XOTC:CECB Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________

FORM 10-Q

[ x ]        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012.

OR

[   ]         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________

Commission File Number   0-24926

CECIL BANCORP, INC.
(Exact name of Registrant as specified in its charter)

Maryland
 
52-1883546
(State or other jurisdiction of
Incorporation or organization)
 
(I.R.S. Employer Identification No.)

127 North Street, Elkton, Maryland
 
21921
 
(Address of principal executive offices)
 
(Zip Code)
 

(410) 398-1650
(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 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[X] YES                      [   ] NO
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
[X] YES                      [   ] NO

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

 
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer o
 
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                      [X] NO

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At August 3, 2012, there were 7,422,164 shares of common stock outstanding
 
 
Page 1

 

CECIL BANCORP, INC. AND SUBSIDIARIES


CONTENTS


   
PAGE
PART I - FINANCIAL INFORMATION
   
     
    ITEM 1.
Financial Statements (unaudited)
   
       
 
Consolidated Balance Sheets -
 
3
 
June 30, 2012 and December 31, 2011
   
       
 
Consolidated Statements of Operations and Comprehensive Income (Loss)
 
4-5
 
for the Three and Six Months Ended June 30, 2012 and 2011)
   
       
 
Consolidated Statements of Cash Flows
 
6
 
for the Six Months Ended June 30, 2012 and 2011 (Unaudited)
   
       
 
Notes to Consolidated Financial Statements
 
7-25
       
    ITEM 2.
Management’s Discussion and Analysis of Financial Condition
 
26-35
 
and Results of Operations
   
     
    ITEM 3.
Quantitative and Qualitative Disclosure About Market Risk
 
35
     
    ITEM 4.
Controls and Procedures
 
35
     
PART II – OTHER INFORMATION
 
35-37
     
SIGNATURES
 
38
     
CERTIFICATIONS
 
39-42
     

 
 
Page 2

 
 
PART I.    Financial Information
ITEM 1.   Financial Statements

CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)

    
June 30,
   
December 31,
 
   
2012
   
2011
 
   
(Unaudited)
       
ASSETS
           
Cash and due from banks
  $ 28,676     $ 19,944  
Interest bearing deposits with banks
    1,829       13,908  
Federal funds sold
    909       559  
  Total cash and cash equivalents
    31,414       34,411  
Investment securities:
               
  Securities available-for-sale at fair value
    26,526       23,656  
  Securities held-to-maturity (fair value of $5,921
               
   in 2012 and $9,736 in 2011)
    5,897       9,745  
Restricted investment securities – at cost
    3,921       4,296  
Loans receivable
    324,190       330,262  
  Less: allowance for loan losses
    (10,908 )     (12,412 )
    Net loans receivable
    313,282       317,850  
Other real estate owned
    41,925       30,966  
Premises and equipment, net
    9,880       10,041  
Accrued interest receivable
    1,541       1,523  
Mortgage servicing rights
    458       467  
Bank owned life insurance
    8,377       8,284  
Deferred tax assets
    9,251       9,318  
Assets held for sale
    -       5,903  
Income taxes receivable
    5,403       5,276  
Other assets
    1,960       1,935  
    TOTAL ASSETS
  $ 459,835     $ 463,671  
LIABILITIES:
               
Deposits
  $ 343,270     $ 339,075  
Other liabilities
    11,758       10,612  
Junior subordinated debentures
    17,000       17,000  
Advances from Federal Home Loan Bank of Atlanta
    53,500       63,500  
Other borrowed funds
    1,169       1,169  
    Total liabilities
    426,697       431,356  
STOCKHOLDERS’ EQUITY:
               
Preferred stock, $.01 par value; authorized 1,000,000 shares
               
  Series A issued and outstanding 11,560 shares, liquidation
               
   preference $1,000 per share, in 2012 and 2011
    11,278       11,200  
  Series B issued and outstanding 164,575 shares, liquidation
               
   preference $17.20 per share, in 2012 and zero in 2011
    2,796       -  
Common stock, $.01 par value; authorized 10,000,000
               
  shares, issued and outstanding 7,422,164 shares in
               
  2012 and 2011
    75       75  
Additional paid in capital
    12,299       12,299  
Retained earnings
    6,568       8,721  
Accumulated other comprehensive income
    122       20  
    Total stockholders’ equity
    33,138       32,315  
    TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 459,835     $ 463,671  

See accompanying notes to consolidated financial statements.
 
