 
    Recorded
Balance
    Unpaid
Principal
Balance
    Specific
Allowance
    Average
Investment in
Impaired  Loans

(1)
    Interest Income
Recognized

(2)
    Average
Investment in

Impaired  Loans
(1)
    Interest Income
Recognized

(2)
 

Loans without a specific valuation allowance:

             

Real estate loans:

             

Commercial

    —          —          N/A        —          —          —          —     

Residential

    —          —          N/A        —          —          —          —     

Construction

    —          —          N/A        —          —          —          —     

Commercial loans and leases

    —          —          N/A        —          —          —          —     

Municipal loans

    —          —          N/A        —          —          —          —     

Consumer loans

    —          —          N/A        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    —          —          N/A        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans with a specific valuation allowance:

             

Real estate loans:

             

Commercial

  $ 5,910      $ 5,913      $ 636      $ 5,462      $ 38      $ 5,208      $ 82   

Residential

    6,312        6,549        471        6,098        19        6,130        40   

Construction

    4,788        5,011        343        4,190        3        3,911        7   

Commercial loans and leases

    1,428        1,457        328        1,137        4        1,013        8   

Municipal loans

    —          —          —          —          —          —          —     

Consumer loans

    59        59        16        48        —          45        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 18,497      $ 18,989      $ 1,794      $ 16,935      $ 64      $ 16,307      $ 137   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

All Impaired Loans

  $ 18,497      $ 18,989      $ 1,794      $ 16,935      $ 64      $ 16,307      $ 137   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes all loans that were classified as impaired at any time during the three-month and six-month periods (not just impaired loans at June 30, 2012), and their average balance for only the period during which they were classified as impaired.
(2) Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during the three months and six months ended June 30, 2012.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

 

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Table of Contents

The following table presents impaired loans as of June 30, 2011 (dollars in thousands):

 

Impaired Loans

At June 30, 2011

 

     Three Months Ended
June 30, 2011
     Six Months Ended
June 30, 2011
 
     Average
Investment in
Impaired  Loans

(1)
     Interest Income
Recognized

(2)
     Average
Investment in
Impaired Loans
(1)
     Interest Income
Recognized

(2)
 

Loans without a specific valuation allowance:

           

Real estate loans:

           

Commercial

     —           —           —           —     

Residential

     —           —           —           —     

Construction

     —           —           —           —     

Commercial loans and leases

     —           —           —           —     

Municipal loans

     —           —           —           —     

Consumer loans

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Loans with a specific valuation allowance:

           

Real estate loans:

           

Commercial

   $ 5,074       $ —         $ 5,629       $ 2   

Residential

     6,028         —           6,312         42   

Construction

     3,677         —           4,393         14   

Commercial loans and leases

     849         —           942         —     

Municipal loans

     —           —           —           —     

Consumer loans

     53         —           52         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,681       $ —         $ 17,328       $ 58   
  

 

 

    

 

 

    

 

 

    

 

 

 

All Impaired Loans

   $ 15,681       $ —         $ 17,328       $ 58   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes all loans that were classified as impaired at any time during the three-month and six-month periods (not just impaired loans at June 30, 2011), and their average balance for only the period during which they were classified as impaired.
(2) Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during the three months and six months ended June 30, 2011.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

 

(20)


Table of Contents

The following table presents impaired loans for the year ended December 31, 2011 (dollars in thousands):

 

Impaired Loans

At December 31, 2011

 

                          Year Ended December 31, 2011  
     Recorded
Balance
     Unpaid
Principal
Balance
     Specific
Allowance
     Average
Investment in
Impaired Loans
(1)
     Interest Income
Recognized

(2)
 

Loans without a specific valuation allowance:

              

Real estate loans:

              

Commercial

     —           —           N/A         —           —     

Residential

     —           —           N/A         —           —     

Construction

     —           —           N/A         —           —     

Commercial loans and leases

     —           —           N/A         —           —     

Municipal loans

     —           —           N/A         —           —     

Consumer loans

     —           —           N/A         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     —           —           N/A         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans with a specific valuation allowance:

              

Real estate loans:

              

Commercial

   $ 4,891       $ 4,891       $ 445       $ 5,318       $ 181   

Residential

     6,440         6,494         707         6,142         100   

Construction

     3,672         3,842         435         3,962         57   

Commercial loans and leases

     935         955         142         952         16   

Municipal loans

     —           —           —           —           —     

Consumer loans

     44         44         8         50         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,982       $ 16,226       $ 1,737       $ 16,424       $ 354   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

All Impaired Loans

   $ 15,982       $ 16,226       $ 1,737       $ 16,424       $ 354   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes all loans that were classified as impaired at any time during 2011 (not just impaired loans at December 31, 2011), and their average balance for only the period during which they were classified as impaired.
(2) Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during 2011.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

 

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Table of Contents

Non-Accrual Loans: Any loan which becomes 90 days delinquent, or has the full collection of principal and interest in doubt, or a portion of principal has been charged off will immediately be placed on non-accrual status. The loan does not have to be placed on non-accrual if the charge-off is part of a Chapter 13 reaffirmation. At the time a loan is placed on non-accrual, all accrued but unpaid interest will be reversed from interest income. Placing the loan on non-accrual does not relieve the borrower of the obligation to repay interest.

For all loan classes, when a loan is in a non-accrual status all cash payments of interest are applied to loan principal.

A loan placed on non-accrual may be restored to accrual status when all delinquent principal and interest has been brought current, and the Bank expects full payment of the remaining contractual principal and interest including any previous charge-offs. The Bank requires a period of satisfactory performance of not less than six months before returning a non-accrual loan to accrual status. Should the loan be reinstated to accrual status, all cash payments of interest received while in non-accrual status will be taken into income over the remaining life of the loan using the level yield accounting method.

The following table presents the Company’s non-accrual loans at June 30, 2012 and December 31, 2011 (dollars in thousands):

 

Loans Accounted for on a Non-Accrual Basis

 

     At June 30,      At December 31,  
     2012      2011  

Real estate loans:

     

Commercial

   $ 740       $ —     

Residential

     4,058         4,500   

Construction

     2,470         3,432   

Commercial loans and leases

     1,116         644   

Municipal loans

     —           —     

Consumer loans

     8         —     
  

 

 

    

 

 

 

Total

   $ 8,392       $ 8,576   
  

 

 

    

 

 

 

Total non-accrual loans at June 30, 2012 and December 31, 2011 included $2,400,000 and $1,706,000 of TDRs, respectively.

