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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
þ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended March 31, 2012
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition Period from _________to_________
Commission File No. 000-28333
36 Sea Island Parkway
Beaufort, SC 29907
(Address of principal executive
offices, including zip code)
(843) 522-1228
(Registrant's telephone number, including area code)
________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or smaller reporting company. See definition of “larger accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,597,207 shares of common stock, $.01 par value, were issued and outstanding on May 10, 2012.
Index
2
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Coastal Banking Company
Consolidated Balance Sheets
March 31, 2012 and December 31, 2011
See accompanying notes to unaudited consolidated financial statements.
3
Coastal Banking Company
Consolidated Statements of Operations
For the Three Months Ended March 31, 2012 and 2011
(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
4
Coastal Banking Company
Consolidated Statements of Comprehensive Income (Loss)
For the Three Months Ended March 31, 2012 and 2011
(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
5
Coastal Banking Company
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2012 and 2011
(Unaudited)
See accompanying notes to unaudited consolidated financial statements.
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Notes to Consolidated Financial Statements – March 31, 2012 and 2011 (Unaudited) and December 31, 2011
Note 1 - Basis of Presentation
Coastal Banking Company, Inc. (the “Company”) is organized under the laws of the State of South Carolina for the purpose of operating as a bank holding company for CBC National Bank (the “Bank”). The Bank commenced business on May 10, 2000 as Lowcountry National Bank. The Company acquired First National Bank of Nassau County, which began its operations in 1999, through its merger with First Capital Bank Holding Corporation (“First Capital”) on October 1, 2005. On October 27, 2006, the Company acquired the Meigs, Georgia office of the Bank through merger of Cairo Banking Co. with and into the Bank. On August 10, 2008, Lowcountry National Bank and First National Bank of Nassau County merged into one charter. Immediately after the merger, the name of the surviving bank was changed to CBC National Bank and the main office relocated to 1891 South 14th Street, Fernandina Beach, Nassau County, Florida. The Bank’s branches did business under the trade names “Lowcountry National Bank,” “First National Bank of Nassau County,” and “The Georgia Bank” in their respective markets. During 2011, the Florida and Georgia Bank branches replaced their local market trade names with CBC National Bank, and the South Carolina branches replaced their local trade name during the first quarter of 2012. The Bank provides full commercial banking services to customers throughout Beaufort County, South Carolina; Nassau County, Florida; and Thomas County, Georgia and is subject to regulation by the Office of the Comptroller of the Currency (the “OCC”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Company is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).
The Bank also has loan production offices in Savannah, Georgia and Jacksonville, Florida, as well as a residential mortgage banking division headquartered in Atlanta, Georgia. The mortgage banking division operates thirteen retail residential loan production offices in California, Connecticut, Florida, Georgia, Kansas, Maryland, New Jersey, New York, and Ohio.
The Company also has an investment in Coastal Banking Company Statutory Trust I (“Trust I”) and Coastal Banking Company Statutory Trust II (“Trust II”). Both trusts are special purpose subsidiaries organized for the sole purpose of issuing trust preferred securities.
The consolidated financial statements include the accounts of the Company and the Bank. All intercompany accounts and transactions have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with the requirements for interim financial statements and, accordingly, they omit disclosures which would substantially duplicate those contained in the Annual Report on Form 10-K for the year ended December 31, 2011. The financial statements as of March 31, 2012 and for the interim periods ended March 31, 2012 and 2011 are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. The financial information as of December 31, 2011 has been derived from the audited financial statements as of that date. For further information, refer to the financial statements and the notes included in the Company’s 2011 annual report to shareholders on Form 10-K as filed with the Securities and Exchange Commission.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates that affect the amounts of assets and liabilities and changes therein. Actual results could differ from those estimates.