 
Page 3

 
CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)

   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
INTEREST INCOME:
                       
  Interest and fees on loans
  $ 4,806     $ 5,365     $ 9,145     $ 11,191  
  Interest on investment securities
    83       97       183       154  
  Dividends on FHLB and FRB stock
    35       17       56       34  
  Other interest income
    15       15       29       33  
    Total interest income
    4,939       5,494       9,413       11,412  
                                 
                                 
INTEREST EXPENSE:
                               
  Interest expense on deposits
    941       1,125       1,910       2,386  
  Interest expense on junior subordinated debentures
    96       179       258       476  
  Interest expense on advances from FHLB
    543       614       1,156       1,221  
  Interest expense on other borrowed funds
    5       9       20       24  
    Total interest expense
     1,585       1,927       3,344       4,107  
                                 
NET INTEREST INCOME
    3,354       3,567       6,069       7,305  
                                 
PROVISION FOR LOAN LOSSES
    110       4,500       3,060       5,000  
                                 
NET INTEREST INCOME (LOSS) AFTER
                               
  PROVISION FOR LOAN LOSSES
    3,244       (933 )     3,009       2,305  
                                 
NONINTEREST INCOME:
                               
  Deposit account fees
    121       140       236       274  
  ATM fees
    123       117       238       223  
  Commission income
    1       -       1       1  
  Gain on sale of loans
    297       30       1,353       87  
  Loss on sale of other real estate owned
    (15 )     (140 )     (225 )     (145 )
  Loss on investments
    -       -       -       (50 )
  Income from bank owned life insurance
    48       56       92       102  
  Other
    159       75       252       149  
                                 
    Total noninterest income
    734       278       1,947       641  
                                 
NONINTEREST EXPENSE:
                               
  Salaries and employee benefits
    1,157       1,405       2,482       2,689  
  Occupancy expense
    176       177       359       400  
  Equipment and data processing expense
    312       328       634       626  
  FDIC deposit insurance premiums
    243       632       530       824  
  Other real estate owned expense and valuation
    1,407       645       1,842       1,341  
  Professional fees
    404       296       914       463  
  Loan collection expense
    344       199       430       14  
  Other
    414       271       763       570  
    Total noninterest expense
    4,457       3,953       7,954       7,427  
                                 
NET LOSS BEFORE INCOME TAXES
    (479 )     (4,608 )     (2,998 )     (4,481 )
                                 
INCOME TAX BENEFIT
    (208 )     (1,874 )     (1,212 )     (1,833 )
                                 
NET LOSS (CARRIED FORWARD)
  $ (271 )   $ (2,734 )   $ (1,786 )   $ (2,648 )
 
Page 4

 
 
CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(dollars in thousands, except per share data)



   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
NET LOSS (BROUGHT FORWARD)
  $ (271 )   $ (2,734 )   $ (1,786 )   $ (2,648 )
                                 
OTHER COMPREHENSIVE LOSS
                               
  Unrealized gains (losses) on
                               
   investment securities,
                               
   net of deferred taxes
    97       (36 )     102       (49 )
 
                               
TOTAL COMPREHENSIVE LOSS
  $ (174 )   $ (2,770 )   $ (1,684 )   $ (2,697 )
                                 
                                 
NET LOSS
  $ (271 )   $ (2,734 )   $ (1,786 )   $ (2,648 )
                                 
PREFERRED STOCK DIVIDENDS
                               
  AND DISCOUNT ACCRETION
    (183 )     (181 )     (367 )     (362 )
                                 
NET LOSS AVAILABLE TO
                               
COMMON STOCKHOLDERS
  $ (454 )   $ (2,915 )   $ (2,153 )   $ (3,010 )
                                 
Loss per common share - basic
  $ (0.06 )   $ (0.39 )   $ (0.29 )   $ (0.41 )
                                 
Loss per common share - diluted
  $ (0.06 )   $ (0.39 )   $ (0.29 )   $ (0.41 )
                                 
Dividends declared per common share
  $ 0.00     $ 0.00     $ 0.00     $ 0.00  
See accompanying notes to consolidated financial statements.