Troubled Debt Restructurings: Our loan and lease portfolio includes certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from loss mitigation efforts and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six months.

When we modify loans and leases in a TDR, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded balance of the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allowance or charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

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Table of Contents

Loans classified as a troubled debt restructuring during the three-month and six-month periods ended June 30, 2012, segregated by class, are shown in the table below (dollars in thousands). These modifications consisted primarily of interest rate concessions.

 

     Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     Modifications      Modifications  
     Number      Recorded Balance
Before
     Recorded Balance
After
     Number      Recorded Balance
Before
     Recorded Balance
After
 

Real estate loans:

                 

Commercial

     —         $ —         $ —           1       $ 141       $ 141   

Residential

     3         1,111         1,111         4         1,633         1,633   

Construction

     1         1,940         1,940         1         1,940         1,940   

Commercial loans and leases

     —           —           —           1         210         210   

Municipal loans

     —           —           —           —           —           —     

Consumer loans

     1         2         2         3         9         9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     5       $ 3,053       $ 3,053         10       $ 3,933       $ 3,933   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled debt restructured loans that had payment defaults during the three-month and six-month periods ended June 30, 2012, segregated by class, are shown in the table below (dollars in thousands). Default occurs when a loan or lease is 90 days or more past due or transferred to nonaccrual and is within 12 months of restructuring.

 

     Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     Number of Defaults      Recorded Balance      Number of Defaults      Recorded Balance  

Real estate loans:

           

Commercial

     —         $ —           —         $ —     

Residential

     —           —           —           —     

Construction

     —           —           —           —     

Commercial loans and leases

     2         123         2         123   

Municipal loans

     —           —           —           —     

Consumer loans

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2       $ 123         2       $ 123   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE F — CURRENT AND FUTURE ACCOUNTING MATTERS

 

   

Financial Accounting Standards Board (“FASB”)

 

   

ASU No. 2011-03; Reconsideration of Effective Control for Repurchase Agreements. In April, 2011, FASB issued ASU No. 2011-03. The amendments in this ASU remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. The amendments in this ASU also eliminate the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company adopted the methodologies prescribed by this ASU effective January 1, 2012. Adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

 

   

ASU No. 2011-04; Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. In May, 2011, FASB issued ASU No. 2011-04. The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The Company has included the required disclosure in the Consolidated Financial Statements in the Quarterly Reports on Form 10-Q beginning with the quarter ended March 31, 2012.

 

   

ASU No. 2011-05; Amendments to Topic 220, Comprehensive Income. In June, 2011, FASB issued ASU No. 2011-05. Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this ASU should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has included the required disclosure in the Consolidated Financial Statements in the Quarterly Reports on Form 10-Q beginning with the quarter ended March 31, 2012.

 

   

ASU No. 2011-08; Testing Goodwill for Impairment. In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The amendments in this ASU will allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under these amendments, an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The amendments include a number of events and circumstances for an entity to consider in conducting the qualitative assessment. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company adopted the methodologies prescribed by this ASU effective January 1, 2012. Adoption of this ASU did not have a material effect on the Company’s financial position or results of operations.

 

   

ASU No. 2011-12; Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU No. 2011-12 defers the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income for all periods presented. The ASU does not change the other requirements of FASB ASU No. 2011-05, Presentation of Comprehensive Income. Entities are still required to present reclassification adjustments within other comprehensive income either on the face of the statement that reports other comprehensive income or in the notes to the financial statements. The requirement to present comprehensive income in either a single continuous statement or two consecutive condensed statements remains for both annual and interim reporting. The deferral of the requirement for the presentation of reclassification adjustments is intended to be temporary until the FASB reconsiders the operational concerns and needs of financial statement users. The Company adopted the amendments in this Update at the same time as ASU 2011-05, which became effective beginning in the interim period ended March 31, 2012. As the Company had no reclassifications adjustments within other comprehensive income, this Update had no impact on its financial statements.

 

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Table of Contents

NOTE G — RETIREMENT PLAN

The Company entered into separate agreements with certain officers and directors that provide retirement benefits. The Company is recording an expense equal to the projected present value of the payment due at the full eligibility date. The liability for the plan at June 30, 2012 and December 31, 2011 was $1,997,000 and $1,949,000, respectively. The expense for the plan was $56,000 and $49,000 for the three-month periods ended June 30, 2012 and June 30, 2011, respectively. The expense for the plan was $112,000 and $98,000 for the six-month periods ended June 30, 2012 and June 30, 2011, respectively.

NOTE H – DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities.

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Recurring Measurements: Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The security valued in Level 1 is a mutual fund.

Level 2 securities include U.S. Government agency and U.S. Government-sponsored enterprise mortgage-backed securities. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs, and the values are reviewed by the Bank’s management. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector grouping and matrix pricing. In addition, model processes, such as an option adjusted spread model is used to develop prepayment and interest rate scenarios for securities with prepayment features. The Company has reviewed the methodologies used by the third party and has determined that the securities are properly classified as Level 2.

Level 3 securities consist of municipal securities and are valued by a third party who uses a discounted cash flow model to determine the price, and the values are reviewed by the Bank’s management. Management challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States. The key inputs to the discounted cash flow model are the coupon, yield, and expected maturity date. Appropriate market yields are determined based on credit, structure, and related Wall Street trades, quotes, and issuances.

 

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Table of Contents

The following table presents the fair value measurements of assets recognized in the accompanying balance sheet measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2012 and December 31, 2011 (dollars in thousands):

 

            Fair Value Measurements Using  
Available-for-sale securities:    Fair Value      Quoted Prices in
Active Markets for
Identical Assets

(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable

Inputs
(Level 3)
 

At June 30, 2012:

           

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 39,317       $ —         $ 39,317       $ —     

Municipal securities

     2,362         —           —           2,362   

Mutual fund

     1,825         1,825         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 43,504       $ 1,825       $ 39,317       $ 2,362   
  

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2011:

           

Ginnie Mae and GSE mortgage-backed pass-through securities

   $ 39,714       $ —         $ 39,714       $ —     

Municipal securities

     2,351         —           —           2,351   

Mutual fund

     1,782         1,782         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 43,847       $ 1,782       $ 39,714       $ 2,351   
  

 

 

    

 

 

    

 

 

    

 

 

 

Transfers between Levels

Transfers between levels did not occur during the three months and six months ended June 30, 2012.

