XNAS:PKBK Parke Bancorp Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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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: March 31, 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 No. 000-51338

PARKE BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
New Jersey
 
65-1241959
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
     
601 Delsea Drive, Washington Township, New Jersey
 
08080
(Address of principal executive offices)
 
(Zip Code)
  
856-256-2500
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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 the definitions of "large accelerated filer”, “accelerated filer", and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer [  ]             Accelerated filer [  ]            Non-accelerated filer [  ]          Smaller reporting company [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]                No [X]

As of May 15, 2012, there were issued and outstanding 4,886,178 shares of the registrant's common stock.
 

 
 

 

PARKE BANCORP, INC.
 

 
FORM 10-Q
 

 
FOR THE QUARTER ENDED SEPTEMBER 30, 2011

INDEX
 
   
Page
Part I
FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
1
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
40
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
50
Item 4.
Controls and Procedures
50
     
Part II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
50
Item 1A.
Risk Factors
50
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
50
Item 3.
Defaults Upon Senior Securities
50
Item 4.
Mine Safety Disclosures
51
Item 5.
Other Information
51
Item 6.
Exhibits
51
  
SIGNATURES

EXHIBITS and CERTIFICATIONS

 
 

 
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Parke Bancorp, Inc. and Subsidiaries
 
Consolidated Balance Sheets
 
(unaudited)
 
 (in thousands except share and per share data)  
 
 
March 31,
   
December 31,
 
   
2012
   
2011
 
Assets
           
Cash and due from financial institutions
  $ 4,314     $ 3,733  
Federal funds sold and cash equivalents
    98,498       106,495  
Cash and cash equivalents
    102,812       110,228  
                 
Investment securities available for sale, at fair value
    21,337       22,517  
Investment securities held to maturity (fair value of  $2,100  at March
31, 2012
and $2,080 at December 31, 2011)
    2,040       2,032  
Total investment securities
    23,377       24,549  
                 
Loans held for sale
    863       225  
                 
Loans, net of unearned income
    612,067       625,117  
Less: Allowance for loan losses
    17,557       19,323  
Net loans
    594,510       605,794  
                 
Accrued interest receivable
    3,039       3,039  
Premises and equipment, net
    4,212       4,122  
Other real estate owned (OREO)
    23,934       19,410  
Restricted stock, at cost
    2,214       3,565  
Bank owned life insurance (BOLI)
    5,586       5,541  
Other assets
    14,057       14,265  
Total Assets
  $ 774,604     $ 790,738  
Liabilities and Equity
               
Liabilities
               
Deposits
               
Noninterest-bearing deposits
  $ 27,283     $ 31,146  
Interest-bearing deposits
    620,211       603,709  
Total deposits
    647,494       634,855  
                 
FHLB borrowings
    20,568       50,607  
Other borrowed funds
    10,000       10,000  
Subordinated debentures
    13,403       13,403  
Accrued interest payable
    605       618  
Other liabilities
    4,182       3,982  
Total liabilities
    696,252       713,465  
Equity
               
Preferred stock, cumulative perpetual, $1,000 liquidation value;
authorized 1,000,000 shares; Issued:
16,288 shares at March 31,
2012
and December 31, 2011
    15,916       15,868  
Common stock, $.10 par value; authorized 10,000,000 shares; Issued:
5,097,078 shares at March 31, 2012 and December 31, 2011
    510       510  
Additional paid-in capital
    45,844       45,844  
Retained earnings
    19,343       17,808  
Accumulated other comprehensive loss
    (619 )     (626 )
Treasury stock, 210,900 shares at March 31, 2012 and December 31, 2011,
at cost
    (2,180 )     (2,180 )
Total shareholders’ equity
    78,814       77,224  
Noncontrolling (minority) interest in consolidated subsidiaries
    (462 )     49  
Total equity
    78,352       77,273  
Total liabilities and equity
  $ 774,604     $ 790,738  
See accompanying notes to consolidated financial statements
 

 
2

 


 
Parke Bancorp Inc. and Subsidiaries
 
CONSOLIDATED STATEMENTS OF INCOME
 
(unaudited)
 
    
For the three months ended March 31,
 
   
2012
   
2011
 
   
(in thousands except share data)
 
Interest income:
           
Interest and fees on loans
  $ 9,512     $ 9,816  
Interest and dividends on investments
    288       374  
Interest on federal funds sold and cash equivalents
    54       22  
Total interest income
    9,854       10,212  
Interest expense:
               
Interest on deposits
    1,772       2,056  
Interest on borrowings
    243       351  
Total interest expense
    2,015       2,407  
Net interest income
    7,839       7,805  
Provision for loan losses
    2,250       2,400  
Net interest income after provision for loan losses
    5,589       5,405  
Noninterest income (loss)
               
Loan fees
    54       64  
Net income from BOLI
    45       44  
Service fees on deposit accounts
    50       55  
Gain on sale of SBA loans
    602       2,244  
Other than temporary impairment losses
    (12 )     (47 )
Portion of loss recognized in other comprehensive income (OCI) (before taxes)
    12       27  
Net impairment losses recognized in earnings
    -       (20 )
(Gain) loss on sale of real estate
    (88 )     52  
Other miscellaneous income
    444       52  
Total noninterest income
    1,107       2,491  
Noninterest expense
               