 
Page 5

CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2012 AND 2011
(dollars in thousands)
   
2012
   
2011
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
  Net loss
  $ (1,786 )   $ (2,648 )
  Adjustments to reconcile net loss to net cash
               
   provided (used) by operating activities:
               
    Depreciation and amortization
    694       387  
    Provision for loan losses
    3,060       5,000  
    Gain on sale of loans
    (1,353 )     (87 )
    Loss on sale of other real estate owned
    225       145  
    Loss on investments
    -       50  
    Loss (gain) on premises and equipment
    6       (10 )
    Gain on assets held for sale
    (18 )     -  
    Increase in cash surrender value of bank owned life insurance
    (92 )     (102 )
    Valuation allowance on other real estate owned
    1,141       928  
    Excess servicing rights
    (46 )     (48 )
    Origination of loans held for sale
    (18,334 )     (4,002 )
    Proceeds from sales of loans held for sale
    19,679       4,050  
    Net change in:
               
      Accrued interest receivable and other assets
    (40 )     (4,276 )
      Other liabilities
    856       (87 )
     Net cash provided by (used in) operating activities
    3,992       (700 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Purchases of investment securities available-for-sale
    (8,962 )     (4,437 )
  Purchases of investment securities held-to-maturity
    (250 )     (13,834 )
  Proceeds from sales, maturities, calls and principal
               
   payments of investment securities available-for-sale
    5,978       171  
  Proceeds from maturities, calls and principal
               
   payments of investment securities held-to-maturity
    3,998       6,128  
  Net redemption of restricted investment securities
    375       18  
  Net (increase) decrease in loans
    (12,150 )     12,950  
  Proceeds from sale of other real estate owned
    1,220       1,267  
  Proceeds from sale of premises and equipment
    25       19  
  Proceeds from sale of assets held for sale
    5,911       -  
  Purchases of premises and equipment
    (125 )     (199 )
     Net cash (used in) provided by investing activities
    (3,980 )     2,083  
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Net increase (decrease) in deposits
    4,195       (15,171 )
  Net decrease in advances from Federal Home Loan Bank of Atlanta
    (10,000 )     -  
  Proceeds from issuance of preferred stock
    2,796       -  
  Proceeds from issuance of common stock
    -       21  
     Net cash used in financing activities
    (3,009 )     (15,150 )
DECREASE IN CASH AND CASH EQUIVALENTS
    (2,997 )     (13,767 )
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    34,411       51,969  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 31,414     $ 38,202  
                 
Supplemental disclosure of cash flows information:
               
  Cash paid for income taxes
  $ -     $ 1,355  
  Cash paid for interest
  $ 3,155     $ 3,636  
  Transfer from loans to other real estate owned
  $ 13,666     $ 6,862  
See accompanying notes to consolidated financial statements.
 
Page 6

 

 
CECIL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011
 
1.           GENERAL
 
In the opinion of Cecil Bancorp, Inc. and subsidiaries (the “Company”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position as of June 30, 2012 and the results of its operations and cash flows for the three and six months ended June 30, 2012 and 2011.  These statements are condensed and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  The statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.  The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year or for any other period.
 
2.           FINANCIAL STATEMENT PREPARATION
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Estimates are used when accounting for uncollectible loans, depreciation and amortization, intangible assets, deferred income taxes, and contingencies, among others.  Actual results could differ from those estimates.
 
3.           RECENT ACCOUNTING PRONOUNCEMENTS
 
FASB ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income”
 
                This ASU increases the prominence of other comprehensive income (“OCI”) in financial statements and provides two options for presenting OCI. The ASU eliminates the current placement near the statement of shareholders’ equity or detailed in the Consolidated Statement of Changes in Shareholders’ Equity. The ASU provides for an OCI statement to be included with the net income statement, and together the two will make a statement of total comprehensive income. Alternatively, businesses can have an OCI statement separate from a net income statement, but the two statements will have to appear consecutively within a financial report. The ASU does not affect the calculation of OCI. The ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The adoption of ASU 2011-05 did not have a material impact on the Company’s financial condition or results of operations.
 