Level 3 Reconciliation

The following is a reconciliation of the beginning and ending balance for the three months and six months ended June 30,2012 of fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs (dollars in thousands):

 

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

Beginning balance

   $ 2,364      $ 2,351   

Total realized and unrealized gains and losses

    

Included in net income

     —          —     

Included in other comprehensive income

     (2     11   

Purchases, issuances and settlements

     —          —     

Transfers in or out of Level 3

     —          —     
  

 

 

   

 

 

 

Ending balance

   $ 2 ,362      $ 2 ,362   
  

 

 

   

 

 

 

Nonrecurring Measurements:

Following is a description of valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Impaired Loans (Collateral Dependent)

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral-dependent loans.

 

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If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value of the Company’s other real estate owned is determined using Level 3 inputs, which include current and prior appraisals and estimated costs to sell.

The following table presents the fair value measurements of assets recognized in the accompanying balance sheet measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2012 and December 31, 2011. The totals represent only those impaired loans and other real estate owned as of that date that experienced a change in fair value since the beginning of the year (dollars in thousands):

 

            Fair Value Measurements Using  
     Fair Value      Quoted Prices in
Active Markets for
Identical Assets

(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

At June 30, 2012:

           

Impaired loans

   $ 8,435       $ —         $ —         $ 8,435   

Other real estate owned

     795         —           —           795   

At December 31, 2011:

           

Impaired loans

   $ 10,442       $ —         $ —         $ 10,442   

Other real estate owned

     2,486         —           —           2,486   

Unobservable (Level 3) Inputs:

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at June 30, 2012 (dollars in thousands):

 

     Fair Value     

Valuation Technique

  

Unobservable Inputs

   Rate/Rate Range
(Weighted Average)
 

Municipal securities

   $  2,362       Discounted cash flow model    Unrated security yield adjustment      2.0
         Liquidity yield adjustment      1.0
        

Extension risk

yield adjustment

    
1.0

Impaired loans

     8,435       Third party valuations   

Discount to reflect realizable value

    

 

0.3% – 100.0

(13.7


%) 

Other real estate owned

     795       Third party valuations    Discount to reflect realizable value     

 

7.0% – 40.4

(28.0


%) 

Sensitivity of Significant Unobservable Inputs

The following is a discussion of the sensitivity of significant unobservable inputs, the interrelationships between those inputs and other unobservable inputs used in recurring fair value measurement and of how those inputs might magnify or mitigate the effect of changes in the unobservable inputs on the fair value measurement.

Municipal Securities

The significant unobservable inputs used in the fair value measurement of the Company’s municipal securities are premiums for unrated securities and marketability yield adjustments. Significant increases (decreases) in either of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, changes in either of those inputs will not affect the other input.

 

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Fair Value of Financial Instruments

Fair values are based on estimates using present value and other valuation techniques in instances where quoted market prices are not available. These techniques are significantly affected by the assumptions used, including discount rates and estimates of future cash flows. As such, the derived fair value estimates may not be realized upon an immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent, and should not be construed to represent, the underlying value of the Company.

The following table presents the estimates of fair value of financial instruments (dollars in thousands):

 

     December 31, 2011  
     Carrying
Value
     Fair
Value
 

Assets

     

Cash and cash equivalents

   $ 9,709       $ 9,709   

Investment securities available for sale

     43,847         43,847   

Loans held for sale

     252         252   

Loans

     312,509         322,066   

Stock in FHLB

     4,472         4,472   

Mortgage servicing rights

     577         577   

Interest and dividends receivable

     1,089         1,089   

Liabilities

     

Deposits

     337,250         339,930   

Borrowings

     49,810         46,780   

Drafts payable

     2,532         2,532   

Interest and dividends payable

     107         107   

The following table presents the estimates of fair value of financial instruments and the level within the fair value hierarchy in which the fair value measurements fall (dollars in thousands):

 

     Fair Value Measurements Using  
     Carrying
Value
     Quoted Prices in
Active Markets for
Identical Assets

(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

At June 30, 2012

           

Assets

           

Cash and cash equivalents

   $ 37,711       $ 37,711       $ —         $ —     

Investment securities available for sale

     43,504         1,825         39,317         2,362   

Loans held for sale

     1,013         —           1,013         —     

Loans

     303,704         —           300,897         16,702   

Stock in FHLB

     4,472         —           4,472         —     

Mortgage servicing rights

     562         —           —           562   

Interest and dividends receivable

     973         —           973         —     

Liabilities

           

Deposits

     361,126         211,466         152,219         —     

Borrowings

     45,810         —           39,128         4,393   

Drafts payable

     1,375         —           1,375         —     

Interest and dividends payable

     100         —           100         —     

 

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The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and Cash Equivalents and Stock in FHLB: The carrying amounts reported in the consolidated balance sheets approximate those assets’ fair values.

Loans Held for Sale: The carrying amounts reported in the consolidated balance sheets approximate those assets’ fair values.

Loans: The fair values for loans are estimated using a discounted cash flow calculation that applies external interest rates used to price new similar loans to a schedule of aggregated expected monthly maturities on loans.

Mortgage Servicing Rights: The initial amount recorded is an estimate of the fair value of the streams of net servicing revenues that will occur over the estimated life of the servicing arrangement, and the initial amount recorded is then amortized over the estimated life. Annually, a valuation of the servicing rights is performed by an independent third party and reviewed by the Bank’s management, with impairment, if any, recognized through a valuation allowance. The valuation is based on the discounted cash flow method utilizing Bloomberg’s Median Forecasted Prepayment Speeds for mortgage-backed securities assumed to possess enough similarities to the Bank’s servicing portfolio to facilitate a comparison.