Compensation and benefits
    1,442       1,414  
Professional services
    276       255  
Occupancy and equipment
    265       260  
Data processing
    94       110  
FDIC Insurance
    270       342  
OREO expense
    369       96  
Other operating expense
    814       720  
Total noninterest expense
    3,530       3,197  
Income before income tax expense
    3,166       4,699  
Income tax expense
    1,272       1,880  
Net income attributable to Company and noncontrolling (minority) interests
interests
    1,894       2,819  
Net income attributable to noncontrolling (minority) interests
 
    (107 )     (527 )
Net income attributable to Company
    1,787       2,292  
Preferred stock dividend and discount accretion
    252       249  
Net income available to common shareholders
  $ 1,535     $ 2,043  
                 
Earnings per common share
               
Basic
  $ 0.31     $ 0.42  
Diluted
  $ 0.31     $ 0.41  
Weighted average shares outstanding
               
Basic
    4,886,178       4,886,178  
Diluted
    4,897,332       5,027,810  
See accompanying notes to consolidated financial statements
 

 
3

 
 
Parke Bancorp Inc. and Subsidiaries
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
(unaudited)
 
  
For the three months ended March 31,
 
 
2012
 
2011
 
 
(in thousands)
 
Net income attributable to Company
           
Other comprehensive income net of tax:
  $ 1,787     $ 2,292  
Unrealized gains (losses) on securities:
               
Non-credit unrealized (losses) gains on securities with OTTI
    (12 )     4  
Net unrealized gains (losses) on securities without OTTI
    15       (59 )
Total unrealized gains (losses) on securities
    3       (55 )
Pension liability adjustments
    4       11  
Total other comprehensive income (loss)
    7       (44 )
Total comprehensive income
  $ 1,794     $ 2,248  
See accompanying notes to consolidated financial statements
 

 
4

 

Parke Bancorp, Inc. and Subsidiaries
 
CONSOLIDATED STATEMENTS OF CHANGE IN TOTAL EQUITY
 
(unaudited)
 
 
Preferred
Stock
 
Shares of
Common
Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Treasury
Stock
 
Total
Shareholders’
Equity
 
Non-Controlling
(Minority)
Interest
 
Total
Equity
 
(In thousands except share numbers)
                                                       
Balance, December 31, 2011
$
15,868
 
5,097,078
 
$
510
 
$
45,844
 
$
17,808
 
$
(626)
 
$
(2,180)
 
$
77,224
 
$
49
$
77,273
Capital withdrawals by noncontrolling
(minority) interest
                                                 
(618)
 
(618)
Comprehensive income:
                                                       
Net income
                         
1,787
               
1,787
   
107
 
1,894
Non-credit unrealized losses on securities
with OTTI, net of taxes
                               
 
(12)
         
 
(12)
       
 
(12)
Net unrealized gains on securities without
OTTI, net of taxes
                               
15
         
15
       
15
Pension liability adjustments, net of taxes
                               
4
         
4
       
4
Total comprehensive income
                                           
1,794
   
107
 
1,901
Dividend on preferred stock (5% annually)
                         
(204)
               
(204)
       
(204)
Accretion of discount on preferred stock
 
48
                     
(48)
               
       
Balance, March 31, 2012
$
15,916
 
5,097,078
 
$
510
 
$
45,844
 
$
19,343
 
$
(619)
 
$
(2,180)
 
$
78,814
 
$
(462)
$
78,352
                                                         

See accompanying notes to consolidated financial statements


 
5

 
 
Parke Bancorp Inc. and Subsidiaries
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(unaudited)
 
   
For the three months ended March 31,
 
   
2012
   
2011
 
   
(in thousands)
 
Cash Flows from Operating Activities
           
Net income
  $ 1,894     $ 2,819  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    92       91  
Provision for loan losses
    2,250       2,400  
Bank owned life insurance
    (45 )     (44 )
Supplemental executive retirement plan expense
    34       112  
Gain on sale of SBA loans
    (602 )     (2,244 )
SBA loans originated for sale
    (6,017 )     (6,980 )
Proceeds from sale of SBA loans originated for sale
    6,671       7,767  
(Gain) loss on sale of other real estate owned
    89       (52 )
Other than temporary decline in value of investments
    0       (20 )
Net accretion of purchase premiums and discounts on securities
    (6 )     (21 )
Deferred income tax benefit
    (13 )      
Changes in operating assets and liabilities:
               
Increase in accrued interest receivable and other assets
    (473 )     (57 )
Increase (decrease) in accrued interest payable and other accrued liabilities
    157       (1,702 )
Net cash provided by operating activities
    4,031       2,069  
Cash Flows from Investing Activities
               
