XNAS:NBTF NB&T Financial Group Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNAS:NBTF Fair Value Estimate
Premium
XNAS:NBTF Consider Buying
Premium
XNAS:NBTF Consider Selling
Premium
XNAS:NBTF Fair Value Uncertainty
Premium
XNAS:NBTF Economic Moat
Premium
XNAS:NBTF Stewardship
Premium
 
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from/to

 

 

NB&T FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Ohio   31-1004998

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

48 N. South Street, Wilmington, Ohio 45177

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number: (937) 382-1441

 

 

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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 definition 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   ¨  (Do not check if a smaller reporting company)    Smaller Reporting Company   x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date: As of August 1, 2012, 3,424,814 common shares were issued and outstanding.

 

 

 


Table of Contents

NB&T FINANCIAL GROUP, INC.

June 30, 2012 Form 10-Q

Table of Contents

 

          Page
   PART I   
Item 1:    Financial Statements    3
   Condensed Consolidated Balance Sheets    3
   Condensed Consolidated Statements of Income    4
   Condensed Consolidated Statements of Comprehensive Income    6
   Condensed Consolidated Statements of Cash Flows    7
   Notes to Condensed Consolidated Financial Statements    8
   Report of Independent Registered Public Accounting Firm    32
Item 2:    Management’s Discussion and Analysis of Financial Condition and Results of Operations    33
Item 3:    Quantitative and Qualitative Disclosures about Market Risk    38
Item 4:    Controls and Procedures    39
   Part II   
Item 1:    Legal Proceedings    40
Item 1A:    Risk Factors    40
Item 2:    Unregistered Sale of Equity Securities and Use of Proceeds    40
Item 3:    Defaults Upon Senior Securities    40
Item 4:    Reserved    40
Item 5:    Other Information    40
Item 6:    Exhibits and Reports on Form 8-K    40
Signatures    41
Index to Exhibits    42

 

2


Table of Contents

NB&T Financial Group, Inc.

Condensed Consolidated Balance Sheets

(Dollars in thousands)

 

      June 30,
2012
    December 31,
2011
 
     (Unaudited)        

Assets

    

Cash and due from banks

   $ 12,842      $ 13,861   

Interest-bearing deposits

     66,928        61,441   

Federal funds sold

     427        366   
  

 

 

   

 

 

 

Cash and cash equivalents

     80,197        75,668   
  

 

 

   

 

 

 

Available-for-sale securities

     156,161        139,744   

Loans, net of allowance for loan losses of $4,508 and $4,668 at June 30, 2012 and December 31, 2011, respectively

     391,992        399,801   

Premises and equipment

     18,396        18,934   

Federal Reserve and Federal Home Loan Bank stock

     10,030        10,025   

Earned income receivable

     2,643        2,948   

Goodwill

     3,625        3,625   

Core deposits and other intangibles

     692        831   

Bank-owned life insurance

     15,727        15,488   

Other real estate owned

     3,032        3,520   

FDIC loss share receivable

     1,625        1,928   

Other

     3,106        3,076   
  

 

 

   

 

 

 

Total assets

   $ 687,226      $ 675,588   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Liabilities

    

Deposits

    

Demand

   $ 102,901      $ 97,732   

Savings, NOW and money market

     349,961        331,524   

Time

     140,117        152,127   
  

 

 

   

 

 

 

Total deposits

     592,979        581,383   
  

 

 

   

 

 

 

Long-term debt

     15,310        15,310   

Interest payable and other liabilities

     7,982        8,105   
  

 

 

   

 

 

 

Total liabilities

     616,271        604,798   
  

 

 

   

 

 

 

Commitments and Contingencies

    

Stockholders’ Equity

    

Preferred stock, no par value, authorized 100,000 shares; none issued

    

Common stock, no par value; authorized 6,000,000 shares; issued – 3,818,950 shares

     1,000        1,000   

Additional paid-in capital

     12,274        12,183   

Retained earnings

     59,375        59,913   

Accumulated other comprehensive income

     2,802        2,208   

Treasury stock, at cost

    

Common; 2012 – 394,136 shares, 2011 – 395,698 shares

     (4,496     (4,514
  

 

 

   

 

 

 

Total stockholders’ equity

     70,955        70,790   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 687,226      $ 675,588   
  

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

3


Table of Contents

NB&T Financial Group, Inc.

Condensed Consolidated Statements of Income

(Dollars in Thousands, except per share amounts)

(Unaudited)

 

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

Interest and Dividend Income

        

Loans

   $ 5,356      $ 6,218      $ 10,943      $ 12,258   

Securities

        

Taxable

     561        902        1,167        1,921   

Tax-exempt

     198        70        359        159   

Dividends on Federal Home Loan and Federal Reserve Bank stock

     110        115        228        232   

Deposits with financial institutions

     53        43        108        88   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and dividend income

     6,278        7,348        12,805        14,658   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest Expense

        

Deposits

     679        1,053        1,425        2,190   

Short-term borrowings

     0        0        0        31   

Long-term debt

     217        217        435        435   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     896        1,270        1,860        2,656   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

     5,382        6,078        10,945        12,002   

Provision for Loan Losses

     332        385        1,632        935   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income After Provision for Loan Losses

     5,050        5,693        9,313        11,067   
  

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Income

        

Trust income

     269        255        545        519   

Service charges on deposits

     815        697        1,550        1,296   

Other service charges and fees

     555        500        1,064        946   

Insurance agency commissions

     84        100        136        155   

Net realized gains (losses) on sales of available-for-sale securities

     161        (10     161        779   

Income from bank owned life insurance

     120        122        239        241   

Other-than-temporary losses on investments:

        

Total other-than-temporary losses

     (35     0        (35     0   

Portion of losses recognized in other comprehensive income (before taxes)

     0        0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (35     0        (35     0   

Other

     333        233        758        519   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

     2,302        1,897        4,418        4,455   
  

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

4


Table of Contents

NB&T Financial Group, Inc.

Condensed Consolidated Statements of Income

(Dollars in Thousands, except per share amounts)

(Unaudited)

 

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

Noninterest Expense

           

Salaries and employee benefits

   $ 2,698       $ 3,112       $ 5,703       $ 6,212   

Net occupancy expense

     567         583         1,135         1,215   

Equipment expense

     348         361         724         747   

Data processing fees

     430         389         861         786   

Professional fees

     452         528         867         1,066   

Marketing expense

     103         155         164         293   

Printing, postage and supplies

     167         172         332         395   

State franchise tax

     230         218         450         434   

FDIC insurance

     125         146         253         367   

Amortization of intangibles

     68         88         138         178   

Net costs of operation of other real estate

     227         145         529         425   

Other

     386         249         659         607   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     5,801         6,146         11,815         12,725   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income Before Income Tax

     1,551         1,444         1,916         2,797   

Provision for Income Taxes

     396         395         400         743   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 1,155       $ 1,049       $ 1,516       $ 2,054   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic Earnings Per Share

   $ .33       $ .31       $ .44       $ .60   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted Earnings Per Share

   $ .33       $ .31       $ .44       $ .60   
  

 

 

    

 

 

    

 

 

    

 

 

 

Dividends Per Share

   $ .30       $ .30       $ .60       $ .60   
  

 

 

    

 

 

    

 

 

    

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

5


Table of Contents

NB&T Financial Group, Inc.

Condensed Consolidated Statements of Comprehensive Income

(Dollars in Thousands)

(Unaudited)

 

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

Net income

   $ 1,155      $ 1,049       $ 1,516      $ 2,054   

Other comprehensive income (loss), before tax effect:

         

Unrealized gains on securities available for sale

     319        1,043         976        466   

Net unrealized gain (loss) on available-for-sale securities for which a portion of an other-than-temporary impairment has been recognized in income

     (4     0         50        0   

Reclassification of amount realized in income

     (126     10         (126     (779
  

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income (loss), before tax effect

     189        1,053         900        (313

Tax expense (credit)

     63        358         306        (106
  

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive income (loss)

     126        695         594        (207
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive Income

   $ 1,281      $ 1,744       $ 2,110      $ 1,847   
  

 

 

   

 

 

    

 

 

   

 

 

 

See Notes to Condensed Consolidated Financial Statements

 

6


Table of Contents

NB&T Financial Group, Inc.

