|• FORM 10-Q • EX-4 • EX-31.1 • EX-31.2 • EX-32.1 • EX-32.2 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly period ended March 31, 2012
Commission file number 001-35296
FARMERS NATIONAL BANC CORP.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
PART IFINANCIAL INFORMATION
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
See accompanying notes
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
See accompanying notes
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
See accompanying notes
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
See accompanying notes
Principles of Consolidation:
Farmers National Banc Corp. (the Company) is a one-bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company provides full banking services through its nationally chartered subsidiary, The Farmers National Bank of Canfield (the Bank). The Company provides trust services through its subsidiary, Farmers Trust Company (the Trust), and insurance services through the Banks subsidiary, Farmers National Insurance. The consolidated financial statements include the accounts of the Company, the Bank and its subsidiary and the Trust. All significant intercompany balances and transactions have been eliminated in the consolidation.
Basis of Presentation:
The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (U.S. GAAP) for complete financial statements. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys 2011 Annual Report to Shareholders included in the Companys Annual Report on Form 10-K for the year ended December 31, 2011. The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The allowance for loan losses, deferred tax assets, carrying amount of goodwill and fair values of financial instruments are particularly subject to change.
Allowance for Loan Losses:
The Company changed its methodology for estimating the valuation allowance for probable incurred loan losses for the three month period ended March 31, 2012. During the most recent period end, management computed the historical loss percentage based upon the loss history of the past 12 quarters. In previous periods, management used a historical loss percentage based on the past 8 quarters. Using a 12 quarter loss history resulted in a larger historical loss ratio than what would have been computed using an 8 quarter history. The primary factor for the change was the lower historical loss percentage applied to homogeneous and pass rated loans due to recent lower levels of net charge-offs. This new 12 quarter history methodology did not result in a provision for loan losses for the three month period ended March 31, 2012.
The Company provides a broad range of financial services to individuals and companies in northeastern Ohio. While the Company's chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is primarily aggregated and reported in two lines of business, the Bank segment and the Trust segment.
Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss consists solely of the change in net unrealized gains and losses on securities available for sale, net of reclassification for gains or losses recognized in income.
Recent Accounting Pronouncements
In May, 2011, the FASB issued an amendment to achieve common fair value measurement and disclosure requirements between U.S. and International accounting principles. Overall, the guidance is consistent with existing U.S. accounting principles; however, there are some amendments that change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this guidance are effective for interim and annual reporting periods beginning after December 15, 2011. The effect of adopting this standard did not have a material effect on the Companys operating results or financial condition, but the additional disclosures are included in the Fair Value footnote.
In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in stockholders equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. The amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. Early adoption is permitted. The Company adopted this amendment for year ended December 31, 2011, by presenting comprehensive income in a new Consolidated Statements of Comprehensive Income. The new statement follows the Consolidated Statements of Income.
The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at March 31, 2012 and December 31, 2011 and the corresponding amounts of unrealized gains and losses recognized in accumulated other comprehensive income:
There were no security sales during the three months ended March 31, 2012 and 2011.
The amortized cost and fair value of the debt securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed and CMO securities are not due at a single maturity date and are shown separately.
The following table summarizes the investment securities with unrealized losses at March 31, 2012 and December 31, 2011, aggregated by major security type and length of time in a continuous unrealized loss position:
Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities are generally evaluated for OTTI under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 320, Investments Debt and Equity Securities. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.
When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investments amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
As of March 31, 2012, the Companys security portfolio consisted of 419 securities, 31 of which were in an unrealized loss position. The majority of the unrealized losses on the Companys securities are related to its holdings of mortgage-backed securities and small business administration securities as discussed below.
Unrealized losses on debt securities issued by state and political subdivisions have not been recognized into income. Generally these securities have maintained their investment grade ratings and management does not have the intent to sell these securities before their anticipated recovery. The fair value is expected to recover as the securities approach their maturity date.