Redemptions of restricted stock
    1,351       2  
Proceeds from maturities and principal payments on mortgage backed securities
    1,184       1,447  
Proceeds from sale of other real estate owned
    480       2,587  
Advances on other real estate owned
    (68 )      
Net decrease in loans
    4,009       6,877  
Purchases of bank premises and equipment
    (182 )     (16 )
Net cash provided by investing activities
    6,774       10,897  
Cash Flows from Financing Activities
               
Payment of dividend on preferred stock
    (203 )     (204 )
Minority interest capital withdrawal, net
    (618 )      
Net decrease in Federal Home Loan Bank and short term borrowings
    (30,039 )     (11,454 )
Payments of Federal Home Loan Bank advances
          (37 )
Net decrease in noninterest-bearing deposits
    (3,863 )     (1,367 )
Net increase (decrease) in interest-bearing deposits
    16,502       (18,886 )
Net cash used in financing activities
    (18,221 )     (31,948 )
Decrease in cash and cash equivalents
    (7,416 )     (18,982 )
Cash and Cash Equivalents, beginning of period
    110,228       57,628  
Cash and Cash Equivalents, end of period
  $ 102,812     $ 38,646  
Supplemental Disclosure of Cash Flow Information:
               
Cash paid during the year for:
               
Interest on deposits and borrowed funds
  $ 2,027     $ 2,561  
Income taxes
  $ 1,000     $ 1,880  
Supplemental Schedule of Noncash Activities:
               
Real estate acquired in settlement of loans
  $ 5,025     $  
                 
See accompanying notes to consolidated financial statements
               

 
6

 

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1.  ORGANIZATION

Parke Bancorp, Inc. ("Parke Bancorp” or the "Company") is a bank holding company incorporated under the laws of the State of New Jersey in January 2005 for the sole purpose of becoming the holding company of Parke Bank (the "Bank").

The Bank is a commercial bank which commenced operations on January 28, 1999. The Bank is chartered by the New Jersey Department of Banking and insured by the Federal Deposit Insurance Corporation ("FDIC"). Parke Bancorp and the Bank maintain their principal offices at 601 Delsea Drive, Washington Township, New Jersey. The Bank also conducts business through branches in Galloway Township, Northfield and Washington Township, New Jersey and Philadelphia, Pennsylvania.

The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.

The Bank is subject to the regulations of certain state and federal agencies, and accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.

The FDIC and the New Jersey Department of Banking and Insurance Consent Orders: On April 9, 2012, the Bank entered into Consent Orders with the FDIC and the New Jersey Department of Banking and Insurance (the “Department”).  Under the Consent Orders, the terms of which are substantially identical, the Bank is required, among other things, subject to review and approval by the FDIC and the Department: (i) to adopt and implement a plan to reduce the Bank’s position in delinquent or classified assets; (ii) to adopt and implement a program providing for a periodic independent review of the Bank’s loan portfolio and the identification of problem credits; (iii) to review and revise the Bank’s loan policies and procedures to address identified lending deficiencies; and (iv) to adopt and implement a plan to reduce and manage each of the concentrations of credit identified by the FDIC and the Department.

The Consent Orders also require the Bank to obtain the prior approval of the FDIC and the New Jersey Department before declaring or paying any dividend or appointing or changing the title or responsibilities of any director or senior executive officer.  Additional regulatory provisions require FDIC prior approval before the Bank enters into any employment agreement or other agreement or plan providing for the payment of a “golden parachute payment” or the making of any golden parachute payment.

NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Financial Statement Presentation: The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and predominant practices within the banking industry.

The accompanying consolidated financial statements include the accounts of Parke Bancorp, Inc. and its wholly-owned subsidiaries Parke Bank, Parke Capital Markets, Farm Folly, Inc. and Taylors Glen LLC. Also included are the accounts of 44 Business Capital Partners LLC, a joint venture formed in 2009 to originate and service SBA loans. Parke Bank has a 51% ownership interest in the joint venture. Parke
 
 
7

 
 
Capital Trust I, Parke Capital Trust II and Parke Capital Trust III are wholly-owned subsidiaries but are not consolidated because they do not meet the requirements for consolidation under applicable accounting guidance.  All significant inter-company balances and transactions have been eliminated.

The accompanying interim financial statements should be read in conjunction with the annual financial statements and notes thereto included in Parke Bancorp Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011 since they do not include all of the information and footnotes required by GAAP. The accompanying interim financial statements for the three months ended March 31, 2012 and 2011 are unaudited. The balance sheet as of December 31, 2011, was derived from the audited financial statements. In the opinion of management, these financial statements include all normal and recurring adjustments necessary for a fair statement of the results for such interim periods. Results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results for the full year.

Use of Estimates: In preparing the interim financial statements, management makes estimates and assumptions based on available information that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and reported amounts of expenses and revenues. Actual results could differ from such estimates. The allowance for loan losses, deferred taxes, evaluation of investment securities for other-than-temporary impairment and fair values of financial instruments and other real estate owned (“OREO”) are significant estimates and particularly subject to change.