Interest and Dividends Receivable/Payable: The fair value of accrued interest and dividends receivable/payable approximates carrying values.

Deposits: The fair values of non-maturity demand, savings, and money market accounts are equal to the amount payable on demand at the balance sheet date. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on deposits to a schedule of aggregated expected monthly maturities on deposits.

Borrowings: The fair value of borrowings is estimated using a discounted cash flow calculation, based on borrowing rates for periods comparable to the remaining terms to maturity of the borrowings.

Drafts Payable: The fair value approximates carrying value.

NOTE I – COLLATERAL FOR LETTERS OF CREDIT

As of June 30, 2012, there were four outstanding letters of credit from the Federal Home Loan Bank of Indianapolis totaling $23.7 million that the Company had collateralized with residential mortgage loans.

 

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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (the “MD&A”) is designed to provide a narrative on our financial condition, results of operations, liquidity, critical accounting policies, off-balance sheet arrangements and the future impact of accounting standards. It is useful to read our MD&A in conjunction with the consolidated financial statements contained in Part I in this Quarterly Report on Form 10-Q (this “Form 10-Q”), our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the “Form 10-K”), and our other reports on Forms 10-Q and 8-K and other publicly available information.

FORWARD-LOOKING STATEMENTS

This Form 10-Q may contain certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on Ameriana Bancorp’s (the “Company”) current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, the outcome of litigation, fluctuations in interest rates and real estate property values in our market area, demand for loans and deposits in the Company’s market area, changes in the quality or composition of our loan portfolio, changes in accounting principles, laws and regulations, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. Additional factors that may affect our results are discussed in the Form 10-K under Part I, Item 1A- “Risk Factors” and in other reports filed with the Securities and Exchange Commission. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Who We Are

Ameriana Bancorp is an Indiana chartered bank holding company subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act of 1956, as amended. The Company became the holding company for Ameriana Bank, an Indiana chartered commercial bank headquartered in New Castle, Indiana (the “Bank”), in 1990. The Company also holds a minority interest in a limited partnership organized to acquire and manage real estate investments, which qualify for federal tax credits.

The Bank began operations in 1890. Since 1935, the Bank has been a member of the Federal Home Loan Bank (the “FHLB”) System. Its deposits are insured to applicable limits by the Deposit Insurance Fund, administered by the Federal Deposit Insurance Corporation (the “FDIC”). In 2002, the Bank converted to an Indiana savings bank and adopted the name “Ameriana Bank and Trust, SB,” and became subject to regulation by the Indiana Department of Financial Institutions and the FDIC. In 2006, the Bank closed its Trust Department and adopted the name Ameriana Bank, SB. In 2009, the Bank converted to an Indiana chartered commercial bank and adopted the name Ameriana Bank. The Bank conducts business through its main office at 2118 Bundy Avenue, New Castle, Indiana and through twelve branch offices located in New Castle, Middletown, Knightstown, Morristown, Greenfield, Anderson, Avon, McCordsville, Carmel, Fishers, Westfield and New Palestine, Indiana. On June 25, 2012, the Bank announced that a decision had been made to discontinue banking center operations at the McCordsville location with a proposed branch closing date of October 13, 2012. The facility will continue to house lending personnel who were moved to that location when the lease for the loan production office was terminated at the end of the first quarter of 2012.

The Bank has two wholly-owned subsidiaries, Ameriana Insurance Agency (“AIA”) and Ameriana Financial Services, Inc. (“AFS”). AIA provides insurance sales from offices in New Castle, Greenfield and Avon, Indiana. AFS operates a brokerage facility in conjunction with LPL Financial that provides non-bank investment product alternatives to its customers and the general public.

What We Do

The Bank is a community-oriented financial institution. Our principal business consists of attracting deposits from the general public and investing those funds along with borrowed funds primarily in mortgage loans on single-family residences, multi-family loans, construction loans, commercial real estate loans, commercial and industrial loans and leases, and, to a lesser extent, consumer loans and loans to municipalities. We have from time to time purchased loans and loan participations in the secondary market. We also invest in various federal and government agency obligations and other investment securities permitted by applicable laws and regulations, including mortgage-backed, municipal and equity securities. We offer customers in our market area time deposits with terms ranging from three months to seven years, interest-bearing and noninterest-bearing checking accounts, savings accounts and money market accounts. Our primary source of borrowings is FHLB advances. Through our subsidiaries, we engage in insurance and investment and brokerage activities.

Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolios and the interest expense incurred on our deposits and borrowings. Our loan portfolio typically earns more interest than the investment portfolio, and our deposits typically have a lower average rate than FHLB advances and other borrowings. Several factors affect our net interest income. These factors include loan, investment, deposit, and borrowing portfolio balances, their composition, the length of their maturity, re-pricing characteristics, liquidity, credit, and interest rate risk, as well as market and competitive conditions and the current interest rate environment.

 

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Executive Overview of the Second Quarter of 2012

The Company recorded net income of $453,000, or $0.15 per share, for the three-month period ended June 30, 2012, its twelfth consecutive profitable quarter.

 

   

Consistent with its capital contingency plan, the Company paid only a de minimis quarterly dividend of $0.01 per share.

 

   

All three of the Bank’s capital ratios at June 30, 2012 were considerably above the levels required under regulatory guidelines to be considered “well capitalized,” and exceeded the higher standards as established in the Board resolution addressed below.

 

   

Net interest income on a fully tax-equivalent basis for the second quarter of 2012 decreased by $31,000, or 0.9%, from the same quarter in 2011, notwithstanding a 0.8% increase in average interest-earning assets over the same period a year earlier.

 

   

Net interest margin of 3.69% on a fully tax-equivalent basis for the second quarter of 2012 represented a decrease of 8 basis points from the first quarter of 2012, and was five basis points lower than the same period in 2011. The decrease was due primarily to an increase in low yielding interest-bearing demand deposits at the Federal Reserve Bank with excess funds that resulted from deposit growth coupled with a decline in the loan portfolio.

 

   

The Bank recorded a $380,000 provision for loan losses in the second quarter of 2012, which was $125,000 greater than the $255,000 provision recorded for both the first quarter of 2012 and the second quarter of 2011.