FASB ASU 2011-04, “Fair Value Measurement (Topic 820) –Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”
 
                This ASU amends the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. The ASU clarifies the application of existing fair value measurement requirements and changes the principles or requirements for measuring fair value or for disclosing information about fair value measurements. The ASU will require new disclosures for any transfers between Levels 1 and 2 of the fair value hierarchy, not just significant transfers, and further expands focus on Level 3 measurements, including quantitative information about the significant unobservable inputs used for all Level 3 measurements, a qualitative discussion about the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed, and a description of the valuation processes. The ASU is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact on the Company’s financial condition or results of operations.
 
 
 
Page 7

 
 
FASB ASU 2011-03, “Transfer and Servicing (Topic 860) –Reconsideration of Effective Control of Repurchase Agreements”
 
                This ASU improves the accounting for repurchase agreements and other agreements that entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The ASU removes from the assessment of effective control: (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this ASU. The ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The adoption of ASU 2011-03 did not have a material impact on the Company’s financial condition or results of operations.
 
4.           EARNINGS PER SHARE
 
Basic earnings per common share are computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share are computed after adjusting the denominator of the basic earnings per share computation for the effects of all dilutive potential common shares outstanding during the period.  The dilutive effects of options, warrants, and their equivalents are computed using the “treasury stock” method.  For the three and six months ended June 30, 2012 and 2011, all 523,076 options and warrants were excluded from the diluted earnings per share calculation because their effect was antidilutive.  All earnings per share calculations have been adjusted to give retroactive effect to the 2-for-1 stock split, effected through a 100% stock dividend, declared by the Board of Directors in May 2011.  The calculation of net (loss) income per common share for the three and six months ended June 30, 2012 and 2011 is as follows:

    
Three Months Ended
June 30, 2012
   
Six Months Ended
June 30, 2012
 
   
2012
   
2011
   
2012
   
2011
 
Basic and diluted:
                       
Net loss
  $ (271,000 )   $ (2,734,000 )   $ (1,786,000 )   $ (2,648,000 )
Preferred stock dividends and discount accretion
    (183,000 )     (181,000 )     (367,000 )     (362,000 )
Net loss available to common stockholders
  $ (454,000 )   $ (2,915,000 )   $ (2,153,000 )   $ (3,010,000 )
                                 
Average common shares outstanding
    7,422,164       7,412,793       7,422,164       7,406,650  
                                 
Basic and diluted loss per common share
  $ (0.06 )   $ (0.39 )   $ (0.29 )   $ (0.41 )

5.       ACCOUNTING FOR STOCK BASED COMPENSATION PLANS
 
    In November 2009, the Company approved the granting of 120,250 restricted stock awards with a fair market value of $2.00 per share.  The awards vest over a period of five years.  All restricted stock awards have been adjusted to give retroactive effect to the 2-for-1 stock split declared by the Board of Directors in May 2011.  A summary of the Company’s activity and related information for restricted stock for the periods indicated is as follows:

  
Six Months Ended
 
Year Ended
 
June 30, 2012
 
December 31, 2011
     
Weighted-
     
Weighted-
     
Average
     
Average
 
Shares
 
Exercise Price
 
Shares
 
Exercise Price
                   
Unvested at beginning of period
111,694
 
$
2.00
 
116,288
 
$
2.00
Forfeited
 —
   
 
(1,926
)
 
 2.00
Awarded
 —
   
 
   
Released
 —
   
 —
 
(2,668
)
 
2.00
Unvested at end of period
111,694
 
$
2.00
 
111,694
 
$
2.00

 
Page 8

 

6.       ASSETS MEASURED AT FAIR VALUE

    The Company applies guidance issued by FASB regarding fair value measurements, which provides a framework for measuring and disclosing fair value under generally accepted accounting principles.  The guidance applies only to fair value measurements required or permitted under current accounting pronouncements, but does not require any new fair value measurements.  Fair value is defined as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the measurement date.  The guidance also expands disclosures about financial instruments that are measured at fair value and eliminates the use of large position discounts for financial instruments quoted in active markets.  The disclosure’s emphasis is on the inputs used to measure fair value and the effect on the measurement on earnings for the period.  The adoption of the guidance did not have any effect on the Company’s financial position or results of operations.  For Level 1 assets, the Company uses quoted prices in active markets.  For Level 2 assets, the Company uses information from a third party pricing service, which is estimated using market prices of comparable instruments or other methods, such as the present value of future cash flows.  The following table shows the value (in thousands) at June 30, 2012 and December 31, 2011 of each major category of assets measured at fair value on the consolidated balance sheets, which consists solely of investment securities available-for-sale.  The changes in fair value were reflected as a component of other comprehensive income and did not affect net income.