Recently Issued Accounting Pronouncements:

In May 2011, FASB issued 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 does not extend the use of fair value accounting, but provides guidance on how it should be applied where its use is already required or permitted. This guidance is to be applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. Adoption of this guidance has not had a material impact on results of operations or financial condition.

In June 2011, the FASB issued guidance to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments are effective for interim and annual periods beginning after December 15, 2011 with retrospective application. The Company adopted the accounting standard on January 1, 2012, as required, with no material impact on its results of operations or financial position.

 
8

 

NOTE 3.  INVESTMENT SECURITIES
 
The following is a summary of the Company's investments in available-for-sale and held-to-maturity securities as of March 31, 2012 and December 31, 2011: 

 As of March 31, 2012
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Other-than-
temporary
impairments
in OCI
 
Fair value
 
 Available-for-sale:
(amounts in thousands)
 
             
U.S. Government sponsored entities
$
1,007
 
$
4
 
$
 
$
 
$
1,011
 
Corporate debt obligations
 
1,500
   
55
   
   
   
1,555
 
Residential mortgage-backed securities
12,640
 
746
 
 
 
13,386
 
Collateralized mortgage obligations
1,404
 
75
 
 
44
 
1,435
 
Collateralized debt obligations
5,556
 
 
1,114
 
492
 
3,950
 
Total available-for-sale
$
22,107
 
$
880
 
$
1,114
 
$
536
 
$
21,337
 
                     
 Held to maturity:
                   
States and political subdivisions
$
2,040
 
$
83
 
$
23
 
$
 
$
2,100
 
 
 
 
 As of December 31, 2011
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
 
Other-than-
temporary
impairments
in OCI
 
Fair value
 
 Available-for-sale:
(amounts in thousands)
 
             
U.S. Government sponsored entities
$
1,006
 
$
5
 
$
 
$
 
$
1,011
 
Corporate debt obligations
 
1,500
   
43
   
57
   
   
1,486
 
Residential mortgage-backed securities
13,697
 
764
 
 
 
14,461
 
Collateralized mortgage obligations
1,534
 
73
 
 
13
 
1,594
 
Collateralized debt obligations
5,556
 
 
1,080
 
511
 
3,965
 
Total available-for-sale
$
23,293
 
$
885
 
$
1,137
 
$
524
 
$
22,517
 
                     
 Held to maturity:
                   
States and political subdivisions
$
2,032
 
$
87
 
$
39
 
$
 
$
2,080
 
 
 

 

 
9

 

The amortized cost and fair value of debt securities classified as available-for-sale and held-to-maturity, by contractual maturity as of March 31, 2012 are as follows:
 
   
Amortized
Cost
   
Fair
Value
 
   
(amounts in thousands)
 
Available-for-sale:
     
Due within one year
  $     $  
Due after one year through five years
    1,000       1,004  
Due after five years through ten years
           
Due after ten years
    7,062       5,512  
Residential mortgage-backed securities and collateralized mortgage obligations
    14,045       14,821  
Total  available-for-sale
  $ 22,107     $ 21,337  

 
Held-to-maturity:
     
Due within one year
  $     $  
Due after one year through five years
           
Due after five years through ten years
           
Due after ten years
    2,040       2,100  
Total held-to-maturity
  $ 2,040     $ 2,100  

Expected maturities will differ from contractual maturities for mortgage related securities because the issuers of certain debt securities do have the right to call or prepay their obligations without any penalty.
 
As of March 31, 2012, securities with a carrying value of $16.1 million, and fair value of $17.0 million, were pledged as collateral for borrowed funds. In addition, securities with a carrying value of $7.7 million, and fair value of $8.2 million, were pledged to secure public deposits.
 

 
10

 

The following tables show the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2012 and December 31, 2011:
 

 
As of March 31, 2012
 
Less Than 12 Months
   
12 Months or Greater
   
Total
 
Description of Securities
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
   
(Amounts in thousands)
 
Available-for-sale:
                                   
Collateralized debt obligations
                3,636       1,114       3,636       1,114  
Total available-for-sale
  $     $     $ 3,636     $ 1,114     $ 3,636     $ 1,114  
                                                 
Held-to-maturity:
                                               
States and political subdivisions
  $     $     $ 784     $ 23     $ 784     $ 23  
 
 
As of December 31, 2011
 
Less Than 12 Months
   
12 Months or Greater
   
Total
 
Description of Securities
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
   
(Amounts in thousands)
 
Available for sale:
                                   
Corporate debt obligations
                443       57       443       57  
Collateralized debt obligations
                3,670       1,080       3,670       1,080  
Total available for sale
  $     $     $ 4,113     $ 1,137     $ 4,113     $ 1,137  
                                                 
Held to maturity:
                                               
States and political subdivisions
  $ 758     $ 39     $     $     $ 758     $ 39  