 

   

Other income of $1.4 million for the second quarter of 2012 represented a $103,000 increase from the same quarter of 2011, and included a $629,000 decrease in the net loss from sales and write-downs of other real estate owned, partially offset by a $448,000 reduction in realized gains on available-for-sale investment securities and an $86,000 decrease in income on other real estate owned.

 

   

Net losses in other real estate owned in the second quarter of 2012 totaled $15,000, compared with $644,000 in the same quarter a year earlier that included a $678,000 write-down of a strip commercial center.

 

   

There were no sales of available-for-sale securities in the second quarter of 2012.

 

   

Other expense for the second quarter of 2012 of $3.9 million was $375,000, or 8.7%, lower than the same quarter in 2011, primarily as a result of a $118,000 decrease in salaries and employee benefits related mostly to positions eliminated through attrition, a $63,000 reduction in the cost of employees medical insurance expense, a $298,000 reduction in other real estate owned expense due mostly to the 2011 sale of an apartment complex, and to lower real estate taxes on other properties than the year earlier quarter that included $130,000 related to a recently acquired golf course and residential real estate development project.

 

   

The Company had income before income taxes of $579,000 for the second quarter of 2012, but recorded income tax expense of only $126,000, which was due primarily to a significant amount of tax-exempt income from bank-owned life insurance.

For the second quarter of 2012, total assets increased by $6.8 million, or 1.5%, to $449.9 million from $443.1 million at March 31, 2012:

 

   

Investments in interest-bearing demand deposits increased $9.3 million from $22.1 million at March 31, 2012 to $31.4 million at June 30, 2012, of which $30.9 million was invested at the Federal Reserve Bank of Chicago and $490,000 at the Federal Home Loan Bank of Indianapolis.

 

   

A $1.4 million increase in the investment securities available-for-sale portfolio during the second quarter of 2012 to $43.5 million resulted from a $2.6 million purchase, coupled with a $421,000 increase in unrealized gains exceeding principal payments on mortgage-backed securities of $1.6 million.

 

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Net loans receivable of $303.7 million at June 30, 2012 represented a decrease of $6.1 million, or 2.0%, for the second quarter of 2012, primarily due to a $7.4 million reduction in the commercial loan and lease portfolio, which was primarily a result of the payoff of several large loans.

 

   

Total non-performing loans of $8.6 million, or 2.8% of total net loans at June 30, 2012, represented a decrease of $30,000 from March 31, 2012.

 

   

The allowance for loan losses of $4.1 million at June 30, 2012 was 1.33% of total loans and 47.8% of non-performing loans, compared to ratios of 1.28% and 46.8%, respectively, at March 31, 2012.

 

   

Other real estate owned of $8.5 million at June 30, 2012 represented a $923,000 increase from March 31, 2012 that resulted from the addition of ten properties totaling $1.1 million, the sale of three properties with a total book value of $151,000, and a $31,000 write-down.

 

   

During the second quarter of 2012, total deposits increased by $6.3 million, or 1.8%, to $361.1 million, as the Bank maintained its strong focus on nurturing existing and attracting new core deposit relationships, while allowing the more rate-sensitive accounts to run off. This strategy resulted in a $10.8 million increase in checking, money market and savings balances, and a $4.5 million decrease in certificates of deposit during the quarter ended June 30, 2012.

Regulatory Action

On July 26, 2010, following a joint examination by and discussions with the FDIC and the Indiana Department of Financial Institutions, the Board of Directors of the Bank adopted a resolution agreeing to, among other things:

 

   

Adopt a capital plan to increase its Tier 1 Leverage Ratio to 8.50% by June 30, 2010 and to maintain a Total Risk-Based Capital Ratio of 12.00%;

 

   

Adopt a written plan to lower classified assets;

 

   

Formulate and implement a written profit plan;

 

   

Receive prior written consent from the FDIC and the Indiana Department of Financial Institutions before declaring or paying any dividends;

 

   

Strive to reduce total holdings of bank-owned life insurance; and

 

   

Furnish quarterly progress reports regarding the Bank’s compliance with all provisions of the resolution.

The Bank is currently in compliance with the provisions of the resolution.

Strategic Issues

To diversify the balance sheet and provide new avenues for loan and deposit growth, the Bank further expanded into Indianapolis, adding three full-service offices in 2008 and 2009 in the suburban markets of Carmel, Fishers and Westfield. As a result, half of the banking centers are located in Indianapolis. These banking centers are focused on generating commercial lending and relationship business, where significant opportunities exist to win market share from smaller institutions lacking capital strength and resources, and large institutions that have concentrated on large business customers.

Although the expansion strategy initially negatively affected earnings, the Bank’s expansion into new markets is critical for its long-term sustainable growth. Additional expansion in Indianapolis, including construction of a new full-service banking center in Plainfield on property purchased by the Bank in early 2008, was put on hold primarily due to the economic environment. On June 25, 2012, the Bank announced the closing of the McCordsville Banking Center scheduled for October 13, 2012. The opening of the Fishers Banking Center in 2008, which is in close proximity to the McCordsville and Geist communities, allowed Ameriana to serve the financial needs of its McCordsville customers from a new convenient location. Ameriana is committed to developing a branch network that meets the changing needs of customers while maximizing profitability for its shareholders.

The economic climate became progressively difficult through most of 2008, as the world-wide financial crisis reached a peak in the second half of the year, and the subsequent economic recovery continued to move slowly through the second quarter of 2012. The severity of this environment and its consequences to the industry created many new formidable challenges for bankers.

Earnings pressure is expected to continue as the weak economy continues to cause stress on credit quality. Deposit acquisition remains competitive; however, the Bank’s disciplined pricing has resulted in a significant reduction in its cost of deposits. The Bank’s pricing strategies, combined with the low interest rate environment, has positively impacted interest rate spread and net interest income. Reducing noninterest expense has been a priority of the Bank, and management has utilized aggressive cost control measures including freezing hiring, job restructuring and eliminating certain discretionary expenditures.

 

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With the Bank’s mantra of “Soundness. Profitability. Growth – in that order, no exceptions,” the priorities, culture and risk strategy of the Bank are focused on asset quality and credit risk management. Despite the current economic pressures, as well as the industry’s challenges related to compliance and regulatory requirements, tightened credit standards, and capital preservation, management remains cautiously optimistic that business conditions will improve over the longer term and is steadfast in the belief that the Company is well positioned to grow and enhance shareholder value as this recovery occurs.