    
Fair Value Measurements at Reporting Date Using
 
Description
 
Carrying
Value
   
Quoted Prices
in Active
Markets For
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
June 30, 2012
                       
Investment securities available-for-sale
                       
Mutual funds – mortgage securities
  $ 712     $ 712     $     $  
Mutual funds – U.S. Government
                               
   securities
    675       675              
Equity securities
    431       431              
SBA securitized loan pools
    4,080             4,080        
Other debt securities
    1,344             1,344        
Mortgage-backed securities
    19,284             19,284        
                                 
Total investment securities available-for-sale
  $ 26,526     $ 1,818     $ 24,708     $  



 
Page 9

 
 

   
Fair Value Measurements at Reporting Date Using
 
Description
 
Carrying
Value
   
Quoted Prices
in Active
Markets For
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
December 31, 2011
                       
Investment securities available-for-sale
                       
Mutual funds – mortgage securities
  $ 711     $ 711     $     $  
Mutual funds – U.S. Government
                               
   securities
    674       674              
Equity securities
    362       362              
SBA securitized loan pools
    4,921             4,921        
Other debt securities
    3,167             3,167        
Mortgage-backed securities
    13,821             13,821        
                                 
Total investment securities available-for-sale
  $ 23,656     $ 1,747     $ 21,909     $  

    We may be required from time to time to measure certain other financial assets and liabilities at fair value on a nonrecurring basis.  These adjustments to fair value usually result from application of lower of cost or market accounting or write-downs of individual assets.  For assets measured at fair value on a nonrecurring basis at June 30, 2012 and December 31, 2011, the following table provides in thousands the level of valuation assumptions used to determine each adjustment and the carrying value of the assets.  For both other real estate owned and impaired loans, Level 3 assets are valued at the lesser of the unpaid principal balance of the loan, or the appraised value of the underlying collateral, net of estimated selling costs, as determined by a third party appraiser.  There have been no changes in valuation techniques for the quarter ended June 30, 2012.  There were no transfers between valuation levels for any assets during the quarter ended June 30, 2012.

    
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
             
         
In Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
   
Carrying
   
Assets
   
Inputs
   
Inputs
 
Description
 
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
June 30, 2012
                       
Other real estate owned:
                       
  Construction & Land Development
  $ 25,248     $ 0     $ 0     $ 25,248  
  1-4 Family Residential
    7,149       0       0       7,149  
  Commercial Real Estate
    9,528       0       0       9,528  
     Total
  $ 41,925     $ 0     $ 0     $ 41,925  
                                 
Impaired loans:
                               
  Construction & Land Development
  $ 8,222     $ 0     $ 0     $ 8,222  
  1-4 Family Residential
    14,303       0       0       14,303  
  Commercial Real Estate
    22,224       0       0       22,224  
  Commercial Business
    225       0       0       225  
     Total
  $ 44,974     $ 0     $ 0     $ 44,974  
                                 

 
Page 10

 

December 31, 2011
                               
Other real estate owned:
                               
  Construction & Land Development
  $ 14,747     $ 0     $ 0     $ 14,747  
  1-4 Family Residential
    7,179       0       0       7,179  
  Commercial Real Estate
    9,040       0       0       9,040  
     Total
  $ 30,966     $ 0     $ 0     $ 30,966  
                                 
Impaired loans:
                               
  Construction & Land Development
  $ 23,266     $ 0     $ 0     $ 23,266  
  1-4 Family Residential
    14,531       0       0       14,531  
  Multi-Family Residential
    286       0       0       286  
  Commercial Real Estate
    23,584       0       0       23,584  
  Commercial Business
    661       0       0       661  
  Consumer
    163       0       0       163  
     Total
  $ 62,491     $ 0     $ 0     $ 62,491  
 
7.           FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC 825-10-50 requires that the Company disclose estimated fair values for both its on and off-balance-sheet financial instruments. The following methods and assumptions were used to estimate the fair value of the Company’s financial instruments. Changes in estimates and assumptions could have a significant impact on these fair values.