All of the Company's holdings of mortgage-backed securities-residential were issued by U.S. government-sponsored entities. Unrealized losses on mortgage-backed securities-residential have not been recognized into income. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities-residential and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be OTTI.
Unrealized losses on small business administration securities issued by U.S. government-sponsored entities have not been recognized into income because the securities are of high credit quality, management does not have the intent to sell these securities before their anticipated recovery and the decline in fair value is largely due to fluctuations in market interest rates and not credit quality. Consequently, the fair value of such debt securities is expected to recover as the securities approach their maturity date.
The Companys equity securities are made up of local and regional bank holdings. The unrealized losses associated with these holdings have not been recognized into income. Generally these securities have suffered as most banking securities have suffered during the recent economic cycle. The fair value is expected to recover as the banking sector recovers. Management does not have the intent to sell these securities before their anticipated recovery.
Loan balances were as follows:
The following tables present the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and 2011:
Three Months Ended March 31, 2012
Three Months Ended March 31, 2011
The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2012 and December 31, 2011. The recorded investment in loans includes the unpaid principal balance and unamortized loan origination fees and costs, but excludes accrued interest receivable, which is not considered to be material:
March 31, 2012
December 31, 2011
The following tables present information related to impaired loans by class of loans as of March 31, 2012 and December 31, 2011:
The following table presents the average recorded investment by class for the three month periods ended March 31, 2012 and 2011:
Interest income recognized during impairment for both periods was immaterial.
Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of March 31, 2012 and December 31, 2011:
The following table presents the aging of the recorded investment in past due loans as of March 31, 2012 and December 31, 2011 by class of loans:
Troubled Debt Restructurings:
Total troubled debt restructurings were $4.2 million and $4.3 million at March 31, 2012 and December 31, 2011, respectively. The Company has allocated $65 thousand and $48 thousand of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2012 and December 31, 2011. There are no commitments to lend additional amounts to borrowers with loans that are classified as troubled debt restructurings at March 31, 2012 and December 31, 2011.
During the three month period ended March 31, 2012, the terms of a certain commercial real estate loan were modified as a troubled debt restructuring. The modification of the terms of the loan included a reduction of the stated interest rate on the loan for the remaining life of the loan which is 41 months. There were no modifications involving an extension of the maturity date. The pre-modification outstanding recorded investment for this loan was $462 thousand and the post-modification outstanding recorded investment was $467 thousand.
The troubled debt restructuring described above had an immaterial affect on the allowance for loan losses at March 31, 2012. There were no charge offs as a result of the allowance adjustment.
There was one residential real estate loan modified as troubled debt restructurings for which there was a payment default during the twelve months following the modification during the quarter ended March 31, 2012. The loan was past due 33 days at March 31, 2012. There was no additional provision or any impact to the allowance for losses associated with this loan. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company establishes a risk rating at origination for all commercial loan and commercial real estate relationships. For relationships over $300 thousand management monitors the loans on an ongoing basis for any changes in the borrowers ability to service their debt. Management also affirms the risk ratings for the loans and leases in their respective portfolios on an annual basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2012 and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential, consumer and indirect loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential, consumer and indirect auto loans based on payment activity as of March 31, 2012 and December 31, 2011. Nonperforming loans are loans past due 90 days and still accruing interest and nonaccrual loans.
Earnings Per Share:
The computation of basic and diluted earnings per share is shown in the following table:
Stock options for 5,000 and 28,500 shares were not considered in the computing of diluted earnings per share for the three months ended March 31, 2012 and 2011, respectively, because they were antidilutive.
Stock Based Compensation:
The Companys Stock Option Plan (the Plan), permitted the grant of share options to its directors, officers and employees. Under the terms of the Plan no additional shares can be issued. Option awards were granted with an exercise price equal to the market price of the Company's common shares at the date of grant, with a vesting period of 5 years and have 10-year contractual terms. At March 31, 2012 there were 5,000 outstanding options of which 3,000 were fully vested and are exercisable.