Accounting Policies Recently Adopted
ASC Topic 310 “Receivables.” New authoritative accounting guidance under ASC Topic 310, “Receivables,” amended prior guidance to provide a greater level of disaggregated information about the credit quality of loans and leases and the Allowance for Loan and Lease Losses (the “Allowance”). The new authoritative guidance also requires additional disclosures related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring. The new authoritative guidance amends only the disclosure requirements for loans and leases and the allowance. The Company adopted the period end disclosures provisions of the new authoritative guidance under ASC Topic 310 in the reporting period ending December 31, 2010. Adoption of the new guidance did not have an impact on the Company’s statements of income and financial condition. The Company adopted the disclosures provisions of the new authoritative guidance about activity that occurs during a reporting period on January 1, 2011; the adoption did not have an impact on the Company’s statements of income and financial condition. The Company adopted the disclosures provisions related to loans modified in a troubled debt restructuring on July 1, 2011; the adoption did not have an impact on the Company’s statements of income and financial condition.
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ASC Topic 310 “Receivables,” Subtopic 310-40 “Troubled Debt Restructurings by Creditors.” New authoritative accounting guidance under Subtopic 310-40, “Receivables — Troubled Debt Restructurings by Creditors” amended prior guidance to provide assistance in determining whether a modification of the terms of a receivable meets the definition of a troubled debt restructuring. The new authoritative guidance provides clarification for evaluating whether a concession has been granted and whether a debtor is experiencing financial difficulties. The new authoritative guidance was effective for the reporting periods beginning after June 15, 2011 and was applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. The Company adopted this new guidance on July 1, 2011 and it did not have an impact on the Company’s statements of income and financial condition.
ASC Topic 820 “Fair Value Measurement.” New authoritative accounting guidance under ASC Topic 820, “Fair Value Measurement” amended prior guidance to achieve common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards. The new authoritative guidance clarifies the highest and best use and valuation premise, measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity, measuring the fair value of financial instruments that are managed within a portfolio, and the application of premiums and discounts in a fair value measurement. The new authoritative guidance also requires additional disclosures about fair value measurements. The Company adopted this new guidance on January 1, 2012 and it did not have an impact on the Company’s statements of income and financial condition.
ASC Topic 220 “Comprehensive Income.” New authoritative accounting guidance under ASC Topic 220, “Comprehensive Income” amended prior guidance to increase the prominence of items reported in other comprehensive income. The new guidance requires that all changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new guidance does not change the items that must be reported in other comprehensive income. The Company adopted this new guidance on January 1, 2012 and it did not have an impact on the Company’s statements of income and financial condition.
Note 2 -Regulatory Oversight, Capital Adequacy, Operating Results, Liquidity and Management’s Plans
Regulatory Oversight
The Bank entered into a formal agreement with the OCC on August 26, 2009 (the “Agreement”) that imposes certain operational and financial directives on the Bank. The specific directives of the Agreement address the credit risk in the Bank’s loan portfolio, action required to protect the Bank’s interest in criticized assets, adherence to the Bank’s written profit plan to improve and sustain earnings, limitations on the maximum allowable level of brokered deposits, excluding reciprocal CDARS deposits, and the establishment of a board level Compliance Committee to monitor the Bank’s adherence to the Agreement.
Additionally, in response to a request by the Federal Reserve Bank of Richmond, the Board of Directors of Coastal Banking Company, Inc. adopted a resolution on January 27, 2010. This resolution required that the Company obtain prior approval of the Federal Reserve Board before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends to common shareholders. The resolution also required that the Company provide the Federal Reserve Bank with prior notification before using its cash assets for purposes other than investments in obligations or equity of the Bank, investments in short-term, liquid assets, or payment of normal and customary expenses, including regularly scheduled interest payments on existing debt.
On November 17, 2010 the Company entered into a Memorandum of Understanding (“MOU”), an informal enforcement action, with the Federal Reserve Bank of Richmond in lieu of the board resolution described above. The terms of the MOU are substantially similar to the terms of the Board Resolution. Generally, the MOU requires the Company to obtain prior approval of the Federal Reserve Bank before incurring additional debt, purchasing or redeeming its capital stock, or declaring or paying cash dividends on its securities, including dividends on its common stock and TARP preferred stock, and interest on its trust preferred securities. Additionally, the MOU requires the Company to comply with banking regulations that prohibit certain indemnification and severance payments and that require prior approval of any appointment of any new directors or the hiring or change in position of any senior executive officers of the Company. The MOU also requires the submission of quarterly progress reports.