Condensed Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

 

     Six Months Ended
June 30,
 
     2012     2011  

Operating Activities

    

Net income

   $ 1,516      $ 2,054   

Items not requiring (providing) cash:

    

Depreciation and amortization

     821        876   

Provision for loan losses

     1,632        935   

Amortization of premiums and discounts on securities

     1,788        727   

Increase in cash surrender value on bank owned life insurance

     (239     (241

Proceeds from FDIC loss share receivable

     303        112   

Stock options expense

     84        91   

Other-than-temporary impairment on available-for-sale securities

     35        0   

Net realized gains on available-for-sale securities

     (161     (779

Net changes in:

    

Loans held for sale

     0        405   

Other assets and liabilities

     1,024        756   
  

 

 

   

 

 

 

Net cash provided by operating activities

     6,803        4,936   
  

 

 

   

 

 

 

Investing Activities

    

Purchases of available-for-sale securities

     (40,843     (70,268

Proceeds from sales of available-for-sale securities

     1,170        23,443   

Proceeds from maturities of available-for-sale securities

     22,529        43,347   

Purchase of Federal Reserve Bank stock

     (5     (4

Net change in loans

     5,452        5,278   

Purchases of premises and equipment

     (144     (276
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     (11,841     1,520   
  

 

 

   

 

 

 

Financing Activities

    

Net change in:

    

Deposits

     11,596        (3,643

Short-term borrowings

     0        (11,742

Proceeds from stock options exercised

     25        0   

Dividends paid

     (2,054     (2,054
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     9,567        (17,439
  

 

 

   

 

 

 

Increase (Decrease) in Cash and Cash Equivalents

     4,529        (10,983

Cash and Cash Equivalents, Beginning of Period

     75,668        81,751   
  

 

 

   

 

 

 

Cash and Cash Equivalents, End of Period

   $ 80,197      $ 70,768   
  

 

 

   

 

 

 

Supplemental Cash Flows Information

    

Interest paid

   $ 1,891      $ 2,760   

Income taxes paid (net of refunds)

     380        320   

Transfers of loans into other real estate owned

     829        396   

See Notes to Condensed Consolidated Financial Statements

 

7


Table of Contents

Notes to Condensed Consolidated Financial Statements

 

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. The Form 10-Q does not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. Immaterial changes in financial condition and results of operations may not be discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The condensed consolidated balance sheet as of December 31, 2011 has been derived from the audited consolidated balance sheet of that date.

In the opinion of management, the condensed consolidated financial statements contain all adjustments necessary to present fairly the financial condition of NB&T Financial Group, Inc. (the “Company” or “NB&T”) as of June 30, 2012 and December 31, 2011, and the results of its operations and cash flows for the three- and six-month periods ended June 30, 2012 and 2011. Those adjustments consist of only normal recurring adjustments. The results of operations for the interim periods reported herein are not necessarily indicative of results of operation to be expected for the entire year. The unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements, accounting policies and financial notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission.

 

Note 2: Securities

The amortized cost and approximate fair values of securities are as follows (thousands):

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Approximate
Fair Value
 

Available-for-Sale Securities:

          

June 30, 2012:

          

U.S. Government sponsored entities

   $ 19,887       $ 303       $ 0      $ 20,190   

Mortgage-backed securities:

          

U.S. Government sponsored entities-residential

     92,955         2,347         (51     95,251   

Private label-residential

     4,924         198         (159     4,963   

State and political subdivisions

     34,150         1,698         (91     35,757   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 151,916       $ 4,546       $ (301   $ 156,161   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011:

          

U.S. Government sponsored entities

   $ 6,321       $ 113       $ 0      $ 6,434   

Mortgage-backed securities:

          

U.S. Government sponsored entities-residential

     97,203         2,080         (115     99,168   

Private label-residential

     6,997         213         (268     6,942   

State and political subdivisions

     25,878         1,322         0        27,200   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 136,399       $ 3,728       $ (383   $ 139,744   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

8


Table of Contents

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

 

     Amortized
Cost
     Fair Value  

Within one year

   $ 2,570       $ 2,591   

One to five years

     10,037         10,292   

Five to ten years

     14,258         14,847   

After ten years

     27,172         28,217   
  

 

 

    

 

 

 
     54,037         55,947   

Mortgage-backed securities

     97,879         100,214   
  

 

 

    

 

 

 

Totals

   $ 151,916       $ 156,161   
  

 

 

    

 

 

 

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $77,314,000 at June 30, 2012, and $76,915,000 at December 31, 2011.

Gross gains of $161,000 and gross losses of $0 resulting from sales of available-for-sale securities were realized during the first six months of 2012. Gross gains of $789,000 and gross losses of $10,000 resulting from sales of available-for-sale securities were realized during the first six months of 2011. Gross gains and losses are determined under the specific identification method.

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

 

     Less than 12 months     12 months or more     Total  
   Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

June 30, 2012

               

Mortgage-backed securities:

               

U.S. Government sponsored entities-residential

   $ 7,766       $ (51   $ 0       $ 0      $ 7,766       $ (51

Private label-residential

     0         0        542         (159     542         (159

Municipal securities

     7,009         (91     0         0        7,009         (91
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Securities

   $ 14,775       $ (142   $ 542       $ (159   $ 15,317       $ (301
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2011

               

Mortgage-backed securities:

               

U.S. Government sponsored entities-residential

   $ 22,560       $ (115   $ 0       $ 0      $ 22,560       $ (115

Private label-residential

     1,364         (24     525         (244     1,889         (268
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Securities

   $ 23,924       $ (139   $ 525       $ (244   $ 24,449       $ (383
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The unrealized losses on securities outstanding 12 months or more of $159,000 at June 30, 2012 were due to one private-label collateralized mortgage obligation, which has been downgraded by three major bond rating agencies. Although the fair value of this security improved in the last six months, as a result of management’s review of the underlying collateral performance and estimate of projected future cash flows, the Company recognized an other-than- temporary impairment charge of $35,000 during the second quarter of 2012 and $200,000 in prior periods.

In the second quarter of 2012, approximately $13,000 of losses were realized on this security with total realized losses through June 30, 2012 totaling approximately $104,000. These losses were in line with prior period loss projections.

 

9


Table of Contents

Other-than-temporary Impairment

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities. For securities where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model. For securities where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model.

The Company routinely conducts periodic reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred. Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities. While all securities are considered, the securities primarily impacted by other-than-temporary impairment testing are private-label mortgage-backed securities. For each private-label mortgage-backed security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred. Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary. The most significant inputs are the following:

 

   

Default Rate

 

   

Severity

 

   

Prepayments

Other inputs may include the actual collateral attributes, which include geographic concentrations, credit ratings and other performance indicators of the underlying asset.

To determine if the unrealized loss for private label mortgage-backed securities is other-than-temporary, the Company projects total estimated defaults of the underlying assets (mortgages) and multiplies that calculated amount by an estimate of realizable value upon sale in the marketplace (severity) in order to determine the projected collateral loss. The Company also evaluates the current credit enhancement underlying the bond to determine the impact on cash flows. If the Company determines that a given mortgage-backed security position will be subject to a write-down or loss, the Company records the expected credit loss as a charge to earnings.

For those securities for which an other-than-temporary impairment was determined to have occurred as of June 30, 2012 (that is, a determination was made that the entire amortized cost bases will not likely be recovered), the following table presents the inputs used to measure the amount of the credit loss recognized in earnings. The table shows the projected weighted average default rates and loss severities for the recent-vintage private-label mortgage-backed securities portfolios at June 30, 2012.

 

     Default
Rate
    Severity  

Alt-A

     21.7     63.7

 

10


Table of Contents

Credit Losses Recognized on Investments

The following table provides information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income (thousands):

 

     Accumulated
Credit
Losses  2012
 

Credit losses on debt securities held

  

Balance, beginning of period

   $ (118

Additions related to other-than-temporary losses not previously recognized

     (35

Reductions related to losses realized which were previously recognized

     19   
  

 

 

 

Balance, end of period

   $ (134
  

 

 

 

 

Note 3: Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:

 

     June 30,
2012
    December 31,
2011
 

Net unrealized gain on available-for-sale securities

   $ 4,404      $ 3,589   

Net unrealized loss on available-for-sale securities for which a portion of an other-than-temporary impairment has been recognized in income

     (159     (244
  

 

 

   

 

 

 
     4,245        3,345   

Tax effect

     1,443        1,137   
  

 

 

   

 

 

 

Net-of-tax amount

   $ 2,802      $ 2,208   
  

 

 

   

 

 

 

 

Note 4: Loans and Allowance for Loan Losses

 

      June 30,
2012
    December 31,
2011
 

Categories of loans include (thousands):

    

Commercial and industrial

   $ 60,401      $ 67,298   

Real estate construction

     4,777        1,064   

Commercial real estate

     179,296        179,556   

Agricultural

     28,464        32,460   

Residential real estate

     115,355        115,920   

Consumer

     8,228        8,257   
  

 

 

   

 

 

 

Total loans

     396,521        404,555   

Less: Net deferred loan fees, premiums and discounts

     (21     (86

Allowance for loan losses

     (4,508     (4,668
  

 

 

   

 

 

 

Net loans

   $ 391,992      $ 399,801   
  

 

 

   

 

 

 

 

11


Table of Contents

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

Commercial

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

Commercial Real Estate

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

Agricultural

Agricultural loans are viewed primarily as cash flow loans where repayment comes from sales of crops and secondarily as loans secured by real estate, farm equipment or livestock. Repayment of these loans is generally dependent on the successful operation of the farming operation and is highly dependent on weather conditions.