The fair value of each option award is estimated on the date of grant using a Black-Scholes model. Total compensation cost charged against income for the stock option plan for the three month period ended March 31, 2012 was not material. No related income tax benefit was recorded.
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 Significant unobservable inputs that reflect a reporting entitys own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value:
Investment Securities: The Company used a third party service to estimate fair value on available for sale securities on a monthly basis. This service provider is considered a leading evaluation pricing service for U.S. domestic fixed income securities. They subscribe to multiple third-party pricing vendors, and supplement that information with matrix pricing methods. The fair values for investment securities are determined by quoted market prices in active markets, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on quoted prices for similar assets in active markets, quoted prices for similar assets in markets that are not active or inputs other than quoted prices, which provide a reasonable basis for fair value determination. Such inputs may include interest rates and yield curves, volatilities, prepayment speeds, credit risks and default rates. Finally, inputs used are derived principally from observable market data (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). The fair values of Level 3 investment securities are determined by using unobservable inputs to measure fair value of assets for which there is little, if any market activity at the measurement date, using reasonable inputs and assumptions based on the best information at the time, to the extent that inputs are available without undue cost and effort by the Companys Controller and Chief Financial Officer. For the period ended March 31, 2012 the fair value of Level 3 investment securities was immaterial.
Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrowers financial statements, or aging reports, adjusted or discounted based on managements historical knowledge, changes in market conditions from the time of the valuation, and managements expertise and knowledge of the client and clients business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair values are commonly based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial and commercial real estate properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Appraisal Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with via independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what adjustments should be made to appraisals to arrive at fair value.
Assets measured at fair value on a recurring basis, including financial assets for which the Company has elected the fair value option, are summarized below:
There were no significant transfers between Level 1 and Level 2 during the three month periods ended March 31, 2012 and 2011.
The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
Assets measured at fair value on a non-recurring basis are summarized below:
Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $5.3 million with a valuation allowance of $1.0 million at March 31, 2012, resulting in an additional provision for loan losses of $81 thousand for the three month period. At December 31, 2011, impaired loans had a principal balance of $4.6 million, with a valuation allowance of $936 thousand. Provision for loan losses was $300 thousand for the three months ended March 31, 2011, for loans carried at fair value. Excluded from the fair value of impaired loans, at March 31, 2012 and December 31, 2011, discussed above are $2.4 million and $2.3 million of loans classified as troubled debt restructurings, which are not carried at fair value.
Impaired commercial real estate loans, both owner occupied and non-owner occupied are valued by independent external appraisals. These external appraisals are prepared using the sales comparison approach and income approach valuation techniques. Management makes subsequent unobservable adjustments to the impaired loan appraisals by reducing the appraised collateral value in the 0%40% range, with a weighted average percentage of 21.7%. Impaired loans other than commercial real estate and other real estate owned are not considered material.
Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $290 thousand at March 31, 2012. The Company sold two other real estate owned properties during the three month period ended March 31, 2012. The Company did not record any adjustments to the carrying amount of other real estate owned for the three months ended March 31, 2012. At December 31, 2011, other real estate owned had a net carrying amount of $346 thousand. During the year ended December 31, 2011 five properties were charged down reflecting updated appraisals which resulted in a write-down of $115 thousand.
The carrying amounts and estimated fair values of financial instruments, at March 31, 2012 and December 31, 2011 are as follows:
The methods and assumptions used to estimate fair value are described as follows:
Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. The Company has determined that cash on hand and non-interest due from bank accounts are Level 1 whereas interest bearing fed funds sold and other are Level 2.
Restricted Stock: It is not practical to determine the fair value of restricted stock due to restrictions placed on its transferability.
Loans: Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
Loans held for sale: The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.
Accrued Interest Receivable/Payable: The carrying amounts of accrued interest receivable and payable approximate fair value resulting in a Level 2 or Level 3 classification. The classification is the result of the association with securities, loans and deposits.
Deposits: The fair values disclosed for demand deposits interest and non-interest checking, passbook savings, and money market accountsare, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of variable rate certificates of deposit approximate their fair values at the reporting date resulting Level 2 classification. Fair value for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
Short-term Borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.