As a result of the Agreement, and the MOU, the Bank and the Company are now operating under heightened regulatory scrutiny and monitoring. Management has taken aggressive steps to address the components of the Agreement and has frequent contact with the OCC as we work to improve our financial condition and comply with all regulatory directives. Monitoring of our progress by our regulators is much more frequent and includes interim on-site visits as well as ongoing telephone consultations. Management recognizes that failure to adequately address the Agreement and the MOU could result in additional actions by the banking regulators with the potential for more severe operating restrictions and oversight requirements, including, but not limited to, the issuance of a consent order and civil money penalties.
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Capital Adequacy
As of March 31, 2012, the Bank exceeded all of the regulatory capital ratio levels to be categorized as “well capitalized.” In light of current market conditions and the Bank’s current risk profile, the Bank has determined that it must achieve and maintain a minimum ratio of total capital to risk-weighted assets of 12% and a minimum leverage ratio of 8% to be considered well capitalized under these market conditions. The Bank exceeded these internal capital ratios as well.
Key to our efforts to maintain existing capital adequacy was the need for the Bank to return to profitability through a continued focus on increasing core earnings and decreasing the levels of adversely classified and nonperforming assets. Management has pursued a number of strategic alternatives to improve the core earnings of the Bank and to reduce the level of classified assets. Current market conditions for banking institutions, the overall uncertainty in financial markets and the Bank’s high level of nonperforming assets are potential barriers to the success of these strategies. If current adverse market factors continue for a prolonged period of time, new adverse market factors emerge, and/or the Bank is unable to successfully execute its plans or adequately address regulatory concerns in a sufficient and timely manner, it could have a material adverse effect on the Bank’s business, results of operations and financial position.
Operating Results
The Company recorded net income of $300,000 for the three months ended March 31, 2012 compared to net income of $15,000 for the three months ended March 31, 2011. The increase in current year net income is a result of higher mortgage banking income, partially offset by higher direct mortgage costs, including salaries and benefits and advertising costs. During both periods, we experienced excessive levels of nonperforming assets, which caused the Company to record increased carrying costs on foreclosed properties and losses on the sale of foreclosed properties. Carrying costs on foreclosed assets are expected to remain elevated throughout 2012 as the Company continues to liquidate these nonperforming assets.
Management has implemented a number of actions in an effort to improve earnings, including continued emphasis on non-interest income from mortgage banking and small business lending activity, significant reductions to the cost of interest bearing liabilities and strict controls over other operating expenses. These actions have been effective in improving core earnings in 2011 and 2012; however, asset quality charges throughout the period continued to negatively impact earnings. Management will continue to focus on asset quality levels as concerns remain that the existing negative economic conditions may worsen, resulting in continued losses that will hinder our ability to return to profitability and further erode capital levels.
Liquidity
Management monitors liquidity on a daily basis and forecasts liquidity needs over a 90 day horizon in order to anticipate and provide for future needs. We also utilize a comprehensive contingency funding policy that uses several key liquidity ratios or metrics to define different stages of the Company’s overall liquidity position. This policy defines actions or strategies that are employed based on the liquidity position of the Company to reduce the risk of a future liquidity shortfall.
The primary sources of liquidity are cash and cash equivalents, deposits, scheduled repayments of loans, unpledged investment securities, available borrowing facilities and proceeds from loan sales receivable. Within deposits we utilize retail deposits from our branch locations, a modest level of brokered deposits, CDARS reciprocal deposits and deposits from other insured depository institutions. The Agreement requires that our brokered deposits, excluding reciprocal CDARs, not exceed 10% of our total deposits, which is consistent with our existing internal liquidity policy. As a result of our existing internal liquidity policy, we have been and anticipate continuing to be in compliance with the brokered deposit limitation provision of the Agreement. Although the FDIC Call Report defines CDARS reciprocal deposits as brokered deposits, CDARS reciprocal deposits are excluded from the brokered deposit limitation provision in the Agreement. At March 31, 2012 we have the capacity to raise up to an additional $10,064,000 in brokered deposits, if needed, and continue to remain in compliance with the 10% limitation in the Agreement. Our borrowing facilities include collateralized repurchase agreements and unsecured federal funds lines with correspondent banks, as well as borrowing agreements with the Federal Home Loan Bank of Atlanta and the Federal Reserve Bank collateralized by pledged loans and securities.