 
Collateralized Debt Obligations:  The Company’s unrealized loss on investments in collateralized debt obligations (“CDOs”) relates to three securities issued by financial institutions, totaling $3.7 million. CDOs are pooled securities primarily secured by trust preferred securities (“TruPS”), subordinated debt and surplus notes issued by small and mid-sized banks and insurance companies. These securities are generally floating rate instruments with 30-year maturities, and are callable at par by the issuer after five years. The current economic downturn has had a significant adverse impact on the financial services industry, consequently, TruPS CDOs do not have an active trading market. With the assistance of competent third-party valuation specialists, the Company utilized the following methodology to determine the fair value:
 
Cash flows were developed based on the estimated speeds at which the trust preferred securities are expected to prepay (a range of 1% to 2%), the estimated rates at which the trust preferred securities are expected to defer payments, the estimated rates at which the trust preferred securities are expected to
 
 
 
11

 
 
default (a range of 0.57% to 0.66%), and the severity of the losses on securities which default (95%). Trust preferred securities generally allow for prepayment by the issuer without a prepayment penalty any time after five years. Due to the lack of new trust preferred issuances and the relatively poor conditions of the financial institution industry, a relatively modest rate of prepayment was assumed going forward. Estimates for conditional default rates (“CDR”) are based on the payment characteristics of the trust preferred securities themselves (e.g. current, deferred, or defaulted) as well as the financial condition of the trust preferred issuers in the pool. Estimates for the near-term rates of deferral and CDR are based on key financial ratios relating to the financial institutions’ capitalization, asset quality, profitability and liquidity. Finally, we consider whether or not the financial institution has received TARP funding, and if it has, the amount. Longer-term rates of deferral and defaults are based on historical averages. The fair value of each bond was assessed by discounting its projected cash flows by a discount rate.  The discount rates were based on the yields of publicly traded TruPS and preferred stock issued by comparably rated banks.  The fair value for previous reporting periods was based on indicative market bids and resulted in much lower values due to the inactive trading market.
 
The underlying issuers have been analyzed, and projections have been made regarding the future performance, considering factors including defaults and interest deferrals.  The analysis indicates that the Company should expect to receive all contractual cash flows.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, it does not consider these investments to be other-than-temporarily impaired at March 31, 2012.
 

 
12

 

Other-Than-Temporarily Impaired Debt Securities

We assess whether we intend to sell or it is more likely than not that we will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired (“OTTI”) and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income.

The present value of expected future cash flows is determined using the best estimate of cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.

We have a process in place to identify debt securities that could potentially have a credit impairment that is other than temporary.  This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.  On a quarterly basis, we review all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. We consider relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other than temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, our intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value.
 
The following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that we have written down for OTTI and the credit component of the loss that is recognized in earnings. OTTI recognized in earnings for credit-impaired debt securities is presented as additions in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit impaired (subsequent credit impairments). The credit loss component is reduced if we sell, intend to sell or believe we will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if we receive cash flows in excess of what we expected to receive over the remaining life of the credit-impaired debt security, the security matures or is fully written down. Changes in the credit loss component of credit-impaired debt securities were as follows for the periods ended March 31, 2012 and 2011.
 
 
13

 
 

    
For the Three Months Ended
March 31,
 
   
2012
   
2011
 
             
   
(amounts in thousands)
 
Beginning balance
  $ 1,950     $ 2,657  
Initial credit impairment
           
Subsequent credit impairments
          20  
Reductions for amounts recognized in earnings due to intent or requirement to sell
           
Reductions for securities sold
           
Reductions for securities deemed worthless
    (399 )     (81 )
Reductions for increases in cash flows expected to be collected
           
Ending balance
  $ 1,551     $ 2,596  

A summary of investment gains and losses recognized in income during the three month periods ended March 31, 2012 and 2011 are as follows:

   
For the Three Months Ended
March 31,
 
   
2012
   
2011
 
             
   
(amounts in thousands)
 
Available-for-sale securities:
           
    Realized gains
  $     $  
Realized (losses)
           
    Other than temporary impairment
          (20 )
Total available-for-sale securities
  $     $ (20 )
                 
Held-to-maturity securities:
               
Realized gains
  $     $  
Realized (losses)
           
    Other than temporary impairment
           
Total held-to-maturity securities
  $     $  



 
14

 

NOTE 4.  LOANS
 
The portfolio of loans outstanding consists of:

    
March 31, 2012
   
December 31, 2011
   
Amount
 
Percentage
of Total
Loans
   
Amount
 
Percentage
of Total
Loans
   
(Amounts in thousands)
Commercial and industrial
$
21,803
 
3.6
%
 
$
24,136
 
3.9
%
Real estate construction:
                     
Residential
 
18,108
 
3.0
     
21,287
 
3.4
 
Commercial
 
44,441
 
7.3
     
50,361
 
8.1
 
Real estate mortgage:
                     