Residential and Consumer

Residential and consumer loans consist of two segments – residential mortgage loans and personal loans. For residential mortgage loans that are secured by 1-4 family residences and are generally owner-occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

 

12


Table of Contents

For all loan classes, the accrual of interest is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. For all loan classes, the entire balance of the loan is considered past due if the minimum payment contractually required to be paid is not received by the contractual due date. For all loan classes, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral. Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

For all loan portfolio segments except residential and consumer loans, the Company promptly charges off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges off residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

For all classes, all interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status. Generally, most impaired loans, except for certain troubled debt restructurings, are on nonaccrual.

Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms, no principal reduction has been granted and the loan has demonstrated the ability to perform in accordance with the renegotiated terms for a period of at least six months.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In the second quarter of 2012, NB&T adopted a new methodology for determining the allowance for loan losses. The new methodology involves use of a calculation model, which allows management to analyze key loan –level data for both impaired and non-impaired loans and apply risk factors to the general reserves based on a loan’s past due status and risk rating. In addition, the model uses the borrower’s address and applies unemployment rate risk factors based on the state of residence. The most significant change between the prior methodology and the current methodology is in the agricultural segment of the portfolio. This segment has had very little historical loss, which is now being applied to the segment. In the prior methodology, the historical loss percentages for commercial and industrial loans were applied to the agricultural segment. The change resulted in a reallocation of the general reserves for that segment of approximately $400,000.

 

13


Table of Contents

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on two principal factors: (1) the one- and three-year rolling average charge-off percentage applied to the current outstanding balance by portfolio type; and (2) estimated losses attributable to loan risk ratings and current unemployment rates. Management believes the one-to-three year historical loss experience methodology is appropriate in the current economic environment. Other adjustments (qualitative/environmental considerations) for each segment may be added to the allowance for each loan segment after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. For impaired loans where the Company utilizes the discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as bad debt expense.

The fair values of collateral dependent impaired loans are based on independent appraisals of the collateral. In general, the Company acquires an updated appraisal upon identification of impairment and periodically thereafter for commercial, commercial real estate and multi-family loans. After determining the collateral value as described, the fair value is calculated based on the determined collateral value less selling expenses. The potential for outdated appraisal values is considered in our determination of the allowance for loan losses through our analysis of various trends and conditions including the local economy, trends in charge-offs and delinquencies, etc. and the related qualitative adjustments assigned by the Company.

Segments of loans with similar risk characteristics are collectively evaluated for impairment based on the segment’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In this scenario, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan. Any loans that are modified are reviewed by the Company to identify if a troubled debt restructuring (“TDR”) has occurred, which is when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two. If such efforts by the Company do not result in a satisfactory arrangement, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Company may terminate foreclosure proceedings if the borrower is able to work-out a satisfactory payment plan.

It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until six months of satisfactory borrower performance, at which time management would consider its return to accrual status. If a loan was accruing at the time of restructuring, the Company reviews the loan to determine if it is appropriate to continue the accrual of interest on the restructured loan.

 

14


Table of Contents

With regard to determination of the amount of the allowance for credit losses, troubled debt restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each portfolio segment within troubled debt restructurings is the same as detailed previously.

The following tables present a breakdown of the allowance for loan losses for the three-month and six-month periods ended June 30, 2012 and 2011 (dollars in thousands):

Three Months Ended June 30, 2012

 

     Commercial      Commercial
Real Estate
    Agricultural     Residential
1-4 Family
    Residential
Home
Equity
    Consumer     Total  

Allowance for loan losses:

               

Beginning balance

   $ 658       $ 2,732      $ 493      $ 366      $ 164      $ 160      $ 4,573   

Charge-offs

     0         (375     0        (39     (18     (4     (436

Recoveries

     0         11        1        1        2        24        39   

Provision

     106         632        (418     32        76        (96     332   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 764       $ 3,000      $ 76      $ 360      $ 224      $ 84      $ 4,508   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2011

 

     Commercial      Commercial
Real Estate
    Agricultural      Residential
1-4 Family
    Residential
Home
Equity
    Consumer     Total  

Allowance for loan losses:

                

Beginning balance

   $ 588       $ 1,943      $ 152       $ 478      $ 227      $ 118      $ 3,506   

Charge-offs

     0         (261     0         (106     (40     (44     (451

Recoveries

     12         8        1         1        1        12        35   

Provision

     201         32        1         104        13        34        385   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 801       $ 1,722      $ 154       $ 477      $ 201      $ 120      $ 3,475   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

15


Table of Contents

Six Months Ended June 30, 2012

 

     Commercial     Commercial
Real Estate
    Agricultural     Residential
1-4 Family
    Residential
Home
Equity
    Consumer     Total  

Allowance for loan losses:

              

Beginning balance

   $ 1,380      $ 2,372      $ 231      $ 373      $ 195      $ 117      $ 4,668   

Charge-offs

     (884     (671     0        (138     (100     (79     (1,872

Recoveries

     1        20        2        2        10        45        80   

Provision

     267        1,279        (157     123        119        1        1,632   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 764      $ 3,000      $ 76      $ 360      $ 224      $ 84      $ 4,508   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2011

 

     Commercial     Commercial
Real Estate
    Agricultural     Residential
1-4 Family
    Residential
Home
Equity
    Consumer     Total  

Allowance for loan losses:

              

Beginning balance

   $ 474      $ 2,057      $ 184      $ 528      $ 337      $ 134      $ 3,714   

Charge-offs

     (4     (1,089     0        (134     (43     (111     (1,381

Recoveries

     13        133        3        6        2        50        207   

Provision

     318        621        (33     77        (95     47        935   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 801      $ 1,722      $ 154      $ 477      $ 201      $ 120      $ 3,475   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

16


Table of Contents

The following tables present the balance in the allowance for loan losses and the recorded investment in financing receivables based on portfolio segment and impairment method as of June 30, 2012 and December 31, 2011 (thousands):

June 30, 2012:

 

     Commercial
Real Estate
     Commercial      Agricultural      Residential
1-4 Family
     Residential
Home
Equity
     Consumer      Total  

Allowance for loan losses:

                    

Ending balance:

                    

Individually evaluated for impairment

   $ 213       $ 1,313       $ 3       $ 2       $ 0       $ 0       $ 1,531   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     551         1,370         73         358         224         84         2,660   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans acquired with deteriorated credit quality:

                    

Individually evaluated for impairment

     0         267         0         0         0         0         267   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     0         50         0         0         0         0         50   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financing Receivables

                    

Ending balance

   $ 60,401       $ 183,653       $ 28,464       $ 85,936       $ 29,839       $ 8,228       $ 396,521   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance:

                    

Individually evaluated for impairment

     3,809         6,783         65         1,115         39         16         11,827   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     56,404         173,975         28,399         84,821         29,800         8,212         381,611   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans acquired with deteriorated credit quality:

                    

Individually evaluated for impairment

     188         913         0         0         0         0         1,101   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     0         1,982         0         0         0         0         1,982   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

17


Table of Contents

December 31, 2011:

 

     Commercial      Commercial
Real Estate
     Agricultural      Residential
1-4 Family
     Residential
Home
Equity
     Consumer      Total  

Allowance for loan losses:

                    

Ending balance:

                    

Individually evaluated for impairment

   $ 1,004       $ 634       $ 0       $ 0       $ 0       $ 0       $ 1,638   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     366         1,365         231         373         195         117         2,647   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans acquired with deteriorated credit quality:

                    

Individually evaluated for impairment

     10         354         0         0         0         0         364   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     0         19         0         0         0         0         19   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financing Receivables

                    

Ending balance

   $ 67,298       $ 180,257       $ 32,460       $ 85,254       $ 31,029       $ 8,257       $ 404,555   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance:

                    