As of March 31, 2012, the Company had $172.3 million in total borrowing capacity, of which we had utilized $56.3 million or 32.7%, leaving remaining available liquidity of $116 million. Additionally, loans available for sale are considered by management as a key source of liquidity as a result of the speed with which these loans are sold and settled for cash. Management expects that, on average, loans originated for sale will be sold and converted to cash within 18 to 20 business days after the loan is originated. The balance of loans available for sale averaged just over $133 million during the first three months of 2012. Accordingly, in the event of a liquidity crisis, we anticipate having the ability to slow or stop loan origination activity to allow the loans available for sale to convert into cash. Based on current and expected liquidity needs and sources, management expects the Company to be able to meet all obligations as they become due.
9
Note 3 – Earnings (losses) Per Share The following table sets forth the computation of basic and diluted earnings (losses) per share for the three months ended March 31.
Note 4 – Investment Securities
Investment securities are as follows:
The following table shows gross unrealized losses and fair value of securities, aggregated by category and length of time that the securities have been in a continuous unrealized loss position, at March 31, 2012.
Investment securities available for sale:
As of March 31, 2012, two individual securities available for sale were in a continuous loss position for twelve months or more. The Company has reviewed these investment securities in accordance with its accounting policy for other than temporary impairment and believes, based on industry analyst reports and credit ratings, that the deterioration in value, as of March 31, 2012, was attributable to changes in market interest rates, and not due to the specific credit quality of the issuer. The unrealized loss is considered temporary because the security issuer carries an acceptable credit profile and the repayment sources of principal and interest are backed by the full faith and credit of the U.S. Government. The Company has the ability and intent to hold this security until such time as the value recovers or the security matures.
10
The following table shows gross unrealized losses and fair value of securities, aggregated by category and length of time that the securities have been in a continuous unrealized loss position, at December 31, 2011. Investment securities available for sale:
As of December 31, 2011, one individual security available for sale was in a continuous loss position for twelve months or more. The Company has reviewed this investment security in accordance with its accounting policy for other than temporary impairment and believes, based on industry analyst reports and credit ratings, that the deterioration in value, as of December 31, 2011, was attributable to changes in market interest rates, and not due to the specific credit quality of the issuer. The unrealized loss is considered temporary because the security issuer carries an acceptable credit profile and the repayment sources of principal and interest are backed by the full faith and credit of the U.S. Government. The Company has the ability and intent to hold this security until such time as the value recovers or the security matures.
In addition, as of December 31, 2011 we recorded an other-than-temporary impairment loss on one municipal security that was in a continuous loss position for over twelve months. The deterioration was due to the specific credit quality of the issuer, and management sold the security during the first quarter of 2012. Because the security’s amortized cost was reduced to equal its fair value at December 31, 2011, it was not included in the unrealized loss table above.
The amortized cost and estimated fair value of investment securities at March 31, 2012, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
Securities were pledged to secure public deposits and Federal Home Loan Bank borrowings with an amortized cost and fair value of $9,313,000 and $9,889,000, respectively, as of March 31, 2012 and $9,147,000 and $9,722,000, respectively, as of December 31, 2011. Pledged securities may not be sold without first pledging replacement securities and obtaining consent of the party to whom the securities are pledged.
Securities were sold under agreement to repurchase with an amortized cost and fair value of $9,433,000 and $9,640,000, respectively, as of December 31, 2011. No securities were sold under agreement to repurchase as of March 31, 2012.
Gains and losses on sales of securities available for sale consist of the following:
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Note 5 — Loans and allowance for loan losses
The composition of loans is summarized as follows:
The Bank grants loans and extensions of credit to individuals and a variety of businesses and corporations located in its general trade areas of Beaufort County, South Carolina, Nassau County, Florida and Thomas County, Georgia. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate and is dependent upon the real estate market.