Commercial – owner occupied
 
148,872
 
24.3
     
147,449
 
23.6
 
Commercial – non owner occupied
 
205,107
 
33.5
     
204,216
 
32.6
 
Residential – 1 to 4 family
 
134,793
 
22.0
     
138,768
 
22.2
 
Residential - Multifamily
 
20,497
 
3.3
     
20,126
 
3.2
 
Consumer
 
18,446
 
3.0
     
18,774
 
3.0
 
Total Loans
$
612,067
 
100.0
%
 
$
625,117
 
100.0
%
                       

The Company maintains interest reserves for the purpose of making periodic and timely interest payments for borrowers that qualify for development and construction loans. Total development and construction loans with interest reserves were $11.6 million and $14.6 million at March 31, 2012 and December 31, 2011, respectively. The amount of interest capitalized from interest reserves and recognized as interest income for the three month periods ended March 31, 2012 and 2011 was $209,000 and $642,000, respectively. Interest reserves provide borrowers temporary sources of cash flow which can be used to make interest payments during the development or construction phases of a project. It is our expectation that equity in the project increases as the project moves towards completion and that cash flows will be positive once sales begin or stabilization occurs. Loans with interest reserves are monitored throughout the life of the project. Interest accrual may be suspended on interest reserve dependent loans that are not delinquent but are risk rated substandard or worse.

Loan Origination/Risk Management:  In the normal course of business the Company is exposed to a variety of operational, reputational, legal, regulatory and credit risks that could adversely affect our financial performance. Most of our asset risk is primarily tied to credit (lending) risk. The Company has lending policies, guidelines and procedures in place that are designed to maximize loan income within an acceptable level of risk. The Board of Directors reviews and approves these policies, guidelines and procedures.  When we originate a loan we make certain subjective judgments about the borrower’s ability to meet the loan’s terms and conditions. We also make objective and subjective value assessments on the assets we finance. The borrower’s ability to repay can be adversely affected by economic changes. Likewise, changes in market conditions and other external factors can affect asset valuations. The Company actively monitors the quality of its loan portfolio. A reporting system supplements the credit review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit risk, loan delinquencies, troubled debt restructures, nonperforming and potential problem loans. Diversification in the loan portfolio is another means of managing risk associated with fluctuations in economic conditions.

 
15

 
With respect to construction loans to developers and builders that are secured by non-owner occupied properties, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally underwritten based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. Commercial real estate loans may be riskier than loans for one-to-four family residences and are typically larger in dollar size. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. The repayment of these loans is generally largely dependent on the successful operation and management of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location within our market area. This diversity helps reduce the Company's exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. The Company also monitors economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately 42.1% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

Consumer loans may carry a higher degree of repayment risk than residential mortgage loans. Repayment is typically dependent upon the borrower’s financial stability which is more likely to be adversely affected by job loss, illness, or personal bankruptcy. To monitor and manage consumer loan risk, policies and procedures are developed and modified as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. Historically the Company’s losses on consumer loans have been negligible.

The Company maintains an outsourced independent loan review program that reviews and validates the credit risk assessment program on a periodic basis. Results of these external independent reviews are presented to management. In 2011 the Company expanded its risk monitoring program by creating a standalone Credit Risk Management Department. The external independent loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit risk management personnel.

Nonaccrual and Past Due Loans:  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they
 
 
16

 
become due, as well as when a loan is 90 days past due, unless the loan is well secured and in the process of collection, as required by regulatory provision. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
An age analysis of past due loans by class follows:

March 31, 2012   30-59 Days
Past Due
   
60-89
Days Past
Due
    Greater
than 90
Days and
Not Accruing
   
 
 
Total Past
Due
    Current     Total
Loans
   
Loans >
90 Days
and
Accruing
 
    (Amounts in thousands)  
                                           
Commercial
  $ 340         $ 603     943     20,860     21,803     $  
Real estate construction:
                                                       
Residential
                3,134       3,134       14,974       18,108        
Commercial
    2,198             7,768       9,966       34,475       44,441        
Real estate mortgage:
                                                       
Residential
    2,961       147       9,738       12,846       142,444       155,290        
Commercial
    1,235       6,649       21,733       29,617       324,362       353,979        
Consumer
                228       228       18,218       18,446        
Total
  $ 6,734     6,796     43,204     56,734     555,333     612,067      
                                                         
 

 December 31, 2011   30-59 Days
Past Due
   
60-89
Days Past
Due
    Greater
than 90
Days and
Not Accruing
   
 
 
Total Past
Due
    Current     Total
Loans
   
Loans >
90 Days
and
Accruing
 
    (Amounts in thousands)  
                                                         
Commercial
  $ 603     $     $     $ 603     $ 23,533     $ 24,136     $  
Real estate construction:
                                                       
Residential
    350             5,265       5,615       15,672       21,287        
Commercial
                7,703       7,703       42,658       50,361        
Real estate mortgage:
                                                       
Residential
    2,587             8,288       10,875       148,019       158,894        
Commercial
    2,932             22,929       25,861       325,804       351,665        
Consumer
                274       274       18,500       18,774        
Total
  $ 6,472     $     $ 44,459     $ 50,931     $ 574,186     $ 625,117     $  
                                                         

Impaired Loans:  Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.