Individually evaluated for impairment

     2,887         5,914         0         997         0         0         9,798   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     64,212         170,953         32,460         84,257         31,029         8,257         391,168   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans acquired with deteriorated credit quality:

                    

Individually evaluated for impairment

     190         1,279         0         0         0         0         1,469   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Collectively evaluated for impairment

     9         2,111         0         0         0         0         2,120   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

18


Table of Contents

The following table outlines the Company’s corporate and consumer credit exposure by category and standard regulatory classification as of June 30, 2012 and December 31, 2011 (thousands):

Corporate Credit Exposure

Credit Risk Profile by Creditworthiness Category:

 

     Commercial      Commercial Real Estate      Agricultural  
     June 30,
2012
     December 31,
2011
     June 30,
2012
     December 31,
2011
     June 30,
2012
     December 31,
2011
 

Pass

   $ 50,087       $ 57,422       $ 162,123       $ 158,142       $ 28,203       $ 32,192   

Other Assets Especially Mentioned

     1,295         1,972         6,476         5,960         0         0   

Substandard

     8,857         7,758         14,911         16,012         261         268   

Doubtful

     146         146         143         143         0         0   

Loss

     0         0         0         0         0         0   

Non-rated

     16         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 60,401       $ 67,298       $ 183,653       $ 180,257       $ 28,464       $ 32,460   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer Credit Exposure

Credit Risk Profile by Internally Assigned Grade

 

     Residential-1 to 4 Family      Residential Home Equity      Consumer  
     June 30,
2012
     December 31,
2011
     June 30,
2012
     December 31,
2011
     June 30,
2012
     December 31,
2011
 

Pass

   $ 82,890       $ 82,030       $ 29,681       $ 30,729       $ 8,160       $ 8,219   

Substandard

     3,046         3,224         158         300         68         38   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 85,936       $ 85,254       $ 29,839       $ 31,029       $ 8,228       $ 8,257   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For purposes of monitoring the credit quality and risk characteristics of its commercial portfolio segment, the Company disaggregates the segment into the following classes: commercial and industrial, commercial real estate and agricultural.

To facilitate the monitoring of credit quality within the commercial portfolio segment, and for purposes of analyzing historical loss rates used in the determination of the allowance for loan losses for the commercial portfolio segment, the Company utilizes the following categories of credit grades: pass, other assets especially mentioned, substandard, doubtful or loss. The five categories, which are derived from standard regulatory rating definitions, are assigned upon initial approval of credit to borrowers and updated periodically thereafter.

Pass ratings, which are assigned to those borrowers that do not have identified potential or well defined weaknesses and for which there is a high likelihood of orderly repayment, are updated periodically based on the size and credit characteristics of the borrower. All other categories are updated on a quarterly basis.

The Company assigns an Other Assets Especially Mentioned rating to loans and leases that have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects for the loan or the Company’s credit position.

The Company assigns a substandard rating to loans that are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. Substandard loans have well defined weaknesses or weaknesses that could jeopardize the orderly repayment of the debt. Loans in this grade also are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies noted are not addressed and corrected.

The Company assigns a doubtful rating to loans that have all the attributes of a substandard rating with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts,

 

19


Table of Contents

conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors that may work to the advantage of and strengthen the credit quality of the loan or lease, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceeding, capital injection, perfecting liens on additional collateral or refinancing plans. Loans rated as loss are loans with advances in excess of calculated current fair value which are considered uncollectible.

For purposes of monitoring the credit quality and risk characteristics of its consumer portfolio segment, the Company disaggregates the segment into the following classes: residential mortgage, home equity and other consumer. The Company considers repayment performance as the best indicator of credit quality for residential mortgage and consumer loans. Consumer loans that have principal and interest payments that have become past due ninety days are classified as substandard unless such loans are both well secured and in the process of collection. All other loans are classified as pass. Well secured loans are collateralized by perfected security interests in real and/or personal property for which the Company estimates proceeds from sale would be sufficient to recover the outstanding principal and accrued interest balance of the loan and pay all costs to sell the collateral. The Company considers a loan in the process of collection if collection efforts or legal action is proceeding and the Company expects to collect funds sufficient to bring the loan current or recover the entire outstanding principal and accrued interest balance.

Generally, all classes of loans are placed on non-accrual status at ninety days past due and interest is considered a loss, unless the loan is well-secured and in the process of collection. Most impaired loans are on non-accrual status. Past due status is based on the contractual terms of the loan. Payments made while a loan is on nonaccrual are treated as reductions of principal. Typically, loans are not returned to accrual status until all loan payments have been current for at least six months. The following tables outline the Company’s past due and nonaccrual loans as of June 30, 2012 and December 31, 2011 (thousands):

June 30, 2012:

 

     Past Due Days             Total      90+ Days         
     30-59      60-89      90+      Total      Current      Financing
Receivables
     &
Accruing
     Non-
accrual
 

Commercial

   $ 2,830       $ 205       $ 1,342       $ 4,377       $ 56,024       $ 60,401       $ 0       $ 3,998   

Commercial Real Estate

     563         277         4,695         5,535         178,118         183,653         0         6,106   

Agricultural

     51         159         81         291         28,173         28,464         16         65   

Residential 1-4 Family

     798         84         705         1,587         84,349         85,936         134         1,574   

Residential Home Equity

     5         19         120         144         29,695         29,839         15         154   

Consumer

     175         5         8         188         8,040         8,228         0         65   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,422       $ 749       $ 6,951       $ 12,122       $ 384,399       $ 396,521       $ 165       $ 11,962   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011:

 

     Past Due Days             Total      90+ Days         
     30-59      60-89      90+      Total      Current      Financing
Receivables
     &
Accruing
     Non-
accrual
 

Commercial

   $ 263       $ 1,640       $ 2,076       $ 3,979       $ 63,319       $ 67,298       $ 0       $ 3,406   

Commercial Real Estate

     393         1,363         4,411         6,167         174,090         180,257         0         5,695   

Agricultural

     90         0         41         131         32,329         32,460         0         41   

Residential 1-4 Family

     1,142         431         810         2,383         82,871         85,254         116         2,442   

Residential Home Equity

     171         99         118         388         30,641         31,029         17         275   

Consumer

     74         53         119         246         8,011         8,257         0         148   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,133       $ 3,586       $ 7,575       $ 13,294       $ 391,261       $ 404,555       $ 133       $ 12,007   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

20


Table of Contents

The following table represents loans considered impaired at June 30, 2012 and December 31, 2011 and the related allowance for loan losses. Interest income recognized is not materially different than interest income that would have been recognized on a cash basis (thousands):

 

                          For the three months
ended
June 30, 2012
     For the six months
ended
June 30, 2012
 

June 30, 2012:

   Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

                    

Commercial

   $ 1,032       $ 1,270       $ 0       $ 894       $ 0       $ 881       $ 0   

Commercial real estate

     4,027         4,252         0         3,871         30         3,916         64   

Agricultural

     30         41         0         15         0         10         0   

Residential-1 to 4 Family

     1,035         1,139         0         1,072         9         1,047         25   

Residential-Home equity

     39         41         0         20         0         13         0   

Consumer

     16         16         0         8         0         5         0   

With an allowance recorded:

                    

Commercial

   $ 2,965       $ 3,016       $ 213       $ 1,723       $ 0       $ 1,889       $ 0   

Commercial real estate

     3,669         3,750         1,580         3,726         0         3,546         0   

Agricultural

     35         35         3         18         0         12         0   

Residential-1 to 4 Family

     80         80         2         40         0         27         0   

Residential-Home equity

     0         0         0         0         0         0         0   

Consumer

     0         0         0         0         0         0         0   

Total:

                    

Commercial

   $ 3,997       $ 4,286       $ 213       $ 2,617       $ 0       $ 2,770       $ 0   

Commercial real estate

     7,696         8,002         1,580         7,597         30         7,462         64   

Agricultural

     65         76         3         33         0         22         0   

Residential-1 to 4 Family

     1,115         1,219         2         1,112         9         1,074         25   

Residential-Home equity

     39         41         0         20         0         13         0   

Consumer

     16         16         0         8         0         5         0   

 

21


Table of Contents
     As of December 31, 2011      For the three months
ended

June 30, 2011
     For the six months
ended
June 30, 2011
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

                    

Commercial

   $ 856       $ 894       $ 0       $ 1,025       $ 0       $ 920       $ 0   

Commercial real estate

     4,006         4,112         0         3,970         0         3,706         17   

Agricultural

     0         0         0         0         0         0         0   

Residential-1 to 4 Family

     997         997         0         1,158         0         1,160         0   

Residential-Home equity

     0         0         0         0         0         0         0   

Consumer

     0         0         0         0         0         0         0   

With an allowance recorded:

                    

Commercial

   $ 2,221       $ 2,251       $ 1,014       $ 1,152       $ 0       $ 832       $ 0   

Commercial real estate

     3,187         3,316         988         1,229         0         1,713         0   

Agricultural

     0         0         0         0         0         0         0   

Residential-1 to 4 Family

     0         0         0         0         0         0         0   

Residential-Home equity

     0         0         0         0         0         0         0   

Consumer

     0         0         0         0         0         0         0   

Total:

                    

Commercial

   $ 3,077       $ 3,145       $ 1,014       $ 2,177       $ 0       $ 1,752       $ 0   

Commercial real estate

     7,193         7,428         988         5,199         0         5,419         17   

Agricultural

     0         0         0         0         0         0         0   

Residential-1 to 4 Family

     997         997         0         1,158         0         1,160         0   

Residential-Home equity

     0         0         0         0         0         0         0   

Consumer

     0         0         0         0         0         0         0   

Interest income recognized is not materially different from cash basis interest.