A loan is considered impaired, in accordance with the impairment accounting guidance (FASB ASC 310-10-35-16), when, based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Additionally, recent FASB guidance requires that by definition, all loans classified as troubled debt restructurings must also be classified as impaired. In cases where management believes a restructured loan will return all amounts due under the restructured loan terms, and those terms do not include the loss of any portion of the original principal balance, restructured loans are not internally classified, monitored or managed as impaired loans. Accordingly, GAAP reporting requirements result in a higher level of loans classified as impaired than are considered as impaired by management. Impaired loans as defined by GAAP are summarized as follows:
12
As of March 31, 2012, there are four restructured loans with a recorded investment of $2,451,000 included in the impaired loans table above, as required by GAAP, that management has not internally classified as impaired. These loans are performing in accordance with their restructured terms such that we expect to recover all loan principal and interest, however, these loans meet the GAAP definition of a TDR. While these loans meet the technical definition of a TDR and must therefore be classified as impaired under GAAP, management evaluates these loans as non-impaired.
Loans exhibiting one or more of the following attributes are placed on a nonaccrual status:
The following is a summary of current, past due and nonaccrual loans:
Management evaluates all loan relationships periodically in order to assess the financial strength of the borrower and the value of any underlying collateral. Based on the results of these evaluations, management will assign internal loan classifications to designate the relative strength of the credit. The internal grades used are Pass, Special Mention, and Substandard. Within the Pass classification, there are sub grades that range from High to Acceptable, all of which indicate that the loan is expected to continue to perform in accordance with its terms. Loans with potential weaknesses that deserve management’s close attention are classified as Special Mention. If the potential weakness in a Special Mention loan was to go uncorrected, it could result in deteriorating prospects for continued loan performance at some future date; however, the loan is not currently adversely classified. The Substandard classification is assigned to loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. These loans have a well-defined weakness that jeopardizes the payment of the debt or the liquidation of the collateral securing the debt, and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Special Mention or Substandard are subject to increased monitoring by management. This typically includes frequent contact with the borrower to actively manage the borrowing relationship as needed to rehabilitate or mitigate the weakness, or potential weakness, identified.
13
A summary of loan credit quality is presented below:
Risk Elements in the Loan Portfolio
The following is a summary of risk elements in the loan portfolio:
As shown above, we have a moderate concentration of interest only loans in our portfolio, and such loans are generally regarded as carrying a higher risk profile than fully amortizing loans. It is important to note that none of the interest only loans in our portfolio allow negative amortization, nor do we have any loans with capitalized interest reserves.
14
We also monitor and evaluate several other loan portfolio characteristics at a total portfolio level rather than by major loan category. These characteristics include: Junior Liens – Loans secured by liens in subordinate positions tend to have a higher risk profile than loans secured by liens in the first or senior position. At March 31, 2012 the Company held $20,901,000 of loans secured by junior liens, which represented approximately 8.4% of the total net loan portfolio. Net loan charge-offs was $143,000 in the quarter ended March 31, 2012 for all loans secured by junior liens for an annualized loss rate of 2.7%. At December 31, 2011 the Company held $21,470,000 of loans secured by junior liens which represented approximately 8.4% of the total net loan portfolio. Historical loss experience as measured by net loan charge offs was $232,000 in the year ended December 31, 2011 for all loans secured by junior liens for an annualized loss rate of 1.1%.
High Loan to Value Ratios – Typically the Company will not originate a new loan with a loan to value (LTV) ratio in excess of 100%. However, declines in collateral values can result in the case of an existing loan renewal with an LTV ratio in excess of 100% based on the current appraised value of the collateral. In such cases the borrower may be asked to pledge additional collateral or to renew the loan for a lesser amount. If the borrower lacks the ability to pay down the loan or provide additional collateral, but has the ability to continue to service the debt, the loan will be renewed with an LTV ratio in excess of 100%. At March 31, 2012 the loan portfolio included 44 loans with an aggregate balance of $17,882,000, or 7.2% of the net loan portfolio, with LTV ratios in excess of 100%. At December 31, 2011 the loan portfolio included 39 loans with an aggregate balance of $12,661,000, or 5.0% of the net loan portfolio, with LTV ratios in excess of 100%.