 All impaired loans have an independent third-party full appraisal to determine the net realizable value (“NRV”) based on the fair value of the underlying collateral, less cost to sell (a range of 5% to 10%) and other costs, such as unpaid real estate taxes, that have been identified, or the present value of discounted cash flows in the case of certain impaired loans that are not collateral dependent. The appraisal will be
 
 
17

 
based on an "as-is" valuation and will follow a reasonable valuation method that addresses the direct sales comparison, income, and cost approaches to market value, reconciles those approaches, and explains the elimination of each approach not used. Appraisals are updated every 12 months or sooner if we have identified possible further deterioration in value. Prior to receiving the updated appraisal, we will establish a specific reserve for any estimated deterioration, based upon our assessment of market conditions, adjusted for estimated costs to sell and other identified costs. If the NRV is greater than the loan amount, then no impairment loss exists. If the NRV is less than the loan amount, the shortfall is recognized by a specific reserve. If the borrower fails to pledge additional collateral in the ninety day period, a charge-off equal to the difference between the loan carrying value and NRV will occur. In certain circumstances, however, a direct charge-off may be taken at the time that the NRV calculation reveals a shortfall. All impaired loans are evaluated based on the criteria stated above on a quarterly basis and any change in the reserve requirements are recorded in the period identified. All partially charged-off loans remain on nonaccrual status until they are brought current as to both principal and interest and have at least six months of payment history and future collectability of principal and interest is assured.

 
18

 


Impaired loans are set forth in the following tables.

March 31, 2012
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
 
 
 
(Amounts in thousands)
 
With no related allowance recorded:
                 
Commercial
  $ 603     603      
Residential real estate construction
    4,060       5,892        
Commercial real estate construction
    14,738       15,017        
Residential real estate mortgage
    11,344       13,692        
Commercial real estate mortgage
    39,413       42,212        
Consumer
    169       169        
      70,327       77,585        
                         
With an allowance recorded:
                       
Commercial
                 
Residential real estate construction
    957       957       437  
Commercial real estate construction
    1,613       1,613       180  
Residential real estate mortgage
    2,434       2,470       468  
Commercial real estate mortgage
    10,717       10,837       230  
Consumer
    59       59       37  
      15,780       15,936       1,352  
                         
Total:
                       
Commercial
    603       603        
Residential real estate construction
    5,017       6,849       437  
Commercial real estate construction
    16,351       16,630       180  
Residential real estate mortgage
    13,778       16,162       468  
Commercial real estate mortgage
    50,130       53,049       230  
Consumer
    228       228       37  
     $ 86,107     53,049     1,352  


 
19

 


December 31, 2011
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
 
 
 
(Amounts in thousands)
 
With no related allowance recorded:
                 
Commercial
  $ 603     $ 603     $  
Residential real estate construction
    4,440       5,246        
Commercial real estate construction
    12,898       13,118        
Residential real estate mortgage
    9,074       11,404        
Commercial real estate mortgage
    37,370       37,798        
Consumer
    229       229        
      64,614       68,398        
                         
With an allowance recorded:
                       
Commercial
                 
Residential real estate construction
    4,170       5,151       1,297  
Commercial real estate construction
    3,329       3,329       380  
Residential real estate mortgage
    6,656       6,857       633  
Commercial real estate mortgage
    18,410       18,530       2,549  
Consumer
                 
      32,565       33,867       4,859  
                         
Total:
                       
Commercial
    603       603        
Residential real estate construction
    8,610       10,397       1,297  
Commercial real estate construction
    16,227       16,447       380  
Residential real estate mortgage
    15,730       18,261       633  
Commercial real estate mortgage
    55,780       56,328       2,549  
Consumer
    229       229        
    $ 97,179     $ 102,265     $ 4,859  


 
20

 

The following table presents by loan portfolio class, the average recorded investment and interest income recognized on impaired loans for the three months ended March 31, 2012 and 2011:


 
Three Months Ended March 31,
 
 
2012
 
2011
 
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
 
(Amounts in thousands)
 
Commercial
  $ 599     $     $ 594     $ 3  
Residential real estate construction
    6,701       34       11,828       102  
Commercial real estate construction
    16,461       79       21,153       167  
Residential real estate mortgage
    14,988       112       21,809       151  
Commercial real estate mortgage
    53,060       475       53,624       704  
Consumer
    231       2       61       1  
Total
  $ 92,041     $ 702     $ 109,069     $ 1,128  



Troubled debt restructurings:  Periodically management evaluates our loans for appropriate risk rating, interest accrual status and potential classification as a TDR, some of which are performing and accruing interest. A TDR is a loan on which we have granted a concession due to a borrower’s financial difficulty. These are concessions that would not otherwise be considered. The terms of these modified loans may include extension of maturity, renewals, change in interest rate, additional collateral requirements or infusion of additional capital into the project by the borrower to reduce debt or to support future debt service. On construction and land development loans we may modify the loan as a result of delays or other project issues such as slower than anticipated sell-outs, insufficient leasing activity and/or a decline in the value of the underlying collateral securing the loan. Management believes that working with a borrower to restructure a loan provides us with a better likelihood of collecting our loan. It is our policy not to renegotiate the terms of a commercial loan simply because of a delinquency status. However, we will use our Troubled Debt Restructuring Program to work with delinquent borrowers when the delinquency is temporary. We consider all loans modified in a troubled debt restructuring to be impaired.