 

22


Table of Contents

The following tables present information regarding troubled debt restructurings (“TDRs”) by segment: (dollars in thousands):

Newly classified troubled debt restructurings:

 

     Three Months Ended June 30, 2012      Six Months Ended June 30, 2012  
     Number of
Contracts
     Outstanding Recorded
Investment
     Number of
Contracts
     Outstanding Recorded
Investment
 
        Pre-
Modification
     Post-
Modification
        Pre-
Modification
     Post-
Modification
 

Commercial

     0       $ 0       $ 0         1       $ 62       $ 25   

Commercial real estate

     1         19         19         1         19         19   

Residential

     1         116         80         2         158         119   

Consumer

     0         0         0         1         18         16   

The following table provides information on how restructured loans were modified during the three-and six-month periods ended June 30, 2012 (in thousands):

 

     June 30, 2012  
     Three Months Ended      Six Months Ended  
     Recorded
Investment
     Amount
charged off
     Recorded
Investment
     Amount
charged off
 

Extended Maturities

   $ 19       $ 0       $ 75       $ 0   

Adjusted Interest Rates

     0         0         0         0   

Lowered payment

     0         0         25         0   

Reduced principal and lowered interest rate

     80         36         89         36   

The allowance for loan losses was not increased for any of the above restructured loans.

All TDRs are considered impaired loans. The Company had the following TDR’s modified in the past twelve months that subsequently defaulted during the quarterly and year-to-date periods (dollars in thousands):

 

     Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 
     Number of
Contracts
     Recorded
Investment
     Number of
Contracts
     Recorded
Investment
 

Residential

     1       $ 95         1       $ 95   

The allowance for loan losses on the above restructured loan is based on the present value of future expected cash flows and takes into account the past due payments.

The Company acquired loans from American National Bank (“ANB”) on March 19, 2010 and by its acquisition by merger of Community National Corporation on December 31, 2009. At the time of each acquisition, there was evidence of deterioration of credit quality since origination for which it was probable, at acquisition, that all contractually required payments would not be collected. ASC 310-30 requires that acquired credit-impaired loans be recorded at fair value and prohibits carryover of the related allowance for loan losses. Loans within the scope of this accounting standard were initially recorded by the Company at fair value. The process of estimating fair value involves estimating the principal and interest cash flows expected to be collected on the credit impaired loans and discounting those cash flows at a market rate of interest. Under this accounting standard, the excess of cash flows

 

23


Table of Contents

expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan in situations where there is reasonable expectation about the timing and amount of cash flows collected. The difference between contractually required payments at acquisition and the cash flows expected at acquisition to be collected, considering the impact of prepayments, is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a charge to the provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent increases in cash flows result in reversal of non-accretable discount (or allowance for loan losses to the extent any had been recorded) with a positive impact on interest income. Disposals of loans, which may include sales of loans, receipt of payments in full by the borrower, foreclosure, or troubled debt restructurings result in removal of the loan from the impaired loan portfolio at its carrying amount. Loans subject to this accounting standard are written down to an amount estimated to be collectible. Accordingly, such loans are no longer classified as nonaccrual even though they may be contractually past due. We expect to fully collect the new carrying values of such loans. If a loan, or a pool of loans, deteriorates post acquisition, a provision for loan losses is recorded. Acquired loans subject to this accounting standard are also excluded from the disclosure of loans 90 days or more past due and still accruing interest; however, the Bank’s regulatory reporting instructions require these loans to be reported as past due based upon the borrower’s contractual obligations. Even though substantially all of them are 90 days or more contractually past due, they are considered to be accruing because the interest income on these loans relates to the establishment of an accretable yield.

The carrying amount of those loans is included in the balance sheet amounts of loans receivable at June 30, 2012. The amounts are as follows (thousands):

 

Commercial

   $ 3,969   

Consumer

     9   
  

 

 

 

Outstanding balance

   $ 3,978   
  

 

 

 

Carrying amount, net of discount of $423

   $ 2,573   
  

 

 

 

Accretable yield

   $ 67   
  

 

 

 

Accretable yield, or income expected to be collected, is as follows:

 

Balance at December 31, 2011

   $ 76   

Additions

     0   

Accretion

     (9

Reclassification from non-accretable difference

     0   

Disposals

     0   
  

 

 

 

Balance at June 30, 2012

   $ 67   
  

 

 

 

 

Note 5: Long-Term Debt

Long-term debt consisted of the following components (thousands):

 

     June 30,
2012
     December 31,
2011
 

Federal Home Loan Bank advances

   $ 5,000       $ 5,000   

Junior subordinated debentures

     10,310         10,310   
  

 

 

    

 

 

 

Total

   $ 15,310       $ 15,310   
  

 

 

    

 

 

 

On June 25, 2007, NB&T Statutory Trust III (“Trust III”), a wholly owned subsidiary of the Company, closed a pooled private offering of 10,000 Capital Securities with a liquidation amount of $1,000 per security. The proceeds of the offering were loaned to the Company in exchange for junior subordinated debentures with terms similar to the

 

24


Table of Contents

Capital Securities. The sole assets of Trust III are the junior subordinated debentures of the Company and payments thereunder. The junior subordinated debentures and the back-up obligations, in the aggregate, constitute a full and unconditional guarantee by the Company of the obligations of Trust III under the Capital Securities. Distributions on the Capital Securities are payable quarterly at a fixed interest rate of 7.071% through September 6, 2012 and thereafter at the annual rate of 1.50% over the 3 month LIBOR. Distributions on the Capital Securities are included in interest expense in the consolidated financial statements. These securities are considered Tier I capital (with certain limitations applicable) under current regulatory guidelines.

The junior subordinated debentures are subject to mandatory redemption, in whole or in part, upon repayment of the Capital Securities at maturity or their earlier redemption at the liquidation amount. Subject to the Company having received prior approval of the Federal Reserve, if then required, the Capital Securities are redeemable prior to the maturity date of September 6, 2037, at the option of the Company. On or after September 6, 2012, the Capital Securities are redeemable at par. Upon occurrence of specific events defined within the trust indenture, the Capital Securities may also be redeemed prior to September 6, 2012 at a premium. The Company has the option to defer distributions on the Capital Securities from time to time for a period not to exceed 20 consecutive semi-annual periods.

As of June 30, 2012 and December 31, 2011, the outstanding principal balance of the Capital Securities was $10,000,000. The Company accounts for its investment in the trust as assets, its subordinated debentures as debt, and the interest paid thereon as interest expense.

 

Note 6: Commitments

Outstanding commitments to extend credit as of June 30, 2012 totaled $73,525,000. Standby letters of credit as of June 30, 2012 totaled $2,002,000.

 

Note 7: Earnings Per Share

The factors used in the earnings per share computation were as follows (thousands, except share and per share amounts):

 

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

Numerator:

           

Net income

   $ 1,155       $ 1,049       $ 1,516       $ 2,054   
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator:

           

Weighted-average common shares outstanding (basic)

     3,424,814         3,424,162         3,424,531         3,424,162   

Effect of stock options

     6,633         12,101         8,136         19,275   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding (diluted)

     3,431,447         3,436,263         3,432,667         3,443,437   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic

   $ .33       $ .31       $ .44       $ .60   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ .33       $ .31       $ .44       $ .60   
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three and six months ended June 30, 2012, stock options covering 223,767 and 191,600 shares of common stock, respectively, were not considered in computing earnings per share as their exercise prices exceeded the fair market value of the Company’s common shares. For both the three and six months ended June 30, 2011, stock options covering 118,700 shares of common stock were not considered in computing earnings per share as their exercise prices exceeded the fair market value of the Company’s common shares.