Long-term Borrowings: The fair values of the Companys long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
Off-balance Sheet Instruments: The fair value of commitments is not material.
The reportable segments are determined by the products and services offered, primarily distinguished between banking and trust operations. They are also distinguished by the level of information provided to the chief operating decision makers in the Company, who use such information to review performance of various components of the business, which are then aggregated. Loans, investments, and deposits provide the revenues in the banking operation, and trust service fees provide the revenue in trust operations. All operations are domestic.
Significant segment totals are reconciled to the financial statements as follows:
Forward Looking Statements
Discussions in this report that are not statements of historical fact (including statements that include terms such as will, may, should, believe, expect, anticipate, estimate, project, intend, and plan) are forward-looking statements that involve risks and uncertainties. Any forward-looking statement is not a guarantee of future performance and actual future results could differ materially from those contained in forward-looking information. Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in the Companys filings with the Securities and Exchange Commission, including without limitation, the risk factors disclosed in Item 1A, Risk Factors, in the Companys Annual Report on Form 10-K for the year ended December 31, 2011.
Many of these factors are beyond the Companys ability to control or predict, and readers are cautioned not to put undue reliance on those forward-looking statements. The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Companys actual results to differ materially from those anticipated or expected in these forward-looking statements:
Other factors not currently anticipated may also materially and adversely affect the Companys results of operations, cash flows and financial position. There can be no assurance that future results will meet expectations. While the Company believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. The Company does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.
Net income for the three months ended March 31, 2012 was $2.5 million, compared to $1.7 million for the same three month period in 2011. On a per share basis, net income for the first quarter ended March 31, 2012 was $0.13 per diluted share, compared to $0.10 for the first quarter ended March 31, 2011 and $0.16 for the fourth quarter ended December 31, 2011. The tangible common equity ratio increased to 9.91% at March 31, 2012, compared to 9.56% at March 31, 2011, mainly as a result of the increase in net income. Farmers total assets reported at March 31, 2012 were $1.1 billion, representing a 9.1% increase compared to $1.0 billion in total assets recorded at March 31, 2011.
Net loans increased $5.2 million, or 0.9%, since December 31, 2011. Most of the loan growth in the past three months has occurred in the commercial real estate portfolio. Net loans were reported at $567.2 million at March 31, 2012, which compares to $562.0 million at December 31, 2011. Farmers believes its demand experience for business and consumer credit is consistent with the experience of other banks in the Federal Reserves Fourth District and banks nationally per the Federal Reserve Beige Book. Deposits increased $46.5 million, or 5.5%, from $840.1 million at December 31, 2011 to $886.6 million at March 31, 2012, as customers continue to seek the safety and security of FDIC insured deposit accounts.
Stockholders equity totaled $115.4 million, or 10.4% of total assets, at March 31, 2012, an increase of $959 thousand, or 0.8%, compared to $114.4 million at December 31, 2011. The increase is the result of net income and mark to market adjustments in investment securities, offset by cash dividends paid to shareholders during the quarter. Shareholders received a special one-time $0.03 cash dividend on February 28, 2012, a regular $0.03 per share cash dividend on March 31, 2012 and a total of $0.15 per share cash dividends paid in the past four quarters. Book value per share increased from $6.10 per share at December 31, 2011 to $6.14 per share at March 31, 2012. Farmers tangible book value per share also increased from $5.76 per share at December 31, 2011 to $5.81 per share at March 31, 2012.
Results of Operations
The following is a comparison of selected financial ratios and other results at or for the three months ended March 31, 2012 and 2011:
Net Interest Income. The following schedule details the various components of net interest income for the periods indicated. All asset yields are calculated on a tax-equivalent basis where applicable. Security yields are based on amortized cost.