Investment Securities - The fair values of investment securities are based on quoted market prices, where available. If a quoted market price is not available, fair value is estimated using quoted market prices of comparable instruments.

Loans receivable - The fair value of the loan portfolio is estimated by evaluating homogeneous categories of loans with similar financial and credit risk characteristics. Loans are segregated by types, such as residential mortgage, commercial real estate and consumer. Each loan category is further segmented into fixed and adjustable-rate interest terms.

The fair values of each loan category are estimated by discounting contractual cash flows adjusted for estimated prepayments. Assumptions regarding prepayment estimates and discount rates are judgmentally determined by using available market information.

Restricted Investment Securities - The fair value of the Company’s investment in stock of the FHLB and FRB approximates its carrying value.

Deposits - The fair values of deposits are estimated using a discounted cash flow calculation, adjusted for estimated decay rates, that applies interest rates currently offered for funding sources with similar maturities. Assumptions regarding discount rates and decay estimates are judgmentally determined by using available market information.

Junior Subordinated Debentures – The fair value was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Advances from the FHLB - The fair value of FHLB advances was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Other Borrowed Funds – The fair value was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Commitments to Extend Credit - The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial
 
 
Page 11

 
 
and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.
 
The estimated fair values of financial instruments (in thousands) at June 30, 2012 are as follows:

         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
         
         
In Active
 
Significant
     
         
Markets for
 
Other
 
Significant
 
         
Identical
 
Observable
 
Unobservable
 
 
Carrying
     
Assets
 
Inputs
 
Inputs
 
 
Value
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Financial assets:
                             
  Investment securities:
                             
      Available-for-sale
  $ 26,526     $ 26,526     $ 1,818     $ 24,708     $  
      Held-to-maturity
    5,897       5,921             5,921        
  Loans receivable
    324,190       365,342                   365,342  
  Restricted investment securities
    3,921       3,921             3,921        
Financial liabilities:
                                       
  Deposits
    343,270       326,641                   326,641  
  Junior subordinated debentures
    17,000       17,004             17,004        
  Advances from FHLB
    53,500       53,552             53,552        
  Other borrowed funds
    1,169       1,168             1,168        


  The estimated fair values of financial instruments (in thousands) at December 31, 2011 are as follows:
 
          
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
         
         
In Active
 
Significant
     
         
Markets for
 
Other
 
Significant
 
         
Identical
 
Observable
 
Unobservable
 
 
Carrying
     
Assets
 
Inputs
 
Inputs
 
 
Value
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Financial assets:
                             
  Investment securities:
                             
      Available-for-sale
  $ 23,656     $ 23,656     $ 1,747     $ 21,909     $  
      Held-to-maturity
    9,745       9,736             9,736        
  Loans receivable
    330,262       401,098                   401,098  
  Restricted investment securities
    4,296       4,296             4,296        
Financial liabilities:
                                       
  Deposits
    339,075       322,027                   322,027  
  Junior subordinated debentures
    17,000       14,711             14,711        
  Advances from FHLB
    63,500       63,662             63,662        
  Other borrowed funds
    1,169       1,168             1,168        


 
Page 12

 

8.           INVESTMENT SECURITIES

Investment securities have been classified in the consolidated balance sheets according to management’s intent and ability to hold the investment.  Investment securities at June 30, 2012 and December 31, 2011 are summarized in the following table (in thousands).

    June 30, 2012  
          Gross     Gross     Estimated  
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
                         
Available-for-Sale:
                       
Mutual funds - mortgage securities
  $ 747     $ 5     $ 40     $ 712  
Mutual funds - U.S. Government securities
    686             11       675  
Equity securities
    226       205             431  
SBA securitized loan pools
    4,137       3       60       4,080  
Other debt securities
    1,350       2       8       1,344  
Mortgage-backed securities
    19,177       148       41       19,284  
    $ 26,323     $ 363     $ 160     $ 26,526  
                                 
Held-to-Maturity:
                               
SBA securitized loan pools
  $ 1,695     $     $ 20     $ 1,675  
Other debt securities
    500       11             511  
Mortgage-backed securities
    3,452       47       14       3,485  
U. S. Treasury securities and obligations
    250                   250  
    $ 5,897     $ 58     $ 34     $ 5,921  