With a community banking history stretching over 120 years, the Bank has built its strong reputation with community outreach programs and being a workplace of choice. By combining its rich tradition with its ability to provide its customers with financial advice and solutions, the Bank will accomplish its mission by:

 

   

being our customer’s first choice for financial advice and solutions;

 

   

informing and educating customers on the basics of money management; and

 

   

understanding and meeting customer’s financial needs throughout their life cycle.

Serving customers requires the commitment of all Ameriana Bank associates to provide exceptional service and sound financial advice. We believe these qualities will differentiate us from our competitors and increase profitability and shareholder value.

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company are maintained in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the Notes to the Company’s Consolidated Financial Statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations of the Company can be affected by these estimates and assumptions, and such estimates and assumptions are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex, and subject to change if actual circumstances differ from those that were assumed. The following are the Company’s critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses provides coverage for probable losses in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, including the level of non-performing, delinquent and classified loans, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for noncommercial loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences and historical losses, adjusted for current trends, for each loan category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the subjective nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger, non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

 

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Mortgage Servicing Rights. Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

Valuation Measurements. Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities and residential mortgage loans held for sale are carried at fair value, as defined by FASB fair value guidance, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts for goodwill and intangible assets. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect the Company’s results of operations.

Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

Under U.S. GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends. At June 30, 2012 and December 31, 2011, we determined that our existing valuation allowance was adequate, largely based on available tax planning strategies and our projections of future taxable income. Any reduction in estimated future taxable income may require us to increase the valuation allowance against our deferred tax assets. Any required increase to the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is more likely than not of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense.

We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact our net income and the carrying value of our assets. We believe our tax liabilities and assets are adequate and are properly recorded in the consolidated financial statements at June 30, 2012.

 

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FINANCIAL CONDITION

Total assets of $449.9 million at June 30, 2012 represented an increase of $20.1 million, or 4.7%, from the December 31, 2011 total of $429.8 million, and was due primarily to an increase in cash and cash equivalents resulting mostly from the Bank’s growth in deposit accounts.

Cash and cash equivalents increased $28.0 million to $37.7 million at June 30, 2012 from the December 31, 2011 total of $9.7 million. Included in the total at June 30, 2012 was $30.9 million of interest-bearing demand deposits at the Federal Reserve Bank of Chicago. Cash and cash equivalents represent an immediate source of liquidity to fund loans or meet deposit outflows.

Investment securities available-for-sale decreased by $343,000 to $43.5 million at June 30, 2012 from $43.8 million at December 31, 2011. This decrease resulted primarily from $4.9 million in sales and $3.2 million of principal repayments on mortgage-backed securities, mostly offset by $7.4 million in purchases of mortgage-backed securities and a $389,000 increase in unrealized gains. All mortgage-backed securities in the portfolio, which totaled $39.3 million at June 30, 2012, are insured by either Ginnie Mae, a U.S. Government agency, or by Fannie Mae or Freddie Mac, each a U.S. Government sponsored enterprise (“GSE”).

Net loans receivable decreased by $8.8 million, or 2.8%, to $303.7 million at June 30, 2012 from $312.5 million at December 31, 2011, due mostly to a $7.4 million decrease in the commercial loan and lease portfolio to $23.6 million that resulted primarily from the payoff of several large loans. The residential mortgage loan portfolio increased $1.6 million to $166.0 million, as the Bank put $9.8 million single-family loans into the portfolio from the total production of $20.8 million during the second quarter. The Bank’s mortgage-banking strategy is reviewed regularly to ensure that it remains consistent with the Bank’s overall balance sheet management objectives.

Premises and equipment of $14.4 million at June 30, 2012 represented a $214,000 decrease from $14.7 million at December 31, 2011. The net decrease was a result of $471,000 of depreciation and $21,000 in dispositions for the six months ended June 30, 2012 exceeding capital expenditures of $278,000 for the period.

Goodwill was $656,000 at June 30, 2012, unchanged from December 31, 2011. Goodwill of $457,000 relates to deposits associated with a banking center acquired in 1998, and $199,000 is the result of three separate insurance business acquisitions. The Bank’s impairment tests reflected no impairment as of June 30, 2012.

We have investments in life insurance on employees and directors with a balance or cash surrender value of $26.6 million and $26.2 million at June 30, 2012 and December 31, 2011, respectively. The non-taxable increase in cash surrender value of this life insurance was $390,000 for the first six months of 2012, compared to $424,000 for the same period a year earlier.

Other real estate owned of $8.5 million at June 30, 2012 represented a $923,000 increase over the total of $7.5 million at December 31, 2011. Eighteen additions to other real estate owned totaling $1.4 million and the sale of six properties with an aggregate book value of $296,000 occurred during the six-month period ended June 30, 2012. The additions included eight single-family homes, eight residential building lots and two parcels of undeveloped land. The sales resulted in a gain of $51,000, and consisted of four single-family properties, a residential building lot and a four unit commercial property. Write-downs of other real estate owned during the six-month period ended June 30, 2012 totaled $222,000, with $130,000 related to an uncompleted apartment project. Each of the write-downs was due to further deterioration of the property’s market value during the period.

Other assets of $9.3 million at June 30, 2012 represented a $578,000 decrease from December 31, 2011, that resulted primarily from a $281,000 reduction in prepaid FDIC insurance premiums, a $118,000 decrease in other prepaid expenses, and a $102,000 decrease in accrued interest and dividends receivable.

Total deposits of $361.1 million at June 30, 2012 represented an increase of $23.9 million, or 7.1%, from $337.2 million at December 31, 2011, as the Bank maintained its strong focus on nurturing existing and attracting new core deposit relationships. During the first six months of 2012, checking, money market and savings balances increased $24.5 million, while certificate of deposit balances decreased $634,000. The Bank has concentrated on strategies designed to grow total balances in multi-product deposit relationships, and continues to utilize pricing strategies designed to produce growth with an acceptable marginal cost for both existing and new deposits.