Average Balance Sheets and Related Yields and Rates
(Dollar Amounts in Thousands)
Net interest income. Net interest income was $9.2 million for the first quarter of 2012, which compared to $9.1 million in the first quarter of 2011. The net interest margin to average earning assets on a fully taxable equivalent basis decreased 32 basis points to 3.90% for the three months ended March 31, 2012, compared to 4.22% for the same period in the prior year. The decrease in net interest margin is largely a result of the change in the mix of interest earning assets. Loans, which yield more than securities, comprised a smaller level of interest-earning assets in the current period. For the three months ended March 31, 2012, loans were 56% of average earning assets, compared to 62% for the three months ended March 31, 2011. In comparing the quarters ended March 31, 2012 and 2011, yields on earning assets decreased 54 basis points, while the cost of interest bearing liabilities decreased 24 basis points.
Noninterest Income. Noninterest income was $2.7 million for the first quarter of 2012, increasing 4.2% from $2.6 million compared to the same quarter of 2011. Trust fees were $1.4 million for the quarter ended March 31, 2012, an increase of $80 thousand, or 6%, compared to the same quarter in 2011. Income from the sale of residential real estate loans was $65 thousand in the first quarter of 2012 as the Company continues to develop its secondary mortgage operations. There were no sales of loans or gains recognized during the three months ended March 31, 2011.
Noninterest Expense. Noninterest expense totaled $8.6 million for the first quarter of 2012, which is $825 thousand more than the $7.8 million in the same quarter in 2011. Most of this increase is a result of a $541 thousand or 12.9% increase salaries and employee benefits, due to a higher number of employees in the current quarter. The higher employee count is attributed primarily to our North Canton and Secondary Mortgage project expansions. Employee health insurance costs also increased $142 thousand as a result of a higher level of claims. Advertising expense is also $103 thousand higher in the first quarter of 2012 compared to the same quarter in 2011. This increase is primarily a result of a higher level of production costs related to television advertisements in the current period.
The following is a detail of non-interest expense line items classified between the Trust and the other entities in the Company for the three month periods ended March 31, 2012 and 2011:
The Companys tax equivalent efficiency ratio for the three month period ended March 31, 2012 was 68.4% compared to 62.6% for the same period in 2011. The decline in the efficiency ratio was the result of the $825 thousand increase in noninterest expenses as explained in the previous paragraph.
Income Taxes. Income tax expense totaled $790 thousand for the quarter ended March 31, 2012 and $321 thousand for the quarter ended March 31, 2011. The increase in the current quarter tax expense can be attributed to the $1.3 million increase in income before taxes. The effective tax rate for the first three months of 2012 was 23.87%, compared to 15.96% for the same period in 2011. The effective tax rate increase over the same period in 2011 was primarily due to the increase in income before taxes while tax exempt income remained stable.
Other Comprehensive Income. For the quarter ended March 31, 2012, the change in net unrealized gains on securities, net of reclassifications, resulted in an unrealized loss, net of tax, of $556 thousand, compared to an unrealized gain of $43 thousand for the same period in 2011. Management believes the decrease in fair value for the three month period ended March 31, 2012 is the result of the low interest rate environment pulling back to more sustainable levels in the debt securities market.
Cash and cash equivalents. Cash and cash equivalents increased $16.2 million during the first three months of 2012. The Company expects these levels to remain steady over the next few months. The increase is largely due to the scarcity of viable investment options that produce a reasonably yield for the risk and managements effort to maintain a larger balance at the Federal Reserve Bank for future liquidity needs.
Securities. Securities available-for-sale increased by $12.0 million since December 31, 2011. Securities were purchased in an effort to increase returns on some of the cash available from the additional core deposit account balances and repurchase agreements sold during the period.
Loans. Gross loans increased $4.8 million, or 0.84%, since December 31, 2011. Most of the loan growth occurred in the commercial real estate loan portfolio. The increase in loans is related to the economic growth being experienced in the Mahoning Valley. The demand experience for the Banks business and consumer credit is consistent with the experience of other banks in the Federal Reserves Fourth District and banks nationally per the Federal Reserve Beige Book. The increase in loan balances was not enough to overcome the low interest rate environment that caused a lower level of loan income for the current quarter compared to the same quarter in 2011. On a fully tax equivalent basis, loans contributed 71.19% of total interest income for the three months ended March 31, 2012 and 73.73% for the same period in 2011.