 

25


Table of Contents
Note  8: Accounting for Uncertainty in Income Taxes

The Company or one of its subsidiaries files income tax returns in the U.S. federal and Ohio jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local examinations by tax authorities for years before 2009.

The Income Taxes Topic of the Codification prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This topic also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of June 30, 2012, the Company did not identify any uncertain tax positions that it believes should be recognized in the financial statements.

 

Note 9: Fair Value Measurements

The Company accounts for fair values in accordance with accounting guidance for Fair Value Measurements prescribed under the FASB Accounting Standards Codification. The ASC defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.

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

 

Level 1   Quoted prices in active markets for identical assets or liabilities
Level 2   Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

The following is a description of the valuation methodologies used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy:

Available-for-Sale Securities

The fair value of available-for-sale securities is determined by various valuation methodologies. Level 2 securities include U.S. Government agencies, mortgage-backed securities, and obligations of political and state subdivisions. Level 2 inputs do not include quoted prices for individual securities in active markets; however, they do include inputs that are either directly or indirectly observable for the individual security being valued. Such observable inputs include interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates. Also included are inputs derived principally from or corroborated by observable market data by correlation or other means.

 

26


Table of Contents

The following table presents the fair value measurements of assets measured at fair value on a recurring basis and the level within the ASC fair value hierarchy in which the fair value measurements fall at June 30, 2012 and December 31, 2011. (See fair values by type of security in Note 2) (thousands):

 

            Fair Value Measurements at Reporting Date Using  

Description

   Fair
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:

           

Available-for-sale securities

   $ 156,161       $ 0       $ 156,161       $ 0   

December 31, 2011:

           

Available-for-sale securities

   $ 139,744       $ 0       $ 139,744       $ 0   

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

Impaired Loans (Collateral Dependent)

At June 30, 2012 and December 31, 2011, impaired loans consisted primarily of loans secured by commercial real estate. Management has determined fair value measurements on impaired loans primarily through evaluations of appraisals performed, less estimated cost to sell. Appraisals are reviewed for accuracy and consistency by the Credit Administration area, and appraisers are selected from the list of approved appraisers maintained by management. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy. NB&T also has some impaired loans secured by accounts receivable, inventory or equipment. Management has determined fair value measurements based on review of recent financial statements or research of current equipment values.

Other Real Estate Owned

Real estate acquired through, or in lieu of, loan foreclosure is held for sale and initially recorded at fair value based on current appraised value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, new appraisals are periodically obtained by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Appraisals are reviewed for accuracy and consistency by the Credit Administration area, and appraisers are selected from the list of approved appraisers maintained by management. OREO is classified within Level 3 of the fair value hierarchy.

 

27


Table of Contents

The following table presents the fair value measurements of assets measured at fair value on a nonrecurring basis and the level within the ASC fair value hierarchy in which the fair value measurements fall at June 30, 2012 and December 31, 2011. The values below only represent those assets with a change in their fair value estimate since the previous year end (thousands).

 

            Fair Value Measurements at Reporting Date Using  
Description    Fair
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:

           

Impaired loans

Other real estate owned

   $

 

1,346

920

  

  

   $

 

0

0

  

  

   $

 

0

0

  

  

   $

 

1,346

920

  

  

December 31, 2011:

           

Impaired loans

Other real estate owned

   $

 

2,647

2,043

  

  

   $

 

0

0

  

  

   $

 

0

0

  

  

   $

 

2,647

2,043

  

  

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill.

 

Description    Fair
Value
     Valuation
Technique
   Unobservable
Inputs
   Range
(Weighted
Average)

June 30, 2012:

           

Impaired loans

   $ 1,346       Market comparable
properties
   Costs to sell    10%

Other real estate owned

   $ 920       Market comparable
properties
   Comparability
adjustments
   Not available

 

28


Table of Contents

The following table presents estimated fair values of the Company’s other financial instruments recognized in the accompanying balance sheets at amounts other than fair value and the level within the fair value hierarchy in which the fair value measurements fall. The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Company does not know whether the fair values shown below represent values at which the respective financial instruments could be sold individually or in the aggregate (thousands):

     Fair Value Measurements Using  
      Carrying
Amount
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

June 30, 2012:

           

Financial assets

           

Cash and cash equivalents

   $ 80,197       $ 80,197       $ 0       $ 0   

Loans including loans held for sale, net

     391,992         0         0         401,147   

Stock in FRB and FHLB

     10,030         0         10,030         0   

Earned income receivable

     2,643         0         2,643         0   

FDIC loss share receivable

     1,625         0         0         1,625   

Financial liabilities

           

Deposits

     592,979         0         595,902         0   

Long-term debt

     15,310         0         9,825         0   

Interest payable

     171         0         171         0   

December 31, 2011:

           

Financial assets

           

Cash and cash equivalents

   $ 75,668       $ 75,668       $ 0       $ 0   

Loans including loans held for sale, net

     399,801         0         0         411,499   

Stock in FRB and FHLB

     10,025         0         10,025         0   

Earned income receivable

     2,948         0         2,948         0   

FDIC loss share receivable

     1,928         0         0         1,928   

Financial liabilities

           

Deposits

     581,383         0         584,573         0   

Long-term debt

     15,310         0         9,938         0   

Interest payable

     202         0         202         0   

 

29


Table of Contents

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.

Cash and Cash Equivalents

The carrying amount approximates fair value.

Loans, net

Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities. The market rates used are based on current rates the Bank would impose for similar loans and reflect a market participant assumption about risks associated with non-performance, illiquidity, and the structure and term of the loans along with local economic and market conditions.

Stock in FRB and FHLB

Fair value is estimated at book value due to restrictions that limit the sale or transfer of such stock.

FDIC loss share receivable

The carrying amount approximates fair value. The carrying amount is based on future expected losses on loans covered under the loss share agreement with the FDIC.

Earned Income Receivable and Interest Payable

The carrying amount approximates fair value. The carrying amount for interest receivable and interest payable is determined using the interest rate, balance and last payment date. Trust income and commissions receivable is based on trust fee schedules, market value of trust assets and brokerage commission schedules.

Deposits

Fair value of term deposits is estimated by discounting the future cash flows using rates of similar deposits with similar maturities. The market rates used were based on current rates the Bank would offer on similar term deposits. The estimated fair value of demand, NOW, savings and money market deposits is the book value since rates are regularly adjusted to market rates and amounts are payable on demand at the reporting date.

Long-term Debt

Fair value of Federal Home Loan debt is estimated by discounting the future cash flows using rates of similar advances with similar maturities. These rates were obtained from current rates offered by the FHLB. Fair value of Trust Preferred debt is estimated by discounting the future cash flows using rates of similar trust preferred debt issuances. These rates were obtained from a knowledgeable independent third party and reviewed by the Company.

Commitments to Originate Loans, Forward Sale Commitments, Letters of Credit, and Lines of Credit

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of forward sale commitments is estimated based on current market prices for loans of similar terms and credit quality. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2012 and December 31, 2011, the fair value of commitments was not material.

 

30


Table of Contents
Note 10: Effect of Recent Accounting Standards

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, which contains amendments explaining further how to measure fair value. The amendments in this update apply to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, liability or a financial instrument. The amendments also require disclosures about quantitative information about the unobservable inputs in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The amendments are to be applied prospectively and are effective for periods beginning after December 15, 2011. These disclosures are included in the June 30, 2012 financial statements.

The FASB issued Accounting Standards Update No. 2011-05 and 2011-12, which will increase the prominence of other comprehensive income (“OCI”) in the financial statements, no longer allowing OCI to be presented in the Statement of Changes in Equity. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has included this statement in the June 30, 2012 financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-08 regarding the testing for goodwill impairment. Under the revised standard, an entity will be allowed to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The amendments are effective on annual or interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. Adoption of this standard has not had a material effect on the Company’s financial statements.

 

31


Table of Contents

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders

NB&T Financial Group, Inc.