Restructured Loans – Historically, the Company has followed a conservative approach by classifying any loan as restructured whenever the terms of a loan were adjusted to the benefit of any borrower in financial distress, regardless of the status of the loan at the time of restructuring. In some cases we have restructured loans for borrowers who were not delinquent, but for various reasons these borrowers were experiencing financial distress that raised a doubt about their continued ability to make payments under current terms. By adjusting the terms of the loan to better fit the borrower’s current financial condition, expectations are that the loan will avoid a future default. In other cases we have restructured loans for borrowers who were in default at the time the loan terms were restructured. The expectation is that by adjusting the terms of such loans, the borrower may begin to make payments again based on the improved loan terms.
The types of changes that are made for troubled borrowers to restructure their obligations include the following:
The potential financial effects of restructuring troubled debts includes a reduction in the level of interest income collected, a complete loss of interest income, or a loss of some portion of the original loan principal. All troubled debt restructurings are tested for impairment. If a loan is considered to be collateral dependent, the measurement of impairment is based on the fair value of the collateral, net of estimated liquidation costs. If the loan is not considered to be collateral dependent, the present value of expected cash flows is used to determine any amount of impairment. Any impairment is then charged to the allowance for loan and lease losses or designated as a specific reserve, and as such will be considered as a component of the reserve calculation.
For regulatory purposes, in 2010 and prior years, restructured loans that were accruing interest (not on nonaccrual status) would be reported as performing restructured loans until the end of the fiscal year in which the restructure occurred. At the beginning of the following fiscal year, the “restructured” designation for these performing restructured loans was removed, provided the borrower was paying in accordance with the restructured loan terms and the loan had a market rate of interest.
Recent interpretations of the topic of restructured loans by the Company’s primary regulator will effectively prohibit the practice of removing the “restructured” designation from any restructured loan during the life of the loan, beginning with the third quarter of 2011. For 2011 and later, all restructured loans will continue to be reported as restructured, even if (1) the underlying conditions that resulted in the borrower’s financial distress were cured, (2) the loan terms were modified back to current fair value levels, (3) the loan is current and accruing interest, and (4) the borrower has not missed a payment since the loan was restructured. As a result, expectations are that the level of restructured loans will continue to increase in the future.
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The following table provides a summary of all loans that are currently designated as restructured for regulatory purposes.
The following table provides the payment status as of March 31, 2012 and March 31, 2011 of all loans that were restructured in the twelve month periods ending on those respective dates.
Loans classified as Special Mention or Substandard – Management evaluates all loan relationships periodically in order to assess the financial strength of the borrower and the value of any underlying collateral. Loans that are found to have a potential or actual weakness are classified as special mention or substandard and subject to increased monitoring by management. This typically includes frequent contact with the borrower to actively manage the borrowing relationship as needed to rehabilitate or mitigate the weakness identified. At March 31, 2012, the Company had $35,325,000 in loans that were internally classified as Special Mention or Substandard, of which $28,290,000, or 80%, were either current or less than 30 days past due. At December 31, 2011, the Company had $38,537,000 in loans that were internally classified as Special Mention or Substandard, of which $28,141,000, or 73%, were either current or less than 30 days past due.
We have established an allowance for loan losses through a provision for loan losses charged to expense on our statement of earnings. Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on management’s analysis of the potential risk in the loan portfolio. The allowance for loan losses represents an amount, which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based upon a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. To the extent that the recovery of loan balances has become collateral dependent, we obtain appraisals not less than annually, and then we reduce these appraised values by the amount estimated for selling and holding costs to determine the liquidated value. Any shortfall between the liquidated value and the loan balance is charged against the allowance for loan losses in the month the related appraisal was received. Our losses will undoubtedly vary from our estimates, and there is a possibility that charge-offs can reduce this allowance. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, commercial and residential real estate market trends, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons.
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An analysis of the activity in the allowance for loan losses is presented below:
The following tables provide additional information concerning changes to the allowance for loan losses within major loan categories:
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Note 6 — Other Real Estate Owned
A summary of other real estate owned is presented as follows:
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