Allowance for Loan Losses. The following table indicates key asset quality ratios that management evaluates on an ongoing basis. The unpaid principal balance of non-performing loans and non-performing assets was used in the calculation of amounts and ratios on the table below.
Asset Quality History
(In Thousands of Dollars)
For the three months ended March 31, 2012, management did not record a provision to the allowance for loan losses, compared to providing $1.9 million over the same three month period in the prior year. Although non-performing loans remained consistent from the previous quarter, other factors lead to not recording a provision in the first quarter. The primary factor was the lower historical loss percentage applied to homogeneous and pass rated loans due to recent lower levels of net charge-offs. During the most recent period end, management computed the historical loss percentage based upon the loss history of the past 12 quarters. In previous periods, management used a historical loss percentage based on the past 8 quarters. Using a 12 quarter loss history resulted in a larger historical loss ratio than what would have been computed using an 8 quarter history. The Company believes that using a loss history of the previous 12 quarters will capture more cyclicality in the loan portfolio. Net charge-offs for the quarter ended March 31, 2012 decreased to $374 thousand, compared to $1.2 million and $1.0 million for the fourth quarter of 2011 and the first quarter of 2011, respectively. The lower level of charge-offs and a lower level of delinquencies from the year ago period, which are factors considered in managements quarterly estimate of loan loss provisions and the adequacy of the allowance for loan losses.
Non-performing loans equaled 1.91% of total loans at March 31, 2012, unchanged from March 31, 2011. Loans 3089 days delinquent decreased $502 thousand, or 14.8%, to $2.9 million since March 31, 2011. Non-performing loans totaled $11.0 million at March 31, 2012, unchanged compared to December 31, 2011 and March 31, 2011, respectively. On March 31, 2012, the ratio of the allowance for loan losses (ALLL) to non-performing loans was 86%, compared to 92% at March 31, 2011. At March 31, 2012, the ALLL/total loan ratio was 1.64%, compared to 1.76% at March 31, 2011. The decrease in this ratio over the last three months is mainly the result of the asset quality metrics and improving net charge-off levels.
Based on the evaluation of the adequacy of the allowance for loan losses, management believes that the allowance for loan losses at March 31, 2012 to be adequate and reflects probable incurred losses in the portfolio. The provision for loan losses is based on management's judgment after taking into consideration all factors connected with the collectability of the existing loan portfolio. Management evaluates the loan portfolio in light of economic conditions, changes in the nature and volume of the loan portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operating expenses include previous credit loss experience, the status of past due interest and principal payments, the quality of financial information supplied by loan customers and the general condition of the industries in the community to which loans have been made.
Deposits. Total deposits increased $46.5 million, or 5.53%, since December 31, 2011. Balances in the Companys non-interest bearing deposits increased $11.0 million, or 11.44%, between December 31, 2011 and March 31, 2012. Money market accounts also increased $23.4 million between December 31, 2011 and March 31, 2012. Savings and other interest bearing demand deposits increased $11.5 million between December 31, 2011 and March 31, 2012. The Companys focus is on core deposit growth and the Company will continue to price deposit rates to remain competitive within the market and to retain customers. At March 31, 2012, core deposits savings and money market accounts, time deposits less than $100,000 and demand deposits represented approximately 88.91% of total deposits.
Borrowings. Total borrowings decreased $8.8 million, or 8.03%, since December 31, 2011. The decrease in borrowings is the result of a $7.4 million decrease in securities sold under repurchase agreements. The decrease in repurchase agreements is due to public funds deposits moving to money market deposit accounts in an effort to remain liquid and to maximize interest rate return.