 

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Borrowings declined by $4.0 million during the first six months of 2012 to $45.8 million, as the Bank repaid a Federal Home Loan Bank note that had been on the books for the first week of fiscal 2012 to meet a short-term funding need. Wholesale funding options and strategies are continuously analyzed to ensure that we retain sufficient sources of credit to fund all of the Bank’s needs, and to control funding costs by using this alternative to organic deposit account funding when appropriate.

Drafts payable of $1.4 million at June 30, 2012 decreased $1.1 million from $2.5 million at December 31, 2011. This difference will vary and is a function of the dollar amount of checks issued near period end and the time required for those checks to clear.

Total shareholders’ equity of $35.5 million at June 30, 2012 represented a $1.0 million increase over the total of $34.5 million at December 31, 2011. The increase resulted from net income of $798,000 and a $257,000 increase in unrealized gains net of income tax related to the Bank’s available-for-sale investment securities portfolio, reduced by $60,000 in dividends declared during the six month period. The Company and the Bank’s regulatory capital ratios were all considerably above the levels required under regulatory guidelines to be considered “well capitalized,” and exceeded the higher standards as established in the July 26, 2010 Board resolution.

RESULTS OF OPERATIONS

Second Quarter of 2012 compared to the Second Quarter of 2011

The Company recorded net income of $453,000, or $0.15 per diluted share, for the second quarter of 2012, compared to net income of $270,000, or $0.09 per diluted share, for the second quarter of 2011.

Credit costs associated with a high level of non-performing assets that resulted from an extended period of weak economic conditions continued to adversely affect earnings during the second quarter of 2012, but to a lesser degree than they did in the same quarter of 2011. The earnings growth for the second quarter of 2012 compared to the same quarter a year earlier was related primarily to a $629,000 reduction in the net loss from sales and write-downs of other real estate owned coupled with a $212,000 reduction in other real estate owned expense net of income, partially offset by $448,000 in net realized gains from sales of available-for-sale investment securities in the second quarter of 2011 compared with none in the second quarter of 2012, and a $125,000 increase in the provision for loan losses compared to the year earlier quarter.

Net Interest Income

The Company’s net interest income on a fully tax-equivalent basis of $3.6 million for the second quarter of 2012 represented a decrease of $31,000 or 0.9%, compared to the same period of 2011, notwithstanding that average interest-earning assets totaled $388.1 million, a 0.8% increase over the same period of 2011. Net interest margin on a fully tax-equivalent basis for the second quarter of 2012 of 3.69% was five basis points lower than the year earlier period. The Bank was able to stabilize net interest income and net interest margin as it benefited from certain market conditions that allowed it to decrease its cost of funds, primarily through the re-pricing of deposit accounts in a relatively stable low interest rate environment, while market conditions also contributed to a decrease in average yield on interest-earning assets.

Tax-exempt interest was $37,000 for the second quarter of 2012 compared to $46,000 for the same period of 2011, and resulted from municipal securities and municipal loans. Tax-equivalent adjustments were $16,000 and $21,000 for the second quarter of 2012 and 2011, respectively.

“Net interest income on a fully tax-equivalent basis” is calculated by increasing net interest income by an amount that represents the additional taxable interest income that would be needed to produce the same amount of after-tax income as the tax-exempt interest income included in net interest income for the period.

“Net interest margin on fully tax-equivalent basis” is calculated by dividing annualized “net interest income on a fully tax-equivalent basis” by average interest-earning assets for the period.

Our “fully tax-equivalent basis” calculations are based on a federal income tax rate of 34%.

 

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Provision for Loan Losses

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated:

 

     (Dollars in thousands)
Three Months Ended June 30,
 
     2012     2011  

Balance at beginning of quarter

   $ 4,032      $ 4,416   

Provision for loan losses

     380        255   

Charge-offs

     (324     (570

Recoveries

     15        18   
  

 

 

   

 

 

 

Net charge-offs

     (309     (552
  

 

 

   

 

 

 

Balance at end of period

   $ 4,103      $ 4,119   
  

 

 

   

 

 

 

Allowance to total loans

     1.33     1.32
  

 

 

   

 

 

 

Allowance to non-performing loans

     47.76     50.63
  

 

 

   

 

 

 

We recorded a provision for loan losses of $380,000 in the second quarter of 2012, a $125,000 increase over the $255,000 provision in the same quarter of 2011. The increased provision is reflective of the continuing pressure of economic conditions on credit quality, including an elevated amount of non-performing loans and charge-offs. Total charge-offs of $324,000 for the second quarter of 2012 included loans with specific reserves totaling $322,000 at March 31, 2012.

The following table summarizes the Company’s non-performing loans:

 

     (Dollars in thousands)
June 30,
 
     2012     2011  

Loans accounted for on a non-accrual basis

   $ 8,392      $ 7,380   

Accruing loans contractually past due 90 days or more

     198        756   
  

 

 

   

 

 

 

Total of non-accrual and 90 days or more past due loans (1)

   $ 8,590      $ 8,136   
  

 

 

   

 

 

 

Percentage of total net loans

     2.79     2.62
  

 

 

   

 

 

 

Other non-performing assets (2)

   $ 8,468      $ 8,918   

Total non-performing assets

   $ 17,058      $ 17,054   
  

 

 

   

 

 

 

Percentage of total assets

     3.79     3.88
  

 

 

   

 

 

 

Troubled debt restructurings in total of nonaccrual and 90 days or more past due loans (1)

   $ 2,400      $ 1,123   

Total troubled debt restructurings

   $ 11,859      $ 8,259   
  

 

 

   

 

 

 

 

(1) Total non-accrual loans and accruing loans 90 days or more past due at June 30, 2012 included $2.4 million of troubled debt restructurings, which consisted of a $1.1 million residential construction loan, five residential non- construction loans totaling $997,000, three commercial loans totaling $318,000, and three consumer loans totaling $8,000.
(2) Other non-performing assets represent property acquired through foreclosure or repossession. This property is carried at the lower of its fair market value or its carrying value.