Wilmington, Ohio

We have reviewed the accompanying condensed consolidated balance sheet of NB&T Financial Group, Inc. as of June 30, 2012 and the related condensed consolidated statements of income and comprehensive income for the three-month and six-month periods ended June 30, 2012 and 2011 and cash flows for the six-month periods ended June 30, 2012 and 2011. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2011 and the related consolidated statements of income, stockholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated March 20, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ BKD, LLP

Cincinnati, Ohio

August 9, 2012

 

32


Table of Contents

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Net income for the second quarter of 2012 was $1.2 million, or $.33 per share, compared to net income for the second quarter of 2011 of $1.0 million, or $.31 per share. Net income increased primarily due to recognition of $161,000 in securities sale gains, compared to $10,000 in securities sale losses in the second quarter of last year. Net income for the first six months of 2012 was $1.5 million, or $.44 per share, compared to $2.1 million, or $.60 per share, for the same period in 2011.

Net Interest Income

Net interest income was $5.4 million for the second quarter of 2012, compared to $6.1 million for the second quarter of 2011. Net interest margin decreased to 3.38% for the second quarter of 2012, compared to 3.95% for the same quarter last year. The net interest margin decreased primarily due to a change in asset mix from higher-yielding loans to lower-yielding securities. Average loans, which had an average rate of 5.47%, declined $14.7 million, while average overnight investments and securities, with an average rate of 1.50%, increased $38.3 million in the second quarter of 2012. Net interest income for the first half of 2012 was $10.9 million, compared to $12.0 million for the first half of 2011.

Provision for Loan Losses

The provision for loan losses for the second quarter of 2012 was $332,000, compared to $385,000 in the same quarter last year. Net charge-offs were $397,000 in the second quarter of 2012, compared to $415,000 in the second quarter of 2011. The provision for loan losses was $1.6 million and $935,000 for the six month periods ended June 30, 2012 and 2011, respectively. Year to date net charge-offs for 2012 were $1.8 million, compared to $416,000 for the first six months of 2011. Charge-offs in 2012 increased primarily due to the write-off of one commercial loan for approximately $850,000, which was fully reserved for at the previous year end. The provision for loan losses was also increased to add specific loan reserves of approximately $622,000 for two commercial real estate loans where management has estimated lower valuations on the real estate securing these loans and to add general reserves related to increased charge-off experience. Non-performing loans were $12.1 million at both June 30, 2012 and December 31, 2011. The June 30, 2012 non-performing loans include a $3.2 million loan relationship put on non-accrual status during the quarter. The borrower’s financial condition has weakened and its working capital line has matured. The borrower and NB&T are currently developing a workout plan. Approximately $727,000 of the non-performing loans outstanding at June 30, 2012 are covered under the Company’s FDIC loss share agreement, with the FDIC sharing in 80% of any future losses associated with those loans.

Non-interest Income

Total non-interest income was $2.3 million for the second quarter of 2012, compared to $1.9 million for the second quarter of 2011. Non-interest income for 2012 was higher due to recognition of $161,000 in securities sale gains, compared to $10,000 in securities sale losses in the second quarter of last year. In addition, overdraft fees have increased in 2012. In the second quarter of 2012, the Bank recognized an additional other-than-temporary impairment loss of $35,000 on one of its private-label mortgage-backed securities. Non-interest income for the first six months of 2012 was $4.4 million, compared to $4.5 million for the same period last year.

Non-interest Expense

Total non-interest expense was $5.8 million for the second quarter of 2012, compared to $6.1 million for the second quarter of 2011. The decline in expense is to due to overall expense reduction primarily in the areas of personnel, benefit costs, branch hours, professional fees, marketing and other processing costs, partially offset by an increase in costs of operation of other real estate. For the first six months of 2012, total non-interest expense was $11.8 million, compared to $12.7 million for the same period in 2011.

 

33


Table of Contents

Income Taxes

The provision for income taxes for the second quarter of 2012 was $396,000, or 25.5% effective rate, compared to $395,000, or 27.4% effective rate, for the second quarter of 2011. The provision for income taxes for the first half of 2012 was $400,000, or 20.9% effective rate, compared to $743,000, or 26.6% effective rate for the same period last year. The lower effective tax rate for the first half of 2012 is primarily due to the decrease in taxable income at the full 34% marginal rate.

Financial Condition

The changes that have occurred in the Company’s financial condition during 2012 are as follows (in thousands):

 

                   2012 Change  
     June 30,
2012
     December 31,
2011
     Amount     Percent  

Total assets

   $ 687,226       $ 675,588       $ 11,638        1.7   

Interest-earning deposits

     66,928         61,441         5,487        8.9   

Federal funds sold

     427         366         61        16.7   

Loans, net

     391,992         399,801         (7,809     (2.0

Securities

     156,161         139,744         16,417        11.8   

Demand deposits

     102,901         97,732         5,169        5.3   

Savings, NOW, MMDA deposits

     349,961         331,524         18,437        5.6   

CD’s $100 and over

     33,253         36,997         (3,744     (10.1

Other time deposits

     106,864         115,130         (8,266     (7.2

Total deposits

     592,979         581,383         11,596        2.0   

Long-term borrowings

     15,310         15,310         0        0   

Stockholders’ equity

     70,955         70,790         165        .2   

At June 30, 2012, total assets were $687.2 million, an increase of $11.6 million from December 31, 2011. The increase is primarily attributable to increases in retail savings and money market deposits, which were invested in short-term, interest-earning deposits and investment securities. Loans declined $7.8 million from December 31, 2011. The decline is largely the result of decreased loan demand and increased sales of fixed-rate residential mortgage loans into the secondary market. Most of the decline in loan demand has occurred as borrowers uncertain about current economic conditions choose to reduce their debt. Lower rates in the secondary mortgage market have led to increased sales of mortgage loans.

Total deposit liabilities increased $11.6 million during the year. The Company has experienced growth in transaction, savings and money market accounts and a decline in certificates of deposit as depositors have chosen to keep their funds in more liquid deposits that offer comparable rates to shorter-term certificates of deposit.

 

34


Table of Contents

Allowance for Loan Losses

The Company’s loan loss experience for the periods ended June 30, 2012 and 2011 is outlined in Note 4 of the financial statements.

The following table sets forth selected information regarding the Company’s loan quality at the dates indicated (in thousands):

 

     June 30,
2012
    December 31,
2011
    June 30,
2011
 

Loans accounted for on non-accrual basis

   $ 11,962      $ 12,007      $ 11,452   

Accruing loans which are past due 90 days

     165        133        1,049   

Other real estate owned

     3,032        3,520        4,175   
  

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 15,159      $ 15,660      $ 16,676   
  

 

 

   

 

 

   

 

 

 

Troubled debt restructurings, accruing

   $ 2,416      $ 2,050      $ 452   

Ratios:

      

Allowance to total loans

     1.14     1.15     0.85

Net charge-offs to average loans (annualized)

     .91     0.34     0.58

Non-performing assets to total loans and other real estate owned

     3.79     3.84     4.15

The allowance is maintained to absorb losses in the portfolio. Management’s determination of the adequacy of the allowance is based on reviews of specific loans, loan loss experience, general economic conditions and other pertinent factors. If, as a result of charge-offs or increases in risk characteristics of the loan portfolio, the allowance is below the level considered by management to be adequate to absorb possible loan losses, the provision for loan losses is increased. Loans deemed not collectible are charged off and deducted from the allowance. Recoveries on loans previously charged off are added to the allowance.

The Company allocates the allowance for loan losses to specifically classified loans and non-classified loans generally based on the one- and three-year net charge-off history. In assessing the adequacy of the allowance for loan losses, the Company considers three principal factors: (1) the one- and three-year rolling average charge-off percentage applied to the current outstanding balance by portfolio type; (2) specific allocations applied to individual loans estimated by management to have a potential loss; and (3) estimated losses attributable to current unemployment rates.

During the second quarter of 2012, the Company charged off approximately $268,000 on one commercial real estate loan where the borrower filed bankruptcy. The loan was charged down to the appraised value of the property securing the loan. In addition, in the first quarter of 2012, the Company charged off approximately $850,000 on one commercial loan, which was fully reserved for in the previous year. As of June 30, 2012, there was $10.1 million in small business relationships on nonaccrual. Approximately $5.1 million of this amount consisted of four relationships, all secured by commercial real estate or business assets. In addition, approximately $1.2 million of loans were acquired from ANB and are covered under the FDIC loss share agreement. Non–accrual residential real estate loans totaled $1.6 million, with the largest balance being $268,000. In addition, approximately $675,000 of loans were acquired from ANB and are covered under the FDIC loss share agreement. Non-accrual agricultural loans totaled $65,000, consumer loans totaled $65,000, and home equity credit loans totaled $154,000.