 
    December 31, 2011  
           Gross      Gross      Estimated  
     Amortized      Unrealized      Unrealized      Fair  
     Cost     Gains       Losses      Value  
Available-for-Sale:
                       
Mutual funds - mortgage securities
  $ 747     $ 5     $ 41     $ 711  
Mutual funds - U.S. Government securities
    686             12       674  
Equity securities
    226       136             362  
SBA securitized loan pools
    4,947       9       35       4,921  
Other debt securities
    3,200       4       37       3,167  
Mortgage-backed securities
    13,817       49       45       13,821  
    $ 23,623     $ 203     $ 170     $ 23,656  
                                 
Held-to-Maturity:
                               
SBA securitized loan pools
  $ 2,161     $       32     $ 2,129  
Other debt securities
    1,500       12             1,512  
Mortgage-backed securities
    5,334       41       30       5,345  
U. S. Treasury securities and obligations
    750                   750  
    $ 9,745     $ 53     $ 62     $ 9,736  


 
Page 13

 


As of June 30, 2012, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

   
Less than 12 Months
   
More than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available-for-Sale:
                                   
  Mutual funds – mortgage securities
  $     $     $ 136     $ 40     $ 136     $ 40  
  Mutual funds – US Govt securities
                675       11       675       11  
  SBA securitized loan pools
    1,918       46       1,280       14       3,198       60  
  Other debt securities
    843       8                   843       8  
  Mortgage-backed securities
    4,336       19       624       22       4,960       41  
Held-to-Maturity:
                                               
  SBA securitized loan pools
    327       2       1,299       18       1,626       20  
  Mortgage-backed securities
    286       3       973       11       1,259       14  
    $ 7,710     $ 78     $ 4,987     $ 116     $ 12,697     $ 194  

As of December 31, 2011, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

    
Less than 12 Months
   
More than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available-for-Sale:
                                   
  Mutual funds – mortgage securities
  $     $     $ 135     $ 41     $ 135     $ 41  
  Mutual funds – US Govt securities
                674       12       674       12  
  SBA securitized loan pools
    3,892       35                   3,892       35  
  Other debt securities
    913       37                   913       37  
  Mortgage-backed securities
    7,141       41       203       4       7,344       45  
Held-to-Maturity:
                                               
  SBA securitized loan pools
    2,129       32                   2,129       32  
  Mortgage-backed securities
    1,799       30                   1,799       30  
    $ 15,874     $ 175     $ 1,012     $ 57     $ 16,886     $ 232  

The securities with unrealized holding losses are impaired due to declines in fair value resulting from changes in interest rates. None of these securities have exhibited a decline in value due to changes in credit risk. Additionally, the Company has the intent and ability to hold the mortgage-backed securities until they mature, and the equity securities until the foreseeable future, does not expect to realize losses on any of the investments, and it is more likely than not that we will not be required to sell. Therefore, management does not consider the declines in fair value to be other than temporary.

9.           CREDIT QUALITY OF LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
 
The Company has segregated its loan portfolio into six segments, including construction and land development, 1-4 family residential, multi-family residential, commercial real estate, commercial business, and consumer.  The Company’s primary market area is in Northeastern Maryland in Cecil and Harford Counties, so exposure to credit risk is significantly affected by changes in these counties.
 
Construction lending primarily involves lending for construction of single family residences, although the Bank does lend funds for the construction of commercial properties and multi-family real estate.  All loans for the construction of speculative sale homes have a loan-to-value ratio of not more than 80%.  The Bank has financed the construction of non-residential properties on a case by case basis.  Loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion.  Construction projects are inspected by contracted inspectors or bank personnel.  
 
Page 14

 
 
Construction loans are underwritten on the basis of the estimated value of the property as completed. The Bank originates loans secured by raw land, which are generally granted to developers have terms of up to three years.  The substantial majority of land loans have a loan-to-value ratio not exceeding 75%.  Land loans have a higher level of risk than loans for the purchase of existing homes since collateral values can only be estimated at the time the loan is approved.  The Bank has sought to minimize this risk by offering such financing primarily to builders and developers to whom the Bank has loaned funds in the past and to persons who have previous experience in such projects.
 