The allowance for loan losses of $4.1 million at June 30, 2012 was $16,000 lower than a year earlier, and the allowance for loan losses to non-performing loans ratio decreased from 50.63% at June 30, 2011 to 47.76% at June 30, 2012 due primarily to a higher total of non-performing loans. Non-performing loans of $8.6 million at June 30, 2012 represented a $454,000 increase from the total of $8.1 million at June 30, 2011, but a $30,000 decrease from the end of the prior quarter. It is management’s opinion that the allowance for loan losses at June 30, 2012 is adequate based on measurements of the credit risk in the entire portfolio as of that date.

 

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Total charge-offs of $324,000 for the second quarter of 2012 included $246,000 related to deterioration in the market value of eleven properties acquired through foreclosure during the quarter, and a $53,000 partial charge-off resulting from a short sale of a commercial lot.

At June 30, 2012, the Bank had $11.9 million in loans categorized as troubled debt restructurings, with twelve loans for $2.4 million also included in the table above in the total for loans accounted for on a non-accrual basis. The total of $11.9 million included a $4.5 million loan on a hotel in northern Indiana, one other commercial real estate loan for $139,000, a $1.1 million loan on a residential condominium project, twenty single-family residential property loans totaling $2.7 million, a land development loan for $1.9 million, three other land loans totaling $1.2 million, three commercial loans totaling $318,000, and three consumer loans totaling $8,000.

Other Income

The Company recorded other income of $1.4 million for the second quarter of 2012, an increase of $103,000 from the total for the same period a year earlier that resulted primarily from the net of the following changes:

 

   

A $629,000 reduction in the net loss from sales and write-downs of other real estate owned to $15,000 for the second quarter of 2012 from a net loss of $644,000 for the second quarter of 2011 that included a $678,000 write-down of a strip commercial center;

 

   

No sales of available-for-sale investment securities in the second quarter of 2012, compared to sales in the year earlier quarter with net realized gains of $448,000; and

 

   

An $86,000 decrease in other real estate owned income to $60,000 that resulted primarily from the sale of an apartment complex late in the second quarter of 2011.

Other Expense

Total other expense of $3.9 million for the second quarter of 2012 was $375,000, or 8.7%, lower than the second quarter of 2011, with the following major differences:

 

   

A $118,000 decrease in salaries and employee benefits resulting from the elimination of positions primarily through attrition, and a $63,000 reduction in the cost of employees medical insurance expense, partially offset by a $23,000 increase in funding costs for the frozen multi-employer defined benefit retirement plan; and

 

   

A $298,000 decrease in other real estate owned expense that resulted primarily from the sale of an apartment complex, and lower real estate expense on other properties than the year earlier quarter that included $130,000 related to a recently acquired golf course and residential real estate development project.

Income Tax Expense

The Company had income before income taxes of $579,000, but recorded an income tax expense of only $126,000 for the second quarter of 2012 due to a significant amount of tax-exempt income, primarily from bank-owned life insurance. For the same quarter of 2011, the Company had income before income taxes of $252,000 and recorded a tax benefit of $18,000 that also resulted primarily from tax-exempt BOLI income.

We have a deferred state tax asset that is primarily the result of operating losses sustained since 2003. We started recording a valuation allowance against our current period state income tax benefit in 2005 due to our concern that we may not be able to use more than the tax asset already recorded on the books without modifying the use of AIMI, our investment subsidiary, which was liquidated effective December 31, 2009. Operating income from AIMI was not subject to state income taxes under state law, and as a result was also a major factor in the growth of the deferred state tax asset.

The Company also has a deferred federal tax asset that is composed of tax benefit from a net operating loss carry-forward and purchased tax credits. The federal loss carry-forward expires in 2026, and the tax credits begin to expire in 2023. The tax credits include alternative minimum tax credits, which have no expiration date. Management believes that the Company will be able to utilize the benefits recorded for loss carry-forwards and credits within the allotted time periods.

 

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In addition to the liquidation of AIMI, the Bank has initiated several strategies designed to expedite the use of both the deferred state tax asset and the deferred federal tax asset. Through sales of $34.5 million of municipal securities and only one purchase since December 31, 2006, that segment of the investment securities portfolio has been reduced to $2.4 million. The proceeds from these sales have been reinvested in taxable financial instruments. The Bank has periodically evaluated a sale/leaseback transaction that could result in a taxable gain on its office properties, and also allow the Bank to convert nonearning assets to assets that will produce taxable income. Additionally, the Bank is exploring options related to reducing its current investment in tax-exempt bank owned life insurance policies that involve the reinvestment of the proceeds in taxable financial instruments with a similar or greater risk-adjusted after-tax yield. Sales of banking centers not important to long-term growth objectives that would result in taxable gains and reduced operating expenses could be considered by the Bank.

Six Months Ended June 30, 2012 compared to the Six Months Ended June 30, 2011

The Company recorded net income of $798,000, or $0.27 per diluted share, for the first six months of 2012, an increase of $407,000 from net income of $391,000, or $0.13 per diluted share, for the first six months of 2011.

The primary factor in the earnings improvement was a decrease in other expense of $657,000, or 7.5%, compared to the first half of 2011 that resulted mostly from a $239,000 reduction in salaries and employee benefits, and a $336,000 reduction in other real estate owned expense.

Net Interest Income

Net interest income on a fully tax-equivalent basis increased $50,000, or 0.7%, to $7.1 million for the first six months of 2012 compared with $7.0 million for the same period of 2011, primarily as a result of a $3.9 million, or 1.0%, increase in the Bank’s average interest-earning assets to $382.8 million for the second quarter of 2012. The Company’s net interest margin on a fully tax-equivalent basis decreased 2 basis points to 3.73% for the first six months of 2012 from 3.75% for the first six months of 2011.

Tax-exempt interest was $73,000 for the first six months of 2012 compared to $97,000 for the same period of 2011. Our tax-exempt interest results from holdings of bank-qualified municipal securities and municipal loans. The tax-equivalent adjustments were $31,000 and $43,000 for the first six months of 2012 and 2011, respectively. The decrease in tax-exempt interest for the first six months of 2012 compared to the same period of 2011 was due primarily to a lower average balance of municipal loans.

Provision for Loan Losses

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated:

 

     (Dollars in thousands)
Six Months Ended June 30,
 
     2012     2011  

Balance at beginning of year

   $ 4,132