Liquidity and Capital Resources

Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as Company cash needs, are met. The Company manages liquidity on both the asset and liability sides of the balance sheet. The loan-to-deposit ratio at June 30, 2012 was 66.9%, compared to 69.6% at December 31, 2011 and 70.3% at the same date in 2011. Loans to total assets were 57.7% at June 30, 2012, compared to 59.9% at December 31,

 

35


Table of Contents

2011 and 60.5% at the same time last year. At June 30, 2012, the Company had $66.9 million in interest-earning deposits. The Company has $156.2 million in available-for-sale securities that are readily marketable. Approximately 49.5% of the available-for-sale portfolio is pledged to secure public deposits, short-term and long-term borrowings and for other purposes as required by law. The balance of the available-for-sale securities could be sold if necessary for liquidity purposes. Also, a stable deposit base, consisting of 94.4% core deposits, makes the Company less susceptible to large fluctuations in funding needs. The Company has the ability to borrow short-term funds from two correspondent banks and the Federal Reserve Bank. The Company also has both short- and long-term borrowing available through the Federal Home Loan Bank (FHLB). The Company has the ability to obtain deposits in the brokered certificate of deposit market to help provide liquidity to fund loan growth.

The Federal Reserve Board has adopted risk-based capital guidelines that assign risk weightings to assets and off-balance sheet items and also define and set minimum capital requirements (risk-based capital ratios). At June 30, 2012 and December 31, 2011, the Company had the following risk-based capital ratios, which are well above the regulatory minimum requirements (dollar amounts in thousands):

 

     Actual     For Capital
Adequacy
Purposes
    To Be Well
Capitalized
Under Prompt
Corrective Action
Provisions
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of June 30, 2012

               

Total Risk-Based Capital (to Risk-Weighted Assets)

               

Consolidated

   $ 79,170         19.20   $ 32,918         8.0     N/A         N/A   

Bank

     73,079         17.74        32,955         8.0      $ 41,194         10.0

Tier I Capital (to Risk-Weighted Assets)

               

Consolidated

     74,662         18.11        16,459         4.0        N/A         N/A   

Bank

     68,571         16.65        16,478         4.0        24,717         6.0   

Tier I Capital (to Average Assets)

               

Consolidated

     74,662         10.80        27,662         4.0        N/A         N/A   

Bank

     68,574         9.98        27,495         4.0        34,369         5.0   

As of December 31, 2011

               

Total Risk-Based Capital (to Risk-Weighted Assets)

               

Consolidated

   $ 79,620         19.15   $ 33,270         8.0     N/A         N/A   

Bank

     71,285         17.16        33,242         8.0      $ 41,552         10.0

Tier I Capital (to Risk-Weighted Assets)

               

Consolidated

     74,952         18.02        16,635         4.0        N/A         N/A   

Bank

     66,617         16.03        16,621         4.0        24,931         6.0   

Tier I Capital (to Average Assets)

               

Consolidated

     74,952         11.03        27,185         4.0        N/A         N/A   

Bank

     66,617         9.87        27,009         4.0        33,762         5.0   

 

36


Table of Contents

CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2011. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.

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

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

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

Fair Value of Securities – The Company uses the Fair Value Measurements prescribed under the FASB Accounting Standards Codification to value its securities. The ASC defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The ASC also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1   Quoted prices in active markets for identical assets or liabilities
Level 2   Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities
Level 3   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

 

37


Table of Contents

The fair value of available-for-sale securities are determined by various valuation methodologies. Level 2 securities include U.S. Government agency securities, mortgage-backed securities, and obligations of political and state subdivisions. Level 2 inputs do not include quoted prices for individual securities in active markets; however, they do include inputs that are either directly or indirectly observable for the individual security being valued. Such observable inputs include interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, credit risks and default rates. Also included are inputs derived principally from or corroborated by observable market data by correlation or other means.

Goodwill and Other Intangibles – The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required by the “Intangibles – Goodwill & Other” topic of the FASB Accounting Standards Codification. Goodwill is subject, at a minimum, to annual tests for impairment. Testing includes evaluating the current market price of the stock versus book value, the current economic value of equity versus current book value, and recent market sales of financial institutions. Based on the review of all three factors, management has concluded goodwill is not impaired. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to interest rate risk, exchange rate risk, equity price risk and commodity price risk. The Company does not maintain a trading account for any class of financial instrument, and is not currently subject to foreign currency exchange rate risk, equity price risk or commodity price risk. The Company’s market risk is composed primarily of interest rate risk.

The Bank manages its interest rate risk regularly through its Asset/Liability Committee. The Committee meets on a monthly basis and reviews various asset and liability management information, including but not limited to, the Bank’s interest rate risk position, liquidity position, projected sources and uses of funds and economic conditions.

The Bank uses simulation models to manage interest rate risk. In the Bank’s simulation models, each asset and liability balance is projected over a two-year horizon. Net interest income is then projected based on expected cash flows and projected interest rates under a stable rate scenario and analyzed on a monthly basis. The results of this analysis are used in decisions made concerning pricing strategies for loans and deposits, balance sheet mix, securities portfolio strategies, liquidity and capital adequacy. The Bank’s current one-year simulation model under stable rates indicates increasing yields on interest-earning assets will exceed increasing costs of interest-bearing liabilities. This position could have a positive effect on projected net interest margin over the next twelve months.

Simulation models are performed for 100, 200, 300 and 400 basis point increases ramped up over a two-year period and also for immediate rate shocks. Due to the low interest rate environment, the down rate changes were not modeled. These rate changes are modeled using both projected dynamic balance sheets and a flat static balance sheet over a two-year period. The results of these simulation models are compared with the stable rate simulation. The model includes assumptions as to repricing and expected prepayments, anticipated calls, and expected decay rates of transaction accounts under the different rate scenarios. The results of these simulations include changes in both net interest income and market value of equity. ALCO guidelines that measure interest rate risk by the percent of change from stable rates, and capital adequacy, have been established, and as the table below indicates at June 30, 2012, the Bank was within the guidelines established by the Board for net interest income changes for increasing rate changes of 100, 200, 300 and 400 basis points. Economic value of equity changes for the 200 and 300 basis points rate changes exceeded the ALCO guidelines due to increasing value of the Bank’s core deposit base. This variance was reviewed by the Board. Because the variance indicates a long-term positive impact, the Board approved the exception at this time.

 

38


Table of Contents

As with any method of measuring interest rate risk, certain shortcomings are inherent in the simulation modeling. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market rates. In addition, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and mortgage-backed securities and early withdrawals from certificates of deposit may deviate significantly from those assumed in making the risk calculations. The Bank’s rate ramp simulation models provide results in extreme interest rate environments and results are used accordingly. Reacting to changes in economic conditions, interest rates and market forces, the Bank has been able to alter the mix of short-and long-term loans and investments, and increase or decrease the emphasis on fixed- and variable-rate products in response to changing market conditions.

 

     Net Interest Income
Change
    Economic Value of
Equity Change
 

Rate Ramp

   6/30/12     ALCO
Guideline
    6/30/12     ALCO
Guideline
 

+ 400

     8.22     ± 20     23.9     ± 30

+ 300

     6.84        ± 15     20.6        ± 20   

+ 200

     5.27        ± 10        16.3        ± 15   

+ 100

     3.23        ±   5        9.6        ± 10   

Item 4 – Controls and Procedures

(a) The Company’s principal executive officer and principal financial officer have concluded, based upon their evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15e under the Securities Exchange Act of 1934) as of June 30, 2012, that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

(b) During the quarter ended June 30, 2012, there were no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

39


Table of Contents

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

Not applicable

Item 1A – Risk Factors

For a discussion of the Company’ risk factors, please see Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 20, 2012, and available at www.sec.gov. These risk factors could materially affect the Company’s business, financial condition or future results. The risk factors described in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that management currently deems to be immaterial also may adversely affect the Company’s business, financial condition and/or operating results. Moreover, the Company undertakes no obligation and disclaims any intention to publish revised information or updates to forward-looking statements contained in such risk factors or in any other statement made at any time by any director, officer, employee or other representative of the Company unless and until any such revisions or updates are expressly required to be disclosed by applicable securities laws or regulations.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

 

  (a) Not applicable

 

  (b) Not applicable

 

  (c) Not applicable

Item 3 – Defaults Upon Senior Securities

Not applicable

Item 4 – Mine Safety Disclosures

Item 5 – Other Information

Not applicable

Item 6 – Exhibits

Index to Exhibits

 

Exhibit

Number

   
    3.1   Third Amended and Restated Articles of Incorporation of NB&T Financial Group, Inc.
    3.2   Amended and Restated Code of Regulations of NB&T Financial Grou