At the time a loan is modified in a troubled debt restructuring, we consider the following factors to determine whether the loan should accrue interest:
 
·  
Whether there is a period of current payment history under the current terms, typically 6 months;
·  
Whether the loan is current at the time of restructuring; and
·  
Whether we expect the loan to continue to perform under the restructured terms with a debt coverage ratio that complies with the Bank’s credit underwriting policy of 1.25 times debt service.

We also review the financial performance of the borrower over the past year to be reasonably assured of repayment and performance according to the modified terms. This review consists of an analysis of the borrower’s historical results; the borrower’s projected results over the next four quarters; current financial information of the borrower and any guarantors. The projected repayment source needs to be reliable, verifiable, quantifiable and sustainable. In addition, all troubled debt restructurings are reviewed quarterly to determine the amount of any impairment.

 
21

 
At the time of restructuring, the amount of the loan principal for which we are not reasonably assured of repayment is charged-off, but not forgiven.

A borrower with a restructured loan must make a minimum of six consecutive monthly payments at the restructured level and be current as to both interest and principal to be on accrual status.

The following is an analysis of TDRs by type of concession as of March 31, 2012 and December 31, 2011. There were no modifications that involved forgiveness of debt.
 
March 31, 2012
TDRs in
compliance
with their
modified
terms and
accruing
interest
 
TDRs that are
not accruing
interest
   
Total
 
 
(Amounts in thousands)
 
Reduction in interest rate
  $ 15,261     $ 19,409     $ 34,670  
A period of interest only payments
    16,831       6,929       23,760  
Total
  $ 32,092     $ 26,338     $ 58,430  
 
There were no TDRs during the three month period ended March 31, 2012 for which there was a subsequent payment default.

December 31, 2011
TDRs in
compliance
with their
modified
terms and
accruing
interest
 
TDRs that are
not accruing
interest
   
Total
 
 
(Amounts in thousands)
 
Reduction in interest rate
  $ 23,601     $ 16,541     $ 40,142  
A period of interest only payments
    17,542       9,279       26,821  
Total
  $ 41,143     $ 25,820     $ 66,963  


 
22

 

The following is an analysis of performing and nonperforming TDRs as of March 31, 2012 and December 31, 2011.
 
March 31, 2012
TDRs in
compliance with
their modified
terms and accruing
interest
   
TDRs that are not
accruing interest
   
Total
 
 
Balance
   
Count
   
Balance
   
Count
   
Balance
   
Count
 
 
(loan balances in thousands)
 
Commercial
  $           $ 603       1     $ 603       1  
Residential  Real Estate Construction
    957       1       1,095       2       2,052       3  
Commercial Real Estate Construction
    500       1       4,350       2       4,850       3  
Commercial Real Estate Mortgage - Owner Occupied
    2,716       5       4,430       6       7,146       11  
Commercial Real Estate Mortgage – Non-owner Occupied
    24,515       7       7,743       5       32,258       12  
Residential Real Estate Mortgage -Multifamily
                3,530       2       3,530       2  
Residential Real Estate Mortgage
    3,404       6       4,450       5       7,854       11  
Consumer
                137       1       137       1  
Total
  $ 32,092       20     $ 26,338       24     $ 58,430       44  
 

December 31, 2011
TDRs in
compliance with
their modified
terms and accruing
interest
   
TDRs that are not
accruing interest
   
Total
 
 
Balance
   
Count
   
Balance
   
Count
   
Balance
   
Count
 
 
(loan balances in thousands)
 
Commercial
  $ 603       1     $           $ 603       1  
Residential  Real Estate Construction
    2,195       2       2,832       3       5,027       5  
Commercial Real Estate Construction
    500       1       4,350       2       4,850       3  
Commercial Real Estate Mortgage - Owner Occupied
    2,740       5       4,450       6       7,190       11  
Commercial Real Estate Mortgage – Non-owner Occupied
    28,232       9       9,196       5       37,428       14  
Commercial Real Estate Mortgage -Multifamily
    3,268       1       515       2       3,783       3  
Residential Real Estate Mortgage
    3,605       7       4,340       6       7,945       13  
Consumer
                137       1       137       1  
Total
  $ 41,143       26     $ 25,820       25     $ 66,963       51  
 
During the three months ended March 31, 2012, there was a decrease of $8.5 million in restructured loans deemed TDRs. The decrease was the result of $4.5 million of balances transferred to OREO; $3.3 million of charge-offs and $700,000 of principal payments. In addition, a $6.3 million hotel loan was removed after further analysis of the borrower’s credit profile and the borrower’s receipt of a loan commitment from another financial institution at a rate of interest lower than the Bank’s rate of interest.

 
23

 

 
Credit Quality Indicators:  As part of the on-going monitoring of the credit quality of the Company's loan portfolio, management tracks certain credit quality indicators including trends related to the risk grades of loans, the level of classified loans, net charge-offs, nonperforming loans (