The Bank offers fixed and adjustable rate conventional mortgage loans on one-to-four family residential dwellings.  Most loans are originated in amounts up to $350,000 on properties located in the Bank’s primary market area.  These loans are generally for terms of 15, 20 and 30 years amortized on a monthly basis with interest and principal due each month.  The Bank retains all adjustable rate mortgage loans it originates and sells the majority of fixed rate loans, primarily to FHLMC, with servicing retained by the Bank.  The retention of adjustable rate loans helps reduce the Bank’s exposure to rising interest rates.  However, it is possible that during periods of rising interest rates, the risk of default on adjustable rate mortgage loans may increase due to the upward adjustment of the interest cost to the borrower.
 
The Bank originates multi-family residential loans in its market area.  These loans are generally larger and involve greater risks than one-to-four family residential loans.  Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios.  The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years.  They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations.
 
The Bank primarily originates commercial real estate loans in its market area.  These loans are generally larger and involve greater risks that one-to-four family residential loans.  Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios.  The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years.  They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations.  The Bank’s commercial real estate loans are typically secured by retail or wholesale establishments, motels/hotels, service industries, and industrial or warehouse facilities.  During 2011, the Bank began making loans under the Small Business Administration (“SBA”) Section 7(a) program, under which the SBA guarantees up to 75% of loans of up to $5 million for the purchase or expansion of small businesses.  The Bank may sell the guaranteed portion of SBA loans into the secondary market and retain the unguaranteed portion in its portfolio.

The Bank offers secured and unsecured commercial business loans and lines of credit to businesses located in its primary market area.  Most business loans have a one-year term, while lines of credit can remain open for longer periods.  All owners, partners, and officers must sign the loan agreement.  The security for a business loan depends on the amount borrowed, the business involved, and the strength of the borrower’s firm.  Commercial business lending entails significant risk, as the payments on such loans may depend upon the successful operation or management of the business involved.  Although the Bank attempts to limit its risk of loss on such loans by limiting the amount and the term, and by requiring personal guarantees of the principals of the business, the risk of loss on these loans is substantially greater than the risk of loss from residential real estate lending.
 
The Bank’s consumer loans consist of automobile loans, deposit account loans, home improvement loans, and other consumer loans.  The loans are generally offered for terms of up to five years at fixed interest rates.  Consumer loans are generally originated at higher interest rates than residential mortgage loans because of their higher risk.  Repossessed collateral for a defaulted loan may not provide an adequate source of repayment as a result of damage, loss, or depreciation.  In addition, collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.
 
On an ongoing basis, the Bank assigns a grade to each of its loans.  The internal grades are pass, special mention, substandard, doubtful, and loss.  Loans graded pass are loans where the borrower exhibits a strong balance sheet position and good earnings and cash flow history.  Loans graded special mention show potential weaknesses that deserve the Bank’s close attention.  If these potential weaknesses are not corrected, they may result in deterioration of the repayment prospects for the loan in the Bank’s credit position at some future date.  Substandard loans are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any.  Substandard loans have a well defined weakness that could
 
 
Page 15

 
 
jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the weaknesses are not corrected.  Loans graded doubtful have all the weaknesses inherent in substandard loans with the added characteristic that the weaknesses make collection or liquidation in full highly improbable.  Assets graded loss are considered uncollectible and of such little value that their continuance as an asset is not warranted.  The classification does not mean the loan has absolutely no recovery value, but that it is not practical to defer charging off the loan even though partial recovery may be effected in the future.
 
In accordance with new standards issued under the Disclosures of Credit Quality of Financing Receivables and the Allowance for Loan Losses, the following tables show credit quality indicators, the aging of receivables, and disaggregated balances of loans receivable and the allowance for loan losses (in thousands) as of June 30, 2012 and December 31, 2011.

Credit Quality Indicators
 
As of June 30, 2012
 
   
Construction
                                     
   
& Land
   
1-4 Family
   
Multi-Family
   
Commercial
   
Commercial
             
   
Development
   
Residential
   
Residential
   
Real Estate
   
Business
   
Consumer
   
Total
 
                                           
Credit risk profile by internally assigned grade:
                                         
                                   </