Capital Resources. Total stockholders equity increased from $114.4 million at December 31, 2011 to $115.4 million at March 31, 2012. The increase is the result of net income and partially offset by fair value adjustments in the Companys investment securities and cash dividends paid to shareholders during the past three months. Shareholders received a $0.06 per share cash dividend during the first quarter of 2012 which included a one-time special $0.03 dividend. Book value per share increased 0.66% from $6.10 per share at December 31, 2011 to $6.14 per share at March 31, 2012. This increase is mainly the result of net income from the quarter ended March 31, 2012.
The capital management function is a regular process that consists of providing capital for both the current financial position and the anticipated future growth of the Company. As of March 31, 2012 the Company's total risk-based capital ratio stood at 17.35%, and the Tier I risk-based capital ratio and Tier I leverage ratio were at 16.09% and 9.55%, respectively. Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject, as of March 31, 2012.
Due to the continuing growth in the Banks business and the higher levels of its allowance for loan losses associated with current economic conditions, senior management and the Board have determined that higher levels of capital are appropriate. The Office of the Comptroller of the Currency (the OCC) concurred in the Boards view that additional capital would be beneficial in supporting its continued growth and operations. As a result, effective February 2, 2010, the OCC proposed and the Bank accepted the following individual minimum capital requirements for the Bank: Tier I Capital to Adjusted Total Assets of 7.20% and Total Capital to Risk-Weighted Assets of 11.00%. At March 31, 2012, the Bank is in compliance with these minimum capital requirements.
Critical Accounting Policies
The Company follows financial accounting and reporting policies that are in accordance with U.S. GAAP. These policies are presented in Note 1 of the consolidated audited financial statements in the Companys Annual Report to Shareholders included in the Companys Annual Report on Form 10-K for the year ended December 31, 2011. Critical accounting policies are those policies that require managements most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified two accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the Companys financial statements. These policies relate to determining the adequacy of the allowance for loan losses and other-than-temporary impairment of securities. The change in methodology for historical loss experience used in calculating the unallocated portion of the allowance for loan losses from 8 previous quarters to now using the 12 previous quarters was previously discussed. Additional information regarding these policies is included in the notes to the aforementioned 2011 consolidated financial statements, Note 1 (Summary of Significant Accounting Policies), Note 2 (Securities), Note 3 (Loans), and the sections captioned Loan Portfolio and Investment Securities.
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. U.S.GAAP establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. The Companys goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Companys trust subsidiary to provide quality, cost-effective trust services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. U.S.GAAP requires an annual evaluation of goodwill for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The fair value of the goodwill, which resides on the books of the Trust, is estimated by reviewing the past and projected operating results for the subsidiary and trust banking industry comparable information.
The Company maintains, in the opinion of management, liquidity sufficient to satisfy depositors' requirements and meet the credit needs of customers. The Company depends on its ability to maintain its market share of deposits as well as acquiring new funds. The Company's ability to attract deposits and borrow funds depends in large measure on its profitability, capitalization and overall financial condition. The Companys objective in liquidity management is to maintain the ability to meet loan commitments, purchase securities or to repay deposits and other liabilities in accordance with their terms without an adverse impact on current or future earnings. Principal sources of liquidity for the Company include assets considered relatively liquid, such as federal funds sold, cash and due from banks, as well as cash flows from maturities and repayments of loans, and securities.
Along with its liquid assets, the Bank has additional sources of liquidity available which help to ensure that adequate funds are available as needed. These other sources include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds and borrowings on approved lines of credit at major domestic banks. At March 31, 2012, these lines of credited totaled $24.5 million and the Bank had not borrowed against these lines. In addition, the Company has a $1.5 million revolving line of credit with a correspondent bank. The outstanding balance at March 31, 2012 was $350 thousand. Management feels that its liquidity position is adequate and continues to monitor the position on a monthly basis. As of March 31, 2012, the Bank had outstanding balances with the Federal Home Loan Bank of Cincinnati (FHLB) of $10.5 million with additional borrowing capacity of approximately $88.1 million with the FHLB as well as access to the Federal Reserve Discount Window, which provides an additional source of funds. The Bank views its membership in the FHLB as a solid source of liquidity.
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